As discussed in an earlier article, property illegality is one large reason a property might be priced lower than market average and thus advertising a higher yield.
Property Illegality comes in multiple forms and this is a series of articles that will go through the different types starting with the over built floor space ratio buildings.
In Japan, all land is regulated to the amount of floor space that can be built on the land. This is translated to English as the “Floor Space Ratio” or 容積率（ようせきりつ / You-seki-ritsu) in Japanese.
The most common issue with illegality is that the structure on the land exceeds the allowed FSR. This can be for a couple of reasons.
First, when the structure was built, it did meet regulations but then the city altered the allowable FSR in subsequent years thus making the existing structure non-compliant. This is usually an issue with older buildings.
The second reason usually is because the current or previous owners built an extension on the existing structure that put the FSR over the limit.
In both of these cases, the way this illegality effects property pricing is because if one was to rebuild on the land, one would not be able to rebuild to the same existing floor space and ergo would not be able to generate the same rent that is currently in place.
In addition, banks are very hesitant to finance to the borrower’s full capacity on properties exceeding FSR limits.
Despite all this, if you are determined to purchase a high yield property of this nature and are willing to use your own cash, then what you need to look at is how difficult and expensive would it be to renovate the structure to comply with existing FSR regulations.
In one case I saw, the structure when originally built complied with FSR regulations. The first floor of the building was half used as an office the other half used as an outdoor parking lot.
The previous owner then built an extension from the office to replace the parking lot and rented it out to a restaurant.
In this case two issues arise: one is that post renovation, the structure now exceeds the FSR limits but the second is that since the renter is a restaurant, then the health and fire departments need to get involved to ascertain whether the restaurant meets health and fire codes.
In this case, evicting the restaurant and demolishing the extension is a simple way to solve the problem and as far as FSR compliance issues goes is relatively straightforward in terms of a solution. That said, the rent generated from the evicted restaurant will be lost thus lowering the yield.
When the city lowers the FSR limits for the land is when it becomes very complicated. It basically means one would have to demolish the existing structure and rebuild to new FSR limits. It means evicting all tenants, demolishing the existing structure, commissioning an architect to design the new structure and commissioning a construction company to build. Then find new tenants.
Basically, due to lack of buyer financing which lowers the price and rentable floor space that exceeds FSR limitations are two combined reasons you see a higher than average yield. Due diligence is the key to finding this issue before they become your problem and not that of someone else.
Editor’s Note: Shirley is Sales Director for Housing Japan. She has sold billions of yen of real estate and arguably has the highest client satisfaction rating in the industry. Shirley writes a weekly column for Housing Japan readers to help illustrate common challenges buyers and sellers have when trading Tokyo residential property.
