It was said of the California Gold Rush of the mid-19th century that the ones who made the money were those who sold the shovels. Today’s shovel sellers in Tokyo are the service providers, agents and brokers eager to entice clients with tales of gold in the hills.
Recently there has been a spate of real estate investment seminars targeting average salarymen and expats in Tokyo. A common opportunity presented is the whole-apartment-building investment, and the idea is simple: Find a building producing a healthy rental yield and organize financing from a willing institution.
Many banks have relaxed their lending requirements to enable anyone with a salary of over ¥7 million and in full-time employment to get an investment mortgage. Throw in permanent residency, a Japanese spouse and some capital, and mortgages of over 10 times an applicant’s salary covering 90-100 percent of the property value at a fairly modest interest rates over 30-plus years can be easily arranged. Create a spreadsheet and make sure your rental yield is comfortably higher than your mortgage repayments and expenses and, hey presto, a cash-flow-positive investment, using little or none of your own capital. Sound too good to be true? Perhaps it is.
Property investment seminars echo the advice given in Robert Kiyosaki’s hugely influential book on personal finance “Rich Dad Poor Dad.” While traditional financial advice counseled living within your means, staying out of debt and investing in a diversified portfolio of asset classes, Kiyosaki argues that this approach is out of date. Instead, he says, use debt (or the more appealing euphemistic term OPM — other people’s money) to your advantage to buy assets that will generate positive cash flow.
Debt that can be used to generate positive cash flow is referred to as “good debt,” as opposed to “bad debt,” which is used to buy something that will depreciate in value and does not produce any cash flow — a car loan, for example. The goal is to achieve financial freedom — the point at which passive income becomes equal to living expenses — and the successful investor can hand in their notice, leave the rat race and is free forever to pursue their own interests.
The underlying theory may well have merit, but it is dependent on finding assets that will consistently generate positive cash flow over time. Whether apartment buildings in Tokyo fit the bill is questionable.
Case of the curiously full apāto
A common sales tactic is to present an investment scenario of potential returns using oversimplified and unrealistic numbers. First of all, gross yields presented assume 100 percent occupancy and do not take into account average vacancy rates. Vacancy rates of wood-frame or light-gauge steel apartments (apāto) in Tokyo’s 23 wards are currently estimated at around 30 percent, and are trending upward. These figures are considerably higher in some suburban areas: Kanagawa Prefecture, for example, has a rate of approximately 37 percent.
One of the reasons for this is the recent surge in the construction of apāto-style buildings brought about by changes to inheritance tax at the beginning of 2015 that made it more appealing to build new rental properties. Consequently, new apartments have been constructed with scant regard for actual rental demand. Vacancy rates are much lower for modern reinforced concrete buildings in Tokyo’s most desirable areas, but these are prohibitively expensive for all but the wealthiest of investors.
Curiously, buildings tend to be presented as full or almost full when offered for sale, giving the investor a positive cash flow from the first day of ownership. If a particular building has a lower vacancy rate than the average for that type of building in that area, the investor needs to understand why. It could be down to good management or some unique feature of the building, but it could also be that the owner has offered significant financial enticements, such as a month or two of free rent, in order to fill the building and make it look more attractive to a naive investor.
It logically follows that to achieve the same level of occupancy, the same financial enticements will have to be offered every time there is a change of tenant. A vacant month or a free month amounts to the same from a financial point of view. Tenancy records dating back to the first tenant that ever lived in the building are needed to give the investor a complete picture of vacancy levels, but often no more than a couple of years of records are available — the excuse being that the owner just wasn’t very diligent when it comes to keeping records.
Agents will try to assuage concerns about vacancies by offering a rental guarantee, but only for a period of one year. However, the real question is not how a building will perform as an investment over one year but over the duration of the mortgage. It is possible to obtain landlord’s insurance, which covers the owner if the vacancy rate rises over a certain level, but this adds to expenses, and insurance companies are savvy enough to know how to not lose out on the deal.
The downward rent spiral
Another glaring omission from the presented investment scenario is the likely downward rent spiral. A declining population in many suburban areas leads to falling demand and, naturally, as buildings get older their desirability diminishes. With shiny new buildings being constructed all the time, owners are under pressure to lower their rent. Of course, mortgage repayments do not fall along with diminishing rent returns and are also subject to possible future interest rate hikes. Maintenance costs increase as buildings age, putting an additional squeeze on an already tightening margin. Owners are left with the dilemma of whether to accept diminishing returns or pay for an expensive renovation to try to reduce vacancy levels and achieve higher rental income.
Investors are often landed with a poorly performing investment that does not produce enough income to cover their mortgage repayments, and are left to cover the shortfall from their own pocket. Some are then convinced by their agent to buy another property to diversify and offset their losses, which ends up exacerbating their plight. The Mortgage Rescue Association holds more than 600 consultations a year, and recently reported a 60 percent annual increase in the number of people experiencing difficulties after buying an investment property.
Those considering making a large investment in Tokyo’s property investment basket should perhaps also bear in mind the serious, and hard-to-predict, potentially catastrophic threats the city faces. Earthquakes, a stricken nuclear power plant or a deranged neighbor with nuclear ambitions could potentially clean out anyone who puts all their eggs in the Tokyo property basket. Disaster insurance policies usually only cover a fraction of the property value, and in the event of a catastrophe these firms may not be in a position to pay out at all. Unless you are a high-net-worth individual with properties all over the world, relying heavily on one investment in Tokyo is a risky thing to do.
There may well be gold in the hills, but there are pitfalls, not to mention a snake or two, and it is the owners, not the agents, who will be left to bear the burden of a bad investment. No doubt there are some good deals and sound investments out there, but there are also some pretty ruthless characters looking to off-load a poorly performing investment to a sucker. Don’t let avarice cloud your reason, and remember you are dealing with some very sharp, very experienced operators, so make sure you take independent advice from a range of sources.
There are other, less risky ways to invest in Tokyo’s property market. For example, buying into a REIT (real estate investment trust) you can’t use OPM and you won’t get rich quick, but it will give you exposure to high-end buildings in the most exclusive parts of Tokyo — and, perhaps most importantly of all, a good night’s sleep!
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IN FIVE EASY PIECES WITH TAKE 5