Japan - March 2021 Regional Residential SPOTLIGHT Savills Research Markets

Retail sales in Beijing were up 4.4% year-on-year to RMB539.8 billion in 1H 2018 Regional Residential Markets Positive demographic trends provide sound fundamentals for some markets

INTRODUCTION investment opportunities, the Japanese Summary Whilst the global pandemic and the residential market will likely continue to gain subsequent recession have thrown the real traction. • The Japanese residential estate market into turmoil, the Japanese That being said, competition for quality market has been attracting the residential market on the other hand, known assets remains fi erce. Compressed yields for interest of overseas investors as for its defensive nature, has been gaining residential properties in the nation’s capital as the global economy has been strong interest from global investors, well as limited opportunities will encourage disrupted by several events, especially in Tokyo. more investors to seek opportunities beyond including the pandemic. The attractiveness of the market is based on Tokyo and venture into regional markets to favourable funding conditions, as well as its achieve their yield targets. In this report, we focus our discussion • Greater Tokyo is undoubtedly stable political and economic fundamentals. These factors have stood out especially in on macro and micro demographic trends. the most popular market due to recent years as social disruptions, including In Japan, over 5 million people move from strong fundamentals supported COVID-19, were experienced around the one city to another every year1, more than by social and economic trends. globe. As the world economy remains clouded 1 This fi gure includes migration of non-Japanese. However, we have used demographic statistics of Japanese throughout the by uncertainty, and abundant liquidity seeks report, unless otherwise noted. • Regional hubs such as Osaka, Nagoya, and Fukuoka also pose opportunities as there is steady intra-regional migration fl ow to GRAPH 1: Expected Cap Rates for Residential Investment, 2003 to 2020 major regional cities. Osaka Nagoya Fukuoka Sendai Tokyo: Jonan Tokyo: Joto • The COVID-19 pandemic 9% has changed lifestyles and 8% preferences for residences, 7% possibly creating some long- lasting impact on the market. 6%

5% • Unlike the logistics market, 4% it may be worth considering why domestic investors, who 3%

possess market insight and EXPECTED CAP RATE 2% plenty of capital, are not as enthusiastic about the 1% residential market. 0% 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 1H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2H 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Source JREI, Savills Research & Consultancy

GRAPH 2: Residential Investment Share by Investor, 2011 to 2020

Cross-Border Institutional Listed/REITs Private Unknown 100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Source RCA, Savills Research & Consultancy

savills.co.jp/research 2 Regional Residential Markets

the entire population of New Zealand. The migration of such a large amount of people has signifi cant implications for Japanese real estate markets, especially in residential As the COVID-19 pandemic has markets where population movements disrupted the real estate markets directly aff ect demand. By carefully analysing a multitude of globally, Japan’s residential sector is social and economic data, we have identifi ed drivers of major demographic trends and drawing the interest of investors due markets that have benefi ted from them. to its stable and defensive nature. Indeed, some regional cities show positive demographic trends and pose investment While Tokyo remains the most opportunities. popular market in the country, major RESIDENTIAL TRANSACTION regional cities that have exhibited TREND The transaction volume of residential sound demographic trends should properties in Japan has been increasing especially since 2018, and geographically, present opportunities especially to Tokyo is by far the most popular market in those who seek higher yields. Japan, followed by regional cities such as Osaka, Nagoya, and Fukuoka. In 2020, Tokyo accounted for 42% of total residential transaction volume while Osaka, Nagoya, and Fukuoka together accounted for 31%. This contrast highlights Tokyo’s about 50 to 100 basis points compared to followed by overseas institutional investors dominating position as the social and Tokyo, which makes venturing into regional such as Allianz, AXA Group, and Nuveen economic powerhouse of the country. markets an alternative for many investors. Real Estate. That said, yields have been compressing In terms of the investor profi le, overseas in the Tokyo residential market and our in- investors are increasingly active in this MACRO DEMOGRAPHIC TRENDS house cap rates for mid-market residential market. Total transaction volume in this In a high-level summary, Greater Tokyo2 is property are 3.4% as of Q1/2021. With sector reached about JPY740 billion and the clear winner as the population infl ow increasing interest in this market, the rates over 60% of that was acquired by overseas to the market (921,000 in 2020) exceeds could compress further going forward. investors in 2020. According to Real Capital the outfl ow from the market (823,000 in Meanwhile, Japan Real Estate Institute’s Analytics (RCA), Blackstone was the top 2020) while, in all other markets, outfl ows (JREI) latest investor survey indicates player in terms of acquisition volume outweigh infl ows (Graph 3). As such, it that regional cities have yield premiums of between January 2019 and December 2020, is no surprise that most investment in Japan is targeting Tokyo, as discussed. In fact, with the exception of 1994 and 1995, Greater Tokyo has maintained positive net-migration since 1954, highlighting the region’s strong gravitational pull. GRAPH 3: Inter-prefectural Migration of Japanese by Region, 2020 One pull factor to Greater Tokyo is a high concentration of major companies in the

Greater Nagoya capital. As illustrated in Graph 4, Tokyo 167,206 has an overwhelming share of large-scale Greater Osaka Greater Osaka 317,842 316,724 companies. In terms of nominal GDP, Tokyo alone recorded JPY108 trillion in FY2019, accounting for approximately 20% of the country’s GDP despite comprising only 10% Greater Tokyo 822,889 Greater Tokyo of the country’s population. This relation 920,894 between migration and economic strength is also clear in Graph 5, which illustrates that net-migration to Greater Tokyo fl uctuates in sync with corporate profi ts. This correlation is likely because when economic conditions

Other Other weaken and companies reduce hiring, fewer 939,555 854,943 job seekers move to Greater Tokyo.

Source Ministry of Internal Aff airs and Communications, Savills Research & Consultancy

2 In this report, Greater Tokyo includes Tokyo, Kanagawa, Chiba, and Saitama.

3 Regional Residential Markets

GRAPH 4: Large-scale Companies per One Million People, 2016 Another primary migration driver is education. Tokyo has a high concentration

500 of top-rated universities, and high-school graduates will relocate from all over Japan 450 to attend them. Graph 6 illustrates that 400 prefectures in Greater Tokyo tend to

350 have high ratios of high-school graduates attending universities in the same region, 300 and consequently, had positive net-migration 250 fi gures in the age group of 15 to 19 years old.

200 In other areas, except for regional hubs such as Osaka, Kyoto, Aichi, and Fukuoka, high- MILLION POEPLE 150 school graduates have high tendency to go to 100 universities outside of their regions, resulting

50 in negative net-migration in this age group. LARGE-SCALE COMPANIES PER ONE LARGE-SCALE COMPANIES To summarise our discussion thus far, 0 Tokyo has been drawing people from across Japan largely due to employment opportunities and education. These factors are deeply rooted in the Japanese social Source Ministry of Internal Aff airs and Communications, Savills Research & Consultancy * Large-scale companies are defi ned by the Small and Medium Enterprise Agency’s criteria set for diff erent system and the long-term trend is unlikely to industries. For instance, in the manufacturing industry, large-scale companies are the ones with more than change, though economic cycles will likely 300 employees or the ones that are capitalised at more than 300 million yen. cause some ebbs and fl ows. Additionally, the recent trend of increasing foreign students GRAPH 5: Japanese Net-migration to Grater Tokyo and Corporate Profi ts, and residents should somewhat impact 1986 to Q2/2020 the overall demographic trend. This non-

Net-migration to Greater Tokyo (LHS) Corporate profit (RHS) Japanese population may further accelerate 180 90 the trends we have identifi ed. As such, from a macro demographic 160 80 perspective, Tokyo and its surrounding 140 70 prefectures including Kanagawa, Saitama, 120 and Chiba have sound fundamentals that

60 JPY TRILLION 100 support their residential markets.

80 50 MICRO DEMOGRAPHIC TRENDS 60 40 While Greater Tokyo is undoubtedly at the 40 30 centre of Japan’s solar system and therefore

THOUSAND PEOPLE THOUSAND 20 a primary destination of migration, over 50% 20 0 of migration actually takes place within the same prefecture. This pattern is apparent in -20 10 Graph 7 that compares net-migration fi gures -40 0 from within and without the same region where the city in question is located. Q3/19- Q2/20 Source Ministry of Internal Aff airs and Communications, Ministry of Finance, Savills Research & Consultancy Specifi cally, cities such as Osaka, Nagoya,

TABLE 1: Japanese Net-migration of 20-39 year-old Population, 2020

ORIGIN NET- MIGRATION KYUSHU/ KANTO KANSAI CHUBU CHUGOKU HOKKAIDO SHIKOKU TOHOKU OKINAWA

KANTO 84,854 - 19,725 27,967 6,444 3,251 10,280 3,111 14,076

KANSAI -8,642 -19,725 - 2,365 3,745 197 1,591 2,794 391

CHUBU -29,050 -27,967 -2,365 - 642 -65 -89 274 520

CHUGOKU -12,367 -6,444 -3,745 -642 - 34 -1,879 325 -16

HOKKAIDO -2,908 -3,251 -197 65 -34 - 37 5 467

DESTINATION KYUSHU/OKINAWA -9,727 -10,280 -1,591 89 1,879 -37 - 200 13

SHIKOKU -6,683 -3,111 -2,794 -274 -325 -5 -200 - 26

TOHOKU -15,477 -14,076 -391 -520 16 -467 -13 -26 -

Source Ministry of Internal Aff airs and Communications, Ministry of Finance, Savills Research & Consultancy

savills.co.jp/research 4 Regional Residential Markets

GRAPH 6: 15-19 Year-Old Japanese Net-migration vs Percentage of High-schools Fukuoka, Sapporo, and Sendai had overall Graduates Attending Universities in The Same Region positive net-migration between 2010 and 2020 mainly due to intra-region migration. 16,000 Tokyo On the other hand, cities in Greater Tokyo, 14,000 such as Yokohama, Kawasaki, Saitama, and 12,000 Chiba had positive net-migration largely due 10,000 to migration from outside of the region. Kanagawa This indicates that while these regional 8,000 Osaka cities do not have powerful forces to attract 6,000 people from outside of their own regions, Fukuoka Kyoto 4,000 Chiba they are still established regional hubs and Miyagi 2,000 can attract migrants within the same regions. Aichi Saitama After all, given the option, many people 0 would choose to remain in the same region -2,000

NET-MIGRATION (15-19 YRS OLD) (15-19 NET-MIGRATION where they have their social network or -4,000 sentimental attachment to their hometowns3. Hokkaido -6,000 As such, for those who seek good employment 20% 30% 40% 50% 60% 70% 80% 90% 100% and education opportunities, but prefer to % OF HIGH-SCOOL GRADUATES ATTENDING UNIVERSITIES IN THE SAME REGION stay close to their homes, moving to major Source Ministry of Internal Aff airs and Communications, cities of their regions is a valid option. Ministry of Education, Culture, Sports, Science and Technology, Savills Research & Consultancy One thing to note is that population growth rates vary widely even in the same city, and therefore, investors need careful GRAPH 7: Japanese Net-migration by Origins, 2010 to 2020 assessments of submarket-level population movements. For instance, although the 140,000 population of Osaka City overall is forecast 120,000 to shrink 4.1% between 2020 and 2030, central wards in the city such as Naniwa, 100,000 Yokohama City Kita, Tennoji, and Chuo are expected to see 80,000 double-digit growth during the same period Kawasaki City (Graph 8). In general, this urbanization 60,000 Saitama City trend can be attributed to the fact that 40,000 more people prefer to live close to their Osaka City 20,000 Chiba City workplaces located in central business Kyoto City districts, though this trend may somewhat 0 Nagoya City Sagamihara City Okayama City Fukuoka City change after the pandemic. Kobe City -20,000 This urbanisation trend will likely Niigata City Sendai City Sapporo City continue as redevelopment projects taking -40,000 Hiroshima City in major regional cities will make central NET-MIGRATION FROM DIFFERENT REGIONS NET-MIGRATION FROM -60,000 areas more convenient and attractive. While -60,000 -20,0000 20,000 60,000 100,000 140,000 construction investment across Japan has NET-MIGRATION FROM THE SAME REGION started to pick up since 2010, it is far cry from Source Ministry of Internal Aff airs and Communications, Savills Research & Consultancy *The sizes of the bubbles represent total net-migration. its peak in early 1990s and redevelopment has been happening in relatively limited areas of major cities (even in Tokyo, major GRAPH 8: Forecast Population Growth, 2020 to 2030F redevelopment projects have been focusing on central areas and station fronts). This Max Min Average disparity across regions will likely make 30% central submarkets more attractive and 25% encourage urbanisation trends. 20% For instance, in our Regional Japanese 15% Offi ce Markets – December 2020, we pointed 10% out that the Noritake project and RAYARD 5% Hisaya-odori Park in Nagoya appear to have 0% increased residential values beyond the -5% station front. The Umekita Second Project -10% in Osaka and the Tenjin Big Bang Project -15% in Fukuoka should have a wide economic -20% impact on the surrounding areas as well. -25%

FORECAST GROWTH (2020 VS 2030F) VS (2020 GROWTH FORECAST Graph 9 reinforces this by illustrating that -30% cities with higher population growth tend to have higher construction volume per person.

3 According to a survey conducted by the Cabinet Offi ce, only 50% of young migrants moved to Greater Tokyo because they wanted to live there. Others would have chosen Source NIPSSR, Ministry of Internal Aff airs and Communications, Savills Research & Consultancy other regions if there had been jobs or schools they liked.

5 Regional Residential Markets

GRAPH 9: Population Growth (2015-2020) vs Construction Volume Per Person Additionally, the compact city vision4 (2015-2019) by Municipality promoted by the Japanese government could 7 push the population to major regional cities in the future by incentivising movement 6 to major regional hubs. Compact cities are designed to promote concentration of urban 5 development around key transportation nodes, such as stations, to improve city 4 functions and minimise operational costs. This is critically important because Japan’s 3 rapidly ageing population has a major implication for the fi nancial strength of 2 municipalities. As illustrated in Graph 10, fi nancial 1 strength, measured as a ratio of basic fi nancial revenue and basic fi nancial 0 demand, decreases as the percentage of CONSTRUCTION VOL. PER PERSON (JPY MILLION) (JPY PERSON PER VOL. CONSTRUCTION -15% -10% -5% 0% 5% 10% 15% the 75-year-old population increases. As of POPULATION GROWTH (2015 VS 2020) FY2018, the average was about 0.5 (meaning Source Ministry of Internal Aff airs and Communications, Ministry of Land, Infrastructure, Transport and that 50% of basic fi nancial demand must Tourism, Savills Research & Consultancy be funded through the central government tax allocation). Considering that the GRAPH 10: Percentage of Over 75-year Population vs. Municipality Financial median percentage of 75-year-population of Strength municipalities is forecast to increase from 2.5 16% in 2015 to 26% in 20355, a large portion of municipalities will likely rely on the 2.0 central government’s life support to fi nance basic needs. This bleak forecast implies that 1.5 population fl ight to major regional cities will likely continue and possibly accelerate in the 1.0 future. A shrinking local economy will push those of working age to urban areas for job 0.5 opportunities. However, they may be more likely to move to major cities in the same regions rather than Greater Tokyo. FINANCIAL STRENGTH INDEX 0.0 RESIDENTIAL LEASING -0.5 Based on the discussion thus far, major 01020304050 regional cities, especially the ones considered % OF OVER 75 YRS. OLD as regional hubs such as Osaka, Nagoya, Source NIPSSR, Ministry of Internal Aff airs and Communications, Savills Research & Consultancy *Three-year simple averages calculated by dividing the total value of basic fi nancial revenue by basic fi nancial and Fukuoka, as well as cities in Tokyo’s demand value. Values below 1.0 indicate that municipalities require central government’s tax revenue neighbouring prefectures, appear to have allocation to meet basic fi nancial demand. sound fundamentals as residential markets. Indeed, Savills in-house residential data GRAPH 11: Rental Index, Q1/2016 to Q4/2020 shows steady rental growth in Osaka, Nagoya, and Fukuoka over the past years. While

Osaka Nagoya Fukuoka Tokyo data is rather limited for Greater Tokyo, 120 overall rental growth in the region, as well as population increases discussed above, 115 indicate that rents have likely increased during the same period. 110 One notable trend is that Tokyo, especially in central areas, appears to have 105 lost some traction concurrent with the COVID-19 pandemic, while other cities 100 retained sturdy rental growth. Due to the

95 pandemic, Tokyo’s population growth has taken a pause, which appears to be aff ecting

RENTAL INDEX (Q1/2016=100) RENTAL 90 the city’s rents. Average rents dipped 4 Compact cities are designed to promote concentration of urban development around key transportation nodes, such as 85 stations, and improve city functions and minimise operational Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 costs. The government is also advocating the benefi t of low carbon emission from reduced vehicle transportation in 2016 2017 2018 2019 2020 compact cities. 5 This is based on the National Institute of Population and Source Savills Research & Consultancy Social Security Research’s (NIPSSR) forecast published in 2018.

savills.co.jp/research 6 Regional Residential Markets

GRAPH 12: Rental Housing Starts vs Net-Migration to Tokyo, 2011 to 2019 COVID-19 pandemic has changed our lifestyle in a profound way and may have

Rental Housing Supply (Steel Frame) Net-migration permanently changed the course of society. 80,000 First of all, remote work arrangements are likely to remain, in many cases through a 70,000 hybrid hub and spoke model. As we have already witnessed, this will slow migration 60,000 to city centres and increase demand for

50,000 larger residential units. This trend could be propelled by the digitalisation eff ort by the 40,000 government. Secondly, domestic companies shifting from “membership type” employment

UNIT/PEOPLE 30,000 to “job type” employment can reduce the number of transfers across regional offi ces. For 20,000 instance, Mitsubishi Chemical plans to allow

10,000 employees to request not to be transferred to other prefectures for six years. 0 With regard to investment trends, the 2011 2012 2013 2014 2015 2016 2017 2018 2019 increasing number of overseas investors in Source Ministry of Land, Infrastructure, Transport and Tourism, Savills Research & Consultancy * In this chart, rental housing supply includes steel reinforced concrete, steel concrete, the residential market has been noticeable. and steel structured buildings. This is in clear contrast with the logistics market where there are many new local and especially in the C5W, while more aff ordable OUTLOOK international entrants to the market. While areas have gained momentum. Additionally, As widely publicised, Japan’s population this trend can be celebrated as validation the shift in preferences for larger and more started to decline in 2011 and is likely to of its attractive stable nature and increased aff ordable units appears to have persisted lead peer countries in its aging trend. maturity of the logistics market, it may be thus far and is expected to remain in place Despite this narrative, some cities have worth considering why domestic investors, for the time being with work-from-home growing populations and sound economic who possess wide market insight and large arrangements becoming more established. fundamentals. These cities tend to be capital, are not as enthusiastic about the That said, in the 23W, net-migration has established regional hubs and benefi ciaries residential market. The market making in exceeded the number of rental housing of positive migration trends. As urbanisation the residential sector is currently being done starts over the past decade, providing is a trend that will likely last for a long time, mostly by aggressive overseas bidders, and sound supply-demand dynamics for the population infl ow to major cities should occasionally with relatively high leverage. market (Graph 12). Indeed, occupancy of continue for the foreseeable future. The While investors with small portfolios could investment-grade residential properties pandemic as well as the economic conditions still fi nd buyers when they exit, those with owned by J-REITs remains tight in Tokyo. impact on this urbanisation trend, but are large numbers of properties might be vexed Markets in cities including Osaka, unlikely to signifi cantly change the direction to divest them, particularly if the pool of Nagoya, and Fukuoka appear to exhibit of this trend. Social changes such as potential buyers will not be as abundant in steady momentum. The diff erence from increasing dual-income households, higher the future. Tokyo can be attributed to the fact that labour participation rates of females, and Nevertheless, favourable funding conditions these cities have a much lower population increasing retirement ages also contribute to as well as stable and defensive cashfl ow density and shorter commutes, which local economies. will remain attractive. Hence, multi-family relatively diminishes the appeal of remote While current trends are likely to residential properties in both Tokyo and work. continue on a macroeconomic scale, the regional hubs are likely to keep sought after.

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