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Negative rates may be driving Japan's rental sector loan spike

Fueled by banks eager to find new borrowers to take out loans, Japan's apartment rental sector may be seeing a new construction bubble.

In the fiscal first half ended Sept. 30, Japanese banks' new loans to the real estate sector hit an all-time high of ¥5.894 trillion, according to data from the Bank of Japan. This number attracted significant attention, as the level is even higher than seen during Japan's real estate bubble in the late 1980s.

Especially worrisome is the category of loans to individuals directed into the construction of new apartment homes aimed for rental use.

"Construction of new apartment homes has been increasing even in places where the population is shrinking," an official at the Financial Services Agency told S&P Global Market Intelligence.

The country's industry watchdog began collecting lending data from banks earlier in December to analyze the situation, the FSA official said.

An enhanced inheritance tax on cash took effect in January 2015, leading the wealthy to look for ways to pass on assets to their children while minimizing the tax burden. One channel that has gained traction among wealthy Japanese people is to fund and own apartment homes that will be let and managed by housing companies.

These outstanding loans have been rising quarter over quarter for seven straight periods since the March 2015 quarter, from ¥20.442 trillion to ¥21.573 trillion as of Sept. 30.

The adoption of the negative interest rate policy in February by the Japanese central bank further encouraged banks to look at loans generated to construct apartment homes for rental as a way to mitigate a wider fall in interest income.

The September quarter saw a 4.6% yearly rise for this loan category, much higher than the 2.9% year-over-year rise in banks' total outstanding loans to individuals for the period.

"This [business strategy] will not work in Japan, where population numbers are shrinking. The banks would pay the price sooner or later," said Shinya Furue, a bank analyst at Norinchukin Research Institute.

As a result of continued investment, the total number of newly constructed homes for rent owned by individuals rose to 425,000 in October, up 22.0% year over year, according to the Ministry of Land, Infrastructure, Transport and Tourism. In comparison, housing starts of new houses were up just 4.9% in October, while housing starts of new apartment homes for sale were up 9.0%.

"We need to keep an eye on developments," the ministry said in a November report.

Not all of these newly built apartment homes will be able to find tenants, particularly in Japan, where the population is shrinking.

There are no statistics available on vacant homes across the country, though real estate information firm TAS Corp. tracks data covering metropolitan areas around the Japanese cities of Tokyo, Nagoya, Osaka and Fukuoka. According to a TAS Corp. report released in November, the rate of vacant units in Tokyo apartment buildings is above 33%.

"Many regional banks do not study each business case closely, as they have been focusing on finding new borrowers to offset falling interest income amid the negative interest rate policy," Furue said. Ultimately, these loans to build rental apartment units may turn nonperforming, Furue noted.

"Problematic lending could accumulate to serious levels," said Takehiro Noguchi, a senior economist at Mizuho Research Institute.

At a Dec. 20 press conference following the central bank's last monetary policy meeting for the year, BOJ Governor Haruhiko Kuroda tamped down concerns about a potential bubble in the rental market. Kuroda said these loans are not "overheating," though the central bank "would like to encourage banks to manage risks."

However, Noguchi is cautiously optimistic about the BOJ's actions to alleviate the operating environment for banks going forward, as consumer prices may rise thanks to a weaker yen and relatively higher crude oil prices.

If the Japanese economy does experience inflation, the BOJ may adjust its target yield for 10-year government bonds from zero percent to slightly higher at some point in 2017.

"If bond yields rise a little higher, banks' business environment would improve, so they would be less likely to desperately look for any borrowers they can find," he said.

As of Dec. 22, US$1 was equivalent to ¥117.52.