Japan: Giving negative interest rates a positive spin

The Bank of Japan’s surprise move into negative interest rates gave property stocks a shot in the arm, but has it turned out to be a short-lived rush? Paul Yandall reports.

When the Bank of Japan (BOJ) announced on January 29 that it would charge banks 0.1 percent on any excess reserves they kept with the central bank, the news hit the listed property market like a surge of adrenalin.

Bond yields fell to unprecedented levels and Japanese share prices, which had been lurching downwards since the start of the year, started rising again with the Nikkei 225 Index climbing almost five percent in two days. The yen, which had been rising steadily against the dollar for more than a month, was suddenly driven down.

It was everything the Bank of Japan’s governor, Haruhiko Kuroda, could have asked for: a short, sharp, surprise shock to rouse a patient – the somnolent Japanese economy – from its slumber.

After the initial jolt, the theory was that Japan’s banks would reduce their reserves held at the central bank and start lending more aggressively, helping to drive consumption and demand in the moribund economy. For property investors, lending would become even cheaper, interest rates would fall and spreads would tighten due to surplus capital.

Bold move

As far as economic stimuli plans go, it was a bold one from a traditionally ultra-conservative institution.

“Initially, the plan was to really surprise the markets and that’s exactly what the BOJ did,” says Nick Wilson, an associate director at agent JLL Japan’s capital markets team. “They’ve tried to show that they’re willing to take steps to use new tools in order to achieve their goals.”

The BOJ’s ¥80 trillion – $709 billion at the current exchange rate – per year Quantitative Easing (QE) plan to kick-start the economy, which began in 2013, remains unchanged.

Perversely, QE is partly to blame for the build-up of reserves at the BOJ, says Wilson. Banks have preferred to store the money generated from QE rather than lend it.

“The bank reserves they are now targeting are really a result of QE itself. Sales proceeds from the BOJ’s asset purchase program have largely ended up in bank deposits and in turn, reserve accounts with the central bank. The idea is to now get some of the latent capital sitting in reserve out into the economy,” adds Wilson.

“This will incentivise some of the capital sitting [at the BOJ] into the market, partly up the risk curve. Positive yields in the real estate market are very attractive, and have been made even more so by the interest rate decision.”

Property stocks were some of the biggest beneficiaries of the negative interest rate announcement with shares of listed developers and Japanese Real Estate Investment Trusts (J-REITs) driven up around 14 percent on average in the following days to reach a new nine-month high. Two of the country’s biggest builders, Mitsui Fudosan and Mitsubishi Estate, jumped 12 percent and 9.7 percent respectively and the Tokyo Stock Exchange (TSE) REIT Index rose almost 7 percent within a couple of days of the announcement.

Starting to unravel

But by mid-February the plan was starting to unravel. The Nikkei had dropped almost 6 percent and the yen was again on the march against the dollar, prompting claims from some commentators that the BOJ’s plan had failed.

For the banks, reluctant to pass the negative interest rate on to their customers, profits could fall by up to 15 percent because of the BOJ’s move, says rating agency Standard & Poor’s. After the initial surge, Japanese bank stocks plunged by as much as 30 percent, contributing to a global market sell-off.

Koichiro Obu: Investors shifting to real estate
Koichiro Obu: Investors shifting to real estate

However, property stocks have remained generally steady. By mid-February, the TSE REIT Index was still tracking up, almost 6 percent, on its pre-announcement level of 1,686.53.

“There have been ups and downs every day since the announcement but in the last three weeks the listed REIT market has been performing better than the general stock market,” says Koichiro Obu, alternatives and real assets director at Deutsche Asset Management Japan.

“That’s a clear reflection that people are trying to shift their capital allocation towards real estate compared to the general stock market. So, for me, the impact of the negative interest rate on the actual underlying real estate asset is positive and it can potentially lift capital values by 5 or 10 percent.”

Noticeable impact

That will have a noticeable impact on one of the world’s most competitive real estate markets.

The Tokyo office sector is already the most preferred investment market in Asia Pacific, according to the Asian Association for Investors in Non-listed Real Estate Vehicles (ANREV) Investment Intentions survey for 2016.

Competition for assets last year saw office values leap 20.6 percent year-on-year in the first half of 2015 and cap rates compressing to as low as 3.3 percent, according to JLL. With interest rates so low, the cost of real estate financing fell to below 1 percent all-in, compared with 1.4 percent in 2014, with loan-to-value ratios reaching up to 90 percent.

That cheap domestic financing has seen off most foreign lenders but Tokyo is still drawing investors despite real estate investment in 2015 dropping by 27 percent to ¥3.5 trillion ($31 billion).

An influx of new foreign institutional investors and sovereign funds from Europe, the Middle East and within Asia itself arrived in the Japanese market in 2015, picking up the slack from local REITs which had eased back on buying, according to PwC’s Emerging Trends in Real Estate Asia Pacific 2016 report.

Thanks to the BOJ’s negative interest rate, the REITs could be back in the game.

“We are seeing evidence already among the listed REITs, as well as the many unlisted REITs that we have in Japan, that both of these vehicles are getting very strong capital inflows due mainly to the negative interest rate,” says Deutsche’s Obu.

“That will give them a lot of incentive to deploy capital and make investments, so their acquisition price in the bidding process will be very strong.”

Japanese pension funds and banks with significant interests in government bonds are barely seeing any return on their money. They will be channelling capital into higher yielding assets, such as real estate, to meet their commitments.

The low-interest rate environment will also keep a lid on financing costs, although banks will be reluctant to move much lower in the current environment.

Risk of slowdown

Japan’s three ‘mega-banks’ – Mitsubishi UFJ, Sumitomo Mitsui and Mizuho – and their associated trust banks, provide most of the country’s real estate loans.

“With the increasing risk of slowdown in the global economy, the banks are likely to maintain a relatively cautious stance in terms of further lowering the lending rate or assuming lower cap rates for property valuations,” says Hiroshi Okubo, head of research for CBRE in Japan.

The result of the BOJ’s negative interest rate move shouldn’t be overstated, adds Okubo.

“There are uncertainties looming in the overall macro economy stemming from the drop in oil price and the strengthening of the yen, which ultimately would have a larger impact on the commercial real estate market.”

A brief history of negative interest rates

Despite the Bank of Japan’s negative interest rate move catching the market cold, it is a tool used more often than most people probably realise.

Central banks in Europe have been using the tactic recently to help boost growth and battle deflation. By charging commercial banks’ excess funds held on deposit at the central bank, it incentivises more lending and investment, helping to stimulate demand.

Sweden’s central bank introduced a -0.25 percent deposit rate in 2009 and held it in place for almost a year in the wake of the global financial crisis. It reintroduced it in 2014 and has a deposit rate of -1.25

percent as of mid-February, although most negative interest rates charged range between 0 and -1 percent.

Switzerland, Denmark and the Eurozone have all implemented negative interest rates recently. The 19 countries in the Eurozone have had negative rates since June 2014 which were lowered to -0.3 percent in December 2015.

Do they work? On the evidence so far, they probably haven’t achieved their aims although, as the Bank of Japan’s governor Haruhiko Kuroda says, he can probably go deeper into negative territory in order to get the desired result.