Crucial to the J-Reit market is the pro-cess of property appraisal, which involves independent specialists valuing properties.
There is no better source of information and perspective on the appraisal process than Japan Real Estate Institute, a non-profit organisation that employs 600 people, including nearly 300 certified real estate appraisers. JREI has 52 offices across Japan and conducted 15,361 appraisal projects in the three years to June 1, 2006.
EuroWeek asked Tak Ichikawa, a senior appraiser with JREI in Tokyo, for the organisation's views on the development of the property market and appraisal techniques.
How has property appraisal in Japan evolved in the past two decades?
We can quite neatly divide the past two decades into the pre- and post-bubble periods.
Until the early 1990s, shortly after the collapse of the stockmarket and the bubble economy, the real estate market in Japan relied on land values alone and therefore focused solely on sale price benchmarks and comparables, even though these benchmarks were clearly heavily influenced, some might say distorted, by the bubble economy.
The income or cashflow approach was hardly considered as a reference, especially as there was little expertise or sophistication on behalf of the valuation community.
Mostly during the period of the Japanese financial crisis from 1997 onwards, a vast amount of real estate loans later became non-performing and at that stage of the market's development, it became essential to use a more accurate and sophisticated valuation methodology, based on cashflows.
The SPC Act [Law on Securitisation of Specified Assets by Special Purpose Companies], enacted in 1998, helped promoted the income approach and the more strenuous research and collection of data to support valuations.
After the revision of the SPC Act in 2000, the first two J-Reits floated on the Tokyo Stock Exchange in September 2001.
With 37 listed J-Reits as of today [August 24], and with a history in recent years of numerous other real estate securitisation deals, there is an ever greater demand for a more and more sophisticated approach to valuation.
Can you explain the key features of the Japanese Real Estate Appraisal Act?
This arrived in 1964 against a backdrop of dramatic rises in land prices, supported by the remarkable expansion of the Japanese economy.
The Japanese government wanted to enact the new law in order to acquire land at a low and reasonable price, and to help standardise land prices and make the valuations more accurate. [The Japanese government at that time needed a vast amount of land to build infrastructure such as roads and railways during the massive expansion phase of the economy and wanted to acquire the land at 'reasonable' prices.]
By way of background, one must understand the particular characteristics of Japan's property market in the past. In Japan, land has always been considered as a separate asset from buildings.
Until about 2000, when the income approach to valuation became the stable and leading benchmark for appraisal, vacant land was imputed to have the highest value because of the freedom for the owner to develop it, while a developed or tenanted property was considered generally less valuable, especially if there were restrictions on the lease.
Who sets the rules for J-Reit appraisals? Is this body expert enough to oversee the appraisal industry?
The Ministry of Land, Infrastructure and Transport publishes and promulgates the Japanese Valuation Standards (JVS), based on advice provided by the National Land Development Council.
The JVS refer back to the Uniform Standards of Professional Appraisal Practice (USPAP) in the US and the International Valuation Standards (IVS). They first appeared in 1964 and were revised in 1969, 1990 and 2002.
The Japanese Association of Real Estate Appraisal (JAREA) requires its members and candidates to abide by the provisions of the JVS, the Bylaws of the JAREA, and the Japanese Real Estate Appraisal Act.
Education and training programmes provided by JAREA have greatly helped the progress of appraisal methodologies in Japan.
Is there a standardised appraisal methodology in Japan for J-Reits and other clients?
Yes, there is a standardised appraisal methodology, which complies with the Japanese Valuation Standards. These standards closely resemble the International Valuation Standards.
No matter who the client is, the appraisal approach takes into account all three elements of valuation methodology — cost, market comparables and cashflows or income.
However, each assignment is for a particular property type and accordingly we will weight one particular approach, depending on the accuracy and reliability of each of the three approaches. For example, in a fully developed and income-generating property, the income approach is weighted more heavily in the overall assessment.
Similarly, if the property is not fully developed, we would perhaps weight income less substantially and look more at comparable properties in the same area or the same market.
In the income approach, because the accuracy of predicting cashflows is crucial to the valuation, some appraisal companies work jointly with real estate services companies to research rents and capitalisation rates.
JREI, for example, has been at the forefront of developing some useful statistics and research, such as a compilation of office rent forecasts we have put together with one of the top real estate agents in Japan, Miki Shoji Co.
Is there a sufficiently comprehensive database for land and building prices throughout the country, and what developments do you expect?
No, there is no comprehensive database available to the public in Japan. According to the 2006 Real Estate Transparency Index survey by Jones Lang LaSalle, Japan ranked 23rd in the world, which shows the limited degree of transparency.
Although Japan's ranking had improved from 26 in 2004, helped largely by the flow of public information on acquisitions from the listed J-Reits, there is still a long way to go before Japan reaches the standards set, for example, by the Multiple Listing Service in the USA.
In Japan to date, the use of the database of sale and lease transactions for land and buildings — which comprises the replies from parties involved in property transactions — has been exclusively limited to appraisers.
Although the Ministry of Land, Infrastructure, and Transport has since July 2005 sought to maintain a database of transactions on its website, it has found considerable difficulty in analysing and presenting the data because market participants do not often want to disclose the information the ministry needs.
This year it was alleged that an architect named Aneha had falsified information on earthquake resistance engineering in some buildings he was involved in.
How big an impact did the Aneha revelations have on the appraisal market? What have the appraisers done to ensure that such falsified documentation cannot appear again?
In terms of professional expertise, appraisers are not responsible for verifying quake resistance reports for buildings. The same is the case for assessment of, for example, land contamination.
However, as part of the total appraisal process, we have begun to pay more attention to the existence of a quake resistance report for the subject property.
The Ministry of Land, Infrastructure and Transport has taken several measures to help ensure falsified quake and other documentation never appear again.
The Japanese Association of Real Estate Appraisal (JAREA) is now working on authenticating a measurement guideline that member appraisal firms should follow and this new guideline will be enforced by this coming winter.
Do foreign investors expect different standards of appraisal, compared with local investors?
No. Because the Japanese Valuation Standards (JVS) almost exactly comply with the International Valuation Standards (IVS), there is no specific reason for foreign investors to expect different standards.
However, it is very important to let them understand the characteristics and customs of the Japanese market, which do not always fit their understanding of property market norms in the US, Europe or other major markets. That way, they can better understand the market fundamentals, including forecast rents and cap rates.
In our next Japanese Real Estate Investor Survey, JREI will present some research across a variety of countries to compare crucial market fundamentals, so as to compare and contrast the Japanese market with other cross-border real estate markets.