It’s not an unfamiliar story: from a peak in 1990, property prices in Japan have plummeted more than 60% on average and over 70% in Tokyo. With land prices historically low and growth in evidence, investment yields from real estate have become attractive to foreign investors. Overall, the level of activity in the Japanese property sector suggests a very healthy state of affairs.
The reality is that despite significant improvements in the Japanese economy, the recovery has stalled and a sustained upturn in property remains unlikely this year. Estimates fron the Organisation for Economic Co-operation and Development suggest that the Japanese economy will grow 1.4% in 2005 and 1.5% in 2006, after an estimated 2.9% expansion in 2004.
Lehman Brothers is predicting a sharper economic downturn this year, exacerbated by a strong yen and market volatility; its projected GDP growth is just 0.6%: “The cyclical recovery has run its course before deflation has been overcome. A good deal of market turbulence and reactive policy-making can be expected,” says chief economist for Asia, Paul Sheard.
Property giant Mitsui Fudosan’s researchers stated in January this year that “the recent economic recovery has enhanced expectations for future earnings and narrowed the overall margin of decline”. That hardly represents a resounding endorsement of a revitalised Japan. But perhaps, after all the hype of previous phoney booms, cautious optimism is exactly what is required.
As reported in the January/February edition of IPE Real Estate, the J-REIT market is a major factor in the renewed confidence of the property sector. The emergence of REITs as a major investment class, and the demand for quality investment property, in Tokyo especially, has underpinned the stabilisation of prices. Private funds, aimed at Japanese institutions and high net worth investors, are also booming. Roughly three-quarters of the J-REIT assets are office buildings, with most trusts concentrating on the high end of the market and a reliable rental stream.
With the REITs market enjoying continued popularity, overseas and local investors are now competing heavily for Japanese real estate assets, especially in Tokyo. Lone Star Funds, a London-based partnership, recently made a successful bid to buy three Tokyo buildings in the Akasaka financial district for about ¥117bn (e850m), making it the largest property purchase in Japan by a foreign investor in six years. Lone Star has recently raised around $5bn (e3.8bn) for a new fund, 80% of which will be used to buy assets in Japan and South Korea.
A Morgan Stanley real estate fund has agreed to buy the Tokyo headquarters of Mitsubishi and
Mitsubishi Motors for ¥140bn.
Meanwhile, Orix, Japan’s largest non-bank financial services company, has agreed to pay ¥23bn for a controlling stake in Daikyo, the country’s biggest condominium builder. The sale of about one-third of Daikyo was organised by the Industrial Revitalization Corporation of Japan, the state-run agency that has managed the company for the past four months, after creditors rejected a debt restructuring.
In February 2005, The CapitaRetail Japan Fund, a private retail property fund sponsored by Singapore’s CapitaLand, purchased Izumiya Hirakata, a freehold suburban mall in Hirakata City, Osaka, for approximately ¥7.5bn.
The Government of Singapore Investment Corporation is also a major investor in central Tokyo real estate. GIC owns the major share of the Shiodome City Centre, a building that cost ¥100bn and opened in April 2003. In June 2004, GIC paid ¥42.5bn for a new twin-tower high-rise building built by Kajima in Tokyo’s Shinagawa ward. Australian investment bank Babcock & Brown plans to launch a Japan Property Trust, the first Australian LPT to invest in Japan. The trust will be seeded with eight office buildings and four retail properties in the central and greater Tokyo area, being bought for ¥47bn. The trust forecasts a distribution yield of 8.3% for the period to June 30, 2005 and 8.7% for year to June 30, 2006.
Residential property values in Japan’s most expensive areas rose steadily in 2004, while average prices continued to fall. Residential land prices in three of Tokyo’s five main districts were positive for the year, according to a report by the Ministry of Land, Infrastructure and Transportation. The new supply of condominiums rose for the first time in four years for the Greater Tokyo region in 2004, according to Jones Lang LaSalle.
Significantly, the rising share of new supply within this region is feeding a rise in inward migration. JLL also notes that “an increased focus on residential properties as an investment is contributing to a rise in the leasing segment. This was reflected in the 5.8% increase in leasing construction starts for housing in 2004. With construction costs and land prices on the rise, buyers may turn hesitant and this could prove to be a boon for the leasing market.”
Japanese companies are planning to speed up property sales ahead of asset impairment accounting rule changes in April, which will require companies to report assets based on market value.
In December, the ruling coalition parties released the 2005 Tax Reform Proposal. The changes will apply to non-residents for tax years beginning on or after April 1, 2005.
An important aspect of the proposal is the inclusion of capital gains arising from the transfer of shares or interests in “real-estate rich” entities as domestic source income. In order to be considered real-estate rich, more than 50% of the total value of the assets of a corporation or the total value of the trust estate must be made up of Japanese real estate, including land, buildings and certain other assets.
Similar to the US Foreign Investment in Real Property Act, this change will primarily have an impact on foreign investors who are residents of jurisdictions whose tax treaties with Japan do not preclude Japanese taxation of gains arising from the disposal of interests in Japanese entities. This includes Japan’s treaty with the US (which has a specific provision allowing Japan to tax such gains) and the UK. Deloitte’s Corporate Tax adviser Gary McIver suggests that investors with such structures may wish to consider restructuring their investments in Japanese companies that may be considered real-estate rich, prior to the law taking effect.

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