Japan Properties: Tokyo’s Expected Condo Market Recovery Expands to Major Cities

Japan Real Estate

Desirable Development Location – Marunouchi District, Tokyo

15 Jun, 2015 –

More than two years into Abenomics, Japan’s prime property developers may finally be about to reap its benefits. Since Prime Minister Shinzo Abe rolled out his ambitious stimulus program, office vacancy rates in Tokyo have fallen steadily to such low levels that there may be little room for further significant declines. Now, however, with a recovering economy and the likelihood of limited additions to supply, these developers are back in a position to command higher rents for the first time in years.

A key feature of the recovery in the Tokyo office market since mid-2013 has been how it has largely bypassed grade A properties. Japan’s economic rebound, fueled by the Abe government’s fiscal expansion and the Bank of Japan‘s monetary easing, has raised companies’ optimism only to a limited degree. Accordingly, corporate spending has remained cautious, and office expansions have mainly benefited more affordable premises in lower-grade buildings with higher vacancy rates.

This trend was reflected in the diverging performance of property stocks last year. Real estate investment trusts, which manage lower-grade office properties, outperformed the overall sector. To be sure, their performance was also helped by the Bank of Japan, which tripled its REIT purchases; the Government Pension Investment Fund, which raised its equity allocation; and accounts under NISA, a new tax-free investment scheme that is drawn to REITs’ dividend yields.

In contrast, the share prices of grade A landlords have languished. Despite relatively low vacancy rates, these landlords’ ability to raise rents was constrained by concerns that Japan’s economic recovery was tentative. It did not help that sales of condominiums — another major asset type in their portfolios — were stalled by a value-added tax hike last year. Since developers have historically paid low dividends, they did not attract the types of investors that bought into REITs.

Sustainable reversal

This situation may be about to change in favor of property developers. First, the Japanese economy is likely to enter a more stable recovery path as the effects of Abenomics become more entrenched and domestic demand, driven by consumption, improves along with a rise in wages. Swiss bank UBS forecasts growth of 0.8% in gross domestic product this year and 1.8% in 2016. As prices normalize after last year’s consumption tax hike, inflation should also stabilize at 0.8% and 0.9% over the same periods.

Second, the office property market has tightened. Few buildings can now take in large-scale relocations, especially among grade A offices. The vacancy rate in Tokyo’s five central wards has declined from 8.3% in July 2013, when the downtrend started, to 5.3% in April. In Japan, 5% is considered the level at which supply and demand achieve balance. For grade A offices, industry estimates place the vacancy rate around 4%.

Meanwhile, new space coming into the market in the next two years is forecast to be quickly absorbed by tenants seeking bigger premises. According to property advisory CBRE, more than half of inquiries made in 2014 were for expansion and new office openings, underpinned by demand from information technology and financial services companies, and professional services such as staffing and advertising agencies.

Third, tenants can now afford higher rents. An upshot of Abenomics is that corporate earnings have increased in recent years, particularly among externally oriented companies, which have greatly benefited from a weaker yen. Among the exporters followed by UBS, profits have soared from 7 trillion yen in the year ending March 2012 to 17 trillion yen in the year to March 2015. With higher earnings, Japanese companies are awash in cash, and hiring has intensified. During the annual wage negotiations in March, most large employers increased base salaries by 2-3% for the second straight year, a historical exception for Japan and a signal that companies are more willing to accept increases in some of their costs, including rent.

For equity investors, an additional plus for developers is the expected recovery of the condominium market. A year after the consumption tax hike, demand in central Tokyo is now solid, and year-on-year sales comparisons should turn positive by mid-2015. As for REITs, the sector offers some good value after a recent correction due to new listings, but selectivity is the key to wise investment. Office REITs should continue to fare well, while commercial and logistics REITs should benefit from rising e-commerce and the expansion of Japan’s economic recovery from Tokyo to other parts of the country.

(Source – “Nikkei Asian Review“, Pic – Marunouchi, Tokyo / “New York Tokyo“)

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