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This is the second in our three-part series on buy to let in Japan. You can read part 1 here and part 3 here. The author works in the sector, has written for “Asian Property Review” (Malaysia), “iProperty Group” publications (Singapore), “Bigger Pockets” & “Real Estate Investing Wealth Monthly” (both US based), been interviewed at length for “Real Estate Japan”, and regularly posts articles on LinkedIn and other social media. I’ve found him very approachable and helpful but haven’t done business with him -this is not an endorsement, just a chance to learn from an expert 🙂
Take it away, Ziv!
Real Estate Investment – The Challenges
1. The Gaijin Factor As mentioned in the previous article in this series, and as those of us living here know all too well, the Japanese market is unique compared with other business environments around the world, particularly when it comes to dealing with foreigners.
While other countries normally speak some English at least to some extent, and always have a host of service providers all too eager to work with overseas investors, one must conduct careful due diligence on any potential business partner, in order to identify the reliable ones to work with and to avoid potential delivery problems or even outright fraud in advance. In Japan, however, the exact opposite holds true – almost no one speaks English to any extent, and while service providers are normally as “by the book” as possible (reliability is still a matter of research and some luck), it is extremely hard to find anyone who will agree to work with “scary foreigners”.
This is, in fact, the major hurdle which most non-native Japanese face when initially considering to enter Japan’s exciting property investment arena. Finding brokers, realtors, property managers, insurance companies or renovation/repair professionals who are comfortable working with non-Japanese, even those who speak, read or write the language fluently, is extremely difficult. Internationally renown hotspots like central Tokyo, Osaka, Niseko or Okinawa are the exception to the norm, but being limited to only those locations, all of which generally offer quite low rental yields, and only to those professionals who will agree to work with foreigners, severely limits one’s selection of investment properties
The first challenge, therefore, is in securing a native Japanese partner – either a family member, close friends with a lot of time on their hands, an employee or a business partner such as a buyers’ or proxy agency – who is able to attend meetings, make and receive telephone calls, fill in forms and paperwork whenever required, etc. This becomes doubly important if and when one travels abroad extensively, as many ex-pats do, since someone must be available to take local calls, receive local postage items and be able to physically pay bills at a post office, bank or local convenience store on a regular basis – the Japanese cannot and will not communicate with clients overseas in the vast majority of cases, and will simply enter “frozen” mode if they receive no imminent reply to their notifications and queries, with disastrous results.
2. Growth/Cashflow Balance
One of the better known investment idioms is that “the profit on a deal is made at the time of purchase” – this is doubly true in property investment, as generally speaking, identifying a good deal and negotiating a good price (when possible) pre-purchase will normally make or break an investment. And it is far easier to provide for a comfortable yield reduction margin when green-lighting a deal, or to reject it for uncomfortably narrow profit margins or high levels of risk, than it is to improve it during the investment’s life cycle. A property price reduction or creative negotiation on fees has a far greater effect on lifetime yields than any other method practicable further down the track, such as renovations, furnishing, tenant-base expansion, or any other method.
In Japan specifically, one must consider the right balance to a property investment portfolio ahead of the purchase, and with a long term view. Capital growth profiteering is problematic in the land of the rising sun, since legislation is geared against flips, short-sales and other short term profit schemes (capital gains tax is 40% in the first five years of ownership, reduced to 20% thereafter). Additionally, looking back at the “lost” two decades since the early 1990’s, one can see that generally speaking, the value of properties tends to go down over time, as opposed to other countries, where the growth/slow cycles are much shorter. And while the last 4-5 years have seen property prices rising in all major cities, concluding with any certainty that this trend will continue far beyond the 2020 Olympics is difficult. Japan is facing several serious demographic and economic challenges, the main two being its’ rapidly shrinking population and rapidly rising public debt to GDP ratio – both of which are currently the worst in the developed world.
The solution lies in a well-balanced and hedged portfolio, focussing mainly on rental yields as primary criteria, with any potential growth to be considered as a bonus if and when it occurs. Fortunately, Japan provides plenty of that, from large tier 2 cities such as Yokohama, Kawasaki, Fukuoka, Sapporo or Nagoya – and well into attractive tier 3 cities such as Kumamoto, Kobe, Hiroshima, or any of the major prefectural capitals around the country (see partial geographic asset diversification strategy and list of cities by population trends here – http://nippontradings.com/financial-data/)
3. Population Trends
Further expanding on the issue touched upon in 2, above, cities must also be chosen carefully, considering Japan’s rapidly declining population. The same list of cities by population trends can be used not only to choose the bigger cities to invest in, but also the ones actually gaining in population to any significant degree. As the smaller villages and townships die out and people migrate into the bigger metropolitan centres, and as government ordinances constantly change, conglomerating clusters of smaller settlements into larger municipal ordinances, opportunities are vastly changing, certain attractive investment locales being practically wiped off the map, while other “come into the light” as newly designated cities.
Here, too, the solution lies in balance, hedging and diversification, with the ideal portfolio structure emphasizing steady, reliable returns in well-established larger cities, and 25-40%of the portfolio at most delving into more adventurous, smaller townships with attractive profiles (bedroom communities to Tokyo, robust economy powerhouses with more than a single industry worth mentioning, internal tourist meccas, and so forth). It is certainly not advisable to stick to only one’s “back yard” when selecting investment destinations, since the market is very large and very dynamic, and such a strategy doesn’t bode well for a nation as weather-disaster prone as Japan. Furthermore, Japanese tenancy laws forbid anyone from entering a tenanted property except the property managers themselves, along with any renovation or repair professionals – and only when specifically requested to do so by the tenant. This means that there is absolutely no advantage in investing “close to home”, since one would have to rely on those property managers in any case, and there would be no advantage in micro-managing or attending in person to any property at any point in time.
Keep all of the above in mind when setting your purchase criteria, and you’ll be well on your way to acquiring and managing an attractive Japanese investment portfolio. Happy investing! J
The author – Ziv Nakajima-Magen is executive manager of Asia-Pacific and a partner at Nippon Tradings International (NTI), a proxy and buyers’ agency representing foreign investors in Japanese real-estate property. He can be reached at info@nippontradings.com or +81 92 600 1613
Questions extremely welcome 🙂
These articles are really interesting, as is Ziv’s site. I suppose my major issue (and think this was discussed a bit in the comments of the last article) is resale. It’s great you can buy a property for about 5 million, but if that brought, say, 40,000 a month in rental income you are still talking over ten years to recoup your outlay. That wouldn’t matter if the property held its value or went up as it tends to overseas, but I don’t have the confidence that it would, so wouldn’t that 5 million likely be invested better in other ways over ten years? I’d love to be convinced otherwise, but wonder if Ziv could say what sort of resale price you could expect on a place going for say 5 million now when it has aged ten or twenty years. With a house, perhaps the land will hold its value or go up even if the house doesn’t, but what is the situation like regarding ageing apartments?
I believe it’s a bit like a car -there’s a depreciation curve that starts off quite steep but levels off…
We bought an old 25-year old manshon this year. Original price 25 million, we bought it cheap for 9 million, I’m pretty sure we could sell it for about what we paid for it. It’s next to a station so the location is good.
Of course I am not an expert so hopefully Ziv will chime in too 🙂
You might be right, Ben. After all, people often say the value falls to zero, but you can never go and buy a place for ‘zero’ can you? Think it hits a low point and maybe hovers there or thereabouts as long as the place still exists.
What Ben said 🙂 The places we’re talking about are generally close to the end of their tax depreciation cycles (47 years for reinforced concrete blocks, from memory), which means they have very little to lose in value, and, as counter-intuitive as it may sound, can only go up.
The only caveat, as mentioned in the previous article’s comments, is the tenancy – if rent has dropped significantly for any reason, the price will also drop accordingly. You’ll often find that tenants who have been living in the same unit for an extended period of time (say, 10 or 15 years, which isn’t all that uncommon in a change-averse society such as Japan), are still paying the same rent they were paying when they moved in, even though these days comparable units would cost them half as much per month – mainly because they do not wish to relocate, and negotiating a better rent is considered “confrontational” (certainly landlords would almost never voluntarily reduce the rent) – in those cases, should the tenant vacate the property, rent forecast would be much lower, and so would the selling price, which is often based solely on potential or actual yield, as far as investment properties are concerned.
All of the above is why, a very important part of the due diligence process on these properties includes comparing average rents for similar units in the vicinity to the actual rent received (assuming you’ve purchased a tenanted property).
Hope this helps!
Oh, and one more caveat – the value for old houses, as opposed to old units, can and certainly does go all the way down to zero, particularly in “inaka” (countryside) areas. Buyer beware, unless it’s for residency purposes 😉
Thanks Ziv – very useful information. Look forward to part 3.
Hi again, Ziv. Loving this series, so thanks again. Interesting to hear that you don’t think there is any advantage to investing close to home as lots of people are big on that in the US.
Last time, you asked me if I had specific examples of the types of rules of thumb I was thinking of. A few in particular that relate to buy-and-hold rental investments would be:
-CapEx 50% rule: Over time, 50% of your real estate investment’s income will be spent on expenses, not including the mortgage. Are you avoiding this altogether by just owning single units? What about renovation costs?
-Rent 2% rule (or sometimes 1% rule): Rent should be at least 2% (or 1%) of the purchase price or it’s not a good deal. True in Japan, or is there anything similar? Basically, I’m just looking to see how you judge whether a property is a good deal or undervalued.
Other questions:
-I’ve read elsewhere that in Japan, you want to target single occupants, not family units. True, and if so can you explain why/say a little bit more about the thinking behind it? I think I know what you’ll say, but figured I’ll ask anyway. 🙂
-Ok- from the above, it makes sense that you’re saying you target older properties that’ve already fully depreciated. If that’s the case, what about the risks of the whole building being bulldozed? What happens in such cases?
-Can you talk a little about multifamily properties, such as a duplex/triplex “apaato” or something on the order of a 6- to 8-unit property? Do you normally suggest sticking with single units, or is this again just to appeal to a wider audience? Is there anything like in the US, where you can get up to 4 units with a normal residential loan, but 5+ units requires a commercial loan?
-Say you have an investment property here in Japan with management in place, then decide to go back to your home country, or move to… Zanzibar, just to pick somewhere totally random. You are now technically not permitted to keep your Japanese bank accounts. What happens then, and how have you yourself dealt with such situations?
Glad to hear you’re finding value in these posts, we aim to please 🙂
From my experience, investing close to home can be a great strategy provided that 1) you’ve got a very small portfolio and have the time, resources and skills to do it all by yourself and 2) you’ve got some advantage (i.e great tenant screening skills/your own tenant database, renovation know-how and the connections to get materials cheaper, and so forth) – if none of the above holds true, I personally find my time and resources are better spent finding and orchestrating the next deal, rather than on fine tuning existing ones – particularly if close to home deals are drying out, which often happens with market dynamics (case in point, Fukuoka, where I live, has now risen beyond comfortable yield levels, and we therefore invest elsewhere in most cases, as do our clients).
As for rules of thumbs as those you’ve mentioned above – they are generally true here as well, but I’m weary of specifying exact numbers such as these, since they tend to statistically work out only over large periods of time and large portfolios – someone who’s only owned 1-5 properties for, say, 1-5 years, will often find that numbers are greatly skewed one way or the other (simply because this is how statistics work). For instance, if you’ve only just purchased your first unit, had your tenant move out three months after the purchase following a decade long tenancy, and had both the AC unit and hot water boiler go at the same time (rare, but happens), the 50% rule goes straight out the window for the next few years, as you scramble to catch up. Similarly, you may find that you don’t need to spend a single cent on the property for the next five years post purchase – again, there goes that rule.
We certainly assist some clients in purchasing buildings, generally smaller blocks of no more than 3-4 floors, but we find the majority of them (and ourselves personally as well) tend to go for the individual units, which tend to generate higher rental yields and carry fewer surprises, since most expenses are covered by building monthly fees. When you own the entire building you’ll always need to put extra money aside, as renovations and repairs will always catch you by surprise, far more than they will internally, if you only own individual units – particularly the smaller ones (which, again, generate higher rental yield than bigger ones in any case).
The reason to own the entire block of units would be the associated large land portion – if prices go up, you stand to gain more – but as mentioned in the article above, this is tricky in Japan, considering two decades of deflation preceding the last few lukewarm growth years, and taking into account the declining population and humongous debt to GDP ratio. So yes, a few well placed purchase could be an excellent idea if you’re poised to make a profit on it over the next 6-10 years or so (don’t forget, again, the double cap gains tax for selling within the first 5), but whether this will be possible or not would take some guesswork and a bit of a gamble – good if you can afford it, meaning, if the rest of your portfolio generates safe, stable income.
We stick to smaller blocks for the reason mentioned above (not wanting to put too many eggs in one basket), and also because once you get to four or five floors it’s harder to populate units at the top levels, unless you have elevators installed – which significantly raises maintenance costs. There is no difference in bank loans as far as I’m aware, but it’s always a good idea to consult with your accountant prior to taking out a loan or purchasing properties, particularly if your asset value is poised to reach app 1mil USD’s worth or so, as there may be tax benefits to corporate ownership as opposed to individual at that level.
When the building gets too old, or even a good few years prior to that, building management companies will try to approach developers and sell it on behalf of the owners cooperative – often these mgmt companies (kumiay kanri) will be in the business themselves, so might make an offer to individual unit owners directly, but that’ll usually be lower than what you’ll be able to get on the open market. Bigger blocks make more money and are better maintained, so this isn’t likely to happen very quickly, smaller blocks make less but are also easier to sell, as we’ve discussed in previous articles. Personally, we’ve only ever facilitated purchased in buildings under 43 years old at this point in time, and they’re huge blocks, and still very well maintained, not showing any signs of significant decline, so wouldn’t be able to comment on the process, as we haven’t had any experience with it yet – we’ve been approached once by a Sapporo building mgmt company who was trying to see if they could buy the units off owners cheap, under the excuse of “the building getting old”, but from our impression it was just an opportunistic money grab attempt, considering the pric
Regarding bank accounts – if you were to actually close your bank account, or for some reason not have a local postal address and phone number, you’d definitely need to hire or nominate someone to receive payments, make payments, and otherwise communicate with local entities on your behalf – as it would be near impossible to get any of the Japanese third parties to communicate with you overseas, let alone remit money internationally.
For this purpose, and assuming you don’t have any reliable relatives or friends who could serve, people would either hire a proxy agent like ourselves, or sign up for virtual office services (alot pricier, but may be worth it if you have a very large portfolio, or other business interests here in your absence).
Very interesting read and posts. In part three will be able to find out anything about financing for buy to lets?
Hi Gareth
Part three is a case study. Financing for buy to lets requires specialized loans which have higher interest rates. You can find them online: http://www.mitoshin.co.jp/personal/loan/lent/ (this seems to be about 3% over max. 20 years)
Definitely ask any unanswered questions by commenting on the third and final installment today!
As the owner of an 8-unit apartment block in Sapporo, I agree with everything Ziv has said and don’t have much more to add. Well done Ziv! I wish I could have read useful information like this before I started. The only further points I feel worth mentioning are:
1) We looked at both old blocks and new ones, and decided that the new ones were far superior in terms of design, layout and construction. Also new ones were more likely to be full for at least the first ten years. So despite the higher cost and depreciation risk we took the plunge and bought a new one.
2) Having said that, the one aspect of construction that we aren’t very pleased about is the insulation. Some tenants have complained about the floors being too cold in winter, especially in those units above the garages. We’ve provided temporary fixes such as carpet tiles, thick rugs and thermal curtains, but at some point I think we might have to pay a lot more to have better insulation installed. Obviously it would have been cheaper and less hassle to have done this at the time of construction!
3) Location is everything, and being within 5 minutes walk of an underground station reduces the depreciation risk enormously. Although we have no intention of selling it, I’ve noticed that similar-sized blocks of the same age and in the same area are selling for the price we paid for ours 12 years ago! In other words, our block hasn’t depreciated at all in its first 12 years. I can only put this down to rising land prices close to underground stations.
That’s it I think. If you have any questions about buying a new block as opposed to an older one, please let me know.
Fascinating stuff, northSaver! Would you be willing to let us know how much you paid for the 8-unit apartment block?
Sorry, not sure how I’ve missed this comment before.
I absolutely agree with your comments, but unfortunately don’t feel comfortable with Japan as a capital growth environment long term (neither do most of our clients). As a result, the points you raised, which are very valid for long term holders of properties or those who plan to try and sell them at a profit are secondary criteria to our deal analysis process – the first two being rental yield (in percentage) and population statistics.
The smaller the difference in yield and population trends, the more we’d be inclined to look at newer builds. Having said that, many of our clients feel the same, and prefer not to get anything too old, which is a perfectly legitimate criteria as well.
As for insulation, size, etc – again, looking at higher yields, we normally go for small units in older blocks – the general frame of mind being that a) these tenants can’t afford to be too choosy and b) that Japan’s most common tenant profile, due to the population and economy decline trend, is, sadly but truly, single folks, low or mid-low income earners, and single retirees.
Thank you for the comments, Ian and Ziv. I was surprised to see this post resurrected!
Ian, the total cost for land, building, fees and taxes was just over 50 million yen, but we took out a 39 million yen mortgage with a 20-year term to pay for it. The outstanding mortgage is now 10 million and the outstanding term 7 years, due to a couple of overpayments we made. But we intend to fully clear the mortgage within 3 to 5 years.
Ziv, we invested in the block as part of our retirement planning. The idea is to receive a good monthly income (based on 75% occupancy) form the block when we retire or semi-retire. I don’t know when or if we’ll sell it, but it was never our intention to sell it for a profit or use it as a capital growth investment. We are only interested in the passive income! So to this end, a newer and more desirable block made more sense to us.
Yes, most of our tenants are young single workers. They don’t stay as long as families, and they don’t pay high rent, but that’s something we have to live with. It’s annoying and expensive paying two month’s commission to the agent every time a tenant changes, so we try to find our own tenants whenever possible!
Thanks and best wishes.