With bond yields near 30 year lows and fears of tapering causing bond prices to fall, what’s a private investor to do? Here’s one idea on how you could earn a 6 – 8.5% return by investing in Tokyo’s buy-to-let market.
Last year professional investors were buying up Tokyo’s real estate, thanks to the wide spread between Japan’s low interest rates and high rental yields (see JETRO report). This year the money continues to flow into the capital, spurred on by expectations of economic growth driven by Japan’s aggressive monetary easing program under Abenomics (see FT article).
Private investors too can profit from Tokyo real estate either by buying Japanese Real Estate Investment Trusts (J-REITs) or by purchasing buy-to-let property. To explore the latter option, Beacon Reports spoke to Erik Oskamp, CEO of Akasaka Real Estate. Founded in 2007, Akasaka Real Estate helps foreigners invest in Tokyo property. The firm manages 220 Tokyo residential properties on behalf of private buy-to-let clients.
When Oskamp came to Tokyo in 2004, he bought a house to live in. The entrepreneurially spirited Dutchman then bought a second buy-to-let apartment. That number has since grown to 22 units. Back then however, property prices were opaque. To make prices transparent, he built a database using the quantitative and statistical methods he had learned while previously working as a computer programmer at big investment banks. The program he wrote collects Tokyo residential real estate prices from public sources, including estate agent’s websites. Whenever residential property comes onto the market, the computer picks the new information up and alerts Oskamp by email.
Using the property database, Oskamp quickly finds the best deals. The database compares “for sale” listings against seven years’ worth of collected data. With price transparency, he can take immediate action to buy property valued at or below market value.
Studying the collected data, Oskamp discovered that small and older properties, typically around 30 years old and below 20 m², produce the highest rental yields. Rental yield is a measure of return on investment. It is equal to rental income divided by a property’s purchase price.
He recommends that clients buy units as small as 10 to 12 m² − literally, ‘boxes.’ “That is the sweet spot,” says Oskamp. Yields decline as property size increases. A small property located in the city center might earn a gross yield of 9 to 10%, whereas a three-bedroom apartment typically earns 5%. Investors should therefore consider purchasing a few smaller properties in preference over one big one.
Small is beautiful
He also recommends buying property that is fully depreciated. Homes depreciate fast in Japan. In the past, they were built of wood, paper (shōji) and lightweight materials designed to flex in earthquakes. So the Japanese developed a habit of always buying new homes. “When you buy a new property, you lose 60% of your money within 30 years,” says Oskamp, adding, “Most people believe that you should buy new properties because they always rent out. But, older properties have a much higher rental yield.”
The firm steers clients towards investment properties in Tokyo and its suburbs rather than the countryside. One reason is that Japanese workers, tired of long commutes, are taking advantage of deflated property prices by moving back into Tokyo’s 23 wards. People are leaving the countryside to escape economic stagnation and to live in Japan’s liveliest city. Even though the country’s total population is projected to rapidly decline, Tokyo’s population has and is expected to continue to grow year after year for some time to come.
One reason that smaller properties earn such high yields is that demand for them is increasing. Demand is driven by the rise in the number of one-person households. Higher divorce rates and an increase in the elderly living on their own is also a contributing factor.
The firm steers clients toward properties needing little renovation too. “Tenants won’t pay a premium for anything new,” says Oskamp. He recommends only buying property where the required renovations would be limited to an application of a new coat of paint, repairing broken appliances, re-paneling of the kitchen and so forth.
He also suggests buying units within apartment complexes that are properly maintained and operated by a building management company. Management companies are responsible for maintaining the condition of a building (but not their individual apartments). They give the building a coat of paint every 10 years and overhaul elevators every 30 years. That shifts responsibility for the bulk of the maintenance work away from the buy-to-let owner and onto to the building management company.
Thankfully, repairs are inexpensive on apartments measuring 15- 20 m². Sometimes a broken pipe needs to be replaced or the bathroom cleaned at the end of a tenancy. Every 25 years or so an apartment’s water heater or air-conditioner needs replacing. “In a small apartment,” says Oskamp, “there is less to trash.”
Net rental yields in central Tokyo are reported by Oskamp to be 6 to 6.5% on units costing 8 – ¥9 million each. In the suburbs, they are 8 to 8.5% on units costing 4 – ¥6 million. Net rental yields are calculated after expensing all costs, including a 5% property rental management fee that Akasaka Real Estate charges to those opting for the additional service. The figure excludes income tax, vacancy periods and other exceptional expenses.
The location you choose to buy depends on your strategy. The highest yields are in the suburbs where prices are stable. The biggest potential for capital gains (and losses) are in central Tokyo.
One reason prices are more stable in the suburbs is that people don’t move as often as they do in the center. Also, there is more land to build on. Increased demand in the suburbs results in a rise in building construction rather than significant increases in home prices. On the other hand, when the economy does well, everyone wants to move into the center where land is limited. That pushes the price of city center properties up and depresses rental yields. “After the 3/11 earthquake,” says Oskamp, “prices in the center went down 15%. In the suburbs however, prices moved down only 3 – 5%.”
Investors who can tolerate added risk might consider investing in the center rather than the suburbs. The combined effects of aggressive monetary policy and fiscal stimulus under Abenomics could lead to higher inflation. Inflation expectations have already caused the yen to depreciate by almost 30% since September 2012. Foreigners are taking advantage of a weaker yen to buy Tokyo property. According to Oskamp, prices are up 20% and may eventually rise by 50%. He believes that real estate prices need to rise anyway to put Tokyo on par, in terms of costs, with other major international cities.
If you have a 10 to 20-year investment time horizon or are seeking an income in retirement, you might consider buying Tokyo property as part of diversified portfolio. There are no legal restrictions against doing so as a foreigner and you don’t need to be resident.
Before you reach for yield in Tokyo’s buy-to-let market, make certain you understand the risks. Real estate is an “alternative” asset class deemed to be riskier than a typical investment in a stock or bond. Property is illiquid. Once bought, there is no guarantee that you can easily sell it when you need the cash. Nor are there any guarantees the property will always be occupied by a paying tenant. As Oskamp rightly points out, you’re not earning the 6 – 8.5% returns without a reason. “Investing in real estate is not risk-free,” says Oskamp.
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