In 1989, a single square kilometer of land in Tokyo, the grounds of the Imperial Palace, was worth more than the entire state of California. All of it, every house in Los Angeles, every vineyard in Napa, every tech campus in Silicon Valley, worth less than one park in Tokyo. That is not a metaphor. That is what people actually believed, and that's what banks actually lent against. And when the bubble popped, Japanese real estate entered a decline that adjusted for inflation has not ended. 35 years later, commercial property in Tokyo is still 70% below its peak. The Nikkei stock index hit 38,957 on December 29th, 1989. It didn't reach that level again until February 2024. Now, here is why this matters for you today. The playbook that Japan invented after the crash, extend and pretend, refinance bad loads instead of foreclosing, keep zombie assets alive rather than admit failure. That playbook is running today, alive and well, in U.S. commercial real estate. Syndicators are making capital calls instead of handing back keys. Lenders are restructuring instead of taking losses. Everyone is waiting for rate cuts to bail them out. We know how this ends. Japan showed us. But also, more broadly, why rehash this ancient history today? Because something else is going on today that has serious impacts on the global economy. And I'll touch base on it at the end of this episode. And you absolutely have to understand this to understand where the world is going. I'm Ari Van Gemran. This is the Timeless Investor Show. Let's get into it. To understand what happened, you need to understand two things: Japan's economic miracle and a meeting at the Plaza Hotel. By the 1980s, Japan had rebuilt from the ashes of World War II into the world's second largest economy. Toyota, Sony, Honda, these were not just companies. They were national champions. They were proof that Japan had cracked the code. Japanese management was studied in American business schools. The prevailing wisdom was that Japan would overtake America as the world's dominant economic power. It felt inevitable. For those of you that watched Blade Runner recently or saw the original back in the day, you'll remember that, you know, the Times Square had Japanese company logos all over the place. It was considered to be an un they were an unstoppable force, right? Like business, business books in that time were written on this topic. And then in 1985, we had the Plaza Accord. The U.S. had a massive trade deficit with Japan. American manufacturers were getting crushed by cheap Japanese imports. So the major economies agreed to depreciate the dollar against other currencies. The yen went from 240 to the dollar to 120 in less than two years, nearly doubled. Think about what that does to an export economy. Japanese goods suddenly cost twice as much for American consumers. So the Bank of Japan, the BOJ, had a choice. Let the economy cool, which would cause short-term pain, and nobody ever wants to do that in a democracy, or let's slash interest rates to stimulate domestic demand. And predictably they chose option two. So the Bank of Japan cut five times between 1986 and 1987, from 5% down to 2.5%. And then they left them there for 27 months. This is the pattern. It repeats in every single bubble. Cheap money, borrowing, rising asset prices, rising collateral values, more lending, feedback loop, euphoria. We're all having a great time. And all of that cheap money flooded into two places stocks and real estate. Some numbers to consider. From 1956 to 1986, land prices in Japan rose 5,000%. Consumer prices only doubled. Land was already expensive. Then, between 1985 and 1991, commercial land in Tokyo's major cities rose another 300%. The Nikkei tripled. At the peak, the Imperial Palace grounds, one in one fifth one 1.15 square kilometers, were worth more than all of California. Tokyo's real estate was worth more than all U.S. real estate combined. Japan as a whole, four times the value of America, despite being 25 times smaller, despite having 200 million fewer people. Prime land in Ginza was selling for$139,000 per square foot. That's 350 times Manhattan prices. This was mania. Consider how good you would be feeling in this situation if you had levered to buy that land and then seen your levered return, many, many X what we're talking about right here. And here's the thing about bubbles that you have to understand. It is never just the numbers. There is always stories. And the stories, and I had a mentor tell me this years ago. The stories behind bubbles are fascinating because they're generally built on something true. Something true that you can actually buy into, right? Then the late 90s tech bubble. What was that driven by? The internet was going to be revolutionary. It was revolutionary. It was absolutely revolutionary. They were just early to the game, right? Every bubble has the seed of some truth behind it, right? We're going through an AI bubble right now. I would argue we're in an AI bubble right now. Is AI a revolutionary technology? Absolutely, it's a revolutionary technology. There's not even a no question in my mind. No question. No question. My mother texted me this morning and said, You will not believe how much Chat GPT has changed my my my world. Amazing. Also, like there's real truth to it. But are we ahead of our skis on valuation? And this bubble is just the same thing. In Japan, the story was this: land is scarce. Japan is a small island. Only 12% of it is buildable. Demand is growing. Therefore, prices can only go up. Should sound pretty familiar to all of you. They're not making any more land. Everyone's moving here. This market is different. We hear these in every single cycle. And they're not inaccurate, right? None of the things the Japanese were saying about their land is inaccurate. Demand was going up. It is scarce. You cannot build it. But the valuation can massively outrun the true fundamental story here. So the Japanese believed they had figured out a new economic model. Japan Inc. was superior. Their management, their workers, their industrial policy, it was all better. This wasn't just confidence. It was national euphoria. Japanese companies went on global shopping sprees. Sony bought Columbia Pictures. Mitsubishi bought The Rock Center. Mitsui paid$260 million above the asking price for the Exxon building so their CEO could be in the Guinness Book of World Records. Credible. Awesome. Golf club memberships traded like securities. The best ones cost$3.7 million. Bankers didn't wait for borrowers. They solicited them. Financial deregulation had freed them to take more risk. They valued companies not for their businesses, but for the hidden value of their land holdings. The land under the factory was worth way more than the factory itself. And when everyone is believing the same story and marching in unison towards the cliff, the risk becomes inevitable. Inevitably, you have a pump. So by 1989, the Bank of Japan got nervous. Asset prices were completely detached from any economic reality. Clearly, inflation was creeping up. So they raised rates from 2.5% to 4.25, then 6% by 1990. The Ministry of Finance capped real estate lending. Just like that, the music stopped. The Nikkei dropped from 38,900 plus to 17,000 in three years, down 55%. Urban land prices fell 70%. Some commercial property dropped 80%. Now think about that on a levered basis. That means you're completely wiped out. Gone. Equity is gone. This decline lasted over a decade. Land prices kept falling until 2002. And adjusted for inflation, Tokyo commercial real estate is still 70% below the 1991 peak. If you bought at the top in 91, you are still underwater 30 plus years later, especially if you're leveraged. So what happened after the crash is actually, I think, more important, although the psychologies of crashes are endlessly fascinating. Because Japan invented, you could argue they invented the extend and pretend playbook. Rather than force banks to recognize losses, Japanese regulators let them keep zombie assets on their books at inflated prices. Values. Banks refinance bad loans rather than foreclosing. Companies that should have died were kept alive through endless restructurings. Why? Because admitting the losses was way too painful. The psychological weight of acknowledging the mistake was greater than the economic cost of perpetuating it. This is loss aversion at a national scale. And the result? The bad investments never cleared. Capital that should have flowed to productive uses was trapped supporting zombie enterprises. Economic growth stagnated because the old wouldn't die to make room for the new. Japan's lost decade became two decades, then three. From 91 to 2003, Japan's economy grew at just 1.14% annually. Real wages fell. Deflation became chronic. An entire generation's economic potential was sacrificed at the altar of stability or national pride, however you want to call it. So let's look at commercial U.S. commercial real estate today. And by the way, we're we are not even close to the Japanese situation. I mean, we, you know, Arkansas wasn't valued at the entire value of the EU, right? It's not quite the same, but there are some parallels. Syndicaters who raised capital in 2021 and 2022 at 3% floating rates are now facing 6 to 7% refinances, and the deals sometimes don't pencil. Their business plans are broken. So what are they doing? Making capital calls, restructuring, extending loans, getting modifications, waiting for rate cuts to build them out. And lenders often are just playing along with the same game. They would rather extend a trouble loan than foreclose and recognize the loss. This is extend and pretend at a smaller scale. The entire industry, of which I am a part, okay, part of, partly culpable for where we are today, myself. We are all hoping that the Fed cuts rates fast enough to make the math work again. We are all hoping the refinance window reopens before we run out of runway. Many syndicators are in this position. But here's the thing: what if rates don't drop as fast as we're all hoping? What if this isn't 2020, where the Fed slashes to zero and rescues everyone? Japan thought they'd recover quickly too. The first buyers after the crash thought they were getting great deals. They thought they had time to bottom. They were wrong, and prices kept falling for years. I am not saying this is the situation in U.S. real estate. We're very far from having had a bubble situation. What we did have was a run-up in excessive pricing on assets with low interest rate debt and an excessive utilization of bridge debt money to acquire properties and then try to drive value in a short period of time. Those deals are falling apart. They're bad. Not everything is bad. It's not that bad in US real estate. But that particular segment is really bad. And as I've talked about many times, real estate in the US sunbelt is particularly damaged right now because it was the subject of quite a bit of euphoria during COVID. It is what it is. But this is the key thing I want to leave you with on this episode. And it's critical. Japan has had ultra low rates for decades, negative rates since 2016. This made the yen the ultimate cheap funding source for global investors. Borrowing in yen at zero, investing in higher yielding assets elsewhere, print money on the spread. This is the carry trade, and it has pumped trillions into global real estate and financial markets. But in March 24, Japan ended negative rates. For the first time since 2007, they raised. By January 2025, they hit 0.5%. Woo! Big number. The highest in 17 years. Think about that. Absolutely crazy. They are expected to keep raising. The cheap money spigot that helped fund speculation globally is turning off. Not off, but it could be off soon. When Japan normalizes, capital flows will shift. The carry trade will unwind. And this, this has big implications for everybody globally. We will break that down on Wednesday. Stay tuned. So, what are the lessons you can take from this episode? Five things I've boiled down for this. One, every bubble is a debt story. Japan's bubble wasn't caused by optimism, it was caused by leverage. Cheap money convinces people of absurd things. The debt is always the killer. Lesson two, when everyone believes the same story, get nervous. In 1989, 32 of the world's 50 largest companies by market cap were Japanese. By 2018, only one remained. One. Toyota. Consensus equals invisible risk. Lesson three, the bottom is never clear at the moment. After Japan crashed, buyers rushed in thinking they were getting deals. They were catching falling knives. You don't want that. Don't try to time bottoms. Focus on buying right. Four, extend and pretend does not work at a national scale. Maybe great for you personally or for me, but it's not great from an economic standpoint. Japan's refusal to let bad investments fail prolong the pain for decades. Sometimes the best decision you can make is to take the loss and move on. Don't compound mistakes with stubbornness. Five, critical. Interest rates dominate everything. Japan's bubble was born from low rates and killed by rising rates. Period. You cannot control monetary policy, but you can structure your investments to survive it. Long-term, fixed rate debt, conservative leverage, and cash reserves. Critical. The Japanese real estate bubble is perhaps the most spectacular property mania in modern history. The numbers were absurd. The confidence was absolute, and the hangover has been rough, really rough. But the lesson here isn't about Japan. It's about human nature. Cheap money creates the illusion of safety. Leverage amplifies it. And when the cost of capital shifts, the whole system breaks and buckles. We saw it in 2008. We saw it from 2021 to 2023, and we will see it again. The only question is: are you positioned to survive it or to profit from it? Own real assets, use conservative leverage, keep reserves, think in decades. Wednesday, we dive into the carry trade, how it works, why Japan's rate hikes matter, and what it means for global capital flows. This was valuable for you. Leave a review, subscribe, hit that notification bell, become a timeless investor. Join us here. We're producing lots of great content every single week. Think well, act wisely, build something timeless. I'm Ari Van Gemeren. Thank you for listening.