Therefore, we say that for this year’s Chinese New Year festive period, sales at retail stores and restaurants would likely have come in below expectations as many avoided visiting malls and cancelled dining reservations. Coupled with the benign outlook for tourism sector, overall retail sales growth is expected to remain dismal as the outbreak takes a toll on domestic spending. Nonetheless, there may be a silver lining for food delivery and e-commerce sales, which are likely to see a higher growth potential as more people avoid staying out.

Like the Severe Acute Respiratory Syndrome (SARS) crisis which dampened regional tourism and economy in 2003, the impact of COVID-19 outbreak could likely persist for the next six months, depending on the virus development. However, as we are not virologists, we would caveat this as a best guess estimate. Despite a more broadly held negative sentiment toward the retail sector amid the virus outbreak, prime retail space rents (in Orchard or suburban malls) are likely to resist downside pressures much better than the rest, unless there is significant escalation of the ongoing outbreak. The occupancy rate for the prime units is also likely to remain stable alongside a limited supply in the pipeline.

We will discuss three main reasons for rents being sticky. One is, even in an environment where businesses have been disrupted by the viral outbreak, tenants are looking beyond the immediacy of the problem. Should they give up the space, under the assumption that the COVID-19 event will not last beyond the short-term, they will be left hanging dry without representation in a prime spot in a mall when business-as-usual returns.

The second is that, despite the 15% property tax rebate for shops and Food and Beverage (F&B) given under Section 3.2 (b)(iii) of the Property Tax Rebate for Qualifying Commercial Properties in Budget 2020 IRAS e-Tax Guide, some landlords are still holding onto their pre-COVID-19 asking rents for available-to-let space.

Thirdly, many prime retail malls in the Downtown Core and suburban areas are owned by REITs and private equity. The ability to adjust rents to match their tenants declining fortunes will be met by strong pushback from unit holders, sponsors and limited partners.

Ultimately, how these three points play out for URA’s rental indices not just in Q1/2020, but also the period much further down the road is unclear. But safe to say there is strong downside bias for rents moving forward.

One point that has been overlooked is that COVID-19 may unearth potential minefields. Prior to this outbreak, there could be some large suppliers, retailers and F&B companies who were already struggling but held a poker face. The COVID-19 outbreak may trigger a chain reaction, should some large ones suddenly fold. Though not as dramatic as what transpired in the financial industry 12 years ago, this could still be a Lehman-like event for the retail industry. This possibility aside, the bigger question is how the retail industry may develop when this outbreak blows over.

We had mentioned in our Q4/2019 retail brief that for the sector, the COVID-19 outbreak represents a “known unknown” event (unlike that for the office and private residential markets – which is an unknown unknown event). The known part is because we can hark back to the SARS period when the sector was confronted with similar conditions. The SARS experience has relevancy because it impacted the same variables that drove retail spend and ultimately spatial demand. The unknown part is when the endgame and how the retail industry may restructure thereafter because during 2003, disruptive (online) and catalysts (food delivery) forces were not that strong.

In the lingo of econometricians, post-outbreak and resolution, fixed and random effects on tourist/consumer and tenant- to- tenant and landlord behavior is expected. But that may still not be the appropriate way to look at this. Because of the severe impact of this outbreak on retailers, coming on the back of many having fought a protracted war with structural changes to the industry (online sales), the retail landscape, post COVID-19, has a chance of a major structural change.

As such, all one can do is look beyond the immediacy of this knowledge gap and focus on the fundamental and structural issues (e.g. online shopping, budget air travel, high hotel room rates, food delivery entities etc.) impacting the retail market. For now, we maintain our rental forecast for available-to-let prime retail space in both Orchard Road and suburban malls.

However, for some landlords, this pandemic could open the door for them to change their mode of rental collection. Presently, local landlords derive most of their retail space revenue from base rents, with a sliver from gross turnover (GTO) (and the rest from car-park, advertising and other miscellaneous collections). A shift towards GTO will have great repercussions, affecting REITs, private equity and listed real estate development companies who have a significant portfolio of retail assets here.

The traditional model of rental collection, that is, charging a high base rent and/or GTO whichever is the higher, may have to change. Landlords of malls in Malaysia, Hong Kong and Indonesia are already increasingly accepting GTO and hybrid rental models. In Singapore, so far, the response to the continued predatory influence of online shopping has been relatively lame, akin to rearranging the deck chairs on the Titanic. But the truth of the matter is that retail asset owners have to face up to reality and the COVID-19 outbreak opens up an opportunity for change.

Admittedly, the initial transition from the current rent collection model to a pure GTO or GTO-biased hybrid construct may result in total revenues collected by landlords declining sharply initially (see Figure 1). The choice is whether one is willing to make a break with the old by going “cold turkey” or slug it out in a long and draining fight with possibly not even a Pyrrhic victory in sight. We acknowledge that it would not be easy for entities such as REITs and invested private equity to transform because the realignment would require herculean efforts to get any form of buy in. There is also the possibility that the property tax authorities may still revert to comparable base rents to calculate their taxes rather than using the net GTO proceeds. Ultimately, it is the choice for each to make.

The upside arising from landlords having more skin in the game is that the asset management industry will expand as landlords need to take on a more proactive role in the running of their malls. Also, the range of products and services offered in a mall will be wider with different malls in different locations adjusting their tenant mix in accordance to the catchment – instead of what we now have, basically cookie cutters of one another.

For now, because of the structural impediments to change, we will continue to see rents remaining sticky with limited downside, at least for the next quarter or two. Beyond that, the market is likely to adjust to the new reality facing retailers and rents may have to come off significantly before recovering.