The Japanese Civil Code provides the general legal framework for real property and real estate transactions, including ownership, co-ownership, superficies, easement and security interests, as well as 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, while 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. As 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, court rulings in relation to land leases and building leases 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 owing to the mandatory provisions of the Land Lease and Building Lease Law, court rulings and established legal doctrines.
Although the COVID-19 pandemic has reduced the volume and speed of transactions to some extent (especially in the case of hotel and resort projects), the Japanese real estate market has been active of late – particularly when it comes to attracting attention from abroad, thanks to low interest rates and the depreciation of the yen. As of 2023, a large supply of high-grade office buildings is now underway in Tokyo. In addition, many development projects for large-scale logistics properties and data centre facilities are pending or have been completed.
An increasing number of companies are integrating property technology (“proptech”) into their real estate services to streamline their business model and develop new opportunities. Real estate tech start-ups, including real estate crowdfunding platform providers, are expanding their presence in the market.
Several important reforms have been implemented in the past few years ‒ the most recent being the reform of the law of obligations under the Civil Code (the “Reformed Civil Code”), which took effect on 1 April 2020, and the reform of the Real Estate Specified Joint Enterprise Law (RESJEL), which took effect on 1 December 2017.
The Reformed Civil Code has affected many aspects of real estate transactions, as it amends various fundamental default rules pertaining to the law of obligations. By virtue of the reformed RESJEL, certain real estate private funds using the popular GK-TK structure (see 5. Investment Vehicles) in Japan could be exempt from the existing permit requirements when acquiring outright ownership of real property if they fulfil a different set of requirements.
By way of an example, the “Exempted Business” (tokutei jigyo) exemption requires a limited liability company in Japan (godo kaisha, or GK) to outsource certain operations and activities as follows.
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 known as “Professional Investors” in the context of the RESJEL. The detailed criteria for Professional Investors are set out in the ordinance under the RESJEL.
The “Qualified Exempted Investors-Targeted Business” (tekikaku tokurei toshika jigyo) exemption requires the GK to, among other things:
The detailed criteria for Super Professional Investors are also set out in the ordinance under the RESJEL.
New legislation concerning real estate transactions for national security purposes became effective on 20 September 2022. The Act on the Review and Regulation of the Use of Real Estate Surrounding Important Facilities and on Remote Territorial Islands will authorise the Japanese government to:
In addition, parties to a real estate purchase agreement must submit a notice of certain prescribed matters (eg, identity of the parties and purpose of use) prior to the execution of the agreement if the real estate is located within the Enhanced Close Monitoring Area. The Act is based on the principle of non-discrimination on grounds of nationality and, as such, applies equally to Japanese and non-Japanese persons.
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. As such, the owner of the land and the owner of the building standing on that land can be different persons.
In the current Japanese market, the most common subject properties or interests for investment purposes are:
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 co-ownership, 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 (typically 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 in which title to and certain other interests (such as mortgages) in 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 in 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.
Applications for registration of title transfer can be completed online; however, the use of registered seals to execute the documents required for registration is still the prevalent practice. In Japan, the pandemic caused no major delays or other disruptions in real estate registration procedures.
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.
Due diligence was not significantly affected by the COVID-19 pandemic, although a wider use of digitalised materials and IT was encouraged. There has been a slight increase in in-person meetings recently, however.
Under the Civil Code, the seller is liable for any defect in the subject property. This defect liability is referred to as “non-conformity liability” in the Reformed Civil Code and 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.
In Japan, representations and warranties in purchase and sale agreements do not necessarily address issues relating to the COVID-19 pandemic.
The primary remedies for statutory liability and sellers’ 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. It is not common in Japan for the parties to use representation and warranty insurance for real estate transactions.
The primary laws relating to real estate transactions include the following:
The buyer may be responsible for soil pollution or the 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; such measures 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 in the following circumstances:
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 the expropriation of privately owned real estate by governmental bodies. Owners of expropriated assets are generally entitled to reasonable compensation. The two major elements of the whole process are:
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:
Corporation tax is also imposed on net income if the seller is a corporation.
In 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 such 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.
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 should 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. As this tax can be substantial depending on the secured obligation, some lenders permit the borrower to make a provisional registration only – at a cost of 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. There have been no specific governmental measures taken in response to the COVID-19 pandemic to restrict a lender’s ability to foreclose or realise collateral in real estate lending.
Unless the existing lenders with perfected security interest agree, they do not become subordinated to any newly created non-preferred debt.
Given that 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 either:
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 above-mentioned criteria. 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. As such, 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. However, 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 constructed in such a way – may be ordered to:
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, each of which uses a different type of entity to acquire property:
Of 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 outlined here.
A GK-TK structure usually involves three types of vehicles in the following way:
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 (typically 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.
A tokutei mokuteki kaisha (TMK) structure involves a specified purpose company, 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. 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”.
A J-REIT is a type of investment fund that is set up in a corporate form under the Investment Trust and Investment Corporation Law to acquire real estate assets (whether actual real properties or TBIs).
As with a TMK, a J-REIT can be eligible for special favourable tax treatment that is not available to a KK or a GK. However, 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 1 March 2023, there were 60 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.
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 resemble those of a limited partnership. In most cases, a GK is incorporated with one corporate entity as the sole managing member representing the GK. Such managing member appoints an operating manager(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 necessary 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.
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 regard 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 other service provider experienced in asset management and permitted under the Asset Liquidation Law. In practice, depending on whether the TMK acquires actual real properties or TBIs, there are two types of asset management:
A J-REIT must have a board of officers, at least one corporate officer, and enough supervisory officers to outnumber the directors (by at least one person) – as well as an accounting auditor, which must either be a certified public accountant or an auditing firm.
The fundamental matters with regard to a J-REIT are quite limited and require the approval of its unit-holders (in the form of a resolution).
Pursuant to the Investment Trust and Investment Corporation Law, a J-REIT must retain the following:
Maintenance costs vary significantly on a case-by-case basis. However, generally speaking, the following applies:
Leases are the most common arrangements for using another person’s land or building. However, 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 owners of 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”. By way of an example, the landowner owes the superficies holder a duty to co-operate in the registration of the superficies that 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 after 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.
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.
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:
Otherwise, the rent and other terms of the general lease are freely negotiable and are not regulated or subject to a voluntary code.
Under a Fixed-Term Land Lease, the tenant may be deprived of the protections and rights listed in the above-mentioned first and fourth items, whereas it may be deprived of the protections and rights listed in the first and second items under a Fixed-Term Building Lease.
COVID-19 Pandemic Legislation
On 27 January 2023, the Japanese government formally decided to downgrade the legal status of the COVID-19 to ”Class 5” – ie, the same category as common infectious diseases such as seasonal influenza – from 8 May 2023. Following the downgrade, the COVID-19 is no longer subject to quarantine and other measures set to be terminated or relaxed. This is expected to normalise social and economic activities in Japan.
As detailed in 6.2 Types of Commercial Leases, 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), whereas building leases for retail or commercial facilities tend to be longer (between ten and 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 is negotiated before entering into the lease agreement.
Monthly payment is the most typical payment term.
It is not common in Japan for lease agreements to address issues relating to the COVID-19 pandemic or any future pandemics. The exception is cases where parties have agreed on special treatment for these events, such as expanding the definition of force majeure to include the COVID-19 pandemic.
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:
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. However, with regard 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 above-mentioned rule on rent adjustment 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 in building leases that are not for residential purposes. The rent on land leases is exempt 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 (eg, replacement of the keys). In addition, it is market practice for the tenant to pay a renewal fee (a multiple of the monthly rent) for each renewal of the lease term.
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 that occur in the real estate and caused by fire and, in some cases, by earthquake and flood.
There may be contractual restrictions on how a tenant can use the real estate, including 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 depend entirely on the agreement between the lessor and the tenant.
In principle, 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. However, 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 thereof remains arguable and 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:
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 the 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 owns 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. It can vary 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 (the “Form Terms and Conditions for Construction Contracts”) that are made available jointly by the pertinent industry associations provide for the construction contractor’s obligation to take out insurance and for defect liability (see 2.5 Typical Representations and Warranties).
With regard to insurance, the Form Terms and Conditions for Construction Contracts require the contractor to purchase and maintain fire insurance or contractors’ 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 regard 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, which is 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.
Specifically, 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, based on the number of days delayed – minus a portion of the construction price equivalent to the part of the work already completed and delivered.
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 sale of a building is subject to consumption tax (equivalent to VAT) at the rate of 10% of the purchase price of the building. The sale of land is not subject to consumption tax. The seller is liable for the consumption tax under tax law. However, 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 whereby 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:
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. This is 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. In certain major cities, however, 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 a fixed asset tax (kotei shisan zei) and a city planning tax (toshi keikaku zei). These are imposed on every owner of real estate, regardless of its purpose. Nonetheless, there are limited exemptions for the above-mentioned 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 2022, 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. 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 a 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 themself or their 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.
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 themself or their 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.
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The Japanese Real Estate Market After COVID-19
The COVID-19 outbreak has had a significant impact on the real estate market. However, the situation is generally improving and the market seems to be recovering.
Despite the pandemic, 2022 saw increased investment in residential properties – not only in Tokyo but also in other core regional cities. Such investment seems to be more active than in 2022 and there has been a noticeable movement towards investment in residential portfolios.
In a context of increasing uncertainty about the market situation (including domestic interest rates), this asset class appears to be attracting attention. This is perhaps down to the fact that residential properties, by their nature, have relatively stable operations. In addition, some opportunistic investors are focusing on the relatively low rents in Japan compared with rent levels in other megacities around the world, such as New York, London and Singapore.
As a result of these combined factors, investment in Japanese residential property continues to grow steadily. According to Nikkei’s real estate market information, foreign investors actively invested in three of the top ten largest real estate sale and purchase transactions (by deal size) in Japan in 2022.
Investment in logistics facilities remained strong in 2022, with a number of funds being freshly created. The COVID-19 outbreak has significantly accelerated investment in logistics assets, no doubt owing to the expansion of e-commerce resulting from the widespread adoption of work-from-home arrangements and the quarantine measures imposed during the state(s) of emergency in Japan and elsewhere. More investors and real estate funds are concentrating on logistics – in particular, those assets that are related to supporting e-commerce and other digital transformation (DX) trends.
Investment in office properties in Japan appears to have stagnated, as vacancy rates have not improved as much as expected. The occupancy rates for high-quality assets in Tokyo seem lower than expected and one reason could be the influx of new office properties in recent years.
Hotel and accommodation assets
Despite a confirmed rise in the number of travellers to Japan, the situation in the hotel and accommodation market remained difficult in 2022. Many private funds and J-REITs with hotel assets continue to face breaches of their financial covenants (from the latter half of 2020 to the present) yet have avoided default by making additional capital injections or providing supplementary cash reserves. However, there are signs of an improvement in this segment of the market – notably, several hotel development projects commenced in 2022.
Inbound investment in Japanese real estate has been increasing continuously. According to a 2022 survey by the Tokyo Stock Exchange, approximately 53% of trades in J-REIT shares were executed by foreign investors and about JPY69 billion flowed into the J-REIT market from foreign investors.
Foreign investors have long played a key role in the Japanese real estate market. In a fairly large number of transactions, special purpose companies (SPCs) sponsored by foreign investors have purchased Japanese real estate using financing with securitisation structures.
As the population of Japan declines, it will become increasingly important to further develop a sophisticated real estate market that attracts inbound investment in order to sustain the growth of the national economy. The Japanese government expects inbound investments will play a key role in the future development of real estate in the country.
This is in line with the recent amendment to the Financial Instruments and Exchange Act (FIEA) concerning the category of Special Permitted Business for Foreign Investors, which came into effect on 22 November 2021. The amendment allows certain funds – in which the main investors are overseas corporations or foreign-resident individuals holding certain assets – to operate in Japan by notification, without limiting the number of investors or requiring investments by an investor that has filed to be a Qualified Institutional Investor under the FIEA.
In the Japanese capital markets, REITs have generally showed a steady performance. The total value of real estate held by REITs, including private REITs, has reached approximately JPY26.8 trillion (on the basis of acquisition price), and the aggregate market capitalisation of listed REITs was about JPY15.8 trillion (approximately USD120 billion) at the end of 2022.
The growth of private REITs has played a role in the Japanese REIT market, with private REITs holding properties valued at about JPY5 trillion (based on acquisition price) in December 2022. There are 44 private REITs, ranging from comprehensive REITs (ie, those diversifying their portfolio in multiple asset types) to sector-specific REITs such as residential, hotel and logistic properties. Sponsors from various business fields have initiated private REITs. Railroad companies, electric power and gas companies, financial institutions (including insurance companies and banks) and other industries are also engaging in the management of REITs or are interested in doing so.
Hostile takeovers of J-REITs are among the key current trends in the REIT market. There were some M&A transactions between J-REITs before 2019; however, they were all friendly mergers conducted through agreements between all relevant parties (including the sponsors). Many were carried out between J-REITs under the same sponsors or affiliated sponsors in an effort to increase their assets under management (AUM), expand the types of their assets, and/or streamline their business.
The first hostile REIT M&A transaction was completed in 2020. A minor shareholder called a shareholders’ meeting of a target REIT with the financial bureau’s permission, during which a new officer nominated by the minor shareholder was selected and a management agreement with a new sponsor was executed following the termination of an existing management agreement. After the meeting, a merger was conducted between the REIT managed by the new sponsor and the target REIT.
Another contemplated hostile transaction case is the hostile bid to take over a listed office J-REIT’s shares, which resulted in the delisting of the REIT through a counter-bid and squeeze-out of minority shareholders by its sponsor. In comparison with a company incorporated under the Companies Act, a REIT has more limited defensive measures against a hostile takeover bid. “Poison pills” and specially designed shares, for example, are not recognised under the Act on Investment Trusts and Investment Corporations, which regulates REITs.
The types of REIT M&A transactions are generally as follows:
These types of transactions are subject to approval from the shareholders of the REIT, so there are hurdles to implementing hostile REIT M&A transactions. Even so, REIT asset management companies cannot overlook the possibility of such transactions, considering that a shareholder holding 3% or more of the issued shares for the preceding six-month period can request that a shareholders’ meeting is held regarding such transactions. Under these circumstances, it is becoming more important for REIT asset management companies to regularly provide sufficient reports to shareholders and ensure that they understand the advantages of having such companies managing 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 will be deemed to agree to the proposal(s) submitted at that meeting (the Deemed Votes in Favour Provision). Shareholders of J-REITs include many individual or corporate investors who are mainly focusing on returns and, as such, are less concerned about attending shareholders’ meetings or 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.
As a general rule, however, a Deemed Votes in Favour Provision can also apply to important proposals such as those for the replacement of management companies or the above-mentioned hostile takeover ‒ thereby making such transactions easier. In response to this, several REITs have amended their certificate of incorporation to ensure that Deemed Votes in Favour Provisions do not apply to certain important agenda items (such as dismissal of officers, termination of a management agreement, and dissolution).
For the first time in 14 years, the Financial Services Agency imposed an administrative sanction on a J-REIT’s management company in 2022. The sanction was imposed because the management company was found to have exercised undue influence on a real estate appraiser in a sale and purchase transaction with the management company’s parent company in order for the seller (the parent company) to sell the property to the J-REIT at favourable price for the seller. This incident suggests that the REIT market’s regulatory authority is tightening its monitoring of management companies with regard to conflicts of interest.
Security Token Offerings
A Security Token Offering (STO) is an attempt to issue a security that is managed and transferred using distributed ledger technology (ie, blockchain). STOs are expected to reduce management costs for real estate funds comprising one asset or very few assets and provide individual investors in a new small-lot real estate investment with middle-risk middle return in Japan. After the amendments to the FIEA and the Payment Service Act on 1 May 2020 established regulations for STOs, several real estate funds were successful in fundraising through STOs. The largest fund raised about JPY7 billion through tokenised security backed by a logistics facility in Kanagawa Prefecture in August 2022.
One of the leading methods for structuring STOs backed by real estate is to use a trust with Certificates of Beneficial Interest. Unlike other types of equity instruments (eg, equity investments in TK partnerships), which generally require written documents with a certified date in order to be transferred and perfected, a beneficial interest in a trust can be transferred and perfected by agreement between the parties without a document with a certified date. This is because the transfer of a beneficial trust interest can be perfected by an entry or record in the beneficial interest register if the trust deed indicates that no beneficiary certificate is issued. Therefore, this beneficial interest registry may be directly linked with a blockchain and nothing other than the registration would be required to complete a transfer (including perfection).
Furthermore, under the Industrial Competitiveness Enhancement Act (which was amended and enforced on 16 June 2021), a transfer may be perfected against the debtor and third parties if a notice or consent to the transfer has been conducted through a certified business operator that uses information systems with certain features. Although so far there have been no cases in which an STO has been conducted using this provision, several business operators (including major trust banks) have acquired certification to conduct demonstration plans of their new information systems.
One of the upcoming issues for STOs is the development of secondary markets. Under the current FIEA, providing an online platform to trade securities is regulated as a Proprietary Trading System (PTS) and requires the Prime Minister’s authorisation. Given the current situation, in which there is no PTS operator dealing tokenised securities, there are discussions about relaxing the regulation on PTS operators dealing non-listed securities.
Outbound investment trends have continued. Throughout the past few years, Japanese investors have continuously expanded their outbound investments into foreign real estate markets, seeking to take advantage of good domestic economic strength mixed with relatively limited investment opportunities within Japan. 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.
It has been 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. There have been three outbound investments by J-REITs to date:
Even after the global COVID-19 pandemic exerted considerable pressure on economic activity in Japan, domestic and foreign investors have actively and consistently invested in Japanese renewable energy businesses.
After the Japanese Feed-in-Tariff regime (the “FIT Regime”) came into effect in July 2012, the proportion of renewable energy in Japan’s power generation mix increased from approximately 9% to 18%.
As the next step towards independent renewable energy, a major amendment to the Japanese Renewable Energy Act was promulgated into law in June 2020 and came into force in April 2022. Under this amendment, Japanese Feed-in-Premium regime (the FIP Regime) has been introduced ‒ thereby representing a shift away from the FIT Regime.
Along with ordinary renewable energy businesses (ie, solar, onshore wind and biomass), development of offshore wind projects has greatly accelerated in recent years. The major developers in this field are domestic energy businesses, including trading companies (shosha), major construction contractors and Japanese utilities providers.
The Offshore Renewable Energy Act came into force in April 2019, with the aim of promoting the development of offshore wind projects in Japan. Under the Offshore Renewable Energy Act, the Japanese government designates specific zones for the development of offshore wind projects (“Promotion Zones”). These sites are available for tender and the award of occupancy permits with a maximum term of 30 years. From 2019 to 2022, eight tender processes commenced under the Offshore Renewable Energy Act for eight Promotion Zones in Nagasaki Prefecture, Chiba Prefecture, Akita Prefecture and Niigata Prefecture. More Promotion Zones are expected to be designated within a few years, according to a government announcement indicating that ten sea areas have progressed to a certain level of preparation for commencing projects.
Per its Green Growth Strategy Towards 2050 Carbon Neutrality (published in December 2020), the Japanese government plans to achieve around 50% to 60% of total power generation through renewable energy by 2050 ‒ with offshore wind power considered a high growth potential sector. In response to the legislation anticipated under this strategy, investments and developments in the renewable energy section will be continuously stimulated during the course of the next few decades.
ESG factors have gained as much attention in the real estate market as in other investment sectors.
In order to create a sustainable environment, it is widely understood that real estate – as a basic component of society – should follow global policy by, for example, contributing to Sustainable Development Goals (SDGs). The real estate industry is thought to have significant potential to play an important role in meeting SDGs, especially with regard to the environment. Buildings have been developed to achieve high environmental performance by reducing energy consumption. Buildings with environmental performance certificates appear to attract more investments than those without such certificates.
In line with the promotion of ESG goals, the number of Japanese participants in Global Real Estate Sustainability Benchmark (GRESB) Real Estate Assessment has been increasing. On the basis of market capitalisation, the participation rate of listed J-REITs was reported to have been approximately 90% in 2019. GRESB Real Estate Assessment is the global ESG benchmark for the sector. It captures information on ESG performance and sustainability best practices for real estate and gives rating results. More and more investors have referred to, or are considering, GRESB Real Estate Assessment for their investment decisions.
The Japanese government is also delivering positive signals regarding ESG/SDGs. It has published policies related to this field, such as:
The Japanese government’s strategy to improve environmental performance in the real estate sector includes the idea of a green lease, which the government also proposes through its Green Lease Guide. In a green lease, the owner and tenant share the costs of environmental improvements to the leased building.
Along with private funds, public money has been flowing into investments aimed at redeveloping and remodelling aged buildings to improve their seismic capacity and environmental efficiency. The green bonds market is also growing and collecting funds to be spent on eco-friendly businesses.
A form of emissions trading called the “J-credit system” is also being developed. The J-credit system is a system under which the government certifies the amount of emission reductions resulting from certain energy-saving equipment and the use of renewable energy as “credits”, which can be the subject of business trading.
ESG measures are currently at an early stage of development in Japan. Although certain examples are being created, it seems that ESG investment methods, disclosure models and the effects of ESG investments have not been established completely. Nevertheless, global ESG trends will continue to grow in the Japanese real estate market and attention should be paid to this development.
One of the latest reforms to Japanese real estate law concerns legislation related to land with unknown owners (including owners whose whereabouts are unknown) – most of which will become effective in April 2023. The background to the legislation is that land with unknown owners – something that is relatively common in Japan – has become a social issue, as it can complicate disaster reconstruction and other projects.
To facilitate transactions for land with unknown owners, the legislation establishes a new management system for such land, under which courts may appoint a manager for such land upon request by an interested party. A court-appointed manager is authorised to sell or otherwise manage such land (with or without the court’s separate permission).
In addition, if multiple owners co-own a parcel of land, they all need to reach an agreement should they wish to proceed with a sale; however, the legislation enables co-owners to proceed with a sale without the consent of an unknown co-owner after obtaining court authorisation. This may increase the market liquidity of lands co-owned by groups that include unknown owners. The legislation also permits the exclusion of the voting rights of unknown owners in order to approve the alteration or management of co-owned property (with court approval).
The legislation includes other rules, such as those enabling a landowner to set up facilities for a lifeline (eg, electricity, gas and water) in neighbouring land or use such facilities owned by a neighbour. These rules are intended to facilitate the easier management of land.
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