Rental increases spread to regional cities

With corporate earnings expected to improve further, demand for expansions and upgrades should continue in 2016. The business conditions diffusion index (DI) in the BoJ’s Tankan survey shows a positive correlation with office occupancy, and tends to be a leading indicator for office occupancy rates. Recent trend in the DI suggests that office occupancy rates are likely to rise further.

In 2016 and 2017 an average of around 190,000 tsubo per year of new supply is scheduled to be completed in Tokyo. This is roughly in line with the average annual volume of supply over the last fifteen years. Now that it is difficult to find large spaces to rent in existing buildings, tenants have more or less been secured for nearly 50% of new supply scheduled for 2016. Rents are therefore expected to continue their upward trend.

In regional cities, the lack of supply is becoming so severe that there are concerns that many of the demand may be put on hold. In Sapporo, Hiroshima and Fukuoka, vacancy rates are at record lows. Rents are expected to rise, or to start rising faster, in every city, because of the tighter supply/demand balance.

However, the market cycle appears to be gradually approaching its peak. In the Tokyo office market, based on the current schedule for new supply and the outlook for economic growth, we forecast rents to peak around the end of 2018 before starting to decline gradually. Reasons for this forecast include (1) the negative impact on consumption from the increase in consumption tax scheduled for April 2017, (2) the fact that expectations of a rise in interest rates and the value of the yen against the dollar are likely to increase as the end of Haruhiko Kuroda's term as Governor of the Bank of Japan, due in 2018, approaches, and (3) a consequent slowdown in the growth of corporate earnings, or even negative growth.

(CBRE Research)