Due Diligence Series Part 1: Investment Properties
In Part I (see below), we’ll cover investment properties, such as condominium units within co-owned buildings.
In Part II, we’ll cover family/holiday/vacation homes, either as condominiums or detached houses.

So you’re ready to buy your first property in Japan? Or maybe you’ve already been down that rabbit hole and are wondering if you’ve done something wrong? One commonly overlooked concept in purchasing real estate around the world is due diligence. By definition, due diligence in terms of real estate is care taken by research and analysis of a property and its affiliations in preparation for a transaction. One of the quirks about the Japanese real estate market, however, is that the due diligence is only conducted once your offer is accepted. 

Before making an offer, you can do basic research such as an analysis of the neighborhood, tenancy rates, income levels, crime rates, population, job growth, and property value trends. However, the real due diligence, the nitty gritty stuff, comes only after an offer is made. 

Why can’t I get the details first?

In Japan, the entire real estate purchase process, like many other things in comparison with the rest of the world, tends to be unique. The purchase process is scrutinizingly documented and there tends to be miles long of paperwork , leaving a clear and distinct paper trail. Most documents and information needed to carry out due diligence will be provided upon acceptance of an offer and before officially sealing the deal. 

This is because the real estate market in Japan is very fast and realtors generally will not want to research, prepare, and provide detailed documentation for the average person with limited interest in any particular property. Once an offer is made by a serious buyer, of course, any documentation available will be given upon request… but not necessarily without requesting it! Therefore, it is vital to know what to look for before when making the decision to buy or not.

What should I look for?

There are some different aspects to look into depending on the type of property, whether it’s an investment property, a vacation property, or a family home. 

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Part 1:

Welcome to Part 1 of the Due Diligence series covering investment properties!

For investment properties, such as individual condominium units within co-owned buildings…

In this case, properties are purchased for investment in Japan as sources of cash flow. There should be a certain stable percentage of income that makes a property worth the actual investment. Due diligence is a bit more complicated for investment purposes rather than a family or vacation home. So let’s break them down…  

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Due Diligence #1: Check that the numbers are correct – that everything represented on the property listing is correct for income and expenses.

Many times these will be incorrect. To ensure that you’ll be getting the anticipated yield, you’ll need to discern which numbers are correct. Whether the monthly rental amount and building management fees listed are accurate or, for example, if there is a water bill or parking space incorrectly included within the property listing as rental income, that means you will be making less than anticipated. 

Due Diligence #2: Check how long those numbers will be stable – if the reserve funds pool is large enough to handle any major renovations, if the market average rent is being charged.

The building of a condominium unit should have a correlated renovation history and status of reserve funds. Major renovations done are usually exterior building strengthening, exterior wall painting and repairs, roof repairs and water-proofing, and elevator systems (which are mandatory for buildings with 6 floors or more). By rule of thumb, these should happen every 10-15 years. If any major renovations occurred in the past 10 years, you could expect for these funds to be depleted, but that also means no major renovations will be needed in the near future!

Also check that the market average rent is being charged if the property is tenanted. If it’s too expensive, when the tenant moves out, the unit will need to be on par with the market average or risk vacancy. A current tenant may be paying higher than average rent if the market average dropped, but usually they won’t don’t try to negotiate rent to be lowered. Therefore, if a tenant that is paying too high leaves, you will be forced to lower the rent closer to the market average in order to find a new tenant and, thus, decreasing your yield. 

Due Diligence #3: Check the building history for smaller maintenance and repairs to confirm that it is being well-maintained. 

If any of the above information is less than clear, it may be a sign that the building management company is mismanaging funds. 

Due Diligence #4: Check tenanted property profiles to mitigate some risk.

If a property is tenanted, finding out whether they are reliable through a little more research. First, how long they have been renting the property. If it’s been a long time, that is already an indicator of reliability. Otherwise, demographic profiles can be another helpful indicator of stability in rental income. 

Riskier profiles would require a bit more to ensure a safety net is in place to mitigate unexpected vacancies or damages. Some of these securities would involve renters’ insurance or a guarantee company that covers damages, payment issues, cleaning, and more. Security deposits also help cover the same costs, should they be requested. Personal guarantors are another option, although they may not be financially stable themselves. 

On a cultural note, the Japanese tend to be very sensitive to public shame, which usually leads to a feeling of obligation to remain in good financial standing and avoid conflict or payment issues. If a tenant finds themselves unable to pay for whatever reason, they’ll usually go as far as to evict themselves and avoid causing further trouble.

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A final note regarding tenants is that you might have a case where a tenant has been reliably living in the property for a very long time. At first glance, this may seem fantastic, but sadly, age needs to be considered in terms of limitations. Elderly tenants have a chance of moving to a nursing home or even passing away on the property, sometimes incurring a major potential cleanup expense. If any tenant has lived in a property for a very long time, thorough and pricey interior renovations will also be needed when they vacate the premises, further resulting in a large expense. Sometimes, checking whether long-term tenants have made any maintenance requests regularly could help to give an idea of how the interior is doing. These and many other factors play an important part in yield stability. 

Due Diligence #5: Check vacant properties for interior and structural integrity, including soil solidity inspections when needed. 

Unlike tenanted properties, vacant properties allow for a buyer to inspect the premises, so professional reports can be obtained for further risk mitigation, usually at the expense of the buyer. 

Such expenses may seem troublesome, but they will go a long way in helping qualm any worries about making investments, and could save you a lot of money if big problems are uncovered before your purchase. 

For due diligence about family/holiday/vacation homes, either as condominiums or detached houses…see Part II here.

Sources:

Nippon Tradings International. https://nippontradings.com/buying-real-estate-property-in-japan-as-a-foreigner-part-3-negotiations-due-diligence/

Nippon Tradings International. https://www.youtube.com/watch?v=1kBrlyyg1YQ

Roofstock. https://learn.roofstock.com/blog/what-is-due-diligence-in-real-estate

GaijinPot Blog. https://blog.gaijinpot.com/the-real-cost-of-buying-and-selling-a-home-in-japan/

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