Japan - April 2020

S P OT L I G H T
Savills Research

COVID-19 andJapan Property©ESR LTD

COVID-19 and Japan Property

Japan’s conservative
approach to pay dividends
Summary• With the economy alreadyunder pressure following
the consumption tax hike ofOctober 2019, the COVID-19
crisis has created a perfectstorm for Japan. The one-year
postponement of the Tokyo
Olympics has further dampened
market sentiment for 2020,
though it is far more welcome
than an outright cancellation.
• Cap rates across sectors otherthan hospitality and retail should
hold in place for the time being
as transaction activity comes toa halt.

valuations have yet to reﬂect the COVID-19
shock – but market players are bracing
themselves for impact.
Indeed, as a black swan event for which
few in the investment community might haveaccounted, investors must now revisit theirassumptions and assess their global positions.
Within the Japanese property market, atpresent, nearly all rumoured transactions
appear to have been suspended or postponed.
Unlike the previous crisis, sellers and owners
have, for the most part, a solid ﬁnancial
standing. As such, excluding holders of hardhit hotels and retail assets that may breachcovenants, owners have no need for a ﬁre sale.

MARKETS ON HOLD
With the world gripped by the COVID-19
pandemic, governments are scrambling toassess disease prevalence and apply stringent
containment measures that limit physicalinteraction – essential for saving lives, but
catastrophic for the economy as global
business activity is eﬀectively put on pause.
The international investment community has
naturally responded with a massive selloﬀ of all
liquid assets, and Japanese markets have beenno exception, with sentiment being further
dampened following the postponement of
the 2020 Olympics. Given the nature of hard
assets, property performance and the resulting

Graph 1: Japan Cumulative Investment Volume by Month

2020

2016

2017

2018

2019

Aug

Sep

6

• Listed Japanese ﬁrms hold
JPY500 trillion in cash and cash
equivalents, whilst households
are less indebted than during thelead up to the global ﬁnancial
crisis, and less so compared tointernational peers.

5

4
JPY TRILLION• Compared to other nations,Japan has less exposure tooverseas demand including
trade and inbound tourism,
lending some insulation fromborder closures.

3

2

1

0
Jan

• The sectors with the mostresilience to the COVID-19
pandemic, in order, are 1)
residential, 2) logistics, 3) office,4) retail, and 5) hospitality.

Feb

Mar

Apr

May

Jun

Jul

Oct

Nov

Dec

Source Real Capital Analytics, Savills Research & Consultancy

Graph 2: Imports And Exports As A Percentage Of GDP, 2018
Imports

Exports

50
45
40% OF GDP

35
30
25
20
15
10
5
0
Australia

China

France

Japan

Korea

OECD
AverageEU
Average

Source OECD, Savills Research & Consultancy

savills.co.jp/research

2

COVID-19 and Japan Property

Certain investors, particularly domestic
ones, still appear interested in acquisitions;however, they appear to be seeking deeply
discounted opportunities, for instance, witha 1% wider cap rate than before. This has led
to a lack of compromise on pricing, as mostowners have no urgency to sell. International
investors, on the other hand, have put overseas
transactions on hold. Indeed, worldwide
travel restrictions are preventing them fromphysically inspecting assets, halting the due
diligence process in its tracks. This trend
is unlikely to shift anytime soon and is notinconceivable to persist months after the
pandemic has started to recede.
While travel restrictions might present aphysical roadblock to investment, the shockto the capital markets could shift the buyer
landscape and open more opportunities tooverseas investors. The J-REIT market saw asigniﬁcant correction after mid-February, with
the TSE REIT Index plummeting almost byhalf towards mid-March. Although the index
has since recovered somewhat, it remains over
30% lower than before the COVID-19 shock.
Unit price/NAV and property purchasing power
have been reduced accordingly, likely putting adamper on acquisition activity this year.
Given that J-REITs have recently been
active buyers, accounting for approximately
30% of market transactions, their now limited
purchasing power should pave way for muchawaited opportunities for other investors who
have previously struggled to acquire properties
in a very competitive acquisition market. Indeed,
private real estate, pension, and sovereign
wealth funds still hold a historically high levelof dry powder to deploy. For that reason, theseinvestors are likely to grow their clout this year
as cash reclaims its throne in the COVID-19
world.
CAP RATES FREEZE…FOR NOWWith essentially no transactions being closed,
there are no real benchmarks by which market
players can judge “actual” property values inWith the Tokyo Olympics in sight,
Japan entered 2020 with high hopes
and sound fundamentals. Sadly, the
COVID-19 pandemic has dashed thesehopes and presents a major challenge
to the domestic property market.
Certain sectors are better positioned
to weather the storm, however, andfrugality among Japanese corporates
and households should offer an
additional buffer to the domestic
market.
the current environment. As a result, cap rates
are, for the moment, frozen in place. Moving
forward, appraisal reports are likely to show
cap rates that are somewhat looser, though
not to the extent that property values decline
so drastically as to cause breaches in lending
covenants.
Lending attitudes have become morereserved, but windows are still open forcertain assets and asset types, especially inthe residential, logistics, and oﬃce sectors.
Assumptions on rent increases and leverage
have been adjusted to a more conservative level,
however. With Japan’s ﬁscal year commencing
in April, lenders may use this opportunity toadopt more conservative strategies.
Meanwhile, most asset owners, otherthan those with hotels and retail properties,
can maintain a wait and see approach while
continuing to collect rental income. Hard-hit
hotels and retail properties will likely face

Graph 3: Inbound Tourist Receipts As A Percentage Of GDP, 2018

INBOUND RECEIPTS (% OF GDP)

14%
12%
10%
8%
6%
4%
2%
0%

Source OECD, Thailand Ministry of Tourism and Sports, Philippine
Department of Tourism, Savills Research & Consultancy

3

immediate rent adjustments and thereby see
cap rates change more rapidly. Oﬃce, logistics,
and multi-family rents should stay relatively
ﬂat for the time being, as rents are ﬁxed during
the contracted period, providing a layer ofprotection for cash ﬂows. Hence, it is likelythat actual property values will not ﬂuctuatemuch, at least until the end of the year. Thatsaid, lower-quality properties may face issues
sooner given that the tenants are generally lesscreditable.
OVERSEAS EXPOSURE MORE
LIMITED THAN IT IS PERCEIVED
Although the Japanese economy is far removed
from the spectacular growth of the 80s and evenfrom the recent growth of the world economy,
it is still one of the most stable in the world.
Some still believe that Japan is highly exportoriented and, as such, COVID-19’s disruptionof global supply chains could damage theJapanese economy disproportionately. Yet,in truth, Japan is more similar to the U.S. inthat domestic demand dominates economic
activity: trade accounts for only around 35%
of GDP, among the lowest in the world. This
misconception may come from the Japanesepublic equity market where, compared withother countries, multiple large manufacturing
companies with sizable market caps have an
outsized weight among major indices.
Similarly, while inbound tourism has been amajor boon to the Japanese economy, serving
as an important growth catalyst since 2013, it
remains a small part of total economic activity
in Japan, with hoteliers and retailers relying
primarily on a stable base of domestic demand
to support their businesses. Speciﬁcally,
inbound tourism still accounts for less than
1% of Japan’s GDP and less than 20% of totalnights stayed in its accommodations, while
inbound retail accounts for a mere 1% of total
retail revenue (Graph 3).

COVID-19 and Japan Property

WHEN FRUGALITY PAYS
DIVIDENDS
Japan’s exceptionally high level ofgovernment debt is well known. However,the story is quite diﬀerent when looking atcompanies and households.
Listed Japanese ﬁrms hold more than
JPY500 trillion in cash and cash equivalents,
an amount that is essentially equivalent tothe country’s annual GDP. For perspective,
U.S. ﬁrms hold around USD4 trillion in cash,
or around 20% of annual GDP. Japan Inc.’s
rampant cash hoarding, marked by modest
investment and limited share buybacks,
has of course been a point of contention foroverseas investors; however, this strategy
has enabled Japanese businesses to be wellpositioned to weather this crisis. Households
have been similarly frugal over the past
decade, with the debt-to-GDP ratio among
Japanese families generally declining since theglobal ﬁnancial crisis (Graph 4).
Despite these ﬁnancial buﬀers among
companies and households, the timing of the
COVID-19 crisis has created a perfect storm
for Japan. Indeed, with the nation still reelingfrom the consumption tax hike enacted in
October, the already-fragile Japanese economy
looks certain to head into a technical recession- and possibly worse. Further, unlike during
the global ﬁnancial crisis, there appears to be
no nation that still has suﬃcient ﬁrepower todrive a global economic recovery.
THE IMPACT TO JAPANESEPROPERTY
In the case of Japan, we believe the sectors
with the most resilience to the COVID-19
pandemic, in order, are 1) residential, 2)
logistics, 3) oﬃce, 4) retail, and 5) hospitality.
Considering local market practices, we

believe that only the hospitality and retailsectors should experience immediate
negative impacts. These sectors are mostsusceptible to government containment
policies, including travel restrictions, andsocial distancing guidelines, and some
hotels and retail property owners havealready received rent reduction requests
from struggling tenants. Unlike in Westerncountries, there are at present no legal
moratoriums on rent payments. The
government has instead requested that realestate owners consider a ﬂexible response toaccommodate struggling tenants. That said,
some lawmakers are considering legallybinding measures.
Investors should now focus on asset
management while assessing the impact
of COVID-19 and rethink their investment
and portfolio strategies. In the short-term,
managing tenant relations and maintaining
rents at an appropriate level should be theprimary concern of owners. Thereafter, some
may want to consider adjusting asset typeallocation to a more defensive mix. In these
testing times, the quality of the underlying
assets as well as the creditworthiness oftenants matters more than ever. Those unable
to satisfy these conditions are therefore
expected to suﬀer disproportionately.
The property markets are ultimately linked
to economic fundamentals, and current
prospects for global economic growth appear
daunting. Double-digit quarterly contractions
in GDP appear inevitable in many parts of theworld, and a short-term recovery scenario isunlikely. Equity and credit markets appear
to have calmed somewhat, but the violent
volatility observed during March may return.
To wit, major economic indicators
continue to deteriorate and corporations

GRAPH 4: Household Debt To GDP Ratio Among Major APAC Markets, 2006 to 2018

Australia

China

Hong Kong

Japan

South Korea

Singapore

HOUSEHOLD DEBT TO GDP (%)

140
120
100
80
60
40
20
0
2006 2007 2008 2009 2010

2011

2012

2013

2014

2015

2016

2017

2018

Source International Monetary Fund, Savills Research & Consultancy

savills.co.jp/research4

are increasingly announcing grim ﬁnancial
results. This may soon derail the capital
markets and subsequently the property
market. In addition, measures to control
extreme volatility in capital markets havebrought interest rates across the world evenlower, which may make Japan’s wide yieldspread less attractive to investors.
To be sure, it is still too early to grasp afull picture of the post-COVID-19 world.
The impacts of this crisis are likely to persist
even after the pandemic comes under somemeasure of control, as populations acrossthe globe alter their behaviour and lifestyle.
These changes should aﬀect the entire
property sector, though the impacts will varyby asset type. As such, this report will focus
on the most likely short-term scenarios andrepercussions by sector based on currentlyavailable data and observed market trends.
OFFICEThe oﬃce market entered 2020 withpromising prospects, which will now morethan likely prove to be short-lived. Yet, allthings considered, Grade A and B oﬃce
markets in Tokyo both saw impressive
rental growth over 2019, whilst maintaining
extremely low vacancy. Many regional
markets have proven to be similarly robust
over the past two years. With oﬃce demandlargely tracking economic growth, however,oﬃce fundamentals are likely to deteriorate
as the economy weakens, albeit with a delayof at least a few months to a half year.
Encouragingly, well over 95% of oﬃce
supply in 2020 has been ﬁlled or pre-leased
and supply in 2021 and 2022 is low, helping
the market remain stable. With vacancy rates
already at record lows, tenants have limited
options if they did decide to move, and forthat reason, landlords would be justiﬁed in
keeping rents unchanged. Moreover, withthe requirement to provide advance notice ifthey do decide to leave, the tangible impact
of tenant relocations could take up to six
months to emerge, adding to market stability,
at least until late 2020.
What’s more, amid a previously buoyant
market, with ﬁerce competition for space,ﬁnancial incentives such as rent-free periods
were limited. Landlords therefore would
most likely prefer to oﬀer these incentives toprospective tenants before allowing vacancies
to rise. Hence, rents should stay ﬂattish before
vacancy goes up. On the other hand, thissomewhat optimistic scenario may not apply
to lower-grade buildings – where our coverage
is limited – accommodating lower-credit
tenants, some of which may be ﬁnanciallyvulnerable and may soon need to seek rent
reductions or shrink leased ﬂoor areas.
With governments across the globe
advising or enforcing self-isolation, theCOVID-19 and Japan Property

requirement to work remotely is likely to shapetenant preferences even after the pandemic
recedes. Indeed, those who had indicated adesire to expand leased ﬂoor space before
the COVID-19 outbreak may change tack as
the current turmoil weighs on demand forworkforce.
Moving forward, there should be casesof companies shrinking oﬃce space by
maintaining some remote working practices, orsetting up satellite oﬃces closer to residential
areas such as Omiya, thereby creating newopportunities for market participants.
Centrally located co-working spaces, incontrast, should lose some of their appeal as aresult of these demand shifts, but co-working
spaces closer to residential areas should be able
to capitalise.
RESIDENTIAL
The multi-family residential sector stands as
the most resilient in the face of the current
crisis. Solid rental growth was observed in mostsubmarkets in Tokyo in Q1/2020 and, so far,fundamentals have appeared sound.
To be sure, the residential sector is certainly
not immune to this ongoing uncertainty.
Corporate activity has slowed, with labourdemand falling as a result. There have evenbeen cases of soon-to-be university graduates
having job oﬀers rescinded by smaller
companies, emphasising the uncertain market
conditions ahead. Coupled with stubbornly low
wage growth, as evidenced by the lower salary
hikes than demanded in the annual springnegotiations (whereby increases in salaries
are negotiated between companies and theirrespective unions), the aﬀordability of current
rent levels will be tested.
Despite the pessimism, it is importantto keep in mind the defensive nature of theresidential sector through times of stress. For
instance, the sector held up relatively well evenafter the global ﬁnancial crisis – rents adjusted
by approximately 10% and occupancy remained
stable in the subsequent years. Furthermore,
ﬁrms have hitherto faced prolonged labour
shortages, and are therefore likely to reduceother expenses before turning to workforce
redundancies.
More broadly, the cash reserves of Japaneseﬁrms serve as a strong reserve to help weather
the COVID-19 storm, and this additional
ﬁrepower should mitigate layoﬀs, pay cuts,
and bankruptcies, thereby providing anotherlayer of protection to the residential sector.
Considering the above, therefore, rental
growth, if any, is expected to be moderate, atleast until the impact of COVID-19 becomes
more apparent.
Looking further ahead, residential unit
preferences may change if a substantial numberof companies continue some form of remote
work and/or ﬂexible working hours after the

pandemic subsides. Having impetus to spend
more time at home may prompt residents toprioritise larger spaces with better amenities as
opposed to proximity to train stations, a featurethat is highly-valued outside of Tokyo’s central
ﬁve wards. Conversely, COVID-19 may deliver a
blow to the emerging co-living and share house
subsector, as convenient locations and social
environments may lose some of their lustre.
RETAIL
Although Japan has yet to implement a strict
lockdown, caution among residents has beenhigh since February, with many avoiding
crowded commercial centres. According toGoogle, as of late March, footfall in retail andentertainment properties in Tokyo has fallen
by over 60%. These numbers are likely to fall
further in April and May as the government
steps up restrictions to further limit businessactivity and the movement of people.
This sharp decline in footfall has
unsurprisingly hit retail revenues. For instance,
Renown, a major apparel retailer, recordeda drop of over 40% in its March store sales.
Meanwhile, Saizeriya, an Italian restaurant
chain, marked a 20% decline – the largest
decrease in a decade. The break-even pointof the food service industry is said to beapproximately 90% and, as such, the pandemic
is a catastrophic blow to this industry.
Department stores, many of which had
already been in a fragile state, are among thehardest hit subsectors of the retail market.
Major department stores showed a 30-40%
decrease in their March sales. Duty free sales– previously the best performing segment –have plummeted by over 90%. On the other
hand, supermarkets, convenience stores, anddrug stores are faring well thanks to growing
demand from people spending more time athome and stocking up on daily essentials.
In this diﬃcult environment, multiple retailproperty managers have begun to receive rent
reduction requests, especially from thinly
capitalised subsectors such as food services andevent planning. More requests should follow
as operating activity is further constrained bysocial distancing guidelines and closed borders.
As a result, we should see some consolidationin this fragile sector, which should be apositive development in the long-term. In themeantime, skilful asset management mattersmore than ever.
Prime retail sales are also under pressure. For
now, however, owners in this subsector have ahigher degree of protection as rents are ﬁ xed
with creditable tenants, whilst the most sought
after locations still have the advantage of highland values and strong demand. As such, theprime subsector is perceived to be defensive.
The disparity amongst winners and losers in
the retail sector has been stark and this trend
is likely to become more pronounced. Those5

who implemented digital platforms early cancontinue to leverage these channels during
the COVID-19 crisis and beyond, while those
who are late to the digital game will continue
to struggle. On a longer-term basis, this crisis
will likely change shopping behaviour, withretailers now needing to respond to not only
e-commerce but post COVID-19 customers.
LOGISTICS
The logistics sector will likely emerge as oneof the survivors of this crisis. Despite supply
increasing signiﬁcantly in Greater Tokyo
during 2019, vacancy rates tightened and rents
rose, highlighting the sector’s solid underlying
fundamentals. The Greater Osaka market
continued to see a recovery from 2017’s supply
glut, with solid rental and occupancy growth.
Even so, the sector is not immune to a shortterm shock, as supply chains are disrupted andlabour shortages may be exacerbated.
New supply in both submarkets is expected
to be solid in 2020. Despite demand remaining
sound, COVID-19 will undoubtedly weighon certain subsectors. For example, demand
for storage locations from high-street
retailers should be curbed, while e-commerce
distribution centres and F&B storage facilities
for grocers should fare well during the
pandemic.
As for investors, the sector’s long-term
prospects remain attractive given the structuralchanges facing the logistics industry. The risein e-commerce is expected to be a long-termtransition, and therefore the sector is somewhat
shielded from short-term adjustments. In
addition, modern facilities, which have featuresthat mitigate labour shortages and are more
resilient to natural disasters, should havesound long-term demand. Also, the nature of
the current crisis – prompting people to avoid
crowded commercial hubs – will likely facilitate
e-commerce by changing consumer behaviour.
For the time being, rental growth should be ﬂat,but long-term prospect looks brighter.
HOSPITALITYThe COVID-19 crisis arguably came at the worst
possible time for already struggling hoteliers inJapan. Indeed, the travel restrictions resulting
from the pandemic are a catastrophic blow for
the fragile sector. Japan Hotel REIT, the largest
hotel J-REIT, posted an almost 30% decrease
in its February RevPAR, and has mentionedthat March RevPAR may decline by 70%. Some
operators will likely need to conduct hardnegotiations with banks to secure a vital cash
reserve to weather the storm. NOI and cap rateadjustments are thus inevitable.
Hospitality is undoubtedly the hardest hit
sector. With the virus spreading across theworld, international travel should continue
to be restricted, and as such, a full recovery is
likely to be a protracted process. While this is a

COVID-19 and Japan Property

challenging time for the industry, it may also
be a great opportunity for cash-rich longerterm investors to pick up attractive assets
with high growth potential. Opportunistic
investors may similarly be able to pick up
distressed assets that perform well undernormal circumstances. As such, this could be
an opportunity for industry consolidation inorder to transform its proﬁtability.
Japan remains an emerging market for
inbound tourism and therefore the adverse
eﬀects from the pandemic are somewhat
more manageable, especially when compared
to regional peers. Broadly speaking, inboundtourism accounts for less than 1% of its GDP,

though certain areas and hotels are more
dependent on these visitors than others.
Although inbound tourism may take a year
or longer to recover, domestic travel demand
could see a faster recovery as the outbreak isbrought under some degree of control. For
instance, popular tourist destinations like
Kyoto have recently been shunned by someJapanese visitors due to over-crowding. The
extreme lull in inbound visitation to Kyoto
and other top destinations should help draw
domestic visitors once more. Regardless,hoteliers and investors may need to pay moreheed to the balance between inbound anddomestic demand going forward.

For more information about this report, please contact us

Savills Japan

Savills Research

Christian Mancini
CEO, Asia Paciﬁc(Ex. Greater China)+81 3 6777 5150
cmancini@savills.co.jp

Tetsuya Kaneko
Director, Head of Research& Consultancy, Japan+81 3 6777 5192
tkaneko@savills.co.jp

Simon Smith
Senior Director
Asia Paciﬁc+852 2842 4573
ssmith@savills.com.hk

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