Spotlighting the potential of Japanese real estate

(1) Inbound investment

Foreign investors have long played a key role in the Japanese real estate market. To sustain growth of the national economy as Japan’s population continues to decline, it is becoming increasingly important to continue developing a sophisticated real estate market to attract inbound investment.

Moving forward, the Japanese government expects inbound investment to play a key role in real estate development. In a fairly large number of transactions sponsored by foreign investors, a special purpose company (SPC) purchases property using financing with securitisation structures.

This article outlines an overview of the real estate market for inbound investments by asset type.

Hotels

Hotel assets appear to be recovering significantly from the pandemic as an investment target due to increased domestic travel and a recovery in the number of inbound visitors. According to the Nikkei’s real estate market advisory, two of the top 10 transactions (by deal size) in 2023 were hotel investment projects, compared to none ranked in 2022.

In line with this trend, the government has recently placed more energy and focus into the tourism industry. Capitalising on the natural beauty of the countryside as a tourism resource, the government recently announced a policy of inviting luxury resort hotels and developers of other facilities to open in all 35 national parks in Japan by 2031.

Offices

While not appearing depressed to the point of being negative, investment in this asset class appears to have stagnated somewhat in 2023, as it did in 2022, due in part to rising vacancy rates.

Nonetheless, while office building prices in Europe and the US have plummeted due to rising interest rates and the post-pandemic trend of telecommuting, office building prices in Japan have remained relatively stable, which appears to be one of the reasons behind a stable level of investment.

Residential

Investment in residential property is increasing, particularly in Tokyo and other core regional cities. In the context of an increasingly uncertain market environment including domestic interest rates, this asset type appears to be attracting attention due to the nature of its relatively stable operation.

In addition, some opportunistic investors have been taking advantage of relatively low rents compared to global rent levels in other mega cities such as New York, London and Singapore. As a result of these combined factors, investment in Japanese residential property appears to be growing steadily.

Logistics

The pandemic prompted a significant acceleration in investment in logistics assets due to the expansion of e-commerce resulting from widespread adoption of work-from-home arrangements and quarantine measures imposed.

Following this trend, investment in logistics facilities remained strong in 2023, with a number of funds being newly launched. In the first half, the largest supply was in the Tokyo area, with transactions aimed at strengthening supply chains – such as base consolidation and investment in logistics systems – attracting attention.

Data centres

With growing demand for cloud computing, data centres are being developed in Japan, and investment in this asset class is on the rise. Complicating matters in regard to data centres, there are hurdles in obtaining non-recourse financing at the land leasehold stage without any income generated from a property, but development of data centres may be conducted through other schemes, such as joint ventures.

Driving the trend is IT technology advancing at an accelerated pace and society becoming more and more reliant on information processing over the internet. In tandem comes mounting concern over IT security, with preservation of safe access to data viewed as crucial to many businesses.

In addition, as the volume of data that must be processed continues to increase, many consumers are opting for, or considering, cloud services instead of establishing their own storage systems. Accordingly, data centres are becoming more prevalent.

These data centres generally house clients’ servers in racks with ample electricity, a temperature controlled environment and tight security, providing IT network services and facilities, including cloud services.

It is often beneficial for Japanese companies to use data centres located in Japan because shorter distances result in faster data exchange speeds. Since a certain number of data centres may be required in Japan, it is anticipated that data centre transactions will increase.

(2) Redevelopment projects

In addition to asset types, redevelopment projects are also an important sector in Japan’s real estate market, with a large number undertaken in metropolitan areas in accordance with the Urban Redevelopment Act. These include large-scale redevelopments in major metropolitan areas in Tokyo such as Roppongi, Azabu and Shibuya.

The purpose of the act is to promote greater use of urban land and facilitate the renewal of urban functions. It has unique features including enabling the participation of developers who are development professionals, and also covering project costs by selling rights in surplus portions to redevelopment, or allocating such rights to developers.

Without these features it would be difficult to proceed with redevelopment projects due to the challenges of aligning the interests of various rights holders for small-scale land and buildings in project areas, while also covering project costs.

Although individuals and local governments can carry out urban redevelopment projects, redevelopment associations are used in many cases. The procedures generally involve: (a) an urban planning decision; (b) preparation and approval of a project plan; and (c) rights conversion, which is the main procedure, converting rights in existing real property into rights in newly redeveloped property.

Increased project costs

One of the material issues regarding redevelopment projects is a significant increase in project costs, with various contributing factors. The main factors are the soaring cost of construction materials due to post-pandemic price increases and the weakened yen, as well as the difficulty in securing human resources.

The construction industry has a chronic shortage of human resources, while employment regulations such as the overtime limit, initiated as part of work-style reform, have applied from 1 April 2024, after a five-year grace period.

An ageing workforce and long working hours are other factors contributing to the difficulty in securing human resources. Together, these factors appear to make it difficult to establish long-term business plans for redevelopment projects.

SPC scheme

In recent years, there has been an upward trend in the number of projects that involve not only the participation of professional contractors or developers, but also the use of a real estate securitisation structure – such as a TK-GK structure or TMK structure – to finance part of the project costs.

There are several ways in which a special purpose company (SPC) can be involved in a redevelopment project, including the SPC becoming a participant in a redevelopment association, or an acquirer of surplus floor space after redevelopment. In this case, the difficulty level is high because both knowledge of real estate liquidation schemes and redevelopment projects is required.

TK-GK and TMK structures are regulated by the Financial Instruments and Exchange Act or the Asset Securitisation Act, respectively, neither of which is directly related to development-related laws and regulations.

For example, at the time of approval of a business plan, the relevant authorities may require that an SPC submit a letter of support from a sponsor to guarantee the SPC’s credibility and commitment to long-term involvement in such projects.

Note: For specific matters regarding relevant laws, types of proprietary interests, structures for ownership of real estate including SPC schemes, and legal due diligence, please refer to our 2023 ABLJ article titled ‘A regional comparison of real estate markets: Japan’.