Four key takeaways from the Japan report

Japan’s real estate market is at a crossroads in several key areas: decarbonization, digitalization and J-REIT disruption.

A long road lies ahead for Japanese real estate owners to reach ambitious net-zero targets, with many challenges to overcome in both the residential and commercial sectors. While the digital opportunities show more promise, the J-REIT market faces significant disruptions. Here are the key takeaways of what is to come in PERE’s latest Japan report.

1It’s not easy going green

Japan has committed to cut its total greenhouse gas emissions by 46 percent by 2030, and to reach net zero by 2050. This puts real estate firmly in the spotlight. Commercial and residential buildings together made up 33 percent of the country’s emissions in 2020. The former was up by 39 percent and residential up 29 percent on the region’s emissions recorded in 1990.

The challenges are many. Simple electrification is not enough, since renewables provide only 22.4 percent of grid power, so a 2030 target of 36-38 percent seems a stretch. The region also has a low percentage of renewable energy facilities or plants in operation, Helen Gurfel, global head of sustainability and innovation at CBRE Investment Management, tells PERE.

Clean energy generated on-site will therefore be vital, especially for residential housing. The Zero Energy Home (ZEH) ratio needs to accelerate “substantially” from its current level of 50 percent. Fortunately, companies are responding. According to real estate services firm Savills, Mitsui Fudosan Residential and Mitsubishi Estate Residence will complete Japan’s largest ZEH condominium development in 2025, with on-site power generation and virtually zero CO2 emissions.

Some players have also implemented decarbonization initiatives in the commercial space. According to Nikkei Asia, Mitsui Fudosan will reduce its emissions by about 10,000 metric tons per year using electricity produced at its own solar power plants. Renewables are being explored now “because electricity has become much more expensive,” says Adam Donahue, head of custom accounts for Asia-Pacific at investment manager LaSalle. “We manage a number of shopping malls in Japan [and in 2023] we hope to generate 800 kilowatts of electricity from… solar panels.”

More scrutiny is expected on the sustainability credentials of an asset, as an increasing number of offshore institutional investors look to Japan. Mark Cameron, head of sustainability for Asia-Pacific at Nuveen Real Estate, tells that the “physical risks associated with climate change” have caused the manager to reconsider deals.

2Retrofitting on the agenda

In larger Japanese cities, approximately 80 percent of the buildings that will be standing in 2050 has already been built. Three percent of existing buildings will need to be retrofitted each year to hit global decarbonization goals, Elke Kornalijnslijper – head of sustainability consulting, Asia-Pacific at broker JLL – tells PERE, and this “will require the financial and physical commitment of both owners and occupiers.” A 55 percent reduction in building emissions compared with 2017 is necessary, according to consultant McKinsey, and can be achieved by installing better insulation and switching to electric heat pumps. Buildings are owned by just a handful of major real estate companies in Japan, all of which are used to retrofitting to withstand frequent earthquakes experienced in the region.

US manager Hines is spending $15 million of capex on its 2021 acquisition, Yokohama New Stage, a 538,000-square-foot office building constructed in 1993. “To begin, we are installing natural wind cooling, converting to LED lighting, and applying anti-UV film onto the glass atrium. We will also be upgrading… to more energy efficient equipment,” Jon Tanaka, senior managing director for Japan at Hines, explains to PERE.

There are plenty of challenges, however. Retrofitting at a time of higher costs and stagnating rents is no mean feat, paired with an absence of clear governmental direction. Many key industry players, such as The Real Estate Companies Association of Japan, have proposed the idea of increased regulations or standards, while Savills has urged energy audits and green building certifications to provide better benchmarking for the market at a time of macroeconomic uncertainty.

However, in assessing energy use, Kornalijnslijper says: “We normally face difficulties compounded by a lack of access to architectural and schematic plans… and insufficient energy meter maintenance data.”

Tenants are often not willing to disclose their energy consumption, and to combat this, utility and SaaS companies are looking at creating a service that takes tenants “out of the equation,” according to Gurfel.

3Former (digital) glory

Japan was once viewed as a digital leader and is now staking a claim to becoming one again. It is seeking to enable better digital infrastructure as a catalyst for a post-pandemic rebound. Foreign direct investment has skyrocketed from an annual average of $663 million in the 2010s to $2.4 billion in 2021, and the Japanese government has since established The Digital Agency to drive investment.

In the past, investments have been hampered by an aging population, an underdeveloped start-up company ecosystem and a general decline in Japan’s digital competitiveness. Between 1994 and 2018, digital investment in Japan stood at just 1.1 times national GDP, according to government figures, versus 2.8 times in the US. According to the 2022 World Digital Competitiveness Rankings, Japan ranks below Singapore, China and South Korea.

There are obstacles to improving this position. “Entering the sector is difficult,” says Fred Fitzalan Howard, associate director and data center lead for Asia-Pacific at consultancy Knight Frank. “Land and power availability in attractive data center locations, such as Tokyo and Osaka, is minimal and costs to secure these land plots have risen aggressively.”

But there are also favorable factors. US trade disagreements largely center on China, and it now looks set to partner with Japan’s semiconductor industry to head off the threat of a chip shortage. Japan also has laws that support and facilitate the digital economy, Joelin Ma, director for real estate, Asia-Pacific at APG Asset Management, tells PERE.

“Land and power availability in attractive data center locations, such as Tokyo and Osaka, is minimal and costs to secure these land plots have risen aggressively”

Fred Fitzalan Howard, Knight Frank

The Japan data center market alone is estimated to grow at a compound annual growth rate of over 7 percent, and reach a value of more than $13 billion by 2027 according to research firm Arizton. There are certainly investments in the pipeline, including Gaw Capital acquiring Fuchu Building in Fuchu Intelligent Park and Hulic developing the Kobunacho Kinen-Kaikan Building, both in or near Japan’s capital.

4Disguised opportunities

After a post-pandemic recovery, the $120 billion market J-REIT market has fallen 13 percent in expectation of rising interest rates and a rise in property cap rates. On average, J-REITs are now trading at a slight discount to net asset value, making them vulnerable to takeover bids.

However, M&A is rarely straightforward in Japan. As of March 2023, the market has recorded just one privatization, and one successful hostile takeover. The conservatism of the nation’s investors, and the often-sizable stakes held by J-REIT external managers, act as barriers to M&A, as do cross-shareholdings by major domestic corporations in the wider market. Corporate governance reforms have led to more transparency and activism, but nothing like that seen in other regions.

“Privatizations are complex transactions,” Calvin Chou, head of Asia-Pacific at asset manager Invesco Real Estate, tells PERE, “and the discounts to NAV in the J-REIT sector are not wide enough to encourage investors to make the effort required.” The hiatus will influence the wider Japanese real estate market, as J-REITs have been one of the largest sources of core capital.

But should the J-REIT index fall further than expected, opportunities could arise. The few transactions that have occurred set a precedent for managers with the capital and an understanding of Japan’s business culture. Certainly, smaller players might find privatization preferable to slow decline. David Cheong, a managing director in manager KKR’s real estate team, says the “smaller REITs don’t get the economies of scale which larger managers have” and these select REITS have “faced more challenges to achieve growth.”

What is more, transactions in the J-REIT space need not necessarily be sparked by discounts or distress.