TOKYO: MOVING THE YIELD CURVE

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1 BUSINESS BRIEFING TOKYO: MOVING UP THE YIELD CURVE ASIA PACIFIC A Cushman & Wakefield [SERVICE LINE] Publication MAY 2015

2 MAY 2015 TWO YEARS ON... Unveiled in late 2012, Abenomics potent mix of reflation, fiscal stimulus and structural change has kick started a revival in Japanese real estate. Two years after, investment volumes (excluding land) have increased by over 60% the highest among the top-tier core markets. Foreign investments have also more than doubled in the same period as record low interest rates and a favorable exchange rate generate positive carry, throwing up opportunities in one of the world s largest commercial real estate market that is backed by a mature and deep economy. The 2020 Olympics win is spurring investments into infrastructure and urban renewal projects, which could gain further momentum once Tokyo gives the green light on Integrated Resorts which will include casinos. The Nikkei has surged to near-15 year highs on the weak yen, while equity capital raised by J-REITs in the first three months of 2015 have surpassed those in the same period last year, driven by rich stock valuations. Despite continued yield compression, quantitative easing by the Central Bank ensures that yield spreads of Tokyo offices against long-term bond yields remain higher than those in global gateway cities. ALL GRADES OFFICE YIELD GAPS Tokyo 420 New York 384 London 355 Seoul 302 Singapore 200 Hong Kong Note: Spread between each country s 10-year government bonds; in bps (basis points) Source: Cushman & Wakefield 2

3 TOKYO: MOVING UP THE YIELD CURVE The revival is not just confined to assets as the city s office leasing sector a bellwether for the economy continues to improve. Vacancy rates for Grade A offices have tightened to below 5%, with strong corporate performance driving demand as companies seek to relocate. Driven by a flight-to-quality trend, the office market is experiencing strong pre-leasing commitments in new buildings with enhanced seismic capabilities. Mitsubishi UFJ Morgan Stanley Securities, forced to move to a cheaper location due to failed investments in 2011, will relocate back to the Otemachi area after Abenomics stimulated investments into the city s capital markets. TOP INVESTMENT DESTINATIONS New York London Tokyo Los Angeles San Fransisco Paris Washington DC Chicago Hong Kong Dallas Sydney Boston Vacancy rates for Grade A offices have tightened to below 5%, with strong corporate performance driving demand as companies seek to relocate. Atlanta Miami Houston Melbourne Shanghai Seattle Denver Franfurt Note: Excludes land Source: Real Capital Analytics, Cushman & Wakefield 3

4 MAY 2015 Office demand is anticipated to keep pace with continual strong corporate performance, led largely by the manufacturing sector against the backdrop of a weakening yen. With corporate earnings having tripled since 2009, the prospect for positive rental revisions are likely to kick in sometime this year. Given that new supply in 2015, while substantial, is still lower than the average level in the past decade, the market is unlikely to weaken. TOKYO S ACCELERATING RENT GROWTH Slow Growth Mumbai SBD Shanghai Beijing, Toronto, Houston Manila London, Singapore Bangkok, San Francisco, Stockholm Munich, New York Boston, Frankfurt, Gurgaon CBD Amsterdam, Hong Kong, Madrid Chicago, Dallas Accelerating TOKYO LANDLORD FAVORABLE Jakarta Calgary, Rio de Jeneiro Bengaluru, Kuala Lumpur Downturn Moscow HCM City, Ottawa Rome Melbourne, Sydney Los Angeles, Seoul Washington, D.C. Berlin, Copenhagen, Mexico City Geneva Brussels, Zurich Paris Recovering TENANT FAVORABLE Rent still elevated but falling from top of market cycle Falling rents promise future opportunity for tenants Rent growth accelerating Ideal for owners of property Rent growth slowing Still landlord favorable but growth is down from peak Rent at or near bottom of market cycle Ideal for tenants leasing or seeking to lease property Note: Grade A office Source: Cushman & Wakefield 4

5 TOKYO: MOVING UP THE YIELD CURVE NON-PRIME OFFICES Core assets in Tokyo s central wards that are available for sale are limited and demand for such assets far outweighs the limited opportunities to buy the weight of this capital leading to rapidly compressing yields. As such, investors seeking exposure to the Abenomics story would have to look to opportunities that reside further up the yield curve. Despite the higher risks involved in terms of financing, property and economic fundamentals in these segments remain sound. INVESTMENT MARKET Non-prime offices generally afford investors easier access into Tokyo s office market, as the city s prime offices remain tightly held by developers and institutional investors, who have investment mandates to adhere to. Unlike investment grade assets, non-prime offices are owned by a wide variety of owners whose main interests might not be in real estate, which makes them more likely to consider selling if the price is right. In terms of targets, Class B and C offices form a larger proportion of Tokyo s office landscape and accord more choices to an investor. The market is also more liquid for strategic sellers seeking an exit as there is a ready pool of buyers in REITs who are big players in the Class B and C office market. Last year, one third of non-prime offices transacted were by these trusts. OFFICE INVENTORY Prime 16% Class B and C Offices Dominates Tokyo Class B/C 58% Class A 26% Note: Based on a sample of 9,800 buildings Source: Cushman & Wakefield, Sanko Estate LEASING FUNDAMENTALS A feature of Class B and C offices is its relatively small floor plates, generally less than 100 tsubos (3,600 sf). Due to their smaller staff strengths, Class B and C offices are usually occupied by small and medium sized enterprises (SMEs), as they do not require exceptionally large floor plates. 5

6 MAY 2015 SMEs are prevalent in Japan, forming the bulk of companies in most sectors but more importantly, they are the backbone of the services sector and a crucial link in the supply chain of the manufacturing and export-led sectors. Currently, there are at least 440,000 SMEs operating in Tokyo alone, employing almost half of the city s workforce. HEADCOUNT BY PROPORTION OF COMPANIES IN TOKYO Companies with less than 50 employees form 97% of corporates in Tokyo % % % > % < % Source: Tokyo Metropolitan. Statistics The huge tenant base to draw upon makes investment sense while demand fundamentals have also improved. While closures involving SMEs escalated in the aftermath of the financial crisis in 2008, leading to higher vacancies, it has recovered fairly well and is expected to continue to improve. Rents are also more stable and just coming out of the trough which would also provide more rental upside. In light of the improved business sentiment, rents are expected to remain on an upward trend. VACANCY RATES Class S Class B Class A Class C Q106 Q306 Q107 Q307 Q108 Q308 Q109 Q309 Q110 Q310 Q111 Q311 Q112 Q312 Q113 Q313 Q114 Q314 Q115 Vacancy rate (%) Note: Central Five Wards; Class S denotes Super Grade A Buildings Source: Cushman & Wakefield 6

7 TOKYO: MOVING UP THE YIELD CURVE RENTS 30,000 25,000 Prime All Grades 20,000 15,000 10,000 5,000 Q106 Q306 Q107 Q307 Q108 Q308 Q109 Q309 Q110 Q310 Q111 Q311 Q112 Q312 JPY/tsubo/mth Q113 Q313 Q114 Q314 Q115 Source: Cushman & Wakefield In particularly, the economic fundamentals faced by SMEs have also grown more favourable. For a start, the weakened yen are making these companies more competitive. Secondly, promoting the SME sector in Japan is a major aspect of Abenomics third arrow, which broadly speaking is to regain Japan s growth potential. The government has pledged to provide assistance to SMEs to innovate and for companies in selected strategic industries, in light of a slowing population base, support expansion overseas. RESILIENCE WITH HIGHER RETURNS Non-prime offices generally accord more stability in operating income as compared to prime grade buildings, due to its more stable rental profile and a lower peak-to-trough ratio. This can be attributed to the asset class lower upside potential during boom periods, as the tenant base, being more conservative and with limited investment avenues NET OPERATING INCOME 140 NOI Index (Q194 = 100) Q106 Q306 Q107 Q307 Q108 Q308 Q109 Q309 Q110 Q310 Q111 Q311 Q112 Q312 Q113 Q313 Q114 Q314 Q115 Class S Class B Class A Class C Source: Cushman & Wakefield, Sanko Estate 7

8 MAY 2015 OFFICE YIELD GAPS 450 RECENT TRANSACTIONS (B AND C OFFICES) bps Source: Cushman & Wakefield restrains any huge expansion needs; it is also more resilient during recessionary periods. Rental yield gaps between prime and Class B and C offices are also expected to be sustained, maintaining relative returns in the short-to-medium term. VALUE-ADD OPPORTUNITIES (F) 2016 (F) 2017 (F) Class S All Grades Currently, over 79% of office space in Tokyo central wards are estimated to be over 20 years of age. This presents huge scope for value-add opportunities for investors. In addition, due to escalating construction costs, refurbishment presents investors with a better value proposition. While rental increases for refurbished assets generally varies between submarkets, against a backdrop of a rising rental market, well located renovated spaces will accord the investor with higher returns, allowing the asset to compete more effectively for tenants. Since most office buildings in Tokyo are Class B and C, refurbishment can enhance the attractiveness of an asset when potential tenants compare it to others within the same location. Development: Shibakoen 3 Chome Building Type: Office Buyer: Nippon REIT Price (million): JPY7,396/US$60.1 Price per sq ft NLA: JPY87,168/US$708 NOI Cap Rate (%): 5.2 Completed: 1981 RECENT TRANSACTIONS (B AND C OFFICES) AGE PROFILE OF SMALL-SIZED BUILDINGS* Total Stock: 5.1 million tsubo Note: Less than 5,000 tsubos (GFA)* Source: Xymax, Cushman & Wakefield 8 21% 79% > 20 Years < 20 Years Development: Forecast Takatanobaba Building Type: Office Buyer: Nippon REIT Price (million): JPY5,550/US$45.1 Price per sq ft NLA: JPY89,947/US$731 NOI Cap Rate (%): 4.9 Completed: 1986

9 TOKYO: MOVING UP THE YIELD CURVE THE CASE FOR RETAIL Tokyo s retail scene is an eclectic mix of high-end brands and quirky street fashion that has made its mark on pop culture. From the streets of Ginza to the luxurious malls along Omotesando as well as in suburban markets, retail malls enjoy high occupancy rates that are backed by consumers with high spending power. While the hike in consumption tax did impact retail sales last year, those negative effects will peter out. Despite a falling birth rate, population in the city of Tokyo has increased as more people are moving to the city. With Abenomics looking to raise incomes of the Japanese, the retail sector will benefit from a more buoyant income stream derived from brisk sales. Due to the weak yen, the city is enjoying record tourist arrivals and urban renewal projects are creating markets in new residential areas with increased buying power. Brian DeFoe, Director of Investment Sales,Tokyo at Cushman & Wakefield talks about the merits and strategies in Tokyo s retail sector. WHAT IS HAPPENING TO TOKYO RETAIL CURRENTLY? Tokyo s retail assets are enjoying a resurgence, with rents returning to pre-crisis levels. The Japanese consumption market has expanded over 20 years despite a shrinking population and episodes of challenging domestic conditions. The economy is also shifting towards being more consumption-driven, as seen by the upward trend of the Consumption to GDP ratio. Japan will continue to remain a priority for most international retailers looking to expand into the region as they know they are entering a high income economy. Main Streets are benefiting from record tourist arrivals. Spurred by the opening of Toranomon Hills, adjacent areas including Shin Tora Dori, which are being developed by Mori Building, will benefit from existing main streets. After the enforcement of consumption tax exemption on October 1, 2014 on tourists personal consumption items such as food, beverages, drugs and cosmetics, monthly consumption of tourists skyrocketed for consecutive months increasing year-on-year by 180.8% in January and 235.8% in February. Japan will continue to remain a priority for most international retailers looking to expand into the region as they know they are entering a high income economy. We see significant growth potential in new residential areas Tokyo Bay Area including the Ariake and Aomi districts which are being developed as the capital prepares for the Summer Olympic Games in This would be a focal point of investment opportunities. The population in the Ariake and Aomi districts is expected to increase due to increased accessibility with new roads and railways being constructed. 9

10 MAY 2015 WHERE DO INVESTMENT OPPORTUNITIES LIE? Similar to the office sector, core retail assets available for sale in the central wards are limited. However, there are still opportunities in the regional submarkets for investors who are willing to take on an asset with unrealized potential which would require some investment towards repositioning, through refurbishments and adjusting of the existing tenant mix to raise footfalls and increase rental yields. Currently, regional malls in the Tokyo Metropolitan Area offer yields that are on average at least 300 bps above what can be found in the central wards, such as those in Saitama, Chiba or Yokohama. We note that net migration to the area has been increasing. Last year, the number of people who moved into the Tokyo Metropolitan Area which includes the neighboring prefectures of Saitama, Chiba and Kanagawa exceeded that of people exiting by 109,408 in 2014, up from 96,524 in 2013; over 90% of the migrants were aged between 15 and 29. ANNUAL HOUSEHOLD CONSUMPTION TO GDP (JAPAN) 61.0% 60.0% Annoucement of Abenomics 59.0% 58.0% GFC 57.0% 56.0% Hike in consumption tax 55.0% 54.0% Q494 Q495 Q496 Q497 Q498 Q499 Q400 JPY (million) Q401 Q402 Q403 Q404 Q405 Q406 Q407 Q408 Q409 Q410 Q411 Q412 Q413 Q414 Source: Cabinet Office (Government of Japan), Cushman & Wakefield TOURIST SPENDING 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2, Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. Note: Tracked department stores only Source: Japan Department Store Association, Cushman & Wakefield 10

11 TOKYO: MOVING UP THE YIELD CURVE PRIME RETAIL YIELDS 10.0% 8.0% Suburban Ginza/Omoetosando 6.0% 4.0% 2.0% 0.0% Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 Q410 Q111 Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114 Q214 Q314 Q414 Q115 Source: Cushman & Wakefield WHAT SHOULD INVESTORS EXPECT? Investors would have to approach the retail assets with more than just owning a building; asset management expertise is critical to maximize returns. The complexities of owning a retail asset is multi-faceted successful retail assets shows the ability to tap into an area s demographics, complement the rise of e-commerce and sustain revenue for its tenant base. VALUE-ADD RETAIL For investors looking at such value-add opportunities, well connected malls with a sizable residential catchment in the major cities of Chiba, Saitama and Kanagawa represent suitable investment targets. To tap into the continued economic revival, landlords should opt for variable leases or those based on turnover to reap the recovery in retail spending. With a successful revamp, investors can negotiate higher rates on renewals. Development: Mallage Shobu Type: Retail Location: Saitama Prefecture Buyer: Croesus Retail Trust Price (million): JPY28,183/US$170 Price per sq ft NLA: JPY28,668/US$233 Initial Yield (%): 6.1% Reversionary Yield (%): 6.8% Completed:

12 MAY 2015 For more information about C&W Research, contact: For more information about C&W Capital Markets Asia Pacific/Japan, contact: Sigrid Zialcita Managing Director, Research, Asia Pacific +(65) Todd Olson Executive Managing Director, North Asia +(81) [email protected] Keisuke Yanagimachi Head of Research, Japan +(81) [email protected] Yoshiyuki Tanaka Executive Director, Capital Markets, Japan +(81) [email protected] Lai Wyai Kay Associate Director, Research, Asia Pacific +(65) [email protected] Brian DeFoe Director, Investment Sales, Japan +(81) [email protected] Cushman & Wakefield (C&W) is known the world-over as an industry knowledge leader. Through the delivery of timely, accurate, high-quality research reports on the leading trends, markets around the world and business issues of the day, we aim to assist our clients in making property decisions that meet their objectives and enhance their competitive position. In addition to producing regular reports such as global rankings and local quarterly updates available on a regular basis, C&W also provides customized studies to meet specific information needs of owners, occupiers and investors. Cushman & Wakefield advises and represents clients on all aspects of property occupancy and investment. Founded in 1917, it has 259 offices in 60 countries, employing more than 16,000 professionals. It offers a complete range of services to its occupier and investor clients for all property types, including leasing, sales and acquisitions, equity, debt and structured finance, corporate finance and investment banking, appraisal, consulting, corporate services, and property, facilities, project and risk management. To learn more, click HERE. This report has been prepared solely for information purposes. It does not purport to be a complete description of the markets or developments contained in this material. The information on which this report is based has been obtained from sources we believe to be reliable, but we have not independently verified such information and we do not guarantee that the information is accurate or complete. Published by Corporate Communications Cushman & Wakefield. All rights reserved. Cushman & Wakefield K.K. Sanno Park Tower 13F, Nagatacho, Chiyoda-ku, Tokyo, , Japan 12