Learn more about the diverging trends emerging in Tokyo’s Grade A office market

In Q3, the vacancy rate increased to 4.1% whilst rents decreased by 13.2%.

As a whole, Tokyo’s Grade A office market in the central five wards (C5W) has continued to see moderate corrections, with vacancy rates increasing and rents on a downward trend. 

According to a Savills report, as of Q3/2022, the average vacancy rate rose from virtually 0% in the pre-pandemic period to 4.1%. Meanwhile, the average market rent has decreased by 13.2% from the pre-pandemic peak of JPY37,800 per tsubo achieved in Q2/2020 - a complete reversal of the accelerated growth that was seen leading up to 2020.

Here’s more from Savills:

Nonetheless, the adverse impact from the pandemic has been felt unevenly across the market. While a number of office buildings have performed poorly, many other properties have in fact demonstrated resilience and have been doing well throughout the pandemic. 

For instance, Graph 1 illustrates that although there are more properties with higher vacancy rates in Q3/2022 compared to Q2/2020, an overwhelming majority have maintained low vacancy rates. Furthermore, the scale of rental corrections varies across the market, with some buildings seeing more significant changes in rent than others (Graph 2).

Diverging trends are also apparent at the submarket level, as we have shown in our past quarterly office briefings. In order to gain a better understanding of the underlying cause, we have carefully analysed each submarket to draw insight. Although different factors are at play in different areas, the two factors that seem to have significantly contributed to diverging performances are building age and accessibility. In this report, we have attempted to quantitatively validate this assertion using linear regression models. 

The findings are summarised in Graph 3. Overall, the reasonably high R2 values show that the models can explain performance variance to a reasonable extent, though many other factors seem to have affected individual property performances. While this indicates the limitations of the models’ explanatory power, at the same time, we believe that these results indicate that value-add opportunities are present. 

Essentially, if individual properties’ performances were dictated by unchangeable factors such as building age and accessibility, there would be little room for investors to add value. Indeed, there are successful examples of offices that have observed rental increments due to bold strategic initiatives and capital expenditure plans.

Overall, Tokyo is expected to remain a popular target market for international investors due to its market size and stability. Indeed, some large transactions recorded in recent quarters highlight strong investor appetite for office assets in the Tokyo market. Specifically, a large interest in Otemachi Place West Tower that was transacted recently is a noticeable example. 

Although it was eventually acquired by domestic investors, it has been reported that several overseas investors joined the bidding process with keen interest. Even outside of prime submarkets, quality properties with value add opportunities are also receiving sound interest from investors with large capital to deploy. As investor interest is expected to increase once recovery starts in earnest, our discussions in this report are intended to provide a framework for thinking through about what is to come next.