Tokyo's property and the emperor's clothes

Dateline: TOKYO
AS JAPAN'S interest rates have soared this year, so the country's stockmarkets have slumped — following
this week's tumble, by two-fifths so far this year. Do people now expect a property slump in Tokyo? Oddly,
they do not. Like London two years ago and California today, Tokyo's leap of faith is that property values
will, at worst, stand still for a few years before the next boom begins.

That faith is reinforced by pat reasoning. It is that, because of Tokyo's tight zoning and building regulations,
there will always be a land "shortage" in Tokyo. These shortages have led to such anomalies as there being
89,000 acres of farmland and 56,000 acres of vacant land in the greater Tokyo area, which in a free market
could be sold for billions of dollars. It is true that these anomalies would disappear in any sensible country,
and take a longer time to fade in Japan. But the theory that they will hold up Tokyo property prices forever
is bunkum.

These artificial "shortages" were there before prices trebled in Tokyo in 1986-89, and will presumably be
there after they halve or worse. Property prices will fall for two reasons: first, because they are now
uneconomically high; and, second, because they will succumb to the same liquidity shortage that has
already caused the Tokyo stockmarket's collapse this year.

The liquidity shortage is shown by rising interest rates and increasing rationing of credit. It was ultra-low
interest rates and easy access to borrowed money that fuelled Japan's property binge in the late 1980s, when
land prices soared to record levels relative to rents.

After a four-year boom, land should now return to more traditional valuations (ie, drastically lower ones).
The question is how uncomfortable — or even fatal-this will prove for parts of the banking system as well
as for over-borrowed developers. Many of these borrowed heavily against land both to punt on shares and
to buy more property. Land has not so much been traded in Japan as used as a source of instant credit.
Japan's land boom encouraged banks to lend money wildly to property developers in the 1980s. They were
short of other people to lend to, as corporate borrowers deserted banks for the securities market. Developers
assumed that ever-rising land values would cover the (now rising) cost of borrowing. The resulting
exposures are huge.

Japan's 12 big commercial (known as city) banks plunged in relatively late. Yet in the year to March 31
1990 their outstanding loans backed by property rose by 22%, to ¥57.3 trillion ($365 billion). This amounts
to 23% of city banks' total loans, up from 16% five years ago. Some well-known banks have even higher
ratios. At end-March Sumitomo Bank had 26% of its total loans of ¥29.9 trillion (and 40.5% of its domestic
loans) out to Japanese property.

The country's seven trust banks have big exposures to land, because of their historically close relations with
property companies, and their role as the only banks licensed to be estate agents. Most of the more than 150
regional banks have been equally keen on lending against the security of land. Two extreme examples are
Keiyo Bank and Musashino Bank, which at the end of March 1989 had 49% and 45% of their total loans
out to property. They had enthusiastically fanned the flames of a housing boom in Tokyo's outer suburbs.
The regulators' worst worries are about the hundreds of shinkin banks, Japan's version of America's credit
unions. At the end of March these had total assets of ¥88 trillion. Most shinkin are small institutions with
only a handful of branches, and have had to cope with deregulated interest rates. Like America's thrifts,
they felt forced to pursue higher-margin and hence riskier business. For small-town banks, this meant
lending to property spivs.

Japan's bureaucrats at the central bank and the finance ministry still expect lenders to adhere to the
Japanese banking practice of lending against only about 70% of a piece of land's hard-to-measure market
value. But the 1980s saw a rash of lending for second mortgages and the like, and such extra lending went
unchecked. The Bank of Japan and the finance ministry have only 108 bank examiners between them.
The bureaucrats at the finance ministry and the central bank are now worried sick about the risk to the
financial system. They would love to push land prices down gently without bursting the bubble. As they do
not want to go to war against land with dramatic rises in interest rates, they resorted last spring to jaw-jaw.
They told all the banks that the growth in their loans to the property industry should not exceed the increase
in their total loan book. All banks must also now file quarterly data about their lending to non-bank
financial institutions such as leasing and consumer-finance companies, neither of which is regulated by the
finance ministry. Such companies have been heavy borrowers from banks to lend on to property
speculators. Some banks are now scared of lending against land, but even more are terrified of collapsing if
they stop doing so.

The Tokyo stockmarket has fewer such inhibitions. So far this year the index of property shares has fallen
by 47%. The railway sector has slumped by an even bigger 51%. It consists of companies valued chiefly by
their "latent assets" (for which, read land) not by the custom on their trains.

Though the stockmarket is shouting a warning, the official benchmark for land prices still refuses to reflect
it. This is the National Land Agency's biannual survey, an indicator notorious for lagging behind events.
For 1989 it showed a year-on-year rise in land prices of 17%. The usual leaks say that the figure for year-
on-year growth to June 30th will again be in double digits. That strengthens the case of those central
bankers that want still tighter money.

There are signs, though, that the property market is cooling. The key central-Tokyo office market is slowing
(see box). And I there is a record 11m square feet of office I space under construction in the central five
wards of Tokyo.

In the residential market the price of second-hand condominiums declined in the three months to May.
Condominium developers expect worse to come. They are rushing to complete projects before the squeeze
hurts, and while prices still remain silly. At the end of 1989 the average new condominium in central Tokyo
cost ¥110.5m, or 17 times the national average annual salary. In Osaka the figure was ¥58.2m, or nine times
the national average. Rising mortgage rates are making those prices ever less affordable.
An analysis by Mr Tom Hill, of Warburg Securities in Tokyo, suggests that Japanese land prices have a lot
further to fall than the consensus expects. Mr Hill argues that Japan's strict rent-control laws for tenants
mean that rents increase at a predictable 4.5% a year. As a result, the stockmarket valuation of the property
sector has generally tracked long-term interest rates. Since institutional investors own property for its
income rather than for its potential resale value, their concern is how much they can earn compared with
the guaranteed yield on long-term government bonds.

During the 1980s the gap between bond yields and central Tokyo office yields swung between 2.4 and 3.2
percentage points in bonds' favour. With Japanese bond yields now over 8%, that spread has widened to at
least five percentage points. Mr Hill's model suggests that, if the gap were to narrow by two percentage
points during the next two years, capital values would fall by 20% assuming rents continued to rise. No rent
rises — because of glutted markets — and the fall would become 40%.

Can the centre hold?

THE way financial institutions are drifting back into Tokyo's downtown business district shows how soft
the property market in Japan could become. Until a year ago, property agents in the fashionable central area
of Marunouchi and Otemachi were contemptuously turning clients away. Even after four years of huge
price rises in 1985-89, the demand for office space in central Tokyo was still more than the market could
supply. Now the young men in sharp suits have all too many empty offices to show their clients.
During the 1980s, as foreign brokerages, banks and other financial firms rushed to Tokyo to join the
greatest bull market of all time, long waiting lists and exorbitant rents for office accommodation sent
disappointed newcomers scurrying to the inner suburbs. Mighty Salomon Brothers set up shop in Ark Hills,
a business and entertainment complex squeezed between the Roppongi and Akasaka watering holes.
American Express went six miles to Ogikubo, on the western fringes of Tokyo, and built a 17-storey office
block for itself.
Even long-established local brokerages had to move out of the Kabutcxho stockmarket district. New Japan
Securities, the fifth-largest brokerage, started the trend. It grew so fast that its head office was scattered
round dozens of buildings close to the Tokyo Stock Exchange. In 1984 New Japan moved most of them to a
single office block in Kyobashi. Four years later it had sprawled into eight buildings there, so moved again
into a single new office block. Sanyo Securities was the first to get a building specially designed for
dealing, but had to move across the river to unfashionable Kiba to find the space.

Today, most of the new buildings ordered in the Tokyo bull market are being completed just as the bear
market gathers downward pace. The biggest stranded hulk looks like being the Urban-Net Otemachi
Building. It opened its doors this month, halfway between the Marunouchi banking neighbourhood and the
Kabuto-cho district. With its 22-storey atrium and fancy space-wasting shape, property men are already
questioning how long the ¥40 billion ($275m) building will be allowed to stand.

The owner of Otemachi's new landmark, NTT Toshikaihatsu, the property arm of Japan's semi-public
telephone company, has been much luckier than most. It signed up its big clients before the property market
went flat. As a so-called "intelligent" building, it is one of the first to come on the market with ceilings high
enough to accommodate all the ducting needed to put in a trading room.

Nomura, Japan's largest securities firm, opened a dealing room in the NTT building, and has moved its
headquarters there. Salomon has forsaken the fleshpots of Roppongi for NTT'S high-tech building. After at
last getting a seat on the Tokyo Stock Exchange, Britain's Barclays de Zoete Wedd has also moved to the
new Otemachi building, from inconvenient Toranomon. All are paying a hefty monthly rent of around
¥25,000 per square metre (ie, an annual $190 per square foot).

Few other buildings can now command anything like that. There are too many partly vacant properties. In
the shiny Urban-Net building, the developer has been forced to take nearly half the space itself.

Copyright of The Economist © 1990 is the property of Economist Newspaper Limited and its content may
not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express
written permission. However, users may print, download, or email articles for individual use. All rights
reserved. Users may not save or store any or all of the content on their own systems or distribute any of the
content on a local area or wide area network (such as corporate intranets or networks).