BUSINESS BRIEFING

MAY 2015A Cushman & Wakefield [SERVICE LINE] Publication

TOKYO: MOVING UP THE YIELD CURVE

ASIA PACIFICA Cushman & Wakefield Research Publication

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A Cushman & Wakefield Research Publication

MAY 2015

ALL GRADES OFFICE YIELD GAPS

500

400

300

200

100

Tokyo

420 New York

384 London

355 Seoul

302Singapore

200 Hong Kong

165

Note: spread between each country’s 10-year government bonds; in bps (basis points) Source: Cushman & Wakefield

TWO YEARS ON...Unveiled in late 2012, Abenomics’ potent mix of reflation, fiscal stimulus and structural change has kick started a revival in Japanese real estate. Two years after, investment volumes (excluding land) have increased by over 60% – the highest among the top-tier core markets. Foreign investments have also more than doubled in the same period as record low interest rates and a favorable exchange rate generate positive carry, throwing up opportunities in one of the world’s largest commercial real estate market that is backed by a mature and deep economy. The 2020 Olympics win is spurring investments into infrastructure and urban renewal projects, which could gain further momentum once Tokyo gives the green light on Integrated Resorts which will include casinos.

The Nikkei has surged to near-15 year highs on the weak yen, while equity capital raised by J-REITs in the first three months of 2015 have surpassed those in the same period last year, driven by rich stock valuations. Despite continued yield compression, quantitative easing by the Central Bank ensures that yield spreads of Tokyo offices against long-term bond yields remain higher than those in global gateway cities.

TOKYO: MOVING UP

THE YIELD CURVE

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TOP INVESTMENT DESTINATIONS

The revival is not just confined to assets as the city’s office leasing sector – a bellwether for the economy – continues to improve. Vacancy rates for Grade A offices have tightened to below 5%, with strong corporate performance driving demand as companies seek to relocate. Driven by a flight-to-quality trend, the office market is experiencing strong pre-leasing commitments in new buildings with enhanced seismic capabilities. Mitsubishi UFJ Morgan Stanley Securities, forced to move to a cheaper location due to failed investments in 2011, will relocate back to the Otemachi area after Abenomics stimulated investments into the city’s capital markets.

Vacancy rates for Grade A offices have tightened to below 5%, with strong corporate performance driving demand as companies seek to relocate.

Note: Excludes land Source: Real Capital Analytics, Cushman & Wakefield

0 13 26 39 52 65

Franfurt

Denver

Seattle

Shanghai

Melbourne

Houston

Miami

Atlanta

Boston

Sydney

Dallas

Hong Kong

Chicago

Washington DC

Paris

San Fransisco

Los Angeles

Tokyo

London

New York

2014 2013

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A Cushman & Wakefield Research Publication

MAY 2015

Office demand is anticipated to keep pace with continual strong corporate performance, led largely by the manufacturing sector against the backdrop of a weakening yen. With corporate earnings having tripled since 2009, the prospect for positive rental revisions are likely to kick in sometime this year. Given that new supply in 2015, while substantial, is still lower than the average level in the past decade, the market is unlikely to weaken.

JakartaCalgary, Rio de Jeneiro

Bengaluru, Kuala LumpurMoscow

HCM City, OttawaRome

Melbourne, SydneyLos Angeles, SeoulWashington, D.C.

Brussels, ZurichParis

Berlin, Copenhagen, Mexico CityGeneva

TOKYO

Mumbai SBDShanghaiBeijing, Toronto, Houston

Rent still elevated but falling from top of market cycleFalling rents promise future opportunity for tenants

Slow Growth

Downturn

Accelerating

LAN

DLO

RD F

AVO

RABL

ETE

NAN

T FA

VORA

BLE

Recovering

Munich, New YorkBoston, Frankfurt, Gurgaon CBDAmsterdam, Hong Kong, Madrid

Chicago, Dallas

ManilaLondon, Singapore

Bangkok, San Francisco, Stockholm

Rent growth slowingStill landlord favorable but growth is down from peak

Rent growth acceleratingIdeal for owners of property

Rent at or near bottom of market cycleIdeal for tenants leasing or seeking to lease property

TOKYO’S ACCELERATING RENT GROWTH

Note: Grade A office Source: Cushman & Wakefield

TOKYO: MOVING UP

THE YIELD CURVE

NON-PRIME OFFICESCore assets in Tokyo’s central wards that are available for sale are limited and demand for such assets far outweighs the limited opportunities to buy – the weight of this capital leading to rapidly compressing yields. As such, investors seeking exposure to the Abenomics story would have to look to opportunities that reside further up the yield curve. Despite the higher risks involved in terms of financing, property and economic fundamentals in these segments remain sound.

INVESTMENT MARKETNon-prime offices generally afford investors easier access into Tokyo’s office market, as the city’s prime offices remain tightly held by developers and institutional investors, who have investment mandates to adhere to. Unlike investment grade assets, non-prime offices are owned by a wide variety of owners whose main interests might not be in real estate, which makes them more likely to consider selling if the price is right.

In terms of targets, Class B and C offices form a larger proportion of Tokyo’s office landscape and accord more choices to an investor. The market is also more liquid for strategic sellers seeking an exit as there is a ready pool of buyers in REITs who are big players in the Class B and C office market. Last year, one third of non-prime offices transacted were by these trusts.

Prime16%

Class A26%

Class B/C58%

Note: based on a sample of 9,800 buildings Source: Cushman & Wakefield, Sanko Estate

OFFICE INVENTORY

Class B and C Offices

Dominates Tokyo

LEASING FUNDAMENTALSA feature of Class B and C offices is its relatively small floor plates, generally less than 100 tsubos (3,600 sf). Due to their smaller staff strengths, Class B and C offices are usually occupied by small and medium sized enterprises (SMEs), as they do not require exceptionally large floor plates.

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A Cushman & Wakefield Research Publication

MAY 2015

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14.0

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Vaca

ncy

rate

(%)

Class S Class AClass B Class C

VACANCY RATES

HEADCOUNT BY PROPORTION OF COMPANIES IN TOKYO

Note: Central Five Wards; Class S denotes Super Grade A Buildings Source: Cushman & Wakefield

SMEs are prevalent in Japan, forming the bulk of companies in most sectors but more importantly, they are the backbone of the services sector and a crucial link in the supply chain of the manufacturing and export-led sectors. Currently, there are at least 440,000 SMEs operating in Tokyo alone, employing almost half of the city’s workforce.

The huge tenant base to draw upon makes investment sense while demand fundamentals have also improved. While closures involving SMEs escalated in the aftermath of the financial crisis in 2008, leading to higher vacancies, it has recovered fairly well and is expected to continue to improve. Rents are also more stable and just coming out of the trough – which would also provide more rental upside. In light of the improved business sentiment, rents are expected to remain on an upward trend.

<5096.4%

>5000.2%

300-4990.2%

100-2991.2%50-99

2.1%Companies

with less than 50 employees form 97% of corporates in

TokyoSource: Tokyo Metro. Statistics

TOKYO: MOVING UP

THE YIELD CURVE

7

5,000

10,000

15,000

20,000

25,000

30,000

Q10

6

Q30

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JPY/

tsub

o/m

th

Prime All Grades

405060708090

100110120130140

Q10

6

Q30

6

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7

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7

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NO

I Ind

ex (Q

194

= 10

0) Class S Class A

Class B Class C

RENTS

Source: Cushman & Wakefield

Source: Cushman & Wakefield, Sanko Estate

NET OPERATING INCOME

In particularly, the economic fundamentals faced by SMEs have also grown more favourable. For a start, the weakened yen are making these companies more competitive. Secondly, promoting the SME sector in Japan is a major aspect of Abenomics’ third arrow, which broadly speaking is to regain Japan’s growth potential. The government has pledged to provide assistance to SMEs to innovate and for companies in selected strategic industries, in light of a slowing population base, support expansion overseas.

RESILIENCE WITH HIGHER RETURNSNon-prime offices generally accord more stability in operating income as compared to prime grade buildings, due to its more stable rental profile and a lower peak-to-trough ratio. This can be attributed to the asset class’ lower upside potential during boom periods, as the tenant base, being more conservative and with limited investment avenues

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A Cushman & Wakefield Research Publication

MAY 2015

restrains any huge expansion needs; it is also more resilient during recessionary periods. Rental yield gaps between prime and Class B and C offices are also expected to be sustained, maintaining relative returns in the short-to-medium term.

VALUE-ADD OPPORTUNITIESCurrently, over 79% of office space in Tokyo central wards are estimated to be over 20 years of age. This presents huge scope for value-add opportunities for investors. In addition, due to escalating construction costs, refurbishment presents investors with a better value proposition. While rental increases for refurbished assets generally varies between submarkets, against a backdrop of a rising rental market, well located renovated spaces will accord the investor with higher returns, allowing the asset to compete more effectively for tenants. Since most office buildings in Tokyo are Class B and C, refurbishment can enhance the attractiveness of an asset when potential tenants compare it to others within the same location.

*less than 5,000 tsubos (GFA) Source: Xymax, Cushman & Wakefield

Total Stock:

> 20 Years < 20 Years

79%

21%

million tsubo5.1

AGE PROFILE OF SMALL-SIZED BUILDINGS*

0

75

150

225bps

300

375

450

2013 2014 2015 (F) 2016 (F) 2017 (F)

Class S All Grades

Source: Cushman & Wakefield

OFFICE YIELD GAPS RECENT TRANSACTIONS (B AND C OFFICES)

Development: Shibakoen 3 Chome Building

Type: OfficeBuyer: Nippon REIT

Price (million): JPY7,396/US$60.1Price per sq ft NLA: JPY87,168/US$708NOI Cap Rate (%): 5.2

Completed: 1981

Development: Forecast Takatanobaba Building

Type: OfficeBuyer: Nippon REIT

Price (million): JPY5,550/US$45.1Price per sq ft NLA: JPY89,947/US$731NOI Cap Rate (%): 4.9

Completed: 1986

TOKYO: MOVING UP

THE YIELD CURVE

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THE CASE FOR RETAILTokyo’s retail scene is an eclectic mix of high-end brands and quirky street fashion that has made its mark on pop culture. From the streets of Ginza to the luxurious malls along Omotesando as well as in suburban markets, retail malls enjoy high occupancy rates that are backed by consumers with high spending power. While the hike in consumption tax did impact retail sales last year, those negative effects will peter out.

Despite a falling birth rate, population in the city of Tokyo has increased as more people are moving to the city. With Abenomics looking to raise incomes of the Japanese, the retail sector will benefit from a more buoyant income stream derived from brisk sales. Due to the weak yen, the city is enjoying record tourist arrivals and urban renewal projects are creating markets in new residential areas with increased buying power.

Brian DeFoe, Director of Investment Sales, Tokyo at Cushman & Wakefield talks about the merits and strategies in Tokyo’s retail sector.

WHAT IS HAPPENING TO TOKYO RETAIL CURRENTLY?Tokyo’s retail assets are enjoying a resurgence, with rents returning to pre-crisis levels. The Japanese consumption market has expanded over 20 years despite a shrinking population and episodes of challenging domestic conditions. The economy is also shifting towards being more consumption-driven, as seen by the upward trend of the Consumption to GDP ratio. Japan will continue to remain a priority for most international retailers looking to expand into the region as they know they are entering a high income economy.

Main Streets are benefiting from record tourist arrivals. Spurred by the opening of Toranomon Hills, adjacent areas including Shin Tora Dori, which are being developed by Mori Building, will benefit from existing main streets. After the enforcement of consumption tax exemption on October 1, 2014 on tourists’ personal consumption items such as food, beverages, drugs and cosmetics, monthly consumption of tourists skyrocketed for consecutive months – increasing year-on-year by 180.8% in January and 235.8% in February.

We see significant growth potential in new residential areas – Tokyo Bay Area including the Ariake and Aomi districts – which are being developed as the capital prepares for the Summer Olympic Games in 2020. This would be a focal point of investment opportunities. The population in the Ariake and Aomi districts is expected to increase due to increased accessibility with new roads and railways being constructed.

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Japan will continue to remain a priority for most international retailers looking to expand into the region as they know they are entering a high income economy.

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A Cushman & Wakefield Research Publication

MAY 2015

54.0%

55.0%

56.0%

57.0%

58.0%

59.0%

60.0%

61.0%

Q49

4

Q49

5

Q49

6

Q49

7

Q49

8

Q49

9

Q40

0

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1

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Q41

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Annoucement of Abenomics

GFC

Hike in consumption tax

02,0004,0006,0008,000

10,00012,00014,00016,00018,000

Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec.

JPY

(milli

on)

2012 20132014 2015

ANNUAL HOUSEHOLD CONSUMPTION TO GDP (JAPAN)

TOURIST SPENDING

Source: Cabinet Office (Government of Japan), Cushman & Wakefield

Note: tracked department stores only Source: Japan Department Store Association, Cushman & Wakefield

WHERE DO INVESTMENT OPPORTUNITIES LIE?Similar to the office sector, core retail assets available for sale in the central wards are limited. However, there are still opportunities in the regional submarkets for investors who are willing to take on an asset with unrealized potential – which would require some investment towards repositioning, through refurbishments and adjusting of the existing tenant mix to raise footfalls and increase rental yields. Currently, regional malls in the Tokyo Metropolitan Area offer yields that are on average at least 300 bps above what can be found in the central wards, such as those in Saitama, Chiba or Yokohama. We note that net migration to the area has been increasing. Last year, the number of people who moved into the Tokyo Metropolitan Area – which includes the neighboring prefectures of Saitama, Chiba and Kanagawa – exceeded that of people exiting by 109,408 in 2014, up from 96,524 in 2013; over 90% of the migrants were aged between 15 and 29.

TOKYO: MOVING UP

THE YIELD CURVE

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0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Q10

8Q

208

Q30

8Q

408

Q10

9Q

209

Q30

9Q

409

Q11

0Q

210

Q31

0Q

410

Q11

1Q

211

Q31

1Q

411

Q11

2Q

212

Q31

2Q

412

Q11

3Q

213

Q31

3Q

413

Q11

4Q

214

Q31

4Q

414

Q11

5

SuburbanGinza/Omoetosando

PRIME RETAIL YIELDS

VALUE-ADD RETAIL

Source: Cushman & Wakefield

Development: Mallage Shobu

Type: Retail

Location: Saitama Prefecture

Buyer: Croesus Retail Trust

Price (million): JPY28,183/US$170

Price per sq ft NLA: JPY28,668/US$233

Initial Yield (%): 6.1%

Reversionary Yield (%): 6.8%

Completed: 2008

WHAT SHOULD INVESTORS EXPECT?Investors would have to approach the retail assets with more than just owning a building; asset management expertise is critical to maximize returns. The complexities of owning a retail asset is multi-faceted – successful retail assets shows the ability to tap into an area’s demographics, complement the rise of e-commerce and sustain revenue for its tenant base.

For investors looking at such value-add opportunities, well connected malls with a sizable residential catchment in the major cities of Chiba, Saitama and Kanagawa represent suitable investment targets. To tap into the continued economic revival, landlords should opt for variable leases or those based on turnover to reap the recovery in retail spending. With a successful revamp, investors can negotiate higher rates on renewals.

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A Cushman & Wakefield Research Publication

MAY 2015

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Cushman & Wakefield K.K. Sanno Park Tower 13F, 2-11-1 Nagatacho, Chiyoda-ku, Tokyo, 100-6113, Japan

www.cushmanwakefield.com

Sigrid Zialcita Managing Director, Research, Asia Pacific +(65) 6232 0875 sigrid.zialcita@ap.cushwake.com

Keisuke Yanagimachi Head of Research, Japan +(81) 3 3596 7098 keisuke.yanagimachi@ap.cushwake.com

Lai Wyai Kay Associate Director, Research, Asia Pacific +(65) 6232 0864 wyaikay.lai@ap.cushwake.com

Todd Olson Executive Managing Director, Japan +(81) 3 3596 7050 todd.oldson@ap.cushwake.com

Yoshiyuki Tanaka President, Asset Management, Japan +(81) 3 3596 7060 yoshiyuki.tanaka@ap.cushwake.com

Brian DeFoe Director, Investment Sales, Japan +(81) 3 3596 7069 brian.defoe@ap.cushwake.com

For more information about C&W Research, contact: For more information about C&W Capital Markets Asia Pacific/Japan, contact: