Real Estate in Japan: Analyzing an investment decision

Journal of Real Estate Practice and Education, 2003 by Geurts, Tom G, Gagne, Margaret L

Focus

This internationally-oriented case deals with an otherwise seemingly straightforward real estate investment analysis that is complicated in two ways. First, although the property under consideration is a simple office building in Kyoto, Japan, the appraisal process is complicated by some unique external factors and an Asian approach to investment analysis that is different from the traditional American approach. The imputed interest method is sometimes used in Asian countries, such as South Korea and Japan (Essayyad and Green, 1999). Second, the case deals with investing in a foreign country with its own cultural and legal challenges. As such, this case provides a setting in which the student must make decisions under circumstances not normally encountered.

Setting

The property in question is a 375 tsubo office building that is expected to generate approximately $1,400,000 of gross income annually. [One tsubo is equal to 35.5 square feet (Yoshida and Fujiki, 1997: 288) so the building is approximately 13,300 square feet]. It is located in the Nishijin district in Kyoto, Japan. An American real estate company is interested in purchasing the property and has sent an American investment analyst to check the numbers being provided by a Japanese appraisal firm and to make an independent estimate of value.

Exhibits

Exhibit 1: Projected Net Operating Income

Exhibit 2: Analysis Using the Imputed Interest Charge (UC) Approach

Exhibit 3: Example of the Japanese UC Approach to Investment Analysis

Teaching Notes

Teaching notes are available and stress the reconciliation of the American net present value (NPV) method of investment analysis and the Japanese method, which uses imputed interest charges. Both methods recognize the importance of the time value of money in evaluating investment opportunities. The Teaching Notes also include issues to consider when using other appraisal methods such as the cost approach, the comparable sales approach and the income direct capitalization approach. The case material is available from Bill Hardin, the Managing Editor of the Journal of Real Estate Practice and Education. His email address is bhardin@cobilan.msstate.edu.

Introduction

Jim Klein sighed and pushed himself back from the conference table. He stood up and walked to the small side table on which water and hot tea were provided. Pouring himself a tall glass of water he reviewed the situation and, in particular, his frustrations. He was sent to Japan to evaluate a property for investment purposes. A simple job, so it seemed. If he had the pro-forma for the building, he would be able to estimate the investment value of the property by applying an appropriate discount rate. However, retrieving the data was not that easy and the challenge had become to reconcile his estimates with the findings presented to him by his Japanese counterparts. he wondered if there were actual discrepancies between his findings and the numbers provided by the Japanese appraisal firm or whether the problem was cultural instead of mathematical.

In his mind, Jim briefly reviewed the facts about the property in question. It is a simple office building in the Nishijin District, not far from the former imperial palace, Kyoto Gosho, in Kyoto, Japan. Kyoto itself is a city inhabited by approximately 1.5 million people with a sizable foreign community of mainly Koreans, Chinese and Americans. This aspect made Kyoto interesting for his employers, since it was hoped that an American-owned office building would attract American tenants, avoiding reliance solely on Japanese tenants. On the other hand, there is some social tension within the city, since the burakumin (foreigners) live in segregated communities throughout the city. This could be a drawback to attracting tenants, especially since the average lease lasts only two years.

Kyoto was the capital of Japan for more than 1,000 years, from 794 until 1868. Indeed, Kyoto literally means "Capital City." After the Meiji Restoration of 1868, the Imperial Household moved to Tokyo, but its inhabitants still refer to it as sekai no Kyoto, or the "World's Capital City." In fact, all Japanese try to go there at least once in their life, with almost a third of the Japanese population visiting the city annually. Tourism is a major part of the commercial activity, with the presence of a famous 59-foot statue of Buddha contributing to the attractiveness of Kyoto as a tourist destination. In addition, it is a political center, serving as the capital of Kyoto-fu, which is in the center of the Kinki Region.

Located on the island of Honshu, it forms the northern point of the Kobe-Osaka-Kyoto (Keihanshin) industrial zone, the second largest urban and industrial agglomeration in Japan. Historically, Kyoto has always had a sizeable artisan tradition, which has resulted in a relatively diversified industrial base, producing fine textiles and traditional Japanese products for which the steady stream of tourists is a willing consumer.

The building itself, as are all the buildings in the Nishijin District, is a non-descript simple office building of approximately 13,300 square feet. The tenants are mostly small silk and other fine textile merchants and traders of other traditional Japanese products, like fans, dolls, Buddhist altar fittings and lacquer ware. Some tenants cater to the tourism industry and those are mainly located on the ground floor, in effect making the ground floor a small center gals (shopping mall).