Top 5 Due Diligence Tips to Mitigate Risk on Japanese Properties

28 Nov, 2019 –

Japanese Real Estate

Japan Investment Properties

Accidents, damages and natural disasters can happen when investing in real estate anywhere in the world. In Japan, most tenants are quite docile and place high value on their integrity by nature. Therefore, the majority of damages to a unit, if any would be through wear and tear rather than accidental or intentional. In case of any internal damage, tenants would be required to pay for damages they are responsible for, while the owner covers the rest. Insurance is at a surprisingly low cost of only USD $1 to $3 per month depending on age, location and size of the property. Most building owner co-ops prefer to keep insurance minimal and set funds aside through the accumulated funds collection from unit owners for building maintenance and potential future renovations/repairs. While coverage is available through insurance, it usually does not cover all costs.

Therefore, part of our service as a proxy to foreign investors is to help mitigate risks by conducting due diligence on the management of the building including accumulated funds status, and on tenant stability and security.

 

Due Diligence on Building’s Accumulated Funds

Although insurance policies cover damages due to fire and earthquakes, tsunami, volcano and flood damages, there are no guarantees. Therefore, we look for a building with healthy accumulated funds to be able to cover the cost of damages not covered by insurance. These are funds collected from all unit owners by building management through monthly invoices for building maintenance, repairs and renovations over time, paid either manually or through automatic payments from the owner’s designated bank account.

Generally, insurance will cover 25% to 50% of the cost of damages to the building depending on the type of damage, location, and age of the building. Some policies state specific partial coverage; others state no coverage for various natural and man-made occurrences. Any remaining losses not covered by insurance are generally covered by the building’s accumulated funds pool.

If there have been no large renovations in the last decade, full damage may be compensated to the building owner as follows:

a) the total amount in the reserve funds pool collected from unit owners (33% of the purchase price per unit is what we ideally like to see in the pool if there have been no significant renovations in the last decade. This is to assure us that there will be enough funds available to cover these renovations when required).

b) up to 50% coverage of the cost of the damage through insurance policy

c) balance covered by any rental income accrued

If a building is faced with damages and does not have sufficient funds to cover the repairs, the building may raise its building fees from each apartment owner or charge a one-time payment, which could result in reduced yields for the unit owner. Therefore, prior to purchase and as part of the due diligence process we look for a correlation between the building’s renovations history and the status of the funds pool. We want to ensure that either:

a) Renovations or repairs have been recently performed and therefore justify lack of funds in the accumulated funds pool

b) Renovations or repairs will be required in the near future and there are sufficient funds to cover them.

 

Security on New Tenants

On vacant units, we strive to ensure secure and stable tenants occupying the units before recommending our clients go ahead with the investment purchase. When placing a new tenant in a property, there are two types of securities aside from personal guarantors. We always insist on having at least one of the two:

a) tenants must either pay a 1 month security deposit

 OR

b) tenants must sign up for rent insurance, which covers up to three months of delinquency and any damages caused during the tenancy. This is the preferred method. Rent insurance may not be available to international students, holiday tenants, or anyone else who does not qualify, as well as anyone else considered high risk who can potentially disappear one day, leaving damages or debt behind.

 

Due Diligence on Tenants of Occupied Units

On tenanted units, the existing tenant may have only paid a security deposit, or only have personal guarantors. Although this cannot be changed upon purchase, we present the tenant information to our client as part of the due diligence to decide whether to refuse the deal or move forward with the purchase accordingly.

 

“Death in Property” Insurance Clause

Because of Japan’s aging population, we recommend a “death in property” insurance clause. For small apartments, the cost is approximately 1,500 to 2,000 JPY ($15 USD) a year. Because it is so inexpensive we, in fact, recommend it to all tenants regardless of age. In the event of a death, renovations/repairs/cleaning expenses of up to about 1 million JPY will be covered under the policy, as will the next two years of vacancy and/or reduced rent. This will also protect your income.

 

Security Deposit and Standard Insurance on Commercial Properties

Commercial properties experience more wear and tear than residential properties. Therefore, commercial building owners will need more expensive insurance for unit interiors, and will also need to put aside funds for all exterior building maintenance, renovations and repairs.

If you own the entire building, depending on the size of the building, you may need to hire a building management company to maintain, manage and take care of the building common areas.

 

(Source – Priti Donnelly, Nippon Tradings International”, Pic – NipponTradingsInternational)
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