Expect a continued favorable domestic lending environment despite modest uptick of interest rates
Japan’s annual real GDP growth is expected to decelerate to 1.0% in 2024 from 1.6% in 2023 as economies continue to normalize from the pandemic. With prolonged pressure on aggregate demand from high-interest rate policy in the United States and Europe, the aggregate real GDP growth of Japan, the United States, and Europe as a whole is expected to decelerate to 0.9% in 2024. Capital market pricing already signals the BoJ’s exit from negative interest rate policy without causing a delay from the Fed’s interest rate cuts in the next several months. An unsynchronized monetary policy across major markets also means continued yen weakness, testing a cyclical low of JPY 150 per USD, as well as inflationary pressures from imported materials.
We expect currency market volatility remains elevated; temporary speculation about the BoJ’s announcement alone has pushed the ten-year interest rate to 0.95%, tracking above a current neutral interest rate of 0.8%, followed by a measured uptick to 1% by the end of 2024. Despite projected increase of interest rates, real estate lending environment remains stable with the outstanding real estate loan reaching at 16.5% of nominal GDP. The banks' DI of real estate loans is projected to remain strong with weak loan demand from other industries.
Expanded domestic investor base has lifted annual transaction volume, up 2.8% y-o-y
An expanded investor base from domestic corporations and smaller funds has lifted the LTM transaction volume4 to JPY8 trillion, up 2.8% y-o-y. Longer investment decision process, typically required for these players, means the aggregate demand remains strong, providing ample exit options to non-domestic funds. Even assuming the benchmark rate increasing to 1%, Japan’s cash-on-cash return is expected to remain positive, unlike other major markets. By investor type, institutional investors maintains the net purchases with increased number of active players. Foreign investors almost eliminated their net purchase to JPY2.9 billion with a series of large sales toward the yearend as their cost of capital nearly doubled during the year. Conversely, J-REITs remains the net seller with sluggish performance in relation to NAV despite their low cost of debt averaging around 0.6% for the maturity averaging around four years.
Allocation to cyclical sector is mixed, with allocation to office plunging from 42% in 2020 to 32% in 2023. Investors' interests are increasingly restrained to a limited number of well-located high-quality assets, resulting expansion of the pricing range of completed transactions. Allocation to hotels has doubled from previous year, albeit widening bid-ask spreads already indicate limited upside forward in relation to undervalued neighborhood retail properties relative to fundamentals. Among non-cycle assets, allocation to logistics saw little change at 20%. Increasing buyer’s risk aversion to large-scale transactions against sellers’ unwillingness to price discount led to lower allocation to Multi Family, falling to 16% of the total transaction volume.
Net inflows of funds from a wide range of investors continue to anchor low expected yields
