Real money demand replaces leveraged buyers

  • 30 Jun 2008
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The Japanese commercial real estate market is slightly past its best, but plenty of investors, at home and abroad, continue to covet its best assets — especially in Tokyo, home to a large proportion of Japan’s vast commercial property stock.

EuroWeek asked Andy Hurfurt, executive director of CBRE Consulting at CB Richard Ellis, for his latest perspective on the Japanese commercial real estate market. 

WEEK: How have rental prices, investor demand and valuations for the Tokyo market held up so far this year?

Pricing for prime Tokyo office and retail properties remained firm through the quarter, supported by strong demand from core and core plus investors.

We published our first quarter 2008 review in early June. In it we reported several key findings. Net effective Grade A office rents in Tokyo’s most prime locations, the Marunouchi/Otemachi/Yurakucho submarket, increased 16.3% year-on-year.

Meanwhile, looking more broadly, average Grade A rents in Tokyo’s central five wards (CFW) fell 4.4% quarter-on-quarter, although robust rental growth was still evident in specific properties.

In terms of vacancy, Tokyo Grade A office vacancy increased 0.3% to 1.5% and vacancy for all-grade offices in Tokyo’s 23 wards also edged up 20bp to reach 2%.

As the effects of the US subprime woes on the global economy slowly unfolded, the first quarter of 2008 saw a number of major financial institutions sell their headquarter buildings in what appeared to be an attempt to increase earnings and improve balance sheets.

Core and core plus funds continued to demonstrate strong demand for well located, high quality properties, attracted by the spread between the benchmark prime Tokyo office yield and 10 year JGB coupon rate of approximately 130bp-150bp.

With tight supply in the future in Tokyo’s main markets, we are looking beyond any short term downturn in rents. We expect the tight supply conditions to offset any softness in occupier demand with the overall average rent for Grade A offices resuming an upward trend next year, albeit at a slower rate of growth than seen in the recent past.

WEEK: Has the credit situation weakened demand?

The Japanese real estate market has enjoyed a resurgence of interest in recent years with an abundance of domestic and overseas funds competing for investment grade properties and pushing up prices. The easy availability of low cost, non-recourse real estate finance was one of the factors driving the market.

With a rapid change in lender sentiment arising as the consequence of the US subprime woes, there has been much speculation that the Japanese real estate market has now entered into a period of correction with waning interest and falling values.

Until recently the market had been flooded with opportunistic investors, but they have now receded into the background, as medium-to-long term, core-style investors have emerged as the main players and continue to increase in prominence as overseas capital continues to flow into Japanese real estate.

The investment market has therefore continued to enjoy brisk activity through 2008 with significant transactions in Tokyo and the major cities. In Tokyo and the other major metropolitan areas, large scale Grade S and Grade A office buildings are expected to continue to be prized investments, mostly for core-style investors. These properties will likely be immune to price adjustments.

In contrast, smaller properties in fringe locations of the major cities and regional hubs will be relatively susceptible to price declines, as market players heavily involved in this class of property are having difficulty acquiring funding. In terms of investor make-up, smaller opportunistic investors will fade and in their place core investors will come to the fore.

Overseas investors still give Japan high ratings in terms of the size of the economy, economic stability, real estate liquidity and other factors. Asia is garnering a great deal of attention globally as the real estate market of the future, but when compared to regions outside of Asia, many still view Japan quite favourably. One reason for this is that Japan’s yield gap remains attractive to global investors.

WEEK: What evidence is there of this continued strength in the purchase market and of its gravitation towards long term or ‘core’ buyers?

There were several landmark transactions including Mitsubishi Estates’ acquisition of a 73% sectional ownership of the Resona Bank headquarters in Otemachi, Chiyoda-ku for approximately ¥162bn. Resona will remain in the building until about 2010, when it plans to relocate to another location.

There were plenty of other notable transactions, as well, the highlight being the sale-leaseback of the Shinsei Bank building in the Uchisaiwaicho district of Chiyoda-ku via Morgan Stanley for ¥118bn for a rumoured 3.1% NOI [net operating income] capitalisation rate.

Another highlight deal was the purchase by GIC Real Estate, the property investment arm of the government of Singapore, of The Westin Hotel Tokyo for ¥77bn from Morgan Stanley and Starwood Capital Group. Built in 1994, the five star hotel is located next to the Yebisu Garden Place complex in Ebisu, Shibuya-ku, and provides 438 rooms over 23 storeys above ground.

And the growing importance of long term European money was reinforced when in February, Deka Immobilien of Germany acquired the Urban BLD Shinsaibashi in Shinsaibashi, Osaka, for approximately Eu120m, or ¥19bn.

Among the J-Reits, which remain fairly active despite more challenging financing conditions for both equity and debt, Japan Prime Realty acquired a 40% sectional ownership of the Shinjuku Center Building in the Nishi-Shinjuku district of Shinjuku-ku for ¥21bn at an estimated NOI yield of 3.8%.

And in March, Top Reit acquired a sectional ownership of Harumi Island Triton Square Office Tower Z in the Harumi district of Chuo-ku for ¥20bn and valued on estimated NOI yield of 4.3%.

WEEK: In Tokyo, which accounts for a very large percentage of the total Japanese commercial real estate market, can you explain why prospects for prime property remain so appealing?

Although there is still robust rental growth evident in specific areas of Tokyo and specific properties, prospective tenants in general in Tokyo enjoy a stronger negotiating position than in recent years. Prime office vacancy is edging up generally in the central five wards of Tokyo, vacant space is taking longer to lease and the number of Grade A buildings with vacant space reached almost 30% of total stock as of March 2008, compared to circa 20% a year earlier.

While the prime office leasing market remained tight throughout the first quarter of 2008, temporary large scale vacancies created by several relocations caused Grade A vacancy to increase by 30bp to 1.5%. At the same time, a general deterioration in business sentiment following further turmoil in global financial markets encouraged some occupiers to put expansion plans on hold, and the take-up of secondary vacancy was slower than in previous quarters.

Nevertheless, Grade A vacancy continued to remain below the 2% level which was last exceeded in the first quarter of 2005. And vacancy for all-grade office buildings in Tokyo’s CFW rose slightly over the quarter, but remained substantially below the 10 year average of 4.4%.

Moreover, although average rent for Grade A offices in the CFW fell slightly, the supply of new Grade A space in 2008 is expected to be substantially below the 2007 total of 563,000 square metres. With no Grade A building completions scheduled for the second quarter and only two buildings expected to come on stream during the remainder of the year, the market will continue to experience a scarcity of high quality supply.

That is why we reach the conclusion that rentals for Grade A offices will start to rise again next year, albeit at a modest pace.

While the latest government data shows continued increases in the average commercial and residential land prices of Japan’s other major cities, investors have become more focused on Tokyo as financing for the more regional markets has become more difficult to obtain.

But J-Reits remained active purchasers outside Tokyo during the first quarter, despite a more challenging fundraising market. For example, Japan Real Estate Investment (JRE) bought the MM Park building in the Minato Mirai district of Yokohama City from Mitsubishi Estate for ¥37.4bn, equating to an estimated NOI yield of 4.8%. And in March JRE bought part of Musashi Kosugi STM building in Kawasaki City for ¥4bn at an estimated NOI yield of 5.8%.

And Nomura Real Estate Office Fund acquired SORA Shin Osaka 21 in Osaka City for ¥19.3bn at an estimated NOI yield of 4.2%, as well as the JCB Sapporo Higashi building in Sapporo City for ¥3.7bn and at an estimated NOI yield of 5.5%.
  • 30 Jun 2008

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Rank Lead Manager Amount $m No of issues Share %
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1 Citi 8,563.70 22 14.58%
2 HSBC 7,832.21 25 13.34%
3 Deutsche Bank 6,701.74 14 11.41%
4 JPMorgan 4,850.50 14 8.26%
5 Bank of America Merrill Lynch 2,611.95 12 4.45%

Bookrunners of LatAm Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
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3 HSBC 3,768.59 4 16.45%
4 JPMorgan 2,812.07 8 12.28%
5 Bank of America Merrill Lynch 1,683.06 6 7.35%

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1 Citi 3,236.25 7 10.30%
2 HSBC 2,253.75 3 7.17%
3 Deutsche Bank 1,703.96 4 5.42%
4 Standard Chartered Bank 1,518.77 3 4.83%
5 JPMorgan 1,341.27 2 4.27%

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Rank Lead Manager Amount $m No of issues Share %
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1 ING 3,668.64 29 9.07%
2 UniCredit 3,440.98 25 8.50%
3 Sumitomo Mitsui Financial Group 3,156.55 13 7.80%
4 Credit Suisse 2,801.35 8 6.92%
5 SG Corporate & Investment Banking 2,478.18 21 6.12%

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2 Mitsubishi UFJ Financial Group 45.42 1 14.11%
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5 Trust Investment Advisors 31.87 2 9.90%