Japanese property plays

Meguro Gajyoen, a hotel and office space in central Tokyo, is a classic example. Lone Star took over the property after the previous owner, Gashu, filed for bankruptcy protection in 2002, claiming JPY88.3 billion ($1.1 billion) in debt. Now, with the loan it secured from Mizuho Financial Group to purchase the property due to mature in March 2012, Lone Star is seeking to sell the asset for a reported JPY100 billion.

The target exit price would cover the private equity firm's debts - held as commercial mortgage-backed securities (CMBSs) - but little else.

Maturing CMBSs that are likely to default account for a large portion of Japan's distressed asset market. Last year, securities issued between 2006 and 2007 worth approximately JPY1.16 trillion reached maturity. By the end of next year, the cumulative total is expected to reach JPY2.7 trillion, and real estate analysts say 30-40% of these may default.

Impaired - can be repaired?

The rest of the distressed market is dominated by impaired recourse and non-recourse loans held by domestic lenders and impaired loans held by foreign lenders. The latter were earmarked for securitization in 2007 and 2008, but this never happened. According to the Japan's Financial Services Agency (FSA), major domestic banks had JPY11.6 trillion in bad debts on their books at the end of September 2010, equating to 2% of total loan exposure. The FSA guidelines say this level shouldn't exceed 1%.

J.P. Toppino, president and CIO of Secured Capital Investment Management and managing partner of PAG Real Estate, believes the overall distressed market is potentially worth $75 billion, but there is a caveat. "There is currently an implied ‘moratorium' on foreclosures that does not expire until 2012 so we expect loan sales to be relatively slow until the 2012 fiscal year," he tells AVCJ.

Even when the moratorium expires, other obstacles will remain, notably the banks. Although many of the high-profile, high-paying tenants - corporations, law firms, accountants - that once occupied most of the country's core office areas departed in the wake of the global financial crisis, lenders are loath to foreclose on the assets and sell them off at a discount. Instead, they just tide property owners over with more cash, effectively waiting for the market to turn around.

"Rather than sell assets at a big discount, property owners are refinancing loans so there are not many deals on the market as we might have expected," says one industry source.

Although deal flow is slower than where Toppino expects it to be in 12-18 months time, he insists that transactions are still available and pricing is attractive. "The current distressed market in Japan is attractive on a risk-adjusted return basis," he says.

The largest distressed deal seen so far was the acquisition of Pacific Century Place Marunouchi, a Grade A office building near Tokyo Station, by Secured Capital in December 2009. (Secured Capital is now a group company of Hong Kong-based private equity firm PAG.) The transaction emerged as a result of restructuring at trouble-hit developer DaVinci Holdings. Secured Capital's leveraged buyout was worth JPY140 billion; DaVinci purchased the property from Hong Kong-based telecom giant PCCW for an estimated JPY200 billion three years earlier.

Prior to this, the largest transaction was AIG's sale of its Japanese headquarters in Tokyo to Nippon Life for JPY1.2 billion dollars in cash in 2009. Morgan Stanley was responsible for two other leading transactions of the last four years: The purchase of the Shinsei Bank building for JPY118 billion in 2008, and acquisition of ANA Group's 13 hotels for JPY280 billion in 2007.

Leverage not easy

Nomura Research expects more assets owned by foreign investors to be put on the market, but highly leveraged buyout deals - 95% leverage wasn't unusual at the peak - are unlikely to be seen again. Private equity sources say that, although banks have started providing loans for investments that will generate sufficient cash flow, they are still far from pre-global financial crisis levels. In addition, Japan's property market is undergoing a revival. Rental prices are rising and the average vacancy rate for an office building in one of Tokyo's seven major business areas has dropped to 7.71%, according to Mitsubishi Real Estate Services.

Domestic investors, who have the advantage of close working relationships with local lenders, are likely to have the edge on foreign players when competing for the few deals that are available. Furthermore, all overseas investors face foreign exchange problems for funds raised in US dollars.

"Japan remains active with a large and mature market and there are many opportunities around core assets," according to E.C. Harris, a consultancy. "The concern regarding investments in Japan is the strengthening yen, which will be a barrier to funds raised in foreign currency."

Although realized deals are still small, but the likes of Fortress Investment, Aetos Capital, Blackstone, CLSA Fudo and Secured Capital are not about to leave. There is a sense that investments in valuable assets - that offer a reasonable return - are slowly finding their way onto the market.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Real estate
• North Asia
• Credit/Special Situations
• Lone Star Funds
• PAG
• Morgan Stanley