Journey of a First-Time Buyer in Japan

This anecdotal journey guides new investors with the goings-on from the exploratory phase to purchase, and the steps and questions in between.


Background
Investors Ann and Bob have a small family and about seven years of experience with real estate investments in the US. They were familiar with Japan through personal visits. Their journey to invest into Japan properties began when Bob was given a job transfer to Tokyo.
Although they were looking to purchase a residence in Tokyo, they wanted to get their feet wet by dabbling in a smaller investment property first. While visiting Japan, they discovered that their choice cities included Fukuoka, amongst others, for the new buildings, weather, lower cost of living compared to Tokyo, as well as potential for growth.
Other cities included Osaka, Yokohama, Tokyo, Nagasaki and Kobe. Yokohama and Tokyo would be their choice for personal residence in order to be closer to Bob’s workplace and their children’s school.
For the investment property, they had in mind a tenanted unit with a budget of below 8.7 million JPY (USD $80K)
that would generate a yield of a minimum of 6 percent net pre-tax, or at least approximately 33,000 JPY ($300) in monthly cash flow.
Their primary concern was income stability, therefore were insistent on having at least one year left on the lease. Alternatively, they would be open to vacant units in good rentable areas, but only if the seller was willing to discount the purchase price up to the holding cost of six months, and the unit must be tenant ready. Additionally, if there were any repairs and upgrades required, then a further discount equivalent to one year of the holding cost.

Professional feedback
Looking at their criteria, while the budget, yield and location were workable, the terms of the lease in Japan are irrelevant as they are not necessarily the basis of income stability.
Here’s why: First and foremost, tenancy laws are tenantoriented. Even though the standard lease term is two years which is automatically renewed upon expiry unless notice is given in advance, the tenant only needs to give a single month’s notice to walk away from the lease. The owner, on the other hand, must give the tenant six months’ notice if the lease will not be renewed.
Also, the most the owner can claim as compensation even in cases when the tenant moves out within the very first 2-year lease term, is one to two months’ rent at most. Following this initial lease period and once the lease has been renewed at least once, the tenant is no longer obliged to pay any compensation as long as they provide the said one-month notice. Therefore, instead of focusing on the lease terms for income stability, the focus should be on good yield in high occupancy areas.
On their alternative choice of purchasing vacant units, given the abundance on the market due to Covid-19, think of purchasing a vacant unit as buying into immediate expenses (building fees), as opposed to buying into immediate income.
On the upside, vacant properties are often renovated and cleaned to get the best bang for the buck, saving the buyer from having to invest in those costs. In addition, there is usually more room to negotiate price.
So, the bottom line is that if an investor’s purpose is stability and immediate income, tenanted properties would be the way to go. If, however, higher potential savings on property price are sought, in addition to a more flexible and creative property use strategy for the longer term, a vacant property may be the way to go.
With this in mind, Ann and Bob decided to focus on tenanted units with good yield.
Decisions, decisions, decisions
Now that a direction has been established, there will be plenty of listings to review with photos, features, and numbers showing the purchase price, purchase costs, monthly costs, net income and cash flow. This can take time, particularly for first-time buyers.
Unlike the US and other markets around the world, offers are made on Japanese properties almost as soon as they are listed. Recognizing the repeated missed opportunities, this couple took the leap and ventured forward with an offer on a property in Yokosuka for 4.7 million JPY ($42.8K), below the asking price of 5 million ($45.5K)
Ann and Bob felt right about their decision. Centrally located in the heart of the Yokosuka, walking distance to a large US army/navy base, and only six minutes to the nearest train station. One room plus kitchen, on the 5th floor of a seven-storey building.
The building has a secure keypad entry, popular with single females. Additional features include a built-in closet and laundry bay. It was built in 1989 after changes to the 1981 Building and Standards Act for earthquake resistant construction methods.
At a yield of 6.62% net pre-tax, the tenanted unit generates immediate monthly income of 33,579 JPY ($306). The offer was made. They waited in anticipation for the due diligence information.
Once the offer is made, the realtor will proceed to provide the due diligence information. This, on the understanding that if the due diligence checks out the customer will in fact, purchase the property.
Since foreigners have a reputation for “getting cold feet”, “window shopping”, or “tire kicking,” often leading to a last minute change of heart, which is much frowned upon in Japan, it is extremely important to ensure that, if an offer is made, and the due diligence info received is then satisfactory, the buyer would be moving forward with the purchase, regardless of the fact that offers made atthis stage are not legally binding. Failure to do so would “burn” the buyer, who will no longer be able to conduct business with the realtor involved, and in many cases with other realtors as well, as word spreads.
The due diligence package includes tenant information, building reserve funds pool status, and renovation history, as well as any unique caveats known to the seller and listing realtor, if these exist – which must be disclosed by law. If the building’s accumulated funds are depleted with no recent renovations to justify the lack of funds, moving forward with a purchase would be risky. If, however, the accumulated funds are depleted, but there is a record of history of repairs, then the account is justifiable.
In this case, the couple was relieved to hear that the initial information was favourable:

  • Tenant is a single male, employed by the Japanese army in residence just over two years (lease already renewed once) with no late payments or other issues – a safe and stable tenant profile.
  • Total reserve funds in the building’s funds pool are approximately 7 mil JPY ($63K) – with payments divided between all unit owners and assuming a similar price, that accounts for just over 3% of the purchase price per unit.
  • The two most common large ticket items in the building’s renovation history – the exterior of the structure and its roof – have both been included in large renovations performed in the seven years preceding purchase which means that the slightly depleted reserve funds pool is more than justified – it is being used for proper maintenance, and the risk of another sudden large renovation being required in the next five to eight years is quite low – meaning, monthly building fees aren’t likely to go up sharply to cover such work.

Ann and Bob also discovered that Covid may affect the yield. fte tenant is paying 50K/month JPY ($455) in rent. However, the average rent for comparable units in the same area is currently lower, at approximately 40,000 JPY ($364) – an effect of the current pandemic situation, which has seen softer purchase prices and rents.
Similarly, there were other uncertainties to consider which could affect the yield such as if/when the tenant moves out, if/when the economy recovers, and if/when the Covid crisis ends. fte couple considered the uncertainties, and agreed to take these relatively low risks onboard, and keep moving forward.

After a few days, further due diligence uncovered the seller’s outstanding mortgage that had to be paid off on settlement. For this reason, the minimum price the seller would agree to was 4.85 mil JPY ($44.1K). Given that it was still below the asking price of 5 million JPY ($45.5K), the couple agreed, considering the tenancy lease still had over a year left on it, and the tenant would most likely renew at his current rate prior to Covid – since Japanese tenants would normally prefer to remain in their current residences, due to a deep-seated cultural reluctance to change, and being extremely averse to what they perceive as “conflict” – which would mean they are highly unlikely to attempt to negotiate a lower rent.
As mentioned earlier, the irrelevance of the terms of the lease is a point that can be hard for foreigners to grasp. Even though the tenant has given no indication to leave, as mentioned earlier, there is no guarantee involved in tenancy leases, and the tenant can simply pay one to two months of compensation and leave anytime – therefore a moot point. In reflection, the couple understood this and agreed to proceed.

 Sold!
With this purchase, the buyers got themselves invaluable learning on this remote journey of investing in Japanese real estate. From how to go through the information to make quick decisions, to understanding what income stability means, then being able to access good management practices by comparing the building’s accumulated funds with the history of renovations. And probably the most challenging part was the mindset of accepting the irrelevance of the terms of the lease.
Once an offer is made, the process takes approximately two months from when an offer is accepted for settlement to occur. fte timeline is approximately two to three weeks for the due diligence process to be completed, two to three weeks for the contract to be signed, and two to three weeks for all legal documents to be prepared by both buyer and seller, witnessed, posted, and received.
After settlement, the new title deeds and property registration documents would take another three to four weeks to arrive from the legal affairs bureau, at which point, they would be bundled up with the formerly accrued documents such as the purchase contract, property specifications report, settlement related funds receipts and statements, etc., and couriered to the new owners.
A toast to the new owners!
Priti Donnelly is the Sales and
Marketing Manager of Nippon
Tradings International (NTI).
She can be contacted at:
info@nippontradings.com
 

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