Inflation: Tracking the changing trajectory of Japan’s property market

Japan’s rapid economic growth in the 1980s was accompanied by soaring property prices. However, when the asset bubble burst in 1991, following a tightening of monetary policy, the real estate market collapsed. Property prices, along with the economy and the stock market, entered an extended period of stagnation.

“Inflation expectations appear to have changed and there are signs it could remain high for some time.”

More recently, the Japanese property market has experienced a recovery. Japan has been a magnet for real estate investors, attracted by the backdrop of ultra-low borrowing costs and the healthy property yield premium (the positive spread between property yields and interest rates). Foreign investment has been growing too as the weakness of the yen relative to other major currencies has meant Japanese property is particularly attractive to overseas, US-dollar based investors.

Changing environment

But, with inflation making a long-awaited return in Japan, the benign environment of the past few years is changing. After decades of deflation, without any price rises, inflation has been above the Bank of Japan’s (BoJ) target for over a year now and, on one measure, inflation is at the highest level in over 40 years.

Inflation expectations appear to have changed and there are signs it could remain high for some time. In this year’s shunto pay-bargaining round, firms have agreed the largest wage increases in many years (in the region of 4%). Big pay rises, combined with structural tightness in the Japanese labour market, could anchor wage inflation for the coming years. This could be a positive development for Japan’s economic outlook, as higher wages could boost domestic consumption and help generate sustainable economic growth.

However, the prospect of persistent inflationary pressure is leading to speculation about the BoJ’s current ultra-loose monetary policy, which was designed to try and boost the economy and generate inflation. In December last year, the central bank surprised markets by relaxing the cap on government bond yields (so-called ‘Yield Curve Control’).

Some investors expect the new BoJ Governor, Kazuo Ueda, to further adjust the easy policy stance in the coming months, either by removing the Yield Curve Control, reducing the central bank’s purchase of government bonds or even raising its policy rate from the current -0.1%.

Coping in an inflationary environment

While the possibility of higher interest rates may see some investors take a more cautious approach towards Japanese real estate, we continue to see investment opportunities in Japan.

In our view, any policy changes are likely to be gradual and careful as policymakers will be mindful of the impact of ending this long-standing unconventional policy, not least because of the amount of government debt and potential impact on the currency.

If interest rates increase gradually over the next two years, we expect real estate yields to expand only marginally (yields move inversely to prices), and real estate values to hold up. The fact is that in most other investible markets globally, real estate yields are now sitting below borrowing costs after interest rate hikes in the last year, making Japan real estate even more attractive, in our view.

Furthermore, we expect resilient, moderate rental growth in certain sectors, which may surprise on the upside alongside inflation. A key factor to consider is that real estate has the potential to cope in an inflationary environment because property is a real asset which theoretically benefits from rising prices.

In the current environment, we believe two sectors look particularly interesting: logistics and rented residential property (known as multi-family housing). 

Multi-family housing – resilient in economic downturns

Multi-family housing (institutionally-owned rented residential apartment blocks) is a well-established property sector in Japan but we believe demand is supported by several ongoing trends, such as urbanisation and the shortage of housing in major cities.

While the total population in Japan has been declining in recent years, migration to larger cities has been increasing. Cities such as Tokyo and Osaka, in particular, remain on course to see population growth among young adults, who continue to migrate from smaller cities for education, job opportunities and the convenience of amenities and infrastructure.

As hybrid working becomes more of a norm globally, employees in Japan are also seeking more flexibility in the way they work. While the growth of ‘telecommuting’ could be problematic for the office sector, we don’t think it will mean a complete reassessment of urban living. Although there was some migration out of the central 23 wards during the Covid-19 pandemic due to hybrid working, more workers have now returned to the office and younger professionals are moving back into central Tokyo, Osaka and Nagoya.

We expect foreign population inflow into key cities will also boost demand for multi-family units over the coming years. In the second half of 2022, as borders reopened, close to 40,000 foreigners moved into the central 23 wards in Tokyo. Japan raised its target for foreign direct investment (FDI) to 100 trillion yen by 2030 (from 80 trillion yen) and just approved Osaka as the site of the country’s first casino, which would likely mean the need for more workers and more housing in the city.

According to the 2020 Population Census, about two-thirds of households in Japan have just one to two persons, contributing to higher propensity to rent^[1]. Home ownership remains low, also partly due to rising apartment prices. We believe this continues to drive the need for well-located homes in key cities, at an affordable price point.

Importantly, the multi-family sector has proven itself resilient through various economic downturns. It is regarded as a counter-cyclical investment amidst the current uncertainty around global economic growth and inflation.

Logistics – beneficiary of growing e-commerce sector

A key driver of the logistics sector in Japan, in our view, is the increase in demand for warehouse space from the growing e-commerce sector. E-commerce penetration in Japan is low but new habits were formed in the pandemic and more shopping is now moving online.

The space requirements for e-commerce are typically three times greater than those associated with traditional retail. Demand will be characterised by modern assets that can accommodate automation functions, in locations with good transport links and accessibility to urban areas, in order to meet increasing delivery demands.

We believe there will be demand for new assets given modern logistics facilities represent just a small fraction of the overall stock in key Japanese markets. Current logistics stock is largely comprised of older warehouses. This presents attractive investment opportunities to create high specification, energy-efficient buildings, especially in regional markets such as Osaka, Fukuoka and Nagoya, which appear relatively underdeveloped compared to Tokyo. Selected hubs could also offer outsized income and growth potential, given e-commerce is rising from a low base.

In addition to e-commerce, the logistics sector could benefit from global companies reassessing their supply chains to improve resilience and diversification. The government is encouraging technology firms to build plants in the country. This is driving demand for logistics space in places like Fukuoka in Kyushu, for example, where microchip maker Taiwan Semiconductor Manufacturing Company plans to build its second semiconductor manufacturing plant in Japan.

We believe the outlook for the logistics sector in Japan looks very promising, given the supply demand dynamic. We think the sector offers a resilient long-term opportunity, but local expertise and a focus on modern logistics space in strategic locations is key.

¹ Japanese Statistics Bureau, Ministry of Internal Affairs and Communications, “Population and Households”, (stat.go.jp).