We have heard nothing other than ‘we are buying Niseko ski flat’ or ‘our fund is adding Tokyo hotel’ for the past few months, as if the rest of the world is all in the dog house…
Clients familiar with our arguments will know we have been negative for at least 2 years on the Japanese market, so this email seeks to give a more rounded exposition on why.
When crowds scramble one way, we go the other
The recent scramble for adding Japanese exposure (see Article 1) is in line with the concurrent rise in the Topix, but in property land there is even more momentum, especially amongst funds:
Granted, funds have been sitting on their hands in the past 2 years as interest rates globally spiked, and their IRR calculations were thrown into disarray. So the wishful hope that Fed rate cuts will be implemented (now proven wrong), plus a reversal of Japanese asset depreciation has sparked a sudden fad into pumping money into the land of the rising (may be now setting) sun…
We are very wary of the much more significant risk of Yen devaluation against whatever puny asset appreciation in the currency in the coming years however, and would prefer other jurisdictions where BOTH currency and asset prices will rise (regular readers will know where that is!).
FX should be central in investment decisions
The point of making price gains but adding translation losses is best illustrated with a view to history:
As shown above, during the haydays of Japanese industrial and cultural ascent, both asset prices in local currency (LC) and exchange rates were on the rise – see left green arrow. The combined effect for foreign investors is even stronger returns in USD terms (red line) than locals (blue line), shown by the purple enlarging triangle.
In the subsequent lost 2 decades, Yen basically went sideways (2nd green arrow), with price drops very comparable in LC and USD (purple parallelogram).
We are now probably into the next leg of Yen derating (see 3rd green arrow) thanks to shrinking population – see Article 3 – and the resurgent commodities complex when all input materials see price spirals. Unsurprisingly, since 2010, despite LC price gains, USD denominated values fell (purple trapezium).
We expect the next (final) down leg in Yen (4th green arrow) to unfold in the next 3 years or so, which can also destroy value for overseas investors (ie down red arrow despite up blue arrow).
To put it in numbers terms, below is a table showing the impact of Yen weakness (red shades) vs USD denominated Tokyo home prices:
Of course, the 2025-29 projections above are purely based on the arrows in chart above and may not play out the way we projected, but the risk that you get negative USD returns (2nd column from right) is very real indeed.
Macro picture for Japan: far from rosy
By the combined will to reintroduce inflation and to inflate away the mountains of govt debt (highest in OECD), the Japanese work force has been earning negative real income for the past two years:
In the meantime, the cost of living crisis left private consumption down for 4 quarters in a row, with little help to exports (net exports were increasingly negative in recent quarters) to contribute to GDP growth:
In the meantime, the geopolitical tensions between China and US is causing the rate environment to surge further, due to:
1) loss of demand for US debts by big traditional owners like China (fr 8.9% to 2.2% in 13 yrs) and HK, in fact Japan has also been falling in total proportion of US treasury holdings (fr 9.5% to 3.4% now):
2) Ukraine/Middle East conflicts likely to trigger more input price inflation, eg oil prices – and as a resource poor but manufacturing intensive economy, higher oil prices (blue line, down is higher prices) will tend to trigger economic contractions (red area). The green line is merely projecting prices returning to $150/barrel, which can easily be exceeded should international wars flare up again:
The result would be grim for Japanese economy. If wars spread to the APAC region, there is an added strong chance of capital flight from Japan given its recent militarisation movements might scare foreign investors away:
3) bond rout will impact Japan more than US – as US fiscal profligacy continues (yes, by adding $3.5tr debt in one year), long bond yields have nowhere to go but up (orange line), this will drag JGBs up with it (green line). Assuming totally benign geopolitical/sovereign debt calm conditions, the laughable 0.87% JGB yield will still nearly triple to 2.5%, and this ‘benign’ expansion of US-JP yield spread may trigger further capital outflows as money seeks higher returns in the US:
The result? Yen could drop another 25% to the 200 mark.
If this Yen drop becomes disorderly, it could result in JGBs trading at premium to TBs, leading to the much more nightmarish outcome of 10.5% JGBs vs say 8.5% TBs:
Such an outcome would mean Yen has to return to 270+ levels, much against the wishful sub-150 levels the ‘anchoring biased’ talking heads out there could imagine… or a 45%+ drop from current levels.
Real yields also too low to be attractive
Back to our usual real property yield table – Sydney/Singapore/Tokyo are some of the lowest returning markets on inflation adjusted basis (3rd column from right), compared to Phnom Penh/Athens which are our preferred investment destinations:
In a bond rout outcome, both European and Japanese markets will suddenly look much worse as US becomes the safe haven, thereby helping HK/NYC (2nd column from right).
Based on these various factors, we will only touch Japan if: a) long term fixed rate borrowing can be locked in; b) Yen leverage and/or hedge are put in place. But how many even the big institutions are taking these precautionary measures? We doubt many. On this note it is interesting to demonstrate how institutions are mere humans, however smart they otherwise appear: see Article 2.
==================Article 1==================
Interest in Japanese real estate grows despite rate rise prospects
Mar 8, 2024
Institutions and family offices are backing real estate for another strong year, despite the prospect of the country’s first interest rate rise since 2007.
==================Article 2==================
Hidden billions in Tokyo real estate lure activist hedge funds
Apr 16, 2024
The long-concealed market value of Tokyo’s largest skyscrapers is being unveiled by activist investors.
==================Article 3==================
Japan’s Population Declines Again: Seniors 75 and Over Top 20 Million for First Time
Apr 24, 2024
An estimate published by Japan’s Ministry of Internal Affairs and Communications shows that the total population as of October 1, 2023, was 124,352,000. This was a drop of 595,000 (0.48%) from the previous year. It is the thirteenth consecutive year that the population decreased. The population of Japanese citizens was 121,193,000, for a record year-on-year decrease of 837,000, or 0.69%.
English 
Chinese
1) Japan’s population is experiencing a significant decline, with fertility rates dropping to a record low of 1.2. With 1/6 residential units vacated, housing demands are expected to get worse.
2) Government interventions have not been sufficient to reverse the trend. Introduction of universal pension, slow economic growth and inflation forced married women to work. Government spending drives inflation and stagnant income, diminishing the financial cushion to start families.
X link: https://x.com/profstonge/status/1818624436221722748