Tokyo: land of rising opportunity and cost

Japan’s former Prime Minister, Shinzo Abe stood on the steps of the New York Stock Exchange in late 2013 and told the world to ‘buy my Abenomics’. It was the start of a programme of major economic reforms, new foreign investment and global positioning which has seen Japan quietly remodel itself – a process of reinvention which continues today under the premiership of Abe’s successor, Yoshide Suga.

While longstanding economic issues prevail, including deflation and the world’s fastest ageing population, Japan remains the world’s third largest economy with a population of 126 million and a reputation for sophisticated technological prowess.

Long overlooked against other Asian neighbours in the 1990s and during the first part of this century, Japan and Tokyo are once again being seen globally as promising investment propositions. Well-educated workers, excellent public transport systems and established institutions make the country a safe and attractive place to invest.

As the world prepares to celebrate the Tokyo Olympics this summer, the nation looks on track to join the economic recovery now gaining pace in east Asia.

Drivers of growth

There are a number of market and government policies currently driving decisions. Private and international interest is balanced and supported by the government’s own spending, with Japan investing US$2.2tn – a figure which remains the highest of any nation.

Global investors including the US tech giants are especially interested in real estate as Japan offers the potential for significant growth in e-commerce, given consumer take-up remains behind China and Europe. Similarly, a stable power grid and proximity to other Asian hubs is fuelling significant growth in a buoyant data centre market.

Prime Minister Suga’s ambition to attract 60 million tourists by 2030 and double the size of the industry is driving investment for real estate and new infrastructure. A swathe of projects are moving forward from new integrated resorts and large hotel developments (including the recently announced teardown and rebuild of the renowned ‘Imperial Hotel’); train station upgrades at Shibuya, Toranomon and Tokyo stations; new stadiums such as Nagoya’s Aichi Smart Arena; and new cultural facilities ready for Japan to host EXPO in 2025.

Japan’s commitment to the Paris Agreement and net zero emissions by 2050 is another catalyst for new investment in renewables such as offshore wind, as well as reopening of some of its existing nuclear power plants.

The country remains the world’s second largest automotive exporter and while some manufacturers are rumoured to be looking at establishing electric vehicle (EV) battery plants in Europe, several of its marques are rebalancing their global footprint towards domestic manufacture once again.

The pipeline of real estate and infrastructure projects, together with the uniqueness of the Japanese construction industry, has seen Tokyo become the number one most expensive place to build in the world.

Against this backdrop, what do real estate clients embarking on construction projects in Tokyo need to consider? What steps should they take to mitigate rising prices in order to set up projects for success?

Full order books

Firstly, clients must understand the resource challenges that are driving construction price inflation. With only five major contractors in the Japanese market, Olympic Games construction meant that some firms were not able to take on other projects, with many long-planned schemes only now coming on stream.

Based on demand and current pipeline, contractor order books are full for the next four to six years and they are therefore able to command >10 percent margins – significant figures compared to margins of 1.5–2.0 percent in some parts of the western world.

The drive to net zero and infrastructure projects around offshore wind in particular will further squeeze capacity. While there will be international contractors entering the market to deliver these renewable projects, they are likely to form joint ventures with Japan’s five main contractors – so resource challenges will still prevail.

Looking beyond cost per sq ft

While clients and real estate investors need to benchmark costs, they should ultimately move beyond a simplistic cost per sq ft methodology in the Tokyo market. A broader understanding is needed of what costs have been in the past, and where, based on capacity and resource availability, they could go in the future.

Comparison with other global cities is not always useful given the unique local market dynamics.

Even within the Japanese market, prices can vary significantly depending on the contractor, landlord, management company and construction methodology.

Labour costs

Labour costs are also not a barometer. While Tokyo labour costs are lower at an average of US$31.3 per hour compared to US$109.0 per hour in New York, the volume of man hours typically invested on a Japanese construction project makes the total labour cost higher than that of a similar-sized project in other global cities such as San Francisco and Geneva, which sit within our ranking of the top five most expensive places to build.

Navigating complexity

Because of these nuances, there is a real need for clients to engage cost managers early before project budgets have been agreed. The complexity of the market requires a cost and programme manager with a deep understanding of the Japanese industry to work with the client’s real estate team to define the budget. For example, the cost of construction logistics in Tokyo remains a key factor in defining a realistic budget.

Some projects in densely populated central Tokyo should allow up to 30 percent of the build cost to be from the logistical and access challenges of working in a confined urban hub. As construction in every market in the world grapples with material supply challenges, Japan and Tokyo are clearly not immune to material shortages and price inflation. Japanese buildings, particularly tall towers, are largely built from steel due to the need to protect against seismic activity. Recent increases in permitted tall building heights in Tokyo mean steel is hotly in demand for new skyscrapers.

As steel fabrication must conform to the Japan Industrial Standard (JIS), this often means steel must be locally sourced from Japanese steel fabricators who meet these specifications. This typically adds a further 15–20 percent onto steel costs, which can’t be mitigated against through alternative sourcing.

Counting the cost of off site

Like all markets, off site construction offers an opportunity in Japan to drive productivity and reduce reliance on site labour. With an ageing workforce and capacity challenge, greater automation and off-site manufacturing is vital, however, like in many other countries, modern methods of construction in Japan still remains in its infancy.

Yet new approaches will not be the silver bullet to tackling cost in the short to medium term. In Japan, perhaps more so than other developed nations, new technologies will always come with higher costs during the initial implementation stages due to the need to upskill and retool a contractor pool that is wedded to traditional approaches and that has limited incentive to change, given the current abundance of demand and their continued monopoly.

Investing in the land of opportunity

The launch of Abenomics was the starting gun for new foreign investment in Japan. In an Olympic year, the investor race in Tokyo looks set to continue.

Tech occupiers are investing, the Bank of Japan is pouring money into the economy and the country is preparing for the infrastructure and industrial and commercial real estate it needs for a net zero world. The challenge for clients who are embarking on projects in the buoyant Tokyo market is to realise the opportunity and get them over the finishing line, on time, and on budget.

For further analysis of the global economic and construction landscape see our International construction market survey 2021.