Report No.16
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Japan Entrepreneur Report No. 16 February 2004
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- Sweet home Japan
- Stale myths fall as new shopping center rises
- New carpet and paint
- Remodeling the housing sector
- Bit and byte
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Sweet home Japan
Heavy blue cigarette smoke wafted toward the ceiling at a Tokyo real
estate brokerage early one Monday morning, giving the weekly sales
meeting a pool hall atmosphere a foreigner might find at odds with the
earnest salesmen in their suits and neatly pressed white shirts. One
agent asked the group if they knew any prospects looking for a three
bedroom, 100 square meter condominium in the Daikanyama area priced at
around 75 million yen. He had just acquired a new customer, Mr. Ishikawa,
who wanted to sell such a property.
Another agent immediately mentioned a potential buyer he knew, a Ms. Ando,
whose budget was around 75 million. The two agents quickly agreed on the
specifics of a strategy typical for their brokerage. They would price Mr.
Ishikawa's property at 78 million yen, show it to the buyer on the
assumption that it would be discounted to 75 million, and, as is common
in Japan, act as agent to both seller and buyer in the transaction.
Less than a five-minute subway ride away, 35-year-old Ando Miki sat at
her computer perusing online sale listings. Years ago, long before she
ever thought about buying a home, she had spent a year studying in the
U.K. and developed a vague sense that consumers overseas had better
access to information about real estate transactions. Still, Ms. Ando
felt she'd gained a good sense of going prices for 100 square meter
condominiums in and around Daikanyama. After all, she was a whiz with the
PC, and the prices her agent mentioned jibed with both Internet listings
and the dozen or more real estate flyers that came stuffed in every
weekend edition of the Asahi newspaper.
Ms. Ando was pleasantly oblivious to the fact that some of the listings
she saw on Japan's largest real estate site were for nonexistent
properties, planted by brokers as a "bait and switch" strategy to pull in
buyers. Unaware of the duplicity, she felt a warm glow inside as she
reminded herself of her savings and the 35 million yen in cash she had
from an inheritance. Together they would make a 60 percent down payment
toward the long-awaited purchase of her first home.
Two weeks later Ms. Ando bought Mr. Ishikawa's Daikanyama condominium for
74.2 million yen, or approximately U.S. $706,000, a price determined
entirely by her budget and her agent's ability to match that budget with
the needs of another client.
The real estate firm Ms. Ando engaged acted as a "dual agent,"
simultaneously representing both buyer and seller. Dual agency is
unethical at best and illegal at worst in the United States (barring full
prior disclosure and a written dual agency agreement signed by both buyer
and seller). Ordinarily, an agent exclusively representing a seller tries
to obtain the highest price for a property, while an agent exclusively
representing a buyer tries to negotiate the lowest price. If the agent
knows both the buyer's maximum budget and the lowest offer a seller will
accept, how can he possibly act simultaneously in the best interests of
both? Yet dual agency is the norm for real estate transactions in Japan.
Ms. Ando paid nearly three-quarters of a million dollars for her
condominium, but that price was "made" by her broker, not determined in a
freely functioning, transparent market. In fact, one could argue that
there is no true residential real estate market in Japan at all, because
a market requires that both buyers and sellers have access to transaction
price information. Such information is simply unavailable to consumers.
Japan's government recently announced it will make some transaction data
available to the public online sometime after April 2005, but a close
look at the government's plan reveals that it is almost certain not to
provide price data for specific buildings, but rather for transactions
identified only as occurring within areas as large as several city blocks.
"If that's the case, it's not true information disclosure and it won't
benefit consumers," wrote certified real estate appraiser Hotta Katsumi
on his Web site. "This kind of half-baked disclosure will only provoke
confusion. In that sense it's worse than not disclosing the data in the
first place."
Mr. Hotta explains that, even within a small area, traffic, street
exposure, elevation, directional orientation, views, and a host of other
attributes differ so greatly between buildings that anything less than
specific identification of individual properties is almost meaningless.
Add to the data problem the absence of title insurance, the lack of
escrow services, an almost nonexistent secondary mortgage market, limited
consumer tax deductions for mortgage interest paid, a tax policy that
encourages land holding rather than land use, building regulations that
foster a scrap and build mentality, and nationwide zoning laws that force
nearly 100 million people to inhabit less than one twentieth of Japan's
land, and you have a sector that is screaming for reform--and bold
entrepreneurship.
"Real estate markets in Japan and the U.S. are polar opposites," Tokyo
real estate agent Nagashima Osamu wrote on his Web site after returning
from an eye-opening study tour to Hawaii. "If the U.S. system was in
force here in Japan, there would be no need for my agency's services." Mr.
Nagashima referred in particular to title insurance, a standard U.S.
practice that could easily replace much of the labor-intensive deed
verification work that real estate agents in Japan typically undertake.
Why am I complaining about this? Consumers in Japan deserve better than
to be forced to pay half a million dollars for a cramped, badly designed,
low quality home. I also see Japan's residential housing market not only
as a gargantuan entrepreneurial opportunity, but also as one potential
key to the nation's economic recovery. An intriguing book published late
last year, Tora! Tora! Lion!, estimates at over five trillion dollars the
cumulative domestic demand, including ripple effects, that could be
generated over the next 20 years simply by increasing by 0.6% the amount
of land in Japan currently approved for urban development.
Sawada Mitsufusa of the Building Center of Japan identifies a market less
restricted by official regulations: remodeling. Mr. Sawada estimates at
more than $500 billion annually the domestic economic gains that could be
realized by starting to rebuild or remodel the majority of the 25 million
homes in Japan that are either dilapidated, unoccupied, or don't meet
1981 earthquake standards. The story about Yasuragi at the end of this
issue of JER lends support to Mr. Sawada's projections.
So far foreign entrepreneurs have targeted Japan's commercial real estate
rather than the residential sector. Business building operations are more
transparent and the market more fluid compared to the residential sector,
and commercial districts are geographically more compact, so management
costs are dramatically lower. International players have been operating
for years on both the supply and demand sides of the market, and there is
a mechanism in place for aggregating and securitizing commercial
properties (real estate investment trusts, or REITs). This means more
profitable opportunities, with the result that problems are getting
solved faster on the commercial side.
In that spirit, as promised last month we bring you the next in Carl
Kay's continuing series about foreign entrepreneurs in Japan: the story
of Seth Sulkin, the first foreigner in Japan to conceive, finance, and
develop a large-scale retail shopping complex from scratch without a
Japanese partner. We hope you enjoy Seth's story. In the meantime, please
drop me a line at <clark@sunbridge.com> if you can share stories of any
foreigners involved in Japan's residential real estate market, especially
those areas covered in Tora! Tora! Lion!
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Stale myths fall as new shopping center rises
It's a grueling challenge for many foreigners to navigate congested,
narrow roads and sardine can parking lots to visit Japan's shopping
centers. And then there is Seth Sulkin, a foreigner hailing from Chicago,
who takes on bigger challenges. His Tokyo-based company, Pacifica Malls,
is the first foreigner-led development firm to conceive, plan, finance,
and actually start building a shopping center in Japan without a Japanese
partner. In an industry dominated by large, domestic firms, Sulkin is
bringing an American model of retail development and a much-needed dose
of creativity to the Japanese mall scene.
"This is not rocket science or magic, just common sense and a few new
ideas," Sulkin said. His project is Vivit Square, a 560,000 square foot
shopping center that will open just outside Tokyo in Funabashi on
December 1, 2004.
Finding even 350,000 square feet of open land on the outskirts of Tokyo
is no small feat. But Sulkin's background makes him ideally suited for
his current task. After starting as a Wall Street Journal reporter, he
worked for many years in the planning and construction of Third World
infrastructure projects, many financed by Japanese lenders. He followed
that with several years doing outsourced buying of American merchandise
for Japanese department stores that could not afford their own U.S.-based
buyers.
It helps that changes have shaken the status quo in Japan's real estate
sector and that land once hoarded by large companies has hit the market.
Vivit Square is being built on the former leisure grounds of Yamaichi
Securities. Once one of Japan's leading financial institutions, the
company went belly-up in 1997, a sudden bankruptcy that shocked Japan
into the realization that its "old guard" was no longer infallible.
"Land has traditionally been viewed differently in Asia than in the
West," says Sulkin, whose insights into Japanese culture serve him well
as he tries to drive changes in old habits and traditions. "There is a
kind of emotional attachment to ownership of land--any land--in Asia. In
the United States this is sometimes seen in farm country, but rarely
would selling land in, say, a suburban retail development, be seen as an
emotional matter. It's just a business."
Because Japanese banks lacked the expertise to judge businesses on the
basis of the operation itself, there was a fixation on using hard-asset
collateral as the main lending criteria. Land was the collateral of
choice--scarce enough to be valuable, easy to define, and seemingly
stable. Companies bought and held extraneous land simply to have
collateral for financing and to gain status in a culture where owning
land symbolized power and success.
But banks in Japan are now far less willing to loan to companies with
poorly performing businesses, even if they own land. Meanwhile land
prices, while still high by world standards, have plummeted over the past
ten years. So companies, denied access to further bank credit, are being
forced to sell unproductive land to raise capital. Others are selling
land under pressure from new accounting rules to clean up their balance
sheets and to please shareholders demanding improved returns on assets.
Flows of new ideas and business models are starting to thaw Japan's rigid
habits and to move the economy. In this new environment, people like
Sulkin have the specialized expertise and individual initiative needed to
create land uses that fit the times. Backed by foreign banks, such as the
newly public Shinsei, their impact will be large, as will their profits.
Meanwhile, the sorry state of the Japanese retail development industry
makes it ripe for profitable innovations.
"About 85% of Japanese shopping centers have zero or one anchor store,
which makes for a very dull shopping experience," Sulkin said. "In many
cases the mall is owned and run by a subsidiary of the same company that
owns the anchor store, so nobody is thinking about the other stores,
about the overall shopping experience of customers, or about maximizing
the profitability of the mall operation itself."
Malls not run by the anchor stores are instead often owned and operated
by huge diversified real estate companies or by trading companies that
also develop office buildings, residential homes and condominiums,
industrial parks, theme parks and everything else involving land, Sulkin
added.
Diversified Japanese companies typically rotate employees between
divisions every few years, they have few people who develop the deep,
specialized knowledge needed to do innovative and profitable retail
development. The result: mediocre replications of boring malls.
Like U.S. mall developers, Sulkin's model and inspiration, Pacifica Malls
focuses on its chosen sector, retail, leaving office towers, homes, and
other endeavors for someone else's plate. Companies such as Simon and
Rouse had founders of the same name who pursued a vision of a specific
type of retail environment and the benefits and profits it could bring.
They executed their ideas as merchant developers by employing their own
teams of retail development specialists and by working with outside
specialist firms.
True to this concept of specialization, Pacifica is the first developer
to engage Gensler, the top U.S. specialist in retail mall design, for
work on a stand-alone Japanese shopping center.
Specialization also offers Sulkin the key economic advantages he needs to
create a winning business model. Pacifica Malls makes the bold claim that
Vivit Square will simultaneously offer a superior shopping experience,
favorable rents to tenant stores, and superior returns on investment.
To pull this off, Sulkin has to get much more than his Japanese
competitors can out of his land and his people. Vivit Square will have
four stories of retail space rather than the one or two common at most
Japanese malls, and all parking will be in a huge multilevel indoor
garage or on the roof of the retail facilities, saving space often wasted
in Japan's suburban malls by uncovered parking lots. This allows Vivit to
house five anchor stores as well as specialty mini-anchors offering
expanded versions of their usual smaller stores. All of the stores will
have convenient, barrier-free access directly from one of the four levels
of parking; an innovation Sulkin says is a first in Japan.
The popular conception is that the Japanese are second-to-none when it
comes to using tight spaces in ingenious ways, but that tale needn't
intimidate would-be entrepreneurs, Sulkin says. Surprisingly, malls in
Japan often lack basic consumer amenities such as public benches to rest
on, drinking fountains and easily accessible restrooms. There are few
trashcans, and the indoor trees that grace U.S. malls are largely absent.
Poor consumer appeal and resulting low operating income of most Japanese
malls shows that the myth of the Japanese as masters of packing a lot
into a small space doesn't apply to their shopping centers, says Sulkin.
Japanese mall operators often lack the incentive and skills to maximize
the use of space in suburban malls.
Pacifica looks to achieve superior economy of space with much lower
personnel costs than its Japanese counterparts. In doing so it exposes
yet another of Japan's business fables.
"It looks like the big Japanese developers keep costs down by outsourcing
so many functions, but actually their total costs are much, much higher
than they need to be," Sulkin said. "The main reason they outsource is
that they lack knowledge of retail development, so they pay others a fee,
which includes a profit margin, to do things they should do themselves.
They tend to pick well-known companies as contractors because they seem
to be a more safe choice, but the big-name contractors are often the most
expensive and least innovative. And Japanese developers often outsource
the wrong things. In particular, they frequently outsource a big chunk of
tenant leasing and mall promotion, the very functions that make or break
the profitability of a retail development. Pacifica does these things
primarily in-house. Even if we wanted to outsource these functions, which
we don't, nobody matches our expertise in these areas. We get better
results and more control at much lower cost."
Vivit's aims are attracting a better mix of high-quality stores than a
typical Japanese mall would, Sulkin says. "We are able to offer a lot to
our store tenants. First of all is shopper traffic. Vivit is adjacent to
a mall called Lalaport, which is twice the size of Vivit and attracted 25
million people last year. I use the word 'attracted' because it is run
more like a theme park than a shopping center. People go there on average
once a month or less and are not buying much while there. Both of
Lalaport's two anchor stores have closed. What's left is literally
hundreds of small stores each offering a very limited selection for daily
needs."
Sulkin has recruited appealing tenants and convinced them to build large
format stores by offering lower rents, lower fees, and better loading
dock facilities than malls like Lalaport. "From my years selling goods to
Japanese stores, I know their needs, how their cash flow works, what they
can afford and what they can't," he said. "Despite a somewhat slow
economy, we have been able to get popular stores to sign up." Sulkin is
counting on Vivit's mix of retailers to drive actual sales, not just
visits.
Much of the focus in Japanese retailing until now has targeted young
women in urban centers. Sulkin sees huge opportunities in applying
American expertise toward developing shopping centers in Japan that
appeal to families and older people. In addition to the Vivit project,
Pacifica's current agenda includes buying and revitalizing ailing malls
to quickly achieve big turnarounds.
Vivit's neighbor Lalaport appears to have been based on the old Japanese
model of "just build it and they will come." This may have worked for
Kevin Costner and even for Japanese retail developers from the 1960s
through the 1980s, when people had plenty of money, still lacked many
basic household goods, and had few choices of where to buy them. But the
previously passive Japanese middle class is now walking and talking with
its wallet, seeking a shopping experience focused more on their comfort
and needs. Shoppers want amenities most Japanese malls lack; they want
nice places to sit down, they want to enjoy good food and drink--in short,
they seek a pleasant outing whether they buy goods or not. Malls slow to
realize this are faring poorly.
Vivit will have an attractive atrium and offer a "daily errands zone"
with a full service bank branch--rare in Japanese shopping centers--along
with other conveniences. Shimamura, Japan's leading musical instrument
retailer, will have a large store with practice rooms, which many amateur
musicians rent because Japanese houses are too thin-walled and close
together for people to practice without bothering their neighbors.
Tellingly, the bank that jumped first at the opportunity to put a branch
in Vivit Square was Tokyo Star, one of the new breed of banks in Japan
controlled by U.S. interests. Shinsei Bank, another such bank, took the
lead in the overall financing of the Vivit project, being more flexible
about applying an innovative form of real estate finance called a non-
recourse loan, which is common in the United States but traditionally
much less so in Japan for a newly developed property.
A non-recourse loan is a debt for which the borrower is not personally
liable. In the case of a shopping center, it means the lender can't look
beyond the property itself for recourse should the loan fail. That allows
a developer to be more aggressive because its assets are protected from
the risk of any single project failing. In the last few years Japanese
banks have finally caught up with their overseas counterparts in terms of
offering non-recourse loans on established properties, but are still
unresponsive when asked to make such loans on new developments like Vivit.
Unlike counterparts such as Shinsei and Tokyo Star, most Japanese banks
lack the skill and confidence to evaluate the business prospects of a new
project such as Vivit.
Foreign businesspeople often believe that even if they bring a superior
business concept to Japan, the life of a new venture is doomed to slow
death by excessive business regulations. Yet in retail development,
Sulkin has found that this is another myth.
"Vivit is going from idea to opening in under three years; in the United
States and Europe, new malls can take ten years and tens of millions of
dollars invested just in the permitting process," he said. "Most of the
laws governing retail development here in Japan are just guidelines. If
we meet or exceed them, things move along briskly. We are consulting
extensively with the authorities and neighbors and doing our best to meet
their concerns, but we can't and don't do everything they ask."
Sulkin sees as indispensable his own role as the leader of the project's
vision and goals. "If you want to get a good outcome, you can't plan by
committee something as complex as Vivit, with all its different
interested parties. Somebody has to champion the original vision, focus
on profitability and at the same time balance the legitimate needs of
shoppers, store tenants and neighbors." His ability to do this is one of
Pacifica's advantages over its large competitors, he says. "The way large
companies rotate staff, it's not clear they have people who know the
business deeply enough to develop the judgment needed to play such a
leadership role. Given how such companies diffuse responsibility away
from a single point, I am not sure they would let one person play the
role I do, even if they had someone who could."
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New carpet and paint
When I lived in Hawaii and held a real estate sales license, one formula
for earning a quick return on a real estate investment was to buy a
condominium unit with a disastrous interior--smoke-damaged ceiling,
tattered drapes and carpet, dingy, scuffed walls, and so forth--then
repaint, install new carpet, and add some cheap cosmetic interior touches
such as a ceiling fan and mirrored closet doors. It was amazing how two
or three thousand dollars of cosmetic work could dramatically boost a
resale price.
That simple but effective strategy is underutilized in Japan. Anyone who
spends a few months in one of the nation's residential districts will be
struck by the generally poor upkeep of most Japanese homes. The
prevailing scrap and build mentality means that, barring physical damage
or leaks, most owners simply do not maintain their residences. Exterior
repainting is surprisingly rare, and makeshift repairs using materials
such as corrugated plastic sheeting are common. How-to real estate books
matter-of-factly advise readers that, while the life of a small apartment
building for amortization purposes might be as long as 27 years, they
should plan on tearing down and rebuilding their units from scratch every
15 years.
That mindset is starting to change, albeit slowly. Problems with
defective housing grew so acute that the government finally set
performance and quality standards for new and used homes in 2000 and 2002,
respectively. While compliance is still spotty, developers now tout new
dwellings as "designed to last 100 years," and the industry in general
gives at least lip service to the notion that homes, unlike cars, should
not drop in value 10 percent each year.
But the broader problem remains: the market is too heavily skewed toward
new rather than used housing. Read on to see how one private sector
entrepreneur is effecting change by refuting the "scrap and build"
mentality.
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Remodeling the housing sector
Suda Tadao must feel like he's riding a bucking bronco. In five short
years, sales at Yasuragi, the company he founded 26 years ago, jumped
nearly tenfold to over U.S. $200 million.
Yasuragi started out as a builder of new single-family homes.
Occasionally the firm would buy distressed residences at auction, then
raze them and use the land as collateral to secure new construction loans.
But in 1996 a routine auction bid transformed the company. Mr. Suda
discovered the home Yasuragi had won to be of such high quality that he
couldn't bring himself to destroy it. He decided instead to completely
remodel and sell it.
The house sold surprisingly quickly, and suddenly, amid languishing sales
of new single-family dwellings, Mr. Suda realized he had stumbled upon a
hot new business model that contradicted the prevailing "scrap and build"
mentality: remodel quality used homes and sell them at prices 30 to 40
percent lower than comparable new housing.
Yasuragi's fledgling remodeling operation got a tailwind from pent-up
consumer demand for lower-priced housing, improving bad debt resolution
that pushed more properties into the auction market, and a new law that
cracked down on illicit activity that had been preventing some auction
winners from quickly taking control of their newly-won properties.
As of last month Yasuragi had remodeled and sold 1,400 homes.
Conventional wisdom says housing demand in Japan is dropping due to
stagnating population growth, consumer uncertainty over the future,
declining real incomes, trends toward marrying later in life or not at
all, an excess of supply over demand, and other factors. But Mr. Suda's
success with Yasuragi suggests demand for housing is not weak, merely
saturated at the overly high price levels required to make building new
homes profitable. Until Japan can push through reform that makes new home
building the win-win proposition it should be for both builders and
consumers, Mr. Suda seems happily destined to continue on his wild ride.
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Bit and byte
Nomura Rumiko, CEO of Hopes, Inc., will speak at the next Entrepreneur
Association of Tokyo meeting Tuesday March 2, 2004. See
<www.ea-tokyo.com> for details.
Tim Clark
Senior Fellow
SunBridge Corp.
Voice (U.S.) 503.235.4419
Fax (U.S.) 503.235.4429
clark@sunbridge.com
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