I am sure you all know Japan’s largest city, Tokyo. But how about the second largest? That’s Osaka in the west of the country. Its GDP is greater than either Hong Kong or Singapore and it’s finally showing signs of recovery.
While Tokyo entered the recovery stage in 2Q12, after experiencing the Global Financial Crisis (GFC) and then the Great East Japan Earthquake in 2011, Osaka only bottomed out in 3Q14.
Tokyo and Osaka Rents
Source: JLL Research
The main reason for the delayed recovery in the Osaka market was the residual downturn in demand lingering post GFC. Grade A office vacancy improved from 2010 to 2012, due partly to temporary demand coming from tenants escaping the Tokyo earthquake damage. However, supply side pressures led to a significant increase in the vacancy rate to almost 12%. This was mainly due to a single project, Grand Front Osaka. This building of approximately 150,000 sqm is located just in front of Osaka Station, west Japan’s largest terminal station and its prime office area. Grand Front Osaka completed with less than 50% occupancy and as a result, the landlord cut rents to attract tenants. This weighed heavily on the market and prevented landlords of other buildings from raising rents. However, two years have passed since completion, and the building is gradually attracting tenants, taking the occupancy rate to nearly 80%. Currently the Osaka Grade A vacancy rate is sitting at 5.5%, a level that supports rental growth, which has indeed been seen since 2Q14.
Osaka Demand & Supply Balance
Source: JLL Research
As the leasing market has recovered, the investment market in Osaka is also becoming quite active. In Tokyo, the average cap rate for Grade A office assets has narrowed to 3.1%, below the previous peak of 3.2% in 2007. Although the risk premium against the risk-free rate remains wider than the previous peak, some market participants are already calling “bubble” territory. Whether this view is true or not, the Tokyo market is definitely “hot”. Osaka currently offers higher yields sitting at 4% and we still see room for some further light compression in the range of 10-20 bps on the back of the weight of capital currently targeting Osaka. Demand is coming from both domestic and foreign buyers. Foreigners are interested in both Grade A and Grade B assets, whilst domestic investors are looking at all grades. One thing is for sure, with Japan still offering very attractive spreads versus other markets in the region, investor interest is set to continue.
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