This is part two. Click here to read Part 1 - What Does 2019 Hold for Japan Real-Estate Investment?

2nd Tier Cities’ Residential Properties Continue to Draw Attention

As projected in last year’s summaries, the more stable and higher yielding residential market continued to draw attention, and funds, away from the commercial arena in Japan – again, due to fears of economic volatility, which normally strike office and commercial markets first and foremost, and also due to the fact that over 20% of households in the country reside in private rental properties (non-wooden structures), a number which is projected to continue and grow. The lack of asset supply on the market, however, which has begun to plague investors in 2017 became a real issue last year, and further added to price inflation, far beyond any rise in wages and rents, which served to further compress yields. Osaka, Nagoya and Fukuoka have been on the main brunt of these price hikes, with Osaka, as pegged last year, overheating to nearly Tokyo-ite proportions. Lack of access to financing anywhere out of Tokyo still creates somewhat of a damper on what could potentially be a much bigger success story for Japan’s regional cities. As things stand, it is only the largest foreign investors who are able to finance purchases in these cities, while the rest of the investor cadre is forced to buy their properties in cash, unless they’re buying super-central, expensive and low yielding Tokyo assets – and even in those cases, many of them are facing insurmountable challenges in accessing reasonable term loans from Japanese financial institutions, in most cases. 

Regardless, however, the lack of available and affordable assets, and over-heated demand in Tokyo, as well as the higher yields out of the city, have continued to buoy Japan’s regional cities, who are slowly but surely cementing their positions as mature economies. These cities are starting to cater more and more to non-resident foreigners, and not only to local investors - and are reaping the results in the form of ever-increasing inbound investment to the point where prices continue to rise and yields continue to compress. Regardless of this, however, and even with Tokyo now flagged as lowest on office rental yields in the Asia-Pacific region aside from Hong-Kong, this doesn’t seem to have deterred interest in the city, which is still one of the world’s most popular investment destinations.

The Osaka Story

Osaka, Japan’s second most popular property market internationally, still has lower office rents when compared with Tokyo, but has enjoyed similar property price hikes, which means that, as postulated by investors at the end of 2017, yields in the city have dropped to similar levels as in Tokyo. Regardless, however, both cities continue to top the recommended Asia-Pacific investment destinations lists by most publications, and are expected to continue to attract attention. There are far fewer office assets available for purchase in Osaka, when compared with Tokyo, but retail, hotel and residential properties in the city continue to hold major interest from overseas investors, and will most likely heat up even more in 2019 in those same sectors. Most investors interviewed are adopting a “buy and hold approach” to commercial property, with buying becoming more difficult and rare – with only a very low percentage of those queried indicating that they have any intention of selling their commercial assets in both cities. On the residential and hotel front, however, buying is still very much on equal priority for investors.

Occupancy Rates Soaring – Rents Rising and Expected to Continue 

Despite some fears concerning over-supply, vacancy rates continue to drop nation-wide in all of Japan’s big cities, which continue to absorb smaller dying townships due to the national decline in population – particularly for grade A buildings in large metropolitan city centres, more specifically Tokyo and Osaka, again. And, since new supply isn’t expected to hit the market before 2020, tenants are finding it difficult to secure the spaces they’re interested in, particularly in the office sector. The biggest unexpected surprise in those two cities has been increasing rents – as high as 3-7% in Tokyo, which was projected to flatten out in 2018. This has now led to an amended expectation of even higher rent hikes in 2019 – between an average expectation of 3% year on year in Tokyo, 4% in Nagoya, and a whopping 7-11% in Osaka, Sapporo and Fukuoka. In the hotel sector, as well, the expected additional 6,000 rooms or so, confirmed as entering the market this year, aren’t likely to alleviate the pressure on occupancy in light of the Rugby World Cup and upcoming Olympics in the next two years. Tokyo hotel occupancy is already around 80% on average throughout the year, with the rest of the country at a comfortable 70%. The same cannot be said for Japanese traditional inns (Ryokans) and natural hot spring resorts (Onsens) unfortunately, which, although growing in occupancy as well, are still averaging less than 50%, most likely due to their seasonality and the severe lack of catering capacity to non-Japanese speaking foreigners in the vast majority of sites. And, while Tokyo’s hotel market is most likely now peaking, and isn’t considered as opportune as it was until 2018,  the rest of the country’s hospitality segment is still ripe for the picking, and will most likely generate very healthy returns in coming years – particularly with the new casino legislation now in the making, which may just send the numbers of wealthy gambling tourists, most notably from China, through the roof.

Nagoya Emerges

Nagoya, which is one of Japan’s main industrial and commercial metropolitan centers, conveniently located between Tokyo and Osaka, and soon to be the beneficiary of the newest and fastest bullet train line from Tokyo, is doing phenomenally well, with 75% occupancies for office properties overall, general occupancy rates across all property types now the highest since 1993, and grade A office space at a historical high occupancy of 99.4%(!!!) Here, as well, CBRE expects even these already expensive rental spaces to go up by approximately 2.8% in 2019, as demolished properties along the new train line being built will mean more office tenant relocations.

Approaching the 2020 Olympics, Japan has also seen a substantial rise in visitor numbers and expected to continue to see strong growth through to the event itself. Tokyo still holds the top spot for preferred city for hotels. While, some observers believe it is too late to get into the hotel sector in Tokyo, others believe the increase in tourism numbers could boost growth in Osaka and regional cities suggesting underlying growth for hotel opportunities for investors. According to Nomura Research Institute, the weak yen and relaxed visa criteria account for the increase in number of travelers to Japan, impacting growth mainly in business hotels, but also in Japanese-style hotels, lodging houses and resorts. 

Getting Creative with Converted Properties

Considering Japan’s notorious obsession with the fresh and new, which is very prevalent in the real-estate sector as well, and the increasing lack of vacancies, it is perhaps no wonder that many investors have chosen to tear down or convert old buildings into newer, higher yielding constructions – whether it’s C grade blocks in less than ideal locations, which are being converted into B grade buildings, shoddy old hotels converted into co-living share houses near universities, and so forth. Similarly, as shared office space continues to become a popular trend for bootstrapped startups and small business operators, many office and other properties are being converted into co-working floors and even entire structures.

The E-Commerce & Logistics Boom Continues on Track 

As projected in last year’s summary, e-commerce retail has continued to explode throughout the country, as it does in the rest of the world, and the cleanup of contaminated land near large cities, which was a unique and creative take by some investors as late as last year, has now become far more commonplace. Added to that is the concept of moving from large scale distribution and shipping centers located in the outskirts of the city to central city build-to-suit smaller facilities, which are a logical step for an e-commerce business that does well and isn’t likely to belly-up over the next few years. In this area, as well, it is widely believed that an economic downturn, or even a mild recession, isn’t likely to damper growth significantly, considering the constant expansion of online services provided to consumers - and so investment in logistics facilities is considered to be a reliable, stable investment for many years to come, to the point where developers are now more than happy to build such facilities even without pre-commitments or leases from potential tenants.
The traditional retail sector, as a direct result of this e-commerce boom, has been suffering, again, as projected last year, with major brands focusing primarily on the very top locations nation-wide, and forsaking more out of the way shopping and retail centers, which are increasingly seen as risky prospects, and rents trending lower as a result as well. And while slight growth in salaries and tourist numbers have served to somewhat dampen the blow, the soon-to-come consumption tax hike, scheduled for this year, is forecasted to hit this particular market hard.

This blog was co-authored with Ziv Nakajima Magen - Nippon Tradings International

(Sources – “Emerging Trends in Real-Estate, APAC” - PwC/ULI, CBRE, Nomura Research Institute, Mitsui Fudosan)

Similar to this:

What Does 2019 Hold for Japan Real-Estate Investment? - Part 1

Real Estate in Japan - Investing with Confidence

History and the rise of Japan properties