DTZ Insight Japan Earthquake Devastation delays Tokyo office recovery

21 March 2011 Authors

Kayoko Hirao Head of Japan Research +81 (0)3 5512 8213 kaoko.hirao@dtz.com Fergus Hicks Forecasting & Strategy Research +44 (0)20 3296 2307 fergus.hicks@dtz.com

The 9.0 magnitude earthquake which struck Japan on March 11 and devastating tsunami which followed will have an impact on the Japanese commercial property markets. However, based on our preliminary analyses, there will be only a limited and short term impact on the Tokyo office market. At this moment, it remains difficult to assess the full impact of this natural disaster. Initial estimates suggest that GDP growth will now be 1.0% this year, compared to a pre-quake forecast of 1.3%. Some analysts, however, suggest that GDP will be hit harder and that growth will drop to 0%. Although the earthquake will drag down the nations growth in the near term, restoration and redevelopment in the north east of Japan is expected to boost economic growth in 2012. The temporary economic stagnation is expected to delay the office market recovery. Even prior to the earthquake, DTZ forecasted prime Tokyo office rents to fall 6.5% in 2011, and to show only a modest recovery in 2012. We now project that rents will drop 9.1% in 2011, stabilise in 2012, and rise in 2013. This is a modest downward revision, especially when compared to the downside scenario from our 2011 Global Outlook (Figure 1). Previously we were expecting prime Tokyo office yields to fall from 4.2% at the end of 2010 to 4.1% at the end of 2011 and 4.0% in 2012. However, if investors revise down their expectations for rental growth, and/or suspend investment plans, we expect yields to remain flat. Furthermore, investors might reassess the risk premium they apply to Japanese commercial property, as well as other markets in which there is a nonnegligible chance of a natural calamity.

Contacts
Yoshiki Kaneko Chief Executive Officer, Japan +81 (0)3 5512 8201 yoshiki.kaneko@dtz.com David Green-Morgan Head of Asia Pacific Research +61 2 8243 9913 david.green-morgan@dtz.com Tony McGough Global Head of Forecasting & Strategy Research +44 (0)20 3296 2314 tony.mcgough@dtz.com Hans Vrensen Global Head of Research +44 (0)20 3296 2159 hans.vrensen@dtz.com

Figure 1

Toyko Prime Office Rents, JPY/tsubo/per month

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Current (post earthquake) Prior to earthquake Feb-2011 downside scenario

Source: DTZ Research

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Japan Earthquake

Devastation to hit economic growth

The 9.0 magnitude earthquake which struck the north eastern part of Japan on March 11 and the subsequent devastating tsunami will have an impact on the Japanese economy. The reaction of financial markets reflects the scale of the calamity and uncertainty over its impact. The Bank of Japan immediately took action to ease monetary policy by providing liquidity to the market. The government is now reviewing the rescue package which will be reflected in the annual fiscal budget plan. By Tuesday 15 March the Nikkei was down nearly 20% from its preearthquake level, echoed by falls in stock markets around the world, however it bounced back 6% the following day. The impact of the devastation on the economy is complex and will take place via many channels. The regions directly affected are the Iwate, Miyagi and Fukushima prefectures, which together account for around 4% of Japanese GDP. The immediate direct impact on the economy will be production lost in these areas from facilities which have been destroyed. Japan will have to import more food to compensate for the loss of production, which will put upward pressure on global food prices. The second impact comes from the rationing of power due to the shutdown of nuclear facilities. This will cause more widespread suspensions in production, with major car and electronics manufacturers having announced that they are temporarily halting production. The fall-back in consumer confidence is likely to have a negative impact on growth as is the appreciation in the yen. Further afield, lost production and the interruption to transport and shipping facilities will impact on global supply chains, particularly for the electronics industry. Although it is extremely hard to assess the impact of this terrible event on GDP, historical experience suggests that calamities have a significant initial impact, but that it is shortlived. Initial estimates from Oxford Economics suggest that Japanese GDP growth in 2011 might be 1%, rather than the 1.3% forecast prior to the quake. This is similar to the 0.2% that the Daiwa Institute of Research thinks that the quake will knock off growth this year. However, the rebuilding effort of infrastructure and houses in the north eastern part of Japan is expected to boost growth later in the year and into 2012.

Company profits will be squeezed due to costs associated with the earthquake. In the financial sector, insurance companies will be hit by the payouts related to the devastation. Our forecast prior to the event was that Tokyo office rents would drop 6.5% in 2011 and show a modest rise of 2.0% in 2012. In our 2011 Global Outlook we estimated that under a downside global economic scenario, which saw Japanese GDP drop 0.3% in 2011 and rise just 1.1% in 2012, Tokyo office rents would fall 10.7% this year and a further 5.7% in 2012. As such, this scenario reflects some of the more pessimistic assessments of what impact the earthquake might have on the economy. However, if growth slows to 1% this year, our best estimate is that Tokyo office rents will drop 9.1% in 2011, stabilise next year and rise in 2013 as the market recovers (Figure 2). The earthquake is also likely to have an impact on the investor side of the market. Prior to the event we were expecting prime office yields in Tokyo to fall from 4.2% at the end of 2010 to 4.1% at the end of 2011 and 4.0% in 2012 as the market recovered. However, if investors revise down their expectations for rental growth yields may hold steady or even rise. Furthermore, the calamity might prompt investors to hold back on present investment plans, putting off yield compression in the short term. In the longer term investors might also reconsider the risk premium that they apply to commercial property in Japan, and other markets exposed to natural calamities with non-negligible probabilities. Although no significant damage to office buildings was reported in Tokyo, a quake of such magnitude has raised awareness amongst tenants of the importance of seismic structure. The weakening economy led them to consolidation prior to this incident; however some corporates are now starting to think about office dispersions to reduce risk, which may drive other types of demands.
Figure 2

Toyko Prime Office Rents, JPY/tsubo/per month

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Tokyo office rent falls could be extended

The earthquake will also have an impact on the Japanese commercial property market. J-REITs have already announced their damages, however they appear quite limited. Moodys has announced that just 0.8% of its rated REITs portfolios are located in the affected areas, such as the city of Sendai, with no significant damage reported. The Tokyo office market is likely to be hit by the knock-on impact of the earthquake in the short to medium term.
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Current (post earthquake) Prior to earthquake Feb-2011 downside scenario

Source: DTZ Research

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Disclaimer
This report should not be relied upon as a basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts have been rigorously checked, DTZ can take no responsibility for any damage or loss suffered as a result of any inadvertent inaccuracy within this report. Information contained herein should not, in whole or part, be published, reproduced or referred to without prior approval. Any such reproduction should be credited to DTZ. DTZ 2011

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