The real estate market in Tokyo is currently experiencing a significant surge, particularly noticeable in the metropolitan area where the prices of newly built condominiums are skyrocketing. This trend has sparked curiosity and intrigue among investors and industry experts alike. The key to understanding this phenomenon lies in the perception of Japan as an ‘undervalued’ market, largely influenced by its low Real Effective Exchange Rate (REER).
The Exchange Rate Factor
The Real Effective Exchange Rate (REER) is a critical indicator that measures the relative strength of a country’s currency against a basket of other currencies, adjusted for inflation. In recent years, Japan’s REER has been on a downward trend, reaching levels similar to those seen over half a century ago, around 1971. This low REER suggests that Japan is facing higher price increases than other countries, contributing to the decline and stagnation of the yen’s REER.
The Impact on Real Estate Prices
The low REER has a profound impact on the prices of assets that are in demand worldwide, including real estate. The recent surge in real estate prices in Tokyo is not only due to the sense of undervaluation brought about by the weak yen attracting capital inflow from foreign investors but also due to supply constraints caused by the pandemic and the Russia-Ukraine war, which have led to a sharp rise in building material prices.
The Inflation Import from Overseas
One of the significant impacts of the low REER is that Japan is essentially importing inflation from overseas. This is evident in the rising prices of accommodation and dining services, which are in high demand worldwide, primarily by foreign tourists visiting Japan.
The Potential Impact on the Japanese Economy
While the rise in inflation will raise the yen’s REER and increase the relative purchasing power of Japan’s currency, it’s crucial to consider whether such a development can be called an improvement in the Japanese economy. The hope is that the surge in consumption by foreign tourists will lead to an increase in employment and wages in Japan, creating a virtuous cycle of income increase, consumption increase, and production increase. However, even if the total consumption amount of foreign tourists in Japan reaches several times its peak before the pandemic (2019), it is still only about 1% of Japan’s Gross Domestic Product (GDP). Therefore, it seems excessive to expect this alone to uplift the Japanese economy.
In essence, the problem Japan faces is not only the rise in asset prices and general prices but also the fact that the perspective of the Japanese side is falling. This is reflected in the yen’s REER, which continues to be at a half-century low. While the rise in inflation will raise the yen’s REER and increase the relative purchasing power of Japan’s currency, which in itself may be a welcome result, it’s crucial to consider the broader implications for the Japanese economy.
The surge in Tokyo’s real estate prices is a complex phenomenon influenced by various factors, including exchange rates, global demand, and inflation. As an investor, understanding these dynamics can help you make informed decisions and capitalize on the opportunities presented by Tokyo’s booming real estate market.