Real estate law in Japan: what a difference a decade makes

Author: Hisashi Hara, Nagashima Ohno & Tsunematsu, Tokyo

As recently as 10 years ago, you might have been hard pressed to find a lawyer practising in Japan who identified himself or herself as a real estate law practitioner. Real estate acquisition and financing transactions were usually so simple and straightforward that no lawyers were involved in the transactions. Then, in the early 1990s, we suffered the collapse of our real estate and stock market bubble. Buried under a mountain of bad debt, the Japanese banking industry was in no shape to finance any real estate transactions and there were no other sources of domestic or offshore funding for real estate transactions. Prices plummeted and the market dried up.

In the mid-1990s, we saw the growth of a new source of funding for real estate acquisitions: non-Japanese (mostly US) investors. Of course, these non-Japanese investors were looking to take advantage of the depressed real estate market in Japan, but their arrival had a couple of notable side-effects that affected the practice of real estate law in Japan. First, the investors brought with them some very aggressive financing structures that had not been used before in Japan, but which had been honed in some of the most sophisticated financial markets in the world. Second, the investors were accustomed to using lawyers in their real estate transactions, at the due diligence/negotiation stage, and to preparing voluminous documentation on the transaction. As a result, lawyers were now needed in Japan to assist in these real estate transactions and these lawyers needed expertise not only in real estate law, but also in corporate (special purpose companies, limited liability companies, etc), finance (non-recourse loans, etc) and capital markets law (securitizations, IPOs, etc).

Real estate investment trusts

At around the same time, the Japanese government began to consider and enact new laws aimed at stimulating the real estate market, and on November 30 2000, one of the most important of those laws came into effect: the Law Concerning Investment Trusts and Investment Corporations of Japan (Law No. 198 of 1951 – Investment Trust Law). The Investment Trust Law provided for the creation of Japanese real estate investment trusts (JREITs). JREITs have changed the real estate market in Japan by allowing the general public to become involved in real estate acquisitions. Since the first JREIT IPO was held a little over five years ago, our law firm has been involved in approximately 60% of all JREIT transactions and there are now approximately 40 publicly traded JREITs, which hold real estate assets valued at approximately ¥3.5 trillion ($30 billion) as of June 30 2006. With the current yield on Japanese government bonds at approximately 1.3% and bank interest rates on savings accounts hovering around 0.5%, it is not surprising that there is great investor interest in JREITs, which have historically had yields between 3% and 5%.

JREITs have attracted interest from both individual and institutional investors, because they combine the earnings potential of real estate with the liquidity of securities. However, the Investment Trust Law provides that JREITs are only allowed to hold the real estate assets, and are required to delegate the asset management responsibilities to a licensed asset management company. These asset management companies owe a fiduciary duty of loyalty to the JREITs and must exercise good faith in the performance of that duty. The fiduciary duties owed by the asset management companies to the JREITs have resulted in additional opportunities for real estate lawyers to expand the scope of their involvement in real estate transactions. Before an asset management company can recommend an asset to a JREIT, it is duty-bound to conduct due diligence and to negotiate the best deal for the investors of the JREITs. Lawyers, accountants and other professionals have been tapped to assist the asset management companies to fill this need.

There is a potential conflict of interest between the JREITs and the asset management companies, and this arises from the fact that asset management companies rely on their management fees as their sole source of income and do not participate in the profits generated from the sale of the JREITs' assets. Therefore, asset management companies are always looking to increase the size of the portfolios of their JREITs and their strong buying power has resulted in a rise in real estate prices in sectors targeted by the JREITs. In addition, JREITs have provided a good exit strategy for real estate developers and landowners, which have helped to make them more willing to consider new development projects. Recently, there has been some discussion in the Japanese government about relaxing the Japan-asset-only limitation on JREITs to allow them to acquire real estate outside Japan. If this comes about, it could make JREITs a force in other markets around the globe.

Over the years, optimism has started to return to Japan's real estate market as a result of the recovery of Japan's economy and the continuing investment demand from JREITs and other domestic and offshore fund investment sources.

Real estate loans

Our law firm has played a small role in the return of the real estate market in Japan. Approximately 10 years ago, we helped one of our clients design the first non-recourse real estate loan in Japan. Real estate loans now account for approximately 20% of all loans made by the major banks in Japan, and non-recourse loans, which have proved very popular, currently account for approximately half of those loans. However, the Financial Services Agency of Japan (FSA) has started to express some concern that Japanese banks are becoming too aggressive in making real estate loans and may be downplaying the risks of such loans. With Japan's last real estate bubble still fresh in its mind, we have recently seen evidence to suggest that the FSA is beginning to restrict lending on real estate. If the FSA does restrict lending by Japanese banks, this will probably provide an opening for non-Japanese banks to come in and fill the expanded demand for lending on real estate in Japan.

All of these changes in the real estate market and the role of the real estate lawyer in Japan have occurred in the last 10 years. From an era of simple contracts, which were created without the assistance of lawyers, the level of sophistication of the transactions, and the scope of practice of Japan's legal practitioners, has grown to a point where, we believe, it is now equal to that of any other market in the world.