Real estate: blossoming in Japan?

April in Japan is the time for students and fresh graduates to start their academic year and careers, and look to the future. And this spring, although the domestic economy is still looking gloomy with no significant material recovery, real estate investment seems to be blooming with some great potential opportunities. 

A ‘less bad' year in 2009

The number of transactions in Japanese real estate investment increased in 2009, partly due to the resuming of capital injections by J-REITs, including Japan Real Estate's acquisition of 30% of the beneficial interests of Shiodome Building, for JPY54.6 billion ($584 million), with a net operating income return of 5.5%. As well, liquidity increased in smaller deals below $10 million per asset towards the end of 2009.

Japan's property investment market also saw two rather remarkable transactions. Secured Capital acquired Pacific Century Place Marunouchi, a grade A office building located in the central business district adjacent to Tokyo Station, from real estate investor Davinci Advisors in December last year for JPY140 billion ($1.5 billion). This was the largest transaction of the year by deal size, just edging out over the JPY115 billion ($1.23 billion) acquisition of AIG Otemachi by Nippon Life Insurance Company in May.

As of year end 2009, the total market size by operating assets of privately-placed real estate funds was JPY13.9 trillion ($148 billion), which is a far more optimistic picture or the market than the period just after the Lehman Brothers collapse in late 2008.

Fundraising activities in Japan, like mainstream private equity fundraising, have been slow over the past two years, but some firms did successfully raise their real estate funds. The real estate investment arm of CLSA Capital Partners successfully raised $815 million for its second fund, CLSA Fudo Capital II, in November 2009. And Secured Capital raised $535 million for its fourth real estate opportunities fund, SCJREP IV, in August 2009. 

Amidst the economic downturn, many investors became reluctant to commit large amounts of capital to any kind of fund, but in particular real estate. The large numbers above for regional funds could indicate that LPs are still expecting to see returns from real estate investments in Japan, not just from China and India. However, other major players such as Davinci and Kenedix, who made aggressive acquisitions before the subprime mortgage problems emerged, are facing trouble refinancing their portfolio assets.

Players after the storm

With the economic storm dying down, how are the few surviving participants approaching the local Japanese market?

Jon-Paul Toppino, President, Representative Director and CIO at Secured Capital Japan, which has endured since 1997, told AVCJ, "Yes, fundraisings were very tough post-Lehman through mid-2009. There was almost no movement in fundraisings because LPs were actively reviewing their existing strategies and the market environment. However, now investors have started to feel a bit more comfortable and started to re-invest in funds, although commitments are smaller than before." Asked how Secured raised $525 million for the new fund, he said, "Foreign LPs are still optimistic about real estate investment for good assets in Japan. It took a longer time to negotiate with LPs. But they see our track record and experience, and so they have decided to invest with us." LPs are still cautious however, about where to allocate their capital because their resources are still limited, he added. 

Hirotaka Uchiyama, Managing Director and Head of Japan for CLSA Capital Partners Fudo KK, also shared his view of fundraising. "Funds just like CLSA Fudo Capital, which raised funds at the right time after the Lehman Brothers shock, have fresh capital, and those players are looking at investment opportunities in Japan." However, he added, "real estate investors who were active in 2007 are in trouble, because the values of their portfolio assets are decreasing against their acquisition value, with higher leverage."

Since the collapse of Lehman, only a few larger deals have closed in Japan, indicating tightening or nearly closed leverage provisions from lenders. However, now that the economy has shown signs of recovery – partly because of increasing secondary transactions in residential spaces – Toppino said, "Lending situations have definitely improved, although the leverage limit is lower than before, and all major local banks, as well as some of the foreign lenders, would consider lending for higher-quality central Tokyo assets." He added that distressed financing may be available, but only up to 50% of the total transaction amount.

The right time to move in?

One of reason LPs continue to allocate capital to real estate funds in Japan is the opportunity in emerging distressed assets. In 2010, approximately $15 billion in CMBSs (commercial mortgage backed securities) will mature, and up to 30-40% of them may default, industry sources predicted. Between 2009 and 2012, the total issuance of CMBSs was said to be about $35 billion, indicating a massive opportunity if those default predictions are true.

With this in mind, many investors believe 2010 could be the right time to make investments in Japan's property assets. But, Uchiyama commented, "Many property assets in Japan are controlled by banks, not by equity [stake]holders. The banks especially will help refinance their assets, beginning in April after the 2009 financial year ends in March. Generally speaking, assets that [have a] cash flow are targets for banks to help in refinancing."

With the large volume of potentially defaulting CMBSs in the market, still no large distressed transactions have emerged.

Ichirota Kato, CEO of MK Capital, a real estate asset manager partly owned by Japanese buyout fund Unison Capital since a capital and business alliance in February this year, told AVCJ, "Actually, there are not many acquisitions of distressed assets, mainly because of the large price gap between sellers' asking prices and investors' offers, since profitable assets often become bonds." He added, "I think that the main issue has been that few lenders [could] provide debt, especially over 60% LTV loans, until now. I am expecting things will get better after April. Excessive credit uneasiness in the financial markets has been soothed. Japanese banks have chronically few borrowers. As they have been increasing capital, they have to earn by lending while controlling NPLs. So they will lend money to real estate backed by stable income and cash flow."

What to invest in

So what types of assets should real estate investors in Japan look at?
Uchiyama said, "Key for CLSA Fudo Capital is investment in assets where we would be able to get financing and study the balance sheets of sellers."

Toppino said, "for domestic institutions, [the price range of] JPY5-20 billion ($53-212 million) investment-grade office buildings in central Tokyo with 90% occupancy rates would be the targets, as well as JPY2-5 billion ($21-53 million) per asset for well-located Tokyo residential properties."

Market prices will be close to bottom for the next twelve months, and class B assets with above-market rents are expected to continue to fall, added Toppino. The current market value is down by 30-50% from the peak in 2007, or 70% below the bubble period between 2003 and 2007.

Causes for concern

Is the current market downturn only caused by the global economic crisis? Kato believes "the local market has been slowly changing since the government implemented restrictive policies on funds in 2006."

Since the Japanese government amended the securities exchange law in June 2006, investment players, including private equity and venture capital firms and real estate funds, have been impacted in some of their acquisition activities. 

Kato continues, "Since 2007, after the subprime crisis, the financial system has been disrupted. However, many real estate investors kept investing in properties in Japan, and sold them to get returns to find capital for new acquisitions. They used short-term loans alongside their balance sheet, so debt built up in the market. This was the fund bubble."

When the market fell, most portfolios saw their asset values drop, while investors were struggling for recapitalization. In the current environment, many players are already out of the game for the coming investment opportunities, and only a few stronger players carrying dry powder are left in the market.

"Not only investors, but also only a few asset managers are left in the market," Kato stressed, "and we see this time is a great opportunity for growing our business. Now real estate funds need to tighten the compliance or corporate governance required by their investors. An asset manager is a company formed to operate the capital of investors and not to seek returns from investments through its own balance sheet," he said, adding that MK Capital will work together with Unison to provide reliable
asset management services.

While the market is about to bloom, it will be a slow process. It is vey important that funds should learn from past experience and not be aggressive in "Tochikorogashi" – property laundering.

All of the fund managers that spoke to AVCJ noted that the economic recovery of Japan is closely linked to economic growth in Asia's emerging economies, and that their investors are carefully monitoring Japan's realty market.

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• Topics
• North Asia
• Real estate
• Real estate
• Real estate
• CLSA Capital Partners
• Unison Capital
• Secured Capital Japan Co.