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Appraising Japanese real estate.

Japanese real estate appraisal is changing significantly to keep pace with a fluctuating real estate market increasingly affected by international and domestic economic, political, legal, and social conditions. The Japanese government continually analyzes the real estate market, attempting to address any perceived problems. In Japan, real estate is considered one of the most important assets the nation possesses.

After discussing Japanese real estate appraisal in general, this article examines how some of the recent major changes affect the principal approaches to the appraisal of various type sof Japanese real estate. The requirements for Japanese certified real estate appraisers are also surveyed.

As they become more involved in international business, many appraisers, investors, lenders, security and real estate brokers, and other real estate professionals in the United States are becoming concerned about Japanese appraisal practices. Japan represents an important real estate market for international real estate appraisers.

Japanese real estate appraisers patterned their appraisal system after that of the United States, emphasizing three main appraisal approaches. While British valuers, who influence appraisal in many parts of the world, do not generally confine their appraisal analyses confine their appraisal analyses analyses to only three approaches, they do tend to focus as well on appraisal concepts and methods that are related to the cost approach, the market comparison approach, and the income approach.

FEATURES OF THE

JAPANESE REAL ESTATE

APPRAISAL SYSTEM

Japanese appraisers apply the cost, market, and income approaches to the valuation of Japanese property, with primary emphasis on the cost approach and the market approach. To appraise land, the market approach is primarily used. To appraise buildings, appraisers most often rely on the cost approach, although the market approach and the income approach may also be used. While the unavailability of comparable properties can limit the use of the market approach to value, government appraisal data may supply the necessary comparables. The market approach generally requires four comparable properties.

When the income approach is used, direct capitalization methods rather than discounted cash flow (DCF) methods are normally employed. If a substantial fee can be acquired, however, a 10-year DCF analysis is used.

The most common forms of measurement used in Japanese appraisal reports are square meters, hectares, and tsubos (i.e., 3.3 square meters). When using the lnpd residual approach, appraisers normally deal in net income per square meter, while in the market approach, the focus is most often price per square meter.

LICENSING OF REAL

ESTATE APPRAISERS

The Japan National Land Agency licenses both real estate appraisal companies and individual appraisers. To qualify for an appraisal fee, an appraisal report must display the license number of the appraisal company as well as the number of the individual appraiser. In addition, the license number of the president of the appraisal company involved may be required. Such license numbers are usually included in mandatory seals on submitted appraisal reports. If the necessary seals are not available, however, an appraiser may earn a fee on a consulting report.

Approximately 6,000 licensed real estate appraisers and 2,390 licensed appraisal companies of all sizes are currently operating in Japan. The appraisal departments of the eight Japanese trust banks, such as the appraisal section of Mitsui Trust and Banking Company, are considered equivalent to real estate appraisal companies. Typical real estate appraisal companies, however, employ only five persons, and many employ married couples.

All public appraisal reports must be performed by licensed appraisers. While unlicensed appraisers can sign only private internal company reports, they can function as managers of appraisers as well. Financial institutions' staff appraisers also do general appraisal work, as do fee appraisers. Such work normally involves 1) financing property; 2) dealing with property sales, title transfer, and property transactions; 3) addressing court disputes involving rent increases, eminent domain, property taxation, and leasehold values; and 4) negotiating with local government to help with property tax assessment.

GENERAL LICENSE

REQUIREMENTS

To be licensed, an appraiser must successfully pass three exams and have two years of full-time real estate appraisal experience or its equivalent. College graduates are exempt from the first exam, which covers general knowledge including language, mathematics, Japanese history, and foreign language. The second exam, a three-day exam, covers accounting, economics, civil law (including real estate law), administrative law (including all real estate regualtions), and real estate appraisal theory.

After successfully passing the second exam, a candidate attends intensive trade association lectures for about four weeks, with eight hours of instruction per day. A candidate can then apply for the third exam, which covers only appraisal theory and report writing. The exams are given in several cities in Japan, generally during the summer when univerisities are on vacation. About 200 candidates per year pass the second exam; about 150 candidates passed the third exam in one recent year. To satisfy the license requirements takes approximately two years.

PERIODIC GOVERNMENT

APPRAISALS

The National Land Agency commissions licensed real estate appraisers to appraise sample properties for the government. The fees paid by the government are relatively low, as they are in most countries. An appraiser can earn approximately Y100,000 yen for appraising a parcel of land for the federal or prefectural program. The agency publishes the sample land appraisal data acquired by the federal government every January 1, and data acquired by the prefectural governments every July 1. The government spends approximately four billion yen every year for property appraisal.

CHIEF APPRAISAL

ASSOCIATION

Originated in 1965, the Japan Association of Real Estate Appraisers (JAREA), with 6,000 members including approximately 500 candidates, is the only Japanese appraisal association allowed to use real estate data generated by the federal government. However, JAREA members have access to only 10% of the data collected by the local government. Such data are acquired by property sellers directly.

CONTENT OF THE

APPRAISAL REPORT

Japanese law specifies the content required for an appraisal report, while JAREA sets the specific format to be used for residential reports. Generally, an appraisal report is five pages to ten pages in length. Regardless of whether the client is Japanese or foreign, the same report format is usually used; however, the complexity of the report development tends to depend on the nature of the fee.

THE COST APPROACH

General use of the cost

approach

A rough estimate of the depreciated cost of a building in Tokyo would be only 20% of total property value. Thus, although most Japanese appraisers have access to cost services similar to the Marshall Valuation Service, they tend to use cost data from JAREA reports instead. The economic life used for a property ranges from 30 years to 50 years, while its tax life is usually 60 years to 65 years. An appraiser uses the actual perceived life of the building in the analysis. Of the forms of depreciation and obsolescence usually recognized, economic obsolescence is considered one of the most subjective.

Changes affecting the used of the

cost approach

Costs of new construction continue to be high as a result of stringent building codes. Japanese building codes must provide for earthquake protection as well as for protection against fire, water, and other damage. The labyrinth of water control systems that extends throughout Japanese prefectures could be severely damaged by a strong earthquake. While a disastrous earthquake has not occured in Tokyo since the 1920s, the threat of such a disaster is always present. In addition, building codes in areas near active volcanoes must provide for both building and occupant protection. (Recently, a Japanese volcano erupted, causing the loss of many lives as well as extensive property destruction.)

As a result of inadequate building construction before the earthquake in the 1920s as well as military destruction during World War II, few office buildings now standing in central Tokyo were built in the first half of the twentieth century.

Depreciation in the value of income properties is occurring at a faster rate in Japan and other industrialized countries as the highly technological and other features of new buildings cause depreciation to be more rapid in previously existing income properties. For example, office buildings are renovated at increasingly shorter intervals in Japan, although these intervals are still much longer than those between renovations in the United Staes. Perhaps this is because office building renovation is not needed to keep Japanese buildings occupied at relatively high rents--high rents continue to increase with 1% to 2% vacancy rates in the major cities such as Tokyo. This is not the case in most other countries, where office building owners tend to renovate to retain tenants who agree to relatively high rents. In the United States and most other countries, when vacancy rates are relatively high, renovation to attain high building performance and marketability supplements higher marketing costs in general. Further, while older department stores and other retail structures need periodic renovation, most Japanese shopping centers do not yet require renovation because they are relatively new--many are less than ten years old.

The value of the land in comparison with the value of improvements to the land remains high in Japan. While land value for an income property in a major U.S. city may be 30% to 40% of total improved property value, land value to total improved property value in a major Japanese city may be as high as 90%. The appraisal of land value is thus a significant real estate appraisers.

Construction costs may decline if foreign construction companies gain entry into Japanese construction markets as a result of the Strategic Impediments Initiative (SII). Through SII, United States trade representatives are asking the Japanese govern,ent to permit foreign construction companies to bid Osaka Airport. If foreign construction companies gain a foothold in this market, they may be able to bid for and receive competitive contracts for private-sector projects as well.

The fact remains, however, that Japan must import most basic construction materials such as iron ore and timber. Importing raw materials drives construction component costs higher than would using domestic raw materials. The Japanese government, however, wishes to preserve its forestland for future generations. Further, iron ore deposits as well as oil and gas for the industrial establishment's power sources are insufficient in Japan. Japan's steel mills tend to produce expensive steel by world standards as a result of relatively high labor costs for scarce steel mill labor. Most steel building components are thus imported from South Korea and other less costly sources.

Construction components produced by Japanese-based companies compete effectively around the world on the basis of quality, reliability, and cost. For instance, Mitsubishi elevators for high-rise buildings compete with Otis elevators from the U.S.-based United Technologies Corporation in world markets.

THE MARKET APPROACH

Property values derived through the market approach are needed in Japan--as in other capitalist countries--for such purposes as property buyer-seller negotiations, property financing, estate settlement by the courts, ad valorem property taxation, property insurance coverage, and eminent domain settlements. As property values have increased steadily over the 1980s and the early 1990s, those found through the market approach have proven more significant in many cases than propety values derived through use of either the cost approach or the income approach.

For several reasons, properties tend to sell infrequently in Japan. The culture honors the ownership of property to such an extent that few property owners wish to sell their valuable properties. In addition, company property owners hold properties for later use in their business. In the United States, this land-holding strategy is sometimes called "warehousing land" for later business purposes. Japanese property companies as well as industrial, trading, and other service companies warehouse land for anticipated future developement. Because land values are generally assumed to always rise, acquisition of land earlier than needed permits companies to pay less for developement. The scarcity of property sales causes many companies to buy potentially useful land when it is available rather than risk appropriate land being unavailable when it is needed.

Generally, the Japanese federal government appraises a nationwide property sample in July while prefectural governments appraise sample properties within each of their prefectures in December. (Federal government budget years usually run from April 1 to March 31.) Japanese real estate appraisers may therefore use recent government appraisals of a subject or comparable properties for the basis of a market approach valuation.

PRIVATE COMPUTERIZED

APPRAISAL SYSTEM

Within the last two years, a real estate appraisal trade association has established for its members a computerized appraisal data bank that covers many recent property sales. At the trade association headquarters, a mainframe computer is connected with various member offices to give them access to recent property sales. This appraisal software permits a company appraiser to select recent sales of comparable properties for use in the market approach to value a subject property.

Not all recent property sales, whether commercial or residential, are submitted to the private data service, and not all real estate appraisers are members of this voluntary private appraisal trade association. A larger portion of current property sales may be submitted to this data bank service in the future, however.

POSSIBLE DEVELOPMENT

OF A JAPANESE REAL

ESTATE CYCLE

The market values of properties in the six largest Japanese cities, taken as a whole, recently declined for the first time in many decades. This may be a sign of the initiation of a real estate cycle in Japan similar to those that occur in Europe, the United States, Australia, and other countries. Japan has been unique in exhibiting only an upward real estate value curve since 1955 or before, while most industrially developed economies as well as developing countries have experienced real estate value cycles.

The downturn in general property values of the six largest Japanese cities during the first quarter of 1991 may continue for the following reasons. The Japanese government generally encourages a 20% decline of overall property values to "burst the property buble," to gain more reasonable ratios of income to house price and income to house rent, to remove the wide disparity between the wealthy and the other income groups of Japanese society, and to reduce the cost of this component of domestic economic expansion.

The class structure of Japan is often described as consisting of the landowners and the landless. Japanese land is owned to a great extent by wealthy families, agencies at various levels of government, nonproperty companies, and the major property companies. For example, the father and two sons of the Mori family own numerous office buildings in central Tokyo. Mitsubishi Estate Company is the recognized owner of many office buildings in the Marunouchi district, which is the cief financial and corporate headquarters district of Tokyo.

The federal government is revising taxes in a way that could suppress land values. In addition, land-holding taxes will again be imposed on property owners starting in January 1992. Exceptions to these taxes will be allowed, however, and only 50,000 or so major landowners will be affected by the tax, which is less than 0.5% on assessed values of primarily income properties. Assessed values of affected income properties represent half or less of their current market value. The increased taxes may raise the operating cost of an income property, thus reducing the net operating income (NOI) if the revenue is not simultaneously increased to compensate for the higher operating cost.

Clearly, landowner/taxpayers will immediately consider passing on the increased property taxes to the tenants. Net leases may permit tenant assumption of the increased taxes as part of the lease contract. If not, the landlords will certainly assess the possibility of raising rents, already high by world standards. If NOI declines, capitalized income will result in lower property appraisals. The increased land holding taxes may be a catalyst for the reduction of Japanese property prices.

Relatively high city property values probably declined in the environment of scarce and relatively expensive Japanese property financing. In March 1990, the Ministry, of Finance asked property lenders to reduce their real property lending to dampen the real property speculation and increasingly high property values. Fear has spread across the Japanese property markets since then, as property owners are afraid reasonably priced property refinancing may not be available when their loans need to "roll over." Further, prospective property owners are wary that necessary financing for impending transactions will not be available or will only be available at a high cost.

Alternative financing options are being studied. Those who depend on future property financing, those who earn fees from property financing, and those who invest in financial instruments are considering more real estate equity and debt securitization to replace the declining volume of real property loans. By the time new real estate financing instruments are created and new enabling legislation is passed, Japanese stock markets may again be rising from the low point reached in 1990. Generally, it is easier to sell securities on a rising market.

THE INCOME APPROACH

Lease provisions change as the balance of demand and supply changes. While security deposits paid in advance tend not to reflect changes in space supply and demand, "key money" (1) appear to change with the competitive property climate. For example, less key money was required in the second phase of a major shopping center completed recently than in the first phase completed about ten years ago. The base rents, quoted in square meters, also change with the supply-demand balance as relatively short-term leases are renegotiated. Office building leases still run for 2 years or 3 years. The lease for a shopping center anchor tenant still runs approximately 20 years, while leases for the smaller storeroom tenants still range from approximately 3 years to 10 years. The balance of base rent to percentage rent for a mall storeroom lease still approximates 80% for base rent and 20% for percentage rent. Indexing of leases is not yet common for either office buildings or shopping centers in Japan.

Because real estate financing rates continue to change, the present value of outstanding mortgage debt, using the current cost of funds as the discount rate, is important to consider in DCF analysis. Cash equivalenct calculations are also important, as an interest-rate cycle of greater amplitude is beginning to take shape in conjunction with a real estate cycle.

Vacancy rates continue to be negligible at 1% to 2% on most property types. As domestic business expands and more income properties are built, a higher average vacancy rate may develop across Japan. Most industrialized countries, such as the United Kingdom or the United States, experience real estate cycles accompanied by cyclical vacancy rates.

The capitalization rate should reflect greater management risk in Japan than in the United States. The United states has a well-developed professional property management industry; a similar industry is being developed in Japan. The Japan Building Owners and Managers Association (BOMA) has been approved by the federal government to establish a professional property management designation with appropriate requirements. The education and experience requirements are currently being formulated through the process of corporate consensus. Japan BOMA has been offering professional property management seminars and courses for the education and retraining of the employees of its member companies for several years. (2)

(1) Key money is the money paid simply to acquire the space once the offer to lease is accepted.

(2) Sources of information for this article were interviews with Tokyo real estate trade association officers, real estate appraisers, real estate company managers, managers of Japanese and foreign financial institutions with offices in Tokyo, real estate consultants, and others in research trips to Japan between 1983 and 1991.

Mary alice Hines, PhD, holds the Clarence W. King Endowed Chair of Real Estate and Finance at Washburn University, Topeka, Kansas. She has previously contributed both domestic and international real estate articles to The Appraisal Journal and has published 28 books and monographs
COPYRIGHT 1992 The Appraisal Institute
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Hines, Mary Alice
Publication:Appraisal Journal
Date:Jan 1, 1992
Words:3297
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