Investing in Japanese Real Estate for Foreigners – Part 3 – Negotiations & Due Diligence

14 Mar, 2016 –

Following through from our previous article, and assuming you’ve established some key relationships with local realtors in your areas of choice (more about choosing these locations in coming publications) – sooner or later, you will most likely come across a potential deal which will suit your criteria. The process, from here on, is quite similar to what you’d expect in any country, but with a few important differences.

(Note – the following text assumes the purchase of tenanted individual residential or commercial units in condominium blocks – the most common and highest cash-flow yielding type of purchase in Japan. With regards to other types of properties, such as vacant properties, entire unit blocks, houses, purely commercial properties, etc, procedures may vary)

1. Making your Offer

Japan Investment Property

Japan Real Estate

Each real-estate property agency will have their own particular offer forms, that you would be expected to fill in and, in most cases, fax to the realtor handling the listing (the Japanese are notoriously fond of paperwork and, similarly, notoriously un-fond of computers and standard e-mail – so it would be quite rare for them to accept e-mailed offers in most cases). If you do not have a fax machine, as is the case for most of us these days, there are plenty of free and low-priced online fax services available on the web.

It is important to note that the market in Japan moves extremely fast, and attractive deals can be gone in a matter of hours from their listings in many cases. What this means in practice, is that you cannot afford to perform thorough due diligence on any particular deal before submitting your offer, but will have to quickly run the numbers onto your spreadsheets and, if they appear favourable, then submit your offer without having the complete information at your disposal. And since, as mentioned previously, pulling an offer back with no apparent reason will burn your relationship with that particular realtor, it is essential that you do not submit more offers than you can practically proceed with, should due diligence turn out to be satisfactory.

It is, however, perfectly acceptable to specify conditions for the purchase on the offer form, which would normally include the following:

A) The price you are willing to pay: Generally speaking, price negotiations of 10-15% at most may be acceptable in Japan, but only in cases where there is some tangible cause to request such a reduction – these include, but are not limited to, such things as a unit being on the first floor (less attractive for female tenants); 3rd floor or above without an elevator; an older block built prior to the latest earthquake-resistant building standards (1981 or earlier – definitely do not purchase anything older than 40 years, as repairs and maintenance costs begin to increase rapidly at this age); distance of more than 10 minutes’ walk to the nearest train or subway station; and so forth. In popular cities, where prices have been going up, the seller will know fully well that they will be able to receive their desired price if they wait another week or two at most, hence may not agree to the discount.

B) The deposit you will pay at contract signing: Traditionally 10% – you can offer 15-20% if you want your offer to stand out – this is a particularly a good strategy in cases where the realtor has informed you that the seller is selling due to a need for urgent, liquid cash.

C) Preferred date of settlement: The earlier, the better, of course – just bear in mind that, being overseas, all documentation will take longer to arrive at its destination – it is wise to allow at least 6 weeks – minimum 4 weeks, provided you’ve done this before, and know how quickly you can provide the required documents.

D) Source of funds: As a foreigner, and without access to traditional local funding, you’ll most likely be paying cash, which is a big advantage – make sure you specify this, as all sellers will always prefer to know they do not need to rely on any bank approvals, which can result in last minute cancellations if the loan falls through.

E) Special notes and conditions: This is the most important part of the offer, and is where you will always note the following – 1. that your offer depends on the building’s renovation history and future renovation plans (if any exist); 2. the status of the accumulated funds pool (which will be essential to pay for any future renovations); and 3. the tenancy information. This will ensure that, should any of the due diligence information not be satisfactory, you will be able to justify pulling back your offer without “losing face”, which is essential to maintain a good relationship with the realtor handling the sale (see “Part 2: Building and Maintaining Relationships“).

F) Contact details: As mentioned in the first installment in this series, it is assumed that you will be using a native Japanese employee or partner, who will be handling all contacts on your behalf – make sure that, while your name and address appear on the offer form, the realtor knows how to reach your Japanese representative, and has viewed a written and notarized authorization, such as a power of attorney document, accompanied by an ad-hoc translation to Japanese. Again, it is essential that all Japanese professionals involved in the purchase be assured that they will have a local Japanese entity to deal with in all matters.

2. Conducting Due Diligence

Once your offer has been accepted (or rejected and re-submitted at a higher price, then accepted), the realtor will begin providing you with due diligence information. At first, this will be in the form of simple e-mails or information relayed via telephone calls – so it is essential that you then verify all of it prior to signing the contract (more on that below).

You want to ensure the following:

A) That the building’s renovation history and the status of its accumulated funds pool correlate.

Essentially, this means that if the building has gone through some major renovations over the last ten years, it is acceptable for the funds pool to be mostly depleted – as no major renovations are likely to be required at any point in the near future. Major renovations normally include either the exterior of the building (painting, re-strengthening, repairs), or its roof (water proofing, repairs). If none of these major renovations have taken place over the last decade, you would want to ensure that at least a third of the purchase price per unit is available for such renovations, or for any natural disasters which may occur – this being Japan, this refers mainly to earthquakes, which are quite common.

The reason we normally like to see a third of the purchase price covered is that, in case of natural disasters, there are two other compensation methods available to you – those being your insurance policy, and government compensation (which may take longer). If one of the two major renovations has been performed, half of the amount (15-17% of the purchase price) will suffice. Additionally, a large list of smaller maintenance and repair items will tell you that the build is well-maintained, which will be helpful when the unit becomes vacant and you want to attract new tenants. Should any of the above information not be forthcoming, you may want to reconsider the deal, as the building management company may be mis-managing funds in one way or another.

B) That the tenant has been in place as long as possible, or if not, that they are of a reliable profile. Generally speaking, in Japan, the best possible tenants would be single females over 30 (while it may not be politically correct to say this out loud, the chances of their marrying, in a country which places far too great a value on youth, rapidly decline at this point); elderly pension receivers or single, full-time employees of large companies (as both do not tend to move around much in Japan). Part-time staffers, small business employees, sole traders (“one man” business owners such as food stall operators, etc) or the chronically unemployed (including younger government welfare recipients) could be more risky.

C) That the tenant has reasonable securities. In order of preference, these are:

i). Rent insurance (which will cover any or all non wear and tear damages, rent payment issues, post-tenancy cleaning and lock replacement, and in some cases even early contract terminations);

ii). A security deposit of 1-3 months rent (which will help cover most of these costs)

iii). If none of the above is available, personal guarantors. The latter may not mean much in other countries, but assuming these guarantors are still alive and are financially stable, the Japanese fear of public shaming will, in most cases, mean they’ll do their best to fulfill their obligations as guarantors.

If all the above go through smoothly, or at the very least can be sorted out to your satisfaction following several rounds of exchanges with the realtor, it’s time to move on to the actual purchase itself. More on that in our next article in this series!

(First Published in “Asian Property Review“, Pic – Conducting Due Diligence/ “Nippon Tradings International”)

 

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