By Junko Fujita
OSAKA, Japan (Reuters) - Three months after eastern Japan was struck by a massive earthquake and tsunami, gloom has once again settled over Osaka's long-depressed property market.
After lurching from one recession to the next over the last two decades, Osaka found a glimmer of hope when institutions and embassies flocked to the country's second-largest economic center to open emergency offices after the March 11 earthquake.
But the mood quickly changed, as landlords in the western city realized that a hoped-for exodus of companies from Tokyo looking for office space isn't going to materialize despite the fear of more quakes and radiation concerns.
"I haven't seen a sign that Osaka's overall markets will improve anytime soon," said Tetsuya Nakajima, Mitsubishi Estate's Osaka-based deputy general manager for office leasing and tenant relations.
"Overall, I don't think it's time for investors to look for properties seriously in Osaka. Rents may fall further and vacancy rates may increase," he said.
Anticipation of better times had driven shares of Osaka-focused real-estate trusts MID Reit and Hankyu Reit since the earthquake.
The stocks rose around 13 percent following the earthquake until May 6, but have shed almost all the gains since then.
The Umeda district in Osaka's main rail station is a bustling maze of shopping malls and department stores. Shoppers pack shops and cafes, sipping French chocolat chaud and sampling rice cakes covered with sweet soy sauce topping.
Yet behind the facade of affluent consumption is the reality of new office buildings awaiting takers, with businesses unable to agree on the rent.
In May, vacancy rates in Osaka nudged up to 12 percent from 11.98 percent, while rents contracted to 11,852 yen $146) per tsubo (3.31 square meters) from 11,902 yen.
Osaka's economy is a little more than a third of Tokyo's and it might be depressed further as western Japan's Kansai Electric Power has asked customers to cut power use as public worries over safety are keeping nuclear reactors offline.
The prefecture of 8.9 million people is the third largest by population after Tokyo and Kanagawa.
With most business remaining in Tokyo, there is not much incentive for companies to expand their offices in Osaka or any other part of Japan, said Teruo Ueda, Osaka-based managing director at CB Richard Ellis.
"New business emerges in Tokyo and that's how new spaces are being filled there," Ueda said.
"But here we don't have much new business so empty spaces need to be filled by existing clients and that's why we struggle with filling vacancies."
Even companies which moved into bigger offices in Osaka are not keen on expanding the office space and shifting some operations from Tokyo.
Toshiba Corp, which integrated its Osaka operations into the newly opened Umeda Hankyu Bldg Office Tower in December, is not planning to move any operations from Tokyo even though the building is 30 percent empty.
Publishing company Recruit Co will be joining Toshiba in the 41-storey Umeda Hankyu office complex.
But despite lower rents and oodles of space in the western Japan city, Recruit also says it would maintain its Tokyo operations at pre-quake levels.
"The earthquake in March jolted Tokyo fairly hard but none of the buildings were seriously affected," said Tomohiro Araki, a real-estate analyst at Nomura Securities.
"That proved the toughness of Tokyo's infrastructure and that's why companies are feeling safe staying in Tokyo."
Construction continued unabated in Osaka, much of it financed with funds gathered from Japanese and foreign investors in 2006 and 2007, when cut-throat competition in Tokyo spurred developers to look elsewhere.
U.S. real-estate funds Lone Star, Aetos Capital and funds set up by Morgan Stanley were among those bought into the Osaka property market.
By the end of 2011 from last year, some 790,000 square meters of new space from 15 new or renovated buildings will have been added to Osaka's already over-supplied market, according to real-estate think tank Miki Shoji.
That represents a 7.4 percent increase in Osaka's business space, equivalent to all the office space available in Tokyo's Minato ward, one of the busiest areas in Japan's largest city.
In Umeda, Umeda Hankyu and the 28-storey Osaka Fukoku Seimei Building, both renovated in 2010, are only 70 percent full, realtors said.
In nearby Honmachi business district, the Honmachi South Garden City building, developed by Sekisui House earlier this year, has yet to find its first tenant, the Japanese housebuilder said.
When new buildings do find tenants, often it merely shifts the vacancies elsewhere, leaving older buildings empty.
Itochu Corp, an Osaka-based trading firm, is planning to move into North Gate Building, a 28-storey office and shopping complex that opened in Umeda in March.
The 42-year old building they will leave in nearby Midosuji, owned by a German fund managed by Morgan Stanley, has yet to find a new tenant, according to local realtors.
The hunt for tenants will intensify in 2013 when a new wave of office space comes online with the opening of the 60,000 square meter Grand Front Osaka, a complex of offices, shops and residences being developed by Mitsubishi Estate, Orix Corp, Sekisui House and nine other companies.
"If we didn't have this project, we would not have to be concerned about the market this much," said Daita Obata, an Osaka-based senior official at Miki Shoji.
"Building owners are worried."
Back on the ground in Umeda's busy department stores and underground concourses, the carefree shopping goes on.
(Editing by Tim Kelly and Vinu Pilakkot)