Which Japanese property sector suffered from the sharpest yield compression?

This sector saw a compression of 100bps in the last 3 years.

The Japanese economy contracted by about 4-5% in 2020. According to JLL, while the economy was 8.3% weaker year on year in 2Q2020, preliminary estimates showed a mild 3% qoq recovery in 4Q2020. This implies that two-thirds of the ‘lost GDP’ caused by the pandemic has already been recovered and fundamentals remain intact. Economists expect GDP to recover back to the previous peak by the end of 2021. 

IMA Asia expects Japan’s economy to expand by 2.5% in 2021 and 1.3% in 2022, driven by a recovery in consumer spending and exports. The government launched a massive fiscal stimulus package worth JPY 73 trn, equivalent to 14% of GDP. The 2021 starting budget is 4% higher than 2020’s initial budget and more supplementary spending may be added to stimulate the economy. 

JLL expects the Bank of Japan to keep the current quantitative easing policy for 2021 or longer, until the economy recovers to pre-COVID levels. We expect monetary policy to be one of the most accommodative in Asia Pacific.

Here’s more from JLL:

The Bank of Japan has adopted quantitative easing from 2013. Since 2016, it has maintained a negative policy rate. With deflation accelerating to 1.2% yoy in Dec 2020 and expectations of no inflation in 2021- 2022, we expect the negative interest rate policy to be maintained for the next 3-5 years.

Over the last ten years, yields for retail and multifamily assets have compressed to converge with office yields to sit just 200 – 220 bps above the cost of debt. The sharpest compression was experienced by the multifamily sector, of 100bps in the last 3 years as more investors took interest in the sector given the large stock and scalability, diversification benefits and tight supply-demand dynamics. The retail sector experienced some yield expansion in 2020 due to structural uncertainties.

Over the next 5 years, we expect funding costs and asset yields to remain relatively stable as Japan’s growth outlook is unlikely to change materially. However, there is potential for yields for high quality, modern logistics assets to compress a further 50-80 bps over the next few years given strong fund flows into the sector and the large yield gap between logistics and other asset classes.

What Could Happen to Tokyo Prime Office Yields?

Prime office yields have hovered about 200-220bps above the cost of debt in Tokyo for the last 10 years. 

Despite COVID 19, there has not been a significant exodus of large office tenants. We expect more occupiers to adopt flexible working arrangements over the next few years, and gradually make minor adjustments to their office footprint. There could be some erosion in net office absorption, but the magnitude and speed are unpredictable. Prime office vacancies are still very low in Tokyo and should cushion this impact somewhat. 

As we expect interest rates to remain relatively stable over the next five years, we think Tokyo prime office yields could stay flattish till 2025. There is a risk of marginal yield expansion should rental prospects become more negative in 3-5 years’ time.

What Could Happen to Tokyo Logistics Yields?

Prime logistics yields have compressed 80bps in the last 7 years as e-commerce adoption gradually grew and demand for logistics expanded. We expect demand for logistics space to remain strong over the next few years. Government statistics indicated e-commerce sales grew over 15% year on year in 2020 while offline retail has contracted. While upcoming logistics supply in 2021-2023 is high, over 90% of the supply has been pre-committed. 

In 2020, over USD 15bn of new logistics and data centre funds have been raised in Asia Pacific, a sharp increase over the last 5 years. We expect investment demand for logistics to grow and yields to compress further.