Foreign and local money pours in

  • 22 Sep 2006
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EuroWeek turned to CB Richard Ellis, the global property market research and consultancy firm, to explain the current state of the Japanese property market and the investment outlook.
Andy Hurfurt, director of CBRE Consulting, and Kiki Lai, research associate at CBRE Research, give the view from Tokyo.

What are the key economic and demographic trends affecting the Japanese property market?

Fifteen years after the collapse of the asset-inflated bubble economy, the Japanese economy in 2006 has finally shown some promising signs of a sustained recovery.

Upbeat news such as the continuation of economic expansion, rising land prices, rising capital expenditure and the upward trend of consumer prices all provide a supportive environment for the property market.

The return of an inflationary environment and the subsequent lifting of the Bank of Japan's quantitative monetary easing and zero interest rate policies in March and July this year further signified the reinvigoration of the Japanese economy.

Many foreign investors perceive Japan as having an attractive property market with a highly productive population and largely undervalued assets.

The BoJ's first interest rate hike for six years and its repercussions on borrowing costs are, we believe, likely to create a greater gap between the high and low ends of the property market, with investors focusing on properties which offer the greatest rental growth potential.

On the demographic front, the declining population is potentially a chronic problem affecting the Japanese property market. The Japanese population (including babies born to Japanese and foreigners in Japan, as well as Japanese people living overseas) began shrinking last year, and many predict that the rate of decline could halve the Japanese population by the end of the century.

The reductions in workforce and consumer numbers may have significant implications for the Japanese property market, even though the number of households is set to increase as more people marry later and as the divorce rate rises.

Experts project that the overall population and the workforce will shrink gradually in the years to come, due to the ageing population and low birth rate. While people working until an older age and greater female participation in the workforce might both partly offset the declining workforce, the falling population and continuing rapid urbanisation will particularly affect rural areas.

Meanwhile, the number of single and childless households is due to increase, since more people are choosing to marry and have children later in life.

This would influence the residential sector in terms of potential growth in demand for single-occupant apartments and senior housing. An ageing population also has implications for the ease of access to all property types such as commercial and residential buildings.

Is the flow of domestic and international money seeking property acquisitions in Japan slowing or accelerating?

Thanks to solid demand for office space and intense competition for investment grade assets, commercial land prices rose in 2005 for the first time for 15 years in Tokyo, Osaka and Nagoya, the three major cities of Japan.

Domestic and foreign investment funds are accelerating their injection of funds into the Japanese property market.

In July, DaVinci Advisors KK, one of the most active property fund operators in Japan, purchased the Shiba Park Building, a landmark building in Minato ward, for ¥143bn ($1.25bn) from Morgan Stanley.

The 14-storey building, nicknamed 'the Battleship', has 103,000 square metres of gross floor area and a 140 metre façade. It was the largest single asset acquisition in Japan to date.

Foreign investors are particularly interested in real estate in large Japanese cities, as they are considered largely undervalued compared with properties in major US and European cities.

Despite significant compression over the past 18 months, the spread of 150bp-200bp offered by prime Tokyo office properties over the yield on 10 year Japanese Government Bonds remains very attractive, relative to the zero or negative spread now seen in many other mature property markets.

Recent years have witnessed a substantial flow of capital into Japanese real estate from around the globe. We would highlight names such as AIG, General Electric, Goldman Sachs, Morgan Stanley, Babcock & Brown, Macquarie Bank, Government Investment Corp of Singapore, CapitaLand, LaSalle Investment Management and ProLogis, among many others.

AIG, for example, has been a significant but discreet investor. Its acquisitions in the first quarter of this calendar year included buying a part share in a newly completed office and retail development for $415m.

There have been reports that GE Real Estate is accelerating its real estate investment activities in Japan. In the first quarter of calendar 2006, GE is reputed to have acquired $1.4bn of properties to add to its existing portfolio of 600-plus assets (as of 2005).

Purchases include the operations and assets of an Osaka-based real estate company and direct investment into properties located mainly in Tokyo and Osaka.

Goldman Sachs is another perennial acquirer and sponsored the first J-Reit specialising in hotels. With an initial portfolio of six properties valued at the equivalent of $635m, Japan Hotel & Resort Reit listed in the first quarter.

Goldman Sachs is believed to possess the largest portfolio of hotel investments in Japan, with an estimated value of about $1.2bn, excluding the Reit assets.

Is the listed property market, comprising developers and J-Reits, likely to keep growing?

Research by Prudential Real Estate Advisors indicates that Japan's real estate market is the second largest in the world, but its listed property market is only the fourth largest, behind the US, Hong Kong and Australia.

During the bubble economy, companies and individuals whose primary business is unrelated to real estate acquired many properties. These owners have largely not managed these properties to their full potential.

Asset impairment accounting, introduced in 2005, and companies' increased focus on their core businesses have combined to encourage the sale of some of this real estate, but there is still a lot of property that remains unprofessionally managed and that continues to underperform.

There is therefore considerable scope for J-Reits and private funds to grow. The J-Reit market is growing apace, with 38 J-Reits listed since the market's inception in September 2001.

Most of the recently listed J-Reits have been related to private funds, but three out of five forthcoming J-Reits are to be sponsored by developers.

These include Mori Building's Mori Hills Reit, Sumitomo Realty and Development's Tokyo Office Fund Investment and Mitsui Fudosan's Nippon Commercial Facilities Fund Investment.

The market therefore appears to be following a similar cycle to the US Reit market, though the changes are occurring at a much faster pace.

In recent years in the US, large developers have taken Reits private and larger Reits have bought smaller ones. We expect this trend to reach the J-Reit market at some point in the future.

J-Reit still offer a healthy spread over the JGB market, but interest rates and risk-free yields are rising. What are the major challenges facing J-Reit managers and can the listed Reit stocks continue to perform well as rates rise?

Reits are essentially lower risk and concomitantly lower return investment products that should offer investors a regular income stream.

As the J-Reit market took off, investors were instead buying for capital gain through stock price appreciation and paying little attention to the underlying assets. All J-Reits were performing alike, namely rising in value.

Today, the performance of different J-Reits is much more diverse and investors have become more sophisticated, assessing the underlying property for capital and rental growth.

The relative scarcity of good quality properties publicly offered to the market and the increased enforcement of regulations by Japanese regulatory bodies have both made it increasingly difficult for investors to find good acquisitions and meet the stringent timeframes for completion that property vendors require.

Investors in some off-market deals are willing to accept deals as much as 25bp-50bp below net operating income capitalisation rate benchmarks set by reported transactions.

Rents on well located office and retail properties are growing robustly and investor sentiment towards real estate remains high.

Competition for attractive investment opportunities is intense and J-Reits will increasingly face a challenge to remain competitive in the market while also maintaining existing distribution levels.

This suggests J-Reits will be pressured to purchase higher-yielding properties to sustain their competitiveness.

With interest rates and the risk-free rate rising, J-Reit asset managers will have to manage their assets and liabilities actively to maximise income. Measures include locking in fixed borrowing costs, active management of assets, increasing leverage and trading properties more actively.

Are there any regulatory or tax changes that are likely to affect the property market or J-Reits?

Mandatory asset impairment rule

The mandatory asset impairment rule was introduced in 2005. It requires firms to recognise the impairment loss if the fair value of their tangible assets depreciates from the stated book value by 50% or more.

Since its implementation, many companies have begun to adopt a strategy of leasing rather than owning properties, to move depreciated real estate assets off balance sheet.

Recent examples include general merchandise stores and major retailers such as The Maruetsu, Daiei, Aeon Co and Ito-Yokado Co. Another example is Mitsukoshi Ltd, a major department store chain, which disposed of about ¥30bn of logistics assets. Prince Hotels sold its 30 unprofitable hotels across Japan.

The sale-and-leaseback concept has provided flows of investments in the market and opened up channels of opportunity for real estate funds and other investors. We expect to see more examples of similar disposals.

Proposal for J-Reits to be allowed to buy assets overseas

The Ministry of Land, Infrastructure and Transport is considering a plan to allow J-Reits to acquire foreign properties.

The proposed plan could be implemented as early as fiscal 2007 (the year to March 30, 2008). It aims to expand the ability of the J-Reits to diversify asset, political and currency risks.

Such a move is likely to be welcomed by some of the J-Reits, as it opens a new avenue for improved fund returns through higher yields and risk diversification.

Rise in consumption tax

There is growing speculation that Japan's consumption tax will be raised over the next few years. Although the exact rate of such a tax is likely to be a key topic in the forthcoming Liberal Democratic Party presidential election campaign, there is speculation that the consumption tax in Japan may later be raised from its current 5% to at least 8% by mid-2010.

According to a survey by the Japan Federation of Housing Organisations in April, 80% of prospective homebuyers in Japan would be affected by the tax rise. [The tax does not apply to property transactions but would depress overall disposable income.

  • 22 Sep 2006

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 414,341.60 1584 9.03%
2 JPMorgan 377,311.36 1724 8.23%
3 Bank of America Merrill Lynch 358,416.32 1295 7.81%
4 Goldman Sachs 266,063.47 914 5.80%
5 Barclays 264,598.20 1056 5.77%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
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1 HSBC 44,979.63 190 6.68%
2 Deutsche Bank 37,125.85 136 5.51%
3 BNP Paribas 36,403.69 206 5.41%
4 JPMorgan 33,752.71 110 5.01%
5 Bank of America Merrill Lynch 32,865.23 106 4.88%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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1 JPMorgan 22,398.41 104 8.72%
2 Morgan Stanley 18,608.72 99 7.25%
3 Citi 17,768.49 110 6.92%
4 UBS 17,372.80 70 6.76%
5 Goldman Sachs 17,228.66 97 6.71%