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Tokyo Tatemono: pioneer of SPCs and non-recourse finance

29 Jun 2008

Publicly-listed property developer Tokyo Tatemono has been one of Japan’s pre-eminent exponents of property development financing on a non-recourse basis since the market began.

EuroWeek met Fumio Inada, general manager in the investment management division at Tokyo Tatemono, and his team.

Tokyo Tatemono was one of the leaders of Japan’s non-recourse finance revolution, which began in the late 1990s.

As one of Japan’s foremost property development companies, Tokyo Tatemono by that time, during the era of distressed assets and distressed bank balance sheets, had got to a position of having far more opportunities and ideas than balance sheet capacity.

The company quickly embraced non-recourse finance as a way to free itself from the shackles of Japan’s historic, plain vanilla, recourse-based funding methodology that had been used to finance the property market from the end of the Second World War until the 1990s. This system had also helped topple the pack of cards that was Japan’s property bubble and financial system.

Fast off the blocks, Tokyo Tatemono created Japan’s very first special purpose company (SPC) shortly after the country’s debut Special Purpose Company Law was ratified in 1998, resulting in the landmark Takanawa Apartments 33 ABS deal of June 1999.

SPCs: off balance sheet growth

As one of Japan’s most dynamic property development and management companies, Tokyo Tatemono has never looked back since that pioneering deal. Since those early days, it has favoured non-recourse or limited recourse funding, employing either of these methods for more than half of all its projects by value.

"While we also keep some projects on our corporate balance sheet, we now employ some kind of SPC on many new development projects we create these days," says Fumio Inada, general manager in the investment management division. "Using SPCs keeps the schemes separate from the company’s balance sheet and keeps the assets and cashflows of each development entirely distinct from us as the sponsor."

Tokyo Tatemono is also one of the founders of the Japanese real estate investment trust (J-Reit) market, having sponsored Japan Prime Realty, one of the more than 40 listed J-Reits in Japan.

At the end of March 2008, Tokyo Tatemono managed gross assets of ¥1.38tr through SPCs in portfolio properties and redevelopment projects, financed with approximately ¥960bn of debt and ¥390bn of equity. Those amounts include investment partners’ equity commitments of ¥190bn.

Tokyo Tatemono was later involved in a landmark development project, in 2002, when it acquired Hong Kong Garden, a deal financed by Shinsei Bank on a non-recourse basis.

The third milestone SPC transaction from Tokyo Tatemono came when it acquired a portfolio of properties in Fukuoka from a big department store group in that region.

The seller sold 21 properties including core sites, with Tokyo Tatemono funding approximately $150m on a non-recourse basis, then selling off 16 of the 21 properties in the next few years.

"That was a notable transaction in our history," says Inada. "We invited some Japanese institutional investors into the SPC, which today holds three of the properties. It has produced excellent returns for Tokyo Tatemono and our fellow investors."

Otemachi deal introduces mezzanine concept

The next landmark Tokyo Tatemono SPC deal came in 2004, when it bought the former Fuji Bank headquarters in Otemachi, one of the most prestigious office addresses in Tokyo.

The value of the acquisition was about $1.4bn, but the land and building are theoretically worth far more today because of rising land prices and the progress of the development plan. The building will be leased by Mizuho.

The springboard for the deal was the fixed term lease agreement of at least five years that Mizuho had entered into, effectively guaranteeing stable rent revenues.

When Mizuho Bank moves into its new office in October this year, the building will be demolished. The land area is roughly 10,000 square metres and the new building is expected to be as much as 16 times that size, based on the land to floor area ratio on the latest development plan.

The transaction at the outset involved total assets worth ¥150bn. Based on the high quality of the tenant, Shinsei Bank granted an ¥87bn non-recourse senior loan to a special purpose company formed by Tokyo Tatemono and the investment partner, which then purchased the property.

Development Bank of Japan extended a ¥15bn junior loan and ¥18bn of mezzanine funding with profit participation. Tokyo Tatemono and the joint investors supplied the ¥30bn of equity.

"That was a historic deal that established DBJ as the most prominent mezzanine investor in Japan," Inada recalls. "It was the deal that really opened the concept of the mezzanine market to all parties."

By 2004 the commercial mortgage backed securities (CMBS) market in Japan was enjoying a steady and growing flow of exciting transactions. The market had evolved from distressed asset situations in the early years, through the later phase of balance sheet management and profit enhancement by banks and property companies, as they hived off their offices, often in sale and leaseback deals.

Non-recourse financing re-emerged in the capital markets when the Shinsei Bank securitisation team launched the landmark Cosmic Funding TMK deal, securitising non-recourse loans the bank had made to Tokyo Tatemono for the Otemachi site.

The deal was collateralised not only by the building leased by Mizuho Bank for its headquarters, but also by another property in the Otemachi business district of Tokyo. Mizuho Securities acted as joint distributor for the transaction with Shinsei Securities. The deal was rated on the basis that the site would be redeveloped.

The Mizuho headquarters building was then valued at around ¥105bn and was wholly leased by Mizuho Bank on a five year contract. The bank also occupied around 40% of the second building on a 10 year contract, then valued at around ¥40bn.

"With Shinsei and Mizuho Securities as joint leads," recalls Inada, "the refinancing of the deal via CMBS became one of the most famous deals in Japan and a very positive turning point for the CMBS market."

2008: A different world

From 2006, property development projects in Japan and especially Tokyo became ever pricier, says Inada, as the market peaked in 2006 and early to mid 2007.

"However, although prices were high and competition for assets was intense," Inada says, "the high liquidity in the loan market and in the CMBS market meant that developers such as Tokyo Tatemono could achieve low pricing for borrowings, as well as relatively easy financing terms, based on the appealing prospects for returns from the properties."

For example, in 2007 Tokyo Tatemono financed its ¥145bn acquisition of the Nakano Police Academy property with a loan to value ratio (LTV) close to 70% and a spread of about 120bp on the non-recourse funds.

Inada says the market has changed markedly today, and that quality, caution and conservatism have become watchwords for the lenders. "The valuations of the underlying assets that the banks apply for the purpose of lending are considerably below the purchase prices paid by the acquirors," he says. For example, a building bought for ¥100bn might be marked down by the lenders to 70% or 80% of that price and the LTV at which they will lend is now based firmly upon that discounted valuation.

"This means that for the very best developments in the very best locations we might be able to end up at the optimum with a 65% LTV," he explains. "Moreover, along with tighter funding, the loan terms are notably less borrower-friendly than in the much more optimistic times of a year or two ago."

Does Inada consider that the banks are excessively cautious? "The underlying real estate market remains positive," he says. "However, along with the financial shocks reverberating across the globe in the past six to nine months, lenders here have been encouraged to apply tighter due diligence and underwriting standards by the Japanese regulators. Accordingly, they are in the process of understanding and adapting from a market that had, frankly, become overheated and excessively liquid. In the end, we expect the market should end up in more normalised conditions."

Inada says Tokyo Tatemono views the changes as encouraging and positive. "The market is already migrating back towards the higher quality, highly experienced players such as ourselves," he concludes.

And Inada and his team will continue to employ non-recourse funding for new projects. "Non-recourse and limited recourse funding through SPVs has been a vital element of our funding strategy for the past nearly 10 years. Securitisation allows our company to tackle far more projects than we could have before. It allows us to leverage our property development and management expertise, without having to worry about funding through our own balance sheet. This market is here to stay and in the months ahead should become stronger and more stable than ever before."
29 Jun 2008