The evidence suggests that the great Japan property bear has stopped roaring. But with many analysts misreading the data, the fantastic opportunities there could be overlooked…
Is Japan’s great bear market in property over? There’s evidence to suggest it is, and if that is really the case, we should also be seeing an end to the decade-and-a-half credit crunch that has crippled the banking sector and almost completely frozen out activity in the real-estate market for years.
I think that is exactly what is happening, but many markets analysts seem to be finding events very confusing indeed. I have been reading a broker’s report this week on the nascent recovery in the Tokyo prime office market. The analyst’s report noted land prices were up a bit, but the implication was that this was more than offset by the negative effects of falling rental yields. Specifically, yields in the central Marunouchi business district were now only 4.4%, he warned, having once been as high as 6.3% (back in 1999). He isn’t the only one putting a negative spin on things: only a month ago or so, a Bloomberg article entitled ‘Tokyo Property Price Gains May Slow As Yields Fall’ quoted another real-estate analyst at a major investment bank saying much the same thing.
But falling rental yields aren’t a bad thing. Instead, they’re just what you’d expect to see once prices start to rise. We know from the (fairly reliable) Miki Shoji data that actual average rents per square foot have started rising in the Tokyo business area in the last year, albeit by just 1.6%. So if rental yields (the rent divided by the price) are falling, while rents are stable, that must mean prices are rising – quite sharply. So what the analysts should be saying about Marunouchi is not that prices are rising yet rental yields are falling, but that prices are rising and therefore rental yields are falling. Since 1999, rents have fallen about 15% in total. If prices were static, that would mean rental yields would have fallen to 5.4%. But they’ve fallen further – to 4.4% – implying that where transactions are taking place, prices may have risen as much as 20% or more.
It’s important to point out that there are still so few transactions going on in the Tokyo market that we may not really have a statistically significant sample, but the general outlook is clear. Tokyo’s prestige office property is being bid up and the shortage of supply means rents are rising faster in smarter areas too. CB Richard Ellis highlighted in its Global Market Review for August that newly agreed Class A rents (brand new, ultra-prime property) in Tokyo, where vacancy rates are only a little over 2%, had “increased by approximately 15% as landlords take advantage of the tight market conditions”, and that an extra “10% rental growth is anticipated to occur by year-end”. And where the ultra-prime central Tokyo office market goes today, outer Tokyo goes next year, and the year after that any recovery can be expected to take off in the remaining main cities across the country.
If Japan’s long property bear is truly over, we would need to see evidence that the credit crunch is over and that the banks are finally happy to lend again. Market watchers keenly scrutinise the bank lending data, searching for signs that loans are rising. So far, the data is still negative year-on-year, but by an ever-diminishing margin. Another good sign, though I doubt the analysts would say so, is that the average loan rate charged has risen from 1.3% to 1.39%. Meanwhile, whereas just 60% of real estate firms’ procured funds came from banks last year, this year that figure is up to a slightly more healthy 70%. It’s not much, but it does suggest that the banks are starting to look down the risk curve and lend to the lower-credit-rated borrowers again.
These are all developments that we must expect (and rejoice) to see prior to any return to a normal bank-financed property market. However, until analysts work out how to interpret the data, there is a sizeable risk that many market participants won’t appreciate the evidence, even when they see it. That would be a shame, because the potential for Japanese property is fantastic. Prime offices yield 6%-7% and residential and out-of-town retail sites usually return 9%-11%, despite borrowing costs averaging 1.4%. Little wonder the banking and real estate sectors have led the stockmarket charge over the last few months.