Take Me Back To “Things To Avoid In Japanese Real Estate, Part I”.
A Floorplan That Is Odd or Unusual
Not every home is rectangular. Some have “eccentric” designers who design them to look like a shuriken, a sausage, or an eyeball. Are the toilets, or is the kitchen, in a disconcerting place? Are the hallways too narrow? Of course some odd or unusual floorplans might appeal to a certain niche. However, it’s unlikely that niche will happen to be in the market right when you sell. Therefore, avoid a floorplan that is odd or unusual.
Some potential tenants, especially the elderly and handicapped, would prefer (or even require) an elevator. Not having one could cost you their business. On the other hand, elevators are expensive to maintain. There must be elevator inspections, maintenance, and repairs, and those aren’t cheap. Some would recommend having an elevator; others would not.
Try To Avoid “Existing Ineligible Properties” and “Illegal Properties”
In a perfect world, the building codes would cover every contingency, and every construction company would build each building flawlessly. In the real world, the government updates building codes every so often. Construction companies make accidental mistakes, or just outright cut corners. Just because a property doesn’t follow the building codes now doesn’t mean they’re going to tear it down. In fact, even if it didn’t follow building codes at the time of construction, it may still stand.
Existing Ineligible Properties
Was the building legal at the time of construction, but doesn’t follow all the buildings codes now? Then it’s an “existing ineligible property” (既存不適格建物, kison futekikaku tatemono). Japan enacted the Building Standards Act (or Law) (建築基準法) in 1950, but has updated it since then. This has resulted in some buildings built before the updates that are still standing. For example, a revision in 1970 specified a limit on floor area for a given amount of land. Would they tear down a building built in 1969 that now had too much floor area for that amount of land? Of course not. However, it would become an “existing ineligible property.” It could still be standing today. Legally, the owner could still sell it, and a buyer could still buy it. However, it would be more difficult for the seller to get a loan.
Why would one want to buy an “existing ineligible property” when existing eligible properties are available? Because, being built long ago, before the town or city sprawled out fully, these buildings are often in prime locations. They’re often near train stations, and the prices are reasonable. Therefore, beginner home owners or real estate investors should not necessarily blanket-avoid them, but should do their homework carefully.
They don’t follow the Building Standards Act (Law), not even at the time of construction. Did the developer/construction company make an honest mistake, or cut corners on purpose? Particularly if the building cost billions of yen to build, they’re not just going to tear it down. Nevertheless, beware of illegal properties.
Try To Avoid Buildings Vulnerable To Seismic Disasters
Japan is part of the same “Pacific Ring of Fire” as Taiwan, New Zealand, California, etc. From time to time, earthquakes and their accompanying tsunami definitely do happen. Japan is a word leader in earthquake-resistant building technologies; damage and casualties are dropping at a given magnitude. It began to enforce the “New Seismic Standards” in 1981, then updated them in 2000 and again in 2007. Check that your building adheres to at least the 1981 standards. The 2000 or 2007 standards certainly wouldn’t hurt, either.
The Building Is In Great Shape, But What About The Land And The Surrounding Area?
When buying Japanese real estate, avoid buildings built on ground that is prone to damage from earthquakes, particularly liquefaction. Check the local flood map to make sure it’s not in danger from flooding, either. Liquefaction is when there are loose particles, such as sand, that combine with water.
During an earthquake, a building can tip or even fall over (for example, in the 1964 Niigata Earthquake). Liquefaction also occurred during the 1995 Great Hanshin Earthquake. Is the building on soft ground? Is it on reclaimed land? Is it near earthquake faults? All three of these can increase the risk of earthquake- and flood-related damage, e.g. from liquefaction.
Even if your building is on solid ground, not near any earthquake faults…and has the latest anti-earthquake standards from 2007, and even backup generators, etc…still think about the surrounding area. After a major earthquake, hopefully the residents in your building will be fine. What will the neighbourhood/town/city be like, though?Buy fire insurance, and earthquake insurance as well. That way, you can receive substantial reimbursement if the tectonic plates decide to shift during your period of ownership.
Try To Avoid Not Keeping Up With Trends
In 1960, just over 35% of Japanese lived in one of the three major metropolitan areas (第三都市, dai san toshi). These are Tokyo, Osaka, and Nagoya. Nowadays, 56.7% do.
This means that investors should avoid rural/suburban Japanese real estate far from Tokyo, Osaka, Nagoya, or other major megalopolises. In the countryside, elementary schools and train stations close down. There just aren’t enough people to justify their upkeep. Meanwhile, big cities continue to grow.
More Single-Member Households
Japan is now grappling with a new trend: a low birth rate. As an investor, you needn’t worry about this as long as you know how to deal with it. Thanks to the aforementioned urbanisation trend, Tokyo, Osaka, and Nagoya will always be full of people. Probably for as long as you (or your grandchildren, probably) are alive. However, there will almost certainly be an increase in single-member households. They’re not going to need 4LDKs or 3LDKs; they’ll prefer affordable 1Ks and 1LDKs. According to one estimate, by 2040, 39.3% of households in Japan will be single-member households. Great for investors buying studio apartments.
If you aren’t paying cash, then you’ll probably use a mortgage. Mortgage rates in Japan right now are incredibly low, only about 1~1.5%. Should you choose a fixed-rate mortgage or a floating rate mortgage?
A fixed-rate mortgage will have one fixed interest rate. It won’t change over the next x number of years (e.g. 35 years in the case of FLAT-35).
On the other hand, a floating rate mortgage is based on the current interest rate. For a while, Japan has had ~0% interest rates and even slightly negative interest rates to encourage spending rather than hoarding. Therefore, right now, a floating rate mortgage doesn’t look too threatening. Will these low interest rates persist, and for how long? Historically, not forever. Accordingly, even if the fixed-rate APR% on offer is higher than the variable rate APR% (which it will be) it will make more sense to lock in the fixed-term rate, knowing that the only way is up moving forward.
How can you mitigate the risks of a floating rate mortgage if you have one? Well, you can pay it off early (if you’re liquid and don’t have other investment options available to you). You can also lock in an interest rate with a fixed-rate mortgage via re-financing.
Try To Avoid Any Situation That Could Result In Not Receiving Rental Income, Either From Prolonged Vacancy Or Delinquent Rent Payment
Beware of areas with low market rent. Take a look around and see what other nearby units are renting for, and if there are many vacancies.
When a renter signs a lease (typically for two years) in Japan, insist that they sign up with a guarantor company’s rental insurance. The cost will be between 50% to 100% of one month’s rent cost and is paid for by the tenant. This process will be managed by your real estate agent.
One of the biggest risks to a real estate investor is a long period of vacancy. During such a period, the landlord is on the hook for management fees, repair fund fees, and property taxes. He or she might even be making mortgage payments. However, no income is coming in. Another risk is having a tenant, but not receiving the rent on time or in full. In many ways, this is even worse than vacancy. Consider joint guarantors and guarantee companies to offset the risk of late- or non-payment.
Things To Avoid In Japanese Real Estate: Conclusion
There are plenty of opportunities to earn generous ROIs on Japanese real estate. If you want low-risk investments, consider some units in the 23 Special Wards of Tokyo, where ROIs are around 5.5%. Tenancy rates are 95%+, meaning very little vacancy risk. Depending on your tolerance for risk, ROIs above 10% are available. However, beware of red flags. Every building has its flaws, and you shouldn’t avoid a building just because it has one minor flaw. However, there are some more serious things you should definitely avoid.