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FC Residential investment corp - Patiently telling residential story

21 Sep 2006

Life is not a bed of roses for J-Reits whose unit prices lag the broader market. FC Residential Investment Corp, a residential property Reit managed by Fund Creation Reit Advisers, is facing some thorny issues, such as how to make new asset purchases while its unit price is more than 18% below net asset value. EuroWeek interviewed the fund's managers.

FCR's market price in early August was about ¥423,000, with a yield of 4.8%. The stock has traded in the range of ¥390,000 to ¥466,000 and never reached the October 2005 IPO price of ¥475,000. To what do you attribute this lacklustre appetite for FCR, and will the situation persist?

Koji Kaneko, chief executive of Fund Creation Reit Advisers We floated last October and since then the unit price has never traded up to the listing price, and liquidity is low. We see one of two things happening next — either the actual prices of residential properties will fall, or, and this is far more likely, the prices of residential Reits will rise.

Of course, we believe that the market price of our Reit represents an unhealthy discount to fair value. The market was disturbed by the revelations of the falsified earthquake resistance reports last year, but the J-Reit market in general has managed to shake off most of the negative news that has emerged in the last year or two.

We see a curious anomaly in the residential property market. There are ever more buyers seeking out residential property acquisitions and at ever lower cap rates, yet stockmarket investors seem to be avoiding investment in the residential J-Reit sector.

If the institutional and corporate money seeking the acquisitions is right, then surely the public market is inefficiently valuing the J-Reits. Both cannot be right.

The outlook for residential property is perhaps better than many local investors perceive, hence there is an opportunity to buy trusts such as FCR at discount prices.

Whatever the outlook for the residential property market, FCR is in a difficult position, as cap rates on residential acquisitions have dropped to around 4.5% for good quality locations.

As FCR is paying close to 4.8% in dividends, the prospects of rapid expansion through acquisition are limited. Moreover, with leverage at about 44%, the trust can only increase its leverage to about 60% and still remain conservatively geared.

How can you expand FCR while there is low liquidity in your stock and as cap rates on residential property acquisitions are falling?

Yuzuru Shinozaki, general manager of Fund Creation Reit Advisers We are obliged to bide our time for a while but hope that the market reassesses our value soon. There remains a large yield spread between JGBs and residential property cap rates and J-Reit yields, so we argue that the residential property buyers are right in their assessment.

Condominium prices in Tokyo are set to rise, pulling all other residential apartment buildings upwards with them. Some argue that condo prices might rise dramatically from next year, but whatever the speed and scale of the rise in prices, we should benefit, as some 70% of our assets are in the prime three central wards in Tokyo.

We are making a considerable effort to demystify the portfolio and clarify the key investment opportunities for investors. We need to boost the stock price and liquidity, as we are currently stuck in a vicious circle in which even if we were considered undervalued, the larger buyers would be cautious due to the illiquidity of the stock. We will continue to build the portfolio carefully, step by step and hope that the investors follow our story.

Is the country's demographic outlook — a shrinking and ageing population — dragging sentiment down?

Koji Kaneko The news is not all bad. While the birth rate is falling and longevity is rising, there is a migration to the major conurbations and more single males and females living alone, which in fact helped the number of households in Tokyo rise about 6% last year.

Location is vital to the construction of a residential portfolio and we believe we have targeted the best locations across the country.

Are investors concerned that managing residential apartment buildings might be more labour-intensive and therefore costly than managing other types of commercial property, with a relatively high tenant turnover, short contract terms and therefore the need to
refurbish regularly?

Koji Kaneko We are a small management team, but we are young and highly committed and energetic. Yes, the management effort is more intensive, but the upside is that rental contracts are fairly short and therefore we can try to raise rents rapidly to seize the potential of the improving economy.

21 Sep 2006