“If you’re not going to put money in real estate, where else?”
– Tamir Sapir, Business mogul
By Realttorney®
According to the World Risk Index 2022, the Philippines is the most disaster-prone country in the world with an index score of 46.86 due to high risk, exposure, and vulnerability. The vulnerability is caused by the number of tropical cyclones that visit the country annually, the location of the country in the Pacific Ring of Fire and typhoon belt, and finally, poverty and underdevelopment.
Meanwhile, the Global Risks Report 2023 disclosed that the top risks faced by the Philippines in the next two years are natural disasters and extreme weather events. In connection with this, a World Bank economist stated that climate change effects, like rising temperatures and sea levels, intensified droughts, and stronger typhoons can slash the GDP of any country by 13.6% in 2024.
“In the absence of government interventions, these disasters inflict the greatest suffering on the poorest”, the economist said. Now, rising debt cost is one facet of the overall damage that climate change is already causing. This in turn can impact the credit ratings of a country like the Philippines, through a credit downgrade by international credit rating agencies.
When a country’s credit rating is downgraded by credit rating agencies such as Fitch Ratings, Moody’s, or Standard & Poor’s, it signifies that the perceived creditworthiness of that country has diminished. This downgrade can have a cascading effect on various sectors of the economy, including the real estate industry. Understanding these implications is crucial for real estate professionals, investors, and policymakers.
What is the economic impact of a credit downgrade?
Increase in Borrowing Costs: A downgrade typically leads to higher interest rates on government bonds and other debt instruments. We saw this during the time of the Marcos Sr. administration. This increase in borrowing costs can ripple through the economy, making financing more expensive for businesses (big corporations and MSMEs) and individuals alike.
Capital Outflows: Investors (especially foreign) may view the downgraded country as riskier, leading to capital outflows as they seek safer investment opportunities elsewhere. This can result in a depreciation of the country’s currency and further exacerbate inflationary pressures.
Reduced Foreign Direct Investment: Downgrades can deter foreign direct investment (FDI) as investors become wary of the heightened risks associated with the country. This can constrain economic growth and lead to a slowdown in various sectors, including real estate.
What is its impact on the real estate industry?
Decline in Demand for Real Estate: As borrowing costs rise and economic uncertainties mount, demand for real estate often declines. The decline in the demand for real estate may affect the residential, office, and commercial segments, as well as the industrial segment, especially if the interest expense (borrowing costs) are sustained for two years or more.
High interest rates greatly affect the willingness of a person to purchase a house and lot, a condominium unit, or a farm lot. This is so when the purchase will be made through a mortgage. Of course, cash is king. A cash purchase often leads to a great discount on the asking price for the real property.
Liquidity Constraints: Tighter credit conditions can make it difficult for developers and property owners to refinance existing debt or secure new financing. This can result in liquidity constraints and, in severe cases, lead to defaults and foreclosures.
As it is, real estate is an illiquid asset. Combining this with a tight credit market, property owners encounter extreme challenges during this inopportune time.
Stalled Development Projects: Reduced access to financing and higher borrowing costs can stall new development projects. We all saw this from 2020 to 2022, as a result of the Covid 19 pandemic. Major real estate developers in the Philippines have been scrambling to restart projects that were forced into hibernation during COVID-19.
Moreover, planned developments that lay in wait on the drawing boards were dusted off in 2023. Why? Because demand is, of course, expected to firm up, too. The 2023 Colliers Global Investor Outlook for the Philippines forecasts a rise in both value and volumes of real estate properties, with annual growth rates of 0.7 percent and 2 percent, respectively, versus 2022.
Financing constraints can have a long-term impact on the supply of real estate inventory, potentially leading to imbalances in certain segments of the market. Unfortunately, I do not know of a metric that measures exactly the number of real estate units already built and the number of real estate units that will be built in the next 1 to 3 years.
Shift in Investor Sentiment: Downgrades can alter investor sentiment towards the real estate sector. Institutional investors, such as real estate investment trusts (REITs) and private equity firms, may re-evaluate their asset allocation strategies, potentially reducing exposure to the downgraded country.
To be clear, when looking at the impact of interest rates on an investment such as a REIT, the relationship of rate to price can be seen as similar to a bond’s relationship with interest rates. When interest rates decline, the price of a bond goes up because its coupon rate becomes more desirable. When interest rates increase, the price of bonds decreases.
Similarly, when interest rates decrease, REITs’ high yields become more attractive, and their prices go up. When interest rates increase, the yield on a REIT becomes less attractive and that pushes its price down.
Policy Responses: In response to a credit rating downgrade, governments may implement austerity measures, fiscal consolidation, or monetary tightening to restore confidence. While these measures are intended to stabilize the economy, they can also dampen consumer sentiment and investment activity in the real estate sector.
Another significant factor that might affect the demand and costs for real estate is legislation. There are a few ways the government might temporarily increase demand for real estate: tax credits, deductions, and subsidies. You can spot possibly erroneous patterns and changes in supply and demand by being aware of the existing government incentives.
For example, maybe it is time to revisit the bill filed by Sen. Sonny Angara in 2014, known as the Home Mortgage Relief Act, which will give tax incentives to Filipinos who are qualified as first-time homebuyers.
For context, the Philippines has experienced credit rating upgrades and downgrades from 1986 up to 2001. The country’s creditworthiness has a direct bearing on its ability to attract foreign investment and maintain stable economic growth.
In the context of the real estate industry, a downgrade could potentially slow down the growth trajectory observed in the last 2 years, affecting property values, investment activity, and development projects, in general.
In summary, a country’s credit rating downgrade can have far-reaching implications for its economy and, by extension, the real estate industry. While the precise impact may vary depending on a range of factors, including the country’s underlying economic fundamentals and policy responses, it is crucial for real estate professionals to monitor these developments closely. Mitigating risks, diversifying portfolios, and maintaining a long-term perspective are key strategies to navigate the complexities arising from credit rating downgrades.
How will you use this information to serve your clients? Let us start a conversation about this.
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Atty. Jojo is a real estate attorney, an estate planning attorney, a licensed real estate broker, and a PRC-accredited Lecturer/ Speaker for Training Programs in Real Estate. He is committed to helping new and veteran real estate service practitioners be well-informed of the latest laws, rules, regulations, and information relevant to the real estate service sector.