COVID-19 – An accelerator of disruption, a new disruptor and possibly a disruptor of disruptors

Firstly, we do not believe that we can assign any probability to this outbreak nor to when it will end. Why is that the case? There is no domain knowledge on this subject matter. Even healthcare professionals and virologists are still to grasp this extremely fluid situation.

Secondly, is this an extreme event much like a Black Swan? Yes and no. Yes, if we treat this outbreak in terms of how it has cost the economy versus the many previous outbreaks of common flu. No, if we consider how it has impacted the demand for real estate. Why “no”? Because this viral outbreak is the second of its kind, after SARS, that has an effect on real estate. We cannot construct a distribution of probabilities based on just two events or even if a third outbreak has occurred. Thirdly, should we go back to the period when SARS broke out to form the baseline scenario? We wouldn’t recommend it.

The reasons are twofold:

• SARS occurred at a time when the Chinese economy constituted just 4.3% of total global GDP. By 2019, it was over 15%. China’s economic enormity is not in its GDP per se, but the central role it plays as a manufacturing engine of the world. From handphones to lawn mowers, global supply chain lines all lead to and from China. During 2003, Chinese companies and individuals were particularly domestic oriented. Chinese capital was not flowing out anywhere near the levels they achieved in 2019. Chinese outbound FDIs around the SARS period was less than US$20 billion. In 2017, it was approximately US$270 billion. Simply put, the impact of Chinese capital flows globally is substantial. In addition, Chinese companies and family offices’ demand for real estate space ex-China is significant today.
• SARS was unchartered territory, an “unknown unknown”, because nothing like that had ever occurred in Singapore. The current COVID-19 outbreak is thus prima fascia perceived to be a “known unknown”, in that there is a precedent, the SARS outbreak. However, we cannot predict the outcome of this virus strain. The way SARS panned out previously is likely to have reduced the current fear and stress levels, but the unknown outcome is still a cause for concern. We cannot assign a probability to this. But, as mentioned in part (i), the global economic nexus is different today compared to the SARS period. Thus, we may say that our experience of SARS is of little help today, except to extend comfort to the population at large (i.e. “We’ve been through SARS and we know what it was like”). The COVID-19 outbreak is therefore as good as an “unknown unknown” event to real estate market analysts. (Nonetheless, the SARS experience is helpful to those in the healthcare industry. This is because it provides lessons on how resources will be drained and how to communicate effectively with the public. However, for the real estate and other industries, it offers hardly any guidance.)

Ultimately, we should refrain from creating ‘what-if’ scenarios as to how the market structure for the various real estate sectors may evolve after this event. The Johari window is an illustration of the futility of drawing up ‘what-if’ scenarios when the outcome is still unknown to both the healthcare and non-healthcare groups. Some may still be tempted to carry on with the construction of various scenarios. The downside to that is that, if we create scenarios for each variable and, when the time dimension is added in (that is as the market moves on from now), we will encounter branch points where the market will make decisions as to which route it will take. Not only do we not know how many branch points there will be, we also do not know which path the market will take at each branch point. This expands the number of outcomes to the point of mind-boggling impracticality, and the choices we are then forced to adopt are simply guesswork. That is as good as useless. Fourthly, the impact of the COVID-19 outbreak varies from sector to sector. Looking at this event from another perspective, the real estate market structure (topology encompassing the behavioural aspects of demand and supply, which influences price and rent) for the office, retail, residential, industrial and hospitality sectors existing up to pre-Chinese New Year 2020 has either been punctured (disconnected) or has been stretched thinly. Until there is better clarity or reduction in market anxiety towards the viral outbreak, the structural landscape remains disconnected. That means all the previously constructed descriptive equations tend towards uselessness.

Office Market vs COVID-19

For today’s blog, we broach on how the office market interfaces with the viral outbreak. Unlike its impact on the COVID-19 outbreak is unlikely to affect the office market up to the medium term (e.g. 12 months). CBD Grade A office tenants are often multinationals who hold a long-term view of the market, not only that of Singapore, but of the region as well. As such, the viral outbreak would not disrupt our views of the sector in 2020. This outbreak has in our view, not path broken the market structure, but it has stretched it. Although the market structure is intact, we believe that it is still not helpful to conduct scenario analysis or attempt a revisit of the SARS period in order to predict how the market will react. This is because this event may have accelerated the evolution of office space usage. Thus ‘what-if’ analyses made now, even if they turn out correct in a few months’ time, may unfold as a result of delayed reaction by companies reorganising their operations to counter future events like this. Therefore, only when this event passes, or is close to passing, can one conduct a better analysis. The long-term impact of the COVID-19 outbreak may alter the landscape of how corporates are structured in the region and this may or may not have an impact on the office market here, and in the region. But we believe it very likely will. Amongst its other effects, this pandemic is akin to a disruptor of disruptors. It has created new branch points for the office market. For example, the recent evacuation of 300 employees from a Grade A office building in the CBD due to a company’s two infected employees may spur companies to rethink the trade-off between working from home and from traditional offices. If so, this will likely affect office demand which then affects landlords and/or co-working operators. Technology will be the catalyst that quickens this new evolution, if it happens. With that come greater business opportunities for tech companies, and more new-to-market companies setting up here, and/or existing ones for additional headcount. However, as of the time of this article, it is still too hazy to see what form this new evolution will morph office space demand into. Nevertheless, there are some areas where we may be able to make some assumptions and we will be spending more time looking at them in future. Though tentative in nature, we believe that we may be able to present some hypotheses on how they will begin to move on from here

• Home office as a viable alternative to taking more office space
• Existing regional centres and business parks will see increasing take-up by companies setting up satellite offices (to be close to workers’ homes). This is a move to de-risk from over concentration by location or building
• Co-working and serviced offices expand to the regional centres to cater to flexible spatial demand by companies. On this, as well as the previous point, we believe that the future for co-working and service offices can go either way. Businesses may wish to engage co-working and service office providers, but whether that benefit may also be more than offset by an issue such as the possibility of contagion brought onto their staff by other companies’ personnel on shared premises remains to be seen. This is a branch point
• Multinational companies upgrading their corporate ecosystem in the regional countries to minimise the risk of relying too much on regional head office staff travelling for work.
• Technology companies may, because of decentralisation, get a boost for their services, resulting in more tech companies setting up operations here.

By no means exhaustive, this outbreak has already seeded new directional vectors for the next epoch of office space demand. From these nascent leads, we also may believe that this COVID-19 outbreak is an accelerator for disruption, a disruptor itself, and potentially also a disruptor of disruptors. For the moment, given that the market structure is merely stretched, we have not changed our 2020 forecast for CBD Grade A office rents. Rents are expected to range from -2% to 0%. But beyond that, there is the possibility of a break in the current market nexus. In the course of the following weeks, I will be adding my thoughts to the residential, retail and industrial sectors.