The sun is rising again for Japan -

Having stumbled its way through the last decade; a powerful combination of economic and demographic change is now sweeping the country.

Japan, still the world's second largest economy despite the burst of the great bubble in 1990, is enjoying a prolonged period of growth; and for the first time in 15 years, land values in Tokyo are rising. While the Government is working to reassert Japan as the financial powerhouse of Asia, mergers and acquisitions are at an all-time high.

The number of Japanese families with large amounts of disposable income and a willingness to spend it on more luxurious life styles is soaring. At the same time, the Government's innovative Visit Japan campaign is opening up the country to thousands more tourists each month, and has an ambitious goal to bring in 10 million a year by 2010.1

All of these factors have naturally impacted the country's tourism industry, particularly the hotel sector, which has recently seen one of Japan's largest real estate transactions. Here, we take a closer look at what's happening, especially within the luxury hotel segment.

The ups and downs

Hotels began to transform the country's skyline back in the 1960s and 1970s, with the 1964 Olympics in Tokyo, the Osaka Expo World Fair in 1970, and the Sapporo Winter Olympics in 1972 all driving development.

Among them was the Hotel New Otani Tokyo, which, along with the Imperial Hotel, Tokyo – which first opened in 1890 – and the Hotel Okura Tokyo, became Japan's classic top three hotels. The trio remained in

a class of their own until the 1990s, when the Four Seasons Hotel Tokyo at Chinzan-so, the Park Hyatt Tokyo, and The Westin Tokyo replaced them in the classic luxury hierarchy.

Many hotels prospered through the ‘age of leisure' of the 1970s and 1980s, a time of high economic growth, increased personal incomes and robust domestic demand. Hotels became the preferred venues for weddings, corporate meetings, negotiations and banquets.

As this period was more about prosperity rather than rivalry among hoteliers, outsiders from other industries – railroad companies, airlines and real estate firms for instance – moved in, as they sought to diversify their business portfolios.

Airlines, in particular, followed aggressive development plans to accommodate the enormous increase in the numbers of Japanese travelling abroad. In most cases, employees from the parent companies were assigned to run the hotels, even though they had no specialist knowledge of the sector. But at a time when everyone was making good money, this was not an issue.

While it's easy to profit in a rising market, when things started to go wrong in 1990, the situation changed. Japan's bubble burst, and the hotel industry was among the first to suffer. With less money to spend on corporate entertainment, weddings and other celebrations, the gap between those with professional management and those without quickly widened.

Consolidation and restructuring began, and even long-established companies were forced to sell company housing, recreation facilities, and other properties they had owned for decades. Companies with hotel subsidiaries in their portfolio couldn't carry the poor performers and had to either shed their hotels or outsource their management while they focused on core activities.

Good news for investors

While the downward spiral was bad news for some hotels, the ensuing fall in rents and property prices was good news for foreign and domestic investors, who were attracted by the falling rents and property prices in central areas. Redevelopment projects began as businesses and individuals relocated back to Tokyo at an accelerating rate.

The more favourable conditions in the real estate market led to the emergence of the first Real Estate Investment Trusts (REITs). J-REIT funds were established in 2001 and by early 2007 had reached a total market capitalisation of over US$48billion (¥6 trillion.)

These funds provide an investment vehicle while promoting transparency and liquidity in the real estate market. However, with a large number of private real estate funds, some analysts believe the commercial property investment market is overheating. This prediction, on top of diminishing returns, has led investors to choose hotels and other operational assets instead, accepting the greater risks for potentially higher returns.

This shift is illustrated by several major purchases, including the Seahawk Hotel & Resort in Fukuoka from Daiei by Colony Capital in 2003, the Shin-Kobe Oriental Hotel from Daiei by a Morgan Stanley real estate fund during the same year, and the acquisition of The Westin Tokyo in Meguro from Sapporo Holdings by the Morgan Stanley Group in 2004. These moves also led to the separation of ownership, management and operations, which had previously been integrated.

The launch of the first J-REIT to specialise in hotels – Japan Hotel and Resort, Inc, which was listed in February 2006 – is another example of the trend.

Sluggish real estate prices have kept property-related costs low for hotel management, encouraging market newcomers. Some international brands, for instance, have been welcomed by developers to join them in redevelopment projects, as a luxury hotel enhances the site value while giving the hotel brand a great opportunity to enter the Japanese market.

The added incentive for the developer is that incorporating a luxury hotel enables them to utilise exceptions to floor space ratios and other building regulations, thereby making the project more cost-effective. The number of new hotels located on the upper floors of office buildings with high-rise lobbies confirms the popularity of this move.

A taste of luxury

Japan has seen a major boost to its luxury hotel market recently. The Conrad, Mandarin Oriental and Ritz Carlton are all boosting the number of high-end rooms in Tokyo. The Peninsula is also scheduled to open in September. Meanwhile, Morgan Stanley plans to acquire IHG ANA's 13 hotels in Japan for US$2 billion (¥280 billion) – one of Japan's largest real estate transactions and one that has attracted massive media interest.

As well as the strengthening economy, the demand behind these developments is from overseas visitors and from Japan's rapidly growing ‘nouveau riche'. Both groups of people are keen to spend their money on luxurious items such as top-notch hotel rooms, and both groups are expanding.

Chart 1 below shows the success of the Government's sustained marketing campaign in bringing in more visitors from around the world. 

According to the Ministry of Land, Infrastructure and Transport, 5.21 million people visited Japan in 2003 when the campaign was launched. This number has risen to 7.33 million in 2006 – up by more than 40%.

Visitors from Asia make up around 70% of the total, and China is expected to become an increasingly important source market. According to the Japanese National Tourism Organisation there were more than 632,000 visitors in February this year, up 22% year-on-year and the highest number on record.

The number of visitors from Canada, for instance, is up by 29%, from France, up 18.6% and the UK up 9.7%

If these patterns continue, the country will undoubtedly hit its 10 million a year target.1

The picture at home

Looking at domestic demand, two factors are having a major impact. First, the retirement of thousands of the ‘baby boomer generation' workers, all with plenty of free time on their hands to travel within their own country and overseas.

Second, the rise of the ‘nouveau riche'. While middle class numbers have actually decreased in the last few years, those earning US$24,400 (¥3 million) or less a year and those with incomes of US$162,000 (¥20 million) or more a year have gone up.

The baby boomers and the newly-rich, with their experience of luxury hotels abroad, are looking for similar standards at home and are happy to pay for it. Those with healthier bank balances are also keen to spend money on spas, beauty salons, health clubs and other private facilities, often found within Tokyo's luxury hotels.

Pushing up demand

While some analysts suggest there is an oversupply of hotel rooms in Japan – with more than 1,700 foreign-owned rooms added to the total in recent years – in reality, the increase in supply is simply pushing up demand. Some hotels are proving so popular that reservations must be made months ahead, and some have to restrict access to facilities such as restaurants to hotel guests only.

These relatively small-scale, ultra-luxury establishments represent a new segment for Japan and while 1,700 is a sizeable amount, it still only represents 2% of the overall hotel market in Tokyo, so the competitive impact remains small. However, as many of these niche hotels are still regarded as a novelty by Japanese consumers, who tend to favour the new, it's too early to predict the longer-term impact.

By the time the Shangri-La Hotel is due to open in March 2009, the competitive landscape will be easier to assess.

More to come

Like any market in its early stages, Japan's luxury hotel sector has had some teething problems. Its rapid expansion raises issues over staffing, as the demand for qualified people to work in this class of hotel – where professional service is rated very highly – is already outstripping supply.

The tourism infrastructure also needs more attention, as access from Narita Airport for visitors is a problem; and the lack of year round international conference business makes it difficult for hotels to maintain a steady flow of income.

However, there are several positive factors that play to Japan's hand. First, Tokyo's status as a world city and key player in the global economy continues to pave the way for strong hotel performance. The city's average room rates now outperform not only their Asian rivals, but also many of the European powerhouses.

According to the HotelBenchmark™ Survey by Deloitte, Tokyo's revenue per available room (revPAR) stands at US$181 for the first five months of 2007 – almost on a par with London (US$188). In fact of all the major Western European cities, only London and the perennially expensive pair, Paris and Geneva at US$196 and US$198 respectively, achieved higher revPAR than Tokyo during this period.

This impressive performance from Tokyo was driven by an average room rate of US$236, which rose by 10% from the same period in 2006.

Second, there are plenty more overseas visitors on the way. The number of people travelling by air is expected to reach 2.3 billion by 20103, and with more luxury hotels opening, Japan will be able to give many of them a warm welcome.

Meanwhile, Tokyo is bidding to host the 2016 Olympics, and the gaming industry is hoping the ban on casinos will be lifted across the country. The signs, therefore, continue to look good for the tourism industry in the land of the rising sun.

Ryuji Sawada
Partner, Deloitte Japan
Tel: +03 6213 1122
Email: ryuji.sawada@tohmatsu.co.jp

1. Japanese National Tourism Organisation (JNTO)
2. Japan Tourism Marketing Co
3. Hospitality 2010 Report, produced by Deloitte, 2006

www.deloitte.com