Positive on property in the Empire of the Sun
Last week’s notes about Japan ended with the comment that “when no one expects inflation, most corporate executives think this is ‘as good as it gets’, and stock prices seem cheap, risk of disappointment seems low.”
We reflect this view with stakes in three Japanese real estate related companies that we own:
- Haseko, Japan’s largest condominium builder, trading on a forward PER of 6.4x, which we feel reflects too negative a view on long term growth and margins. Upside could come from a rising dividend rate, which is currently only about 20% of profits.
- Open House, a central Tokyo focused property developer, with a highly entrepreneurial culture and a commitment to good capital management, trading on a forward PER of 8.6x.
- Investors’ Cloud, a fast growing ‘virtual’ property developer, that uses online marketing to match investors with vacant land to build small apartment blocks for the rental market. It extracts high development margins without tying up much capital, and a growing pool of ongoing management fees. While the stock isn’t superficially cheap on a forward PER of 24.5x, we believe it will get further re-rated as its unique business model is understood.
With all three long positions we expect to profit from volume growth, even if margins have peaked. With Open House and Investors’ Cloud in particular, we are also tapping into another theme that has made us money in other low growth sectors in Japan in the past: gains for corporate players as family businesses close down without successors.
Partly hedging the above we have a short position in Iida Group, an ultra-low cost housing developer in outer Tokyo. The stock looks cheap on a forward PER of 6.9x. Governance also appears weak, with no overhead savings following a six-way merger of companies controlled by different family members three years ago. The various subsidiaries, mostly run by sons of the founder, are investing in high risk overseas ventures, which we believe will end in costly write-downs.
The second way we may make profit is if wage and employment growth drive up housing prices.
The persistence of low reported inflation in Japan partly reflects measurement issues. As a result inflation seems stuck well below 1%, which at least means there is little pressure to tighten monetary policy, leaving us confident the critical ten year bond rate will stay close to 0%.
To us what actually matters are hard data on employment and housing.
On Friday, May data for unemployment showed a small bounce to 3.1%, but still close to multi-decade lows. Unlike the US and Australia, the steady decline in unemployment in recent years, is not caused by working age people giving up on ever getting a job but instead is driven by women entering the work force and people over the age of 65 staying in it.
Figure 1 - Japan Unemployment Rate
Figure 2 – Japan Growth in Participation Rate
More working has kept a lid on wage rises, but this may be about to change. Until recently average wage growth was constrained by a switch from well-paid full time permanent jobs, to worse paid, part time or temporary jobs. As this chart below shows, this is no longer true, and full time employment is now growing faster than part time employment.
Figure 3 – Japan Full Time and Part Time Employment Growth
Source: Ministry of Health, Labour and Welfare
This isn’t surprising as Japanese employers are desperate for workers, with the job to applicant ratio higher than it was even in the 1980s bubble.
Figure 4 – Japan Job to Applicant
This should be good news for the property market. A rising participation rate reflects and enables a continuing rise in the number of households in Japan, despite the population having peaked. Haseko expects the number of households in big cities, especially Tokyo, to keep rising for another eight years. Nationwide housing starts continue to creep up, but are nowhere near previous peaks.
Figure 5 – Japan Housing Starts (millions)
The fact that more households are in a relatively finite space is bringing a steady rise in the price of new apartments, but more importantly it is also causing a rise in the price of old units as well. As this chart shows the rise is particularly strong in Tokyo, and less so in the areas around it such as Chiba, (which is another reason we prefer Open House to Iida):
Figure 6 – Condominium Price Indices
Source: Japan Real Estate Institute
Could we be on the cusp of something Japanese stock market and residential property market investors have completely given up on in a low inflation world: Capital gains on the family home? If so, the low level of home prices, and the near certainty that interest rates will stay low even if wages start to creep up, means this could go on for many years.
Even in Tokyo, where condominium prices have been rising steadily for a decade, affordability stays very high. The interest cost to buy an apartment on a 95% loan to valuation basis (about 1%) is lower than the rent (about 3%-4% of the value of the apartment). So even allowing for the cash cost of paying off the principal over 30 years, from a cash-flow perspective, Tokyoites pay little more to buy than rent - and at the end of 30 years they own their own home.
Banks, flush with unused deposits are also keen to lend and loan growth is picking up:
Figure 7 – Japan Bank Loan Growth
Source: Bank of Japan
This complex story cannot be seen entirely through Australian eyes, not least because Japanese owners have typically not wanted to own ‘second hand’ housing, and as a result a lot of the Japanese property market is based on redevelopment rather than green field building.
Nevertheless we believe we are not paying much for stocks which are highly leveraged to any positive surprise in terms of price or volume.