COVID-19 and valuation in Indonesia

Over the past few years, growth in price and demand for property in Indonesia have both stagnated. Residential property price growth has been declining since 2018, as has demand for commercial property such as office space and retail.

There are 2 main factors that have led to this. First, a tendency for oversupply has not been accompanied by growth in demand levels; second, price growth, in terms of the amount of money expected, required, or paid for something, has not been comparable to economic growth and purchasing power.

Before there was a chance to adjust oversupply and over-yield due to speculation, the COVID-19 pandemic further aggravated these trends in Indonesia's property market. Bank Indonesia recorded sharply corrected residential property sales in the first quarter of 2020 of –30.52% compared with the last quarter of 2019, with price growth of only 0.46% in that time. Price and demand appear to be remaining stagnant.

Similarly, occupation in the office sector has fallen dramatically, with a projected reduction of 20%. The sector also faces many requests from tenants for postponement of payments.  

Hotels were quite severely affected, too, with restrictions in both domestic and international tourism – at the time of writing, occupancy is only around 10–30% in business and tourism sectors alike. Meetings, conferences and exhibitions, the second largest income generator for hotels after room occupation, have come to a standstill, so this drop in income will also have a direct impact on hotel value.

The retail sector was significantly affected as well; even before the epidemic it had been severely disrupted by the growth of online retail, as elsewhere in the world, forcing several large brands to close outlets in well-known shopping centres in Jakarta. During 2019, retail performance in the city and its surrounding areas declined, with a stagnant occupancy rate of 85%, while net absorption  was only one-third of the level of new supply, and rental rates have consequently been lowered in a bid to increase tenancies.

The Indonesian capital market experienced a sharp decline due to the many funds being withdrawn by foreign investors. PT Lippo Karawaci, a company with a large investment portfolio in hotels, apartments and offices, saw a sharp decline in share prices of 46% between 10 March and 23 March.

Several sectors are seeking cost efficiencies due to the global economic turmoil, which has severely affected businesses and left many closed or in survival mode, including real estate and property developers. Responses range from revising annual budgets to putting people on unpaid leave, or ultimately, redundancies.

The Indonesian property market in the past few years has seen an unstable relationship between price and value – excessive market expectations resulting in overaggressive supply expansion that is not accompanied by actual demand or increased purchasing power. At present, the property prices being sought are exceeding assets’ true economic value, as owners may be in a position of having to sell while reluctant to accept that there has been a decrease in prices or general purchasing power.  

This perception that property prices will not decline is particularly strong in Indonesia, even when the market indicates otherwise. You can find many residential and small retail properties that are vacant in some parts of the country, but they tend to stick to their offering price even after 2 or 3 years on the market.

There are 2 ways of looking at the value of property: first, based on the benefits received by the buyer on purchasing the asset; second, based on the costs to the seller of being able to provide these benefits. In valuation, it can be hard to know which of these factors to prioritise, as in economist Alfred Marshall’s scissors analogy: "We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production." For example, a swimming pool that costs $30,000 to install does not necessarily increase the value of a residential property by $30,000; rather, the pool’s dollar contribution to value is measured in terms of its benefit or utility in the market.

As a sector that deals in physical space, property may mean something very different after the pandemic. COVID-19 has changed how people perceive property as a product, including their expectations of the benefits it can generate. The most important thing now in commercial property, for example, might be whether an individual feels safe and protected when entering a building – whether the room has been regularly disinfected, whether the elevator is still using physical buttons, and other questions related to health protocols.

The shift from valuing property’s physical qualities towards valuing the benefits it generates forces developers to review their assets, because COVID-19 has revealed the features that customers value and which benefits are now considered essential. No longer focusing primarily on cutting costs to increase profit, developers must be able to innovate to survive these uncertain market conditions.

Housing developments with a cluster system – such as the 20–40-house clusters typical in Indonesia – may for instance make further use of smart technology to increase their attractiveness. Using such technology to manage air circulation could be a preference for the office space of the future, to lower the risks of airborne disease. Implementation of technology that allows occupants to avoid direct contact with elevator buttons or entrances equipped with automatic sensor systems will also be in demand.

New business models – such as changing conventional rental rates to sharing fees or gross turnover where rental costs will depend on gross tenant income – might be an appealing strategy for a retail developer to maintain their occupancy levels, with marketing schemes for all types of asset using more digital channels than face-to-face interactions.

Such development will have its costs, but further price reductions may be necessary to entice buyers and investors. In any case, innovation will be needed to re-ignite demand amid uncertain conditions and decreased purchasing power. At this point, the market will test its new equilibrium and see whether prices get closer to true economic value – or further away from it.