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Count the costs: Which comes first, wages or rents?

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Count the costs: Which comes first, wages or rents?

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Count the costs: Which comes first, wages or rents?

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Grade A office space refers to those top-notch commercial premises typically located in the Central Business District and close to a train station, with characteristics such as two to three lift lobbies and smart building features.

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“The problem is most of the malls are held by the main operators, monopolising the whole markets… Over the last five years, increases have been killing us softly, bleeding slowly.” - Alan Goh (above), chief executive of Katrina Group.

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“Employers ‘cannot afford’ to pay higher wages where the labour is not very productive, which is due to the fact that employers themselves do not invest in increasing productivity from domestic labour because they have the alternative of hiring cheaper foreign labour instead.” - Linda Lim (above), professor emerita at University of Michigan’s Stephen M Ross School of Business.

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In not setting a ceiling to rental or a floor to salary – except in the three sectors where wages are low – the government is being consistent in allowing market forces to determine the prices for leasing and hiring workers, says professor of finance, economics and real estate at NUS Business School Sumit Agarwal.

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“Many employers themselves have experience with deciding whether to adjust prices because there is high demand for their services or products, so while they might not like it, they can see why a landlord is justified in doing so,” says Walter Theseira, associate professor of economics at the Singapore University of Social Sciences.

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Tay Huey Ying, JLL Singapore’s head of research and consultancy, points out that in Singapore where there are many competing uses for scarce land, the limited supply of office space relative to demand often places pressure on companies to give in to rental hikes in an upmarket.

AS COMPANIES saw their business dwindle when Singapore entered circuit-breaker mode to stem the spread of the coronavirus, calls grew for rental rebates from landlords. Their frustrations boiled over at what they perceived as "unfair" rentals and wanted such charges reined in. Before the pandemic hit Singapore, however, these tenants might have grumbled about high rents without taking much action - at least not publicly.

Yet when talk turns to raising wages and paying a fair salary for the job, business owners seem much more resistant, even as they stomach higher rentals for the spaces they occupy. Indeed, committing to a minimum wage for employees has always been controversial and has drawn much debate - at both corporate and government levels. It would seem that companies are not as resistant to rental hikes as to a minimum wage.

It's a question of which is more acceptable to companies, says Walter Theseira, associate professor of economics at the Singapore University of Social Sciences. The academic notes that it is not too different from what makes consumers more willing to accept some kinds of price changes and not others.

He cites research that shows people view some types of price changes as fair but not other price increases. Generally speaking, what determines fairness is a sense of whether the seller - for example, the landlord or the worker - is entitled to their profit or surplus.

Price changes that are due to some types of changes in market prices are often accepted as fair, as most merchants justify the increases on higher input costs. In contrast, price changes viewed as unfair would be those that appear to exploit a short-term shift in market conditions - for example, charging more during the holiday season.

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Prof Theseira surmises that companies don't think raising employee wages to a minimum level as mandated by law is fair, because they don't think workers are entitled to it.

"Now if employers had to increase wages because they could not hire workers at the prevailing wage, that is something that would be regarded as fair - but having an external force, the government, impose a higher wage surely strikes many employers as being unconnected to market forces," he says.

Also, companies could accept price increases as a result of market forces, so they are more willing to accept - even if grudgingly - that they have to pay higher rentals when there is higher demand for rentals in their area.

Prof Theseira says: "After all, many employers themselves have experience with deciding whether to adjust prices because there is high demand for their services or products, so while they might not like it, they can see why a landlord is justified in doing so."

But with the pandemic sweeping in and pushing businesses into crisis mode, the difference in perception is beginning to emerge as somewhat imbalanced.

"Interestingly, one issue with Covid-19 is that many firms don't in fact see landlords refusing to lower rent as fair at all - they can see visible evidence that demand has fallen for rentals, so they no longer think that the landlord is entitled to the rent the same way they might during an economic expansion where there is more demand than supply for rental spaces."

Demand vs supply, costs vs returns

Tay Huey Ying, JLL Singapore's head of research and consultancy, points out that in Singapore where there are many competing uses for scarce land, the limited supply of office space relative to demand often places pressure on companies to give in to rental hikes in an upmarket.

Grade A office space refers to those top-notch commercial premises typically located in the Central Business District (CBD) and close to a train station, with characteristics such as column-free large floor plates, two to three lift lobbies and smart building features. Tenants leasing such office space are typically the multinational corporations.

The relative scarcity of high-quality and well-located space compared to the availability of labour, is one major factor that accounts for the difference in assessment of the two costs.

Linda Lim, professor emerita at University of Michigan's Stephen M Ross School of Business, echoes the view that land is scarce but labour is abundant in Singapore.

An abundance of lower-wage foreign labour and skills has held down wages in Singapore. This has discouraged employers from investing in employees' upskilling and capital investment to increase productivity.

"Employers 'cannot afford' to pay higher wages where the labour is not very productive, which is due to the fact that employers themselves do not invest in increasing productivity from domestic labour because they have the alternative of hiring cheaper foreign labour instead," adds Prof Lim.

The question is why employers view so-called unskilled labour as cost that should be kept low.

Prof Lim had noted in an earlier interview that unskilled labour is a small proportion of total cost for a rich country like Singapore. And that small cost of increased wages for low-wage workers can be absorbed by increased efficiencies in business operations. She questioned why the focus falls only on the increased cost - and not returns - of unskilled labour when talk turns to raising wages.

"You could, for example, have smaller increases in other costs like rent or utilities, or you could have a small reduction in landlord/property-owner profits," she counters.

Song Seng Wun, economist at CIMB Private Banking, points out that the attitude of companies towards labour matters. "If you think those lower-paid workers are no more than just someone … you can easily replace, without a doubt, they are just being seen as a factor of production…"

Also, he notes, if companies run a labour-intensive business with lots of low-wage earners, they may be more reluctant to pay higher salaries because every dollar increase per worker has to be multiplied by the number of workers benefiting from the minimum wage policy.

Douglas Foo, president of Singapore Manufacturing Association, however, stresses that most employers do not begrudge an increase in wages for employees, especially where such employees continually seek to improve themselves through upskilling, resulting in productivity gains and improving work performance. He says: "Businesses are very well aware that the future of the enterprise is a function of great human capital."

Unequal positions, less bargaining power

But as Alan Goh, chief executive of Katrina Group, points out, businesses like it - a food and beverage (F&B) player - do not have much bargaining power against landlords, especially when many malls are operated by real estate investment trusts (Reits).

He notes these publicly-listed landlords work towards yields for their unitholders. "It's beyond us… The problem is most of the malls are held by the main operators, monopolising the whole markets… Over the last five years, increases have been killing us softly, bleeding slowly."

Katrina operates about 40 outlets in Singapore under various brands including Streats and Bali Thai.

F&B companies like Katrina find themselves squeezed at both ends. They cannot afford to pay employees wages that are below market rates because locals shun the industry due to the long hours, working on weekends and public holidays as well as the hot kitchen environment, Mr Goh says.

Generally, rentals and wages each account for 20 per cent to over 30 per cent of cost for F&B operators, and ingredients account for another 30 per cent, leaving a very slim low-single-digit net profit margin.

Market structure or competition will generally determine the extent to which companies can bargain on prices of what they buy or sell.

If companies see themselves as not being able to negotiate on rents but must be price-takers, this indicates that landlords are in a monopolistic position. That is, there are relatively few big landlords who set rents with insufficient competition to put pressure on them to win tenants, says Prof Lim.

She adds: "In the case of Singapore where there is a limited supply of land, and the government, GLCs (government-linked corporations) etc own or control most of it, this is very likely the situation."

In contrast, labour suppliers are in a weak competitive situation due to the ready availability of cheap foreign labour, says Prof Lim. Workers are "price-takers" and have a weak bargaining position versus employers as long as employers have alternative sources of labour. But companies do not have alternative supply of land.

Because companies cannot bargain down rents they pay due to monopolistic landlords, they are left with only labour costs that are variable. So they cannot afford to pay higher wages because they must pay higher rents, adds Prof Lim.

"So what is happening here is a transfer of income from wage-earners (labour) to property-owners (rentiers), or from labour to capital. To the extent that the property owner is the government (the Housing Development Board, CapitaLand, Mapletree, etc) it is also a transfer from workers to the government," says Prof Lim.

Should the government then step in to limit the costs of rents to help ease pressures on business?

Christopher Gee, senior research fellow at the Institute of Policy Studies, notes that state intervention in a free market creates distortions. For instance, controlling rent in a global city where land is scarce results in inefficiencies. The government, however, is still able to have a say in how land is used through zoning, determining of plot ratio and other means.

Therefore, unless it's a public good that a particular tenant is producing, the government would not consider stepping in when the tenant is unable to afford rent. Instead, market forces should be allowed to find their equilibrium.

Singapore abolished the Control of Rent Act in 2001 as the law had become irrelevant, when the majority of Singaporeans had public housing and were no longer at the mercy of landlords that jacked-up rents.

Rent control discouraged competition, with some tenants profiteering when they sublet the space and generated income while paying a fixed, under-market rent to their landlords.

Similarly, the government is less willing to implement a minimum wage policy because of several concerns, including how employers might mitigate higher costs arising from paying workers a minimum wage by letting some workers go. Therefore, it uses the progressive wage model for the security, landscape and cleaning sectors for now.

According to the model, the government maps out a pathway for wages of workers in these sectors to rise along with training and improvements in productivity and standards.

Policymakers argue that employers benefit from higher profits translated from workers' higher productivity while their customers should also enjoy better standards and quality.

Sumit Agarwal, professor of finance, economics and real estate at NUS Business School, says that in not setting a ceiling to rental or a floor to salary - except in the three sectors where wages are low - the government is being consistent in allowing market forces to determine the prices for leasing and hiring workers.

Perhaps a similar approach for tenants and rents might be considered. Prof Agarwal suggests a progressive rental model targeted at specific segments of tenants that the government would like to help, for example, the small businesses that represent the essence of Singapore. They could be squeezed out as a result of not being able to afford rents determined by market forces.

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