Sun finally rising in Japan

The outlook for Japan is a big consideration for APN’s Asian REIT investment team. With the Japanese REIT (JREIT) market constituting around half of the fund’s investment universe, we pay close attention to it. Fortunately, and contrary to popular misconception, the country’s economic, financial and real estate markets are travelling well.

Japan isn’t an investment destination that captures the imagination. The so-called lost decade has by some measures turned into two lost decades, a function of a huge asset price bubble, deflation, a weak economy and an aging and declining population. It hardly sounds like a recipe for investment success.

Explaining the reasons for our recent and contrary optimism about the country wouldn’t make much sense without first capturing the flavour of Japan’s recent troubles. Let’s start with inflation, or, more accurately, the lack of it.

Through the 1980s, average annual inflation in Japan was 2.5%. In the 1990’s it fell to 1.2%.  Since 2000 it has been a staggeringly low 0.1%, due to lengthy periods of deflation pre and post the Global Financial Crisis (GFC) contributing to this benign figure.

In April 2014, Japan’s consumption tax increased from 5% to 8%, pushing inflation up to 3.6% in June 2014 after which it quickly fell below 1% again. We are however seeing signs of a sustainable level of positive inflation in recent quarters on the back of significant work by the Abe government.

Australia has taken a markedly different track as reflected in the chart below which looks at inflation in the two countries since the 1980. Over the 1980’s inflation averaged 8.5%, the 1990’s declined significantly to 3.0% and since 2000 this has fallen further to 2.7%.

Japan vs Aus Inflation

Economists will tell you that deflation is a bigger problem than inflation. When consumers expect future prices to fall they tend to delay major purchases in the hope of getting a lower price. This depresses economic activity. Governments might try and stimulate demand through tax cuts, public works and fiscal stimulus but unless consumers’ expectations of inflation move from negative to positive it tends not to work.

John Maynard Keynes called this “pushing on a string” and it aptly describes Japan’s policy response to deflation. Nothing seemed to work.

The second chart compares real gross domestic product (GDP), a measure of the value of a countries economic output. Again, the comparison casts Japan in an unfavourable light. It has delivered an average of 0.9% GDP growth a year since 2000 while Australia has produced over three times this with an average of 2.9% p.a. over the same period.

Japan v Aus real GDP

Perhaps the best reflection of Japan’s economic disarray over recent decades is reflected by its share market.  Since 1995, the Nikkei 225 (Japan’s main share market index) has returned a staggeringly low 1.86% p.a. through what has generally been a period of robust expansion around the globe.

Chart 3 Japan v Aus all ords

Over the same period the Australian All Ordinaries Index (All Ords) returned 9.89% p.a. or over five times the return of the Japanese market. No wonder offshore investors have avoided Japan for so long.

So, what’s changed?

If you look at the second chart, you’ll notice that GDP growth started to pick up after the election of current Prime minister’s Shinzo Abe in December 2012. His landslide victory enabled a formerly hamstrung Government to introduce some major changes. Some policies were unpopular, but they provided the foundation for a sustained economic revival.

The benefits of clear policy direction and leadership stability (prior to Abe Japan had six Prime ministers in six years) has improved investor confidence in a sustained economic recovery.

Japanese GDP growth is now experiencing its longest period of expansion in a decade and is trending up at a time when many other global economies (including Australia’s) are slowing.

Inflation is also going in the right direction. A figure of 1% per annum might not sound like much but the last time it was higher was 20 years ago (excluding GFC and consumption tax impacts). The Bank of Japan (BoJ) has been unrelenting in using quantitative easing (QE) to attain their inflation target of 2%, committing to long bond yields of around 0% until this is achieved.    

The Japanese stock market, a pointer to how corporate Japan is performing, has also moved higher since late 2012 as predictions of economic growth improve (driven by strong investment and exports).

To the bigger question for investors in APN’s Asian REIT Fund now that Japan’s lost decades are finally over: what does all this mean for commercial real estate?

Well, the figures speak for themselves. According to JLL1, investments in Japanese commercial real estate assets increased 10% over 2017. This was way ahead of the rest of the world at 6%. In Tokyo, the world’s largest city in terms of population and GDP, growth was even more impressive; the megacity enjoyed a 20% increase in investment volumes, the fifth largest increase on JLL’s list of the top 26 global cities.

JLL also noted that “foreign investors were very active in the market”, no doubt due to the outlook for further rental and capital value growth over coming years.

Since 2013, when the central Tokyo office vacancy rate began to fall from a peak of over 9%, APN believed improved Japanese economic and corporate performance would lead to a recovery in the Tokyo office market. It was then that we increased the Asian REIT Fund’s exposure to this market.

Fund investors are now enjoying the fruits from that view. As at June 2018, the Tokyo CBD office vacancy figure was 2.6% and our investors are being rewarded with sustainable income growth from our Japanese REIT (JREIT) office investments alongside a steady appreciation of office asset values.

Of course, headwinds remain. The country’s aging population is impacting labour supply, notably in industries such as construction.  The Government is now more proactive in addressing these issues, in this case through increasing foreign worker numbers where shortages exist. APN’s insurance against this issue, incidentally, was in focusing on JREIT’s with Tokyo exposure because, whilst Japan’s population is declining, Tokyo’s is increasing.

With Japan’s economic growth targets being revised upwards the prospects for real estate look bright. While growth rates may not match some Asian neighbours, the quality and sustainability of the real estate rents suits APN’s Asian REIT Fund’s commitment to provide investors with monthly distributions which currently yield over 6% p.a.2

Finally, the lost decade (or two) appears over, and that’s good news for everybody.

This article has been prepared by APN Funds Management Limited (ACN 080 674 479, AFSL No. 237500) for general information purposes only and without taking your objectives, financial situation or needs into account. Predictions of future performance are based on reasonable assumptions but not guaranteed. You should consider these matters and read the product disclosure statement (PDS) for each of the funds described in this article in its entirety before you make an investment decision. The PDS contains important information about risks, costs and fees associated with an investment in the relevant fund. For a copy of the PDS and more details about a fund and its performance click here. To receive further updates and insights from the APN team, sign up for Review, our monthly email newsletter.

1. JLL Global Market Perspective – February 2018.
2. As at 31/07/18 the APN Asia REIT Fund dividend yield was 6.14% p.a. Current running yield is calculated daily by dividing the annualised distribution rate by the latest entry unit price. Distributions may include a capital gains component. Distributions are not guaranteed and past performance is not an indicator of future returns.