The Philippines: Still a bargain

Michael Alan Hamlin

Posted on April 24, 2008

But what does the US “psychological recession” mean for the Philippines?

With Makati office rents hitting an all time high of P1,200 per square meter for grade A space and vacancy rates plummeting to just above zero, observers might be tempted to suggest that the latest real estate bubble is ripe for popping. But they would be wrong according to Rick Santos, chairman of CB Richard Ellis Philippines (CBRE). “Growth is sustainable,” he told reporters in a briefing last week. “We are very optimistic for increased investment.” (Disclosure: CBRE is a client of my firm.)

Unlike previous real estate bubbles in which developers were building on spec in anticipation of investor interest, developers this time around are responding to real demand, Santos said. That’s especially true for investors in the business process outsourcing sector. “Most office projects planned for BPO expansion and new entrants are not built without commitment,” Santos explained, “because developers learned our lessons very well in 1997.”

Santos implied that developers have adopted a sort of “just-in-time” business model, making them extremely flexible, able to build as demand comes in and to “shift gear and hold back planned construction” when it doesn’t. But for now Santos sees developers “working hard to catch actual demand” because “we are still a bargain” when compared to alternative investment opportunities.

CBRE Philippines vice chairman Joey Radovan sees BPO players moving outside Makati, where rental rates are generally about 50 percent lower. Despite demand for BPO office space, the number of competing business centers and developers within those centers appears to be keeping rates in check. Rents in Ortigas, Alabang, Eastwood, Fort Bonifacio, and the Bay Area are all hovering in a band between P550 and P700 according to Radovan.

BPO investors are attracted to more than low rents when they shift operations outside Makati, Radovan said. The low-rise buildings prevalent in suburban BPO parks are attractive because they require less maintenance and offer more security since one occupier can take an entire building. In Filinvest’s Northgate Cyberzone in Alabang, for instance, Genpact recently inaugurated a new six-story building. Genpact is not only the only occupier, it services a single client from the building.

It’s also getting easier to move around the Philippines as a result of increased infrastructure spending and investment. New toll ways, railroads, and commuter trains are making it far easier to shift people and operations to formerly far-flung locations. When phase three of the North Rail project is completed, commuters will be able to travel from Fort Bonifacio to Clark Field in about 30 minutes, for instance.

As a result of these trends, Radovan expects office rents in Makati to stabilize this year in the range of P800-P1,000 per square meter, noting that “expansion of traditional office occupiers” outside the BPO sector “will be proportionate to economic growth.” Because the overall economy is expected to slow in 2008 despite increased remittances by overseas foreign workers and growth in tourism and BPO, Makati appears set to experience a modest slowdown in demand for commercial office space.

But slower US growth won’t slow growth in BPO. Santos and Radovan said that with the US in at least a “psychological recession” most companies there are “either cutting down on operating cost by right-sizing their businesses or outsourcing their back office operations to more cost efficient locations,” such as the Philippines. I suspect that most US-based multinationals are in fact doing both of these things.

Another reason BPO growth is strategic is that it is much more than contact centers. While contact centers are the largest BPO sector, by next year they will account for less than half of total BPO industry revenues for the first time. Other fast-growing sectors include back office business processes such as accounting and HR administration; legal, medical, and other transcription services, engineering design, software development, and creative services such as animation and digital content.

According to the Business Processing Association of the Philippines, by 2010 back office business processing will generate almost as much revenue as contact centers. By then the Philippines will have largely diversified its BPO industry. While contact centers will still be the single largest source of revenues, back office processes will be a close second, and other sectors combined will generate almost a third of revenues.

The danger for the Philippine economy, as I suggested last week, is that while the BPO industry will become sufficiently diversified, that’s not true for the economy overall, which is overly reliant on the ticking time bomb of OFW remittances. Hints of new investment in the manufacturing and mining sector are encouraging. But so far, they are little more than hints. That needs to change, while we’re still a bargain.

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