The Journal The Authority on Global Business in Japan

Tokyo’s property market is again looking toward the sky. But are the good vibes built on strong fundamentals of rising demand for space, solid returns, and greater investment from overseas, or is a flood of cheap money creating a new bubble?

The data certainly appears solid. For the five major commercial markets of Tokyo, encompassing Chuo, Chiyoda, Minato, Shibuya, and Shinjuku Wards, the office vacancy rate has fallen to just over 4 percent, which is considered full capacity in most countries.

The residential market similarly shows a brisk pace of sales for new condominiums. Even the price of land, which has been on a 25-year slide, is finally showing some progress—at least in the big cities.

Amid the overall tight supply for space, office rents have risen only modestly, up 4 percent in November 2015 from year-earlier levels. To some, that suggests the office rental market has room for higher rates; for others it suggests that demand for space may be weaker than it appears.

Meanwhile, there are warnings that a disruption is likely in the market. There is also concern that the current influx of domestic and foreign money, looking for that rare combination of solid returns and relative safety, may be pushing the envelope too far.

Hiroshi Okubo, CBRE

Hiroshi Okubo, CBRE

“We expect the office leasing market in Tokyo to be in an uptrend for the next three years,” says Hiroshi Okubo, head of research for the diversified real estate services firm CBRE. “On our current projections, however, we expect rents to peak out around the end of 2018, due to both an increase in supply and potential weakness in demand,” he says.

This trend is evident across most of the city’s central business districts (CBDs). Shibuya, which is rebranding itself from a haven for schoolgirls to an increasingly powerful magnet for high-tech firms and startups, has seen its average rents rise and vacancy rates fall.

Roppongi is popular among foreigners both for work and play, and is likewise in the midst of changing its identity as a hub for rundown watering holes frequented by foreign traders to a buttoned-down office district.

Shinjuku remains the laggard in the group in terms of the rents it can command, having lost some top-tier international corporate names in recent years. It has, however, rebuilt itself as a business-to-business center, with a largely domestic tenant base.

It posted a solid 5.1 percent gain in asking rents in 2015, the largest increase of any of the five CBDs, according to figures from real estate broker Miki Shoji.

Cranes are a common sight on the Tokyo skyline.

Cranes are a common sight on the Tokyo skyline.

The Shin-Marunouchi Building is the highest property in Chiyoda Ward.

The Shin-Marunouchi Building is the highest property in Chiyoda Ward.

EAST SIDE TRANSFORMATION
But the big winner in all this remains the areas around Tokyo Station: Marunouchi, Nihonbashi, and Otemachi. Considering Tokyo Station was once home to army barracks, it’s interesting to note how this side of town has stolen a march on virtually every other CBD.

Roppongi Hills MORI Tower is a focal point of the area's "city within a city" concept.

Roppongi Hills MORI Tower is a focal point of the area’s “city within a city” concept.

Mitsubishi Estate Co., Ltd. purchased an 86-acre tract of then-unused land in 1890 that is part of the 300-acre Marunouchi zone, and has worked assiduously to make it the most desirable business address in town. Mitsui Fudosan Co., Ltd. also has ambitious plans for Nihonbashi, the district that has been its home for more than 300 years.

The area’s transformation has entailed more than just new construction and landmark buildings—the imposing Marunouchi and Shin-Marunouchi towers, as well as the Coredo Muromachi complex, are leading examples.

There also has been a broader transformation of the area from a somewhat staid office district to a popular dining and shopping destination, with sidewalks seeing just as much activity on weekends as weekdays.

Other work underway includes construction of the first upscale apartment units in the district, a branch of the St. Luke’s medical center, and the first ryokan (traditional Japanese inn) in Marunouchi, run by Hoshino Resorts.

“We want to provide for the residential, cultural, and medical needs of people in the area to make Marunouchi more competitive. This is something that you cannot do just anywhere in Tokyo. These are not necessarily revenue generators, but are important in looking at the neighborhood as a whole,” according to Mitsubishi Estate spokesman Sho Tanaka.

Toshihiro Mochizuki,  Mitsui Fudosan

Toshihiro Mochizuki,Mitsui Fudosan

Speaking about Nihonbashi, Toshihiro Mochizuki, leader of Mitsui Fudosan’s office leasing department, said, “We have a close relationship with this neighborhood, the companies that are here, and the people who live and work around us.”

In recent years, Mitsui has undertaken a series of major redevelopment projects in an area that was the real heart of the city in centuries gone by, a center for trade, culture, finance, and commerce.

On the east side of Chuo Dori, Mitsui Fudosan has already finished the Coredo projects, a series of retail, office, and residential facilities, while further investment has gone into the Mitsui Memorial Museum, the Nihonbashi Mitsui Hall, a new Toho Cinemas complex, the Nihonbashi 2-chome project, and an updated Fukutoku Shrine, which has taken care of residents’ spiritual needs for more than a thousand years.

The results of such investments are clear. CBRE puts the vacancy rate for Marunouchi at under 1 percent for the first time in seven years. Like Japan’s interest rates, at that level there is little room for a further drop.

And Mitsubishi is backing up this confidence with hard cash. In August, it announced plans for Japan’s tallest skyscraper, at 390 meters, as part of a new four-building complex on the eastern side of Tokyo Station.

At that height, while roughly on a par with New York’s Empire State Building at 381 meters, it will nevertheless trail far behind the current winner of the tallest-building sweepstakes—Dubai’s Burj Khalifa, at a vertigo-inducing 828 meters.

The Tokyo complex—known by its working name, Tokiwabashi District Redevelopment Project—will have a total floor space of 680,000m2, adding in a single stroke nearly 10 percent to all the current office space in Marunouchi. Completion is scheduled for fiscal 2028.

The residential market is also seeing a boom, with much of the current buying activity attributed to rich Japanese retirees, and driven partly by the structure of inheritance taxes that makes high-rise apartments an attractive investment.

Further, average prices are rising as apartments are getting bigger. According to the Real Estate Economic Institute, the average price for the first 11 months of 2015 climbed 8.4 percent YOY to ¥54.7 million.

Never wanting to be overshadowed, Kyoto saw the highest sales price for any apartment nationwide in the past 20 years, at ¥749 million. At that level, the term “mansion” probably is appropriate.

For rich international investors, even that price may look cheap. Last year saw a New York penthouse sell for just over $100 million (¥12 billion at current exchange rate).

Brokers active in the Tokyo market say that foreigners are indeed eager buyers these days, but their influence is often overstated, with the vast majority of residential investment coming domestically. Among the foreigners, brokers cite Taiwan, South Korea, and to a lesser extent Hong Kong as being the major centers.

While a lower dependence on mainland China could help the market stay afloat despite a myriad of warnings about the world’s No. 2 economy, investors from all three markets are likely to feel the chilly economic winds from China.

The Nihonbashi 2-chome project near Tokyo Station will be completed in 2018.

The Nihonbashi 2-chome project near Tokyo Station will be completed in 2018.

TOO GOOD TO BE TRUE?
Institutional investing is where the big money comes into play. Foreign institutional investors are now estimated to represent 20 percent of market transactions throughout Japan, according to CBRE.

Global players such as the Blackstone Group and Fortress Investment Group are active in the Japan market.

Blackstone boasts a portfolio of 13,200 residential units in 280 properties nationwide, and recently announced a $450 million deal to buy London-listed Japan Residential Investment Company. Fortress, meanwhile, launched its third Japan Opportunity Fund, with equity capital at $1.1 billion.

The influx of investment capital has pushed up prices and is putting pressure on the rates of return as a result. A recent CBRE survey of investment trends shows the benchmark rate of return on investments in Otemachi fell to 3.75 percent, the lowest rate since the survey began in 2003.

Demand is also seen in the equities market, where Japan Real Estate Investment Trusts (JREIT) have been snapped up in the overall market boom in the era of Abenomics.

Eager investors include the Bank of Japan, which has been pumping money into JREIT since it began its monetary easing program in April 2013 under its Governor Haruhiko Kuroda.

All of this optimism may be too good to be true. Skeptics point to a number of factors that could derail the market. These include the lofty pricing seen in some sectors, an increase in the supply pipeline that will hit in a few years, as well as long-term concerns over Japan’s economy.

Some real estate experts see any upcoming dip as cyclical, following the last downturn that started with the 2008 global financial crisis and continued through the March 2011 Great East Japan Earthquake.

“While the Tokyo property investment market remains one of the most attractive in Asia, we are reaching a stage in the cycle where sellers of prime assets can have expectations beyond which even the aggressive pricing investors are willing to underwrite,” says John Howald, director, International Investments, Jones Lang LaSalle.

“This could create an expectations gap between buyers and sellers,” he adds.

Compiled by the Japan Real Estate Institute

Compiled by the Japan Real Estate Institute

PAST ITS PRIME OR ROOM TO GROW?
Some suggest the bubble has arrived, especially in the JREIT market. In a November 2015 report, Deutsche Bank takes the bubble idea for granted and instead jumps to the issue of “how long will the real estate bubble hold?”

Deutsche lists a number of concerns, including ongoing economic weakness that is likely to worsen when the consumption tax is raised in April 2017.

It also points to what it says are signs of potentially risky lending by regional banks, and a regulatory crackdown on apartment purchases to lower inheritance taxes.

However, some industry analysts say that despite the high valuations, the market is healthier than it was in 2007. “Office rents in Tokyo are now just 60 percent of the peak in 2007. We have seen a much more moderate increase in rents, and if our forecast is right, we still have another 10 to 15 percent to go,” said CBRE’s Okubo.

That view is echoed by the property group Savills, which says in its latest Asian Cities report, “considering that Tokyo is still lagging in terms of rental recovery compared to other major international cities, capital values in Tokyo have reasonable potential for steady appreciation going forward.”

As ever, the longer-term trends are more difficult to divine. Some market bears point to an expected continued decline in Japan’s workforce as the nation ages and the population shrinks.

The current total labor force of 66.03 million is actually smaller than it was in 1993 and well below the peak of 68 million reached in 1998. While that figure covers all types of workers, the number of those in offices is likely to decrease over time as well.

Other headwinds include fundamental shifts in working styles, to telecommuting, hot-desking, and property rationalization programs by companies looking to reduce the amount of space needed.

With these trends in mind, Mitsubishi Estate launched a comprehensive study into what its corporate tenants will need in the decades ahead, in a bid to figure out what the future may hold.

“It is often said that companies may have less demand for space, but the importance of face-to-face communications will remain,” says Mitsubishi’s Tanaka.

THE IMPERIAL PALACE AND CALIFORNIA

Many readers familiar with the Tokyo property market may have heard a rumor that during the peak of the 1980s bubble economy, the land of the Imperial Palace was worth more than all of California.

No exact source has ever been identified for this statement. An Internet search turns up no evidence to support the idea. However, on March 23, 1990, The Wall Street Journal ran a front-page story headlined “Real Concern: Land Prices in Japan Are Getting So Steep the Nation Is Jittery.”

Amid text on the day’s record-high prices, the inability to afford a home, and the idea of 100-year mortgages is the following: “The land under the neatly manicured gardens and ancient building of Tokyo’s Imperial Palace is valued at about $70 billion—more than all the land in Florida.”

At that price and the exchange rate of ¥153 to the dollar at the time, the land would have been worth about ¥5.4 million per square meter. The exact calculation is tricky since it is not clear how much of the grounds they included, such as the public park, the area around the Budokan complex, and the moats.

The figure is actually well below the price being quoted for premier Ginza property at the time, which had risen to as much as ¥30 million per square meter. But here, again, on what basis is a bit murky.

Even trickier is how to value an entire state. The last one on the market was Alaska, which went for $7.2 million in 1867, a mere $116 million at today’s prices.

The story also shows the assumptions that can prove to be seriously mistaken in the 20-20 lens of history. It says that inflation was a major concern, and that despite the worries of Japan’s banks at the time about a joint tumble in the property and equity markets, few analysts thought that was likely.

“The prospect of a real land-price collapse strikes most analysts as remote. ‘The most we can expect is for land prices to level off,’ ” it says, quoting an economist at what was then Sumitomo Bank.

So the question remains: did urban legend just swap one orange-producing state for another, and was it really true? As the journalistic saying goes, “Never let the facts get in the way of a good story.”

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William Sposato writes and quotes on macroeconomic issues and monetary policy. His experience includes editorial roles at the Wall Street Journal in Japan and Thomson Reuters.
[The area formerly housing] army barracks ... has stolen a march on virtually every other CBD.