LeoPalace21 Reveals Defects in Buildings Constructed in 2018: Another 3,700 Buildings Affected

In a fresh blow to its brand, LeoPalace 21, the operator of over 30,000 budget apartment units across Japan, announced on April 10th that it has uncovered shoddy construction in another 3,784 buildings, bringing the total number of buildings with construction defects to 14,599. Until now defects had only been found in properties built up to 2014, but yesterday’s announcement makes clear that buildings built as late as 2018 were not compliant with building codes.

The ongoing scandal has serious implications not only for tenants in the affected buildings but also for the company’s profitability and the owners who rely on income from sub-leasing apartments to LeoPalace21.

Up till now

Yesterday’s announcement follows the original May 2018 admission and February 7th revelation that 14,443 tenants were living in buildings with insufficient fireproofing.

LeoPalace 21 has asked tenants living in buildings found to have defective fireproofing in ceilings to move, with the company bearing their relocation costs. About 30% (1,399) of tenants in 4,518 units across 400 buildings do not yet have a set moving date, although the defects were announced at the beginning of February. The company had urged residents to move by the end of March but as March is the peak month in the moving season, it seems that many people were not able to quickly find new accommodation.

Below are highlights from yesterday’s announcement of newly found construction defects.

56% of all buildings inspected, 3 main defects

LeoPalace21 operates a total of 52 apartment building “series” (building models), out of which ten had been subject to follow-up inspections after the original defects were found last spring. The inspection was then expanded to other series as the investigation continued. By the end of March this year, inspections for 21,811 buildings, or 56% of the total, were complete.

The three main defects found were: non-compliant gaps (found in 3,766 buildings), missing communal walls in building attics (1,892 buildings), and defective balconies (found in 1,427 buildings).

LeoPalace21 maintains that the defects are not in violation of the Building Standards Law, but when the scandal broke last spring, local government inspectors carried out surveys of the affected buildings and concluded that the buildings were in violation of building codes.

Repairs

The company announced that it does not expect additional repair costs to arise from these newly found defects. However, LeoPalace21 has already chalked up 43 billion JPY in extraordinary losses (as of the end of the fiscal year that ended on March 31st), due to repair costs associated with construction defects.

The company has been instructed by the Ministry of Land to accelerate and complete repairs for defects (found up to now) by October of this year, but it seems likely that the newly announced defects will have an effect on how quickly repairs for all the affected properties can be made.

Occupancy rate and tenant recruitment

The occupancy rate of LeoPalace21 buildings has taken a beating since the scandal originally broke.

In March, the company’s buildings had an average occupancy rate of 84%, despite March being the peak month in the moving season, when people tend to move in order to start new jobs and when students start university. The rate recorded in March was also the lowest in the past year.

The occupancy rate is expected to rise due to new tenants moving-in in March, but the rate has fallen year-on-year for the past eight months.

LeoPalace21 has stopped tenant recruitment for some of its properties. When repairs are completed, it will resume tenant recruitment, but it remains unclear if and and by how much the occupancy rate will recover.

“Reverse Gap”

LeoPalace21’s business model depends on keeping properties leased up with at least an 80% occupancy rate. The company basically sub-leases properties in bulk from apartment owners and pays them a guaranteed monthly amount in rental revenue. The difference in the rent charged to the tenant and the amount it pays out to owners is what the company earns.

Due to the construction failures, LeoPalace21 has promised owners that it will not reduce the amount of rental income it pays to them for the next two years. However, if the occupancy rate falls below 80%, LeoPalace21 will not be able to cover the gap between rental revenue and outlays to owners. The result will be a “reverse gap,” in which the company will be bleeding funds to meet its obligations to the people who have sub-leased their units to the company.

Source: Nikkei Shinbun, April 10, 2019

Lead photo: LeoPalace21 headquarters building (Wikimedia)