Tokyo Reversing Slide in Office Rentals: Real Estate

Tokyo’s office market is showing signs of recovery after a two-decade decline, prompting companies such as Apple Inc. and Morgan Stanley to relocate before rents rise and vacancies fall.

Real estate broker Jones Lang LaSalle Inc. and Barclays Plc are forecasting leasing costs for prime office space will climb this year and next. The vacancy rate for grade-A buildings in the city’s major business districts fell for a second quarter to 8.8 percent as of December from a record 10.3 percent in the three months to June, according to broker CBRE Group Inc.

“We are now seeing some very early signs of a return in confidence to the market,” said Neil Hitchen, regional director at Jones Lang LaSalle in Tokyo. Tenants “are renegotiating terms early to try to take advantage of the tenant-favorable market conditions and get in good shape for the next few years,” he said.

The rebound may signal the end of a 21-year slide that cut rents for all categories of offices in the city’s five central wards by 63 percent, according to Miki Shoji Co., a Tokyo-based broker. Japan has been struggling with deflation that has caused companies and households to put off spending since the late 1990s, after asset prices collapsed.

Landlords are now seeking rent increases and investors are considering acquisitions as Prime Minister Shinzo Abe pursues fiscal and monetary stimulus to pull Japan out of its third recession in five years. Contracted rents for prime office space in the central wards rose 13 percent to 23,969 yen ($257) per tsubo in the fourth quarter from the previous three months, according to Sanko Estate Co., a Tokyo-based broker. Prime refers to the most stable high-income producing properties.

Rising Expectations

“There is an increase in expectations that real estate investment will become more active, helped by monetary easing since Abe took over the government,” said Masashi Hirano, president and chief executive officer of Tokio Marine Property Investment Management Inc., a unit of Japan’s second-biggest casualty insurer. Tokio Marine Property plans to raise a fund to invest in Tokyo’s office buildings for the first time since 2008, Hirano said.

Tokyo isn’t alone. Office vacancies in Osaka, the second-biggest city, are declining after reaching a record high of 12.4 percent in March 2011.

While vacancy rates are improving, leasing costs remain under pressure. Rents for all classes of office space in the central wards were at an all-time low of 16,554 yen per tsubo in January, compared with the peak of 44,193 yen per tsubo in 1991, according to Miki Shoji. A tsubo, the standard measure of property in Japan, is 3.3 square meters or 35.5 square feet.

False Start

The five central wards, the heart of Tokyo’s shopping, entertainment and business districts, are Chiyoda, Chuo, Minato, Shinjuku and Shibuya.

Investors and landlords remain cautious because turnarounds have fizzled in the past. Tokyo’s office vacancy rate fell for two straight quarters through September 2011 before 176,000 tsubo of new prime space flooded the market last year, according to DTZ.

Office rents in the central wards rose in the three years to 2008, before the global financial crisis, as increasing demand pushed vacancies to around 4 percent in 2005, leading landlords to raise rents, according to Miki Shoji.

Even after years of decline, rents for prime offices in Marunouchi and Otemachi, both in Chiyoda ward, were the third-most expensive after Hong Kong’s Central district and the West End in London as of the third quarter last year, according to the latest survey by CBRE. Office space in Tokyo costs $197.27 per square foot on an annual basis, while in Hong Kong it costs $246.30 per square foot.

Mitsubishi Estate

“We doubt that rents will go shooting up across the market, or even in local CBD areas, but individual buildings can have pricing strength if they are well occupied,” said James Fink, senior managing director at broker Colliers International in Tokyo. “It’s going to take a while for the overall market to recover because it’s been so beaten down.”

In 2012, 47 percent of 638 company tenants based in greater Tokyo and surveyed by CBRE were considering moving offices, compared with 37 percent in 2010.

Jones Lang LaSalle sees an annual average increase of about 5 percent in rents this year and next, while Barclays sees a cumulative gain of 20 percent through the end of 2014.

A rebound would be welcome news for the biggest landlords in the wards, including Mitsubishi Estate Co., Mitsui Fudosan Co. and Sumitomo Realty & Development Co.

Shares of Mitsubishi Estate, which has gained 83 percent in the past six months, fell 2.1 percent to 2,484 yen in Tokyo today, while Mitsui Fudosan declined 2.1 percent to 2,439 yen, bringing its gain in the past half year to 67 percent.

Planning Ahead

Mitsubishi Estate and Mitsui Fudosan, Japan’s biggest developers, are asking for higher rents, according to Masahiro Mochizuki, an analyst at Credit Suisse Group AG, who rates the two builders outperform.

Mitsubishi Estate won’t lower rents despite the recent increase in the vacancy rate in Marunouchi because the developer expects more companies to fill in the space as they seek to relocate to the area, Keiji Takano, a spokesman, said at the earnings press conference on Feb. 4.

“We have shifted our strategy not to lower rents in Marunouchi,” he said.

Companies are planning ahead. Apple will move its Tokyo headquarters to the 54-story Roppongi Hills complex, in Minato ward, from Shinjuku ward as early as April, two people familiar with the iPhone maker’s plan told Bloomberg News in January. The $2.2 billion development owned by Mori Building Co. is home to Goldman Sachs Group Inc. and Barclays.

Morgan Stanley

Morgan Stanley is moving back to Otemachi, an area neighboring the Imperial Palace. It signed an office lease with Mitsubishi Estate to take space in the 34-story Otemachi Financial City South Tower amid “attractive conditions for tenants of prime commercial locations,” the bank said in December. It moved to Ebisu, a mainly residential neighborhood of boutiques and restaurants in Shibuya ward, from Otemachi in 1996.

“The market is starting to find the bottom,” Colliers’s Fink said. “Most buildings that had very high vacancy when the crisis began in 2008 and 2009 reduced rents and leased up most vacancy. Because they are full, the landlords are able to ask for higher rent from new tenants and for lease renewals.”

The tenant profile of Marunouchi also has diversified over the past decade, contributing to stability in demand, said Fred Takahashi, who represents tenants at CBRE.

Tenant Profile

In 2000, manufacturing companies such as Mitsubishi Heavy Industries Ltd., which makes trains, ships and planes, and Fujitsu Ltd., Japan’s biggest provider of computer services, accounted for 43 percent of Marunouchi’s tenants, according to Mitsubishi Estate. That percentage fell by about half over the past decade, while the ratio of financial and service providers, including accounting and law firms, almost doubled, according to the developer, the biggest landlord in the district.

The Marunouchi area is home to Japan’s three-largest lenders: Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc.

The area is undergoing rejuvenation after the completion in October of a 50 billion yen renovation of Tokyo Station.

Bridgestone Corp., the world’s largest tire maker, said it plans to move in January 2014 into a new building near Tokyo Station, from the 61-year-old building it currently occupies southeast of the station. Inc., a San Francisco-based maker of online customer-management software, plans to move to JP Tower in Marunouchi from Roppongi Hills in the middle of this year. Among others that moved into the neighborhood are Digital Arts Inc., which develops games for the iPhone, and GungHo Online Entertainment Inc., an Internet game developer.

Limited Supply

Limited supply will put a floor under rents, said DTZ. New supply of offices in Tokyo will be about 40 percent of last year’s level, when the most space since 2003 was added, according to DTZ, which forecasts rents to increase by 7 percent this year.

“As we see signs of a recovery for vacancy rates, we should be able to see rental growth in the latter half of the year,” said Singapore-based Hidetoshi Ono, the head of Japan Core Fund at AXA Real Estate Investment Managers. AXA Real Estate’s Tokyo Office Property Fund is in the process of buying several office buildings in the capital in the first quarter as it bets office rents and prices will rise, Ono said, declining to elaborate.

The capitalization rate, a measure of investment yield, for office buildings in Tokyo declined for two straight months to 5.3 percent in January from 5.5 percent in November, the highest since Real Capital Analytics Inc. started compiling the data in 2009. A drop in the cap rate, which is a property’s net income divided by the purchase price, usually signals an increase in real estate prices.

Target Japan

Hartford, Connecticut-based Cornerstone Real Estate Advisers LLC, which managed $38.9 billion as of Dec. 31, opened a Tokyo office in September and is considering raising a fund to invest in properties in the city, including office buildings and real estate debt.

“We are setting up our investment platform in Asia and our first target is Japan,” said Kelly Hayes, a Tokyo-based director at Cornerstone, a subsidiary of Massachusetts Mutual Life Insurance Co. of Springfield, Massachusetts. “We are seeing bottoming out of rents. That started before Abenomics, but Abenomics certainly will help propel that.”

Billionaire Akira Mori, owner of office buildings in central Tokyo, is among those betting on a turnaround. Mori said in November he plans to invest in property in the city for the first time since he declared the end of the real estate boom in 2008.

“Japan’s economic recovery, a peak-out in new office supply and the take up of new office space that we are seeing for the first half of this year will enable landlords to boost rents,” said Takashi Hashimoto, an analyst at Barclays in Tokyo.