If one would prepare a list of Japanese victims to the global credit crisis, the property sector would be a strong contender to top the ranking. Real estate, although supported by rental streams that tend to generate stable cash-flows, is generally a relatively highly leveraged investment and vulnerable to disruptions in the supply of credit. Over the past two years Japan has had its share of private real estate funds in tail-spin and REITs facing default. Recently the market seems to have re-discovered a more stable footing to the degree that even your columnist now can call himself a proud landlord in the land of the rising sun.
A good indicator of the fortunes of real estate in Japan is the listed real estate investment trust (REIT) market. The tax-efficient REIT structure was introduced in Japan in 2001 and some 40 companies have been listed since then. The TSE REIT index covering all Tokyo-listed REITs reached its all time high above 2600 at the dawn of the credit crisis in May 2007 whereas in October 2008 at 700 it had lost 73% of its value top to bottom. What happened in the meantime is the typical tale of dried up liquidity that accompanies a credit crunch where smaller sized real estate companies, including some sponsors of REITs, were unable to realize exits for their property assets and found themselves shut out from the funding sources required to keep these assets on balance-sheet. REITs themselves also found credit harder to come-by and the bankruptcy of New City Residence Investment Corporation in October 2008, the first ever J-REIT default meant a new chapter for the industry. Banks reigned in their lending to property related companies and scrambled to recover what could be recovered, oftentimes via repossession and forced disposal.
In the unlisted segment of the market, some pension fund investors were approached with the request to add capital to their investment in order not to lose all of the initially invested equity. Several non-listed funds had breached covenants in their lending facility and faced the prospect of a forced sale of buildings unless leverage was reduced. Confronted with the possibility to lose the capital invested and comforted by the mostly healthy state of the buildings themselves in terms of occupancy and rental streams, some investors choose to double up in order to avoid marking down.
During the course of 2009 sentiment towards Japanese real estate turned for the better as the government took supportive measures and the credit environment improved gradually. In April a jointly established public-private fund was announced whose role is to provide, otherwise healthy, J-REITs with funds to roll over debt. Some REITs have subsequently raised capital in equity markets. Although dilutive to earnings and dividends per share initially, it brings them in a better position to exploit some of the buying opportunities that present themselves. January even saw the issuance of an unsecured bond by high-quality J-REIT Nippon Building Fund, the industry’s first in nearly 2 years.
That opportunities exist was exemplified by the changing of hands of Pacific Century Place building. This 32-story landmark located right next to Tokyo station was purchased for the said sum of USD 1.6bln out of foreclosure by Secured Capital Japan, an off-shoot from a US-based property investment company. The seller, Shinsei Bank, had repossessed the building from a private real estate fund run by DaVinci, one of the funds unable to stay out of the clutches of the bank.
Meanwhile, rent-levels are starting to firm up and it seems the times that a tenant could negotiate rent-concessions of 6 months or more for moving into a new premises are well behind us. On a comparative basis, yields on prime Japanese office are far from unattractive: an average yield of 5.5% means nearly 4% more yield than the 10 year JGB. Absolute yield levels may be higher in countries such as the USA and United Kingdom, but so are risk-free rates so from a spread perspective Japan is leading. Similarly most J-REITs now trade at a significant discount to their asset values. Thus far asset values have been depressed by mark-downs as the lack of buyers meant higher cap-rates (cap rates and asset values are like bond-yields and bond-prices: a higher cap-rate [bond-yield] means a lower property value [bond price]).However, with investors coming back to the market, cap-rates have started to tighten supporting property values. The sale, at a very tight cap-rate, of the Resona Maruha building, overlooking the imperial palace grounds in central Tokyo at a large profit to the owner Tokyu REIT, led to a surge in its stock-price as investors reassessed the potential hidden value in the balance sheets of some of the J-REITs. Entering 2010, J-REITs have seen part of the money inflows from international investors into the Japanese stock market come their way.
Real estate investing remains a wide-spread activity for individuals as well and with bank deposit rates expressed in hundredths of percentage points, the yields obtainable from owning a small apartment occupied by a stable tenant are an obvious alternative to consider. Having done so, your columnist is now a proud owner of a one-room apartment slightly west of the Yamanote railway-line encircling the center of the city. I have used these pages to say this before, but, again, the proof of the pudding is in the eating. Now let’s hope I can have my cake and eat it too !
By Oscar Volder CFA, Investment Specialist at Fortis Investments in Tokyo