Investors prefer high yields but banks prefer younger buildings
Regardless of cash buyer or loan user, any property investor prefers higher yield. Particularly, those who are suggested by a bank over 4% loan rate would never consider the properties yielding slightly over 5% and tend to seek much higher one if any.
Cashflow analysis is important not only for the investors but for bank’s loan review, too, but how much they can finance is mostly based on the property value, and the value they tend to closely look at is of the building rather than of the land. Any building starts to depreciate immediately after completion of the construction. The younger the building is, the higher value banks see in the property and the more comfortably they offer loan to the investor. And most of the young buildings yield low.
“Banks see high yield as risk.”
This is what I have recently heard from a bank loan specialist. When you think about junk bond market, you will see the point.
High yield properties have reasons why they are priced so. Notable ones may be one the followings:
- The building is old.
- The building is located far from the nearest station or has access problems (with use of bus or no public transportation available).
- The building construction has some problems (e.g. exceeding the limit of floor-area ratio or building coverage ratio, the current state not matched up with what the building certification (建築確認書 or kenchiku kakuninsho ) indicates, etc.)
- The property bears “告知事項 or kokuchi jiko” (e.g. associated with any accident or trouble in the past such as suicidal event, murder, etc.)
Building age may not necessarily matter from tenant’s perspective if it is located in the area where everyone dreams to live such as Omotesando, Daikanyama, Azabu, Shirokanedai, etc. ). However, such exceptional properties are limited, and overall, banks see little justification to finance you for old building.
#2 and #4 would put potential tenants off their intent to rent, which is likely to lead to vacancy risks. Regarding #3, the extent to which valuation is affected depends on the level of the problems, and the approach seems to vary among banks. Some may not care while others turn down the loan application itself.
But the difference between the current state of the building and what was approved at the construction (#3) seems to be seen as a big flaw of the property because the building certification is useless in light of what it is supposed to serve as.
Therefore, as with bond market, it can be said that properties on the market with high yield imply higher risks compared to low-yield properties.
In the next article, I would like to show you rough distribution of yields in Tokyo area.