MW-76 -- Will the Liquid Flow?

J@pan Inc Magazine Presents:
Weekly Financial Commentary from Tokyo

Issue No. 76
Monday, May 17, 2004

@@ VIEWPOINT: Will the Liquid Flow?

[Owing to special circumstances, we are publishing MW earlier
than usual this week.]

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@@ VIEWPOINT: Will the Liquid Flow?

Last week we clearly established ourselves, maybe not by fact, but
certainly in opinion as bullish on the Japanese stock market and, by
inference, the Japanese economy. There are many areas for concern
regarding this opinion, not least the state of the real estate market.
Lest we ever forget, it was the real estate market that has caused
the extensive problems in the banking system; securing a liquid,
transparent real estate market will be a very healthy sign of a
resolution to the overhang of assets that have been provisioned
against on balance sheets of various institutions, and the return
of these assets to value creation rather than stagnation.

Of course, this isn't the present case. The sources of these problems
are extensive and varied, but I think they can generally be seen in
two distinct groups: first, the mindset of participants; and second,
structural barriers.

The first dates back to the manner in which both buyers and lenders
looked at real-estate. Historically real-estate was viewed as an
appreciating asset that would never go down in price; the rationale
to purchase Japanese real estate was not for income generation, but
for price appreciation. The banks too had historically made use of
appraisals that took no account of the ability of the real estate to
generate income but merely what they believed a buyer would be
willing to pay.

To a certain extent this mentality is still alive in the real estate
market, but it is diminishing and income based valuations are becoming
far more prevalent.

Structurally there has been a very strange anomaly in Japan which has
worked against the liquidity of the market: Namely, taxes.

Real estate in Japan is taxed upon transfer and then on an ongoing
basis; but it is skewed in such a way that the taxes on transfer are
significantly more than those to be paid on an ongoing basis. This is
very different to the situation in the US or UK, where the transfer
taxes are small in comparison with the ongoing taxes on ownership of
the real estate. Thus in a marginal situation, the incentive for
owners of US real estate is to sell and allow someone who can deploy
their capital more effectively manage the real estate, whereas in
Japan the incentive is to hold on to marginal real estate and hope for
a better day. Thus the cpoor allocation of capital continues.

But much is changing: The attitude toward the asset value will be
rudely awoken by the introduction of Asset Impairment Accounting
for fiscal 2004, and thus the historical advantage of holding a piece
of real estate (or any asset) at an inflated cost price will be
removed -- and there will be further pressure to improve the
performance of each asset.

Coupled with this, there have been many reductions in the transfer
tax over the last few years which have reduced the barriers for
transfer of real estate. These changes in tax and accounting are
presently improving the liquidity of real estate assets, and thus
the transparency of the market will, in the long run, be good for
the banks, the economy and everyone living in Japan.

One observation from growing economies in the last 10 years is
that strong economies have had strong real estate prices
(Australia, US and the UK) and vice versa (Germany and Japan).

But are these real estate prices merely a sign of a strong
economy or the driver of a strong economy? My opinion is that
there is a symbiotic relationship here, and real estate is such
a major portion of any developed economy that it needs to be
watched very intently by any investor. I believe that the
strength seen in the manufacturing sector coupled with the changes
above will provide the catalyst for the real estate market to
become more liquid and grow, and with a better deployment of
capital, support the economic revival of Japan.

If you would like to investigate the details of the taxes or
the changes in accounting for real estate in Japan, we recommend
the 2003 Real Estate Securitization Handbook. Written by the
Association for Real Estate Securitization, the English edition
is available from the publisher, TP Publishing, and can be
bought from them directly at:

-- John Charles-Decourcy

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Written by John Charles-Decourcy (

Edited by J@pan Inc staff (


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