Should I rent or buy in Japan? This is a fairly common question that we encounter when speaking with clients. Much of the conventional wisdom would claim that buying is always better than renting, with the reason being that “rent is just throwing money away- at least with a mortgage I’m building equity”. While the statement is technically correct, it has a laundry list of built in assumptions. From a financial perspective, it may in fact not only be far less risky to rent, but also cheaper.
That said, the purpose of this article is not to discourage people from purchasing their own home. There are many scenarios whereby a home purchase is a solid foundation for building up a portfolio of long term assets and security; and Japan also offers some of the lowest home interest rates in the world. However, we would like to dispel some of the common misconceptions associated with home ownership. Before going forward, it is important to clarify that this article will be on the subject of purchasing a primary residence. This will not address real estate investment, buy-to-let, or property speculation; it will only analyze the primary nuts and bolts of the seemingly innocent question of “should I rent or buy?”.
The best way to begin thinking through this question is to lay out all the quantifiable costs associated with home ownership and then weigh them against the benefits. The first hurdle to get over in recouping costs in the form of equity will be the transaction costs:
–Broker Fee: The standard broker fee in Japan is 3.24% of the transaction price, plus 64,800 JPY. Normally the buyer and the seller each have their own broker; though in some cases one broker could represent both parties. It is unusual to find a Japanese property broker willing to offer a discount on these fees. This is usually tax deductible for both the buyer and the seller.
–Judicial Scrivener Fee: In order to arrange for a title transfer, you are required to retain the services of a judicial scrivener. Their fees can vary quite a bit and as part of their invoice they will include the registration tax. Overall you should expect to pay around 60-120,000 JPY plus 1.5% of the transaction price. If you are using a mortgage, you will need to pay another 0.4% of the total mortgage amount (0.1% for residential properties).
-Stamp Duty: If you have experienced just about any other kind of transaction in Japan, you will not be a stranger to going to the post office to buy a stamp to fix upon the paperwork. Buying real estate is no different. This stamp will range between 10,000 JPY and 80,000 JPY.
–Acquisition Tax: Not due immediately at closing, but this bill will need to be settled with the local government office within a few months of purchasing the property. The tax as a % will vary (depending on how big a budget the local government needs in that year), but expect to pay between 0.5% and 1%.
-Annual Possession Taxes: The first year these taxes will not be as heavy, as the taxes are technically only liable to the property owner as of January 1st. That said, in Japan it is customary to reimburse the seller for your share of the taxes for that year. The annual possession taxes are 1.4% fixed assets tax and 0.3% city planning tax. For primary residence (non-investment property), these are reduced to 1/3 and 2/3 of the standard tax, respectively.
Total: This comes out to around 7% that will need to be paid up front in transaction costs. This puts the home owner at a negative position from the start, and that will then need to be recouped over time. The good news is you will start to dig yourself out of this hole with your first mortgage payment. The bad news is, not all of the monthly mortgage payment goes towards building equity…
Let’s look at an example with some simple loan terms for easier math:
–Purchase Price: 60,000,000 JPY
–Loan Amount: 50,000,000 JPY
–Loan Terms: 30 year mortgage at 1% interest
–Total Transaction Costs: 4,200,000 JPY
This mortgage would require a monthly payment of around 160,000 JPY and, in the beginning, each month around 40,000 JPY from that payment goes towards paying interest and 120,000 JPY will go towards paying back the mortgage. These are favorable terms for a loan relative to much of the rest of the world (where interest rates could easily be around 4.5%, which would almost double the monthly payment). This allows the homeowner to build approximately 1.4 Million in equity the first year (120,000 JPY per month * 12 months = 1.4 Million). In the above example the homeowner would have paid around 4.2 Million JPY in transaction costs, which makes it sound like it will only take about 3 years to get back to even (4,200,000 / 1,400,000 = 3).
Unfortunately it’s not quite that simple…
Owning and residing in a piece of real property can involve some very real annual costs. Aside from general depreciation over time, you will experience periodic costs that need to be paid for out of pocket. The following are some of the primary costs:
Ongoing Out-of-Pocket Costs:
–Annual Possession Tax: Already mentioned above in the transaction section, this tax will come back to roost every year as the central and local government require tax revenues to keep things going. As a residential property this will run at 1/3 of 1.5% for the fixed asset tax, and 2/3 of 0.3% for the city planning tax.
–Insurance: Various types of insurance will form a notable annual expense. Fire insurance, for example, is often quite cheap to acquire, only a few thousand JPY per year. The bank may however require a life insurance benefit built into the loan to essentially forgive the loan in the event of the main income earner’s death. A standard practice would be to charge a one-off 2% of the total loan value up front, though in return the bank may reduce the interest rate.
–Maintenance costs: Now that you aren’t renting, if something breaks or wears out, it will be your responsibility to fix it. From leaky or broken faucets, to periodically having to make major purchases such as new air conditioners, new window seals, new hot water heaters, etc.; all the way up to repairing the roof or a deteriorating exterior. If you own an apartment, you will likely have to contribute towards other general building repairs, such as new elevator purchase or periodic major repairs, etc.
Returning to the example above, the annual equity gain of 1.4 Million will be reduced by annual costs of 600-800,000 JPY per year on average. Now it looks like it will take 5 or 6 years just to earn back all the fees paid from transaction costs. (4,200,000 / 800,000 = 5.25)
However, let’s address the scenarios in which you would need to move. What if you lose your job, or your company transfers you to another area? (or you simply decide to move to another area/country); or perhaps you have a child or two (or three) and need to expand to a bigger place? If you move out, there will be another round of transaction fees, though this time not so high (around another 3-4% total). Adding to the above, the round-trip transaction costs now add up to approximately 6.3 Million JPY, all of which needs to be recouped in exchange for buying a property and then potentially moving out.
In other words, for the famous “rent is just throwing money away, at least with a mortgage I’m building equity” statement to hold water, you may need to be certain that you are able and ready to stay put in one place for more than 7 or 8 years, just to break even.
This is the basic methodology for assessing the transaction costs and equity buildup in a home. There are a few more major considerations that could make the property purchase more or less favorable, though a proper analysis would require a conversation with a professional and property-specific information.
Other major considerations:
–Do land value and property value historically increase or decrease in your targeted area? Historically, real estate tends to average around 5-6% annual growth. That said, depreciation and operating costs tend to average about 2-4%; which brings the net return down to around 3% (which, after inflation, is almost no growth). Japan is also unique in that property structure values almost always only go down after purchase, and land values don’t appreciate either…
–What about opportunity cost? If you took the money used for the down payment and transaction costs, and instead put it into any other investment and achieved a market return, how much could you earn over that period of time?
–While renting, is your employer paying your rent direct from salary? Often in Japan, employers can pay rent on your behalf using before-tax earnings; this could mean hundreds of thousands of JPY worth in annual tax benefits disappearing if you got a mortgage instead. Your annual income tax bill will increase.
–If you moved out but kept the property and rented it out, what then? If it changed to an investment property, would your loan interest rates go up? The friendly rate you secured was on the basis of a primary residence- not an investment property. If you left Japan how would that effect the loan and interest terms? Would average rental yields cover the interest, equity, taxes, and maintenance costs?
-What are the intangible benefits of home ownership? This article has crunched some of the numbers, but what value do you place on home ownership? Does it outweigh the costs?
As is the case with many of the most common questions, there is no one simple answer. A great many different variables of an individual’s personal situation must be considered. In working closely with clients to provide guidance on all other aspects of their financial situation, we are typically in a good position to help answer the question “should I rent or buy in Japan?”.
- Tokyo Bureau Of Taxation – Fudosan
- Japan National Tax Agency – Tax System on Possession of Land
- Japan Ministry Of Land, Infrastructure, Transport and Tourism – Tax Table of Registration and License Tax