Navigating Rent Hikes and Legal Battles in Tokyo's Office Market

Background of Rent Increase Claims for Existing Office Building Leases 

With the end of the COVID-19 pandemic, there has been a trend of companies returning to central Tokyo offices. As demand for office space has risen, the vacancy rate in major central office buildings has reportedly fallen below 5%. In addition, due to factors such as soaring construction costs, rents for newly built office buildings have increased, and there is also a movement to raise rents for existing buildings on the basis of rising ancillary costs. Where landlords and tenants are unable to agree on a rent increase, landlords will seek to resolve the matter through court proceedings by invoking the right to claim a rent increase under Article 32 of the Act on Land and Building Leases (Shakuchi Shakka Ho) (the "Rent Increase Claim").  

Because determining the fair rent necessary for a Rent Increase Claim requires a specialized, quantitative assessment based on economic analysis, both the exercise of the Rent Increase Claim and responses to such claims should be undertaken with professional advice.

Purpose and Requirements of the Rent Increase Claim 

The Rent Increase Claim is a feature unique to Japan's lease law regime. In general, tenants under regular building leases are protected, and when a tenant wishes to renew at the end of the lease term, the landlord is, in practical terms, unable to refuse. Since a lease may therefore continue for an extended period depending on the tenant's wishes, the law recognizes a mechanism to reflect post-contract changes in economic conditions in the rent terms through the Rent Increase Claim.  

The claim may be exercised even during the lease term and takes effect upon notice to the tenant. Tenants may likewise claim a rent decrease.  

While landlords may enter into fixed-term building leases, under which tenants have no right of renewal, negotiations with prospective occupants often result in regular leases being accepted.  

The Rent Increase Claim requires that, due to a change in circumstances after the most recent point at which the parties agreed to the rent terms (the "Most Recent Agreement Point"), the current rent has become unreasonable. That is, in typical cases, there has been a divergence between the previously agreed rent and the prevailing market rent due to the passage of time since the Most Recent Agreement Point.  

However, depending on the particular relationship between the parties and the prior agreement, such as where the parties intentionally set a below-market rent, a Rent Increase Claim may be denied despite an increase in market rents, or any increase allowed may be limited in scope.  

Concept of "Continued Rent" and Four Valuation Methods

When the Rent Increase Claim is exercised, the rent is raised immediately to an appropriate level, referred to as the "Fair Rent" (sohtoh chinryo) or "Continued Rent" (keizoku chinryo). It is important to note that the Continued Rent is distinct from the "Initial Rent" (shinki chinryo), a fair market rent as of the valuation date, i.e., the point in time when the Rent Increase Claim is made (the "Valuation Date"). There is no necessity that the two be aligned. In many cases, the amount of the Continued Rent is determined to be between the current rent and the Initial Rent.  

The methods for determining the Continued Rent are prescribed in the Real Estate Appraisal Standards (fudosan kantei-hyoka kijun) issued and periodically updated by the Ministry of Land, Infrastructure, Transport and Tourism. Real estate appraisers evaluate the Continued Rent in accordance with these standards. While the standards do not bind the courts, judges in many cases respect the standards when issuing judgments.  

Under the Real Estate Appraisal Standards, Continued Rent is determined by calculating indicative rents using the following four methods and then synthesizing the results with appropriate weighting: 

• Differential Allocation Method (sagaku haibun ho)
• Sliding Method (slide ho)
• Yield Method (rimawari ho)
• Comparable Lease Transactions Method (chintai-jirei hikaku ho)

Of these, the Differential Allocation Method and the Sliding Method are particularly important in practice and described further below.

Differential Allocation Method. Under the Differential Allocation Method, the difference between the current rent and the Initial Rent is divided into portions allocated to the landlord and to the tenant, and the rent is increased by the amount allocated to the landlord. For example, if the current rent is 50 and the Initial Rent is 90, the difference of 40 might be split into 25 allocated to the landlord and 15 allocated to the tenant, resulting in a Continued Rent of 75, which is the sum of the current rent and the landlord's allocated portion. The following diagram may help in understanding the explanation above. 

The Initial Rent is determined either by reference to concluded transactions for similar buildings as of the Valuation Date or by calculating the replacement cost of the building and applying a fair yield rate. 

When allocating the difference between the current rent and the Initial Rent, the allocation ratio is determined after analyzing the causes of the difference, which are divided into following two categories:

• Changes in economic conditions (e.g., increases in market rents) and other circumstances from the Most Recent Agreement Point to the Valuation Date; and
• Various circumstances from lease inception to the Most Recent Agreement Point, including the terms of the lease agreement and the history of past rent changes.

Sliding Method. The sliding method derives an indicative rent by "sliding" the net rent, defined as current rent less depreciation, maintenance and management costs, repair costs, public dues and taxes, insurance premiums, etc., by using a rate of change derived from various economic indices. Examples of such indices include the following.

• Macroeconomic indices: Gross domestic product, domestic corporate goods price index, corporate service price index.
• Real estate price-related indices: Official land price survey (koji chika), roadside land price (rosen-ka), construction cost deflator. 

The rate of change reflects variations associated with changes in economic conditions between the Most Recent Agreement Point and the Valuation Date. For example, if the relevant economic index is 100 at the Most Recent Agreement Point and 120 at the Valuation Date, the rate of change is 20%.  

Court Procedures for Rent Increase Claims 

Court proceedings for the Rent Increase Claims have two procedural features. First, a landlord may not immediately file a lawsuit and must first petition for court-administered mediation. If the parties fail to reach agreement on the rent amount through mediation, the landlord may file a regular lawsuit.  

Second, in a rent increase lawsuit, the court will typically appoint an expert to appraise the Continued Rent. While the appraisal does not bind the judge, judges refer to the quantitative information in the appraisal report and may rely on it as appropriate when issuing a decision. The appraisal can therefore be outcome-determinative.