Industry Focus: Guarantors Not Guaranteed

By Ken Worsley

The real estate industry is crumbling, taking down the recently created guarantor services with them. Will the trade survive?

Anyone renting an apartment in Japan will be well acquainted with the guarantor system, employed by landlords and real estate agents to ensure that each lease has a co-signer. Of course, landlords prefer that the guarantor be either a family member with stable employment or the tenant’s employer, yet over the past decade, an increasing number of apartment renters in Japan are having a difficult time securing guarantors. To fill this gap, more and more companies have begun offering guarantor services, in which a renter pays somewhere in the neighborhood of half a month’s rent in order to have a firm stand-in as guarantor.

At the end of June, the company ‘Re- Plus’ was providing guarantor services for about 600,000 renters in Japan. On September 24, Re-Plus filed for bankruptcy with the Tokyo District Court, with liabilities of about 32.6 billion yen. In addition to providing guarantor services, Re-Plus was also heavily involved in the management of real estate funds. As a result of the recent credit crunch, the company found it increasingly difficult to secure funding from banks, and was thus forced into bankruptcy.

It is, however, worth taking a look at what happened with the firm’s guarantor services, as the meltdown of this area turned out to generate heavy losses. Over the summer, Re-Plus began to fail making payments to landlords, as an increasing number of renters defaulted on rental contracts that the firm had backed as a guarantor. In August, Re-Plus claimed that late payments were due to a problem with its computer systems.

We’ve heard that one before
The Re-Plus bankruptcy appears to have been driven by two primary factors. First, there is an oversupply of new condominium units available in Tokyo, as prices rise and sales decline. According to the Real Estate Economic Institute, the average price of a new condo unit in the Tokyo metro area (including Tokyo, Saitama, Kanagawa and Chiba) jumped 9.3 percent to 46.98 million yen in fiscal 2007. If central Tokyo alone is considered, the average price of a new condo saw a 16.0 percent increase in fiscal 2007.

Over the same period, new condo sales fell 17.9 percent in the Tokyo metro area. The combination of employment uncertainty, the increase in the number of non-salaried workers, stagnant wages and increased prices has made buying a new condo unit increasingly difficult for the average family. At the same time, the increase in the proportion of single-person households in the Tokyo area has narrowed the market for potential buyers of larger units.

Re-Plus, a service for renters who don’t have guarantors, is one of many property related companies to collapse.

Back in March this year, Mori Trust CEO Akira Mori told Bloomberg, “Sellers couldn’t rid themselves of the vision that real estate prices would increase.”

Sound familiar?
The second factor behind the failure of Re- Plus’s guarantor business has been partially outlined above. There are simply more potential renters who may not have the sort of credit standing and employment background that landlords are looking for. Thus, the guarantor service provider is saddled with a higher default risk right from the start. In the case of Re-Plus, it also appears that lax screening processes allowed for the approval of renters who were simply too highly at risk of default.

Over the past year, many of the unsold new condo units in the Tokyo area have been turned into rental apartments. As the real estate investment business continues to be squeezed on the funding end in terms of difficulty to secure credit, another question arises: How dependent is the revenue model at real estate investment funds on renters who are at high risk of defaulting on their leases at condos that have been converted into rental apartments? How much growth have lax standards pumped into the market?

Residential land prices seem to already be falling, even in many parts of Japan’s larger cities. This trend threatens to worsen as funds from overseas continue to evaporate due to the worldwide financial crisis. Since August 2007, Japan’s Real Estate Investment Trust (REIT) indexes have seen a 44 percent fall, greater than that seen in the US (15 percent), Europe (34 percent) or Australia (41 percent).

Japan’s real estate investment firms now face a stark choice: Should they continue to allow potential renters with a high degree of default risk to sign leases? Can they afford not to?

By no means does the failure of Re-Plus indicate an end to the business of providing guarantor services. On the contrary, demand for that service is likely to increase as more workers shift to non-salaried status and the number of single-person households continues to grow. What Re-Plus has shown the industry, however, is that the business model itself is too risky, and needs to be revamped. Whether this means that applications need to be subject to more stringent screening or whether the guarantor service itself should simply cost more remains to be seen.

Ken Worsley is editor of Japan Economy News.
He can be reached at japaneconomynews@gmail.com