Wooden apartment buildings in Japan are considered one of the best options for students, young workers starting out in life, and generally, anyone looking for a rental bargain. Investors new to the Japanese residential real estate market, however, may not know that they also offer excellent benefits compared to investing in reinforced concrete or steel frame buildings.
In this article, we will go over the benefits and risks of investing in wooden apartment buildings, with respect to getting financing, investment return and exit strategy.
Advantages and disadvantages of different construction materials
There are three main types of construction material used in multi-family housing in Japan.
- Reinforced concrete (RC)
- Steel frame
- Wood frame
Construction material is not necessarily the main basis on which you should choose an investment target, but it’s important to understand how the building material can affect depreciation and maintenance costs.
As explained by Mr. Tsuyoshi Hikichi, the CEO of Azuki Partners, a bilingual real estate consulting company based in Tokyo, one popular investment strategy in Japan is to buy a reinforced concrete building in a provincial city, outside the main population centers of Tokyo and Osaka.
The theory is that these types of buildings offer depreciation benefits, since the value of land in areas outside major cities tends to be lower in value as a proportion of the total value of the property (which is equal to the value of the land plus the value of the structure).
The tax code also gives preference to reinforced concrete buildings compared to other building materials. The legal useful life of reinforced concrete buildings is set by statute at 47 years.
Steel frame buildings have a legal useful life of 19 to 34 years depending on the density of the steel; and the useful life of wooden structures is calculated using a value of 22 years.
To calculate how much can be deducted as an expense for depreciation, first it’s necessary to calculate the durable life of the building. The formula is
- Durable life = (Legal Useful Life – Building Age) + Building age × 20%
This value is then multiplied by a certain decimal to get the allowable depreciation amount. Other things being equal, reinforced buildings offer the best value when calculating depreciation and tax savings.
Long-term population decline and vacancy risk
However, as pointed out by Mr. Hikichi, one major disadvantage of buying an RC building outside a big city is that provincial cities are affected by long-term population decline.
This means that there is high vacancy risk in investing in RC buildings and the concurrent necessity of reducing rent in the long term.
Reinforced concrete buildings also have high maintenance costs, including the costs of maintaining elevators and water tanks and paying for fire inspections.
With respect to maintenance expenses, steel frame buildings, which offer depreciation benefits somewhere between RC and wooden buildings, have the disadvantage of being subject to leakage.
Steel frame buildings have outer walls that are covered with ALC (autoclaved light concrete) boards, which can deteriorate over time and crack as the result of earthquakes. In this case, owners face not just maintenance costs but also major repair expenses.
Steel frame buildings are generally less expensive than reinforced concrete buildings but buyers should be aware that maintenance costs can be a substantial running cost.
To cover maintenance costs, it may be tempting to consider raising rents but it’s important to consider that in provincial cities, rental demand is low and declining in the long term. Increasing rents will be difficult if you are to keep the property leased up.
For the reasons above, many Japanese banks deem reinforced concrete and steel frame buildings to be relatively high-risk investments.
As explained by Mr. Hikichi, this is why he has seen many investors in Tokyo, Chiba and Kanagawa choose to buy wooden buildings – they offer an excellent balance of risk to reward.
#1 Financing is available
Japanese banks are open to financing investment in wooden buildings and depending on the details of your loan application, it may be easier to get a loan for a wooden building compared to buildings constructed of other materials, for the reasons mentioned above.
#2 Long-term stable income
Wooden buildings are available for purchase for ¥100 million (about $680,000 USD) or less. With a zero down loan, the monthly payment comes to about ¥300,000. This means it is possible to have some positive cash flow after making the monthly payment.
#3 Lower maintenance costs
Wooden buildings tend to have lower maintenance costs than RC or steel frame structures since you do not have to worry about maintaining elevators or water tanks.
Wood frame buildings also fit the Japanese climate well and have long-term durability, which will keep maintenance costs low for a relatively long time.
#4 Low teardown costs allow for a good exit strategy
The cost to dismantle a wooden building is relatively inexpensive.
If the value of the land remains stable, an owner can exit their investment by tearing down the building when it has reached the end of its useful life and put up the land for sale as a vacant lot.
Alternatively, you can rebuild a new wooden apartment, increase the rent (since it will be a brand new structure) and sell to another investor.
#5 Relatively high-yield investment
Due to their relatively low maintenance costs, it is possible to find wooden apartment buildings in Tokyo, Chiba and Kanagawa that offer over 8% gross yield, with a stable cash flow.
What are the main risks?
However, it is also important to point out the risks of investing in wooden buildings.
As alluded to above in the discussion on depreciation, because the legal useful life of wooden buildings is 22 years, the depreciation period is also relatively short. As the building ages, it will be more difficult to sell, so it is important to be flexible in setting your exit strategy.
Wooden apartment buildings also basically only consist of single units (1R or 1K apartments). This is the most common type of apartment unit, so if you buy in the wrong location, there is a high risk of vacancy.
However, overall, wooden apartment buildings are relatively low-risk investments, for which it is easier to receive financing and can offer a stable passive income stream.
For more information
If you are interested in learning more about investing in Japanese residential real estate, including wooden apartment buildings, please fill out the form below to contact Azuki Partners and a representative will follow up with you.