Seth Sulkin is the President and CEO of Pacifica Malls K.K., a Tokyo-based real estate asset manager specializing in commercial properties.
On April 21, Bank of Japan Deputy Governor Miyagi Nishimura said in a speech that he sees “beams of light” pointing to the end of Japan’s severe deflation problem. If true, that would be welcome news to the real estate market, but there are many reasons to be cautious. According to press reports, the Bank of Japan’s own forecast is for a drop in consumer prices of 0.5 percent in fiscal 2010 and a further fall of 0.2 percent in fiscal 2011. Even with nominal interest rates close to zero, the real interest rate is negative, which is not good for consumer spending or real estate investment, which is generally seen as an inflation hedge.
That being said, Japanese views toward real estate are not generally as cut and dried as would be more common in the U.S., Europe or Australia. History and culture still play an important role in how Japanese individuals and companies buy, hold and sell real estate, which means that numbers alone do not determine decision-making.
Take, for example, the concept of a fixed-term lease. In the U.S., it is standard that a tenant’s right to use space is limited to the term of the lease. In a traditional Japanese lease, however, a tenant can stay in perpetuity with no mechanism for the landlord to regain control of the space. About 10 years ago, the Japanese government introduced a fixed-term lease law applying to both buildings and land. The fixed-term lease law did not replace the concept of a traditional lease. Both are now in use, although traditional leases generally remain the norm outside the Tokyo area.
Where the fixed-term law had a really huge impact, however, was for ground leases. For such a small, crowded country, Japan actually seems to have a huge amount of unused or underutilized land. Knowing that control over the land would revert after a defined amount of time encouraged individuals and companies that didn’t want to sell land for tax or sentimental reasons to lease it to tenants such as supermarkets, car showrooms and shopping centers. Many of these fixed-term ground leases were for 20 years or more, so we haven’t seen what will happen at the end of the period, but legally, landlords can force tenants to demolish buildings and restore the land to the original condition.
Illustration by Phil Couzens
In large part, because of this legacy of resistance to traditional ground leases, the concept of selling land separate from ownership of the buildings on top (generally referred to as sokochi) was not considered investment-grade. Personally, I feel more confident that my tenant will continue paying rent when his investment in my property consists of a building. If he is only renting a space in a building that I own, it is much easier to walk away.
Given that transparency in the Japanese real estate market is so low compared to other key Asian markets such as Hong Kong, Singapore and Australia, real estate professionals tend to look at the behavior of J-REITs as a proxy for what is happening, given that they must disclose certain aspects of their transactions and decision-making. Because sokochi were considered to have low liquidity and banks did not like to lend against them, J-REITs have generally stayed away from buying them. Recently, however, the Japan Retail Fund (JRF), one of the largest J-REITs, made a very rational decision to recycle its portfolio of assets to try and increase its dividend payouts.
With continued deflation and no recovery in domestic demand expected in the foreseeable future that would lead to higher rental income, JRF sold a property with high depreciation cost and bought several assets with low depreciation, including a few sokochi, which naturally have no depreciation, as the tenant owns the improvements. J-REITs can only distribute profits left after depreciation, so in this case, economic rationality overcame traditional cultural resistance to buying sokochi. This is an important step in the maturity of the market.
