After peaking in 2007, the Tokyo office market bottomed out in 2011 due to the Global Financial Crisis (GFC) and the Tōhoku earthquake and tsunami disaster. Since then, despite support from the “Abenomics” policies, the office rental market has struggled to fully recover compared with other major markets. Although the market average rent in Tokyo still hovers around 70% of the 2007 peak, cities such as Hong Kong and London have already exceeded their pre-GFC highs. Even New York, the epicentre of the GFC, has already recovered around 90% of its rental market peak.
There are several potential reasons for this lack of strong rent growth in the Tokyo office market. It is key to remember that Tokyo is hosting the 2020 Olympics, and this has resulted in a concentration of redevelopment projects based in central Tokyo. This development boom is boosting Grade A office supply in the city, leading to an increase in total office stock that is more than triple what it was in 2000 and 1.8 times larger than the 2007 market peak. Therefore, simply comparing 2007 and the present based on the average market rent might not accurately reflect the actual market condition.
In 2007, the monthly market average rent for Tokyo Grade A office space was priced at JPY 51,955 per tsubo, including the common area maintenance, or CAM, charge. However, as of end-June 2019, the latest numbers indicate that the monthly rent average was still only JPY 39,262 per tsubo. If we consider the total office stock, at end-2007, the entire leasable floor space of the Tokyo CBD amounted to 5,314,908 sqm with a 1.7% vacancy rate. This equals 5,224,555 sqm of operating office floor space with the market average rent, theoretically, generating JPY 271.65 billion rent revenue on the entire Grade A office stock. Similarly, as of end-June 2019, the total stock with a 0.8% vacancy rate generated, in theory, up to JPY 343.77 billion. Importantly, due to typical market practices, tenant leasing contracts usually span several years, which can cause delays in average rent increases as the market improves. Therefore, although we expect the theoretical and real-world figures to eventually converge, the real-world cash flow generated by the real estate market tends to be lower than the above assumption concerning rent revenue.
This means that the total rent revenue generated by the Tokyo Grade A office rental market has increased from the previous market peak in 2007. However, the “average market rent level” is still far below 2007 levels. This discrepancy suggests that market size is affecting the average rent. Consider the following hypothetical scenario: if we imagine that the total office market size had not changed since 2007 and the entire hypothetical rent revenue at end-June 2019 was absorbed, then the market average rent would become JPY 64,680. On the other hand, although the market average rent bottomed out in 2011, the total rent revenue was lowest in 2010 if we consider the total payment amount multiplied by the occupancy rate. Using another hypothetical scenario, we can imagine that, if the available total rent revenue dropped to 2010 levels with total office stock figures from end-June 2019, the average rent level would be JPY 19,497.
Source: JLL
In actuality, the market does not function as calculated above; as rent rises, tenants typically compromise by downsizing their leased office space, or the office operating area improves as the market rent goes down. However, as a guideline, we speculate that the Tokyo market average rent might be slowing down due to the expansion of the entire market size. The “theoretical” total tenant rent payment has increased almost 30% compared with the 2007 market peak; this total amount is divided by the higher amount of larger office stock, which offsets the market average rent increase. Therefore, going forward, as the market size grows, the average rent increase is expected to slow in the Tokyo Grade A office market.
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