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Japan Prime Realty Investment Corp: JPR balances strategy and pragmatism

10 Dec 2004

Japan Prime Realty Investment Corp is, like the other J-Reits, faced with rising property prices and flat rentals. It is therefore adapting its acquisition strategy and is among other things, looking to buy up what it terms ?value-up properties'.

Japan Prime Realty Investment Corp (JPR) uses a handful of buzzwords to characterise its approach to the future.

Words such as balance, steadiness, selectivity and practicality are rife throughout the trust's investor presentation material. And when EuroWeek recently visited JPR in Tokyo another word ? winner ? was also heard loud and clear.

?Japan Prime Realty has what it takes to emerge as a winner in Japan's Reit market,? claims Toshihiro Hagiwara, president of Tokyo Realty Investment Management (TRIM), the asset manager of Japan Prime Realty Investment Corp. ?Our track record and distinctive characteristics show us achieving steady portfolio expansion through the acquisition of a balanced property portfolio, and we are on target to reach our goal of ¥300bn of assets by 2006.?

The market has changed quite dramatically since May 2002, when JPR listed for ¥58bn. Since those early pioneering days for J-Reits, JPR has made rapid strides forward. By October 29 this year, JPR's market value had climbed to ¥131.2bn, underpinned by a portfolio totalling ¥175.8bn.

JPR was founded by a group of influential shareholders. Leading listed property developer Tokyo Tatemono owns 26% of TRIM, while the other shareholders are Meiji Yasuda Life Insurance (24%), Taisei Corp, the construction and property group (20%), Yasuda Real Estate (20%) and Sompo Japan Insurance (10%).

As one might expect, considering these powerful backers, JPR was an early mover in the market. ?JPR has enjoyed a remarkable period since listing,? says Hagiwara. ?The J-Reit market has evolved rapidly and commercial real estate has emerged from the lacklustre state it had been in for many years, while market liquidity and transparency have both surged.?

JPR's stated acquisition policy focuses on collaborating with its founder shareholders. By October this year, JPR owned 40 properties. Since listing it had acquired 18 of these, worth about ¥73bn, from its five sponsors, with about 49% of those by value procured from Tokyo Tatemono.

?With the competition for acquisitions and a growing pool of money chasing deals, we must these days try to lock in the acquisition of properties under development,? Hagiwara explains. ?By trying to identify and acquire properties off-market, we can in part avoid the intense competition in the real estate market, and thereby very selectively add to the portfolio.?

JPR's business plan identifies several key objectives. ?Our strategy focuses on internal growth and on external growth,? Hagiwara says. ?We are realistic about the opportunities, given the economic situation. For example, in the current environment of flat rental yields, in order to achieve internal growth we must improve the operating ratios and cut the administrative costs for our properties.?

JPR plans to cut property management fees by 15% by 2006. Combined with other cost-cutting initiatives, this is intended to shave about 1% off JPR's expense ratio by 2006.

Like the other J-Reits, JPR must rely heavily on external growth. In doing so, TRIM will continue to focus largely on the office sector, while allocating up to 20% of the portfolio to retail and other commercial properties.

The trust has acquired ¥36bn of properties during 2004, of which 57% are in Tokyo's central business districts, 32% in Greater Tokyo and 11% in other cities in Japan. Offices make up 94% of the acquisitions and retail properties 6%.

?We aim to balance through diversification by type of property, tenant and geographically in Japan, although with the majority of assets in Tokyo,? says Hagiwara.

JPR also has a policy of finding and buying what it terms ?value-up properties'. These are properties with occupancy rates below 80% where the management team believes it can turn the building around and achieve higher occupancy and higher rents, while at the same time reducing costs.

?We aim to have up to 15% of the total portfolio in such properties and these will add value to shareholders as we apply our management and brand formula to the properties,? explains Hagiwara.

There is also the potential to dispose of properties if the right price can be achieved. ?We always consider the benefits of realising profits from the sale of properties with higher valuations,? Hagiwara adds.

Management strategy is one thing, and the reality of the market place is another. Hagiwara and his team are realistic about what they can achieve.

?Prices have been rising and rentals are flat or weak, so we have had to adapt our acquisition strategy to cope with this new environment,? he says.

?Our core strategy,? he adds, ?remains to buy completed and tenanted buildings, but we are also looking at buildings up to 18 months before completion. There is additional risk, but that can be offset by the reduced prices we obtain for effectively guaranteeing a developer an exit.?

JPR is unusual among the J-Reits, in that it allocates about 40% of its assets to the regional property markets, although that share has contracted from just over 42% at listing to about 35% today.

Hagiwara explains: ?Cap rates in the provincial cities are about 6% and in Tokyo closer to 4.5%. We have categorised certain cities as ?investment grade cities' which have a certain size of the rental market. We can also invest outside those cities, but only in top-class properties.?

(The capitalisation rate, or cap rate, is a measure of a property's yield, calculated as its net operating income before tax and interest, divided by its market value.)

Japan's regional property markets, compared with Tokyo's central business districts, have lower rents, higher vacancy ratios, a smaller and slower growing rental market, smaller purchase sizes and lower liquidity.

?Although it is the Greater Tokyo economy that has been the most robust,? says Hagiwara, ?the regional market can produce good returns if the acquisition policy is targeted and selective. We obtain higher returns from these regional properties, but they are higher risk and require more hands-on management and are also less liquid. Accordingly, we will continue to limit investment in cities outside Tokyo to specific levels.?

Although rents remain weak, the TRIM management team is optimistic about the commercial property market, based on its experience of the time required to find new tenants, which has been falling.

?The economy is slowly improving,? Hagiwara says, ?and our properties, which are at the higher end of the quality spectrum, are the early beneficiaries of this recovery cycle.? 

10 Dec 2004