The Journal The Authority on Global Business in Japan

Opinion | Real Estate

October 2013
A PRECIPITOUS STANCE
Abe’s administration must carefully consider implications of consumption tax hike
By Seth Sulkin

As of this column deadline, a gaggle of economists and sundry advisors were meeting to help Prime Minister Shinzo Abe thread the needle on consumption tax. They were looking for a magic way to raise the tax, from the current 5 percent, without pushing the Japanese economy into recession.

Thus far, there seem to be more opinions than Abe has advisors. Bank of Japan Governor Haruhiko Kuroda, for example, confidently stated that the economy is strong enough to shrug off an increase to 8 percent in April 2014.

Meanwhile, professor emeritus of economics at Yale University Koichi Hamada believes the economy is so weak that the tax increase should be delayed by one year.

Former Bank of Japan policy board member Etsuro Honda has proposed that the tax go up by 1 percent per year for the next five years. This, he believes, would prevent any big swings in personal consumption and business investment.

Whatever Abe decides‚ which will in part be based on GDP figures released on September 9‚ there will be a big impact on real estate, particularly in the residential sector.

Many people may not realize that consumption tax is only applied to buildings, not land. Thus, commercial buildings in prime areas such as Ginza and Omotesando typically account for a mere 10 percent of total asset value. So an increase in the consumption tax probably won’t have much of an impact.

However, high-rise apartment buildings‚ which are extremely popular at the moment‚ would be disproportionately affected. Fitting hundreds of units onto a single plot of land means each unit only owns a tiny sliver of the underlying site.

The consumption tax rate hike could increase the acquisition cost of a typical Tokyo apartment by ¥1 million or more. This would feel like a large amount to the average consumer.

At present, condo sales are well ahead of last year’s levels, while July’s sales in the Greater Tokyo area were the highest since 2007, according to the Real Estate Economic Institute Co., Ltd.

This is due to accelerated demand ahead of the consumption tax increase and the year-end expiration of a tax break on housing loans. Many buyers are also looking to lock-in low interest rates before Abenomics results in higher inflation.

Depending on when and how much Abe decides to raise the tax, condo sales as well as purchases of other big-ticket items, such as cars and appliances, could fall off a cliff.

When former Prime Minister Ryutaro Hashimoto raised the consumption tax from 3 percent to 5 percent in 1997, the impact on consumer and business sentiment was so severe that he was forced to resign.

Given Abe’s high public support, few are predicting the same outcome. Yet, it would be a mistake to underestimate the propensity of Japanese to move in a pack and stop spending money in response to a tax hike.

While condo developers are enjoying high sales levels at the moment, they will face tough times once the consumption tax increase has been implemented.

Since the Great East Japan Earthquake and tsunami in 2011, there has been a nationwide shortage of construction workers and building materials. This has led to project delays and even some cancellations, as unit cost increases of 20 percent or more kill the economics of condo developments.

In the current buoyant market, it is sometimes possible to pass on higher construction costs to consumers. However, once the consumption tax rise kicks in, demand will immediately shrink and home buyers will look for bargains to offset the higher consumption and loan taxes.

Moreover, assuming the stock market tanks in anticipation of a slower economy, sales of high-end oku-shon (condos that cost at least ¥100 million), are likely to plummet as the wealthy no longer have capital gains from their investment portfolios to plow into real estate.

If the impact of the consumption tax hike is severe and prolonged, reduced personal and business investment could indirectly lead to lower occupancy in all types of real estate, as well as lower rents.

Shoring up government finances and broadening the tax base are critical steps, but in listening to Abe’s advisors fight for influence through the media, I wish they would offer more nuanced and creative pro-growth solutions, to offset at least part of the negative impact of the tax increase.

Seth

DividerSeth Sulkin is
president and
CEO of Pacifica Capital K.K.

Divider