Guest editorial: “COVID and real estate: cascading impacts or temporary adjustment?”

Citation

Kelly, H. (2023), "Guest editorial: “COVID and real estate: cascading impacts or temporary adjustment?”", Journal of Property Investment & Finance, Vol. 41 No. 5, pp. 469-472. https://doi.org/10.1108/JPIF-08-2023-210

Introduction

As we seek to evaluate the property investment and finance landscape in 2023, the most prominent concern continues to be the world's attempt to understand and to act in a late-Covid era. We choose that term rather than “post-Covid” deliberately. As of early/mid 2023, the pandemic is still very much with us. Here is a weekly epidemiological report from the World Health Organization from April 2023:

Globally, nearly 3.3 million new cases and over 23 000 deaths were reported in the last 28 days (6 March to 2 April 2023), a decrease of 28 and 30%, respectively, compared to the previous 28 days (6 February to 5 March 2023). Despite this overall downward trend, it is important to note that 74 (31%) countries have reported increases in new cases of 20% or greater during the last 28 days compared to the previous 28-day period. As of 2 April 2023, over 762 million confirmed cases and over 6.8 million deaths have been reported globally (WHO, 2023)

Even beyond the raw numbers of new cases and deaths in a month, the disruptive impact of the novel coronavirus must be considered in terms of the aggregate social and economic dislocation experienced over the course – still not completed – of this deadly disease. Such disruptive change cannot be turned off like a spigot, even if we were to see new case numbers and additional death fall towards zero. Across the world, the impacts would linger.

So, despite the 5 May 2023 WHO declaration that the pandemic emergency was officially ended, the organisation acknowledged that monthly deaths were still in the tens of thousands and that continued caution was advised that the virus could be expected to continue its transmission.

It behoves us to consider disruption as a particular form of change, distinct from other species of change such as cycles and trends.

Disruption involves a sudden, profound shock to a system that constitutes a radical challenge to system integrity. Disruptions may resolve into some degree of return to status quo ante, but may issue into some permanent and irreversible change requiring systemic reconceptualisation. Risk managers sometimes refer to disruptions as “event risk.” Following Taleb (2007), disruptions can be considered low-probability, high-impact events, dubbed “black swans.” For a discussion of this theme in the specific context of real estate market economics see Kelly (2018).

Accommodating disruptions into neoclassical economics may require reconceptualisation at the level of Kuhn's “paradigm shift” (Kuhn, 1970).

The popular embrace of ‘disruption’ as an engine for forward economic change dates from Clayton Christensen's 1997 book, The Innovator's Dilemma (Christensen, 1997). In this book, the author echoes the thought of an earlier Harvard professor, Joseph Schumpeter, in seeing ‘creative destruction’ as a recurrent force in the economy (Schumpeter, 1942). At its best, this line of thinking reflects a willingness to discard comfortable but unproductive ways of doing things in favour of an innovative leap forward. At its worst, however, the concept can become an apologia for mischief that covers the very high failure rate of economic experiments. A bias in favour of disruption stands in contrast to a previously widely accepted incrementalist approach called ‘continuous improvement’, a business philosophy associated with the management techniques espoused by W. Edwards Deming (1982). All three of these resources are well worth reading for those considering the future of property investment and finance.

Veterans of real estate practice and academic study are no strangers to crisis. Consider the history displayed in this graphic: “Thirty Years of Crisis Management at the Fed”.

Each of the crises required a kind of executive intervention drawing on combination of technical skill, prudential judgement and a heuristic sense of a more sustainable future framework. Disruption is a form of change that can be either positive or negative and, indeed, may be good for some in the economy and bad for others. It seems likely that disruption will continue to be a force in our lives. One important characteristic of disruption is that it is a form of discontinuous change, and therefore one that resists being conveniently mathematically modelled. It thus calls upon synthetic judgement, not just analytical thinking, by investors and managers. For a discussion of this synthetic approach at the level of the firm see Nadler et al. (1994).

It is with this in mind that we include a ‘mixed-methods’ approach to the study of Covid and its implications for real estate investment and finance. The pages of this special issue of JPIF contain explorations from both a quantitative/analytical approach with empirical data, and a qualitative/experiential approach using surveys and interviews. From both approaches we can glean information of practical value for equity and debt investors in the property markets.

We are convinced that there is much to learn from the differing experiences the pandemic brought to countries and real estate markets around the world. Impacts have varied across property types, most assuredly, as they have across investment entities in direct ownership or securitised entities. Further, efforts to mitigate the impact of the public health emergency necessarily reflect operational choices that must take into account local cultural norms as well as the exigencies of investment performance.

We may well keep in mind the maxim attributed to Albert Einstein: “Explanations should be as simple as possible, but no simpler.” This is just an updated way to state the principle of Ockham's Razor. But oversimplifying brings its own risk of missing the mark in a complicated world.

The impact of disruption on real estate and economic cycles can be better understood by recognising that real estate markets – both primary and secondary – are complex adaptive systems. The literature on the behaviour of such systems is now extensive. A basic observation is that complex systems are ensembles with a dynamic of interactions, but whose behaviour may not be predictable merely by the behaviour of its components.

To be clear, ‘complexity’ and ‘chaos’ are not synonyms. Indeed, the scientists who study complex adaptive systems carefully assert that such systems may function ‘on the edge of chaos.’ These scientists actually employ the rigour of advanced mathematics to understand system behaviour, and do so to surprising effect (Bettancourt et al., 2007).

Nevertheless, progressive adaptation promotes an increase in diversity. In the words of one author, “complexity breeds diversity, which increases complexity, which breeds diversity …” (Taylor, 2001). Put another way, such systems are co-adaptive and at a very minimum should be understood as ill-suited for the simplification normally articulated in the predictions of cyclical recurrence.

Both the economy as a whole and cities as a particular subset can be studied as complex adaptive systems, and therefore moving on the edge of chaos. One key insight into the economics side is that perhaps ‘equilibrium’ is not all it is cracked up to be. Instead of developing expectations based on a state of a system that never truly settles down, perhaps we need to focus on a perspective that emphasises comprehension and explanation. After all, meteorology and evolutionary biology are scientifically rigorous without nailing their subjects down deterministically (Waldrop, 1992). A closely aligned insight gave rise to the entire field of behavioural economics in the work of Tversky and Kahneman (1974), Kahneman (2011), and Thaler (2015). The economy is a system populated by human beings and their interactions are governed by analysis and by psychology both, as traders have known from as long as markets have existed. For a brief and readable discussion, see Niederjohnm and Holder (2019).

The study of urban change, in line with the work of Bettancourt et al. cited above, has been intensively pursued by Michael Batty of University College (2005), amongst others. Batty explores the impact of scale [urban size] and hierarchy [a city's rank-order in a network of cities], factors that not only differentiate urban areas from each other, but help direct the kinds of land-use (i.e. building forms) most likely to be economically successful. Naturally, this investigation needs to consider the pace of growth and here a new factor of uncertainty is introduced. Batty and others (Mitchell, 2009) have noted that the acceleration of growth factors in a city (however desirable such growth may be), interacting with each other over time, can have a destabilising effect physically, socially and economically. Focussing on dynamics, Batty says, “we consider disequilibrium to be a more characteristic state of urban systems” than stability and relative predictability.

Overall, then, we might well draw the lesson that humility is a virtue worth keeping in mind in assessing our ability to anticipate, much less quantify, an open-ended future. Those predicting with confidence the way that forces like work-from-home, ecommerce, artificial intelligence tools as well as advances in PropTech and Fintech may well be viewed with scepticism. Alfred Marshall used an epigram from Linnaeus to head his masterwork in economics, Natura non facit saltum, “Nature does not make great leaps”.

While there is a certain heroic romanticism to disruptive innovators urging, “Go big or go home,” for real estate we may be better served by biologist E.O. Wilson's (1998) observation that “Big mutations almost always reduce survival rates and reproductive capacity.” As we seek to adapt to late-Covid amid the complexity of the 2020s, I hope the solid research and modest claims contained in this special JPIF issue offer solid ground for advancement, more reliable than speculation about a future than may be only a Wiley Coyote leap into oblivion.

May 2023