As international equity markets took a beating in 2022, many investors have looked to other sectors to shore up their portfolios.

In the last few years, Japanese residential real estate has drawn a lot of attention from overseas investors because of the promise of stable, albeit relatively low yields. Then came the yen shock of 2022. Driven mainly by the US federal reserve’s three consecutive rate hikes of 75 basis points, starting in July, the yen plummeted against the US dollar.

On average, in 2021, the average exchange rate between the US dollar and Japanese yen was ¥109.46 (Source: exchangerates.org.uk). In 2022, the average rate shot to ¥131.46 , a depreciation of about 16.8%. At its lowest, the US dollar-Japanese yen exchange rate touched ¥150.1288 on October 20. This has represented a windfall for investors holding US dollars and looking to invest in yen-based assets like rental properties.

There are many valid reasons and benefits to investing in Japanese residential real estate. Of course, there are also risks to watch out for.

Vacancy Risk

When you invest in a rental property, one of the biggest risks is that it will not be immediately leased out or that it will stay vacant for an extended period. As an owner, you will lose your revenue stream and also have to spend additional funds on advertising to look for new tenants.

Vacancy risk can increase at certain times of the year. For example, if you buy a property in the low rental season, you may find that you cannot immediately find a tenant for it, making it necessary for you to carry the mortgage, property management fees and repair reserve fees until rental demand increases. Local market conditions can also affect vacancy risk. For example, the closing of a college campus would very likely affect the need for rental properties in the surrounding area, resulting in a higher vacancy rate for student apartments in the neighborhood.

Risk of delayed rent payment

A delay in rent payment will also affect the profitability of your investment. Whenever this situation happens, you either want to talk to the tenant directly or send a notice asking for the payment as soon as possible. If you are overseas investor, this is a situation where it is very advantageous for you to have a local property manager acting on your behalf.

Risk of major repair expenses

As a building ages, its livability deteriorates. Over time, common areas such as hallways, exterior walls and plumbing will all need to repaired, replaced or renovated. So when you are making an investment plan, it’s a good idea to include repair costs in your profit-and-loss calculation.

Condominium owners in Japan are required to pay repair reserve fees on a monthly basis to cover eventual major repairs to the building. Repair reserve fees will also tend to increase as the building ages, as more and more parts of the building require renovation. This is a risk that some investors fail to fully consider when they initially pencil out the cost side of the equation.

Risk of interest rate increases

If you choose an adjustable rate mortgage, you take the risk that interest rates will increase, thereby increasing your monthly mortgage payment. A sound financial plan will take interest rate increases into account!

Risk of natural disasters

Japan is a country prone to earthquakes, tsunami and landslides. Homeowners in Japan are required to take out fire insurance but not flood or earthquake insurance, although it is highly recommended.

As part of the diligence in buying a property in Japan, you should be aware of the various natural disaster risks that the neighborhood is prone to, such as flooding, earthquakes or landslides. This information will be disclosed to you as part of the explanation of important matters; this information can also be found in hazard maps put out by the local government.

Tips for mitigating investment risks Choose a trustworthy management company

Most residential property investors in Japan hand over the actual management of the property to a property management (PM) company.

It is important that you choose a management company that is good at finding tenants, at dealing with a wide range of tenant issues and complaints, and very importantly, at negotiating with tenants who do not pay their rent on time.

If you are planning to sell your property in the future, you should also considering going with a management company that is experienced as a seller’s agent.

Finally, don’t forget to include the property management fee in your calculations, as one of the costs of owning the property.

Location matters

Location is (almost!) everything in real estate.

In Japan, properties that are about 10 minutes away from a train or a subway station are generally popular among renters. A property near supermarkets or convenience stores, hospitals, universities and parks, as well as business districts will tend to have lower vacancy rates.

Neighborhoods slated for redevelopment will also see demand rise in the future. If you buy into an area before a redevelopment project is completed, the property may see price appreciation as well as lower vacancy risk as the neighborhood becomes more convenient and modern.

Consider all of your investment costs

Here are just some of the main expenses to keep in mind when investing in a rental property:

1. Property management fee
2. Repair reserve fees
3. Building management fee
4. Fire and earthquake insurance
5. Fixed asset tax
6. City planning tax