Investors should consider the implications of prime minister Abe’s policies on the Japanese real estate markets, writes Cuong Nguyen
Much of the world, including institutional investors, is taking a renewed interest in Japan. Following the election in December 2012 of prime minister Shinzo Abe and return to power of the Liberal Democratic Party (LDP), Japan’s stockmarket has risen significantly.
Prime minister Abe’s expansionary fiscal policy coupled with the Bank of Japan’s (BoJ) more aggressive monetary stimulus, both of which are intended to boost economic growth and raise inflation, has improved market sentiment.
The steps taken by the new government in an effort to restore growth to the Japanese economy are positive. From an institutional investor perspective, there are some bright spots in Japan, representing interesting investment opportunities.
Within Japanese real estate, the office and logistics sectors are a good example. In recent months, a structural shift has occurred. The growth in the third-party logistics industry and e-commerce is driving companies to seek greater efficiencies from their supply chains.
This has led many firms to move from older style to more efficient new premises; a trend that is likely to continue in the medium term. In the office sector, rents for prime assets declined significantly following the financial crisis and the difference between prime and secondary office rents are at historic lows.
This has driven more large companies to take up residence in prime real estate premises. In addition, many companies that would traditionally have rented lower-grade offices have upgraded and moved into higher quality, more efficient premises. With more corporates now installed in high quality office blocks, there is scope for significant rental growth among prime properties in the years to come.
Another bright spot for Japanese real estate investment is the J-REIT market, which has been a beneficiary of Japan’s monetary expansion as the BoJ will continue to increase its holding of J-REIT debt and equity securities as part of its recently announced monetary policy. The government’s J-REIT purchase programme has resulted in a lowering of the risk premia ascribed to them – that is they are seen as lower risk than previously.
This has sparked significant activity in the J-REIT market, with J-REITs increasing public equity issuance with four initial public offerings (IPO) since November 2012, particularly in the logistics sector. Attractive portfolio yields, the structural shift from older to newer, more efficient property, and improved transparency in the market have generated renewed interest from retail and institutional investors.
It’s clear that Japan provides good opportunities for institutional investors to invest into sectors of the economy that are experiencing structural change. And, in the short term, J-REITs are likely to remain active and influence pricing positively for certain sectors, in particular office and logistics. However, investors considering increasing allocations to Japanese real estate would be wise to proceed with caution.
The Japanese economy has been mired in deflation, high levels of government debt and a shrinking population for much of the past 20 years. More recently, Japan’s trade balance has turned negative following 30 years of surplus, further compounding the structural challenges facing the Japanese economy. There is some debate as to whether Abenomics can provide enough of a catalyst to rescind these challenges and deliver sustained growth and structural changes required within the Japanese economy and real estate markets.
Until the economy recovers, the BoJ has stated an open commitment to buy a range of financial assets, including assets held by the private sector. It has the balance sheet capacity to do this. The question is whether the proposed expansive monetary policy will be effective and what risks are attached to its implementation.
Some commentators look to the US, where extensive QE is prompting a moderate economic recovery, and assume this will work in Japan. But in contrast to the US, the Japanese economy has an inflexible labour market, low levels of immigration, low service-sector productivity growth and high-energy costs. Japan’s working population is widely believed to have peaked in 2012. If growth in productivity does not exceed the rate of population decline the economy will contract. And Japan’s labour market itself faces structural challenges that undermine the ability of Japanese companies to increase productivity.
For example, there is a heavy reliance on contract workers. While this has increased the flexibility with which corporations can respond to the demand for labour over the business cycle, it is creating labour market dualism leading to lower levels of employee training, lower productivity, lower wages and therefore a lower propensity to consume. The inherent structural issues facing the Japanese economy will not be overcome solely by extensive QE. While initial market reaction to the promise of more extensive QE have been positive, a weakening of the JPY and strong rally in the pricing of risk assets, the longer term effectiveness of extensive QE to overcome the structural issues referred to above must be questioned.
To supplement the proposed aggressive monetary policy stance, Abe has outlined broad details of a JPY10.3trn fiscal package designed to boost economic growth. Private sector demand in Japan needs to increase and in the short term is reliant on government stimulus to do so. But previous government expenditure has delivered a negligible multiplier effect to the economy. Concerns remain as to whether the latest bout of fiscal stimulus will be invested productively and create real value for the economy and boost private sector demand.
It is also important to consider the key risks associated with Abe’s monetary and fiscal policies. For example, if the 2% inflation goal is achieved without a commensurate increase in wages, this would result in a decline in purchasing power for consumers. This would have negative ramifications on private consumption, particularly for contract workers. The objective of increasing aggregate demand via creating an incentive for households to increase consumption would be negated.
Institutional investors must look at the impact that Abe’s policies will have on the medium term, sustainable performance of the economy and, by definition, on the real estate market. Based on the initial policy announcements, there appear to be few elements that will mitigate the inherent issues facing Japan’s economy. Until there is evidence of real structural reform that deals with Japan’s deeply embedded deflation, deficits, government debt and demographic challenges, it is difficult for a long-term, value-driven investor to significantly re-rate the Japanese real estate market.
Institutional investors would be wise to review investment opportunities in the Japanese real estate market based on medium-term fundamentals as opposed to the short-term momentum that the fiscal and monetary stimulus may bring to the real estate market.
Cuong Nguyen is senior research analyst at PRUPIM Singapore