The Current State of the “Japan Way” CRE Strategy

Japanese companies fall behind western companies when it comes to real estate strategy (CRE strategy). Have the three roadblocks to CRE promotion been cleared?

September 05, 2018

Looking back on the present using a 2015 survey

In July 2015, JLL released Japan Corporate Real Estate Trends 2015 JLL Japan CRE Index (“Previous Research”). The research delved deep into CRE strategies employed in Japanese companies, and discovered that Japanese companies’ CRE strategies were more focused on a short-term cost reduction compare to global companies' strategies, and also identified three major impediments to the CRE promotion—scattered CRE functions, lack of sustainable and consistent support and commitment by the top management, and lack of collaboration with a wider range of enterprises. However, Japanese companies have, generally speaking, a divisional structure consisting of multiple departments and sub-companies, and their business bases are dispersed. Therefore, these roadblocks will not be cleared at once by simply following the global trend and promoting CRE. The research suggested that clearing the road requires reform, which can be achieved by forging the “Japan Way” that suits Japanese companies better. Toshiro Sato, manager of the JLL Corporate Sales Headquarters, who directed the research, summarizes the current state of CRE strategies—three years after the “Japan Way” research—as follows.

Changes in corporate environment give a boost to CRE promotion

We can identify two changes in the corporate environment that had a great impact on the CRE strategies of Japanese companies. One of them is the fact that more Japanese companies have started to acknowledge the importance of corporate governance. In 2014, the Japanese Ministry of Economy, Trade and Industry published a report, Competitiveness and Incentives for Sustainable Growth: Building Favorable Relationships between Companies and Investors (the “Ito Review”). With the goal of improving the return on equity (ROE), the review explained the importance of breaking away from short-termism and creating long-term corporate value which both shareholders and companies deal with. This presented an opportunity to rethink Japanese companies’ management strategies, and raised the top managements’ awareness toward the necessity of governance—which is especially strong in a dispersed corporate structure. As a result, it brought about an environment where CRE promotion gained more power, including in business collaborations.

The other is the change in working environments that lies behind the “work style reform.” Japanese companies are now faced with a wave of shortages in the workforce and shorter working hours as a result of declining birth rates and an aging population, and now, CRE promotion is also a requirement in order to be able to improve productivity as a solution for these issues, including reformation of office environment. The Previous Research found out that the most frequent request from top managements to CRE divisions was cost reduction, which accounted for as much as 82% of the total responses. On the other hand, only 31% of respondents requested comfort in work—including a request to allow flexible work styles (mobile working and free address, for example). This number is extremely low in comparison to global companies’ results at 62%. Having said that, there seems to be a rapid increase in Japanese companies that think that CRE promotion with the aims of increasing productivity and providing comfort in work—no matter how much it may cost—will result in improvements in ROE and long-term profits, and work in line with their management strategies. This is a major change. However, they are severely short of human resources specializing in CRE, and are hesitant because they are uncertain if they can secure the resources needed for reform and what effect reform would have. We haven’t seen many Japanese companies make it to the implementation stage yet. The changes in the corporate environment are giving a strong boost to CRE promotion, but companies are still unable to draw clear strategies for reform that are more effective than cost cutting.

Saving costs alone won’t improve ROE

Many managers of Japanese companies have presented their intention to focus on corporate value, including improving ROE, to their external stakeholders. On the contrary, in regard to their offices and other real estate, they still tend to be more focused on short-term cost reduction within the companies. ROE is an indicator that shows the comparison between equity capital and net profit, which is also called shareholders’ equity. The higher a company’s ROE is, the higher dividends a company is considered to bring by better using the capital its shareholders invested—its stock will go up as well as its corporate value. ROE is calculated by dividing current net profit by equity capital, and if a company with a higher equity ratio effectively compresses its total assets, its equity capital (denominator) will shrink, resulting in a better ROE. However, quite a few Japanese companies still have a lot of idle and excess real estate that doesn’t make any profit.

Having said that, it is extremely difficult to improve ROE only by means of asset compression in the case of manufacturers. Actually, net profit on a profit and loss statement has a bigger impact. As a result, companies put more weight on cutting costs—which means increasing net profit. Meanwhile, office rents have been on the rise since the Previous Research. In response, companies have been focusing on how to reduce rent unit prices. Most real estate costs are calculated by multiplying the unit price by floor area. It is not useful to focus only on rent unit prices when rent is rising and revise each unit prices under numerous contracts—it won’t make a significant improvement in ROE.

Then, what do they need? They need a CRE strategy supported by strong governance, which considers real estate, including offices, as business infrastructure, rather than merely something that costs money, and they need to have a clear understanding of the fact that the comfort of workers and productivity levels directly lead to more business profit than cost reduction alone can bring about. By doing so, they will be able to cut costs by reexamining the costs of entire offices and reducing excess space. New workplaces and offices are necessary for work style reform. Companies should take the money they save by taking the above steps and use it to develop new workplaces or rent offices outside the locations they already have.

Japanese companies have a high share of real estate in their total assets, and they occupy office spaces in cities where the rent unit prices are some of the highest in the world. With a dispersed corporate structure and a pressing demand for work style reform and improvements in corporate value, Japanese companies need to take a step forward and away from the current state of affairs. So, what is required in order to promote the “Japan Way” that will help them move forward?

Proponents of work style reform, are so obsessed with shortening working hours that the movement’s purpose of changing people’s working environments in order to increase productivity is lost to them. Meanwhile, global companies based in foreign countries value their employees’ happiness, and have integrated the concept of workers’ well-being into the office environment, where workers stay physically, mentally, and socially well. Although Japanese CRE and HR personnel have been studying the topic, consistent commitment and concrete support by the top management are indispensable for putting it into practice.

Japanese companies promoting CRE with a focus on ROIC

Among Japanese companies, we can find some concrete success stories of CRE strategies. Generally speaking, it is difficult to find ways to improve ROE and ROA (return on assets). Thereby, some Japanese companies developed a company-wide tool using return on invested capital (ROIC) to restructure their management capital, which allows them to dispose of non-current assets and re-distribute them to assets with higher profitability. The standardized tool is applicable to business bases both inside and outside Japan, and helps the companies make progress on a company level. Their goals were achieved thanks to the advance of the corporate governance and firm determination of the top managements of these companies.

If the management gains a deeper understanding of how important CRE strategies are, they will come to recognize that there is room for improvement in ROIC. Then, the next question will be how to reform a workplace into a place for earning profit. JLL proposes the Future of Work concept as a solution. The concept presents five basic policies for CRE promotion —human experience, financial performance, digital drive, continuous innovation, and operational excellence, the most important of which is human experience. Human experience is driven by three elements: engagement (connection with and affection toward one’s company), empowerment (free choice in workplaces and tools), and fulfillment (happiness and satisfaction). When a working environment is enhanced so that it fulfills these three elements, employees can experience well-being, and voluntarily increase their productivity. This is an effective strategy for improving the ROIC with limited work hours—the most valuable management capital.

Research on CRE that JLL has been doing will be summarized in new Global Future of Work report, which will be published soon. It will give Japanese companies major hints on devising strategies for the future. We hope to provide the latest insights into changes in the global trends in CRE strategies, including the recognition gap between global companies and Japanese companies.

(Interviewed Toshiro Sato, Department Manager of the JLL Japan Corporate Sales Headquarters)