Real estate investment in Japan is often considered a medium-risk, medium-return venture. In this article, we will explore the nine primary risks associated with real estate investment in Japan.
- Vacancy Risk
- Maintenance Risk
- Interest Rate Risk
- Rent Default Risk
- Earthquake Risk
- Fire Risk
- Bankruptcy Risk
- Rent Decline Risk
- Property Value Fluctuation Risk
Let’s delve into each risk in detail.
1. Vacancy Risk
Vacancy risk is the risk of having no tenants in your property, which results in zero income. It’s a significant concern for every real estate investor in Japan. To mitigate this risk, consider the following:
- Choosing a Prime Location: The first step is to select a property in a location where long-term demand is expected.
- Strong Property Management Company: A reliable property management company can handle various tasks, from tenant management to building maintenance. Most property owners delegate these responsibilities to a management company, especially in multi-unit residential buildings like apartments and condominiums.
Additionally, you may consider vacancy guarantees or subleasing options.
- Subleasing: In this model, a subleasing company rents the entire building and then sublets it to individual tenants. The building owner doesn’t have to worry about vacancies, as the subleasing company takes care of the rental operations. However, this option may incur additional fees, potentially affecting your cash flow negatively.
2. Maintenance Risk
Maintenance risk refers to the risk of incurring repair and equipment costs, which can arise regardless of whether the property is new or old. To mitigate this risk, consider the following:
- Types of Repairs: This includes plumbing replacement, exterior wall and roof repainting, and interior renovations.
- Renovation: Renovation aims to restore an aging building to its original condition. This is especially common in older rental apartments to attract new tenants after the previous ones have moved out.
- Budgeting for Maintenance: To avoid unexpected expenses and financial shortages, it’s essential to include repair costs in your budget. Condominium management associations often collect a maintenance reserve fund for such purposes.
- Recommended Savings: For a studio apartment, it’s advisable to set aside around 5,000 to 6,000 yen per month for maintenance costs.
Additionally, you may consider renovations or upgrades to not only maintain but also increase the property’s value.
3. Interest Rate Risk
Interest rate risk refers to the risk of rising interest rates on a real estate investment loan, which can increase the total repayment amount. To mitigate this risk, consider the following:
- Down Payment: A substantial down payment can reduce the loan amount and interest payments.
- Accelerated Repayment: There are two types of loan repayments—contractual repayment and accelerated repayment. The latter allows you to repay a portion of the loan in addition to the contractual repayment when you have extra funds.
- Variable Interest Rates: According to a survey by the Housing Finance Support Organization, 73.9% of home loan users opt for variable interest rates due to the currently low rates. In the case of real estate investment loans, this percentage is even higher.
If you have the financial flexibility, consider making a down payment or opting for accelerated repayment to reduce this risk further.
4. Rent Default Risk
Rent default risk refers to the risk of tenants failing to pay rent. According to a survey by the Japan Rental Housing Management Association, as of the second half of 2020, the rent default rate was 5.0% nationwide, 4.1% in the Tokyo metropolitan area, 8.2% in the Kansai region, and 4.8% elsewhere. This equates to one in 20 tenants defaulting on rent.
The risk of rent default is a significant concern for property owners, as it interrupts income and poses a risk of non-recovery.
- Two-Month Default Rate: The default rate drops to 1.1% when considering a two-month period, suggesting that many cases are likely due to forgetfulness rather than inability to pay. However, it’s a risk that cannot be ignored.
- Reliable Property Management Company: To hedge against this risk, choosing a trustworthy property management company is essential. They handle a wide range of tasks, from tenant management to building maintenance.
For those who have other full-time occupations and invest in real estate, it’s challenging to manage rent default risk personally. Therefore, most property owners delegate this responsibility to a property management company.
5. Earthquake Risk
Earthquake risk refers to the risk of building damage due to earthquakes. Given that Japan is prone to earthquakes, it’s challenging to eliminate this risk entirely. However, you can take measures to minimize the damage should an earthquake occur. These include:
- New Seismic Standards: Opt for properties that meet the new seismic standards set in 1981, designed to withstand earthquakes of up to a seismic intensity of 6-7.
- Strong Ground Areas: Choose locations with strong ground conditions. Websites like the Ministry of Land, Infrastructure, Transport and Tourism’s “Hazard Map Portal Site” and the “Earthquake Hazard Station” provided by the National Research Institute for Earth Science and Disaster Resilience can help you assess the seismic risk of different areas.
- Earthquake Insurance: It’s crucial to enroll in earthquake insurance, which is usually an add-on to fire insurance policies. This insurance covers damages caused by earthquakes, volcanic eruptions, and tsunamis.
It’s essential to check whether a property meets the new seismic standards and to consider enrolling in earthquake insurance for comprehensive protection.
6. Fire Risk
Fire risk refers to the risk of building damage due to fires. To hedge against this risk, consider the following:
- Owner’s Fire Insurance: As the property owner, enrolling in fire insurance is a proactive step to mitigate risks.
- Tenant’s Fire Insurance: Encourage your tenants to also take out fire insurance for additional protection.
- Insurance Premiums: For smaller units like one-room apartments, insurance premiums are often relatively affordable.
According to a 2015 report by the Cabinet Office on disaster preparedness, approximately 85% of property owners have enrolled in fire insurance. It’s crucial to have both the owner and the tenant enrolled in fire insurance for comprehensive coverage.
7. Bankruptcy Risk
Bankruptcy risk refers to the risk of the property seller’s company or the property management company you’ve entrusted going bankrupt. To mitigate this risk, consider the following:
- Finding an Alternate Management Company: If the property management company you’ve entrusted goes bankrupt, you can mitigate the impact by quickly finding an alternative company to handle the property management.
Having a backup plan, complete with a roster of reliable alternative property management firms, is a smart move to ensure you’re not caught off guard.
8. Risk of Rent Decline
As buildings age, the rent they can command tends to decrease. A report by Mitsui Sumitomo Trust Foundation Research Institute in 2013, titled “The Impact of Aging on Housing Rent and Its Reasons,” provides data on how rent declines due to aging in both newer and older properties.
According to the research “The Impact of Aging on Housing Rent and Its Reasons” by Mitsui Sumitomo Trust done by Foundation Research Institute, buildings aged between 3 and 10 years experience the most significant drop in rent. Interestingly, single-room types, exemplified by one-room apartments, see a more moderate decline in rent after 20 years.
9. Risk of Fluctuating Property Values
The value of real estate can both rise and fall due to external factors. For example, the introduction of new train lines or urban development can boost property values in the surrounding areas. Conversely, if a town’s brand image deteriorates, its property values are likely to decline as well.
To mitigate the risks associated with real estate investment, careful area selection is essential. Take, for instance, Musashi-Kosugi, which has consistently ranked high in recent “Desirable Places to Live” surveys. The average publicly announced land price there was approximately ¥360,000 per square meter in 2005; by 2019, it had surged to about ¥950,000 per square meter. While this is an example of an increase, decreases are also entirely possible.
If you’re considering real estate investment in Japan, make sure to research urban development plans and other relevant factors in the area you’re interested in.
Is Real Estate Investment in Japan Actually Risky?
In light of the data, it’s clear that real estate investment has its own set of risks. However, it also offers a level of stability that is hard to find in other investment avenues. For instance, after the financial crisis triggered by the Lehman Brothers collapse, the Nikkei Stock Average plummeted by approximately 40%. In stark contrast, the decline in rent for one-room apartments in the Tokyo metropolitan area was less than 1%. Additionally, data from the East Japan Real Estate Distribution Organization showed that the average rent for apartments in Tokyo’s 23 wards only declined by about 17% during the same period.
In conclusion, while real estate investment may seem fraught with risks at first glance, its long-term predictability and resilience against economic downturns make it a compelling option. Whether you’re a seasoned investor or a beginner, the key to mitigating risks lies in thorough research and careful planning. By understanding the various risks involved and how to navigate them, you can make more informed decisions and potentially enjoy stable, long-term returns.