In its Monetary Policy Meeting (MPM) on December 19, 2022, the Bank of Japan raised the upper limit of its tolerance band for long-term interest rates from 0.25% to 0.5%, and again a further rise is anticipated. However, compared to Europe and the United States, where interest rates are rising rapidly, Japan’s interest rate levels are still low. So far, it is not expected to majorly impact the real estate market.

The yield on 10-year government bonds is a benchmark for long-term interest rates, but the Bank of Japan has capped the rate by purchasing the bonds. Although it is difficult to estimate an appropriate yield, if a simple average line is drawn for highly distorted 8-year and 15-year government bonds, the 10-year government bond yield suggests around 1% (Figure 1).

Figure 1: JGB Yield Curve

Source：JLL Research based on data from the Ministry of Finance, Japan

Also, other indicators, the OIS (Overnight Index Swap) interest rate on January 17, before the Bank of Japan’s policy meeting, was around 1% for 10-year. It can be “assumed” that the market’s expected value for long-term interest rates is 1%.

Looking at the changes in the actual 10-year government bond yield and Tokyo CBD Grade-A Office yield, which represent the real estate risk premium (Figure 2), long-term interest rates have remained at almost 0% since the Bank of Japan introduced negative interest rates in 2016. Against the backdrop of ultra-loose funding environment, real estate investors have been willing to take on more risks. The resulting decline in real estate risk premium has led to cap rate compression.

Figure 2: Yield spread between Tokyo CBD Grade-A Office yield & 10-years JGB yield

Source：JLL Research, Oxford Economics

Regarding the future outlook as announced by the Bank of Japan, it is believed that it will take time for prices to rise at a normal pace. As the economic slowdown takes shape, price increases are expected to settle down in the near-term. As such, monetary easing is expected to continue despite the recent adjustment by the Bank of Japan.

In any case, even if Japan’s long-term interest rate rises gradually to 1%, which is the expected value of the market, the risk premium and the yield differential with real estate will still be sufficiently secured. So this is not expected to have a major impact on the real estate market at the moment. In relative to some overseas markets where interest rates and real estate risk premiums are both rising, Japan remains an attractive real estate investment market.

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