Recently, the property sub-index (PProp) reduced its underperformance gap with the PSEi. This comes after heavyweights SMPH, ALI, and MEG gained an average of 17.4 percent in the last month, compared to the index’s +9.9 percent gain. Investors seem to be wagering that the industry would gain significantly from the reopening of the economy. We are adopting a much more cautious approach, as explained below.

Groundless optimism. Simply stated, there is no reason to expect a rapid recovery in the property industry. The POGOs that fueled the market from 2018 to 2019 are retreating, leaving a large quantity of vacant office space. Additionally, there is a chance that the offshore gambling sector may shrink further. Capital expenditures continue to be low, and loan growth has slowed, suggesting that companies are not growing. There are many empty residential condos in Makati and elsewhere, according to anecdotal evidence. Mall foot traffic is still less than half of what it was pre-pandemic, and this is unlikely to change much as vaccination rates remain low and vaccine reluctance continues high. Finally, local tourism has stalled, and international visitors are unlikely to return until herd immunity is established. While there are pockets of growth (e.g., high-end residential, horizontal projects), they will not be sufficient to overcome the property sector’s overall decline.

Indeed, we believed there was still a case to be made for a more optimistic assessment of property stocks. This comes on the heels of IBPAP’s announcement last week that the BPO sector is expecting growth of up to 15% this year, the fastest in a long time. We recognized, however, that this development would not definitely translate into greater office space absorption this year or even in 2022. This is because, on average, 70% of BPO workers work from home, and this hybrid structure, according to IBPAP president Rey Untal, will continue until next year. And even in 2023 and beyond, demand growth may not be as robust as investors anticipate. Numerous prominent businesses have allegedly made WFH a permanent policy. On the other hand, according to comments from a few BPOs, only 30% to 50% of workers may return to their workplaces after the pandemic. As the CEO of a large developer allegedly said, the hybrid work approach seems to be here to stay. Given that BPOs and contact centers occupy the majority of office space, this will have a long-lasting effect on the real estate industry.

There are knock-on consequences. To conclude, the BPO sector responded swiftly and effectively to the pandemic, and the benefits of relocating many or the majority of workers to a permanent WFH arrangement (e.g., reduced occupancy costs, increased employee satisfaction) seem to exceed the disadvantages. This is expected to continue to reduce office demand for some time, contributing to additional rental rate declines that may not stabilize until next year. Meanwhile, the ripple effects will very certainly extend into the vertical residential sector. Vacancies are already high, but if BPO workers do not return to their offices, demand for condominium rentals would decline further and permanently. This may even impact retail and commercial businesses that have sprung up expressly to cater to POGOs and BPOs in recent years.

Continue to be underweight. For the reasons outlined above, we are maintaining our Underweight recommendation on the property sector. The primary reason for this is SMPH, which, despite the cushion provided by its malls, has a significant exposure to condominiums and is trading at a premium to its historical average value. While we prefer ALI to SM Prime, we remain bearish on the company due to its significant exposure to office and vertical developments. Meanwhile, our confidence in our recent purchase calls on VLL, FLI, and RLC has waned. Nonetheless, VLL is likely the best positioned to weather the sector’s downturn due to its limited exposure to office and vertical residential, while its horizontal segment will provide support. FLI’s horizontal division and forthcoming REIT offering, on the other hand, should mitigate the company’s significant exposure to the office sector. And, although RLC does have a significant office exposure, it shown resilience in Q1 and has a negligible vertical residential impact. Additionally, we believe that the commercial sector will recover the most quickly (next to horizontal), which should benefit RLC.

The most important call. Our recommendations are unchanged except for the downgrade of MEG from buy to neutral. It would have been a sell given the company’s very high combined exposure to office and residential real estate, but the stock is already selling 1.2 standard deviations below its 10-year mean. We may potentially become more negative on the company depending on how fast office rents decline and how quickly demand recovers, but we think neutral is fair for now.


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