Explaining Japanese real estate investment structures – a historical perspective

Real estate investment in Japan is becoming an increasingly attractive proposition for global investors. As the world’s third largest economy, it has a vast, sophisticated market and a governing party committed to increasing inward foreign investment. For many non-domestic investors, however, the process of investing into Japan can be daunting due to lack of cultural awareness or familiarity with the common Japanese structuring vehicles used for such transactions.

It is now normal practice for inward investment into Japan to use an offshore fund or corporate vehicle as part of the structure. These offshore domiciled and administered entities typically then acquire the underlying real estate asset utilising a Japanese “KK-TK” or “GK-TK” structure. The term “KK-TK” or “GK-TK” is largely ambiguous to the foreign investor, so what are these structures and how did they evolve?

It all started with a need for protection and limited recourse

The mid- to late-1980s was an era that saw Japanese equity markets rise to unsurpassed levels, supported by a confidence driven by the strength of the Japanese Yen and the Bank of Japan’s excessive monetary easing policy. Real estate in Japan also benefitted from the liquidity and availability of credit, which subsequently pushed up the price of this asset class to previously unimaginable levels.

In early 1992 the bubble burst, leading to the previous unsustainable era becoming known as the “bubble” economy. As property prices in Tokyo fell by as much as 60% in value, investors were left with an asset that was significantly lower in value than the loan secured over the property. The lenders had recourse to the full repayment of the financing provided, but the borrowers/investors were unable to repay the debt in full due to the fall in real estate values.

The industry therefore needed to create a method of financing whereby the provider of the finance had limited recourse if the security (real estate) was insufficient to repay the debt.

A common method outside of Japan was to use a limited liability special purpose vehicle (SPV)  to hold the real estate asset. The security interest in the form of a mortgage was then created over the asset and held by the SPV, ultimately protecting the owner from the potential of having to repay any difference between the value of the investment and the outstanding loan liability.

In Japan, however, this route was found to be impracticable, whilst the creation of a mortgage also generated additional tax burdens. Instead, the chosen solution was to place the real estate assets in a trust and allow the interest in the trust (the “trust interest”) be bought and sold, then pledged (as opposed to “mortgaged”).

Achieving bankruptcy remoteness

To complete the structure one other element was required, generally known – especially in the world of securitisation – as “bankruptcy remoteness”.  Bankruptcy remoteness protects investors or companies within a structure from becoming affected or contaminated should another party in the structure be forced into bankruptcy. To build this condition into the structure, the equity investor must not carry a voting right. This is where TK, or Tokumei Kumiai, comes into the “YK-TK” referred to below.

TK is a special subset of partnership under Japanese law. As TK investors cannot usually force the limited recourse vehicle into bankruptcy, lenders would be happy to look only at collateral values (i.e. the value of the asset that secures the loan) when making lending decisions.

Why YK?

At that time, many individuals were dissatisfied with TK-only structures. In theory, there were still certain circumstances that could force a company into bankruptcy proceedings.  In the late 1990s, there was a form of company called Yugen Kaisha, or YK.  If a YK was the borrower, then no one could force it into a form of bankruptcy where the security interest is caught in the proceedings. Therefore, as long as the borrower was a YK and the lender was a secured creditor, the lender would not have to worry about a potential bankruptcy as they could always rely on the value of the security.

From YK-TK to GK-TK and KK-TK

This is how the structure “YK-TK” came to be realised. However, it became impossible to establish new YKs after a new corporate code was introduced in Japan in 2006.Instead of YK, participants could use Godo Kaisha (GK) for the same purpose. A GK looks similar to a limited liability company in other countries. Importantly, a GK is not the same as a KK (Kabushiki Kaisha, a share-issuing company incorporated in Japan), meaning it is not subject to Company Reorganisation and thus is a preferred vehicle among some individuals.

There is also a general consensus in the market, however, that a KK would unlikely be granted a Company Reorganisation bankruptcy status. This is why you can also find KK-TK structures in the Japanese market.

As the appetite for real estate investment in Japan continues to grow, its monetary easing policy, the depreciation of the yen and its strong historic returns in the real estate market are all contributing factors as investors look for a wider array of investment opportunities. Moreover, as Japan prepares to host the 2020 Olympics, further real estate investment opportunities are likely to arise while it is expected that the type and form of structures in the domestic market will also evolve to meet investor needs.

Time will attest whether a stellar rise in RE investment is likely, but one thing is certain: all eyes are on Japan.

 

Expect Moore

At Moore Management we have considerable experience setting up offshore funds and corporate vehicles to invest in Japanese structures so that our clients do not have to do so directly.

We have an office in Japan and we know Japan. Our Tokyo office exists to serve not only our local clients, but also our international clients who want to invest in Japan. As your fund administrator, we deal with the Japanese structures on your behalf, communicating in Japanese and taking care of the local legal and administrative procedures.

If you are interested in investing in Japan through Moore Management (or First Names Group) administered structures, or would like to find out more about the services we offer, please don’t hesitate to get in touch.

E: Manabu.Nagano@mooremanagement.com

T: +81 3 6441 3986

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