Residential Lending

A Mini-Bubble Brewing in Japan’s Residential Apartment Market

By Jeff Wynkoop

There are signs a mini-bubble may be forming in Japan due to the sharp increase in the number of new apartment loans handed out over the last few years. アパートローン(apaato rōn, ‘apartment loans’ also known in English as multi-family loans) are loans provided to fund the acquisition, construction, renovation, or addition to residential properties not intended to be owner occupied.

According to the Bank of Japan (BOJ), the outstanding balance of apartment loans nationwide was up 4.9% at the end of December 2016 when compared to December 2015.

There are many reasons for the sudden popularity of apartment loans, and not all of them are related to the real estate market itself.

Effects of 2015 Inheritance Tax Law Revision

The Japanese inheritance tax law was revised in 2015, lowering exemption levels so that more people became subject to inheritance tax. In turn, many of these people decided to take action to reduce their heirs’ future tax liability.

Under Japanese inheritance tax rules, when land is transferred to an heir upon an owner’s death, the tax basis for the land is reduced by 20% provided an apartment building is located on the land. 

In the last few years many wealthy landowners have thus decided to have new apartment buildings built on their vacant land so their heirs could enjoy reduced inheritance tax liability in the future.

The problem is that this is leading to an oversupply of new residential buildings in locations which are a distant walk from a train station (15 minutes or more). This new supply is causing rents to stagnate and even fall in certain areas outside of the main urban centers.

For instance, in places like Sagamihara in northcentral Kanagawa Prefecture, real estate agents fear that all of the newly-built buildings with ‘vacant’ signs far from the station portend a bad outcome, since as they point out the Japanese population is decreasing, while the number of investment properties seems to be growing every day.

Pressures on the Lender Side

There is pressure to grow apartment loan portfolios on the lender’s side as well.

In the current negative interest rate environment, Japanese banks, especially regional banks, are having a hard time making money. Because banks can charge higher interest rates for apartment loans than for other real estate loans such as home mortgage loans, they have been active in searching for individuals wishing to take out a loan to build an apartment. Apartment loans are also an important tool for regional banks to remain competitive nationally because they offer such banks a ready way to expand their borrower base outside of their local markets.

Some banks have been working regularly with real estate companies to find new clients, so that together they can present complete apartment investment projects (comprehensive offers for financing, construction management, property management, etc.) to potential clients.

Last year there were several disputes between owners and property managers regarding these investment projects (and alleged guaranteed rent levels), and in December 2016 the Financial Services Agency (FSA) officially requested banks change their loan underwriting criteria so that when considering an individual’s apartment loan application, the bank should take into consideration the likely future economic viability of the project as a whole.

Bank of Japan Plans to Examine Underwriting Standards

Many of the apartment loan clients are high net worth individuals, so the FSA is concerned whether banks are being excessively lenient in giving out loans in so many cases.  The BOJ has also declared that in its annual survey of financial institutions for the 2017 fiscal year, it will examine whether underwriting standards for apartment loans are appropriate, and whether banks are undertaking a systematic assessment of the economic viability of each apartment loan prior to the loan being given. Both the FSA and the BOJ are concerned that non-performing apartment loans could become a future problem for lenders, with worrisome knockoff effects for other parts of the economy.

Source: Sankei News, April 4, 2017

Jeff Wynkoop is the author of Legal Issues in Japanese Real Estate Investment.