The unmaking of the ‘widow-making’ trade? 

For decades, the ‘widow-making’ trade referred to investors betting on rising Japanese yields when they actually continued to fall. In December 2022, the Bank of Japan (BoJ) surprised markets by adjusting its yield curve control policy, which allowed the Japanese 10-year bond yield to rise higher. After the unexpected rate hike in July 2024, investors are questioning if this time will be different. Will Japanese property yields rise?

The abrdn Global Macro Research team doesn’t expect a sharp rise in Japanese policy rates. While wage increases are starting to show, core and services inflation is slowing. Yet, Japan’s exit from its ‘lost decades’ seems only partially convincing, given demographic trends and challenging productivity. Easing by the US Federal Reserve is also expected to relieve pressure on the Japanese yen. From mid-August, the Japanese two-year government bond yield softened to 0.32% from 0.46% at the start of August.

In our view, there are more fundamental questions for real estate investors. Do higher interest rates necessarily translate into higher property yields in Japan? If not, what could be a more important driver? And how should capital allocators position themselves, given the heightened uncertainties?

Rental growth is a more important driver of Japanese property yields

Data going back to 2002 suggests that rising Japanese bond yields don’t indicate higher property yields in the following year (Figure 1). This suggests that other factors are driving Japanese property yields. One aspect could be the rental growth outlook. Higher long-term bond yields have typically coincided with faster rental growth – like what we’re seeing today. As Japanese 10-year bond yields rose from just 0.3% in the fourth quarter of 2022 to a high of 1.09% by the end of June 2024, the year-on-year (YoY) rental growth for selective market/sectors – like Tokyo’s prime retail properties and multifamily rental apartments – also accelerated. Even Tokyo’s grade-A offices, which had an average YoY rental decline of 6% in the fourth quarter of 2022, have turned around to register a gain of 1.9% in the second quarter of 2024[1].  

“Investors are happy allocating capital to Japanese properties if there is healthy rental growth, since an increase in interest rates doesn’t alter the leveraged return proposition by much.”

Japanese properties have traded at large yield gaps to borrowing costs (Figure 2), chiefly because of ultra-low interest rates. This could explain why rental growth has been a more important driver of yields/capital values. Essentially, investors are happy allocating capital to Japanese properties if there is healthy rental growth, since an increase in interest rates doesn’t alter the leveraged return proposition by much. 

This context may be especially relevant today. While Japanese property yield gaps have compressed to levels that are considered tight relative to their history, they remain attractive compared with their peers. As such, healthy investment demand may keep a lid on Japanese property yields, particularly in sectors where the rental growth outlook has improved.

Listed real estate and multifamily assets may offer better risk-adjusted returns

Our analysis suggests there may be limited upside risks to Japanese property yields, even if interest rates were to rise a bit more. But the near-term investment outlook has become more uncertain. Investors assessing Japanese real estate opportunities may consider the following to cap downside risks:

Figure 1: Historically, higher Japanese bond yields didn’t precede higher property yields 

Note: pp = percentage point

Figure 2: Japanese yield gaps – tight relative to history but still attractive relative to peers

Note: yield gap = market yield - 5-year swap rate; 1SD = 1 Standard Deviation; APAC DM ex-Japan = the weighted average of Australia, Singapore, Hong Kong and South Korea by market capitalisation

Final thoughts…

Despite the uncertainties around borrowing costs in Japan, we believe Japanese properties remain an attractive asset class and we don’t expect a material increase in property yields. For investors who are more cautious, investing in sectors with improving rental growth or via the listed route may provide downside protection.