The average price of a second-hand apartment in Tokyo’s 23 wards has been steadily increasing since the end of 2012. In contrast to strong growth in sale prices, the rental market has lagged behind, with rent levels remaining relatively flat. Unless disposable incomes start to rise, it may be difficult for rents to increase at the same rate as sale prices.

Rising sale prices and flat rents have resulted in rental yields on investment-grade apartments hitting new lows. An investment-grade apartment is designed primarily for investors looking to rent out the unit to a tenant rather than home buyers. Apartments tend to be smaller in size and in buildings with fewer amenities and a cheaper finish. The market price of an investment-grade apartment will depend not only on comparable transactions, but also its current or expected yield.

The gross yield on real estate is comprised of two factors – low-risk interest rates (i.e. 10-year government bond yields) plus a risk premium.

In early 2009, gross yields were as high as 7%, but have since fallen into gradual decline and are now around the 5%. Some experts say that this is about the minimum accepted range for Japanese investors of real estate. For luxury real estate, gross yields can be as low as 1 ~ 3%.

A report by investment-property listing site Kenbiya in 2017 reported the average gross yield on investment apartments alongside Tokyo’s Yamanote Line saw a year-on-year decline for 23 of the 27 stations included in the survey. Only 6 stations had average yields in the 6% range, half the number in 2016. 21 stations had average yields in the 4 and 5% range.

Over the same period, the yield on 10-year government bonds has dropped by about 1.5 points to the 0% range, even briefly dipping into minus interest rates. Without any major economic changes, domestically and globally, government bond yields are not likely to see any drastic increases nor do they have much more room to decrease.

That leaves the risk premium. The typical risk premium is around 5 ~ 6%. If rents stay flat, government bond yields remain low and the risk premium stays in its normal range, there is little room for the price of investment-grade apartments to increase. Any further increase in the price of investment-grade apartments would require domestic investors to consider yields lower than what they have historically been comfortable with.

The Nikkei Shimbun, January 6, 2018.
Kenbiya, January 23, 2018.