The tide is changing for commercial real estate in Japan, with lower returns signaling the “first meaningful slowdown in the current cycle”, according to preliminary findings published by Deutsche Asset Management.
In its first quarter Japan Real Estate Market report, the firm has estimated that the total return for unlevered direct real estate investment in Japan slipped to 8.2 percent in August last year, down from 8.7 percent recorded in December, 2015.
While August was the latest period analyzed in the report, Koichiro Obu, the firm’s head of research and strategy for Asia Pacific, told PERE commercial real estate returns are expected to have dipped further thereafter to around 7.5 percent.
The report has attributed the drop in returns to softening capital growth driven by already tightened cap rates in valuations. The cap rates in Tokyo office for instance declined to a preliminary 3.5 percent in the third quarter of last year, a 40 basis points drop from a year earlier.
However, according to Obu the cap rate compression period is now ending and total returns in Japan are mostly being generated from income returns. This especially holds true in the residential sector where cap rates have compressed by around 50 basis points.
The slowdown in returns, the report noted, is also the most evident in the residential sector where the average returns declined to 6.9 percent in August 2016 from 9.5 percent in June 2015. In others real estate sectors, returns have remained flat.
Meanwhile, there has also been a drop in investment volumes. Total volume of commercial real estate transactions in Japan for 12 months ending December last year was JPY 2.9 trillion ($25.4 billion; €24 billion) a 17 percent drop from the previous period ending September. While specific quarterly figures were not cited, Deutsche Asset Management attributed the declining transaction volumes especially in central Tokyo to a lack of investable grade assets and fully priced valuations.
The report’s analyses of the major real estate transactions suggest that listed Japanese real estate investment trusts (REITs) remain the dominant buyers of properties, especially in the office and hotel sectors. For example, 43 percent of all transactions in Tokyo were done by listed J-REITs.