Real estate borrowers reconsider financing terms in Japan

Borrowers in Japan’s real estate market are re-evaluating their financing strategies in response to rising interest rates.

Last month, the Bank of Japan enacted its second interest rate hike in 17 years. The rate rise followed an initial increase at the end of March, collectively raising the policy interest rate from negative to 0.25 percent within six months.

Ken Sakuramoto, head of capital markets at Singapore-headquartered real estate investment manager Aravest, noted that while the rate hike was anticipated, its timing was sooner than expected. “We knew it was coming; the question was whether it would be this month or next,” he said.

Despite foreseeing the adjustment, Sakuramoto prompted to reconsider financing terms in Japan because of the latest rate hike. He pointed out that many investors chose floating rates due to historically low rates, but rising rates now pose a risk. Fixed rates, although more expensive, offer stability.

“I know a lot of foreign investors, I would say 70 to 80 percent of them, they borrowed on floating rates because the interest rate was so low,” he said. “I wonder how much sentiment on the financing terms has changed.”

Hidetoshi Ono, head of Japan at Tsao Family Office, believed floating rates are still more advantageous for short to medium-term investments due to the lower cost compared to fixed rates. Ono noted that fixed rate loans would cost 80-100 basis points more than floating rate debt, but might make sense for investments held over 10 years.

From his conversations with domestic lenders, he learned that most investors still prefer floating rates because they are cheaper. He added there is a consensus that the Japanese government can raise interest rates by up to 50 basis points without significantly impacting the economy.

Gary Kwok, CEO of Tokyo-based AXE Management Partners, concurred that floating rates are currently cheaper but is more open to fixed rates now than he was five months ago.

When AXE acquired three hotel properties in March for 10.7 billion yen ($75 million; €69.3 million), Kwok financed the transaction with a floating rate loan, which was significantly less expensive than a five-year fixed rate at the time, according to a PERE report. He said future investment decisions will depend on the difference in cost between fixed and floating rates at that time.

Kwok also highlighted that international investors might prefer fixed rates more than their domestic counterparts, given how interest rates have risen significantly in some markets over the past two years. An Asia-based managing director at a US real estate firm echoed this sentiment, emphasizing the security that fixed rates provide against potential volatility.

“While sticking with a floating rate today might be cheaper, is it not more sensible to fix your debt now and have the certainty to your investors that you are protected against the possibility of a more volatile rate hike?” he stated.

Rethinking underwriting

In fact, some international investors started reassessing their underwriting as early as last year in anticipation of Japan’s rate hikes.

“We have been thinking through and deciding between floating and fixed rates over the last year,” said Tim Jowett, managing director and head of Asia research at US real estate firm Hines. He emphasized the importance of locking in fixed rates in a rising rate environment, even if borrowing at floating rates appears less costly in the short term.

M&G Real Estate also adjusted the required rate of return for investments in Japan before the second rate hike. The firm is also proactively managing its loans to minimize the impact of interest rate increases to investment returns.

“As the cost of capital increases, funds would require a commensurate increase in investment returns, either through a higher cap rate or higher stabilized rental growth,” said Jing Dong Lai, CEO of M&G Real Estate Asia.