Real Estate 2020

Last Updated April 14, 2020

Japan

Law and Practice

Authors



Mori Hamada & Matsumoto has 12 partners (nine Tokyo-based partners and three partners based in Singapore, Yangon and Bangkok) in the real estate team, plus two partners in the Japanese REITs (J-REITs) practice. Fifty other lawyers are also involved in real estate-related matters. The real estate practice extends from traditional acquisition and leasing transactions to complex fund structures involving a special-purpose vehicle or a trust, or even investment structures for overseas properties. The team's work in this practice primarily includes the following: private fund formation for domestic and overseas properties, J-REITs, real estate acquisition, development and disposition, and real estate financing. Recent highlights include advising Google on the acquisition of land for its first data centre in Japan, acting for Diamond Realty on establishing an open-ended fund to invest in US properties, and advising SP Setia on its development of a MICE facility in Japan.

The Civil Code provides the general legal framework for real property and real estate transactions, including ownership, co-ownership, superficies, easement and security interests, and for sale and purchase and leasing transactions. 

In addition to the Civil Code, the Law on Unit Ownership of Buildings governs unit ownership (kubun shoyu ken) and the relationship among the unit owners of a multi-unit building, and the Land Lease and Building Lease Law applies to leases of buildings and leasehold interests or superficies in land for the purposes of owning a building on a parcel of land. Since this law was enacted to enhance protection of the tenant’s interest, some provisions are mandatory and cannot be circumvented by the parties to a land lease or building lease. Also, there are court rulings relating to land leases and building leases which have established legal doctrines that generally restrict the lessor’s rights and protect the tenants. Thus, when reviewing a lease of Japanese real property from a lessor’s perspective, one must remember that some contractual provisions may not work due to the mandatory provisions of the Land Lease and Building Lease Law, court rulings and established legal doctrines.

The Japanese real estate market has been active of late, attracting increasing attention domestically and from abroad. 

In particular, driven by an increasing number of inbound tourists, there have been a number of acquisition transactions or development projects involving hotels and resorts. These properties are expected to be one of the most sought-after asset types among both Japanese and non-Japanese investors. 

Also, many development projects of large-scale logistics properties and data centre facilities have been completed or are underway.

An increasing number of companies are developing and integrating proptech into their real estate services to streamline their business model and develop new opportunities. Real estate tech startups, including real estate crowdfunding platform providers, are expanding their presence in the market.

Several important reforms have been implemented in the last few years, the latest of which is the reform of the Civil Code (the Reformed Civil Code) which will become effective on 1 April 2020, and the reform of the Real Estate Specified Joint Enterprise Law (the RESJEL), which took effect on 1 December 2017. The Reformed Civil Code will affect many aspects of real estate transactions since it amends various fundamental default rules in the area of the law of obligations. By virtue of the reformed RESJEL, certain real estate private funds using the widely used GK-TK structure (see 5 Investment Vehicles) in Japan could be exempted from the existing permit requirements when acquiring outright ownership of real property by fulfilling a different set of requirements. 

For instance, the “Exempted Business (tokutei jigyo)” exemption requires the GK, a limited liability company in Japan, to outsource the following:

  • the business operations of purchasing, selling, exchanging or leasing real estate to a real estate specified joint enterprise operator who has a permit under the RESJEL for those business operations (so-called Category 3 Operator); and
  • the solicitation activities for entering into TK Agreements to a real estate specified joint enterprise operator who has a permit under the RESJEL for those activities (so-called Category 4 Operator). 

In addition, if the GK is to conduct development or construction work, and the cost of such work shall exceed 10% of the fair value of the property relative to the TK business, TK investors must either have certain expertise and experience in real estate investments or be stock companies (kabushiki kaisha) whose paid-in capital is at least JPY500 million (such investors are “Professional Investors” in the context of the RESJEL). The detailed criteria for Professional Investors are set out in the ordinance under the RESJEL.

Another exemption, the “Qualified Exempted Investors-targeted Business (tekikaku tokurei toshika jigyo)” exemption, requires the GK to do the following, among other things:

  • outsource the business operations of purchasing, selling, exchanging or leasing real estate to a licensed real estate broker; and
  • obtain TK investments only from certain Professional Investors with a particularly high degree of expertise and experience in real estate investments (so-called Super Professional Investors).

The detailed criteria for Super Professional Investors are also set out in the ordinance under the RESJEL.

Real property under Japanese law includes land and any fixtures on the land – ie, buildings that may be traded independently from the land. Land and buildings are independent real properties and can be traded separately, so the owner of the land and the owner of the building standing on that land can be different people. 

In the current Japanese market, the most common subject properties or interests for investment purposes are: 

  • fee simple ownership of the land or the building, or both;
  • a combination of the right to use the land (leasehold interest or superficies) and fee simple ownership of the building; 
  • co-ownership (kyo-yu) of the land or the building, or both; and
  • a combination of co-ownership of the land and unit ownership of private units in a multi-unit building.

Co-ownership refers to a type of ownership where one person owns a certain percentage interest in the entire property and other owners own the remaining percentage interests. 

Unit ownership is a type of ownership recognised for a multi-unit building under the Law on Unit Ownership of Buildings. A unit owner is entitled to own exclusive private units in the building, to own and use common areas (such as the entrance hall of the building) jointly with other unit owners, and to use the underlying land in the form of ownership interests, leasehold interests or superficies. 

In addition, many real properties are held under trust arrangements, in which case the investor would acquire a trust beneficial interest (TBI) in respect of the entrusted real property. Under a trust arrangement, the real property is owned by the trustee (usually, a licensed trust bank in Japan) as part of the assets of the trust, and the investor becomes a beneficiary of the trust by acquiring the TBI.

The Civil Code generally governs the transfer of title. Other laws may also be relevant, depending on the ownership structure. For example, the Law on Unit Ownership of Buildings provides for certain rules on the transfer of unit ownership.

Specific restrictions may apply to specific types of real estate. One such restriction is the requirement under the Agricultural Land Law that the acquisition of agricultural land is subject to governmental permission.

How to Effect a Title Transfer

A transfer of title to real estate is effected pursuant to an agreement between the seller and the buyer. Most sale and purchase agreements provide that the transfer of title takes effect upon the full payment of the purchase price by the buyer. 

Registration of Title to Real Estate

Japan has a real estate registration (toki) system where title to and certain other interests (such as mortgages) on real estate are registered. In practice, parties to a real estate transaction usually rely on the real estate registration because it is generally the best indication of the true owner of or holder of interest on a real property.

Registration of a Title Transfer

A transfer must be registered pursuant to the real estate registration system in order for it to be perfected. If a transfer of real property is not registered, the buyer cannot assert its title against a third party.

Title Insurance

Title insurance is not commonly used in the Japanese real estate market.

A real estate due diligence process usually involves some or all of the following elements:

  • Document review: documents to be reviewed include publicly available materials such as a certified copy of the real estate registration, as well as the contracts that have been entered into in respect of the subject property. An “explanation sheet of important matters” (juyo jiko setsumei sho) prepared by a broker or the seller is usually one of the major documents that should be reviewed, as it is supposed to provide an orderly overview of the property (including pre-closing or post-closing requirements under public laws applicable to the transfer of the property) and highlight issues relating to the property.
  • On-site inspection: the buyer often retains, and brings to on-site inspections, an appraiser and a property inspector, who will prepare the necessary third party reports.
  • Question-and-answer sessions: these are conducted in writing, by email or by telephone, or at face-to-face meetings.
  • Third party reports: for commercial real estate, the buyer often arranges for professional service providers to prepare a real estate appraisal report and an engineering report. It is not uncommon to ask lawyers to perform a legal due diligence investigation as well. Furthermore, if the buyer does not anticipate receiving any explanation sheet of important matters from the broker or the seller, then it is advisable for the buyer to retain a real estate adviser to prepare a property overview report to ascertain the various legal requirements applicable to the property.

Under the Civil Code, the seller is liable for any defect in the subject property. This defect liability may be limited by agreement on the scope, duration or amount of liability. Aside from such statutory liability, the seller and the buyer often agree on contractual representations and warranties regarding the subject property. This defect liability is referred to as “non-conformity liability” in the Reformed Civil Code.

The primary remedies for statutory liability and seller’s misrepresentations are termination of the purchase agreement and compensation for damages (or indemnity). Many sellers, however, negotiate the exclusion of the termination of the agreement as a post-closing remedy available to the buyer.

The primary laws relating to real estate transactions include the following:

  • laws governing private parties’ rights and obligations are the Civil Code, the Law on Unit Ownership of Buildings, the Land Lease and Building Lease Law, and the Real Estate Registration Law;
  • laws regarding regulations and public policy are the City Planning Law, the Construction Standards Law, the Soil Contamination Countermeasures Law, the Real Estate Transaction Business Law, and local government ordinances;
  • laws related to trusts and TBI transactions are the Trust Law, the Trust Business Law, and the Financial Instruments and Exchange Law; and
  • the Foreign Exchange and Foreign Trade Law relates to foreign investments.

The buyer may be responsible for soil pollution or environmental contamination of a property. If the soil contamination is likely to harm human health, the land will be designated as an area requiring action (yo sochi kuiki) under the Soil Contamination Countermeasures Law, and the landowner is required to take the necessary measures to remedy the contamination. The measures to be taken depend on the class of hazardous substances found on the land, and on the state and degree of contamination. In practice, the removal of contaminated soil is the prevailing remedial method. 

That said, a prefectural governor may order the polluter, rather than the owner, to take the required countermeasures if (i) it is clear that the soil contamination was caused by that polluter, who is not the owner, (ii) the prefectural governor determines that it is appropriate for that polluter to take countermeasures, and (iii) the owner agrees.

The City Planning Law is the main source of zoning regulations. An “explanation sheet of important matters” prepared by a broker or the seller would address the zoning restrictions applicable to the subject property under the City Planning Law. A buyer may also consult with relevant governmental bodies to ascertain the applicable local or specific zoning or planning regulations.

The extent to which a project may involve dealing with governmental bodies varies significantly on a case-by-case basis.

The Land Expropriation Law provides the requirements and procedure for expropriation by governmental bodies of privately owned real estate. Owners of expropriated assets are generally entitled to reasonable compensation. The two major elements of the whole process are a confirmation that the project necessitating the expropriation serves the public interest, and the determination of the amount of compensation.

Asset Deal

The outright transfer of real property (asset deal) is subject to real estate acquisition tax (fudosan shutoku zei), registration and licence tax (toroku menkyo zei), consumption tax (shohi-zei) and stamp duty. Depending on the type of real property and the timing of the transactions, and subject to some exceptions, the tax rates are as follows: 

  • registration and licence tax: 1.5% to 2% of the Taxable Base of the property, which is the property value recorded in the tax rolls for purposes of fixed assets tax; 
  • real estate acquisition tax: 3% to 4% of the Taxable Base; 
  • consumption tax: 10% of the purchase price of the building; and 
  • stamp duty: up to JPY600,000 (or up to JPY480,000 under the current special tax treatment). 

Corporation tax is also imposed on net income if the seller is a corporation. 

Share Deal

In the case of a share deal, corporate sellers are subject to corporation tax but not consumption tax, real estate acquisition tax, or registration and licence tax. Moreover, the share purchase agreement is basically not subject to stamp duty.

Allocation of Responsibilities for Taxes

Typically, the real estate acquisition tax, the registration and licence tax and the consumption tax are borne by the buyer, and the corporation tax is borne by the seller. The responsibility for the stamp duty is allocated based on agreement between the buyer and the seller.

Special Methods to Mitigate Tax Liability

For tax treatments that can be accomplished by using a trust structure or a tokutei mokuteki kaisha (TMK), please see 8.2 Mitigation of Tax Liability.

There are no legal restrictions on the acquisition of real property in Japan by non-residents, except that those buyers are required to make a post-transaction filing pursuant to the Foreign Exchange and Foreign Trade Law.

As further elaborated in 5 Investment Vehicles, there are three commonly used investment structures in real estate investments, and financing structures vary depending on the investment vehicles used for the transaction:

  • under the GK-TK structure, the acquisition is financed via tokumei kumiai (TK) and bank loans;
  • the financing instruments used for a TMK structure are preferred shares, “specified bonds” and “specified loans”; and 
  • investment corporations or toshi hojin (J-REITs) issue equity units and bonds, and take out loans, to finance their real estate acquisitions.

Financing structures for share deals vary depending on the purpose and nature of the deal.

A mortgage is the most typical security interest created by a borrower who holds outright ownership of real estate. If the borrower and the lender intend to enter into financing transactions on a continual basis, a revolving mortgage may be created instead. If the borrower holds an interest in real estate in the form of a TBI, a pledge over the TBI is the principal security interest in place of a mortgage. Some lenders may require pledges over insurance claims.

There are no special restrictions on granting security over real estate to foreign lenders. However, a licensing requirement applies if a foreign financial institution lends money in Japan as part of its money lending business, unless the institution is a licensed bank in its home country and has a Japanese branch. Thus, foreign institutions that do not satisfy those requirements often consider purchasing bonds, rather than making loans. Investors must note that bonds issued by Japanese corporations must be unsecured, unless special procedures are taken in accordance with the Secured Bond Trust Law.

Interest payments to non-resident lenders are generally subject to withholding taxes.

Formal (ie, non-provisional) registration of a mortgage is subject to a registration and licence tax, at a rate of 0.4% of the secured amount. Because this tax can be substantial depending on the secured obligation, some lenders permit the borrower to make a provisional registration only, which costs JPY1,000 for each real property. Once the mortgage is formally registered based on the provisional registration, the mortgagee enjoys priority over other mortgagees who register their mortgages after the provisional registration. However, provisional registration is of little use unless formal registration is completed based on the provisional registration. Therefore, lenders need to ensure that they are always in possession of all documents necessary to allow them to formally register the mortgage. 

Judicial foreclosure of a mortgage involves various costs. The applicant has to prepay up to JPY2 million (in the case of the Tokyo District Court) to a competent court, which will be credited to the court’s expenses.

If there are minority shareholders in a company that is providing security to secure a debt owed by its parent company, the directors of the security provider usually obtain the consent of said minority shareholders to ensure that the directors are not deemed to be in breach of their fiduciary duty and duty of care.

In the case of a borrower’s default, a mortgagee would typically accelerate the entire outstanding debt pursuant to the credit agreement. After the secured obligation becomes due, the mortgagee may judicially enforce the mortgage by submitting the real estate registration certificate on which the mortgage is registered. The priority of the mortgage vis-à-vis other mortgages is determined based on the order of mortgage registration.

Unless the existing lenders with perfected security interest agree, they do not become subordinated to any newly created non-preferred debt.

Because a financer such as a lender is not an “owner” for purposes of the Soil Contamination Countermeasures Law, a lender is not responsible for soil contamination investigations and countermeasures, unless it acquires the land from the borrower in default through the enforcement of a security.

According to a notice issued by the Ministry of Environment, even if the borrower assigns its land to a lender for the purpose of security (joto-tampo), the borrower but not the lender is deemed to be the “owner” of the land and will be responsible for any investigations and countermeasures under the Soil Contamination Countermeasures Law.

The creation of a security interest by a financially distressed borrower may be invalidated (by the insolvency trustee or the debtor-in-possession under the theory of bankruptcy avoidance) if the security interest was created to secure existing debt: 

  • after the filing of an insolvency petition with respect to the borrower (and the creditor knew that the petition had been filed); 
  • during the period when the borrower is “unable to pay” (ie, unable to pay its debts generally when they fall due) (and the creditor knew that the borrower was unable to pay, or that the borrower did not pay its debts generally when they fell due); or
  • 30 days or less before the borrower became “unable to pay”, and the borrower voluntarily created such security interest in favour of a specific creditor (and the creditor knew that such creation of security would prejudice other creditors). 

The perfection of a security interest may also be avoided even where the creation of a security interest itself may not be avoided, pursuant to the criteria set out above. This is to prevent the holder of a security interest that has been hidden for a long time from obtaining priority over general creditors after the borrower gets into a financial crisis. The requirements of such avoidance include the perfection being made after the suspension of payments or the filing of an insolvency petition, and not being made within 15 days of the creation of the security interest.

The Tokyo Interbank Offered Rate (TIBOR) is widely used as a benchmark to determine the base rate for floating interest rates, so the expiration of the LIBOR index is not really expected to have a significant impact on real estate financing transactions in Japan.

The City Planning Law is the main source of planning and zoning regulations. Local ordinances are also relevant.

The Construction Standards Law is the primary law regulating the construction of new buildings and the refurbishment of existing buildings. The law establishes minimum standards concerning building sites, structures, equipment and building use.

Under the Construction Standards Law, the confirmation of authorised entities regarding the details of construction or refurbishment must be obtained for the construction of new buildings or any major refurbishment of existing buildings. Authorised entities include local governments such as cities, towns and villages, and private building agencies accredited by the government.

A building developer or building owner must apply for confirmation from the relevant local governments or government-accredited private building agencies. The detailed requirements for such confirmation, including the steps to be taken vis-à-vis third parties, may differ under the relevant local ordinances.

Theoretically, it is not impossible to litigate against an authority’s decision, although such litigation is not commonly seen in practice.

Unless the development project involves a property or facility that is currently or was previously owned by a governmental body, it is not common to enter into agreements with governmental bodies to facilitate a development project.

The contractor of a building under construction in violation of the Construction Standards Law or the City Planning Law, or the owner of a building that has been thus constructed, may be ordered to suspend the construction or to demolish or refurbish the building, or otherwise to ensure compliance of the building with legal requirements.

Generally speaking, real property tends to be owned directly by joint stock companies (kabushiki kaisha or KK), which is the most popular form of corporate entity available under the Companies Law.

When it comes to real estate investment, there are three typical investment structures: the GK-TK structure, the TMK structure and the J-REIT structure, each of which uses a different type of entity to acquire property.

Among these three structures, the GK-TK structure and the TMK structure are primarily used to acquire a specific asset or portfolio identified at the outset. The TMK structure is more often preferred by non-Japanese investors.

However, the J-REIT is used as a going-concern vehicle for real estate investment, the asset portfolio for which can be continually expanded or replaced with new assets. 

The main features of each structure are discussed below.

GK-TK Structure

A GK-TK structure usually involves three types of vehicles:

  • the fund is formed as a limited liability company (godo kaisha or GK);
  • the GK is to acquire and hold one or more TBIs in a real estate trust (Property Trust); and
  • the GK obtains quasi-equity investment from a TK investor under a TK agreement, and takes out a loan from a third party financial institution.

A GK is one of the ordinary corporate forms available under the Companies Law, with all equity holders (members) of the GK bearing limited liability. As there is no specific minimum capital requirement, the paid-in capital of a GK is usually nominal (such as JPY100,000).

For tax and other regulatory or practical reasons, real property is often traded under trust arrangements in Japan – ie, property is acquired in the form of a TBI rather than an outright purchase of the property. In that case, the real property is owned by the trustee of the Property Trust (usually, a licensed trust bank in Japan) for the benefit of the GK as beneficiary.

A TK is one of the forms of partnership available under the Commercial Code, and is formed by an agreement between the GK as operator and a TK investor. As a legal matter, the funds contributed by the TK investor belong to the GK as operator, and all acts of the TK business are done in the name of the GK.

TMK Structure

A TMK structure involves a specified purpose company (tokutei mokuteki kaisha or TMK), which is a corporate entity specifically designed to acquire a specific asset (such as real estate assets) by issuing asset-backed securities under the Asset Liquidation Law. 

The best feature of a TMK is that, by fulfilling certain requirements, it will be eligible for special favourable tax treatment that is not available to a KK or a GK. The downside is the imposition of various regulatory requirements and special restrictions under the Asset Liquidation Law.

In most cases, a TMK finances the acquisition of real estate assets (which can be actual real properties or TBIs) by issuing preferred shares and obtaining third party debt.

The TMK’s equity consists of “specified shares” and “preferred shares”, with no minimum capital requirement. Specified shares are similar to ordinary voting shares of a KK. The amount of specified shares is nominal and is not supposed to be used for the acquisition of real estate assets, and the preferred shares comprise most of the TMK’s equity.

The third party debt is usually obtained in the form of “specified bonds” or “specified loans”.

J-REIT Structure

A J-REIT is a type of investment fund in a corporate form under the Investment Trust and Investment Corporation Law, which is set up to acquire real estate assets (whether actual real properties or TBIs).

Similar to a TMK, a J-REIT can be eligible for special favourable tax treatment that is not available to a KK or a GK, but it is subject to various regulatory requirements and restrictions under the Investment Trust and Investment Corporation Law.

A J-REIT’s equity is issued in the form of investment units, and the minimum equity requirement is JPY100 million.

The investment units of a J-REIT can be listed and traded on a stock exchange. As of 31 January 2020, there were 64 publicly listed J-REITs in Japan.

Please see 5.1 Types of Entities Available to Investors to Hold Real Estate Assets.

Please see 5.1 Types of Entities Available to Investors to Hold Real Estate Assets.

Governance requirements vary, depending on the structure.

GK-TK Structure

The governance of a GK is simpler and more flexible than a KK, and the characteristics of the operations and governance of a GK are intended to be more similar to those of a limited partnership. In most cases, a GK is incorporated with one corporate entity being the sole managing member representing the GK, and such managing member appoints an individual (operating manager or shokumu shikkosha) to act as its representative and perform the duties of a managing member.

In a GK-TK structure, the GK is structured as a special purpose company that has no human resources. Thus, it is intended for the GK to retain an asset manager, who takes a lead role in the GK’s activities. Such asset manager must be a registered investment adviser or manager under the Financial Instruments and Exchange Law.

TMK Structure

A TMK must always have at least one director and one statutory auditor. In addition, one accounting auditor is usually required to be appointed, who must be either a certified public accountant or an auditing firm.

Certain fundamental matters with respect to a TMK require the approval of its shareholders (in the form of a resolution). In general, only specified shareholders have voting rights at shareholders’ meetings.

The management and disposal of the real estate assets owned by the TMK must be subcontracted to a third party, which must be a trust company or certain other service provider experienced in asset management and permitted under the Asset Liquidation Law. In practice, there are two types of asset management, depending on whether the TMK acquires actual real properties or TBIs:

  • Ÿactual real properties: the TMK needs to retain an asset manager who is licensed to engage in a real estate transaction business under the Real Estate Transaction Business Law; or
  • TBIs: the trustee of a Property Trust is responsible for the management and disposal of the real estate assets, and the TMK needs to retain an asset manager who is a registered investment adviser or manager under the Financial Instruments and Exchange Law.

J-REIT Structure

A J-REIT must have at least one corporate officer, supervisory officers outnumbering the directors (by at least one person), a board of officers and an accounting auditor, which must be either a certified public accountant or an auditing firm.

The fundamental matters with respect to a J-REIT are quite limited, and require the approval of its unitholders (in the form of a resolution).

Pursuant to the Investment Trust and Investment Corporation Law, a J-REIT must retain the following:

  • an asset manager who is a registered investment manager under the Financial Instruments and Exchange Law and a licensed real estate transaction business provider with a discretionary agency permit under the Real Estate Transaction Business Law;
  • an asset custodian; and
  • an administrative agent.

Maintenance cost varies significantly on a case-by-case basis. However, generally speaking:

  • Ÿthe cost to maintain a TMK structure is higher than for a GK-TK structure;
  • Ÿthe cost to maintain a J-REIT structure is significantly higher than for a GK-TK structure or a TMK structure; and
  • Ÿthe cost to maintain a publicly listed J-REIT is higher than for a private J-REIT.

Leases are the most common arrangements by which to use another person’s land or building, but superficies (chijo-ken) is a common alternative. 

The purpose of a lease is not limited, and leases are available for both land and buildings. In contrast, superficies is available only to own buildings or trees. 

In general, holders of superficies are in a stronger position than leaseholders against the landowner, as they are holders of a “real right”. For instance, the landowner owes the superficies holder a duty to co-operate in the registration of the superficies which is required for perfection, but the lessor does not owe such a duty to the tenant.

There are two types of land or building leases based on the lease term – namely, a general lease and a fixed-term lease. 

A general lease is subject to renewal, which the lessor is entitled to refuse only when there is a justifiable reason, taking into account the lessor’s and the tenant’s respective needs to use the property, the history of the lease, the present use of the property, and the amount of compensation being offered by the lessor to the tenant to vacate the property.

A fixed-term lease allows for three alternative arrangements for land leases (each a “Fixed-Term Land Lease”), as follows:

  • those relating to land on which a building is built for business or residential purposes and that have a term of at least 50 years are not renewable, and must be executed in writing;
  • those relating to land on which a building used only for business purposes (ie, not for residential purposes) is built and that have a term of at least 30 years but under 50 years are not renewable, and must be executed by way of notarial deeds; and
  • those relating to land on which a building used only for business purposes (ie, not for residential purposes) is built and that have a term of at least ten years but under 30 years are not renewable, and must be executed by way of notarial deeds (a “Category 3 Fixed-Term Land Lease”). 

A “Fixed-Term Building Lease” is also available. This lease must be in writing, is not renewable and will terminate upon the expiry of the lease term.

General Lease

In a general lease for land or buildings, lease terms that are contrary to or reduce certain statutory protections or rights granted to the tenant under the Land Lease and Building Lease Law are void. These statutory protections and rights include the following:

  • the lessor must have a justifiable reason to refuse a renewal of the lease; 
  • the tenant may demand that the rent be decreased in response to market conditions, and cannot be deprived of the right to demand a decrease of the rent even if they explicitly agree not to exercise that right;
  • in the case of a land lease only, the leasehold interest in the land is perfected without registration if the land tenant owns a registered building on the leased land;
  • in the case of a land lease only, the land tenant has the right to request the landlord to purchase the building upon the termination of the land lease; and
  • in the case of a building lease, the leasehold interest in the building is perfected without need of registration if the leased building is delivered to the tenant.

Otherwise, the rent and other terms of the general lease are freely negotiable and not regulated or subject to a voluntary code. 

Fixed-Term Lease

The tenant may be deprived of the protections and rights under the first and fourth items listed above under a Fixed-Term Land Lease, and of the protections and rights under the first and second items under a Fixed-Term Building Lease.

The initial term of a land lease for owning a building is required by law to be at least 30 years, and tends to range from 30 years to 50 years, except where the land lease is a Category 3 Fixed-Term Land Lease. 

Building leases are typically for a much shorter term. Office space leases are often for a short term (most commonly two to five years), while building leases for retail or commercial facilities tend to be longer and could be for ten to 20 years. 

The maintenance and repair of the premises actually occupied by the tenant are typically the responsibility of the tenant. However, if certain renovation works are required by the tenant before it can start using the premises, the allocation of the responsibility and the cost for such works are negotiated before entering into the lease agreement.

Monthly payment is the most typical payment term.

Lease agreements usually schedule a regular rent review, which is conducted every three to five years in many cases. During a rent review, the parties will negotiate an increase or decrease in the rent for the next three to five years.

Aside from a contractual rent review, the Land Lease and Building Lease Law entitles either party to a lease to demand that the rent be increased or decreased in response to market conditions. If the parties cannot come to an agreement, a court may order an adjustment after considering the following: 

  • any change in tax or other liabilities imposed on the leased real estate (or the underlying land in the case of a building lease); 
  • the value of the leased real estate (or the underlying land in the case of a building lease), and other relevant economic conditions; and 
  • Ÿrents in neighbouring areas. 

If the court determines that the rent should be decreased, the lessor will be ordered to return any excess rent and pay interest at the rate of 10% per annum on the excess amount.

If the lessor and tenant specifically agree not to increase the rent for a certain period, the lessor cannot exercise its right to demand an increase in the rent but, with respect to a land lease and a general building lease, the tenant cannot be deprived of the right to demand a decrease in the rent, even if it has explicitly agreed not to exercise that right under the lease. 

However, a different rule applies to a Fixed-Term Building Lease, under which the lessor and the tenant may exclude the application of the rule on rent adjustment described above by setting forth express provisions on rent revisions.

Please see 6.5 Rent Variation.

Consumption tax (which is equivalent to VAT) is payable on the rent on building leases other than for residential purposes. The rent on land leases is exempted from consumption tax.

Typical costs payable by a tenant at the start of a lease include a deposit (often calculated by a multiple of the monthly rent, depending on the type of lease and the real estate), brokerage fees, insurance premiums and other expenses, such as for replacement of the keys.

The maintenance and repair costs of common areas are paid by the building owner, primarily from the money paid by tenants as common area fees.

Utilities and telecommunications serving a property occupied by several tenants are paid for by the building owner, primarily from the money paid by tenants as common area fees.

Typically, a tenant pays for insurance covering damage caused by accidents occurring in the real estate and by fire and, in some cases, earthquake and flood.

There may be contractual restrictions on how a tenant uses the real estate, restrictions on the use of common areas, and prohibitions on the handling of hazardous materials or explosives.

The extent to and the conditions under which the tenant is permitted to alter or improve the real estate are entirely up to the agreement between the lessor and the tenant.

There are no specific regulations or laws that apply to leases of particular categories of real estate.

In the case of a bankruptcy procedure (hasan tetsuzuki) or a corporate reorganisation procedure (kaisha kousei tetsuzuki), a bankruptcy trustee – or a debtor in possession in the case of a civil rehabilitation procedure (minji saisei tetsuzuki) – has a statutory right to determine whether to terminate the lease agreement or to continue the lease by performing its obligations. 

If the bankruptcy trustee of the tenant or the tenant as debtor in possession opts for the termination of the lease, the treatment of the unpaid rents depends on when the due date arose: unpaid rents accruing before the commencement of the relevant insolvency procedure are treated, in principle, as general insolvency claims and are therefore subject to the insolvency procedure and subordinated to preferential claims, while rents that become due after the commencement of the insolvency procedure are paid from the insolvency estate in preference to other general insolvency claims, and are not subject to the insolvency procedure. 

If continuation of the lease is chosen instead, unpaid rents accruing before the commencement of the relevant insolvency procedure would be treated as general insolvency claims, although there is a different academic view that treats such unpaid rents as preferential claims. Furthermore, if the lease is continued, the rents that are due on or after the commencement of the relevant insolvency procedure are paid from the insolvency estate in preference to other general insolvency claims. 

In practice, lease agreements often provide for the lessor’s right to terminate the lease upon the commencement of an insolvency procedure on the part of the tenant. However, there are a few legal precedents that reject such a contractual provision, so the validity of such a provision remains arguable and, in practice, it is widely understood that the lessor should not rely on such a provision.

Furthermore, if the tenant is subleasing the leased property to a person who holds a leasehold interest that is perfected, then the above-mentioned statutory right of the bankruptcy trustee (and the debtor in possession) does not apply vis-à-vis the subtenant. If the insolvent tenant chooses to terminate its lease vis-à-vis the landlord, it inevitably causes a breach of its obligation to lease vis-à-vis the subtenant. Therefore, in practice, the insolvent tenant may not be able to opt for the termination of the lease if it is subleasing the leased property.

Typically, a tenant is required to pay a deposit at the start of the lease as security for any failure to pay in the future. A typical lease agreement contains a provision that allows the landlord to utilise the deposit to cover any outstanding obligation of the tenant.

A tenant is obliged to vacate and return the leased property on or before the expiration or termination of the lease term if the lease is not renewed. Lease agreements typically provide for the payment of liquidated damages in the form of monthly rents equal to twice the last agreed monthly rent, for the period from the day after the expiry or termination of the lease term up to the day the tenant actually vacates the leased real estate. 

Generally, the lessor does not have to do anything to ensure that the tenant vacates the property on time, as long as the lease duly expires or terminates. However, there is a special requirement in a Fixed-Term Building Lease that the lessor must provide written notice of the expiry of the lease term from one year to six months prior to the expiry date in order to oblige the tenant to vacate the leased property by the end of the lease term.

A tenant may assign its leasehold interest in the lease or sublease all or a portion of the leased premises if it is able to obtain the owner’s approval.

Typically, lease agreements provide that the following events give the landlord a right to terminate the lease:

  • breach of obligation by the tenant, such as the failure to pay rent;
  • commencement of an insolvency procedure by the tenant;
  • the occurrence of events that constitute grounds for the commencement of an insolvency procedure, such as being “unable to pay” (ie, unable to pay debts generally when they fall due); and
  • the issuance of an order for compulsory execution, petition for auction sale or compulsory disposition for delinquent public charges.

Having said this, the court takes the view that the lessor is entitled to terminate the lease only if the tenant’s breach amounts to a destruction of the relationship of trust between the lessor and the tenant, regardless of any provision in the lease agreement. Therefore, in practice, it is widely accepted that the lessor will not be able to terminate the lease simply by relying on the termination provision of the lease agreement. 

A statutory right to terminate in the case of the tenant’s insolvency is discussed in 6.15 Effect of Tenant's Insolvency.

A Fixed-Term Land Lease and a Fixed-Term Building Lease must be made in writing (see 6.2 Types of Commercial Leases). 

A leasehold interest in the land must be registered pursuant to the real estate registration system in order for it to be perfected. However, if the lessee own a building standing on the land, the lessee may perfect its leasehold interest in the land by registering its ownership of the building. 

A leasehold interest in a building could also be perfected by either registering it pursuant to the real estate registration system or upon the delivery of the subject building by the landlord to the tenant, in which case the tenant can assert its leasehold interest against any person who acquires the building after delivery. 

Registration of a leasehold interest is subject to a registration and licence tax at the rate of 0.4% of the Taxable Base of the property. In general, it is the tenant who pays the registration and licence tax.

In order to force a tenant to leave, the lessor must first obtain a court judgment ordering the tenant to vacate the leased property on the basis of the termination of the lease. If the tenant does not comply with the judgment, the lessor will need to file a petition for compulsory enforcement against the tenant to compel it to surrender the leased property. 

The length of time necessary to obtain such a judgment and to complete a compulsory enforcement largely depends on the tenant’s response in court hearings and the tenant’s reaction to the requirement to surrender, and varies from a few months to one year.

Leases cannot be terminated by any third party, including central government or municipal authorities.

The most typical construction price structure is the fixed price arrangement, whereby the parties agree on the price at the signing of the construction contract, taking into account estimated costs and expenses as well as the contractor’s profit. For a large construction project, the price adjustment mechanism may be implemented to reflect fluctuating procurement prices of materials or services linked to the cost element of the construction price.

Typically, design and construction works are provided under separate independent agreements – ie, the owner tends to enter into a design contract with a design company and a construction contract with a construction company. Each contract’s terms and conditions are usually prepared and negotiated based on general terms and conditions made available as templates by the pertinent industry associations in Japan.

The general terms and conditions of a typical construction contract that are made available jointly by the pertinent industry associations (the “Form Terms and Conditions for Construction Contracts”) provide for the construction contractor’s obligation to take out insurance, and for defect liability. This defect liability is referred to as “non-conformity liability” in the Reformed Civil Code.

With respect to insurance, the Form Terms and Conditions for Construction Contracts require the contractor to purchase and maintain fire insurance or contractor’s all risk insurance for the completed portion of the work, materials and building equipment and other materials delivered to the construction site. The details of the insurance coverage are left for the parties to agree.

With respect to defect liability, the Form Terms and Conditions for Construction Contracts provide that the owner may demand that the contractor repairs the defect, reduces construction fees, and/or pays damages. In principle, the contractor’s liability is subject to a time limitation of one to two years, depending on the construction materials (such as wood, stone, metal or concrete). However, in the case of a newly constructed residential building, the defect liability period for certain major structural works is mandatorily set at ten years after the delivery of the building, pursuant to the Housing Quality Assurance Law, a special law to ensure the quality of residential buildings.

Schedule-related risks can be managed by the payment of liquidated damages by the contractor. Such contractual arrangements are allowed under Japanese law, and the courts are bound by the amount of liquidated damages agreed, without having to ascertain the actual damages incurred. 

In particular, the Form Terms and Conditions for Construction Contracts provide that if the contractor fails to deliver the completed work by the due date for any reason attributable to the contractor, the owner may claim liquidated damages calculated at 10% per annum of the agreed construction price (minus a portion of the construction price equivalent to the part of the work already completed and delivered), calculated on the basis of the number of days delayed.

On the other hand, the Form Terms and Conditions for Construction Contracts allow the contractor to seek an extension of the due date if there is any justifiable reason, such as a force majeure event or a need for adjustment of the works. If the delay is caused by any reason not attributable to the contractor and the owner agrees to extend the due date, the owner is not entitled to liquidated damages.

For domestic construction projects, additional forms of security such as performance bonds or parent guarantees are not common. Normally, it is difficult to get major construction companies to provide additional security.

The law grants contractors the right to retain (ryuchi ken) or refuse to deliver the completed building in the event of non-payment, as long as the contractor has possession of the building. This right to retain does not require any registration.

Construction contracts typically provide for the payment of the last instalment of the construction price in exchange for the delivery of the completed building.

The Construction Standards Law requires the owner to obtain an inspection certificate (kensa zumi shou) before it is allowed to use a newly constructed building. The process is as follows:

  • the owner must apply for inspection by the relevant local government or government-accredited private building agency within four days of the completion of the construction; 
  • the inspection will be carried out within seven days of the application being accepted; and 
  • if it is confirmed that the construction and the site comply with relevant laws and regulations, the inspection certificate will be issued.

The sale of a building is subject to consumption tax (equivalent of VAT) at the rate of 10% of the purchase price of the building. The sale of land is not subject to consumption tax.

Although the seller is liable for the consumption tax under tax law, in practice the buyer is contractually obliged to pay an amount equivalent to the consumption tax on top of the purchase price of the building. 

In general, sellers whose taxable sales did not exceed JPY10 million in the penultimate taxable year are exempt from consumption tax.

The most common method to mitigate tax liability is to use a trust structure where the investor purchases the TBI in a Property Trust rather than the outright ownership of the real property itself. Please also see 2.1 Categories of Property Rights and 5.1 Types of Entities Available to Investors to Hold Real Estate Assets

In doing so, generally:

  • the registration and licence tax for the establishment of a Property Trust is reduced from 1.5% (for land) or 2.0% (for buildings) of the Taxable Base of the property (which is applicable in an outright purchase of real property) to 0.3% (for land) or 0.4% (for buildings) of the Taxable Base of the property. In addition, JPY1,000 is paid for each TBI transfer; and
  • the real estate acquisition tax is reduced from 1.5% (for building land), 3.0% (for non-building land and residential buildings) or 4.0% (for non-residential buildings) of the Taxable Base of the property (which is applicable in an outright transfer of real estate) to zero.

Alternatively, by using a TMK as an acquisition vehicle, the registration and licence tax is reduced to 1.3% of the Taxable Base of the property, and the real estate acquisition tax is effectively reduced to 0.6% (for building land), 1.2% (for non-building land and residential buildings) or 1.6% (for non-residential buildings) of the Taxable Base of the property because, in computing real estate acquisition tax, the TMK is allowed to reduce the Taxable Base of the property to 40% of the regular taxable base.

In Japan, no universal municipal taxes are paid on the occupation of business premises, except in certain major cities where taxes (of a relatively low amount) are imposed on the basis of the size of the taxpayer’s premises or the amount of salaries paid. 

The main municipal taxes paid on real estate per se are fixed asset tax (kotei shisan zei) and a city planning tax (toshi keikaku zei), which are imposed on every owner of real estate, irrespective of its purpose. However, there are limited exemptions for the above municipal taxes in certain designated areas where the municipal government is promoting certain industry sectors.

Income Tax Withholding for Foreign Investors

There is income tax withholding for non-resident individuals and foreign corporations. 

Taxation on Rental Income

Rental income from real estate is subject to corporation tax if the lessor is a foreign corporation, or to income tax if the lessor is a non-resident individual. In 2020, the applicable corporation tax rate is 15% (for small income of a small enterprise) or 23.2% (in other cases), plus a local corporation tax of 10.3% of the amount of the corporation tax and a special corporation enterprise tax of various rates, while the applicable progressive income tax rates range from 5% to 45%, plus a special income tax for reconstruction, at 2.1% of the amount of the income tax. 

If the lessor is a non-resident individual or foreign corporation, the tenant is required to withhold 20.42% of the rent, payable to the tax authority no later than the tenth day of the month following the date of the payment of the rent. Withholding is not required if the tenant is a natural person using the property as a residence for himself or his relatives. Any amount withheld by the tenant from the rent can be used as a deduction for corporation or income tax.

There is no exemption for taxation on rental income from real property in Japan.

Taxation on Gains from the Disposition of Real Property

Capital gains from the disposition of real property in Japan are subject to corporation or income tax in the same manner as rental income, as described above.

If the owner of the real property to be sold is a non-resident individual or foreign corporation, the buyer is required to withhold 10.21% of the purchase price, payable to the tax authority no later than the tenth day of the month following the date of payment of the purchase price. Withholding is not required if the purchase price does not exceed JPY100 million and the buyer will use the property as a residence for himself or his relatives. Any amount withheld by the buyer from the purchase price can be used as a deduction for corporation or income tax.

There is no exemption for taxation on capital gains from the disposition of real property in Japan.

A depreciation deduction is available for a person who owns a building. The depreciation expense is allocated to each taxation year equally or by a declining rate for the life of the building as prescribed by law, depending on the structure and purpose of the building. Land is not a depreciable asset.

Mori Hamada & Matsumoto

Marunouchi Park Building
2-6-1 Marunouchi
Chiyoda-ku
Tokyo 100-8222
Japan

+81 3 6212 8330

+81 3 6212 8230

mhm_info@mhm-global.com www.mhmjapan.com
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Trends and Developments


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Nishimura & Asahi has substantial experience in a wide array of real estate securitisation in both domestic and cross-border transactions. The firm's real estate finance team has a proven track record in advising both lenders and borrowers in finance transactions throughout the real estate industry, offering expert assistance to clients in all stages of their transactions, from the term sheet and structuring stage through closing, tranching, syndication and securitisation, administration, servicing and, if required, restructuring. Since the early 2000s, the firm's lawyers have played a significant role in advising publicly traded REITs, private REITs, and real estate operating and finance companies in all stages of their life cycles, from REIT formation, roll-up transactions and initial public offerings to secondary debt and equity offerings, and REIT transactions. Nishimura & Asahi advises on real estate sales and purchases, investment, lease and management in Japan and abroad; as the growth in real estate funds and private equity investment in real estate increases, the firm has been advising all of the key fund-related specialties. Furthermore, the firm specialises in environmental law, providing risk analysis and settling disputes on soil pollution, asbestos and other environmental law issues that arise regarding real estate; capabilities extend to environmental law-related issues to be complied with by business entities and Corporate Social Responsibility (CSR).

Cross-border Transactions

Outbound investments

Japanese investors are continuously expanding their outbound investments in foreign real estate markets, searching for opportunities to take advantage of good domestic economic strength mixed with relatively limited investment opportunities within Japan. Over the past few years, a number of Japanese real estate developers have announced that they are or will be investing in real estate and real estate development businesses outside of Japan. In line with this trend, Japanese funds and investors are seeking outbound investments through J-REITs (Japanese real estate investment trusts) in addition to purchasing limited partnership (LP) interests, REITs or other types of securities whose underlying assets are foreign real estate. It is potentially beneficial for J-REITs to diversify their portfolios across various locations in order to mitigate risks associated with the Japanese real estate market, to some extent.

J-REITs are allowed to acquire property overseas. Although J-REITs were previously generally prohibited from holding more than 50% of the shares of a real estate holding company, the Financial Services Agency has issued a statement which confirmed that J-REITs are able to hold up to 100% of the equity of foreign real estate companies in certain foreign countries, including the USA, India, Indonesia, China, Vietnam and Malaysia.

Following the publication of this statement, Aeon Reit Investment Corporation (a J-REIT) invested in a commercial property in Malaysia by acquiring 100% of the equity of a Malaysian SPC, and Invincible Investment Corporation invested in hotels in the Cayman Islands in 2018. In 2019, a private J-REIT sponsored by Daiwa House invested in 100% of the equity of a Limited Liability Company that co-owns real estate in the USA.

Inbound investments

There have also been continuous increases of inbound investments into Japanese real estate. According to a Tokyo Stock Exchange survey in 2019, foreign investors held approximately 26% of J-REIT shares, and approximately 50% of the trading of J-REIT shares was executed by foreign investors. In addition, about JPY70 billion (approximately USD640 million) flowed into the J-REIT market in 2019.

Foreign investors have long played a key role in the Japanese real estate market. There has been a fairly large volume of transactions where SPCs sponsored by foreign investors have purchased Japanese real estate using financing with securitisation structures. In fact, foreign investors invested in seven of the top ten real estate sale and purchase transactions (by deal size) in 2019, according to Nikkei’s real estate market information. Foreign investors were previously focused mainly on office and residential properties, but are shifting their attention to various other types of properties, including logistics, hotels and accommodations.

As the population of Japan declines, it will be important to continue to develop a sophisticated real estate market to attract inbound investment in order to sustain the growth of the national economy. The Japanese government expects that inbound investments will play a key role in real estate development in the country. This is also in line with the recent enactment of a new statute to allow Integrated Resorts (IRs) and Meeting, Incentive Travel & Event/Exhibition (MICE) properties to attract visitors from foreign countries.

Tourism Industry – Hotels, MICE and Casinos

The Japanese government has recently put its energy and focus into the Japanese tourism industry. The number of visitors coming to Japan has been soaring in the past six or seven years, with more than 30 million people visiting in 2019. 

With the increase of foreign visitors, a number of construction projects for building hotels and other types of accommodations have been initiated, and some are under way, especially in mega cities and areas near international airports. As the number of repeat visitors to Japan increases, regional cities are also pulling in foreign guests with their unique attractions, such as ski destinations in Niseko, Hokkaido for example. It has been said that there are fewer five-star hotels in Japan than other parts of Asia seeking to attract tourists. However, an increasing number of luxury hotels have been developed, with more being planned, as wealthy visitors are coming to Japan more than before.

One of the Japanese government’s policies in relation to the tourism industry is to promote the development of MICE projects. The expansion of MICE projects is intended to have an important effect not just on the tourism industry but also on the wider economy, because MICE can facilitate business innovation between top-tier companies as their core members gather to meet from around the globe. MICE projects are intended to provide an opportunity to improve the international competitiveness of Japanese industry by drawing on the exchange of information and other resources at MICE gatherings. On top of these effects, MICE projects are thought to cause an economic boost in local business activities, since the length of stay for visitors attending MICE events is generally longer than that for tourist visitors. The overall economic impact brought by MICE developments in 2016 was estimated to be approximately JPY1 trillion (USD9 billion), according to a government survey. Twelve cities, including Tokyo, Yokohama, Osaka and Kyoto, have been selected to be global MICE cities by the Japanese government. Government support for further MICE development in these cities is being implemented.

Amid this movement, a new statute related to MICE (the Act on Development of Specified Integrated Resort Area – the IR Act) was enacted in 2018. Among other things, the statute governs the development of complex tourist facilities (including MICE and casinos), as well as the management and regulation of these facilities. One of the most remarkable aspects of the IR Act is that it legalises casinos for the first time in Japan. Gambling is generally treated as criminal activity in Japan, with some exceptions, such as horse racing. The IR Act expressly permits casinos – based on an examination of their overall positive contribution to the public interest – by advancing an internationally competitive tourism industry, boosting regional economies, and providing tax revenue. The casinos will only be permitted as a part of integrated resorts, which will be developed in accordance with authorised area development plans under the IR Act. Casinos will not be independently operated outside of IRs, and the size of each casino will be limited to 3% of the total floor space of each integrated resort facility.

One thing to be noted about the IR Act is that the initial authorisation to open an IR facility is only valid for ten years. The authorisation may be extended, but this limited period is likely to be a significant risk factor for financing providers, potentially challenging the funding of the construction and management of the IR facilities.

With the rules of the Japan Casino Regulatory Commission and other regulations still to be published, the legal structure for IR developments is likely to be revealed more in the near future. Since the IR Act limits the number of IR areas in Japan to three, several cities are competing for them, including Osaka.

Logistics, Data Centres and other Industrial Facilities

Logistics facilities is another asset class that is attracting attention in the Japanese real estate market. Nikkei’s report shows that four of the top ten real estate sale and purchase transactions (by deal size) in 2019 were logistics properties. The market for electronic commerce is increasingly developed, with the amount of consumer transactions using electronic commerce reaching USD160 billion in 2018, up from USD126 billion in 2015, according to a report issued by the Ministry of Economy, Trade and Industry. With this growth, logistics companies are seeking facilities in proper locations to accommodate their increasing inventory. There are ten J-REITs listed on the Tokyo Stock Exchange specifically investing in this space, and four of them have been newly listed since 2017.

In addition to logistics, data centres are a rather new type of asset. Data centres generally house servers in racks with ample electricity, controlled temperature and tight security, and provide IT network services and facilities, including cloud services. Leases for data centres have some unique aspects compared with other types of property leases, since data centres are primarily designed to accommodate IT facilities, such as servers. Also, these leases often include important terms relating to the provision of additional services incidental to the lease (eg, the supply of electricity, technical support, etc). Consequently, unique legal issues may need to be addressed when reviewing data centre transactions (eg, whether the Act on Land and Building Lease (Act No 90 of 1991) applies to a data centre’s lease contract).

REITs

In the Japanese capital markets, REITs showed a strong and steady performance in 2019. The aggregate market value of REITs reached about JPY16 trillion (approximately USD145 billion) at the end of 2019, which exceeded the aggregate market value of the real estate sector companies listed on the First Section of the Tokyo Stock Exchange for the first time.

One of the key events of interest in 2019 was the first hostile takeover of a J-REIT. There have been some M&A transactions between J-REITs during the past ten years, but all of them have been friendly mergers under previous agreements between all relevant parties (including the sponsors). In addition, many of them were carried out between the J-REITs under the same sponsors or friendly sponsors in an effort to increase their assets under management (AUM), expand the types of their assets and/or streamline their business.

The types of REIT M&A transactions are generally as follows:

  • mergers between two REITs (via a consolidation-type merger or an absorption-type merger);
  • the acquisition of an asset management company’s shares; and
  • the acquisition of all portfolio assets held by one REIT by the acquiring REIT.

As a general rule, a shareholders’ meeting will need to be held to approve a merger between two REITs.

It has generally been considered difficult to implement a hostile takeover of a J-REIT, mainly for the following reasons:

  • the requirements to qualify to avoid double taxation (ie, the deduction of dividends from a REIT’s taxable income) cannot be met if more than 50% of a J-REIT’s shares are purchased and owned by a specific investor group; and
  • acquiring the shares of a J-REIT is not sufficient to take control of a REIT – it is also necessary to take control of or replace the target REIT’s asset management company, since the asset management company has the authority to dispose of the real estate owned by the J-REIT.

Regarding the second reason in particular, a J-REIT’s asset manager is typically an unlisted subsidiary of its sponsor, so shares of such asset management company are usually not available to be acquired by a hostile acquirer. Furthermore, in terms of licensing, as a REIT’s asset management company can be replaced only by a company already licensed as another REIT’s asset management company, such replacement may give rise to a conflict of interest between two REITs.

To avoid these problems, the hostile takeover mentioned above adopted the following transactions: replacing the target REIT’s asset management company with the asset management company of the acquiring REIT and then entering into a merger agreement between the two REITs, subject to the necessary approvals of the shareholders' meeting.

These types of transactions should be subject to merger approval by shareholders of both REITs, so it will not be easy for other REITs to follow the same strategies. Even so, REIT asset management companies cannot overlook the possibility of such transactions, considering that a shareholder holding not less than 3% of issued shares for the preceding six-month period can request that a shareholders’ meeting be held regarding such transactions. Under these circumstances, it is becoming more important for REIT asset management companies to regularly provide a sufficient account to shareholders and to obtain their understanding of the advantages of having them manage REIT assets as well as their investment policies and investment records.

Furthermore, under the Act on Investment Trusts and Investment Corporations, a J-REIT may provide in its certificate of incorporation that shareholders who do not attend a shareholders’ meeting or exercise their voting rights in the shareholders’ meeting will be deemed to agree to the proposal(s) submitted to that meeting (the “Deemed Votes in Favour Provision”). Shareholders of J-REITs include many individual or corporate investors mainly hunting for high returns who are less concerned about attending shareholders’ meetings and exercising their voting rights. Therefore, most J-REIT asset management companies provide Deemed Votes in Favour Provisions in REIT certificates of incorporation in order to constitute a quorum and pass necessary resolutions at shareholders’ meetings. However, a Deemed Votes in Favour Provision can also apply to important proposals such as proposals for the replacement of management companies or the hostile takeover mentioned above, and consequently can make such transactions easier. Thus, Deemed Votes in Favour Provisions remain an issue for the future, from a legislative perspective as well.

Real Estate Tech/Proptech

These days, new businesses in the real estate market – called Real Estate Tech or proptech – are developing in Japan, taking advantage of information technology (IT). Real Estate Tech refers to various types of businesses, such as:

  • crowdfunding for real estate investment;
  • improving the efficiency of real estate transactions with IT (eg, the conversion of written legal documents into electronic versions);
  • matching users and owners of properties; and
  • estimation of the value of, or appraisal of, real estate by using big data.

Real Estate Tech enables issuers to offer their financial instruments to many investors. This means that issuers may design new types of financial instruments for individual investors. The recent amendment of the Real Estate Specified Joint Enterprise Act (Act No. 77 of 1994 – REJEA) in 2017 has helped this innovation by facilitating the arrangement of new investment schemes for small properties with fewer legal requirements and costs. With Real Estate Tech and the current REJEA, it has become easier to design new investment structures with more flexibility to invest in small properties with funds from small investors.

In response to such diversification of financial transactions accompanying the progress of information technology, the Financial Instruments and Exchange Act (Act No. 25 of 1948 – FIEA) and the Payment Services Act (Act No. 59 of 2008) were amended in March 2019, and will be enforced within a year; the drafts of the relevant cabinet order and ordinance have been published. In this amendment, certain types of financial instruments fall under securities under the FIEA, such as TK investments in which crypto-assets are invested. In addition, if such financial instruments are able to be transferred through an internet system including blockchain technology, the regulations applied to such instruments would be those for securities with high liquidity, which is different from the current regulation. These amendments aim to catch up with progress in information technology, so the tech players are paying more attention to the future trends and development of these types of securities based on the amendments.

ESG

Environmental, Social and Governance (ESG) factors have gained some attention in the real estate market as well as other investment sectors. The Government Pension Investment Fund, a major investor in Japan, signed the Principles for Responsible Investment advocated by the United Nations in 2015, and has been taking ESG factors into consideration when investing in assets, including real estate. This development seems to be influencing other investors. To create a sustainable environment, it is generally understood that real estate, as a basic component of society, should follow global policy, such as SDGs (Sustainable Development Goals), and contribute thereto. The real estate industry is thought to have significant potential to play an important role in meeting SDGs, especially with respect to the environment. There have been developments of buildings that achieve high environmental performance to reduce energy consumption. Buildings with environmental performance certificates appear to attract investments more than those without such certificates.

In line with the promotion of ESG, the number of Japanese participants in GRESB Real Estate Assessment has been increasing. The participation rate of Listed J-REITs in the Assessment is reported to have been approximately 90% (on the basis of market capitalisation) in 2019. GRESB Real Estate Assessment is the global ESG benchmark capturing information as to ESG performance and sustainability best practices for real estate, and gives rating results. It appears that more and more investors have referred to GRESB Real Estate Assessment for their investment decisions, or are considering doing so.

The Japanese government is also delivering positive signals regarding ESG/SDGs and publishing its policies related to this field, such as SDGs Action Plan 2020, Financial Administration and SDGs, and the interim report for the promotion of ESG investment in real estate. The idea of a green lease is part of government strategies to improve property environmental performance that the Japanese government is also suggesting through its Green Lease Guideline. In a green lease, the owner and tenant share the costs for environmental improvements of the leased building.

Also, public money, together with private funds, has been flowing into investments to redevelop aged buildings and remodel them to have seismic or environmental capacity. The green bonds market is also growing and collecting funds to be spent on eco-friendly businesses.

ESG is currently early in its development in Japan, and it seems that ESG investment methods, disclosure models and ESG effects investment have not been established completely. Nevertheless, the global ESG trend will continue to grow in the Japanese real estate market, and attention needs to be paid to this development.

The Amendment of the General Civil Code

The law concerning contracts and obligations in the general Civil Code was amended in 2017, and the amendment became effective on 1 April 2020 (the “Effective Date”). The amendment includes changes to general rules relating to transfers of claims, guarantees and standard terms and conditions applied to similar transactions, etc. Although this amendment of the general Civil Code does not appear to have brought about any drastic changes to existing court rulings or other business operations related to real estate transactions between companies, the amendment is likely to require some changes (including terminological changes) in contract documents, so it is recommended to keep it in mind when conducting Japanese transactions following the Effective Date.

Nishimura & Asahi

Otemon Tower
1-1-2 Otemachi, Chiyoda-ku
Tokyo 100-8124
Japan

+81 3 6250 6200

+81 3 6250 7200

info@jurists.co.jp www.jurists.co.jp
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Mori Hamada & Matsumoto has 12 partners (nine Tokyo-based partners and three partners based in Singapore, Yangon and Bangkok) in the real estate team, plus two partners in the Japanese REITs (J-REITs) practice. Fifty other lawyers are also involved in real estate-related matters. The real estate practice extends from traditional acquisition and leasing transactions to complex fund structures involving a special-purpose vehicle or a trust, or even investment structures for overseas properties. The team's work in this practice primarily includes the following: private fund formation for domestic and overseas properties, J-REITs, real estate acquisition, development and disposition, and real estate financing. Recent highlights include advising Google on the acquisition of land for its first data centre in Japan, acting for Diamond Realty on establishing an open-ended fund to invest in US properties, and advising SP Setia on its development of a MICE facility in Japan.

Trends and Development

Authors



Nishimura & Asahi has substantial experience in a wide array of real estate securitisation in both domestic and cross-border transactions. The firm's real estate finance team has a proven track record in advising both lenders and borrowers in finance transactions throughout the real estate industry, offering expert assistance to clients in all stages of their transactions, from the term sheet and structuring stage through closing, tranching, syndication and securitisation, administration, servicing and, if required, restructuring. Since the early 2000s, the firm's lawyers have played a significant role in advising publicly traded REITs, private REITs, and real estate operating and finance companies in all stages of their life cycles, from REIT formation, roll-up transactions and initial public offerings to secondary debt and equity offerings, and REIT transactions. Nishimura & Asahi advises on real estate sales and purchases, investment, lease and management in Japan and abroad; as the growth in real estate funds and private equity investment in real estate increases, the firm has been advising all of the key fund-related specialties. Furthermore, the firm specialises in environmental law, providing risk analysis and settling disputes on soil pollution, asbestos and other environmental law issues that arise regarding real estate; capabilities extend to environmental law-related issues to be complied with by business entities and Corporate Social Responsibility (CSR).

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