In the face of both global and domestic macro headwinds, the Japanese real estate market performed well in 2019. Enduring political and economic stability – bolstered by low interest rates and a competitive yield gap – continue to promote an attractive environment for real estate investment. The defensive nature of prime assets in Japan appears to be a key draw, especially in the late stage of a property cycle that is shadowed by global uncertainty.
As early as 2015, market participants began showing concern over large office supply scheduled to enter the Tokyo market, fearing an abrupt end to what would have been a short-lived upswing. However, these fears proved to be largely unfounded as, despite historically high supply levels in both 2016 and 2018, no major secondary vacancy has materialised thus far, and supply through 2020 has been mostly pre-leased. With the existing market experiencing air-tight conditions, there are no immediate concerns regarding the performance of hard assets.
Office property prices are approaching 2008 levels, though high valuations still appear justifiable in light of solid underlying fundamentals. Cap rates are much lower than the previous peak, but the government bond interest rate is 150 basis points (bps) lower and the yield spread is even healthier, at almost 300 bps. Prime office rents have grown steadily, yet still stand around 70-75% of the previous peak. This may leave room for further upside potential - with limited downside risk.