colliers radar investment | research | manila | 17 june

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The Philippine government enacted the Real Estate Investment Trust (REIT) law in 2009 with a stated goal of “democratizing wealth” and attracting more foreign investment into the property sector. Due to a number of regulatory roadblocks, including taxation issues and a high public ownership requirement, REITs are only now being prepared for launch. REITs are likely to be implemented this year as the government has agreed to relax the law’s restrictive rules.

To best take advantage of REITs, Colliers recommends that developers –

> Consider divesting their properties into REITs to access a cheaper source of capital

> Use REIT proceeds to renovate and reposition assets such as offices, malls, and warehouses

> Use REIT funds to develop integrated communities in key cities outside Manila

> Set aside a portion of REIT proceeds to acquire properties built on reclaimed land in Manila and take part in reclamation activities

> Acquire co-living and flexible workspace businesses that could eventually be diversified into a REIT.

Summary & Recommendations

Joey BondocSenior Research ManagerResearch | Philippines

PHP26bn (USD500mn)

Size of Ayala Land’s planned REIT listing composed of commercial office assets in the Makati CBD.

Aside from traditional asset classes such as office, retail, warehouses, and hotels, Colliers believes that other segments of the economy are likely to benefit from the launch of REITs in the Philippines. With the government being more active in attracting private sector investment, property firms should also explore possible public-private partnership (PPP) projects that cover hospitals and schools. Lastly, Colliers believes that developers should be on the lookout for the enactment of the proposed relaxation of the foreign ownership cap on the construction and retail sectors. In our opinion, easing of foreign ownership restrictions in these sectors should contribute to an attractive REIT sector in the Philippines in the future.

33%The minimum public ownership (MPO) agreed by the Securities and Exchange Commission (SEC),a decrease from the previously proposed 40%-67%.

4.8%*

Average dividend yield of the prime Asian REIT markets of Hong Kong, Singapore, Malaysia, Taiwan, Japan and South Korea.

11.1 million sq m

As of Q1 2019, the total leasable office space in Metro Manila and the maximum potential size of the office REIT market.

*Source: Colliers International

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RECOMMENDATIONSThe successful launch of REITs in the Philippines bodes well for the property market and the Philippine economy in general as it is likely to attract more foreign investments into the country. REITS should also stoke the construction sector which has significant multiplier effects to the economy.

Benefiting Filipino investors and end-users

The launch also places the Philippines at par with other Asian economies that have fully developed capital and real estate markets. Colliers believes that REIT implementation in the Philippines will result in the further differentiation and innovation of property development projects in the Philippines which should eventually benefit Filipino investors and end-users. Overall, a successful REIT launch should take advantage of the government’s ambitious infrastructure development plans as well as the objective of relaxing foreign ownership in crucial economic sectors such as construction are retail.

With regulatory roadblocks likely to be addressed by the government, the first REIT will probably be launched before the end of 2019. To maximize this investment vehicle, developers should:

> Consider divesting their properties into REITs to access a cheaper source of capital to refurbish and reposition their properties. Among the assets that developers should consider redeveloping are office towers in older business districts such as Makati CBD and Ortigas Center as well as warehouses in the Cavite-Laguna-Batangas (CALABA) corridor.

Diversifying into logistics

Colliers believes that developers need to upgrade their warehouses continuously to keep up with the needs of logistics tenants. DoubleDragon, a Philippine developer which recently diversified into the development of industrial parks and warehouses, is addressing this by constructing standard factory buildings that have proper ventilation, high headroom, and extensive floor sizes. We also believe that implementing automated warehouse systems will ensure the smooth and cost-efficient system of transferring goods from factories to households.

Short-term recommendations

> Use REITs as a benchmark for valuing assets. The Philippine property market is quite opaque with actual market information not readily available. Thus, disclosure of values through REIT transactions should enhance transparency in the property sector moving forward, benefiting all market participants.

> Consider priming assets for REIT listing. This is particularly important for mid-tier developers that intend to raise funds by selling assets to major developers in the future. In our opinion, smaller players should consider refurbishing their offices and malls in and outside Manila.

Long-term recommendations

> Maximize the opportunity presented by the thriving co-living and flexible workspace sectors, which are ripe for inclusion in REITs. National players’ exposure to these segments has become more pronounced, indicative of their viability for REIT listing in the long term. Developers should be more aggressive in acquiring these property segments in the future given their viability for REIT listing.

> Use REIT proceeds to develop integrated communities in key cities outside Manila. Colliers believes that among the more attractive locations are Metro Clark in Pampanga, Iloilo, Cebu, Bacolod, and Davao. This should support national developers’ goal of expanding their market-wide footprints outside of Metro Manila.

> Look at possible hospital and school public-private partnership (PPP) projects. We encourage developers to keep an eye on the government’s thrust of attracting more foreign investments into social infrastructure.

> Watch for the relaxation of the foreign ownership cap in certain sectors such as construction and retail trade. Easing of foreign ownership restrictions in these sectors should contribute to a more attractive REIT environment moving forward.

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Japan

Singapore

Thailand

Singapore Malaysia Thailand Japan IndiaYear REIT Law Was Enacted

1999 2002 2007 2000 2014

Number of REITs

44 15 58 63 1

Value of REIT Sector (in US$)

$72 bn $10.3 bn $10.3 bn $127.93 bn $690 Mn

Overseas Investment

YesYes but approval required

Yes Yes Yes

PayoutAt least 90% of tax transparent income

No minimum payout prescribed, but tax exemption is available only when at least 90% of the earnings are distributed

90% of net profit within 90 days of the end of each accounting period

> 90% of its distributable profits during the same applicable tax period

Not less than 90% of net distributable cash flows

Average Dividend Yield

6.8% 6.0% - 4.0%6.5-7% (Blackstone Plan)

Interesting Asset Class

Hospitality, Industrial, and Business Parks, Office, Retail

Industrial, Office, and Hospitality

HospitalityIndustrial, Senior Assisted Living

Office

Minimum Public Ownership

25% 30% 25% 20% 25%

COMPARISON OF REITS ACROSS ASIA

Source: Colliers International; European Public Real Estate Association (EPRA) Global REIT Survey 2018; UBS Welcome to the REIT World Report 2019; Online news articles

Malaysia

India

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Indonesia

Taiwan

Philippines

Hong Kong

Hong Kong Taiwan Indonesia Philippines KoreaYear REIT Law Was Enacted

2003 2003 2007 2009 2001

Number of REITs

12 7 2 - 6

Value of REIT Sector (in US$)

$42.7 bn $1.8 bn $1.37 bn - $1.3 bn

Overseas Investment

YesYes but approval required

NoYes but approval required

Yes

Payout>90% of net income after tax, specified in trust deed

Must adhere to the scheme provided in the REIT contract within six months after the close of the fiscal year

>90% of distributable income annually

90% distributable income

90% or more of distributable income

Average Dividend Yield

5.0% 2.6% 8.8% - 4.4%

Interesting Asset Class

Office, Retail, and Hospitality

Retail and Office OfficeOffice and Retail

Office

Minimum Public Ownership

25% 30% 33% 30%

Source: Colliers International; European Public Real Estate Association (EPRA) Global REIT Survey 2018; UBS Welcome to the REIT World Report 2019; Online news articles

COMPARISON OF REITS ACROSS ASIA

Korea

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The Implementing Rules and Regulations (IRR) issued in 2011 mandate that a REIT must have an MPO of 40% in its first two years after listing and this must increase to 67% in its third year.

Recently revised requirements promise a bright outlook for the Philippine REIT and real estate sector in general as the first phase of the Comprehensive Tax Reform enacted in 2018 exempts the transfer of assets to a REIT from the 12% VAT, while the Securities and Exchange Commission (SEC) has agreed to lower the MPO to only 33%. Industry analysts expect the SEC to issue an amended REIT IRR highlighting the 33% MPO requirement before the end of H1 2019. Colliers believes that this should firm up developers’ REIT plans before the end of 2019.

The SEC has observed that most ASEAN countries have no or minimal MPOs. Countries such as Japan, Singapore and Malaysia had MPOs of between 20% and 30%, and this is the primary justification for the relaxed MPO requirement in the Philippines.

DEVELOPERS LOOKING INTO REITs

¹What Is a REIT? (n.d.). Retrieved from https://www.reitasiapac.com/what-is-a-reit/ ² Atchison, K. & Yeung, V.S. (2014). The Impact of REITs on Asian Economies. Asia Pacific Real Estate Association.

REITs: A BACKGROUNDA Real Estate Investment Trust (REIT) is a publicly listed corporation that allows investors to buy shares in recurring income-producing real estate assets such as office buildings, hospitals, warehouses, hotels, and shopping malls. In most cases, REITs operate by leasing space and passing on collected rent payments to their investors in the form of dividends. In many jurisdictions in the Asia Pacific region, as mandated by law REITs distribute at least 90 percent of their earnings in the form of dividends or they enjoy tax benefits1.

A study commissioned by the Asia Pacific Real Estate Association (APREA) noted that REITs help improve Asian economies as they attract foreign capital into the property sector, unlock capital, and generate additional jobs for the local economy in allied industries such as asset management, investment appraisal, investment banking, development management and construction. The report noted that REIT proceeds are often used to refurbish and reposition real estate properties, resulting in an improved environment for both developers and tenants2.

REITs IN THE PHILIPPINES: DEMOCRATIZING WEALTHThe Philippine Congress passed the REIT law or Republic Act (RA) 9856 in December 2009. The measure was intended to “democratize wealth” by allowing Filipinos to invest in the real estate market without owning actual property or the disadvantages of high transaction costs and illiquidity. The Philippine government enacted the measure to develop the country’s capital market, broaden developers’ fundraising options, unlock the value of real estate firms’ properties and expand developers’ leasable portfolio.

REIT REGULATORY ROADBLOCKSDespite RA 9856 being enacted in 2009, REITs have yet to be launched due to two major regulatory roadblocks. These include the 12% Value-Added Tax (VAT) imposed on the transfer of real estate properties to REITs and the restrictive minimum public ownership (MPO) regulation.

Source: European Public Real Estate Association (EPRA) as of May 2019.

127.9

72.0

42.7

10.3 10.31.8 1.4 1.3 0.6

0

20

40

60

80

100

120

140

Size of REITs in selected Asian countries (USD billion)

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For example, mall rental growth is flattish, but rents are likely to pick up new supply tapers in 2021-2022. For industrial, while rental growth for warehouses in southern parts of Manila is slowing, we still see potential in warehouses north of Manila in areas such as Clark in Pampanga and Tarlac. We see the logistics sector thriving moving forward as this will probably hinge on the government's massive infrastructure push. In our opinion, developers can capture opportunities by modernizing warehouses.

Colliers believes that listed developers have the resources to tap REIT listing. The law requires a minimum market capitalization of PHP300 million (USD5.8 million). The listed property developers have an average market capitalization of PHP277.1 billion (USD5.3 billion) with SM Prime Holdings being the largest at PHP1.16 trillion (USD22.3 billion) and with Rockwell Land the smallest at PHP12.66 billion (USD243.5 million).

A number of major developers have expressed interest in listing assets under REITs especially after the government clarifies its stance on taxation and the MPO. Colliers believes that office buildings are the most suitable asset class for a REIT given the sector’s performance over the past five years as well as our stable growth projection from 2019 to 2021. We believe that some assets such as malls and warehouses may be upgraded using REIT proceeds while newer segments like flexible workspace and co-living ought to become attractive options as these sectors mature and developments continue to be developed according to evolving end-user preferences.

After the Asian and Global Financial crises, major real estate developers in the Philippines began searching for other revenue streams. Some developers expanded their portfolios beyond residential developments to include retail, office, hotel, and industrial projects, and to some extent even medical and educational projects. This strategy has proved pivotal to their sustained growth, since having a diversified portfolio of real estate products enables them to reap the benefits from growing sectors of the property market, while at the same time shields them from any corrections in other sectors that are experiencing downturns. This is among the reasons that are likely to make REITs, an investment instrument that relies on recurring income, a pivotal part of the development of the Philippine property sector.

Among the developers that have expressed an intention to launch a REIT is Ayala Land, Inc., which has a Philippine Stock Exchange ticker symbol (PSE) of ALI. The company is planning to raise up to PHP26 billion (USD500 million) through its REIT vehicle, Ayala Land REIT Inc. The developer has announced it will offer office towers in the Makati CBD for its initial listing.

Another developer aggressively looking at launching a REIT is DoubleDragon Properties. The company has been aggressive in building office towers in the Bay Area that mainly cater to offshore gaming firms, a major driver of office leasing in Metro Manila since Q4 2016, as well as warehouses in key locations outside Manila, such as Tarlac.

Other property developers reportedly preparing to launch REITs are Megaworld, SM Prime Holdings, and Robinsons Land.

CASHING IN ON REITSThe Philippine property market has been on an upswing. In our opinion, the segment’s growth has been anchored on an economy that has been growing by an average of 6.3% per annum from 2010 to 2018, according to data from the Philippine Statistics Authority (PSA). The PSA is projecting gross domestic product (GDP) growth of about 6% to 6.5% per annum in 2019 and 2020 and this sustained growth should support the expansion of the real estate sector.

However, individual market segments have been recording mixed results. While some sectors have posted record-high supply and demand in 2018, and are therefore attractive asset classes to be included in a REIT, some have been recording subpar growth over the past three to four years.

*As of June 04, 2019. Source: Philippine Electronic Disclosure Generation Technology (PSE EDGE)USD1 to PHP53 as of the end of Q1 2019

Company (Philippine Stock Exchange Ticker Symbol) Value (PHP) Value (USD)

SM Prime Holdings (SMPH) 1,160 bn 21.9 bn

Ayala Land, Inc. (ALI) 772 bn 14.6 bn

Megaworld Corporation (MEG) 196 bn 3.7 bn

Robinsons Land Corporation (RLC) 141 bn 2.7 bn

Vista Land Corporation (VLL) 91.0 bn 1.7 bn

DoubleDragon Properties (DD) 61.6 bn 1.2 bn

Filinvest Land, Inc. (FLI) 42.4 bn 0.8 bn

Shang Properties (SHNG) 14.3 bn 0.3 bn

Rockwell Land Corporation (ROCK) 12.7 bn 0.2 bn

Market Capitalization of Selected Developers*

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OFFICE: SEIZING RECORD-HIGH DEMAND AND SUPPLYThe office segment is one of the more robust property sectors in the country today. From 2016 to 2018, Colliers saw the completion of 2.6 million sq metres (28 million sq feet) of new office supply or about 869,000 sq metres (9.4 million sq feet) per year. Net take-up of about 778,000 sq metres (8.4 million sq feet) per year resulted in a Metro-wide vacancy of only 4.7% at the end of 2018. In 2018, for instance, Metro Manila’s office market recorded a record-high supply and take-up of 1.18 million sq metres (12.8 million sq feet).

We believe that the office sector’s growth will be sustained as demand from occupants is likely to move in step with new supply from developers. From 2019 to 2021, Colliers projects about 1.08 million sq metres (11.6 million sqfeet) of new supply per year and a net take-up of 957,700 sq metres (10.3 million sq feet) per annum.

Colliers believes that the office sector remains an attractive asset class because of steady demand from offshore gaming and outsourcing companies.

Meanwhile, traditional and non-outsourcing firms including those involved in logistics, advertising and consultancy are continuously growing on the back of a sustained macroeconomic growth. Engineering and construction firms that support the government's ambitious infrastructure development program are also expanding and continuously absorbing significant office space.

We also see emerging office occupants such as local and international flexible workspace operators as well as financial technology (fintech) companies sustaining demand in Metro Manila.

With low vacancy and stable demand from a diverse group of tenants, office lease rates have increased by an average of 7.0% per annum over the past five years. This is faster than the average rise of retail rents of 5.6% during the period.

Colliers sees office rents increasing by about 5% per annum from 2019-2021, making office buildings and attractive asset class to include in a REIT.

But a major challenge to office developers is the delay in the approval of Philippine Economic Zone Authority (PEZA) buildings. Being in a PEZA-proclaimed park or building enables occupants to avail of tax and non-tax incentives and the slow PEZA proclamation could hamper the growth of the outsourcing sector, which continues to be among the drivers of office leasing in the country.

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Source: Colliers International

Office vs. Retail lease rates growth 2008-2021E

Office

Growth Rate

Retail

Growth Rate

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Ayala seeks first-mover advantage

In our opinion, Ayala Land’s decision to offer its office buildings in Makati CBD makes sense as the business hub remains the most attractive location in the country. Office lease rates rose by an average of 5.8% per year from 2016 to 2018 while vacancy is a measly 1.4% as of the end of Q1 2019, indicative of strong demand from a mix of multinational and outsourcing occupants.

The Bay Area is another attractive location for office leasing. Vacancy in the Bay Area was a meager 0.5% in 2018 and we see vacancy steady at about 1.2% per year from 2019 to 2021. Lease rates in the Bay Area grew by an average of 14.1% per year from 2016 to 2018 and we see rents rising by 13.5% annually over the next three years. Hence, we also see offices in the area becoming an attractive option for REIT listing. Among the developers within the Bay Area with portfolios sufficiently large to tap a REIT listing are DoubleDragon, Federal Land, Filinvest Land, D.M. Wenceslao & Associates Inc. and SM Prime Holdings.

Top developers’ proportion of nationwide office stock, 2018(sq meters)

Source: Developers’ financial statements and disclosures

RETAIL: TIME TO REFURBISHColliers believes that the first retail REIT will launch in the next three years as developers are unlikely to resist the opportunity to use the proceeds of a REIT to renovate existing malls, attract more interesting tenants and retain consumer traffic in the face of the growing e-commerce market.

While the rise in mall lease rates has been decelerating (2.5% annually from 2016 to 2018 from 4% in 2013 to 2015) and Metro Manila vacancy rising to 10% in Q1 2019 from 9% in Q3 2018, we believe that the fundamentals of the retail market are promising for a REIT.

This is complemented by three factors:

1. the fact that food and beverage (F&B) accounts for 30% to 50% of retail space in the Philippines;

2. Filipinos’ fondness for F&B, which continues to grow at a sustained pace despite inflation peaking in 2018;

3. higher disposable incomes following the reduction in personal income tax rates that started in 2018. Overall, consumer outlook in the country has been improving as shown by the Philippine central bank’s latest survey3.

3Bangko Sentral ng Pilipinas (BSP) Consumer Outlook Survey Q1 2019

29% 29% 15% 14% 13%0%

5%

10%

15%

20%

25%

30%

35%

Megaworld Ayala Land SM RobinsonsLand

Filinvest Land

Megaworld Ayala Land SM Robinsons Land Filinvest Land

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5.7%

2.5%1.2%

5.9%

4.3%

8.0%

6.5%

5.2%5.9%

6.6%7.9% 7.7%

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CAGR of consumer spending sub-sectors (2010-2018)

Source: Philippine Statistics Authority

These factors should entice retailers to occupy space in malls, particularly those in integrated communities. Over the next three years, we expect the F&B and footwear & clothing to account for 40% and 17% of new retail space absorption, respectively. From 2019 to 2021, we see the delivery of about 1 million sq metres (10.8 million sq feet) of new retail supply or about 350,000 sq metres (3.8 million sq feet) per year, providing mall developers a myriad of options to include in a REIT.

Colliers still sees rents growing albeit by a slower 1.4% per year from 2019 to 2021 from 2.5% annual average from 2016 to 2018. We see rates growing by least 2.0% after 2021 as the delivery of new supply tapers.

Colliers believes that the retail sector will become more attractive for REIT listing once the Philippine Congress approves a measure that intends to reduce the minimum paid-up capital required for foreign retailers to open shop in the country. From USD2.5 million (PHP132.5 million), the minimum capital required is likely to be reduced to USD200,000 (PHP10.6 million). This should entice more foreign retailers to enter the country, resulting in greater absorption of retail space.

In our opinion, developers that have a myriad of options when it comes to diversification of retail properties into REIT include SM Prime Holdings, Ayala Land, Robinsons Land, Araneta Group, and Megaworld given their expansive retail footprint in Metro Manila.

Meanwhile, other developers including Vista Land and Double Dragon should consider using REIT proceeds to expand their retail portfolio in the provinces over the next three to five years. Vista Land, in particular, should explore the possibility of complementing its expansive residential footprint in Bacolod, Cebu, Iloilo, and Davao with new and expansive malls.

HOSPITALITY: ACQUIREINTERNATIONAL BRANDS OR DEVELOP HOMEGROWN?Over the next three years, Colliers sees hotel REITs being an attractive option for developers given the sustained demand from the traditional sources such as Koreans, Chinese, Japanese, and Americans. Over the past three years, foreign arrivals have been growing by an average of 10% per year with the Tourism Department projecting arrivals to grow by about 15% in 2019 to 8.2 million tourists. Chinese tourists, in particular, have been rising by 27% per annum from 2016 to 2018.

The growing number of foreign tourists should be supported by rising demand for Meetings, Incentives, Conventions and Exhibition (MICE) facilities due to local and international events as well as a continued push for more domestic travel, driven by the popularity of the staycation concept in Metro Manila.

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Colliers believes that REIT proceeds can be used by developers to either acquire international brands or build homegrown brands.

Over the past three years we have seen national players such as Ayala Land, Megaworld, Rockwell, and Filinvest being more aggressive in launching their own hotel brands such as Seda, Savoy, Aruga, and Quest.

Meanwhile, local developers, especially those based in Cebu, have been active in bringing in international brands. These include Cebu Landmasters with the first Radisson Red in the country, AppleOne Properties’ Resorts Worldwide, Sheraton and Starwood Hotels in Mactan, and Grand Land’s Dusit Hotel.

We project an occupancy of 70% in 2019 as we expect a subdued completion of new hotel rooms during the period. This is higher than the 69% posted in 2018.

We see similar occupancy from 2020 to 2021 as the delivery of new hotel rooms in the country’s capital tapers off coupled with a more aggressive completion of new hotels in nearby urban areas such as Clark.

Developers have been aggressive in building new hotels in Clark as they intend to capture a rise in tourist arrivals coinciding with the scheduled completion of the redeveloped Clark International Airport.

Colliers International believes that improving the country’s travel and tourism competitiveness plays a crucial role in sustaining hotel occupancy rates and enticing local and foreign businesses to increase their leisure-related investments in the country. Among the major issues that the Philippine government needs to immediately address are safety and security, air transport infrastructure, and the business registration process. The latter is particularly important if the government wants to attract more leisure-related investments.

About Colliers International Group Inc.

Colliers International (NASDAQ, TSX: CIGI) is a leading global real estate services and investment management company. With operations in 68 countries, our 14,000 enterprising people work collaboratively to provideexpert advice and services to maximize the value of property for real estate occupiers, owners and investors. For more than 20 years, our experienced leadership team, owning more than 40% of our equity, havedelivered industry-leading investment returns for shareholders. In 2018, corporate revenues were $2.8 billion ($3.3 billion including affiliates), with more than $26 billion of assets under management.

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Copyright © 2019 Colliers International

The information contained herein has been obtained from sources deemed reliable. While every reasonable effort has been made to ensure its accuracy, we cannot guarantee it. No responsibility is assumed for anyinaccuracies. Readers are encouraged to consult their professional advisors prior to acting on any of the material contained in this report.

For further information, please contact:

David A. YoungChief Operating Officer | Philippines+632 858 [email protected]

Richard RaymundoManaging Director | Philippines+632 858 [email protected]

Donica CuencaResearch Analyst | Research | Philippines+632 858 [email protected]

Martin AguilaResearch Analyst | Research | Philippines+632 863 [email protected]

Primary Author:

Joey Roi BondocManager | Research | Philippines+632 858 [email protected]

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colliers radar investment | research | manila | 17 june

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