This country-specific Q&A provides an overview to real estate laws and regulations that may occur in Japan.
It will cover the most pertinent issues including ownership structures, restrictions, transfers, taxes and environmental contamination.
This Q&A is part of the global guide to Real Estate. For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/real-estate
In Japan, our economic and legal system is based on private ownership, and therefore, generally speaking, real estate transactions are not restricted. The real estate and transactions thereof are basically governed by the Civil Code of Japan, and the building and underlying land are subject to separate ownership under the Civil Code.
How is ownership of real estate proved?
Ownership of real estate is confirmed through public real estate registries, which show registered ownership (and registered encumbrances). While such registration does not guarantee good title and title insurance is not available in Japan, it is generally perceived as sufficient evidence of ownership in the market and unless due diligence reveals a specific issue there is only a low risk that the registry does not show the correct ownership of the property.
Are there any restrictions on who can own real estate?
There are no restrictions on who can own real estate in Japan. Administrative regulations may require certain filings for certain classes of owners.
What types of proprietary interests in real estate can be created?
Ownership in real estate is held either in fee simple or in trust (in which case a trustor, usually a trust bank, holds ownership), which combine with other common property rights such as leases and superficies to allow for a variety of investment structures.
Leaseholds can be created in land or structures, and are the most common type of use right. A contractual lease right can be perfected (i.e. a lessee can assert its leasehold right against a new owner of the property or a third party) if the leasehold right is registered (which requires the consent of the owner). In addition, a leasehold of land can be perfected if the lessee owns a registered building on the leased land. A leasehold right of a building can be perfected if the building has been delivered to the lessee. Japanese building leases are categorized as either standard leases (futsuu chintai shaku) or fixed term leases (teiki tatemono chintai shaku). The principal difference between these two types of leases relates to the renewal provisions. Under the standard lease, as a default rule, the lease term is automatically renewed for an unspecified term under the existing terms and conditions unless (i) the lessee desires to terminate the lease agreement or (ii) the lessor has a “justifiable basis” under law to terminate the lease and gives at least six (6) months’ notice of termination. Under a standard lease, any agreement which would put the lessee in a more disadvantageous position would be invalid. In contrast, under a fixed-term lease, such automatic renewal provision would not apply so long as the lease satisfies certain fixed-term lease formalities (such as the lease being in writing, providing for a definite term with no right of renewal, and delivery to the lessee of a written explanation of the non-renewal provisions before entering into the lease).
Superficies are similar (but the strongest) rights to use land, but unlike a leasehold right, the superficies is a proprietary right to use land for a specific purpose, such as owning facilities or trees. Unlike the leasehold right, as a general rule, the holder of a superficies can transfer it to a third party without the consent of the owner.
Various security interests can also be created in real estate properties, and the most common of which is a mortgage. In transactions where the property is held in trust, a pledge of trust beneficiary interest is commonly used instead of a mortgage.
Is ownership of real estate and the buildings on it separate?
Ownership of land and the buildings thereon is separate. As a result, the sale of land will not automatically be accompanied by a sale of the building thereon unless the parties specifically agree to a sale of the building.
What are common ownership structures for ownership of commercial real estate?
The owner (mostly corporate entity) most commonly holds commercial real estate in fee simple. However, in the non-recourse transactions undertaken by investment funds and other sophisticated investors, typically an SPC is created to obtain financing and to hold the fee simple properties or the trust beneficiary interest thereof (in which case a trustee owns fee simple properties). Some advantages of the trust structure are: (1) lower acquisition and registration taxes, (2) the Real Estate Syndication Law (which requires the SPC to have a certain license unless exceptions are met) does not apply, (3) the benefit of the trustee’s cash management, and (4) the benefit of the trustee’s due diligence of the property.
Nonetheless, the use of a certain type of SPC called a “TMK” (for tokumei mokuteki kaisha) under the Law Concerning Asset Liquidation can avoid falling under the Real Estate Syndication Law, making it easier for the TMK to use ownership of fee simple. The use of a TMK may also have beneficial tax consequences to many investors.
What is the usual legal due diligence process that is undertaken when acquiring commercial real estate?
Legal due diligence covers (i) check of title, perfection thereof, and any line over target properties based on registries, (2) review of any property related documents which a new owner would succeed such as tenant lease agreements, (3) review other property related documents such as engineering reports and border confirmation documents to see if there is anything which impacts the client’s right over the properties.
Typically, legal due diligence would not cover (i) what kind of administrative or regional regulations apply to the area or the target property and the compliance therewith, (2) if buildings are in compliance with architectural or construction related laws (including fire preventions and facilities), (3) the applicability or possible effect of city planning or zone use, (4) environmental liabilities, and (5) any matters which require physical due diligence (such as confirming actual boundary confirmations). Those would be covered by other professionals such as licensed real estate brokers and land and house investigators.
Legal due diligence is often led by purchaser’s counsel. During the course of due diligence, purchaser typically communicates with seller through interviews, questionnaires or letters to request the relevant material or necessary documents or confirm legal risks. There is no market standard form or report or enquiry. In a purchase and sale agreement, seller will often represent and warrant title as well as any other pending issues, such as boundary confirmation, and may deliver third party opinion letters.
What legal issues (if any) cannot be covered by usual legal due diligence?
In general, legal due diligence would not cover (i) what kind of administrative or regional regulations apply to the area or the target property and the compliance thereof, (2) if building is in compliance with architectural or construction related laws (including fire preventions and facilities), (3) the applicability or possible effect of city planning or zone use, (4) environmental liabilities, and (5) any matters which require physical due diligence (such as actual boundary confirmations). Those would be covered by other professionals such as licensed real estate brokers and land and house investigators.
If there are many tenants, legal due diligence may also exclude reviewing all tenant related agreements except for material tenant agreements (if any).
What is the usual process for transfer of commercial real estate?
A transaction involving a large-scale property typically begins with a non-binding letter of intent (“LOI”), which generally includes intentions of parties to sale/purchase a target property, purchase price, property descriptions and conditions. Although a non-binding clause is commonly provided in the LOI, there are some judicial precedents holding that a party should compensate for damages incurred by counter-party in certain cases, such as unexpected refusal to execute in the very final stage of a negotiation.
Most transactions will include certain market-standard terms and conditions and there are some purchase and sale agreement formats in the market. However, real estate professionals (brokers, financial institutions, real estate investment funds, asset management companies) have and use their own formats, confirmed by legal counsel.
At closing, seller extinguishes any encumbrances and registrations thereof and seller and purchaser register the transfer of ownership to purchaser. In general, parties appoint and entrust a judicial scrivener to prepare required documents and make arrangement for these registrations. If a target property is entrusted, seller and buyer obtain trustee’s notarized consent (with a fixed date stamp) for transfer of a trust beneficiary interest and perfection thereof.
· Preparation of agreements
· Negotiation of conditions
· Collection/ Preparation of documents regarding target property
· Consultation with a judicial scrivener regarding termination of existing agreements to a target property.
· Confirmation of repayment conditions and deletion of security interests with lender(s) (if financed)
· Correspondence to inquiries from buyer
· Start of a legal due diligence
· Preparation of agreements
· Negotiation of conditions
· Draft a questionnaire
· Consultation with lender(s), property manager(s), and trustee (if a target property is entrusted).
· Solicitation to equity investors
· In typical commercial transactions, due diligence is completed before the execution of purchase and sale agreement, and purchaser would not have the right to terminate PSA without a cause or due to unsatisfactory result of the due diligence.
Signing to Closing
· Confirmation of loan repayment conditions and deletion of security interests with lender(s)
· Confirmation of documents for closing
· Execution of termination agreements with relevant parties
· Confirmation of purchase price and settlement amounts
· Negotiation of financing agreements
· Preparation for closing (i.e. pickup of a closing venue, confirmation of documents)
· Confirmation of purchase price and settlement amounts
· Funding pursuant to financing agreements (and/or investment agreements)
· Repayment of any existing debt and discharge of security interest
· Deliver of property related documents
· Perfection for title transfer of a target property
· Settlement and arrangement of purchase amount
· Confirmation of conditions precedent for closing
· Settlement and arrangement of purchase amount
· Perfection for title transfer of a target property
· Receiving loan amounts under a financing agreements
· Perfection for lender’s security rights (i.e., registration, consent with fixed date, etc.)
· Execution of related agreement (i.e. property management agreement, etc.)
· Settlement of amounts after closing
· Performance of post-closing items
· Settlement of amounts after closing
· Confirmation of performance of post-closing items by seller
Is it common for commercial real estate transfers to be effected by way of share transfer as well as asset transfer?
Although commercial real estate transfers are sometimes effected by way of share transfer, it is not common because of the additional due diligence on the asset owner that must be conducted by purchaser.
However, where asset owner also has a considerable amount of unrealized losses arising from the target properties, purchaser may choose a share transfer in order to take advantage of the unrealized losses against any gains from the future sale of the properties.
Share transfers are also used when the asset owner is an SPC and the scope of due diligence is limited, or in connection with the transfer of a portfolio of properties, where the bulk acquisition justifies due diligence of the asset holding company in addition to due diligence of the properties.
On the sale of interests in land does the benefit of any occupational leases and income automatically transfer?
As a general rule, perfected leasehold rights transfer automatically upon the sale of leased land or structures. If the lessor is not the owner of property (for example, in case a tenant sub-leases its premises to an end tenant), tenant leases between the tenant and end tenants would not transfer without the consent of end tenants.
What common rights, interests and burdens can be created or attach over real estate and how are these protected?
Various rights, interests and burdens can be created or attached to real estate by agreement or by operation of law. Creation and removal of these rights is generally straightforward. Rights created by agreement to own or use property include: leasehold and superficies – right to use a third party’s property in exchange for the payment of rents; easements – rights to use a third party’s land for the benefit of the easement holder’s own property, such as a right to pass through the adjacent land to go to public road; and options to purchase property.
Security interests created by agreement include mortgages securing debt obligations and pledges of real estate properties securing debt obligations. Security interests created by operation of law include liens securing fees arising from construction of the property and retention rights, such as a construction company having a retention right over the building it constructed to secure payment of its fees.
Registration of rights created by agreement listed above is not required for such rights to be enforceable against the grantor, but registration is required in order to ensure such rights and interests are enforceable against a subsequent bona fide purchaser.
Registration of estimated construction fees prior to commencement of construction must be made to secure the effect of liens securing fees arising from construction of properties. No registration is required for retention rights.
Are split of legal and beneficial ownership of real estate (ie Trust structures) recognised?
Yes. Title to real estate property may be held in trust, with a trustee holding legal title and beneficial title held by separate beneficiaries. To secure the property as a trust property against third parties, registration of transfer of legal title from trustor to trustee must be filed, as well as registration of trust. Generally speaking, the trustee must obtain consent from beneficiaries to sell the trust property. Therefore, a purchaser of a trust property should confirm that each beneficiary has consented to the transfer of such property.
In practice, sale of trust properties are not so common because it is more cost effective to acquire trust beneficiary interests than fee properties, as real estate acquisition tax would not apply to the acquisition of trust beneficiary interest, and amount for registration tax for trust beneficiary interest is minimal (1,000 yen as of December, 2017). Also, generally, a trustee is not flexible regarding the terms of the purchase and sale agreement to avoid any liability associated with the property, and so purchasers tend to prefer entering into a purchase and sale agreements with a beneficiary rather than with the trustee.
What are the main taxes associated with commercial real estate ownership and transfer of commercial real estate?
The main taxes associated with commercial real estate ownership and transfer are as follows.
Tax associate with Ownership of Properties:
Annual Fixed Asset Tax and City Planning Tax are levied on owners of fixed assets (regardless of resident or non-resident) (land, buildings, depreciable assets) typically on the first of January each year by the relevant municipality. The owner as of January 1st is responsible for these taxes, even if ownership of the property changes on the 2nd of January or a subsequent date. Typically, when the sale of property occurs, seller and purchaser agree to pro-rate those taxes.
Tax associated with Proceeds of Rent and Sale of Properties:
While a resident (to Japan, for tax purposes) company who receives rents or proceeds from the sale of real estate properties is not subject to withholding tax (but subject to corporate income tax), a foreign company which makes direct investment into real estate properties in Japan is subject to withholding tax for rent proceeds and for proceeds arising from a sale of properties, regardless of if such company has permanent establishment in Japan or not. Note that in order to avoid imposing on tenants an obligation to pay to authority the amount of withholding tax, transaction are typically structured with a master lessor company (a resident company) between tenants and the asset holding foreign company.
Instead of making a direct investment, a resident company or a foreign investor often makes an investment through a so-called TK investment (i.e. quasi equity investment) to an asset holding SPC, because a TK investment can avoid double taxation and is subject only to taxes on investors’ level if certain requirements are met. In such case, the TK investor’s (foreign investor’s) right to receive profit is subject to withholding tax for the proceeds arising from asset TK business conducted by holding SPC. If the investor does not have permanent establishment in Japan, then there is no further taxation on such proceeds, but if there is a permanent establishment, the investor is subject to corporate income tax as well.
The permanent establishment would likely be established if there is a branch or office of such investor in Japan or if there is an agent which is authorized to enter into agreement on behalf of investors in Japan. TK investment is a passive investment, therefore, as long as investment is categorized as a TK investment from legal and tax perspective, it is unlikely that TK investment would result the permanent establishment. (To avoid doubt, mere ownership of commercial real estate in Japan by a non-resident does not constitute a permanent establishment.)
Note that tax treaties applicable to parties may reduce the rate of or exempt the withholding tax.
Tax associated with acquisition of real estate properties:
A separate acquisition tax is imposed upon the acquisition of fee properties. Currently (as of 2017), as a general rule, acquisition tax is 3 to 4 % of the evaluated price of fixed assets, depending on the property. Moreover, consumption tax applies to the acquisition of real property other than land (8% of the purchase price as of 2017).
Also, a registration tax will apply when the purchaser registers the acquisition of fee properties.
What are common terms of commercial leases and are there regulatory controls on the terms of leases?
A lease of real property in Japan is governed by a number of Japanese laws, including the Land Lease and Building Lease Law of Japan (Law No. 90, of 1991, the “Lease Law”). There are two types of leases normally used in Japan: (i) the so-called standard or typical lease (futsuu chintai shaku) and (ii) the fixed term lease (teiki tatemono chintai shaku). The principal difference between these two types of leases relates to the renewal provisions.
Standard Lease: A standard lease has an initial term, but under the default rule, this term is automatically renewed for an unspecified term under the existing terms and conditions unless (i) the lessee does not desire to continue the lease agreement or (ii) the lessor has a “justifiable basis” to terminate or not to renew the lease under the Lease Law and gives at least six (6) months’ notice to lessee. Even if lessor and lessee agree something different from the above, any agreement which would put lessee more disadvantageous position than that under default rule, would be deemed invalid under Lease Law. Either the lessor or the lessee may request an increase or decrease of the rent due to changes in market conditions, irrespective of the terms of the lease. However, the lessor may not demand an increase of the rent if the lease prohibits such an increase.
Fixed-term Lease: An amendment to the Lease Law in 2000 somewhat mitigated the effects of the Lease Law by permitting the lessee of a fixed-term lease to waive the right to renew its lease. Automatic renewal will not apply if the lease is in writing, provides for a definite term with no right of renewal, and the lessee has received a written explanation of the non-renewal provisions before entering into the lease. For fixed-term leases, the parties may also waive their statutory right to rent adjustment by special agreement, provided the terms of any adjustment or non-adjustment can be objectively measured.
Other general terms of leases:
With respect to lease transfers, the owner can transfer real property to a third party without the tenant’s consent unless otherwise agreed in the lease. The tenant, however, may not, without the owner’s consent, transfer its lease rights with respect to all or any part of the property to any third party unless otherwise agreed in the lease. In a master lease structure, the master lessor and master lessee typically agree that master lessee can sub-lease the premises to tenants as long as certain requirements (such as tenants do not fall into the category of anti-social organizations) are met.
Common contractual termination events that entitle the owner to terminate a lease include failure to pay rent, material breach of contract and insolvency of the tenant. Please note, however, Japanese courts have restricted a lessor’s right to terminate the lease to cases where the tenant’s breach is serious enough to destroy the relationship of trust between the lessor and the tenant. Accordingly, even if a one-time failure of rent payment is a termination event under a lease agreement, if contested by tenants and brought to courts, courts would be unlikely to hold the termination of the lease is valid based on such event.
Tenants are commonly given a right to cancel a lease by giving advance notice. In the case of a fixed-term building lease, however, the lease agreement typically prohibits a tenant from cancelling the lease before the expiry of the lease term.
With respect to cost relating to real estate property, since the lessor has an obligation to lease the premises to tenants, it is generally understood that the lessor has the obligation to repair premises to ensure the use of the premises by the tenant. Therefore, under lease agreements the lessor typically bears: (i) taxes and public dues related to the real estate property; (ii) insurance premiums for fire insurance; (iii) necessary costs and repair expenses for maintenance and management of the skeleton and walls of the real estate property and maintenance of fixtures/facilities (excluding daily repairs and maintenance costs and expenses), while the lessee typically bears: (i) utilities, communication expenses, cleaning and sanitary expenses, expenses for maintenance and inspection of various facilities, and any and all other expenses resulting from use of the real estate property. While parties are free to agree otherwise, in ordinary tenant lease transactions, courts tend to limit the repair obligation of the tenant to damages arising from normal use of the premises, and for example, tend to deny the repair obligation of roof or skeleton the building arising from a force majeure.
How are use, planning and zoning restrictions on real estate regulated?
In addition to the national-level City Planning Law, various regional laws apply to the use, planning and zoning restrictions of real estate properties. Therefore, it is difficult to determine exactly what laws apply to any given property, and the best way is to confirm with the municipality in which the property is located. This is typically done by real estate brokers.
If the property is located within an area categorizes as a “city planning area”, then as a general rule, a development permit is needed to develop the property. Within the city planning area there are main two categories, “urbanization promotion areas” and “urbanization control areas”. Generally speaking, development is more restricted in urbanization control areas than in urbanization promotion areas; in urbanization promotion areas, as long as all the general requirements are satisfied, a development permit should be issued, while in urbanization control areas, development is prohibited unless permitted under some exception.
There are around twelve categorises of land use zones in city planning areas which provide a pattern for land-use zoning, such as residential, commercial and industrial uses. Each land use zone has specifications concerning the uses of building which can be constructed in the zone.
Who can be liable for environmental contamination on real estate?
Generally speaking an owner of land with environmental issues shall be liable for the damages of third parties arising from the contamination/pollution if they are attributable for the cause thereof. Furthermore, an owner of the land and facilities thereon shall be liable for damages of third parties arising from defect of installation or maintenance of facilities of the land (i.e. deemed to have defect if contamination or pollution which exceeds certain level to tolerance), regardless of the fact that the owner was attributable to the cause or not.
With respective administrative liability, not only the owner, but also the manager or occupier of land may be liable for environmental contamination to a certain extent.
Under the Soil Contamination Countermeasures Law, an owner, manager or occupier of land must investigate the land if (1) the land contains a discontinued factory where specific hazardous materials have been manufactured, used or disposed of, (2) requested to do so by the applicable authority upon submission of a mandatory report of extensive changes to the character of the land, or (3) the land is recognized by the Prefectural Governor as having a risk of damaging health due to contamination.
The regulator may order the owner, manager or occupier to clean up the contamination if such land is designated as an area which requires certain measures to be taken. Such order would be imposed on the third party instead if it is clear that the contamination was cause by the act of such third party and it is deemed appropriate that such third party (polluter) bears liability to clean up the contamination.
Separate laws regulate the treatment of asbestos and PCB containing equipment in structures.
In sale and purchase transactions of commercial real estate, seller and purchaser typically agree upon the allocation of liabilities which may arise from the environmental issues regarding the subject properties.
Is expropriation of real estate possible?
Yes. While as described below, the government has the power to take private property in certain limited occasions, in market, expropriation itself is very rare and plus, generally, purchasers can check such possibility or if the target property is subject to expropriation plan by reading documents regarding important matters of the properties prepared by broker of seller or purchaser. Thus, the risk that the purchased property becomes subject to unexpected expropriation is quite low.
Expropriation may be made for certain public purposes, such as for infrastructure purposes (roads, railways, airport, highways, etc.), in exchange for appropriate compensation. The relevant authority must draft a plan of public business and convene a meeting to explain such plan, the procedure of acquiring properties, and compensation, etc. to those who could be affected by the plan. The plan must be approved by the Minister of Land, Infrastructure and Transport or relevant authority, and then be approved by the expropriation committee in order to take private property in exchange for compensation. Note that normally the government would first negotiate with residents to purchase properties by offering appropriate compensation, and expropriation occurs only when the government and owner could not reach to the sale of the property.
Is it possible to create mortgages over real estate and how are these protected and enforced?
Mortgages and revolving mortgages can be created and are very common in the market.
Mortgages are created by agreement of the parties and perfected by registration. If registered as 1st priority, a mortgagee can assert its priority over those who subsequently acquire the property or create mortgages. Mortgages are enforced through the foreclosure court or through a voluntary sale.
Upon an event of default under either a senior or junior mortgage, the applicable mortgagee can initiate the foreclosure process by filing an application for foreclosure and making a deposit with the court for expenses in connection with the foreclosure and auction proceedings. The court then issues a commencement order which is served on the property owner and attaches the property in favour of the foreclosing mortgagee, preventing the property owner from further transferring or encumbering the property while the foreclosure process is underway. In the process, the property owner is given certain opportunities to contest (substantive disputes by the property owner will require a separate proceeding in the District Court) and secured creditors with perfected liens, creditors with judicial liens and the tax authorities will be given a chance to register their claims with the court. The court will then order an appraisal to set the minimum bid for auction, and the sale at auction will extinguish any liens on the property and title will immediately pass to the winning purchaser. The court will then distribute the sale proceeds in order of priority. Tax liens will have priority over mortgages only to the extent that the underlying taxes were due and unpaid prior to provisional registration of the applicable mortgage.
While the mortgage foreclosure process is fairly straightforward and efficient, many lenders are often able to obtain even faster recovery through a voluntary sale of the property. Assuming the property owner is cooperative, a voluntary sale can happen as quickly as one month after the expiration of any negotiated standstill periods, provided that a willing purchaser can be located. A voluntary property sale will require cooperation from both the property owner as well as coordination with any junior secured creditors who will need to agree to release their liens prior to the property changing hands.
Are there material costs associated with the creation of mortgages over real estate?
In principal, no transfer tax is due and the costs of creation of a mortgage are limited to registration of the mortgage, stamp taxes, and fees to be paid to scrivener and/or lawyer. Mortgage registration tax is 0.4% of secured loan amount unless falling into certain exceptions (as of December, 2017).
Is it possible to create a trust structure for mortgage security over real estate?
Yes, amendments to the trust law enforced in 2007 made it clear that mortgages can be created in favour of a security trust to hold on trust. However, some unresolved technical legal issues have kept such structure from being commonly adopted and we rarely see a trust structure for security in the market.
Also, the Secured Bonds Trust Act provides security trusts specifically for bonds. However, since the law is not flexible from the bondholder’s standpoint (for example, when a defaults occurs, a trustee must enforce the security regardless under the law, while in practice bondholders may wait and see the borrower’s situation and market), the trust structure to secure bonds are not commonly used.
What is the main legislation relating to commercial real estate ownership?
The Civil Code of Japan provides for the ownership of the commercial real estate and the Act of Building Unit Ownership, etc. governs unit ownership of a building which is structurally divided for multiple owners (condominium or strata ownership). The trust law provides creation of ownership of trust beneficiary interest. From a procedural perspective, the Real Estate Registration Act provides procedures for registration of ownership of properties.