Real estate investors: Beware of sales talk

First-time property investors across Japan are starting to find themselves with poor performing investments that don’t meet what they were promised by salespersons. Despite cashflow-positive claims made at investor seminars, some buyers are finding out that their rental property is running in the red, which means they pay cash out of their own pocket each month just to keep up with loan repayments. Some are then convinced by salespersons to buy additional properties to help offset their current losses. The newly suggested properties may appear to be cashflow positive on paper, but in reality they also turn out to run at a loss, only worsening the investor’s situation.

A common tactic is for a salesperson to provide a scenario of the potential return assuming the longest mortgage possible (resulting in lower monthly payments), and not warning the buyer about the possibility of interest rate hikes, monthly building fees increasing in the future, or large-scale building repairs and maintenance that need to be carried out at the owners’ expense. The simulations may also incorrectly assume that rents will remain unchanged and not factor into account future vacancy or a decrease in rents.

Some sales pitches include promises to buy back the the property for the same amount after a fixed period of time, or promising a guaranteed rent, only for the promises to be broken after the sale. Salespersons might also fail to inform the buyer that by taking out investment loans now, they may find it more difficult to get a home loan for their personal residence in the future, especially when they have borrowed at their maximum capacity.

The Mortgage Rescue Association deals with approximately 600 consultations each year. Inquiries from people who were struggling after buying investment properties has increased by 60% over the past year. There has also been a noticeable increase in calls from female investors.

It wasn’t that long ago that women, despite being full-time employees, would be turned down for home loans from Japanese banks. This has changed in recent years, with banks often providing no-money-down property loans regardless of gender. Investment loans, which often involved a much stricter approval process, have also become relatively easier to obtain for women on high incomes.

Real estate sales companies will often tie-up with a regional bank to offer ‘easy finance’ on investment properties. Faced with low demand in regional areas and eager to increase their customer base, regional banks have been aggressively lending to investors buying properties in urban areas such as Tokyo and Kanagawa.

According to Tokyo Kantei, the annual supply of brand-new studio apartments across the greater Tokyo area exceeded 10,000 units in 2016. The average price was 27,650,000 Yen, while the average rent was 85,399 Yen/month, resulting in an average gross yield of 3.71%. Properties with floor-plans that are not user-friendly, and over a 7 minute walk from the nearest train station are said to have a difficult time finding buyers.

Be a smart investor

 

Investors should focus on net yield (after all operating costs have been deducted) instead of gross yield. Be careful not to fall for a salesperson’s promises of high returns, without considering the potential for these numbers to have been inflated, overestimated or simplified.

Be aware that investment loans come with higher interest rates than home loans. Interest rates can range from 2 ~ 4% on the low end. But, borrowing at 2% for a property providing a 4% net yield can still result in monthly mortgage repayments exceeding net income, especially with a full loan.

Consider that you may need to reduce the rent when the current tenant moves out in order to attract a new one. As a result, potential returns in the future may be lower than initial estimates.

Look out for sales talk. Common sales pitches in Japan include: “Even if the property is running at a loss, you can always file for a tax refund each year to offset the loss” and “Think of your monthly outgoings as a form of additional pension payments – once you have paid off the property, the future rental income will help support your retirement”.

If you are buying a multi-tenant building such as an office building or block of apartments, get copies of the rental leases and take look at the rent roll to see how long the current tenants have been renting, rent amounts and vacancies. Be very cautious if the seller’s side refuses to provide this information.

Factor in the potential for running costs to increase. Can you afford mortgage payments if interest rates were to increase, and have you considered future repair and renovation costs, vacancy periods with no rental income, and the gradual increase of building maintenance costs?

Don’t make the mistake of assuming rents will increase or even stay the same indefinitely. Unless there is a change in the market, rents tend to decrease as a building ages and deteriorates.

What happens if you find yourself with non-performing investment properties?

 

You can contact The Mortgage Rescue Association (Home page: ) in Shinjuku for assistance. Often, investors in this situation have to settle for a short sale. Since property loans in Japan are full-recourse, the borrower is still liable to repay any debt left over after the sale of the property. If the debt cannot be paid, they may need to file for bankruptcy.

If the investor was scammed or coerced into buying the property, they may be able to seek a reversal of the sale and/or compensation by taking the case to court.

The Tokyo-based Credit Lease Damage Defense Counsel set up a special branch dealing with apartment investors. The group has filed a class action lawsuit on behalf of 26 investors with the Tokyo District Court. In a previous court ruling, a sales company and salesperson were ordered to pay 13.55 million Yen to an investor who had been coerced into buying an apartment using illegal sales tactics.

Cases Studies:

[Case 1]

An investor had purchased a studio apartment in Shinagawa several years ago for around 20 million Yen only to find out that the monthly rent was not enough to cover the 100,000 Yen a month mortgage. The owner listed the property for sale as a short-sale, but finding a buyer took some time. Eventually the property was sold for 14 million Yen, leaving the investor with a debt of around 3 million Yen.

[Case 2]

A company employee purchased two studio apartments in Osaka to rent out. At first, the rental income from both units was enough to cover the loan repayments. However, the tenant in the first apartment moved out several months after purchase, and a little while later the tenant in the second apartment also issued notice to end their lease. With a loan balance of 21 million Yen, the investor managed to sell the two apartments at a short-sale for a total of 19 million Yen. The investor was then left paying 35,000 Yen/month over the next six years to pay off the outstanding debt.

[Case 3]

A company employee purchased a single apartment in Meguro to rent out. The investment was providing a reasonable cash flow, so they purchased a second apartment in the building a year later. With some good success under their belt, they purchased a third apartment – an off-the-plan studio in a brand new 100-unit building close to a station. As soon as the building was completed, 2 of the investor’s 3 apartments, including the brand-new one, were vacant. It took about six months and a rent reduction before new tenants could be found.

After an increase in the monthly building repair fund fees, the investment no longer matched the original simulations prior to purchase. The owner found themselves making a loss of 400,000 Yen per year from their 3 apartments and decided to sell them. All 3 were purchased using full loans, which meant a lot of the principal was still owing. Each apartment had a market value of around 18 million Yen, but an outstanding loan of around 21 million Yen. The total expected loss from the sale of the 3 apartments would be 9 million Yen. After a year on the market, the 3 apartments were finally sold. After depleting their savings, the investor was left with a debt of 3.5 million Yen.

Sources:
AERA, April 3, 2017.
The Mortgage Rescue Association

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