Are Wooden Apartment Blocks a Good Investment? A look at the advantages and disadvantages.
The material that a building is made of-wood, reinforced concrete, or steel-plays a major role in real estate investment.
Here we will explain the basics of managing a wooden apartment block and analyze their advantages and disadvantages.
(As advertised) High profit margins
Difficult to get loans and higher monthly payments due to shorter lifespan
High gross yield
Noise complaints are more common
Lower repair, remodeling costs
Repairs, remodeling are more common
Higher risk of damage in a natural disaster
What does it mean to manage an apartment block?
In Japanese, the word “apaato” is generally used to describe a wooden building with several apartment units. Apartment management refers to buying the entire apartment building and renting it out. As a comparison, “mansion”-condominium buildings built with reinforced concrete (RC) and steel reinforced concrete (SRC) -are sold to investors as single units. However, wooden apartments on the other hand are usually sold en bloc.
One of the most important aspects of any real estate investment is the yield. The yield is the ratio of annual income to the total investment amount. There are two types of yield: gross (calculated with only the annual income and the price of the property) and actual yield which takes all of the other fees associated with property ownership into consideration.
When comparing RC, SRC, and wooden block apartments, apartment blocks have a major advantage - as advertised in numerous publications aimed at investors. Generally, condominiums are only sold as single units to investors. However, all of the units of a single apartment block are usually sold at the same time to a single owner.
Additionally, investors can expect higher yields from apartments - just like you often see advertised. However, the income and yields that you see come with the condition that all of the units are completely tenanted. If there is a vacancy, the yield, of course, decreases as well. On top of that, the "yield" that you see listed on advertisements is the gross yield, so the actual yield is somewhat lower after taking other costs into consideration. For this reason, making a split-second decision by just looking at the income and yield is incredibly risky.
Depreciation and Mortgage Payments: The line between success and failure
If you are considering operating an apartment block, you will need to pay particular attention to the lifespan. The lifespan refers to the number of years that the machinery and building will hold their value and is determined by law. Wooden apartment blocks have a lifespan of 22 years.
This lifespan is important to consider, because it impacts the depreciation and mortgage payments.
Depreciation and Lifespan
First, let's look at the relationship between depreciation and lifespan. Depreciation is a method of allocating the purchase cost of a fixed asset over its entire lifespan rather than just in the year it was purchased. There are two different methods of calculation: listing a set amount or a set percentage of the total each year. The lifespan for apartment blocks is 22 years.
Therefore, it is possible to split the cost over the entire lifespan, but the calculations run differently for second-hand properties. It is general practice to receive an estimate for the remaining lifespan of an apartment block, but this process is not simple. The method of calculation for the lifespan for tax purposes is as follows.
If the lifespan of the building has already expired:
Legal lifespan x 20%
The legal lifespan for apartment blocks is 22 years, so
22 years × 20％＝4 years
Structures for which the lifespan has not yet expired are calculated as follows:
(Total Lifespan - Years in Service) + Years in Service x 20%
For example, a structure that has been in use for 10 years would be calculated in the following way:
(22-10)+10 ×0.2＝14 years
If the lifespan changes, the depreciation each year is also affected. Having a good understanding of depreciation is extremely important when investing in real estate, so be sure to check into it before buying.
Relationship Between Mortgage Payments and Lifespan
Next, we'll take a look at the relationship between mortgage payments and lifespan. Taking out a mortgage is common practice when investing in real estate without paying the full amount in cash. In this case, the term of the loan is a good indicator of the lifespan of the property. When applying for a mortgage, the financer receives the foreclosure rights to be able to use the property as collateral should the purchaser not be able to make payments. For that reason, the lifespan of the property is one of the most important factors in determining the term of the loan. Therefore, logically, the longer the term of the mortgage, the lower the monthly payments. Thus, this is great from the cash flow perspective. On the other hand, the shorter the term, the higher the monthly payments, and so it is more likely that an owner might not make enough to cover the entire sum.
As we saw before, apartment blocks have a legal lifespan of 22 years. In comparison, new RC buildings have a legal lifespan of 47 years. From this, we can see that apartment blocks are associated with higher monthly payments and are more difficult to find a mortgage for compared to RC buildings.
Looking a little more in depth at this point, second-hand units have an even shorter lifespan. The calculation of the remaining lifespan is not the only factor that affects the mortgage term. However, it is one important indicator that should not be overlooked when purchasing real estate.
Management Risks: Noise, Wear and Tear, etc.
One example of management risks of apartment blocks is noise issues. There can be major differences in noise cancellation depending construction, but generally speaking apartment blocks have less noise-cancellation than SRC, RC buildings. So, issues can arise between neighbors due to loud noises. This is an important risk to consider, since tenants could decide to move out of their unit due to noise issues which increases the vacancy rate in the building.
Wear and Tear
One characteristic of apartment blocks is that they wear down faster than RC and SRC buildings. If a building continues to wear down, the exterior becomes less attractive and the interior looks older. This, of course, leads to more tenants moving out and a higher vacancy rate. In order to prevent this, areas that are worn down need to repaired and remodeled regularly to keep the building in good condition. However, the costs associated with repairs and reforms are relatively low compared to RC and SRC buildings. But since apartment blocks tend to wear down more quickly, it isn't possible to give an overall monetary amount that fits all buildings. In any case, funds for repairs and reforms should be set aside in addition to monthly mortgage payments to offset the risks to a long-term stable income.
Another down side to apartment blocks is the impact of natural disasters. In some cases due to structural issues, apartment blocks could suffer damage during natural disasters such as earthquakes and fires. If the damage is only partial, the funds set aside for repairs and maintenance could be use to repair the structure. However, if the entire building collapses before the mortgage is paid off, it could be a large minus for the owner.
Apartment blocks are also at risk of fire damage. Since the structures themselves are made of wood, a fire that stars in one units could quickly spread to other units and burn the entire building down.
For these kinds of circumstances, it is possible to take out insurance to cover earthquakes and fires. However, they may not cover all of the repair costs, and it may not be possible to receive rent payments while the building undergoes repairs.
As with all investments, apartment blocks have several advantages and disadvantages. Although the gross yields of apartment blocks is higher at first glance, the effects of depreciation and the inherent risks of wooden structures should also be considered. If you are considering purchasing an apartment block and want more information before making your final decision, our team is available for consultations on the various advantages and disadvantages associated with these properties.
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