Grave of the Japanese Dream

For many Japanese families, owning their own home is a dream. But, their dream homes lose their value so quickly just like the life of fireflies… why do they keep building?

Source: iMBD

Setsuko: Why must fireflies die so young?

Hanare in Nara

During the last year’s holiday season, I rented a 100+ years old farmhouse called Hanare (detached in Japanese) in Kawakami. By car, it only takes about 2 hours from Osaka (roughly 50 miles), but it is literally in the middle of nowhere — the nearest convenience store (read Seven, Eleven, Men, Women) is 40-min away by car. Kawakami is a typical ageing village with a population of 1,200. 60% of the population is 65 years or older. Over the last 35 years, the village’s population declined by more than 80%. The farmhouse was abandoned for more than a decade until it was recently renovated by a young Japanese couple for city dwellers, who want to experience a slow life. (you can book this property via Airbnb: https://abnb.me/EVmg/Ns1E6RIIoJ)

Again, it is a typical scene in Japan’s ageing society.

Source: Hanare

Source: Ministry of Internal Affairs and Communications

According to Japan’s Statistics Bureau, the home vacancy rate reached 13.5% in 2013 and more than 8 million houses are unoccupied. Nomura Research Institute forecast that the home vacancy rate will eventually reach 30.4 with 21 million houses unoccupied in 20133.

Source: Statistics Bureau

While there are so many houses unoccupied, Japanese households continue building new houses. Each year since 2009, 0.8–1.0 million new houses are built in Japan. On the other hand, the similar new housing start statistics show that the United States with roughly 3x of Japan’s population is only adding 1.2 million houses every year. Unlike Japan’s declining population (-0.1%), the United States’ population is growing (0.7%).

Source: Statistics Bureau

Grave of the Japanese Dream

Since our last article on Japan, The Deflation is Dead, Long Live the Inflation! on 30 June 2014, BOJ introduced a new powerful measure of fixing the yield curve, which will eventually be translated into significant inflation although we haven’t statistically seen it yet. A conventional wisdom tells us that the best hedge against inflation is real estate and, together with the low interest rate, Japanese households kept building new homes. Some overseas investors are also interested in Japanese housing markets because of its high nominal yield (5–7% gross yield is not unusual). However, the real estate in Japan is neither a good long-term investment or an effective hedge against inflation.

Goldman Sachs recently published a very intriguing article titled: Japan’s Housing Market (2): Why are residential asset values so low in Japan? (by Naoahiko Baba, Chief Economist in Japan) Over the last few years, many people asked our opinion on the investment opportunity of Japan’s residential properties. Apparently, those who asked this question wanted to hear confirmation from Japanese (i.e. Shinya) that it was a good time to buy a property in Japan and we always disappointed them by saying “never”. However, the yield on Japanese properties is indeed one of the highest in the world (4–8%) and the valuation is still depressed. Why is it so bad to invest in Japanese properties? Baba’s paper shows some ugly reality of Japanese real estate investments.

• Japan’s residential assets (stock) lose value far more rapidly than those in the US, and the value is around JPY 500 tn lower than cumulative yearly residential investment. Average asset value per dwelling has been on a gradual downtrend since the mid-1990s.
• Despite the rapid worsening in demographics, the number of per-capita housing starts in Japan is more than double that in the US or UK, reflecting a deep-rooted preference for new homes. Homeowners also show little interest in serious renovation, resulting in an underdeveloped existing home market. Japan’s residential stock more closely resembles durable consumer goods than assets.
• Unoccupied homes are becoming a social issue, with the vacancy rate reaching 13.5% in 2013.

Source: Cabinet Office, BEA, Goldman Sachs

Goldman Sachs also shows that the average lifespan of residential property in Japan is only 30 years vs. 70 years in US and 80 years in UK. Japanese don’t really like living in the old houses and renovation does not create value for old houses. The market price of 50 years old houses is zero, no matter how lovely they are. Like Hanare in Nara, they are abandoned and disappear.

Therefore, Japanese households must keep building new homes as they abandon old ones. Housing starts per thousand people in Japan is 7 units per year vs. 3.5 units in US and 2.5 units in the UK.

Fireflies cannot survive the summer. So are Japanese houses. Given 30 years of the average lifespan, the value of a Japanese house depreciates 3–4% a year. Many multifamily apartments depreciate at much faster pace. Although the gross yield of a Japanese property is 5–7%, it is not difficult to imagine its net yield after depreciation.

Like Americans (read: Requiem for the American Dream), homeownership has been a dream for Japanese families, however, the Land of the Rising Sun is becoming a graveyard of the abandoned houses, whose value diminished in merely 30 years.

Why Keep Building?

So, why do they keep building new units while more than 13% of existing properties are left vacant? There are a handful of explanations based on their cultural and social factors why Japanese prefer new houses, but this behavior has very little economic sense. For Japanese banks, home loan is a very important source of revenue. In Japan, the fixed rate mortgage is offered by Japan Housing Financial Agency, sponsored by the government and the floating rate mortgage and convertible-fixed rate mortgage (the interest rate will be reset after 2–10 years) is offered by commercial banks. Not surprisingly, commercial banks have less incentive to offer the fixed rate mortgage although the 35-year fixed rate is quite low (1.34%-1.99% as of Dec 2017) and almost half of Japan’s mortgage is now floating rate. The securitization market for the floating rate mortgage is not well-developed and the majority is still held on bank’s balance sheet. This is our guess, but many Japanese households hesitate to take a long-term fixed-rate mortgage since their houses (except for the land) will lose the entire value when they finish paying off the debt.

Source: Japan Housing Financial Agency

Bank of Japan’s Financial System Report is one of the best publications to understand the economic health of Japan. Their views are very independent of the Japanese government and intellectually honest. The most recent report (Bank of Japan Financial System Report Apr 2017) featured increasing risks of Japan’s housing markets, which Japanese banks are heavily exposed. Unlike the United States, Japanese banks originate and own a large chunk of housing loans.

We do not know what would be the ending of this movie, but it could be as tear-jerking as the Grave of the Fireflies.

Shinya Deguchi

Grave of the Fireflies (1988)

The story of Seita and Satsuko, two young Japanese siblings, living in the declining days of World War II. When an American firebombing separates the two children from their parents, the two siblings must rely completely on one another while they struggle to fight for their survival. Directed by Isao Takahata. (source: iMDB)