Japanese real estate: What drives it?
At the recent Monetary Policy Meeting held from 31st October to 1st November 2016, The Bank of Japan decided to maintain its current policy of quantitative easing.
Short-term interest rates are currently minus 0.1%, and the long-term rate, as measured by the coupon on 10-year government bonds, is hovering around 0%.
The loose monetary policy which was implemented as part of the government's economic stimulus package proposed by Prime Minister Shinzo Abe, or more famously known as 'Abenomics', has certainly had a revitalizing effect on the real estate market.
Is there a price bubble at the moment?
As property prices continue on their upward trajectory, newspapers are constantly churning out reports reminding people of the economic bubble that took place at the end of the 1980s and warning of an overheating real estate market and the dire prospects of a crash.
So are these concerns well-founded? To provide some perspective on whether there is a property bubble in Japan, we will use the residential price index issued by the Ministry of Land, Infrastructure and Transport as a benchmark.
This is an index of domestic real estate transaction prices with 2010 being used as the base year and the corresponding price levels at that time are assigned a value of 100.
The latest index was published on 26th October and shows the latest findings up to July 2016.
For the overall housing category, the index reading for July this year was 106.7, marking 41 consecutive months of growth since March 2013.
However, when we look deeper into the component parts of the index, it can be seen that the prices of land and detached houses are actually falling, having previously been stagnant.
On the other hand, the apartment prices have risen steadily since March 2013, with the index for July 2016 showing remarkable growth at +6.3% compared with the same period the previous year.
Thus, the rise in the overall housing price index does not really reflect a price increase for the real estate market as a whole but is only limited to the apartment segment.
Growth is particularly strong in Tohoku, Kyushu, Okinawa and Hokkaido regions
Apartments are showing significant growth in every region in Japan, with particularly strong growth in Tohoku, Kyushu, Okinawa, and Hokkaido.
Especially for the Tohoku region, the price index exceeds 100 for all the 3 categories: land, detached houses and apartments.
Outside of these regions, there are also cases of prefectures in other regions where the price index is also in excess of 100 in all 3 categories. 2 prime examples are Tokyo (which is in the Kanto region) and Aichi (located in the Chubu region).
In contrast, the Osaka prefecture is showing a declining trend in prices for land and detached houses despite being a metropolitan area.
Because of the declining population size and the aging demographics in Japan, demand for housing is actually decreasing overall, with prices for land and detached houses stagnating.
It seems that dilapidation amongst detached properties, as well as an increase in the number of empty properties in rural areas, is also having a downward effect on prices.
However, with apartment prices showing strong growth nationwide, with a backdrop of a rising real estate market in Tohoku, Kyushu, Okinawa, Hokkaido, Tokyo and Aichi prefectures, demand for housing in metropolitan areas remains strong underpinned by continued population growth in these areas.
More specifically in Tohoku, the general rise in prices in the region can be attributed to a prior price drop in the wake of the earthquake there and followed by the subsequent demand for reconstruction.
For Tokyo and Nagoya, there are other factors behind rising apartment prices besides housing demand. This evidenced by apartment prices rising even in areas where the population itself is decreasing.
Wherever apartments are built, the concentration of the population in city center areas in these regions will support residential demand.
The shift to investment demand drives real estate prices
If housing demand is not the main factor behind the rise in apartment prices, then what are the actual key drivers? We outline several reasons below, with investment demand being a recurring theme for many of them.
1) The steep rise in the cost of construction work
The price of new-build apartments is usually based on land purchase cost + construction cost + sales margin when the property is sold.
Demand for reconstruction is also a factor. Construction expenses are said to have increased 20% in recent years, and this is certainly a key factor in Tohoku.
2) Investment inflows due to monetary easing
It is no coincidence that apartment prices started rising at the same time as Kuroda’s appointment as President of the Bank of Japan, and his subsequent focus on a low-interest rate policy.
Real estate in the form of apartments offering stable yields and generating a monthly cash income can typically be viewed as an attractive investment in an ultra-low interest rate environment.
Rising rural apartment prices in areas such as Hokkaido, Tohoku and Kyushu are not unrelated to the fact that there is a perception of value in the regional real estate market compared to apartment prices in metropolitan areas.
3) Inbound growth
Foreign tourists visiting Japan exceeded the original 20 million government target for 2020 in October 2016. The government is now targeting 40 million overseas visitors ahead of the Tokyo Olympics and Paralympic Games.
With hotel occupancy rates in Tokyo and tourist resorts running at elevated levels, sale prices for hotels are rising sharply.
Under such circumstances, rental condominiums that can be utilized for 'minpaku' (continuous rental of rooms for private use – Airbnb-style) are becoming increasingly popular.
Once laws and regulations regarding 'minpaku' are clarified, real estate agents and real estate investment trusts are likely to become more involved in the business of private apartment room rental, which will further stoke demand for this type of property.
4) Global capital flows
Compared with real estate in Singapore, Hong Kong, Taiwan where prices are still rising, Japanese real estate looks relatively inexpensive, particularly with the yen weak at present.
The Japanese market is attractive as a place to switch funds, moving out of Chinese real estate, for example, which has soared and where already there are now concerns about a collapse.
5) Elderly Market
Investment in apartments as a protective measure against inheritance tax also contributes to overall demand. It is especially easy to invest in apartment blocks where apartment ownership is subdivided, enabling simple distribution of the underlying assets.
Unless the law changes, these types of apartments will remain popular investments.
The demand for housing and investment demand as described above is currently the principal driver of the market. If this hypothesis is correct, then it is unlikely to see general housing and land prices rise for the time being.
However, as long as the direction of monetary policy does not change, it can be assumed that apartment prices will remain firmly underpinned.
Tips to consider
However, there remain plenty of skeptics who are convinced that the current upward trend of apartment prices is a signal of a bubble forming. Regardless of your views, it is always good to have some safeguards in place in case things start to turn sour:
Use real estate investment trusts (REITs). REITs are financial instruments that can be bought and sold on an exchange; it is also possible to sell them with a view to buying back later on (i.e. to go short).
Taking a short position in a REIT is a way of protecting against the risk of a fall in the price of the assets that you own. It is an ideal risk hedge: if real estate prices fall, you profit from buying back the REIT short position.
2) Mortgage Refinancing
In terms of factors which reduce investment demand and puts pressure on apartment prices, a change in interest rate policy, namely a rate increase is the main risk to bear in mind.
If you have an outstanding loan, it is worth considering whether to refinance the loan at a more favorable interest rate before the value of the collateral drops.
In the current negative interest rate environment, there is little difference between floating rates and fixed rates. However, if your existing loan is at floating rates, you should convert it to fixed rates as soon as you can to minimize the risk of future interest rate movements.
In terms of an exit strategy, selling is the most effective method to realize your gains. If you are currently profitable and you fear the risk of falling prices, the best means is to sell and lock in the profit.
Once you have done this you are free to turn your attention to what you will invest in next.
Identifying turning points in the market
Apartment prices are driving the real estate market overall, and in turn, it is strong investment demand for these apartments that is driving up the prices. Underlying all of this is the backdrop of an ultra-low interest rate policy.
Trends in the real estate market will be highly dependent on the timing of a turn in interest rate policy. In anticipation of this, you would do well to ensure your portfolio of assets is properly organized and to calmly consider your response to the potential risks of eventual interest rate tightening.