Aetos Capital was founded in 1999 to pursue opportunistic real estate investment strategies worldwide. Japan quickly became a core target for the firm and since 2002, Aetos Japan has completed almost $10bn of property acquisitions in the country, many of them using leverage to maximise returns.EuroWeek recently asked Dan Klebes, a managing director of Aetos Capital and chief investment officer of Aetos Japan, for his views and outlook on the Japanese property market. He has worked on Japanese property deals worth more than $13bn during more than 15 years in Japan.
EuroWeek: How would you characterise Aetos operations in Japan?
Aetos Capital is an independent investment management firm owned by its partners. Our objective is to provide focused investment strategies that generate superior risk-adjusted returns to a sophisticated set of clients around the world.
Aetos Capital Asia was launched in 2002 and secured $740m in total commitments. In November 2005, Aetos Capital Asia II (ACA II) closed with commitments of $2.2bn. Both of these funds allow us to play in the big league as buyers, employing leverage to achieve total deal volume several times larger than the equity in the funds.
The focus of ACA II is largely on Japan and on investments in large, complicated real estate assets and in companies that own real estate, as we are active in property and corporate restructuring, because we believe this is where we can add most value and leverage our collective expertise.
EuroWeek: Aetos completed the purchase of the Hotel Nikko Tokyo in March 2007, a 453 room, four star hotel located in Tokyos Odaiba district. Aetos then refinanced the purchase earlier this year with a non-recourse loan. Can you explain the deal and the refinancing package?
We bought the building from Japan Airlines and Itochu Corporation for around $550m.
The deal was predicated on operating the hotel, with a clear strategy for improving the business and returns. We have already improved gross operating profits by about 10% in year one.
The first step of the purchase was via our corporate fund. We then refinanced the purchase via Deutsche Bank this spring and achieved a good outcome in the prevailing tight financing market conditions.
We ended up with a roughly 70% loan to value ratio [LTV] for a single asset hotel deal. In the best market conditions in recent years we might have expected a better advance rate, perhaps 75%-80%, and a lower all-in cost of funding, but we were pleased with the latest result.
In this deal there was no question of trying to obtain mezzanine funding. We needed flexibility in the cashflows as we wanted to take some rooms out of commission and mezzanine finance, even if it had been available it is extremely scarce and expensive today would not have suited.
EuroWeek: Together with Goldman Sachs, Aetos Japan in late 2007 bought and delisted Simplex Investment Advisors, an asset management company, in a $1.5bn tender offer. How did that deal come about and what are your plans for that firm and its assets?
This is precisely the sort of corporate restructuring situation in which we can shine in the current environment. In more normal conditions there might have been greater competition for the deal, as constraints in the credit markets helped create this opportunity.
Simplex had been listed on the OTC section of the Tokyo Stock Exchange since 2005. The company owns or manages over 200 real estate assets throughout Japan with a book value in excess of $6.8bn, with over $4.5bn of those assets owned on balance sheet. We considered the public market was failing to value these assets appropriately.
The companys two major shareholders (Nikko Cordial Corporation and an individual) together owned over 70% of the shares. Due to a number of factors, including Nikko Cordials wish to liquidate its holding in Simplex before the October announcement of its merger with Citigroup, Simplex was put in play in August 2007.
With 75% of the assets in Tokyo and 80% or so of the assets comprised of office buildings, we have taken a three to four year view on reorganising the assets, with a plan to divest some to third parties, move other assets into new vehicles and refinance many of the assets in more sophisticated structures.
EuroWeek: How has the funding market for real estate changed in the past year?
The sea change in the financing market in Japan came in the last quarter of 2007, when the conduit lenders saw that the liquidity in the CMBS market was drying up and they were effectively losing their balance sheets.
The use of leverage is important to achieve our target IRRs [internal rates of return]. The advance rate the amount we can fund without equity is therefore actually more important to us than the all-in cost of funding.
For five year non-recourse funding, the all-in cost of funding was at a spread of roughly 200bp to 225bp above yen Libor and LTVs of 75% and above were commonplace. Today, assuming one can find the provider, LTVs have shrunk to 60% to 70% and the all-in spread is between 250bp and 300bp, with plenty of lenders aiming for the top end of that range.
The international lenders are few and far between nowadays, whereas they were much more aggressive until mid to late 2007. Japanese banks continue to lend; while they have been fairly conservative, even during the heady times for the property market from 2004 to 2007, they have tightened since mid-2007 on all levels LTVs, valuations, due diligence and loan documentation.
EuroWeek: Does the current financing environment make it very difficult for Aetos to make new acquisitions?
It is a double-edged sword. While funding is more limited, more conservative and more expensive, there is less competition for the assets available.
We are lucky as we have plenty of cash and our earlier five year borrowings are not yet due for refinancing. Moreover, there is a market to sell the right kind of properties, although the less prime and also the regional markets are considerably less liquid.
My view is that the fundamentals for property remain very strong in Tokyo, but the dislocation in financial markets may result for a time in slightly higher cap rates as there is far less competition for properties, with the conduit buyers largely out of the game. The incremental aggressive buyer that would bid cap rates down that extra 25bp during the real bull market is not providing the same competition as before, except for the best properties.
In todays market, even leveraged-type buyers that could eventually fund deals are mostly absent from the bidding table as they cannot line up sufficiently committed prefinancing for a bid to make it worthwhile for the vendor to consider them seriously.
We have access to capital so we can bypass that prefinancing and we are relishing the opportunity to compete more effectively for deals that in recent years we might not have had a viable chance of winning, due to a lot of competition. However, we would need to feel comfortable ourselves that we can refinance within a reasonable period before we step up to the plate.
EuroWeek: Are there still plenty of opportunities for Aetos in the current market?
We continue to see outstanding investment opportunities in Japan, where there are plenty of opportunities for corporate restructuring, for example of highly leveraged property companies and owners facing financial distress.
Corporations are continuing to divest non-core real estate and the trend is accelerating. Excellent arbitrage opportunities exist in complicated public and private corporate real estate situations.
We consider much of Japans commercial property to be valued attractively, particularly relative to other Japanese investment alternatives. The Japanese economy has stabilised and is growing modestly. Interest rates remain low 10 year JGBs are still well below 2%. Real estate fundamentals are improving, particularly in the major markets of Tokyo and Osaka. We see significant improvement in certain property types, such as offices and hotels.
Rental tenants are stable. The heavy supply of new space in the past five to seven years has been comfortably absorbed, and with rising rents. With the lower flow of new space in the coming few years, the fundamental story is altogether rather appealing for buyers.As the situation is not uniform throughout the country, we believe as a buyer we need to be a stock picker not an index type investor.