Diverging outlooks for Japan's office and retail real estate

THE Japanese economy is in good health, having recorded seven consecutive quarters of GDP growth between Q1 2016 and Q3 2017.

This period marks the longest continuous run of quarterly economic expansion for more than 16 years and has been driven mainly by exports and companies' capital expenditure on the back of the global economic recovery and a relatively-stable currency.

While the lack of growth in real wages has continued to stagnate consumer spending, the bullish stock market and stable exchange rates have helped department stores record a significant recovery in luxury and duty-free sales.

The tight labour market is expected to accelerate wage inflation in 2018, and lead an overall recovery in private consumption. Unemployment stood at a 24-year low of 2.7 per cent as of November 2017, while consumer confidence is also improving, supported by the strengthening job market.

CBRE Global Research expects Japan to record real GDP growth of 1.7 per cent in 2017 and a similar level in 2018. However, given that inflation is likely to remain low, we expect the current loose monetary policy to be maintained, regardless of whether Haruhiko Kuroda, whose term as governor of the Bank of Japan comes to an end in April 2018, is reappointed. Interest rates are therefore expected to remain at their current ultra-low level for some time.

While Japan is likely to maintain its current loose monetary policy, the US Federal Reserve is set to continue with its policy of "normalisation", which entails further increases in the federal funds rate. This may, at least initially, support the weaker yen via a widening interest rate gap between the US and Japan.

Tokyo is likely to see a gradual shift from a landlords' market to an occupiers' market, with average new supply in 2018 and 2019 estimated at 233,000 tsubo (a Japanese unit of area measure, roughly 3.3 sq m, equivalent to the area of two tatami mats), a figure 30 per cent higher than the average over the past 10 years.

By sub-sectors, office demand remains solid on the back of the stable economy and record corporate profits, while the tight labour market continues to encourage occupiers to seek primary locations and higher-grade premises which would help to attract and retain talent.

However, in an environment where it is still difficult to raise prices of merchandise or services, companies remain cost-conscious.

CBRE Research expects office vacancy rates in Tokyo to rise by about 3 percentage points to just under the 5 per cent mark by the end of 2019. As a result, Grade A assumed achievable rents are forecast to drop by around 8 per cent by the end of 2019.

New supply in regional cities is expected to be limited, even in cities where the vacancy is lower than in Tokyo. The tight supply-demand balance is therefore likely to persist, and rents are expected to continue rising in Osaka, Nagoya and other regional cities.

In the retail scene, the growth of the e-commerce sector is starting to affect the retail property market, with prime high street locations seeing more stores implementing show-room strategies. Demand will be driven by drugstores targeting inbound tourists and also by food and beverage retailers, as spending habits shift from merchandise to "experience".

Ginza high street-retail rents have adjusted following the slowdown in demand from luxury brand retailers since 2016. However, luxury goods sales have recovered on the back of the bullish stock market and relatively stable currency.

Should this trend continue, luxury retailer demand may also pick up, leading to rents bottoming out during 2018. The spread of showroom stores may also push up rents, particularly in prime locations.

In the investment market, investors retain a strong appetite for Japanese real estate but supply, particularly that of prime assets, remains limited.

At the same time, there is growing uncertainty around the rental outlook for some asset classes and areas, which is causing the price gap to widen between buyers and sellers. CBRE Research expects this to result in a year-on-year decline in transaction volume in 2018.

That said, capitalisation rates are likely to remain at their current low levels, particularly as there is little risk of a rise in interest rates. In particular, further compression may occur in mid-sized offices in Tokyo, prime offices in regional cities, as well as logistics facilities in the Greater Tokyo area.