A weaker yen, attractive interest rates and increasing consumer demand spurred by post-COVID market re-opening has made Japan’s real estate market one of the hottest Asian investment options for global investors in 2023. This is keeping real estate lawyers extremely busy.
Investments into Japan’s property sector have been garnering increased attention from global investors in the past year, as stable regulatory conditions and a loose monetary policy provide a window of opportunity to capitalise on the country’s declining currency value and low-interest rates.
The Bank of Japan’s Financial Systems Report for October said that real estate-related loans have continued to increase amid the rebalancing of private debt and economic activity. The report also found that foreign investors are driving an increase in funding demand in the country’s real estate transactions market.
Total foreign investments in Japanese real estate climbed by 45 percent in the ﬁrst half of 2023, led by substantial investments from institutional investors, private equity ﬁrms, sovereign wealth funds and corporations, a CBRE report found.
This significant rise in interest among global investors is not simply a “right place at the right time” moment for Japan. A combination of monetary and regulatory decisions has put Japan on the cusp of a real estate boom and a ﬁercely competitive market that could bring a lot more work for the country’s legal advisors in the near future. Theo Seltzer, a partner in U.S. law ﬁrm Morrison Foerster’s Tokyo-based real estate team, summarises the main reasons for this rise. “The key factors driving the surge in foreign investments in Japan’s real estate market in the past year include a weak yen as compared to other currencies, particularly the U.S. dollar; Japan interest rates remaining very low as compared to other jurisdictions as the Bank of Japan has not followed other central banks in a steep rise in interest rates, which allows investors to obtain a positive leverage; Japan banks still welcoming new business; Japan being a stable, rule-of-law country, making it attractive in a time of general global concerns; and Japan – in particular the large cities – having a large pool of investible high-quality real estate assets.”
Gerald Fujii, a partner at Withers’ Tokyo ofﬁce, also points out that years of Japanese experience and sophistication in foreign investments provides an ideal and seamless platform for increased global capital to pour into the nation. “Other factors include the fact that Japan is a sophisticated market that is well-served by high-quality managers, lawyers, tax advisors and other real estate professionals who have many years of experience providing services to foreign investors,” says Fujii.
WINDOW OF OPPORTUNITY
The Bank of Japan’s decision to maintain a loose monetary policy has resulted in the yen dropping almost 14 percent against the U.S. dollar in 2023, which industry watchers say is a thirty-year low.
“As the value of the Japanese yen reached historic lows against other major currencies like the U.S. Dollar, a window of opportunity opened to cross-border players holding available investment funds in other currencies to acquire Japan assets priced attractively in Japanese yen. Investors are taking advantage of this window of opportunity. As the value of the yen likely increases in the future, opportunistic investors will see their returns boosted by favourable exchange rate changes,” says Joel Rothstein, chair of U.S. law ﬁrm Greenberg Traurig’s Asia real estate practice.
While partly driven by the devaluing currency, the surge in investment is also driven by low interest rates and a stable geopolitical climate, particularly for those looking to reallocate funds from China, where a real estate crisis and geopolitical concerns have chilled investments.
“Japan’s geopolitical landscape has fostered relative economic stability, leading the government to initiate strategies aimed at enticing foreign investments. This drive is supported by Japan’s low-interest rates and a weakened Japanese yen in the foreign exchange market,” says Jun Usami, executive partner at White & Case’s Tokyo ofﬁce and co-head of the ﬁrm’s corporate practice in the country.
“The Japan investment market is beneﬁting from the reallocation of Asia investment capital away from other markets. As the China market has faced headwinds, global real estate funds and asset managers have been reallocating resources that previously would have gone to China to markets like Japan and Australia, and in the case of more developing markets, to Vietnam,” adds Greenberg Traurig’s Rothstein.
Another pivotal factor in this growth story has been the rising demand for a variety of real estate spaces, particularly traditional ofﬁces, healthcare amenities, logistics and warehousing facilities, data centres and hotels.
“Foreign real estate investors are drawn to hotel property in 2023 since the number of foreign tourists has revived to the pre-COVID level,” says Shingo Hat-tori, founder of Tokyo-based law ﬁrm Hattori Law.
Top brands like Hilton and Accor are actively increasing their Japan portfolio, among others in the market, Hattori adds.
Urban residential projects are still the most attractive real estate asset for global capital, given low-interest rates and promises of increasingly high returns.
“Multifamily housing tops the list of targeted asset classes for cross-border investors. In just the last three years, we closed at least 15 large portfolio deals for international real estate funds, family ofﬁces and asset managers,” Rothstein says.
The demand for office spaces has also risen steeply following the ‘back-to-office’ call by most large companies after the pandemic-induced lockdowns.
“One surprising area where we see some activity is the ofﬁce asset class. In Japan, remote work has not taken hold post-COVID in the same way it has in many other markets around the world. People generally still go to the ofﬁce. A well-located ofﬁce building with the right tenant mix can still attract international investor interest,” Rothstein says.
While the surge in real estate investments has been traditionally focused in Tokyo and Osaka, the increasing prices in the cities and the rapid urbanisation of other regions have led to growing global investment in real estate assets across the country.
“Japan’s status as a popular investment destination also means that it is a competitive market with compressing cap rates. As a consequence, investors have expanded their geographic reach beyond the traditional investment hubs of Tokyo and Osaka. Increasingly, we see cross-border investors venturing to places like Nagoya, Fukuoka and Sapporo, where deals might not attract as many competitive bidders. Approximately 30 percent or more of the deals we have executed in the last two to three years have actually been outside of Tokyo and Osaka,” Rothstein says.
Usami of White & Case also points out that major cities like Osaka, Nagoya, and Fukuoka are experiencing notable advancements in their ofﬁce infrastructure, fueling growth in their respective local economies.
Hattori adds that Niseko and Nagano are also gems, and some foreign hotel operators are keen to develop their businesses in other regions of Japan.
REGULATORY, STRUCTURING CHALLENGES
Legal experts agree that the landscape for foreign investment in Japan’s real estate market remains largely stable. Navigating these regulations, especially given the language barriers in the country, poses an impediment, if at all, to investors.
“Japanese laws provide avenues for foreign investors to capitalise on established investment frameworks such as TMK, facilitating advantageous tax treatment. However, navigating the real estate landscape involves intricate regulatory requirements and constraints, encompassing both national and local regulations,” says Usami.
Fujii at Wither agrees, explaining the structuring of foreign real estate investment in Japan. “There are two well-established structures used by sophisticated real investors in Japan, the TMK structure and the TK-GK structure. The TMK structure (named for the type of entity that holds the asset, the tokutei mokuteki kaisha) is a highly regulated and complex structure that is popular because of its favourable tax treatment (it is taxed like a REIT). The TK-GK structure (named for the entity that holds the asset, a godo kaisha, and a silent partnership arrangement (a tokumei kumiai), which is used to capitalise the GK) is popular because it is easy to set up and manage and can also be tax efﬁcient with proper structuring advice,” says Fujii.
“A recent development that investors should be aware of is that the Japanese tax authorities are taking a closer look at TMK structures from certain jurisdictions that take advantage of reduced tax rates applicable under tax treaties between Japan and such jurisdictions,” he adds.
Rothstein adds that most clients are taken aback by the complexities of deal structuring when navigating the country’s laws and availing incentives. “The reaction I usually get when a client undertakes its ﬁrst deal in Japan and is presented with a structure chart depicting the recommended ownership and investment structure both onshore and offshore from Japan, is why is this chart so complicated?” explains Rothstein.
Rothstein explains that there are three crucial aspects of real-estate deal-making that are the source of complexity: First, tax planning; second, regulatory licensing requirements; and ﬁnally, lender requirements for non-recourse ﬁnancing.
“We always advise cross-border investor clients to fully develop the optimal ownership and investment structure before commencing the transaction. Closing in the wrong investment structure would be a costly mistake. Substantial costs and adverse tax consequences could result if a deal is restructured post-closing,” Rothstein adds.
While foreigners face no restrictions in purchasing Japanese real estate, Hattori says that there are certainly new laws that have added certain limitations, which are important from a compliance perspective before making an investment.
“Japan adopted the Act on the Review and Regulations of the Use of Real Estate Surrounding Important Facilities and Remote Territorial Islands in 2021. This Act designates speciﬁc areas close to defence facilities, nuclear power plants, etc., as monitored areas and requires speciﬁc disclosures to the government. This might impact foreign investors, and it’s necessary to take care of the area designation in the due diligence process,” says Hattori.
The Japanese real estate market also places a higher burden of diligence on the buyer, with little or no commitments on the buyer.
“The current market practice is that real estate assets are transferred on an ‘as-is’ basis with sellers giving minimal or no representations and warranties regarding the real estate. Purchasers will need to rely on their due diligence process, with the assistance of their counsel, advisors and other professionals, to get comfortable with the risks associated with the property. Although not widely used, W&I insurance is available in the market to cover such risks, says Fujii. Another large challenge arises from the domestic nature of Japan’s real estate market, making it difﬁcult to purchase land without experts ﬂuent in the Japanese language.
“Japan’s real estate market predominantly operates on a local scale, where language barriers could pose signiﬁcant hurdles. Engaging bilingual professionals capable of offering insights into both domestic and international market disparities is crucial,” says Usami. Using professional real estate agents is also necessary to obtain and comb through necessary government registration documents, which are in Japanese, adds Hattori.
“For foreign investors, it’s quite important to check registered information by the Japanese government database written in Japanese. Then, it’s important to register your transaction to the government to secure your transaction. If you do not do it, other people might purchase the property with a priority higher than yours,” explains Hattori.
ON THE GROUND
Due to this domestic-focused market and language and cultural barriers, legal experts advise clients to have a local presence to deal with Japan’s unique regulatory challenges.
“Foreign investors frequently opt to engage local bilingual professionals, including lawyers and real estate agents. Establishing joint ventures (JVs) with local market participants, such as developers, is a popular approach to mitigate the associated risks,” says Usami. “While Japan has for quite a long time been stable and a good bet for foreign investment, it is especially important to have legal counsel who has experience of working through the various real estate cycles,” Usami adds.
Rothstein agrees, adding that he generally advises clients to have a dedicated on-ground team or local co-investor in Japan to source and close the right deals. “In a competitive market where there is more capital available to be deployed than there are deals to invest in, some investors eager to do deals may end up overpaying for properties. Rigorous due diligence and underwriting of properties remains of paramount importance.” “Consequently, they likely are better able to value and assess investments. Moreover, some of the best opportunities are off-market opportunities. These opportunities generally are best discovered through relationships and contacts that may only really be cultivated by having a presence in Japan,” Rothstein adds.