Real Estate Japan recently spoke with Hotaru Fujimoto of Premium Value Bank (PVB) to ask her about the basics of investing in residential apartment buildings in Japan. If you are looking to diversity your portfolio and/or are looking for a high-yield, stable income stream, residential apartment investing may be something to consider.
What is the profile of an investor for whom whole building investment would be appropriate?
Ms. Fujimoto tells us that anyone who is employed in Japan and has permanent residency (PR) status or any kind of work visa is a good candidate for getting financing for whole building investment. We had expected that the barriers to entry would be higher, but seemingly, if you meet these minimum requirements, whole building investment may be appropriate for you.
Why would someone invest directly in real estate, as opposed to indirect investment (for example, through J-REITs)? What are the advantages of directly owning a property in your investment portfolio, rather than holding a fund that invests in real estate?
There are several advantages to owning real estate directly in your portfolio, but the most significant is the ability to leverage your capital. Generally you cannot get a loan from a bank to invest in securities, but you can to invest directly in real estate, which enables you to do more with your starting capital. Positive leverage allows you to earn equity returns on the entire purchase amount (after deducting loan payments). In addition, through direct ownership you can receive the benefit of depreciation and other operating expenses, which in many cases can be used as a tax shield for other income.
According to Ms. Fujimoto, for example, as a foreigner living in Japan with the proper working visa and income, it is possible for you to get a property investment loan with a loan-to-value (LTV) ratio as high as 90%. The LTV is equal to the mortgage amount divided by the appraised value of the property or the purchase price. The higher the LTV, the greater the risk for the bank. On the other hand, the higher LTV, the more that you, as the borrower, can finance your investment.
According to Ms. Fujimoto, there are at least two Japanese banks where a foreigner who 1) has a working visa and 2) has an annual income of at least 7 million yen can qualify for a property investment loan: Suruga Bank and Shihan Bank Japan. Individual cases will vary, but in general, Suruga Bank offers LTVs of about 90%. Shihan Bank Japan offers LTVs of 70% to 90%. Depending on the candidate’s financial situation as well as the particular characteristics of the property, it’s possible to borrow more.
A typical loan term is 25 to 30 years. The longer the term, the better the opportunity to generate cash flow. According to Ms. Fujimoto, the investment property loans are usually structured as adjustable rate mortgages, with an initial fixed interest rate. The initial fixed term varies from bank to bank, but is usually in the range of 3.3% to 4.5%.
If a hypothetical investor (a foreigner living in Japan with 7 million yen income and a working visa) wanted to invest in an apartment building appraised at about 70 million yen (about $565,000 at today’s exchange rate), they could conceivably get a mortgage for 90% of the appraised value, or about 63 million yen.
The typical upfront cost is 10% to 30% of the sales price plus the closing costs.
In our example, let’s suppose the investor puts down 10% or about 7 million yen in down payment plus 4.9 million yen in closing costs (which is usually about 7% of the purchase price) for a total of about 11.9 million yen. So for a building valued at 70 million yen, you would have to have about 11.9 million yen (about $96,500 at today’s exchange rate) up front. For our ballpark calculation, let’s round $96,500 up to $100,000.
On the other hand, our hypothetical investor could also take his $100,000 and buy investment units in J-REITs if he wanted to invest in the Japanese real estate market.
A REIT (short for Real Estate Investment Trust), is a security that sells like a stock on the major exchanges and directly invests in real estate, either through owning properties or mortgages. J-REITs are the Japanese equivalent of REITs (which had their origin in the United States in the 1960s). By investing in a REIT, an individual investor can invest in a broad (or narrow, depending on their investment objective) portfolio of rental income earning properties that are professionally managed by a property manager on behalf of the REIT.
For many investors, one of the attractions of investing in REITs or J-REITS is their relatively high dividend yield. According to the Association for Real Estate Securitization (ARES) of Japan, as of November 2014, there were 48 J-REITs listed on the Tokyo Stock Exchange, with a market cap of 10 trillion yen. Their average dividend yield was 3.1%. In comparison, the 10-year Japanese government bond was yielding about 0.465% in October 2014 (Source: OECD).
Typically, investors also include REITs or J-REITS in their stock portfolio because of their liquidity, simple tax treatment, and because they offer diversification. Historically, REITs are only partially correlated to the S&P 500 since they must derive at least 90% of their income from directly operating and/or managing real estate.
However, this is also one of the main benefits to owning direct real estate versus J-REITs: the value of J-REIT stocks are more likely to be affected by the sudden movements of the global stock market (thereby lessening their portfolio diversification effect). Owning real estate directly is a cleaner diversification strategy.
So, let’s go back to our hypothetical investor, who wants to invest in Japanese real estate with their $100,000. They could buy $100,000 worth of investment units in J-REITs. Another option is to directly invest in real estate and leverage this capital to buy the hypothetical 70 million yen appraised property we mentioned above. The argument for the latter is that banks do not typically lend money for you to invest in equities. Direct property investment lets you leverage your capital to buy an asset that is valued at many multiples of your starting capital.
Ms. Fujimoto points out other interesting advantages of residential building investment:
— As the owner of a residential apartment building, you are considered a small-business owner and can grow your credit as you use your rental income to repay your loan. As you build your credit, you can qualify for higher loan amounts if you should choose to buy a bigger property in the future.
— When you invest directly in real estate, you are in charge of how the property is managed. As a practical matter, however, many people who invest in residential apartment buildings use a professional property management company to deal with the actual management of the building.
J-REITs, in contrast, are a “hands-off” form of investment. As a unit holder in a J-REIT, you do not have a say in how the properties themselves are managed. REIT and J-REIT dividend distributions have historically tended to be stable, but investing in a REIT or J-REIT does not guarantee that the property management company is doing a good job of maximizing rental income from the properties, and thus the distributions.
— In Japan, getting a property loan also gives you or your successor an unencumbered right to the property and any rental income, in case you pass away or sustain a serious injury. This is because when you get a property loan from a Japanese bank you are required to also take out “group life insurance.” If you pass away before the loan is paid off, the insurance company pays the balance of the mortgage, and the asset passes unencumbered to your successor.
What are the main advantages of investing in residential apartment buildings as opposed to individual unit investment?
Ms. Fujimoto explains that the main advantage of investing in an entire apartment building, as opposed to an individual unit is that it lowers the risk of loss of income in case you are not able to have a tenant in place. If you bought an individual apartment or condo, you would have to pay the mortgage yourself because there is only one income stream. Investing in whole buildings allows you to lower the vacancy risk. According to Ms. Fujimoto, in the deals that Premium Value Bank structures for its clients, even if one or two tenants move out, the investor would still be getting sufficient income from the remaining clients to cover the loan.
Other Issues to Consider
We only asked Ms. Fujimoto about a few of the things to consider when thinking about whole building investment. Other things that you might be wondering:
- How do you go about finding properties that match your investment criteria?
- What kind of yields can you expect?
- How do you find tenants and manage your property?
- What are the tax considerations?
- How can you increase the value of your property through renovation?
Photo credit: Shinichi Sugiyama