Very important information to read:
This article is intended as a preliminary guide only and refers to some but not all elements required to consider in detail prior to starting any property dealings or due diligence. Property dealings are often complex, especially in foreign countries and we highly recommend you seek independent professional advice... read more... Since its inception in 2001, the Japanese market for REITs (real estate investment trusts) has grown fast to become the second largest in the world, valued at approximately USD $107 billion according to March 2017 data from The Association for Real Estate Securitization.
Currently, 59 J-REITs in the categories office, residence, retail, hotel, elderly housing & facilities, logistics, leased fee car parking, and others/diversified are listed on the Japanese Stock Exchange. It is a legal requirement for J-REITs to distribute more than 90% of their profits as dividends to their investors. With this attractive payout rate, they are sometimes heralded as entry-level investments for those new to real estate or who can’t afford to buy an investment property.
So, are J-REITs an option for a passive income stream, similar to an investment property?
REITs do offer advantages over buying property to investors: Foremost, they require a low capital outlay, with investment starting at just a few thousand dollars.
Further they offer liquidity, as REITs are traded stocks that can be sold on the exchange anytime. Additionally, transaction and management costs are low and no legal and stamp duties are required, keeping the initial purchasing costs much lower than those of an individual property.
Finally, the product also offers diversification, as the investment is not in one single property and several REITs can be purchased and mixed.
The cap rate
However, investors must understand the factors of influence before investing.
One important indicator to understand is the cap rate (short for capitalisation rate), often stated in J-REIT profiles. Simply put, this is the rate of return on an investment property based on the income that the property is expected to generate. It can be calculated by dividing the property's NOI (net operational income; income after property taxes, management and running costs) by the current market value or acquisition cost of the property.
For REITs, an average cap rate of the properties invested in is calculated. Therefore, this value can be used to estimate a unitholder’s potential return on their investment and the profitability of individual REITs.
J-REITs averaged cap rates between 3.98% (retail REITs in urban areas) and 5.18% (hotel REITs nationwide) for all categories in June 2017, according to Volume 25 of the Daiwa Real Estate Market Report.
This led to dividend payouts of between 6.6% and 3.2%, which compare favorably to the average rental yield (which is based on the same calculations as the cap rate) of a residential investment property in the upmarket wards of Chiyoda (2.39%), Minato (2.66%) and Shibuya (2.45%). Properties in some of Tokyo’s 23 wards still achieve higher yields, e.g. an average of 4.44% in Chuo-ku (according to REINS, status May 2017).
On the other hand, owning property not only offers returns but also builds equity, a striking argument for many to invest in a single property they own themselves, even at lower return rates. And the yields might prove to be more stable than those of REITs, which are under the influence of more factors than the real estate market.
J-REITs influenced by many factors: The stock market, interest rates and industry trends
The largest risk of J-REIT investment, in comparison with property investment, is the influence of the capital market, according to Tetsuya Kaneko, Director and Head of Research & Consultancy at Savills Japan.
“Previously, the price movement between J-REITs and equity seemed divergent, but it is in fact correlated," says Kaneko. "Also, the Bank of Japan is a large unitholder of multiple J-REITs and if they dispose their holdings, the impact would be considerable. Finally, long-time investors may remember what happened to J-REIT during and after the global financial crisis: the unit price plummeted probably more than necessary due to upset of the capital markets.”
As Nikkei-listed stocks, any movement in the stock market will be reflected in J-REITs, making them a more volatile instrument than directly buying a property for investment.
Regional banks and other financial institutions are currently among the biggest unitholders in J-REITs, as they cannot rely on the loan business due to the historically low interest rate set by the Bank of Japan (BoJ) — at least as long as Abenomics, the motor behind the low interest rate set by the Bank of Japan to curb deflation, remains in place. However, re-elections are on the horizon this autumn and with several scandals in the past months, Prime Minister Abe’s continued leadership is not guaranteed. Additionally, financial institutions have urged the BoJ to revise the policy.
Naturally, REITs are susceptible to the same influences as the general real estate market of Japan. Management costs and fluctuations in rent and occupancy rate influence the dividend payout to unitholders. And the steady increase of price per tsubo over last few years in Tokyo, combined with stable rent rates, has directly been reflected in a declining cap rate of J-REITs across all industries, according to Ziv Nakajima-Magen at Nippon Tradings International.
Potential J-REIT unitholders should carefully study the Japanese real estate market and the industry they are interested in investing in. For example, with the influx of tourism, a hotel REIT issued by Ichigo Hotel Group is currently the best-performing J-REIT, offering 6.6% in dividends (according to Japan REIT, as of May 2018).
“I would recommend J-REIT, especially to those interested in property investment but with a limited budget,” says Kaneko. “The J-REIT is a good mid-risk, mid-return product that is easy to manage with a high level of liquidity.”
On the other hand, he points out that “J-REIT investors cannot utilize, leverage or enforce their own operation/management strategy. Those are large advantages for property investors, boosting expected returns.”
While Kaneko recommends the instrument, he adds a final word of caution for any investment: “J-REIT investors must remember the major risks of J-REITs before investing.”
By Mareike Dornhege
Click here to visit the Association of Real Estate Securitization website
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Very important information to read:
This article and the above linked articles are not complete and are intended as preliminary guides only. These guides refer to some elements to consider prior to starting any property dealings or due diligence. Property dealings are often complex areas, especially in foreign countries and we highly recommend you seek independent professional advice... read more... 
