The following is a transcript of a presentation entitled Japanese real estate: Time to buy? that was delivered at the Canadian Chamber of Commerce in Hong Kong on November 17, 2010. Video of the presentation is available here.
The presentation introduces the basics of investing in Japanese real estate, including:
- Demographic trends that shape demand for homes in Japan
- How internal migration is creating demand for Tokyo apartments
- How the Japanese housing market differs from the United States and Britain
- Japan-specific risks such as soil pollution, nuclear power, earthquakes and landslides
- How local people think about houses in Japan
- Opportunities and risks in foreclosed homes in Japan
- The unique problems facing communities in rural Japan
- Where to find real estate investment opportunities in Japan
For more information, please see Landed Japan.
Japanese real estate: Time to buy?
When I arrived in Tokyo in 1988, Japanese real estate was reputed to be the most expensive on earth. One of the most memorable claims was that the land under the Imperial Palace in Tokyo was worth more than the state of California. At the time, the idea of anyone except the richest expatriate buying a home in Japan was laughable.
But over the last 22 years, Japanese land prices have fallen in yen terms. Prices have also dropped relative to Hong Kong, London, New York and Sydney, making a pied à terre or an income property in Tokyo a very real option for many people.
Today, Japanese real estate is—in a word—cheap.
Several factors make Japan interesting. First, unlike Hong Kong and China, Japanese real estate is at—or near—the bottom of the cycle. And there are no restrictions on foreigners buying land, homes or investment property in Japan.
Mortgages are available from domestic and international lenders. The Bank of Japan’s zero interest rate policy, which it reaffirmed in October, makes financing inexpensive.
Sentiment seems to be turning, too. Declines in the price of residential land have slowed. And in September, Japan’s largest casualty insurer, Tokio Marine, announced plans to invest ¥50 billion—or about US$600 million—in residential real estate.
Finally, despite a steady stream of negative news from the Japanese and international media, Japan is still the world’s second- or third-largest economy. It has an educated workforce, advanced technologies and a history of overcoming challenges, such as currency appreciation and rising oil prices. And Japan ranked 11th in the United Nations’ Human Development Index, ahead of Switzerland, France, Hong Kong and Singapore.
So, is this a good time to buy Japanese real estate? I believe it is. In fact, I bought an apartment in Tokyo this week.
But if you’re going to buy, you must understand Japan’s demographic trends and the quirks of its property market. Let’s start with the demographics.
As the 19th century French philosopher Auguste Comte noted, demography is destiny. Nowhere is this more true than in Japan’s housing market, which is being shaped by three key demographic trends:
- A population that is aging and shrinking;
- A growing number of small households;
- And widespread migration to big cities.
As a result of these trends, some neighborhoods and types of property will perform better and be far more liquid than others.
Nationwide, more than one person in five is now over 65, and a quarter of the population will be over 75 by 2025. Over 89% of Japan’s elderly own their homes, most of which are freestanding houses. Many of these homes were bought for young, growing families and are too big for their current inhabitants. As a result, there is a glut of large, old homes.
When elderly people buy or rent a home, they want to be close to train and subway stations. They prefer apartment buildings with elevators.
Proximity to hospitals, entertainment and social services is more important than having a school nearby. Elderly people also want universal design, which incorporates things like big light switches, wide doorways and wheelchair ramps, features that are relatively rare in Japan.
Across the country, households are shrinking. This trend is driven by:
- Higher rates of divorce
- Underemployed young men who can’t afford to get married
- Smaller families among those who do marry
- And old people living apart from their kids.
As a result, cozy dwellings that are cheaper to occupy and maintain are more likely to retain their value than large homes.
Japan’s population is expected to drop from 127 million today to between 90 and 102 million by 2050. The likelihood of this trend reversing—through an increase in the birthrate or an influx of immigrants—is tiny.
Some experts believe that official population projections are optimistic and that empty playgrounds like this one will be a common site.
Obviously, a smaller population means less demand for housing, and smart investors will buy in locations where people will want to live.
Moving to Tokyo
Increasingly, that means the Tokyo Metropolitan Area—which includes Kanagawa, Saitama and Chiba—and to a lesser degree, Osaka and Nagoya. As Japan’s commercial, administrative, educational and cultural hub, Tokyo is a magnet for talent, attracting more than 117,000 new residents in 2009. That same year, 37 of 47 prefectures reported net out-migration, with Hokkaido alone losing over 12,000 people. And those who stay behind tend to be older people, such as retirees, who are unlikely to have children.
That means you’ll want to be very careful buying anything outside Japan’s major cities.
Each of these trends will influence the price you pay today, and the price you’ll receive when you eventually sell your property.
Now let’s look at some of the quirks that make Japanese real estate unique.
In any country, buying a home is a classic case of information asymmetry. You might buy one or two properties in your lifetime. When you do, you’ll use an agent with intimate knowledge of the neighborhood. You’ll work with a lender who knows the mortgage market inside out. And you’ll buy from a vendor who is aware of her property’s shortcomings, including the upstairs neighbor who likes to entertain until the wee hours of the morning.
In short, everyone in this process knows more than you do. That puts you at a significant disadvantage. And that disadvantage grows if you are operating in a foreign language and are dealing with unfamiliar laws and customs.
If you’re an overseas buyer, there are several other things to consider before you take the plunge. One is the yen, which is near 15-year highs against the U.S. dollar. Despite its recent surge, the yen is overvalued by just 5% according to The Economist’s Big Mac Index. Many large Japanese exporters are now forecasting an exchange rate of ¥90 to the dollar. And as the Americans and Europeans continue to devalue their currencies, I believe the yen will remain strong for the short- to medium term.
Financing is another issue. Despite the low default rate on home loans, large Japanese banks have been reluctant to extend mortgages to foreign borrowers, particularly if they are not permanent residents. And non-Japanese buyers are often surprised to discover that, if they borrow from a domestic bank, their overseas credit history is largely irrelevant.
Fortunately, this situation is changing. Some mid-sized local banks, such as Shinsei and Suruga, actively market home loans to foreigners, as do international lenders like National Australia Bank and HSBC. However, these loans carry restrictions on the borrower’s age and the property’s use and location. As a rule, it’s much easier to finance a new condo in Tokyo than a ski chalet in Hokkaido.
International lenders will often pre-approve your loan and use English-language application forms. The sale and purchase agreement and other documents, however, will be in Japanese and translations of these documents are not legally binding. Fortunately, most transactions use standard forms issued by organizations like the Association of Real Estate Agents.
For domestic and international buyers, however, one of the biggest challenges is a lack of pricing information in Japan. Here in Hong Kong, you can enter an address into a bank’s website and instantly get an estimated mortgage value. Large real estate agencies maintain websites that list asking and transaction prices, as well as rents. And for a few dollars, the Land Registry will give you a printout showing the amount paid by a property’s previous owners, as well as any outstanding encumbrances or orders from the Buildings Department.
Japan is at the opposite end of the transparency spectrum. While the government recently launched an online transaction registry, the data only goes back to 2005 and it is not comprehensive. Japan does have the Real Estate Information Network System, or REINS, which is similar to the online service that is found in Canada and the U.S., but REINS is only accessible to real estate agents. This lack of transparency is expensive: One study estimated that the average person buying a used condominium spends more than ¥1 million on search costs, such as visiting open houses.
Another difference is in attitudes toward used homes. In Japan, people like new things, and homes are often seen as consumer goods. Pre-owned homes represent just 13% of sales, compared with 78% in the U.S. and 89% in Britain. On average, Japanese homes are demolished after 30 years, versus 55 years in the U.S. and 77 years in the U.K.
As a result, a home that would be halfway through its usable life in the West is ready for the wrecking ball in Japan. Many old buildings actually have negative value, because a buyer must pay someone to demolish the structure and remove the rubble before they can rebuild.
Long working hours and short building lifespans mean that do-it-yourself home repairs are uncommon in Japan. That can lead to maintenance problems in pre-owned homes. And you may have trouble finding someone to inspect your pre-owned home before you buy it.
Because old houses and condos are unpopular with local buyers, you can sometimes find bargains. But seismic retrofitting is optional, so avoid homes built before construction standards were tightened in 1981. Standards were raised again in 2000, when the Housing Quality Assurance Act and 10-year warranties on new homes were introduced.
And beware projects associated with architect Hidetsugu Aneha, who faked design data for 99 buildings in the Tokyo area, including this condo. Aneha-san was sentenced to a five-year prison term in December 2006.
Concerns about climate change have prompted the government to promote the construction of more durable houses that can be renovated and resold. But this is a recent initiative, and much of the existing housing stock was built to last 30 years. The government also offers tax breaks and other incentives to encourage the use of environmentally friendly technologies, such as double-glazing and solar cells. Given Japan’s reliance on imported energy, this is a positive development.
As I mentioned, you can buy income property in Japan. There’s been a glut of office space for many years, and returns on commercial real estate—which is normally sold on an en-bloc or multi-floor basis—have been miserable. Residential property, on the other hand, can generate gross yields of over 10%.
If you buy residential income property, be sure to study Japan’s tenant-protection laws. Key money and other customs make it expensive to rent a home in Japan. But tenants—especially those with old-style leases—enjoy considerable legal protection.
Fortunately, property disputes rarely go to court. Negotiated settlements are more common. But, because Japan’s legal system is opaque and focuses on maintaining social harmony, legal issues tend to less clear-cut than they are in the West.
Buying and selling real estate is a “hands-on” process in Japan. For most transactions, a simple sale and purchase agreement is complemented by a document called the “explanation of important matters,” which a licensed real estate agent will read aloud to you before the S&P agreement is executed. It can take several hours to read the explanation, which covers everything from the payment schedule to the warranty terms.
Title transfer is handled by a judicial scrivener, a specialist lawyer who submits the documents to the registry at the Legal Affairs Bureau. Buildings and land are registered separately, which allows the construction of houses and condominiums on land that is held under a long-term lease. This is important, because the value is in the land, not the structure.
Watch out, too, for natural hazards. Japan is famous for earthquakes, but the risk is not evenly distributed across the country. Japan was also the site of the deadliest landslide in recorded history, which killed over 15,000 people in Shimabara City in 1792. Most years, landslides kill more people than earthquakes.
Typhoons and floods are another threat: About 20% of Tokyo lies below the normal high-water mark, making the city vulnerable to storm surges and tsunamis. Fortunately, detailed flood and earthquake maps are available, making it easy to avoid these hazards.
There are also man-made dangers. Over one-third of the nation’s former manufacturing sites, many of which are in urban areas, are contaminated with arsenic, lead and other toxins. Tens of thousands of tons of polychlorinated biphenyls, or PCBs, remain in storage awaiting treatment. And asbestos was used as recently as 2006.
Japan also has a large nuclear power industry with an abysmal safety record. Google “Monju” or “Rokkasho” for details.
I don’t want to overstate the threat posed by these hazards. But they are real, and worth including in your due diligence efforts.
You’ll also want to perform careful due diligence if you buy a foreclosed property. The downturn that began in the fall of 2008 created a spike in the number of foreclosed homes, which can sell at large discounts. Several companies help people buy foreclosures and if your Japanese is good enough, you can deal directly with the courts.
Discounts on these homes are greater in rural areas and secondary cities than in popular locations, like Tokyo. And you’ll need cash, because lenders rarely provide financing for foreclosed homes. You can’t inspect the inside of these homes before you buy, although photos may be available. And many properties have tenants, some of whom may be yakuza.
Finally, and perhaps most important, many foreclosures have been picked-over by professional investors before they reach the market. You can find bargains, but they are rare in desirable locations.
Rural areas and secondary cities—which offer clean air and affordable space—are another source of bargains. Both, however, are suffering from the effects of migration to Tokyo and other large cities. Depopulation is made worse by the closure of manufacturing plants, many of which are moving offshore to escape high wages and the soaring yen. When these factories close, skilled jobs disappear and rarely return.
In the past, the national government financed rail lines, highways, dams and other large infrastructure projects in rural areas. These projects provided much-needed construction jobs that helped to sustain the local economy. However, many of these projects are now being reviewed, scaled back or canceled, adding to the economic uncertainty.
As local governments run out of money, they are shutting schools and hospitals. Railway lines, airports, ferry routes and even gas stations are closing, and there is a nationwide shortage of doctors that is particularly bad in rural areas.
There is a very real possibility that cutbacks could create a vicious circle, where lower service levels cause more people to leave, reducing the tax base and causing even more cutbacks.
These problems affect communities throughout Japan, including places like Yubari, in Hokkaido. A former coal mining center, Yubari’s population fell from 110,000 in 1960 to less than 12,000 today. The city declared bankruptcy and now has accumulated debts of ¥32 billion.
Yubari’s problems, which have been covered at length in the Japanese media, make sobering reading for anyone thinking of buying a rural home or a recreational property. Many of Japan’s resorts are surrounded by similarly depressed economies.
That said, if you have a long investing horizon, rural areas offer an intriguing opportunity.
It’s no secret that Japan’s farmers are retiring, and that few of their children are interested in running the family farm. By 2005, nearly 400,000 hectares of farmland had been abandoned. That’s almost twice the size of metropolitan Tokyo.
Japan’s farms are tiny. On average, they are 1/20 the size of a German farm and 1% of an American acreage. Their small size makes them inefficient, and many farmers depend on subsidies to survive.
As the number of farmers decreases and young people continue to migrate to cities like Tokyo and Yokohama, the political influence of rural areas will fall. At some point—probably around the middle of the century—the cost of subsidizing farmers and rural municipalities will become unsustainable.
Eventually, the government will allow—and ultimately encourage—the consolidation of Japan’s smallholdings and the introduction of corporate farming. This won’t happen tomorrow—there are powerful government, agricultural and community groups with an interest in maintaining the status quo—but it will happen. And it will be driven by advances in technology, as well as international trade and political forces.
For example, robotics and biotechnology are being used to boost the efficiency of the nation’s farms. Japan is slowly warming to the idea of joining a Pacific-rim free-trade agreement. And companies like FamilyMart have announced plans to grow food in Japan and sell it in China.
But the wholesale restructuring of Japan’s agricultural sector is a long way off. So where should you buy today?
Where to buy
Let’s start with the location. Tokyo will continue to benefit from the internal migration that I mentioned earlier. I’d buy in Tokyo’s 23 wards, near one of the main commuter lines that connect through Shibuya, Shinjuku, Ikebukuro or Ueno stations, which are indicated here with stars. The area inside the Yamamote train line, which circles central Tokyo and is shown here in black, has many popular, upmarket neighborhoods. There are also attractive values in working-class wards, like Itabashi-ku, where I purchased an apartment.
In Japan, nearly everyone uses public transit, so a home near a train or subway station is always a good bet. And don’t forget to check the neighborhood’s flood and earthquake maps.
Small apartments will benefit from the demographic trends I mentioned earlier, especially if they have elderly-friendly designs. Be sure the building is on owned—not leased—land. For self-use, newer homes have better earthquake resistance and energy efficiency. Older apartments are usually fully depreciated and offer higher rental yields.
Finally, a word of caution. There is lots of inexpensive property available in Japan. And when something is unusually cheap, there’s almost always good reason, such as a nearby cemetery, a major structural repair project, or a new freeway planned for the neighborhood.
That said, there are good values in Japan. And with a little research you can own a home, an income property or a distinctive vacation home in a country that, until very recently, was beyond the reach of all but the wealthiest buyers.
And now, I’ll be happy answer your questions.