The Central Business District in Tokyo’s Grade A office market has been experiencing a recovery since 2Q2012, after hitting market bottom due to the Great East Japan Earthquake in 2011. Although the market experienced its twentieth consecutive quarter of growth, the rental level still remains below 70 per cent of the market peak from back in 2008, before the Global Financial Crisis.

While other major markets such as London, New York and Hong Kong have already recovered close to 90 per cent or more of their previous peaks, Tokyo has room for further rental growth. However, if we consider the next five-year supply projections in Tokyo, we might need to reconsider the future of rental growth in the Tokyo market.

Figure 1: Historical movement of Grade A supply and demand
Source: JLL Jan 2017

Compared to the 10-year average of Tokyo’s Grade A office supply, which is 315,000 sqm, the next five-year average is 415,000 sqm, or 32 per cent higher. Furthermore, the figures for the next three years up till 2018, 2019 and 2020, are 604,000 sqm, 443,000 sqm, and 729,000 sqm, which far exceeds the ten-year average.

Huge supply pipeline: Potential high vacancy

This huge supply amount is expected to cause a certain amount of vacant space. This is particularly true of the projects concentrated in the Minato-ward bay area, such as the Tamachi, Hamamatsucho and Takeshiba areas where the developments are built on vacant land.

In these areas, the land was not used for office space. In contrast, projects in the Marunouchi and Otemachi areas are re-development projects with existing tenants having to relocate. This means that potential tenants will have to move in from other areas into the projects in the bay area, whereas in Marunouchi and Otemachi, some demand will be created by demolishing the existing buildings. However, in the bay area, take-up in the buildings will start from scratch.

In addition, there are several projects concentrated in Toranomon, which was previously used for hotels. This would also require potential tenants to move in from outside the Toranomon area. With average rental levels in Toranomon around JPY 36,000/tsubo/month (USD 109/sqft/annum) which would entail competition with the Minato-ward bay area mentioned previously.

As these new projects come online from 2018 to 2020 creating vacant space, landlords are likely to offer lower rents to attract new tenants. This would impact the existing buildings as the current Tokyo Grade A office average rent is now JPY 36,439/tsubo/month (USD 110/sqft/annum).

However, the current rental level is still less than 20 per cent above the bottom of the market in 2Q 2012. Considering the rental decline of more than 40 per cent from the 2008 peak to the 2012 bottom, there is very limited downward risk of rents falling as the previous low was caused by the Global Financial Crisis, followed by the Great East Japan Earthquake – both of which are considered black swan events.

This time the downward risk will come from the supply side and we expect the rental decline to be very limited and of a temporary nature that will be followed by a recovery.

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