Japan: A strong performance amidst challenging conditions

Knight Frank’s Horizon Report III – Look Beyond the Norm found the proportion of Japanese transactions in Asia-Pacific rose steadily from 18.9% in 2021 to 25.4% in 2023. Despite a marginal rise in short-term interest rates in March 2024, market sentiment remained largely unaffected, particularly among domestic investors. However, cross-border activity has been restrained due to reduced confidence among international investors and elevated global interest rates.

In Q2 2024, investment volume from overseas buyers contracted by almost 60% to US$1.2 billion, compared with a high base in Q2 2023 driven by several high-profile portfolio deals and large-ticket assets.

Nevertheless, international investors are gradually re-entering the Japanese market, capitalising on favourable long-term prospects. This is most evident in established players seeking opportunities in prime locations and high-quality assets that offer stable yield spreads. Approximately 23% of total cross-border flows are projected to be directed toward Japan in 2024. In May BentallGreenOak acquired Honmachi Garden City in Osaka, a mixed-use building, from Sekisui House REIT for US$422.9 million, with cap rates of 3.0% for the hotel component and 3.4% for the office component.

Outlook

As of the second quarter of 2024, Japan has asserted its claim as Asia-Pacific's largest real estate investment market. The central bank's decision to maintain its accommodative stance, while most of the world was hiking rates, raised allocations to Japanese real estate. Moves to normalise monetary policy will continue to fuel investors' appetite, now motivated more by property fundamentals.

Japan remains a safe haven for global capital due to the Bank of Japan's cautious approach. The Central Bank monitors market conditions, prioritizing sustainable wage growth and moderate inflation before implementing significant rate hikes. A short-term rise of 10-30 basis points is possible with minimal impact on value-add players. However, if long-term interest rates rise, investors may demand higher cap rates, leading to more pronounced discrepancies in bid-ask spreads and reduced liquidity.

Asset class trends

• The living sector continues to attract investor interest, though capital rate compression has led to increased selectivity in multifamily asset acquisitions. Some investors are also exploring opportunities in the senior living sector, leveraging the country's demographic shift.
• The office sector is seeing a recovery, driven by positive shifts in demand and the resurgence of expansion efforts among domestic companies. This confluence of factors creates optimal acquisition opportunities for investors.
• The industrial sector is being reshaped by upcoming labour law changes aimed at improving truck driver welfare, potentially increasing demand for modern, quality logistics facilities in prime locations. Facilities with poor specifications that struggle to secure tenants provide some value-add opportunities.
• The hotel sector is experiencing positive momentum due to strong inbound tourism numbers and the yen's continued weakness, generating increased interest from institutional investors. Some investors adopting value-add or opportunistic strategies are also converting hotels to multifamily properties to gain exposure to this niche sector.