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Japan real estate a safe long-term bet for investors

Article - September 15, 2016

The commercial property and rental markets have experienced significant gains, while the Trans-Pacific Partnership and 2020 Tokyo Olympics bode well for the construction and real estate industry as a whole

Japan’s real estate market can appear daunting to overseas investors, but its long-term stability and size – Tokyo is, after all, the world’s most populous city – have been attracting significant capital flows from abroad, most conspicuously from neighboring Asian countries. For investors concerned by the uncertainty and volatility in international capital markets, the longer term may well prove to be the smarter option, making Japan’s residential, commercial, hotel and industrial properties worth a closer look, along with related sectors such as construction.

Beginning in 2016, the Bank of Japan’s policy of negative interest rates has allowed companies to negotiate favorable terms from banks for long-term loans at near-zero rates.

“We are waiting to see the effects of the negative interest rates in the short term,” says Eiji Kutsukake, President of Nomura Real Estate Holdings Inc., which has undertaken large-scale developments of smart cities in Funabashi Morino City and Zutto City.

“Despite the declining population, there are still possibilities for developing markets and developing business in [real estate]” Eiji Kutsukake, President, Nomura Real Estate Holdings

“In the long term, there will be some negatives and positives of Abenomics, but I believe eventually there will be a positive effect overall. This is contrary to what the media is popularly reporting. “

A shrinking population has kept residential housing demand relatively low, however, even though banks choking on their reserves of unproductive cash would be only too glad to lend them the money.

In such an environment, investment grade properties continue to generate better than acceptable returns as they recover in sync with other global economic drivers. Real estate is particularly attractive on account of the secure flow of rental income it produces and is often sought after for balancing portfolios. In the case of Japan, there is the additional advantage that no restrictions apply to foreigners owning property regardless of residence or visa status.

 Even in the worst of times, Japan Inc. was never in danger of tarnishing its reputation for excellence and quality. Executives learned not to lose sight of those standards as they became more forward-looking, outward-looking and innovative. At the same time, the realization hit home that the most successful business is not necessarily the one that makes the biggest profits.

So Japan has had to change its mindset along with its skillset and open up to ideas that challenge the “traditional Japanese way of doing things” while its businesses look for new overseas markets in order to learn from them as well as to sell to them.

Two upcoming events are certain to attract even more interest in Japanese real estate. Before U.S. President Barack Obama leaves office next January, he hopes to sign the Trans-Pacific Partnership (TPP) accord into law, creating a free trade zone among 12 Pacific Rim countries that is expected to add $23.2 billion to Japan’s GDP. How does this impact on housing? Pundits claim the realignment of logistic networks and creation of new trade flow patterns will bring about the displacement of entire population centers. These will have to be rebuilt practically from scratch, the experts say.

One thing is certain: the construction sector is sure to be working overtime to construct state-of-the-art sports facilities valued at $3.8 billion and hotels to accommodate some 20 million visitors taking advantage of the weak yen to spend time in Japan in the run-up to the 2020 Tokyo Summer Olympics.

Meanwhile, commercial property is on an uptick. The vacancy rate for prime office space in Tokyo was just 2% in 2016, and income from rental property grew by about the same amount over the previous year, registering its first significant gains since the macro upheavals of the early 1990s.

That counts as good news in the current environment of sluggish growth and low interest rates, and even more so in a country recovering from two decades of runaway deflation that produced an enormous bubble of inflated assets. Until it popped late in 1991, the price of quality land in Osaka had shot up by 33%, and in one Tokyo district increased 122% in 1988. Two years later, prices had plunged by 13% to 18% across the board in Japan’s six largest cities, marking the start of the “lost decade” of painful recovery.

As failed banks closed their doors, loans went unpaid and GDP seeped through the floorboards, while the Tokyo skyline underwent changes. The Bank of Japan kept on pumping money into the system and some of that liquidity went into property acquisition. Now the office blocks and shopping centers built back then are to be retired, replaced or removed.

Why is this happening just now? During the deflationary decades, Japanese people clung to their savings in the certain knowledge it would appreciate in value inside their mattresses. Companies avoided capital expenditure like the plague. This accounts for the slightly dated look at the headquarters of certain corporate giants dating from the 1970-1990 period, many of which are earmarked for an upgrade.

This Japanese approach to urban renewal is known as “scrap and build” and there is more latent opportunity in their paradigm than just a chance to bid for demolition tenders, insists Mampei Ohmoto, President of the civil engineering and construction firm Ohmoto Gumi.

“Towards the Olympics, many hotels are going to be established in the city, so we want to take that project and be responsible for that“ Mampei Ohmoto, President, Ohmoto Gumi

“Unfortunately, compared to other countries, we do not have all that many big and beautiful buildings and monuments. I hear that the roads in Paris were designed mainly by Napoleon III. Establishing a beautiful city is a priority, as it contributes to the economy,” says the head of the 108 year-old firm that posted record profits in 2015.

“Many European companies have a long-term vision, instead of looking at the short-term benefits, and I want this company to be like that. I want to be humble, but at the same time, be challenged by new projects,” adds Mr. Ohmoto. “For example, Japan might face a recession after the 2020 Olympics. Who can tell?”

Scrap and build requires powerful, purpose-built machinery to clear away the remnants of old construction and make way for the new. Okada Aiyon Corporation is an Osaka-based firm that specializes in manufacturing and servicing the heavy equipment used to break up, crush, pulverize, slice, grapple and lift chunks of unwanted concrete in demolition operations.

Concrete has a life cycle of about 50 years, explains Toshiyuki Kanda, Okada Aiyon’s President, and “when Japan experienced the massive boom of the 1970s, that was when all the skyscrapers and tall buildings were built. Recently, there was an accident on the Chuo Highway where the Sasako Tunnel collapsed and many people were injured. The main reason was the outdated infrastructure.“

“Our core strength as of today is in Japan and North America, but for the future, our focus is on the Far East and Western Europe” Toshiyuki Kanda President, Okada Aiyon Corp.

The need to upgrade is a major concern of Japan’s construction and engineering sector, in a country that registers around 5,000 earth tremors each year. Fortunately, few are as lethal as the 40-meter tall tsunami churned from the depths of the sea by the March 2011 quake which disabled the Fukushima nuclear plant, killed almost 20,000 people and triggered the world’s most serious nuclear emergency since Chernobyl.

Authorities know that even without factoring in random threats from tsunamis and nuclear meltdowns, Japanese earthquakes tend to be fairly frequent and uncommonly deadly – over 140,000 people perished in the Great Kanto quake that leveled Tokyo and its port city of Yokohama on September 1, 1923.

Awareness and forethought were not enough to stop it. In his plans for Tokyo’s grand Imperial Hotel, architect Frank Lloyd Wright incorporated elements that offered as much protection as the science of the period knew how to put into it including cantilevered support beams, seismic separation joints and other features that allowed the hotel to sustain only minor damage from the quake that occurred on the day of its opening.

Given that in Japan, geology is destiny, it is hard to fathom why a duly rigorous seismic building code for commercial property was not introduced until 1981, and its regulations made applicable to all existing structures after 1985. As a result, pre-1980s construction that has not been retro-fitted and certified as earthquake resistant will undoubtedly be priced considerably lower than similar properties built in accordance with the strict new codes.

In a country prone to such natural disasters, building management service providers are crucial and offer property owners peace of mind. One such firm is Biken Techno Corporation, which offers owners a full range of what its President, Ryusei Kajiyama, describes as “facility management services” that include building security, food handling and sanitation, equipment updates and emergency repairs. At present, it has 232 properties under management for some 80 clients.

“In order to survive and compete with other companies in similar sectors, it is important to figure out where to invest and to seek our priorities” Ryusei Kajiyama, President, Biken Techno

Over the past decade, Biken’s five subsidiaries and 11 associated companies have expanded the range of its people-oriented services into the nursing, hospital management and real estate/hotel sectors. Now Mr. Kajiyama’s sights are set on Bangkok. “We have seen the quality of our service improve and are constantly looking to make new improvements by taking the good parts from every sector,” he says.

What will the buildings of the future be like? Mr. Kutsukake, the President of Nomura Real Estate, one of the country’s top developers with around 1,600 employees, believes new construction should incorporate relevant new technologies, offering the people who live or work in them the benefits of sustainability, energy efficiency and an overriding emphasis on quality.

With 55 years of experience and nearly 200,000 units built, Nomura is committed to developing innovative residential properties marketed under its PROUD brand, including Sustainable Smart Towns designed for “active seniors” in the 50 to 70 age bracket who have more disposable income and leisure time at their disposal but prefer to have a range of multifunctional conveniences within easy reach.

“Japan is experiencing social shifts such as a population decline, low birthrate, and diversification of working styles due to women’s participation in society, greater energy-saving awareness, and so on,” says Mr. Kutsukake. “Reacting to those changes, we plan to develop sustainable cities that are energy efficient and concentrate multiple functions and communities where various generations live in harmony.”