Major Changes Coming to Appraisal System for Residential Housing in Japan

By Jeff Wynkoop

According to the Nikkei Shinbun, the Ministry of Land, Infrastructure, Transport, and Tourism (MLIT) will implement a major change to the way residential housing is appraised with the aim of juicing the second-hand housing market. The new guidelines will be announced at the end of July.

The MLIT will be implementing a new system that will allow for individual structural improvements (for example improvements to beams, walls, and pipes) to be evaluated and counted in a property’s “reference price,” a new value to be established with the implementation of the new rules. The “reference price” will be used in addition to the appraised value to help determine the fair value of a property.

Under the current system, the appraised value of a residential property is based almost entirely on only three factors: the year of construction, the floorplan, and its location, and houses are appraised as a whole. Unlike in the United States, for example, individual home improvements in Japan are not considered when appraising the value of second-hand homes.

Raising the share of second-hand home sales

In 2013, sales of second-hand homes only accounted for about 14.7% of total residential home sales in Japan. In contrast, sales of second-hand homes comprise 70% to 90% of all home sales in Europe and the United States.

In 2006, the MLTT implemented the Basic Act for Housing (BAH), the main purpose of which was to establish basic principles to ensure and improve stable housing for people and to clarify the responsibilities of the public sector in this regard.

The BAH established quantitative targets for such things as improving Japan’s housing stock (for example, earthquake-resistance and energy efficiency standards for homes), the housing market, and the living environment for elderly care.

In terms of the second-hand market, the BAH set the goal of raising the share of second-hand home sales transactions from about 13% (in 2006) to 23% by 2016. As noted above, the percentage currently stands at 14.7%, so some improvement has been made, but the target is far from being met.

As we’ve mentioned in other posts, Japan faces a growing problem of vacant houses. In 2013, there were about 8.2 million vacant houses throughout Japan, the highest number on record. This problem is expected to increase as the population continues to decline, so the issue of how to increase sales of second-hand homes is not just a short-term issue.

Why does Japan lag in second-hand home sales?

The usual explanation for why it has been so difficult to spur second-home sales has to do with the tax rules for fixed-asset (property) depreciation. Under Japan’s tax laws, the useful life of a house made of wood or composite construction is set at twenty-two years. Almost all residential houses built in Japan fall into this wood-construction category. So the appraised value of houses that are over twenty years usually falls to almost zero.

If you were to buy a second-hand house after its whole useful life has already expired (for example, if you bought a wooden-construction house in the 23rd year after it was built), you would only be able to deduct a fraction of its useful life as an expense for tax purposes, which is a disincentive from a tax planning perspective.

This tax rule has also had the unintended effect of providing a disincentive for some homeowners to invest in maintaining their property as it ages. In Japan, a homeowner and his family may get personal enjoyment from a home improvement, but under the current appraisal rules, the improvement will add very little to the value of the house as an asset.

As the Nikkei points out, however, it is not just this tax rule that accounts for Japan lagging behind western countries in second-hand homes sales. During the asset and real estate bubble years (1986 to 1991), as long the value of the land was increasing (and it was!), it didn’t really matter what the value of the structure was appraised at. It became customary to appraise older homes at lower values, regardless of their structural integrity because very often the new owner would tear it down anyway to build a new home.

Another factor in the low volume of second-hand home sales is to see the problem from the perspective of potential second-hand home buyers.

As mentioned above, under the current appraisal rules, the appraised value of a residential house is based almost entirely on only three factors: the year of construction, the floorplan, and where it is located.

A potential second-hand home buyer cannot deduce anything about the structural safety of a house from its appraised value. This is because currently, the appraised value is mainly based mainly the three factors mentioned above, irrespective of its actual structural integrity or any improvements that may have been made to it.

Hoped for Effects

What can we expect with the implementation of the new rules at the end of July?

First, the MLTT notes that there will be a need for more third-party home inspectors. In the United States, about 80% of home buyers contract a home inspector to check a house for problems before they complete a purchase transaction. In Japan, according to the Nikkei, most homebuyers do not use a third-party inspector.

The MLTT also posits that having a “reference price” that includes structural improvements in determining the fair value of a house will help both mortgage originators and borrowers better assess whether a particular property is suitable for a borrower.

The MLTT points out that if second-hand home sales grow as a percentage of total home sales, one effect may be to depress sales of newly constructed homes, but the policy change may also have the effect of increasing purchases of second-hand homes for investment purposes. In Japan, the percentage of homes bought for the purposes of renovation and resale (popularly known as a “fix and flip” in the United States) was about 28.4% in 2013. According to the Nikkei, this percentage also lags western countries, so has potential for growth in Japan.
Source: Nikkei Shinbum, June 7, 2015