Real Estate -- Out of the Rubble

By Timm Tuttle

A new insurance system has emerged but will the handful of operators be able to handle the workload?

Nearly four years after a scandal exploded over structurally unsafe housing in Japan, the country’s government is set to introduce a new system protecting home and condominium owners against defects in construction. Against a dismal economic background, that added measure of safety is potentially good news for a housing market dealing with still jittery buyers. It’s also welcome news for the financial industry and investors who are excited by a greatly expanded, government-mandated market for housing defect insurance.

In late 2005, architect and builder, Hidetsugu Aneha, was investigated for violation of laws including the Architect Act, after he and others were found to have falsified structural data and construction costs related to earthquake safety. While Aneha went to prison the following year, that did nothing to rescue the new house and condo purchasers kicked out of their unsafe homes, nor for the hotels forced to close operations or the real estate and construction companies driven to bankruptcy.

Who was to blame? Aneha and the others involved in the deception were at fault of course, but the incident exposed gaps in the oversight system as well. Both the defendants and investigators pointed fingers at lax inspectors who failed to detect the falsified data. One alleged flaw in the works centered on a 1998 revision to the Building Standard Law, letting private firms join government agencies in carrying out compliance inspections. While that served policies aimed at deregulating the industry, observers charged the private inspectors’ profit-driven focus on speed ran roughshod over careful evaluation of 300-page structural calculation reports, to an unfortunate end.

The “Aneha Incident” shattered a complacent belief at all levels, from government to homeowners, that such deception and corner-cutting couldn’t happen in the housing industry. It also uncovered a gaping hole in the legal framework for protecting the end victims of defective residential construction: homeowners. In the wake of the scandal, bankrupted realtors and builders were unable to compensate homeowners, whose investments were wiped out. The unlucky deed holders were left with no recourse but to take out second loans or write off their purchase of now-condemned property.

In response, Japan instituted tougher requirements for architect licensing and for evaluation of construction calculations. In 2007 the government also unveiled a new law addressing the financial risk aspect, the Law for Execution of Warranty Against Housing Defects (Juutaku Kashi Tanpo Rikouhou). Taking effect for all new houses, apartment buildings and other residential construction passing from seller to buyer from October of this year, the law mandates that the builder, realtor or other final seller either guarantee financial reserves against such defects in structural integrity and waterproofing, or bear the cost of 10-year insurance against those defects. While the property seller will hold the policy, payouts will cover the costs of rebuilding or otherwise compensating property buyers—even under bankruptcy of the policy holder, or the sort of extreme negligence or attempts to cover up defects that would void the builder’s coverage.

At the center of the new scheme will sit about 10 “designated insurers” (sekinin hoken houjin). Builders or other final sellers will purchase the insurance contracts from these designated insurers, which in turn will re-insure with around 20 large domestic insurers. In addition to acting as primary insurers for the builders, the designated insurers will carry out mandated inspections during construction and investigation of defect reports.

The Ministry of Land, Infrastructure, Transport and Tourism (MLIT) oversees the scheme and has set the requirements for designated insurers. These include inspection capability, experience working with the re-insurers, and minimum capital requirements not backed by construction or real estate industry concerns. Five existing firms have already been named designated insurers, while another handful is working toward that goal. Among those is a newcomer being set up by a group of entrepreneurs including Motoharu Ominato, a Niigata-based construction firm president. “So far, five firms have been designated, including a couple of large ones. But there are worries that they won’t be able to keep up with inspections, and that’ll cause a bottleneck in Japan’s new housing supply,” says Ominato. “More players will be needed to keep up with the inspections, as well as with the jump in insurance contracts.”

The new law will mean a significant jump in the number of insurance contracts. Up to now, defect insurance for residences has so far been a voluntary purchase for homeowners, and not a common one at that. In 2006, only 13.9 percent of 1,285,246 new housing units (33.0 percent of 500,100 new single housing units and a scant 1.7 percent of 785,146 condo/apartment units) were delivered under defect insurance policies. From fall of this year, that percentage will jump seven-fold to the mandated 100 percent. The cost of the insurance will get passed on to homeowners, but will be a modest added expense: typically 60,000 to 80,000 yen for a house or 40,000 to 80,000 for an apartment for the 10-year period. The return on that cost should be greater peace of mind for homeowners, plus greater resale value of insured residences.

In short, Japan suddenly has a new market for defect insurance of about a million new housing units per year, and that has insurers excited.

In short, Japan suddenly has a new market for defect insurance of about a million new housing units per year, and that has insurers excited. As one example, recent employee recruitment material from a designated insurer, juutaku anshin hoshou, excitedly points to the expanded defect insurance market as a growth engine that’ll help carry the company to a planned 2011 stock exchange listing. In addition to sales of the insurance—which, it is expected, will be renewable beyond the mandated 10 years —the designated insurers can also expect revenue from inspections, incident investigations, and sale of conventional services and insurance policies to homeowners.

What interest does all this hold for foreign observers? Other than the obvious relevance to those buying or selling residences in Japan, the scheme isn’t of major concern to overseas construction firms, which aren’t active in Japan on any large scale. Nor are foreign financial firms likely to become designated insurers, given requirements that include staff architects experienced in building inspections.

But designated insurers seeking capital create an opportunity for overseas investors to take part in this niche financial service sector. Of his in-progress venture, Ominato adds, “The defect insurance is a product with government-mandated demand, while requirements for entry will limit the number of suppliers. Thanks to those factors, we can offer investors an opportunity for unusually stable returns.”

It will take some time for the industry to recover. In the meantime a completely new industry will need to be created to deal with the mess. It will take more time to see how it all pans out. JI

Timm Tuttle is co-owner of Paccess Inc, assisting companies with market entry, strategic partner search, and trade development, in the United States, Japan, and Latin America.
www.paccess.com