The Bigger Picture
It should come as no surprise that 2020, which will most likely go down in history as the year which sprung one of the biggest, if not THE biggest and least expected surprises of the last few decades on the global economy, has brought forth not only one, but several major shifts to the world’s real estate property markets – and its effects on Japan are equally profound. Equally, however, if not even more profound, is just how subdued this effect has been, in light of the global turmoil evident in almost all other countries around the globe, and more specifically in the Asia-Pacific region.
While Japan hasn’t, by any means, escaped the effects of the global Covid pandemic and the economic malaise it has wrought on national economies – the only country in the region which has actually seen an uptick in property transactions and volumes is South-Korea – in Japan, the decline, while evident, has been fairly marginal. Transaction volumes fell approximately -22% year-on-year through to September 2020 – which places Japan at the top of the “losers table” compared to the five most active markets in the region, as measured by year on year change in transactions. Directly under South Korea, which has experienced a transaction growth of 22%, as mentioned above – slightly above China, at -25% – just under half the decline of Australia, at -43% – and at the very bottom is Hong-Kong, at a staggering -63% decline in year-on-year transactions – having taken nearly three times the hit Japan’s property market has suffered.
The reasons for this relatively minor effect vary – but if 2019 has been characterized by a “quest for yield” frame of mind – the foremost factor in 2020 is the obvious “flight to safety” mentality, which has historically always favored the land of the rising sun. This tendency sees investors seeking out markets with deep domestic demand and less reliance on foreign trade – a globally traded and relatively stable currency (a requirement which rules out China) – and a national environment far less affected by geopolitical risk – all boxes which Japan has always ticked, and most likely will continue to in decades to come.
Further strengthening this stability sentiment, are the facts that Japan also has the highest fiscal stimulus package policy in the region as a share of GDP (43% as of July 2020) – a huge available pool of liquid assets – and cash-rich tenants, particularly as far as the commercial sector is concerned.
And, while Japan’s domestic investors, as always, tend to “sit on their hands” when instability surfaces – as opposed to South Korean investors, who have simply directed their cash reserves towards domestic purchases as opposed to overseas ventures – the influx of foreign buyers foraging for deals in a severely depleted reserve of global safe havens, seems to have served the country well.
Lastly, the fact that Japanese landlords, and in particular large corporations and institutional property owners, tend to have, overall, abundant savings, has also contributed to generally stable pricing of real estate property assets. Many of the country’s core assets are owned by domestic corporations, who could afford to adopt a “wait and see” approach, hoping for a quick V shaped crisis which would see national and global economies pull a quick recovery. Things do differ in various sectors, however, as we’ll see below – and are also likely to change significantly, as we head into 2021 with any sign of recovery still far over the horizon.
(The data and quotes in this piece come from a variety of sources, the main ones among them being “Savills”, “CBRE”, “Price Waterhouse Coopers” and the Urban Land Institute)
Overall, while rents have remained relatively stable throughout 2020, particularly in central metropolitan locations, it is widely believed that, as occupancies continue to trend downwards, rents will most likely follow across all asset classes. It remains to be seen, however, whether prices will also trend down – since the crisis HAS created an uptick in demand, particularly for “grade A” assets – and, while supply is certainly forecasted to increase, this will not necessarily translate into large price reductions for these assets. Much to the chagrin of investors, if rents decline faster than prices, yields will compress as a result.
And, since, again, the “flight to safety” mentality will most likely see more and more foreign capital flow into the country, which is considered to be one of the few places globally where the economy and job market remain fluid and positive overall – previously attractive sectors, barring the hospitality and co-living sectors, are likely to remain in relatively high demand.
A closer look at the micro-dynamics in each and every sector, and each segment within those sectors, however, reveals a far more diverse landscape –
Decentralization and Change Are Key for Office & Residential
The office and residential sectors, while not projected to dip significantly (multi-family residential is actually enjoying a significant rise in popularity) are going through some major changes.
While some investors are avoiding the office sector out of fear of spikes in vacancies moving into 2021 and 2022, the general frame of thought tends to be that, rather than an overall decline, it’s far more likely that both sectors will experience a significant shift in popularity of asset classes.
While Japanese companies historically do not tend to initiate mass layoffs, and the current crisis has also not seen them do so, they will most definitely need to reduce expenses – and the best way for them to do this would be to reduce their corporate foot print in high priced locations, and shift to smaller offices in more distant suburbs, secondary and satellite cities, as well as prefectural capitals. They will also need to relocate as many employees as possible to working from home – and, in spite of a historical tendency in Japan to delay change for as long as humanly possible, remote working has taken root relatively quickly – with many companies adopting or planning to adopt the practice to some extent at least, if only for the purpose of cutting costs, as mentioned in the previous section.
With the effects of the pandemic starting to be felt in Q2/2020, new leasing activity has all but halted in most major cities, with average Grade A rents in Tokyo’s central wards contracting for the first time in almost a decade. Vacancy rates have also expanded, particularly in areas featuring high exposure to technology firms and start-ups – a trend that has been exaggerated even further for Grade B properties and their corresponding leases.
On the bright side, most of the incoming 2021 supply of new office space in Tokyo has apparently already been pre-leased, with the next wave of supply set for 2023 – by which time, industry professionals hope, recovery may be in the cards.
Also, while the pandemic may increase vacancies in former business hubs such as central Tokyo and Osaka, it is also projected to increase occupancy in other, less central commercial hubs – while at the same time driving a need for larger residential spaces which would be able to accommodate home offices, and the added presence of company staffers at home throughout the week. And, since the vast majority of Japanese metropolitan residences have been following a trend of space reduction over the past few decades, there is a severe lack of market supply and rapidly increasing demand for residential condominium units which are over 45 square meters in size. This asset class is already seeing an uptick in prices as a result, and driving a new trend of construction planning for most residential developers nation-wide.
Headwinds to the residential sector, however, include stagnant rents – a staple of the gap between GDP/corporate earnings growth, and stagnant salaries, which have yet to see any trickle-down effect benefits in Japan – as well as the reluctance of institutional landlords to reduce asking prices, and a wish to maintain previous pricing levels, for as long as they’re able to. Regardless, however, the safe and stable profile of residential properties, and the depth of this segment in Japan, as opposed to other Asia-Pacific countries – and, in particular, the robustness and diversity inherent in the pool of properties available for purchase by foreign investors – all remain a major source of attraction.
All of the above tends to further cement the attractiveness of Japan’s secondary cities, which have already been trending upwards in recent years due to their growing appeal as vibrant family and economic bases, less heavily populated urban centers – a factor which has become even more appealing, with the need for more social distancing – and far lower living and corporate operating costs.
The Biggest Losers – Hospitality, Retail & Co-Living Spaces
Not surprisingly, Japan’s hospitality sector, which has been the focus of much global and domestic hype since the announcement of the now postponed Tokyo Olympics and Osaka World Expo events, and suffered from an oversupply of new developments as a result, has been hit the hardest by the complete and sudden lack of foreign tourism.
This has, however, led to an entirely new trend of re-purposing of some of these assets, with many savvy investors purchasing them at significant discounts, only to turn them into “flex” (flexible floor space rental schemes) and shared office spaces, multi-family residential condominium blocks, and even data-centers (more on those further below).
As mentioned above, however, the bulk of this distressed property pool – as well as some of the country’s core office assets, particularly in Tokyo – is projected to hit the market towards mid-late 2021 – and investors who have been patiently waiting to deploy their capital accordingly are waiting on the sidelines, ready to pounce as soon as this starts happening – which isn’t likely to be too far down the track. The general assumption is that, corporate owners of these hospitality assets, which have gained in value significantly since the 2012 “Abenomics” shift has begun, will most definitely wish to capitalize on their 8-year profits streak, before these go down the drain as a result of economic malaise.
Co-Living spaces, which, similarly, have been one of the most popular trends all across the APAC region in previous years, have taken a major blow, for obvious reasons – sharing one’s living space with complete strangers is simply not a viable strategy for renters in a post-Covid world – and these properties and businesses are quickly going bankrupt, or finding creative ways to re-purpose themselves for other uses – with many renovating and then implementing rental schemes such as “flex” or co-working spaces, and luxury “standard” residential properties in place of interior fittings suitable for co-living tenants.
Retail, as well, while most definitely hit hard by the pandemic, has somehow avoided a complete meltdown, buoyed in part by the stubborn and enduring popularity of high-street store spaces, train and subway station shops, where rents have held steady this year – and also due to having already begun to take on creative re-shuffling of tenants towards necessities such as groceries, office supplies and other essentials since 2018 – with the surge of e-commerce, and the resulting decline of suburban malls, shopping centers, and small neighborhood shops.
Still, the complete cessation of international tourism has taken a huge toll on all major retail hubs – particularly in the electronics and cosmetics sectors, which are extremely reliant on incoming Chinese and other South-East Asian visitors.
J-REITS Offer Great Bargains
Similarly, Japan’s Real Estate Investment Trusts (J-REITs), which tend to be far more liquid and volatile than their underlying assets due to their very nature, have been trending down significantly in their share cost to Net Asset Value (NAV) ratios – and while the assets under ownership themselves have not decreased in value significantly, for all of the reasons mentioned above – the funds holding them have been heavily discounted – in the office and hospitality sectors in particular others – and are thereby presenting excellent opportunities for value investors interested in capitalizing on this trend.
Logistics – WAY too Hot
It’s a textbook example of “too much heat” for the logistics sector, with the pandemic further enhancing its already vastly increased popularity as an asset class of choice for both domestic AND foreign investors – a trend which has already been greatly inflated in the last two years, due to the ever-increasing shift from brick and mortar to online retail and e-commerce.
And while yields may still be relatively bearable, particularly for institutional investors who have lower requirements in this regard – the huge demand for an asset class which is in short supply already, and represents the smallest portion of the commercial sector, is dictating a fast hike in prices for existing properties, which has now begun to spill over to the viable land portion of the market as well – since many investors are choosing to build their own facilities, rather than compete for a severely depleted pool of ready assets, thereby starting to sharply drive up prices for relevant land plots in close proximity to big metropolitan centers as a result.
Tokyo May Be Losing its’ “Mojo”
While the number of Japanese residents in Tokyo had increased by around 30,000 year-on-year as of October 2020, the sum of foreign residents had decreased by a similar amount. One would assume, therefore, that once the borders are reopened, some positive momentum should return, and the population is likely to remain high.
However, considering the other trends in the office and residential space outlined above – reports from other sources put the number of Tokyo-ites leaving the city and being relocated to work from home at approximately 10,000 monthly – it’s quite possible that the next few years will feature a shift of population away from Tokyo and other metropolitan city centres, not only to suburbia, but also towards secondary and satellite cities such as Fukuoka, Nagoya, Saitama, Kobe – and perhaps even bring forth a much-lauded rejuvenation of previously struggling towns and villages in Japan’s countryside – only time will tell whether this will be a lasting trend, but there certainly seems to be an appetite for it among those who can afford to do so, and both local AND national government is encouraging this practice by offering various incentives to those who choose to relocate.
Again, from a real estate investment perspective, and should high central city rents for offices and retail spaces no longer be sustainable – residential properties WOULD seem to be the go-to defensive play that many investors will prefer to pursue in the foreseeable future. Of the 3 trillion JPY in real estate property investments that have been measured by Q3 2020, and in spite of the reduction in total transactions stated above – residential property investments have actually soared by approximately 71% year-on-year – with foreign investors accounting for two thirds of the total – clearly demonstrating where their sentiments lie at this time.
Shifts in Alternative Assets Classes
As mentioned above, the co-living space, hailed until last year as one of the most popular emerging alternative asset classes, has all but died under the current “new normal”.
The healthcare & nursing home sector, however, as well as assisted senior living – particularly in the upper end luxury segments – remains as essential as ever for the world’s fastest aging society. Revenues and popularity continue to trend upwards – although costs of re-adjusting to the Covid environment with virus prevention measures and increased compensation for staff does weigh on profits, and slightly dampens said upwards trajectory path. In conjunction with these hard healthcare assets, many J-REITs have also dramatically expanded their exposure to this sector, increasing the total healthcare assets under management (AUM) by 37.3%, in comparison with only a 4.4% total increase in all sectors combined, between December 2019 and September 2020.
Data centers continue to be an extremely popular asset class, as e-commerce and the preparations for 5G rollouts remain major driving forces, and the work-from-home trend places further strain on existing infrastructures out of the city centers – however, the specialized expertise required to operate in this space places it out of reach for almost all investors, aside from heavily technological owners-occupiers, IT systems integrators & tele-communication companies (TELCOs).
Student housing, perhaps surprisingly, is another alternative asset class which is doing extremely well, regardless of the current and hopefully temporary ban on foreign students entering the country – CBRE reports that disclosures from Kyoritsu Maintenance, a major student housing operator, reveal that occupancy in their dormitory business segment was still over 90% as of September 2020.
The main takeaways from all of the above seem to boil down into a few major, mainly opportunistic points worth taking note of –
• Distressed opportunities, while already present in the hospitality, former co-living & retail sectors, require either sufficient capital to ride out the current storm, due to lack of immediate income post-purchase – or, alternatively, equally high or higher capital, for re-purposing and creative use of such assets. In other sectors, while the market is certainly softer, it may be wiser to wait for Q2-3/2021, when institutional and corporate landlords may begin to sell far more attractive commercial assets at far more significant discounts.
• Residential properties remain the asset class of choice for the vast majority of investors – mainly in secondary and satellite cities and prefectural capitals, as in previous years – and these locations are now becoming hotter still due to the commercial shift from central business districts in Tokyo and Osaka towards other such locations.
• If current and former “cash-cows” tended to be smaller sized condo units, these days seem to indicate an equalizing shift towards larger properties, which are in short supply and subject to rapidly increasing demand, due to the need for working space and home offices in residential properties nation-wide.
• Caution is advised in the logistics sector – while healthcare, nursing homes & senior assisted living, as well as student housing assets, are maturing nicely, and slowly beginning to provide more and more opportunities for a wider segment of the investor population.
• J-REITs, while already among the most popular globally, and in spite of losing a large portion of their value in the hardest hit sectors, are now excellent buys, due to the gap between their share prices and the NAV of their underlying assets.
(Closing note: The annual summary and projections above reflect the observations, opinions and reports of major industry players and analysts, who tend to operate in the upper echelons of the global property market, and are therefore mainly reflective of macro national trends – on the lower, more affordable edge of the property market, where the vast majority of our clientele tends to be active, things are actually moving a lot quicker, mainly due to individual and small-medium business (SME) landlords having far more limited cash reserves, and being forced to liquidate far earlier than their institutional and corporate counterparts. We here at NTI have been noticing a rapidly softening market in Tokyo, Yokohama, Kawasaki, Osaka and Nagoya since the very start of the global pandemic, as early as in March 2020 – and are cautiously expecting this trend may spread to other secondary cities such as Fukuoka, Kyoto, Saitama and Sapporo in the next few months – if not earlier).
(Co-authored with Priti Donnelly)