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Published by the CIPS Network of the National Association of REALTORSŪ
First Quarter 2004
The Japanese Economy Will Benefit from Improved Real Estate Markets
By David Lereah
The expression: "don't look a gift horse in its mouth," reverberated in my thoughts during a recent 15-hour flight returning from Tokyo to Washington, DC. I had just spent four days participating in an exchange of information and ideas between NAR leadership and their Japanese counterparts at the first Japan - U.S. Summit on housing. The sense that I returned with was that sometimes you don't know how good things are until someone else points it out.
After many years of sluggish economic performance, the Japanese government is turning its policy focus to real estate, having observed how the U.S. real estate markets have supported and elevated U.S. economic growth over the past several years. Having been frustrated by its inability to turn its onceproud economy around, Japan has implemented a wide variety of monetary and fiscal programs aimed at bringing its economy into full recovery, to no avail. Now, the government has turned to the real estate sector for a needed boost for the economy. Its purpose at the Summit was to understand how the U.S. real estate market contributes to economic growth.
Real estate underpins U.S. economy
The U.S. housing sector has accounted for about 33 percent of all U.S. economic growth in the past several years. Additionally, the housing sector impacts about 20 percent of our Gross Domestic Product each year. Also, about 40 percent of disposable household income is spent on housing and housing-related goods and services.
The value of U.S. real estate now exceeds $14 trillion, while the number of owned homes totals 120 million, averaging over 2,000 square feet in size. No other nation's housing sector comes close to that. The growth of U.S. real estate activity is unique among nations. Since 1970, U.S. home sales have more than doubled in volume on an annual basis, while mortgage debt outstanding has increased tenfold, annually.
The trillion-dollar question for Japan is: What are the differences between the U.S. and Japanese real estate markets that have resulted in the dominance of U.S. housing activity and its subsequent contribution to the overall economic activity in the U.S.? To find some answers, our approach with the Japanese leaders followed a simple outline: (1) to identify the marked differences (vibrancy comparisons) in housing activity between the two nations; (2) to compare the role of government in the housing sector; (3) to identify structural differences in the housing sector between the two nations; (4) to review the historical and current real estate difficulties in both the U.S. and Japan; and (5) to conclude with observations and hurdles to overcome for the Japanese housing sector.
Vibrancy comparisons
Comparisons of current U.S. and Japanese housing activity prove revealing. Perhaps the most startling comparison was that, on average, 16 percent of U.S. households relocate in a given year, compared to only 6 percent of Japanese households. The lower mobility rate may have more to do with cultural differences-Japanese families have a higher tendency to pass their homes on to their children than American families do. Japanese workers tend to stay at one company for a longer period of time than their American counterparts. These lower mobility rates have negative consequences for Japan's housing sector in comparison with the U.S. For example, annual home sales in Japan are a scant 0.6 percent compared to 5 percent in the U.S., and the ratio of existing to new home sales is 1 to 5 in Japan versus 6 to 1 in the U.S.
It is also clear, however, that unlike the U.S., Japan does not encourage first-time home buying. Just 13 percent of the 25 to 34 years old group in Japan will purchase a home each year compared to a 40 percent of that age group in the U.S. Not surprisingly, the typical down payment for first time homebuyers in Japan (40 to 60 percent) is significantly higher in Japan than the U.S. (5 to 20 percent). Finally, U.S. homeownership rate is 68 percent compared to 60 percent in Japan.
The differing roles of government
There are marked differences in government involvement in the housing sectors of the U.S. and Japan. The U.S government has made an enormous effort to support the U.S. housing sector through favorable tax policy and direct and indirect government housing programs. The role of government in Japan's housing sector is relatively limited.
U.S. policy permits tax deductions on mortgage interest (primary residence, secondary residence, and home equity) and property taxes, and granting capital gains tax relief. In Japan, mortgage interest deductions are limited, there is no permanent relief, and there is no capital gains tax relief. In addition, the Japanese estate tax is extremely burdensome on real estate. In the U.S., there are many exceptions (e.g., setup of trusts, large allowance, etc.) associated with the 50 percent estate tax rate; Japan's 70 percent estate tax rate is the highest in the world and offers no such exclusions.
Perhaps one of the most important differences between the two nations is the fact that U.S. mortgage loans are basically non-recourse loans, while Japan's mortgage loans are not. In the U.S., lenders have the right to foreclose property, but other recourse is prohibited or is just not practiced. Conversely, in Japan, lenders have the right to go after personal assets to recover loans. This is a great inhibitor for the Japanese real estate market versus the U.S.
The U.S. government-via Federal Housing Administration and the Veterans Administration programs-provides significant purchasing assistance to homebuyers. Down-payment assistance programs for low-income households are common. In the U.S., two great mortgage suppliers-Fannie Mae and Freddie Mac-represent a significant government subsidy to America's households, through product innovation, lower mortgage rates and an overall reduction in home buying costs. Very few such programs exist in Japan.
Industry structure comparisons
In reviewing the primary and secondary housing markets of both nations, we saw marked contrasts between the U.S. housing system and a simpler Japan housing system. For example, the U.S. primary housing market is comprised of such market participants as REALTORSŪ, mortgage bankers, mortgage brokers, and title insurance companies, home inspectors, and appraisers. These are mature industries that are regulated and licensed. Japan has no mortgage banking industry (most lending is done primarily through commercial banks), no mortgage brokerage industry, and no title insurance industry. A few large banking companies, real estate companies and homebuilders dominate Japan's primary housing market.
The secondary housing market, which is a crucial ingredient for the success of the U.S. housing system-via Fannie Mae and Freddie Mac-is very limited in Japan. There are no government-sponsored agencies in Japan to provide a stable flow of mortgage funding to the housing sector. Japan has few institutions that are in business to smooth and manage the risks inherent in the buying and selling of homes. The U.S. has many risk intermediaries such as Fannie Mae and Freddie Mac that guarantees mortgages for the pooling of loans made by mortgage banking companies, private mortgage insurance and public (FHA) mortgage insurance, hazard insurance, title insurance, E & O insurance, and fidelity insurance.
The U.S. housing markets also have an advantage when it comes to the dissemination of property information via the Internet. Multiple listing services, virtual office Web sites, and national home price listings Web sites such as REALTOR.comŪ provide potential homebuyers with the necessary information to conduct house searches. Japan has an Internet-based property-listing site, but postings are usually delayed about seven days.
Historical lessons available for Japan
Mark Twain once said, "history never repeats itself, but sometimes it rhymes." There are lessons to be learned from U.S. history. The savings and loan crisis in the late 1980s and early 1990s had similar characteristics to the current circumstances in the Japanese real estate and banking industries. Japan's decade-long banking crisis has created a substantial number of problem real estate loans, resulting in a considerable drop in land and home prices. The Japanese government has instituted a practice of leniency with its financial institutions, permitting banks to restructure their problem loans rather than dispose of them. As a consequence, a great deal of money is tied up in problem loans, representing a severe misallocation of resources in the Japanese economy.
When the U.S. faced its savings and loan crisis in the late 1980s and early 1990s, a high percentage of its lending institutions experienced serious earnings reductions problems because of problem real estate loans partly due to changes in the 1986 Tax Reform Act. The U.S. government acted decisively, creating the Resolution Trust Corporation (RTC) whose sole purpose was to manage the disposition of problem assets. Bank regulators permitted over 300 banks and savings and loan associations to fail. Their problem loans were quickly sold by the RTC at discounted prices to the public in about four years. This massive sale and removal of problem loans from the U.S. banking system virtually eliminated investor uncertainty in the marketplace, permitting America's financial system to get back on track.
Some final observations
In Japan today, there are a low number of real estate transactions occurring, partly due to cultural and traditional business practices and partly due to the lack of government assistance. Japan's real estate taxes place a relatively high burden on individuals, inhibiting their participation in the buying and selling of real estate. There is a limited secondary market for residential mortgage loans in Japan, seriously limiting liquidity in the nation's housing sector.
Some of the solutions that have been successful in the U.S. might help revive Japan's real estate market by creating an environment favorable to real estate transactions. Lowering the real estate tax burden on individuals would reenergize participation in the home buying process. More frequent and timely data collection on real estate pricing would provide advantageous market information to support buyers and sellers of real estate. Creation of an active secondary market for residential mortgage loans would provide greater liquidity for the housing sector and a greater variety of mortgage products available to households. A partnership between government and private enterprise would establish public and private risk intermediaries to reduce uncertainty in both primary and secondary real estate and mortgage lending markets.
Japan, the U.S., and the global economy can only benefit from improvement in the Japanese real estate market.
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