Dark clouds for Japanese real estate

Liquid Real Estate, Euromoney magazine, October 2008

Conditions are turning tough in Japanese listed real estate. The TOPIX Real Estate index dropped 23% from mid-May (its peak so far this year) to the end of August, and the TSE REIT index is down 32.2% year to date.

In global terms, that’s actually not that bad, but the pressure appears to be towards continuing decline. Office vacancy rates are rising in Tokyo and have been doing so for six months now, surprising some analysts. “The recent pace of the rise in the Tokyo office vacancy rate has been faster than we initially expected and while we believe the current pace is likely to slow down towards the beginning of 2009, it may rise towards mid 4%, getting closer to 5% in 2010,” notes Macquarie analyst Hiroshi Okubo.

On top of that, a number of real estate and housing companies – including six listed ones – have filed for bankruptcy this year after failing to either get refinancing or buyers. While not bankrupted, some big names, such as Urban Corporation and Ardepro, have been hit by concerns about their ability to access credit. Smaller J-REITs have been downgrading earnings. And residential property doesn’t look great either. “The condo sector is stuck between a rock and a hard place, where some developers have been faced with the rise in land prices as well as construction costs on the one hand, but not being able to pass on to the buyers, whose affordability has already declined due to rising prices and flat growth in wages,” Okubo says. He believes a price decline of 10 to 20% would be needed before any pick-up in demand should be expected.

As everywhere, the challenge is knowing when to hide and when to buy. Some see value: Merrill Lynch recently noted that around half of all J-REITs are now trading below book value. They also pay what is, by Japanese standards, an exceptionally high yield of over 5%. “Companies appear to be getting increasingly cautious in the face of low visibility on the future of the economy, but we get a sense that supply/demand conditions are tight,” says Yoshizumi Kimura, an analyst at Citi, speaking on the office market in a recent report. “Coupled with limited supply volumes, this makes for a firm outlook on the rental market, in our view.”

Analysts tend to recommend exposure to listed developers with the strength in the balance sheet to ride out the credit crunch, at which point they will be well positioned to pick off distressed assets or competitors. Macquarie has kept an outperform recommendation on Nippon Building Fund, Japan Real Estate and Nomura Office Fund, although it has downgraded its target price on each of them; “They are our preferred exposure in the JREIT space as they are well-capitalised with strong balance sheets with both internal and external growth opportunities,” the broker notes.

Big transactions have taken place this year, in particular the acquisition of the Resona Bank headquarters in Otemachi, with Mitsubishi Estate acquiring a 73% sectional ownership of the building for Y162 billion. Other deals have included GIC Real Estate, the property investment arm of the Government of Singapore Investment Corporation, purchasing the Westin Tokyo from a Morgan Stanley real estate fund for Y77 billion; Morgan Stanley Real Estate Investment acquiring the Citigroup Centre in Shinagawa-ku from Citibank for Y48 billion; and another Morgan Stanley acquisition, of the Shinsei Bank Building in Chiyoda-ku, for Y118 billion. REITs, too, have been acquisitive this year, with examples including Industrial and Infrastructure Fund acquiring IIF Haneda Airport Maintenance Center for Y42.2 billion, and Japan Retail Fund acquiring Aeon Sapporo Hassam Shopping Center in Sapporo for Y18.4 billion.

That said, all of these were in the first half of the year, and transactions have slowed considerably since. Like everywhere else, it’s all about confidence.