ASIAVIEW: An experiment gone awry?

For the first time in four years, Japan's property market recorded a significant slump in annual investment volumes. According to data released by the Tokyo-based real estate consultancy Urban Research Institute in early April, ¥4.08 trillion (€33 billion; $37.4 billion) worth of property investments were made in 2015, signalling a 23 percent contraction in comparison to the year before. The volume of investments by foreign investors dropped 50 percent to ¥543.1 billion, while the number of deals fell to a mere 29 from 97. Inflated property prices were attributed as one of the reasons for this subdued performance.

Those expecting 2016 to fare better will be disappointed. It appears that Japan's recent monetary policy maneuvers are largely to blame.

The Bank of Japan's decision to adopt negative interest rates – an unprecedented move for a country struggling to break out of a protracted deflationary slump – has led to more unintended consequences than anyone anticipated. Instead of falling, the yen has surged to an 18-month high against the US dollar and appreciated against all 15 other major global currencies in 2016.

For the property sector, however, Japan's floundering experiment with negative interest rates has already started to change the composition of the market and impact investment volumes. Preliminary figures from property consultancy JLL suggest transaction volumes in Japan dropped to just below $10 billion in the first quarter of 2016, down from nearly $13 billion in the same period last year.

Also, there is now a tangible shift away from pure equity investments toward debt deals. In an environment of cheaper credit, managers are preferring to refinance deals instead of selling. PERE has heard how transaction volumes this quarter would have actually been higher than the same time period last year if they included all the large assets that were supposed to be sold but were eventually refinanced.

Last December, a consortium of investors led by Asia Pacific Land reportedly started inviting bids for the Shiba Park Building, with plans to sell the landmark Tokyo property for more than ¥160 billion. APL, in partnership with the Abu Dhabi Investment Council, the Hong Kong-based investment manager PAG and the US foundation CV Starr, had acquired the 1.1 million square foot property for ¥110 billion in August 2013. However, according to a February report in Reuters, the sale process was shelved and a decision was made to refinance as much as ¥135 billion in five-year debt to take advantage of the low interest rates.

It is not too often that a core asset of this size and scale in central Tokyo is up for grabs, especially since many of the large properties in Japan are owned by developers and are not traded often.

To be sure, there is enough equity capital, both foreign and domestic, chasing deals. A broker says he has met more foreign buyers eager to buy property this year than any three-month period last year. But the surge in property and land prices due to continuing investors' interest, along with low rental growth – largely attributed to commercial tenants' concerns amid an uncertain economic outlook – is continuing to create a downward pressure on yields. According to a Nikkei report, rental yields are currently estimated to be around 3 percent for high-grade properties in central Tokyo, while foreign investment funds typically prefer to buy assets at a 5 percent yield. In the case of the Shiba Park Building sale, the asking price was reportedly thought to be too high for potential bidders.

A constricted supply, further limited by owners' preference for refinancing, only makes things worse.

Barring private equity fund managers which are obligated to sell assets if the fund's expiry period is nearing, investors have no motivation to sell into the market currently. Balance sheet investors would prefer to keep the levered yields on the property rather than struggle with the cash generated from the sale proceeds. Depositing it in the bank would yield nothing, and recycling it back into the property market at a time of inflated asset values does not make financial sense.    

In a recent interview with Bloomberg, Tomohisa Fujiki, head of interest-rate strategy at BNP Paribas Securities Japan, termed the situation as being in “Alice in Wonderland every day.” Given their ongoing misadventures, participants in the property industry may feel that they, too, have fallen down the rabbit hole.