The real estate investment boom is reaching its peak and some say it is the "beginning of the end. But has the real estate market really reached a turning point? We take a neutral look at current market trends and risk factors, and explore future prospects.
Market Overview: The Japanese real estate market has been booming in recent years, with Japan the only country to see a prominent increase in investment amidst a stagnant global real estate investment market in 2023, with investment amounting to approximately 2,748.3 billion yen in the first three quarters of 2023. This trend will continue in 2024, with domestic real estate investment in the first three quarters of 2024 reaching approximately 3,856.7 billion yen, already exceeding that of the full year of 2023. Domestic investors are leading the way, and in some respects, domestic investors have been aggressively acquiring investment opportunities created by the divestiture of foreign investors.
Commercial real estate: The office building market is recovering due to a recovery in demand after the Corona disaster, but the market is "polarized" with large differences by region and grade. The vacancy rate in Tokyo's five main wards was 6.31% at the end of 2023, still above the appropriate vacancy rate (5%), and has remained above 5% since 2021, raising concerns about oversupply even in central Tokyo. On the other hand, in popular areas such as Chiyoda Ward, the vacancy rate has dropped to the 2% range, and there are signs of a resurgence in the rental market, and demand for well-located, high-quality office space is strong. Rents also began to rise in the second half of 2023 for Grade A office buildings in central Tokyo, with the average asking rent reaching its highest level since the Lehman Brothers collapse. The price index for commercial facilities (stores) temporarily slumped after Corona, but is picking up in 2023. The hotel market is also booming due to the resurgence of inbound tourism, with domestic hotel transactions reaching a record level (approx. 570 billion yen) in 2023.
Residential Real Estate: Condominium prices continue to soar, especially in the Tokyo metropolitan area, and used condominium prices continue to reach record highs. According to the Ministry of Land, Infrastructure, Transport and Tourism's Real Estate Price Index, price indexes for both residential and commercial properties are on an upward trend in 2023, and the residential index is on track to exceed its pre-Lehman peak. In particular, prices of condominiums in central Tokyo are rising due to excess demand, and UBS's Global Real Estate Bubble Index rates Tokyo's housing market as having the second highest bubble risk in the world. On the other hand, housing demand is sluggish in regional areas, and there are regional differences in the momentum of price appreciation. Although the number of new housing starts turned downward in 2023, the total number of housing starts itself is expected to continue to increase slightly in the foreseeable future due to an increase in the number of households.
Investment real estate market: The investment market, which views real estate as income-producing property, has also seen a continuous inflow of funds, driven by low interest rates. In 2023, transactions were active in a wide range of sectors, including office, logistics, and residential. Emerging sectors such as logistics facilities and data centers in particular were supported by high demand. However, there are indications that the pace of land price increases in the investment market as a whole has begun to slow down in 2024, indicating an adjustment in the sense of overheating. In general, while prices continue to rise in the Japanese real estate market, the market is still at a stage where the question of "what is the appropriate level" is being asked.
The Bank of Japan' s long-standing ultra-low interest rate policy is reaching a turning point. Since the end of 2022, the Bank of Japan has steered the yield curve control (YCC) toward more flexibility and raised the upper limit of long-term interest rates. As a result, the yield on the 10-year JGB has risen from its guidance target of around 0% , andwe are now in a phase of rising interest rates.
For real estate investors, the risk of rising interest rates cannot be ignored. For investors with a high borrowing ratio, rising interest rates lead to an increase in interest payment burdens and worsen the income and expenditure of properties. In addition, the more competitive a property's yield has been, the less attractive it is to invest in it when the spread between the yield and the government bond yield narrows due to rising interest rates, and this can exert downward pressure on the price. There is a risk that Japan's unique strength, the appeal of the yield spread due to the low interest rate environment, will gradually fade away in the future. In particular, a sharp rise in long-term interest rates could put downward pressure on real estate prices. On the other hand, moderate inflation and rising rents will increase real estate earnings, so it will be a tug-of-war between interest rates and real estate prices. In general, interest rate normalization is a double-edged sword for the real estate market, with both negative and positive sides. If a balance between moderate interest rate hikes and economic growth (soft landing) is achieved, the impact on the market will be contained.
Japan is facing a structural population decline and an aging population with a declining birthrate, and the foundation for real estate demand is shaking. The total population is decreasing by about 0.5% annually, and the total population of 124.35 million as of 2023 is approximately 590,000 less than the previous year (the 13th consecutive year of decline). Population outflow continues, especially in rural areas, and the decline in demand for rural properties is particularly pronounced. While the population is increasingly concentrated in urban areas, especially among young people, the number of vacant houses is increasing in rural and suburban areas, and property values are diminishing in some areas.
The problem of vacant housing units:According to the Ministry of Internal Affairs and Communications' Housing and Land Survey (2023), the number of vacant housing units nationwide reached a record high of approximately 9 million (13.8% of the total number of vacant housing units). While the percentage of vacant houses has remained almost unchanged over the past decade, the number of vacant houses itself has continued to increase along with the total number of houses, and has doubled since 1993. The percentage of vacant houses is particularly high in rural areas, where one out of every five houses is vacant. There is concern that this "housing glut" will become increasingly serious as the population decline accelerates. Real estate that is not in demand will see its asset value decline, making it difficult to sell or rent as an investment property.
Vacancies in commercial real estate: Offices and commercial buildings are also at risk of rising vacancy rates. The impact of the Corona disaster and the spread of remote work has led to a structural decline in office demand in some major cities. The office vacancy rate in Tokyo's 23 wards rose sharply from the 5% to 7% range in 2021, but then declined to the low 3% range in 2023 when there was little new supply. However, a large supply is scheduled to come on stream in 2024, and the vacancy rate is expected to come under upward pressure again. In fact, vacancy rates in the five major wards of central Tokyo remained high at around 6% throughout 2023, and the supply-demand balance continued to ease in many areas. Tenants' office strategies are also changing, with moves to improve the working environment by consolidating locations and utilizing satellite offices in the suburbs. The risk of increased vacancy due to population decline and changes in work styles is particularly serious for offices and shopping districts in regional cities. In areas with shrinking populations, commercial facilities are closing and idle real estate is increasing, which is a deteriorating earnings factor for real estate owners.
Demographic changes are thus affecting the foundations of the real estate market, both residential and commercial. However, there are some bright spots: the total number of households is expected to increase until around 2030, due to an increase in the number of single-person households. The increase in the number of households may support housing demand, and future projections for the vacancy rate have been revised lower than previously thought (Nomura Research Institute's projection of the vacancy rate in 2033 has been revised downward significantly, from over 30% to 18.3%). However, it should be noted that this is due to strong demand in urban areas, which will lead to widening disparities between regions. In the future, structural changes will be required, such as the utilization of housing stock (renovation and conversion) and a review of urban planning according to the supply-demand balance .
In recent years, the inflow of foreign money has become an important factor in the Japanese real estate market. Ultra-low interest rates and a weak yen have made Japanese real estate an attractive investment destination for foreign investors. In fact, while Japan, the U.S., and Europe will be divided on monetary policy in 2024, the pace of interest rate hikes in Japan will be slow and the yield spread will remain high, and the historically low yen will also provide a tailwind.
However, there is a difference in temperature in the movements of foreign investors: in 2023, some foreign funds moved to sell off office properties in Tokyo due to the cooling down of the global office market. The percentage of foreign investment in Tokyo's five central wards fell to a record low of 7% in 2023 (it was around 20-30% in normal times), and the presence of foreign money has waned. In the background, the slump in demand for office space due to the establishment of remote offices in Europe and the U.S. has temporarily strengthened the Japanese market's reluctance to invest in office space, even by global standards. However, this was a temporary phenomenon. Tokyo's office occupancy rate will reach 90% by 2023, much higher than New York (51%) and London (60%), and in fact, "there are still many foreign investors interested in the Japanese office market. In fact, foreign money turned aggressive again in 2024, with the amount of investment by foreign investors in the fourth quarter of 2024 jumping 3.3 times compared to the same period of the previous year. In particular, investment in the hotel sector was particularly active, with hotel investment in the quarter reaching a record high of 3.7 times that of the previous year (approx. 449 billion yen), and several large office transactions were also executed. In this way, foreign capital is sensitive to market trends and quickly adjusts its position in the market, and its presence has a significant impact on the domestic market.
Positive effects of foreign money inflows include improved market liquidity and new demand generation. For example, in 2023, a foreign sovereign wealth fund sold several office buildings in Tokyo and shifted its investments to logistics facilities. In this way, there is a movement to retain funds in the Japanese market while replacing investment portfolios, contributing to the flow of funds. On the other hand, one risk is the possibility of the market being influenced by foreign funds. If foreign investors pull out or refrain from buying depending on exchange rate fluctuations and economic trends in various countries, there could be downward pressure on Japanese real estate prices (so-called "capital flight" risk). In particular, there is a concern that the reverse currency risk will increase profit-taking sales when the yen appreciates. However, at the present time, the yen's weakness and the relative stability of the Japanese market have led to a continued inflow of foreign money, and Japanese real estate continues to be a promising diversifying investment destination** for global investors. Monitoring of domestic and foreign capital movements is important, as foreign investors' movements may change in the future depending on the Bank of Japan's policies and foreign exchange rates.
There are several possible scenarios for the real estate market in the future. Here we look at three representative scenarios.
(1) Soft landing scenario: This is a case in which the market adjusts gently through a combination of gradual reduction in monetary easing and economic growth. With moderate wage growth and inflation, and interest rates gradually normalizing, we assume that real estate prices will not fall sharply and will settle down with a gradual adjustment. Even if the Bank of Japan lifts negative interest rates and long-term interest rates rise to the 1% level, real estate investment yields will not be significantly impaired if the economy continues to expand and rents continue to rise at the same time. In this scenario, the real estate market may not "burst" but rather experience a slight price correction or temporary stagnation and then return to a stable growth path. The financial authorities will also take a cautious approach to avoid market turmoil, resulting in a soft landing.
(2) Bubble scenario: This is a case in which interest rates soar due to high inflation or policy errors, or real estate demand plummets due to economic recession, resulting in a sharp decline in prices. Currently, some experts are of the opinion that a future market decline is inevitable and that the real estate market may reach a major turning point. This is a scenario in which adjustments will be made especially in overheated segments such as investment condominiums and high-end properties in central Tokyo, and the price declines will spread nationwide. In this case, one can recall the bursting of a real estate bubble like that of the early 1990s. In fact, according to UBS analysis, there is a high level of concern about bubbles in some cities such as Tokyo, where housing prices have already fallen by more than 20% since the start of global interest rate hikes in cities that were previously diagnosed as bubble risks. In Japan, for example, if the economy slows down and mortgage rates rise sharply, housing prices will probably fall due to a decrease in purchasing power. In the commercial sector as well, a combination of increased vacancies and deteriorating earnings could cool investment sentiment and lead to a sharp price adjustment. At present, however, the Japanese economy is on a gradual recovery path and financial institutions have not significantly changed their lending stance toward real estate, so there is room to avoid a sharp collapse scenario. However, we cannot afford to be complacent, depending on interest rate trends and global economic risks (geopolitical risks, etc.).
(iii) Structural Transformation Scenario: This is a case in which the market transforms to adapt to long-term demographic and social structural changes beyond the short-term business cycle. The Japanese real estate market will face the structural challenge of shrinking demand due to the declining birthrate and aging and shrinking population. In this scenario, the real estate industry will shift from its traditional "emphasis on new construction and ownership" to a shift toward effective use of stock and "emphasis on utilization. For example, vacant houses will be utilized (renovated or converted to regional exchange centers), office buildings will be reused (converted to residential or logistics facilities), and redevelopment of old buildings will be promoted. In addition, advances in real estate technology may improve the accuracy of matching supply and demand, thereby eliminating underutilized real estate. The government may also strengthen measures against vacant houses and urban downsizing, and progress may be made in streamlining urban structures and transitioning to compact cities. Even if the market size is gradually shrinking, new business models (e.g., rental as a service, sharing economy real estate use) will emerge, and the real estate business itself will undergo a qualitative shift in the future. In other words, as the phrase "the beginning of the end" suggests, this is a scenario from a long-term perspective of the end of the old real estate investment model and the transition to a new paradigm.
Which of the above scenarios will become a reality will depend on interest rate trends,economic growth, as well as policy responses andsociety's ability to adapt. Perhaps a path that avoids an extreme bubble burst while seeking a soft landing and structural transformation would be preferable.
With uncertainty about the future of real estate investment, the key is risk diversification andexit strategies. In order to protect the value of your assets in the face of changing market conditions, keep the following points in mind
Portfolio Diversification: You can equalize your risk by investing in multiple properties and sectors rather than concentrating on one property type or geographic region. For example, you can diversify your portfolio by investing in suburban residential and logistics facilities as well as urban office buildings, or by investing in some overseas real estate as well as in Japan. In fact, some domestic investors are diversifying their investments overseas while the Japanese market is strong. By diversifying into multiple assets, they are able to compensate for a slump in one market by investing in other assets. It is also important to consider combining other assets, such as cash and stocks, to maintain a balance that avoids an over-emphasis on real estate.
Clarify exit strategy: Real estate is illiquid, so the timing and method of sale must be planned in advance. One strategy is to sell at a profit while the market is strong. In fact, foreign investors are in the habit of recombining their assets while the market is strong, and in 2023, we saw foreign funds selling their Japanese office buildings to lock in profits and reinvest in other uses. Individual investors should also assess the age of the property and the future potential of the area, and set criteria for when and at what price they would sell. For example, they should consider selling local properties that are experiencing declining rental demand as soon as possible and replacing them with properties in urban centers, or consider exiting before loan interest rates rise. In addition to selling, refinancing andchanging the management style (e.g., changing the method of lending, converting to private accommodations, etc.) are also part of the exit strategy. Since the real estate market fluctuates periodically, it is important to constantly monitor market trends and flexibly review your strategy.
Use of experts: In uncertain times, it is also effective to seek advice from trusted real estate experts and agents. Ask several real estate companies for an appraisal and opinion to get an objective assessment of the value of your property. By referring to the opinions of not only major firms but also community-based agents, you will be able to make a more accurate judgment. It is also a good idea to consult with a tax accountant or FP to develop a comprehensive exit plan that includes taxes on the gain from the sale and the liquidation of outstanding loan balances.
With these risk diversification and exit strategies in place, it will be easier to avoid catastrophic losses even if market conditions change. Particularly in a phase such as the current one, where there is a mixture of overheating and uncertainty, prudence will be required to "prepare for the worst-case scenario.
The exciting phrase "the beginning of the end for real estate investment" suggests that a turning point in the market may be near. Indeed, there are signs that Japan's real estate market is entering an adjustment phase from its previous upward trend. Faced with structural issues such as rising interest rates and a declining population, it is unlikely that the market will continue to rise steadily as it has up to now. At the same time, however, the Japanese economy is on the road to recovery and the foundation of real estate demand has not been seriously undermined. A soft landing scenario is quite possible, and it is important to assess risks and opportunities from a neutral perspective rather than being overly pessimistic or optimistic.
What is important for investors is to be flexible enough to respond to changes in the environment and to gather information. By listening to data and experts and being sensitive to market signals, the "beginning of the end" can be turned into new opportunities. Real estate remains a useful long-term asset value preservation and inflation hedge, and with proper property selection and risk management, opportunities will remain for the savvy investor. Whether you choose to continue or reduce your real estate investments in the future, diversification and having a clear exit strategy are the keys to protecting and growing your assets in uncertain times. It is important not to get caught up in the "end" of the market, but to be prepared for the new phase that lies ahead.