The Income Stream Paradigm

Investment properties are, generally, only as good as the rental income they generate.

Sure, there are speculative markets and strategies out there – buying cheap for later resale at a profit, land banking, flipping, wholesaling and so forth – but the traditional, reliable and (hopefully!) stable model of buy-to-hold or build-to-hold stipulates recurring monthly rental income from a constantly occupied property, generating a sort of “paycheck” for the landlord.

If and when a property becomes vacant, the owner would normally aim to have it cleaned up, renovated or repaired if required, then re-leased as soon as humanly possible, to allow the steady income-stream to resume ASAP.

There are, however, certain periods of time, locations and property profiles which make re-populating a property a bit more challenging – and these events can require some creative thinking and solutions, if one is to tackle the vacancy and related expenses as quickly and efficiently as they possibly can.

It’s also important to understand the difference between structure and strata ownership as it relates to vacancies – if one owns the entire structure, whether it’s a house or multi-family/commercial building – a vacancy merely means lost income. If, however, one owns a unit or multiple units in co-owned buildings, which are being managed by a building management company on behalf of the owners’ co-op, monthly building fees are still payable, regardless of whether the unit is vacant or occupied – and in older and other higher maintenance buildings (think serviced apartments, blocks surrounded by gardens, or with gyms, swimming pools and other resort facilities) – these monthly fees can amount to significant expense, with no income to cover it if the unit is vacant – so re-populating it as swiftly as possible, even at potentially lower rent or higher expense, becomes a much higher priority.

How to Handle the Problem?

In Japan, like most other countries, the same generic solutions to the extended vacancy problem exist –

Buy in Popular, Accessible Areas

The best way to minimize vacancy periods is, of course, to purchase central city properties, or properties in high-occupancy, highly desirable areas to begin with. Locations featuring growing or stable population numbers exist on both ends of the affordability scales – even in Japan – and there are particular areas in each and every city which will always be in demand – whether the property in question is a luxurious high-rise penthouse, a mid-income family home, or a low income blue collar studio/1-bedroom condominium unit. Regardless of the purchase and rental price level, there are popular areas where low, medium and high income tenants prefer to live, respectively – and purchasing in these areas specifically will of course all but guarantee relatively short vacancies, and a steady supply of potential tenants at any given point in time.

Accessibility is of course also a major issue, and generally speaking, smaller properties without attached parking, which would mean potential tenants wouldn’t own a car, also need to be within convenient distance to popular public transit options such as train, subway or tram stations. Bus stations, while far more numerous, are a remote second place option, for most potential tenants.

It IS important, regardless, to make sure the pre-purchase due diligence includes not only the current rent paid by the tenant (if purchasing a tenanted property), but also comparable vacant properties in the same area (and in the case of condo units, in the same building if possible) – to give ourselves a rough idea of what rent we can expect to achieve when the current tenant moves out, and also how many vacant listings are advertised in our area and price bracket at any given time – since more vacancies often mean we’ll be facing tougher competition for the same tenant base, and will have to get more creative when it’s time for us to look for a new tenant to populate the property.

Understand the Reason for the Extended Vacancy

Regardless of area, however, extended vacancies can occur for a variety of reasons – and if a few weeks or months have passed since the property has been advertised for leasing, and there are still no applicants, it’s important to first understand why this is the case – as this will influence the approach and solution we will choose to try and amend the situation.

Different problems call for different solutions, so the first step is to understand whether the extended vacancy is due to –

* Seasonal reasons – In Japan, high moving season is generally between January and April, once everyone has returned home from visiting their relatives for the new year festivities, students and faculty begin to prepare for the approaching new academic year (starting in April in Japan), which may include them having to move closer to campus – and companies begin to prepare for recruiting fresh university graduates, and re-shuffling existing staffers to new positions in new locations.

(The exception to this rule is Hokkaido and other snow-country Northern locations – in Sapporo, for instance, where it’s very likely to be snowing between October to April, high moving season is normally in the late spring and early summer, between June to September – since no one likes to move and go shopping for new home essentials during the harsh winter).

The lowest moving seasons in Japan are during the three major public holidays, each of which is about a week or ten days long – “Golden Week” at the start of May, “Obon” in August, and the Christmas/New Year period at the end of December – during these times, most Japanese will be travelling home to visit their elderly parents and other relatives, and will not make plans for any major life changes – moving included – in the few weeks leading into and out of these periods.

* Rent is Higher / Competition is Fierce – even during high moving seasons, and even in popular areas, supply and demand issues may still apply – if the property is aimed at medium/high income earners (such as family sized or more luxurious properties), it’s possible that, regardless of season, owners/occupiers have recently moved out or re-sized, families have re-structured due to marriage, divorce or being forced to move in with their elderly parents to support them (common practice in Japan, particularly for women) – or elderly folks have been forced to move into aged care facilities. All of these events can and do occur regardless of season, and create an extra supply of available rental properties in a particular area.

A similar thing happens when a popular area becomes over-developed, and there are now plenty of available brand new or near new properties for rent, at prices that are only slightly higher than older comparable properties in that same area.

In all of these cases, the extra supply creates severe pressure on rents, and you may find that whatever you and your property manager have first assumed would be a reasonable price is now actually too high, compared with other available properties in the area.

* Inferior Interior / Lack of Features – even in cases and periods of time where there are only a few alternatives for potential tenants, the rent amount is on par with other properties of the same profile and size, and demand is higher than supply, your property may still be lacking in comparison with other properties. In Japan specifically, a modern interior design is significant for many potential tenants, particularly of a younger profile, and the following features make a major difference in which property they’ll prefer to go for –

1. East or South-East facing balcony or corner unit (in case of condos) – ideal for sunlight all through the day
2. Separate toilet and bathroom – considering the generally small size of these rooms, having the toilet (dirty place) in close proximity to the bath (cleaning place) is a major disadvantage. In larger properties, or those built from 1990 or later, these rooms will normally be separate.
3. Fresh wallpaper (preferably with modern design – walls in Japan are usually wall-papered rather than painted) and new or renovated flooring (preferably wood, tatami straw mats for bedrooms – linoleum is considered cheap and unpleasant)
4. Laundry bay area, with dedicated water supply and drainage
5. Built-in closets/cupboards
6. Modern kitchens
7. For condo blocks without elevators, no higher than 3rd floor – for condo blocks WITH elevators, the higher the better.

* Unattractive Building Features (for condos) – while the building features and services are normally out of our control in cases of co-owned blocks, it’s important to recognize that any building which has the following features, will also be far more attractive for potential tenants –

1. Secure keypad/auto-lock entry to building lobby
2. Video intercom system
3. Onsite management personnel (part or full time)
4. Laundry room (particularly if the unit doesn’t have a laundry bay)
5. Walled/fenced – no street access, and preferably no direct view to first floor windows/balconies
6. Well-maintained exterior and public areas (greenery around the building is always attractive as well)
7. Delivery lockers
8. Security cameras and automatic floodlights

Choose the Right Solution

There are multiple possible solutions to extended vacancies, which differ mainly in their immediate out of pocket costs VS their longer potential effect on income. Different approaches would also yield different results, depending on the reason or combination of reasons leading to the extended vacancy.

For instance – if there are already plenty of cheap properties available for rent in your area, reducing the rent will only take you so far – it may be better to offer a furnished apartment, to stand out from the competition. Another example – if there are already plenty of nicely renovated properties in your area, adding additional renovation features will not differentiate it significantly from other comparable potentials – in this case, offering some bonuses to potential tenants may be the way to go. Be sure to work with a proactive, savvy PM or portfolio manager who can conduct the appropriate research, and tailor the best solution for your unique scenario, out of the following options or combination of them –

* Rent Reduction is the easiest solution to implement, and doesn’t cost the owner anything in the immediate term – however, since rents are normally not raised when a lease is renewed in Japan (commercial rents are more flexible, but residential rents normally remain the same for the entire tenancy period, barring periods of exceptional economic growth, which are rare), one must take into account the total loss of income over an average lease period – which, for studios/1 bedroom units is usually 4.5 years, and for family sized properties is usually 7.5 years. Calculate the total amount of income reduction over this typical lease period to find out the real cost, then compare to the other potential solutions (listed below).

It is also important to try and avoid a “race to the bottom” scenario – if comparable supply in the area is very high, it’s possible that other landlords are similarly constantly reducing their asking rents, resulting in yields that can become too compressed for comfort, particularly for co-owned strata type condo units with high monthly building fees. In these cases, other solutions should be considered instead.

* Increased Advertising – this is the solution most property managers will tend to lean towards, as it means more money in their pockets – and what this means is that the standard 1-2 months gross rent commission, payable to the property manager upon sourcing a tenant, is expanded to anywhere from 3-5 months instead – this gives them more leeway to cooperate with other property managers who may have access to more tenants, put up bigger and more prominent ads online or in local publications, and promise a higher commission to anyone who can source a tenant on their behalf – thereby increasing your property’s exposure to a wider tenant-base.

Note – When considering this option, as well as the other options which translate into an immediate expense or loss of income – it’s important to ensure that the new tenancy lease will include a penalty for early vacating by the new tenant – to avoid a situation where a tenant moves in, then leaves several months afterwards, mid-lease, without paying any compensation (tenancy laws in Japan are highly tenant-oriented, and it can be quite difficult to obtain any compensation for lease terminations if not enshrined in the lease itself). If this clause is not included, you may face a situation where you’ve paid 4 months’ worth of rent in tenanting/placement related fees, only to have a wayward tenant abscond or leave 2-3 months later – those early vacating fees will cover you for all or some of that period at least.

* Free Rent or Discounted Move-In Fees – this option can also cost an additional 1-3 months of rental income, and is used to offer a financial “bonus” to tenants who choose your property over others. It can be anything – usually the first 1-2 months rent-free, or owner participation in move-in fees, reducing the significant bulk expense that tenants need to fork out in cash – things such as a guarantee company’s sign-up fee, the fee for replacing the lock and keys, the initial cleaning deposit, or all of the above. Savvy, pro-active property managers will often suggest to advertise these bonus options as a “pack plan” on all of their rental listings, giving tenants an option to choose between a standard rental plan, and one with a slightly increased monthly rent amount, which includes these discount bonuses – the idea being that giving tenants the choice to reduce their move-in fees is always an attractive feature.

* Fancy Renovation / Furnishing – this last option obviously costs the most in immediate out-of-pocket expenses for the landlord – anywhere from a few hundred dollars in electric appliances, through a few thousands for full furnishing, and all the way up to tens of thousands in attractive feature installations and upgrades (things like decorative/accented wallpaper, floating/sound-proof ceilings and flooring, laundry bay installations in case none exist, and even completely new bathrooms, and separation of the bathroom from the toilet) – the advantage of choosing this path, if one is willing to pay for it and can afford it, is that is raises the attractivity factor of the property far above the average properties “competing” for tenants in the area – and, in the case of renovations or complete furnishing operations, can also raise its potential rent income (ask your PM to run a quick check on average rent amounts for units with and without these features, if any exist in the area, to verify this last assumption though – as it won’t always be the case).

Renovations, as opposed to simple furnishing, can also raise the value of the property for resale purposes – although the fancier feature installation usually won’t raise the value far beyond the cost of the renovation itself, unless you’ve got the connections or DIY skills to significantly reduce the cost of labor and/or materials involved.

An added advantage of furnishing is that it also gives you the option to lease the property on a monthly basis, as opposed to standard long term leases – which, in attractive locations and depending on occupancy, can also significantly increase rental income – in the best case scenarios perhaps even double it. If you do choose to go this route, though, you’ll need to make sure your PM can provide monthly lease advertising and placement services – most companies will specialize in either long OR short term rentals, not both – and if you work with a PM who only handles short term leasing, you won’t be able to try and advertise for both lease options.

When All Else Fails

Of course, in some severe cases, there’s simply not much that can be done – a particular area or property, previously popular with a wide variety of tenants, may have simply gone “downhill” for reasons out of our control, usually socio-economic or city-planning related – in which case it may be best to simply let the property go, and put it back on market – cut our losses and re-invest our funds in something which yields better and easier income. Hopefully you would have made back at least some of the potential gap between your original purchase and subsequent sale prices while it was still tenanted – so consult with your realtor or buyers’ agent as to what would be the best and most cost-efficient strategy to selling the property (tenanted at a huge discount VS vacant, renovated VS “as is”), and let it go – there’s always the next deal!

(Source: Ziv Nakajima-Magen | Pic: Nippon Tradings International)