In the run up to the Olympics, many (particularly those that do not yet themselves own real estate in Japan) will tell you that the Tokyo real estate market is “overpriced”. When making an assumption about any price being “high” or “low” you must provide a benchmark or comparison upon which to base your statement. Something can only be “overpriced” if you first understand its fair value. Without an understanding of fair or ‘intrinsic’ value any assumption about price is simply an opinion- and there is no place for opinion in investing.
One metric for assessment could be to look at the taxable (government assigned) value of a property relative to its sale price. Considering the tendency for the taxable value to be between 50% to 80% of the actual sale price for Tokyo property, we could probably all agree that if a property sold for a price that was 200% of its taxable value it was “overpriced”. How often will this happen? Not very often at all- and not without good reason.
If you are to see properties exchanging for increasingly higher prices, they are likely to be luxury homes and trophy assets. These properties, once they become desirable to the super-rich, are often very scarce (for example, a particular Tower-Mansion in Azabu becomes popular, and there are only 60 units inside), so when a unit finally comes on the market, there are no alternatives available as there are no other units on the market at that time to ‘benchmark’ the price against; thus the seller can determine a price that he is willing to sell for- with no consideration for the actual ‘value‘ of the asset. If Mrs. wealthy buyer then falls in love with the fixtures and fittings of the bathroom in the apartment then she is not likely to spend any time whatsoever considering the ‘intrinsic value’ of the property either, and will likely use the emotional metric of ‘am I happy to buy this thing, for this price?‘ to determine her decision. If you are indeed in the market for a luxury property in Tokyo at this time, then exercise caution. There are still good deals out there, but there are no shortage of deals that offer little alpha in terms of value over the price.
Where the generalised “Tokyo is expensive” claim holds even less weight is with regard to investment properties- and in particular investments into whole buildings, where more than one unit is owned, for the purpose of producing a yield for the investor. There are numerous metrics to price an investment property (most commonly used being Cap-Rate and the Income Multipliers). These metrics do not consider the Japan-specific “taxable value” of a piece of real estate at all. It is not required and does not feature as a result. As an investor buying yield producing assets you are concerned foremost with the money required to purchase the property, and thereafter the money coming back to you by way of rent (/yield). The reality is more complex: you would consider transaction costs, taxes, maintenance, insurance and the proceeds realised in the future when you sell the property to get a comprehensive picture of the return on investment during its lifespan, but let’s keep it simple… Fundamentally, an investment property, in Tokyo, or anywhere else for that matter, will -NOT- sell for a price which pushes the return on investment (yield) down to a level which is not competitive. The investor cannot live in multiple apartments at one time and the sole reason for the purchase is profit.
For example, if a building contains x6 apartments and the building costs 100, and each year it produces 6 in income, that’s an annual return of 6%. If the cost of the building now goes up to 110, and the rent stays the same, the return on investment moves down to 5.45%. Still not bad. If the owner however tries to sell the building for 200, the return on investment is now 3%. A potential investor would likely not buy the property as more fairly priced yield can be found elsewhere.
In short, price is a component of yield, and thus return on investment. If an investor is happy with the yield, they will pay the price. No investor ever “overpaid” for a property that was “overpriced” because they knew what the yield was on day one and made the decision to buy it at that exact price. People looking for luxury homes in Tokyo to live in should exercise caution. Investors looking for real estate in Tokyo already know that the information they need does not come in the form of opinions.
Editors Note: Martin King is a UK-born, long-term Japan resident Financial Adviser who works with investors from all over the world to help protect and grow their wealth.