For a country notorious for pedestrian decision-making, legislative red tape and an inbuilt suspicion of foreign investment, Japan’s real estate regulators surprised many in May when they pushed through a quiet but far-reaching piece of legislation. With the minimum of fanfare, the Tokyo Stock Exchange tweaked existing listing requirements governing Japanese real estate investment trusts (J-Reits), granting them permission to invest in overseas property for the first time.
The aim of the TSE and the ministry of land, infrastructure, transportation and tourism (MLIT) was clear: to bring J-Reit fundamentals closer to international norms, and ensure that the country’s market for Reits doesn’t lag too far behind globally integrated property markets, such as those in the US, Australia and Singapore. "This is not necessarily a move [designed to] promote cross-border investment," says Toshiyuki Anegawa, a Reit analyst at Merrill Lynch in Tokyo. "MLIT wants to get the J-Reit framework closer to international standards from a long-term point of view."
Regulators and politicians haven’t been alone in lobbying for the new legislation. Many Tokyo-listed Reits, notably Japan Retail Fund, have been hugely active in pushing for the recent rule change. JRF, along with several industry peers and the ministry, believes that by opening up foreign markets, J-Reit managers can diversify their capital-raising methods, and spread risk more evenly. Legislators are also trying to make the market less insular: before the May rule change, Japan was one of only four countries active in the Reit market that banned local firms from investing overseas (the others are South Korea, Thailand and Bulgaria).
In theory the new legislation provides a much-needed fillip to the country’s malingering Reit market. Despite boasting a large, wealthy population with a collectively instinctive knowledge of property valuations, the J-Reit market has grown by fits and starts since its inception.
When it was launched in September 2001, the market consisted of two listed Reits with a combined market capitalization of ¥260.3 billion ($2.4 billion). By the start of 2008, Japanese and foreign investors (no restrictions were imposed on foreign investment in locally incorporated and listed Reits) were able to pick and choose from 40 J-Reits with a market cap of nearly ¥5 trillion, an increase of almost 20 times in just seven years.
Yet the local Reit market has consistently failed to realize its vast potential. Locally listed Reits make up about 0.9% of the Japanese Topix market, compared with 9% of Australia’s ASX and 2.8% of the much larger S&P 500.
Dividend yields are also substantially lower in Japan than elsewhere – standing at 3% at the turn of the year, compared with 4.07% in the US, 4.6% in Australia and 4.91% in Singapore. Local stock prices have hardly been encouraging, particularly to Japanese retail investors, many of whom have fled the market. JRF’s stock is down 26% in the year to June 11 and 55% over the past 13 months. It’s little wonder their managers were so gung-ho about encouraging outward investment by local managers: many will do anything to see their stock prices pulled out of the basement.
That said, plummeting valuations are a boon for some value-seeking investors convinced that the listed Reit market has bottomed out. CLSA picks MID Reit as an undervalued office play, along with Japan Prime Realty, Orix J-Reit and Premier Investment. The investment bank and brokerage also advises that the recent recovery in consumer spending will benefit provincial Fukuoka Reit, and to a lesser extent Japan Retail Fund. CLSA also advises buyers to look at Frontier Reit and Japan Logistics Fund, both of which offer stable revenue streams with plenty of room for leveraging. Frontier Reit is particularly compelling, with its stable of suburban retail properties with long-term leases.
So are Japan’s Reit managers ready for the new legislation? Moreover, do any of them really want to invest in overseas properties – or feel confident enough of their understanding of foreign property legislation and taxation issues, let alone their ability to juggle complex currency risks? Analysts say most Japanese Reit managers simply aren’t up to the task of managing foreign property – at least for now.
 |
| "None of the J-Reits really has any experience in terms of investing in or managing overseas assets. Some have no intention of [investing overseas] and so I wouldn’t expect much change. J-Reit managers simply don’t have the market experience." |
"None of the J-Reits really has any experience in terms of investing in or managing overseas assets," says Andreas Schuster, head of real estate research at CLSA in Tokyo. "Some have no intention of [investing overseas] and so I wouldn’t expect much change. J-Reit managers simply don’t have the market experience. They would need help in dealing with issues like currency exposure." Merrill’s Anegawa adds: "Most major J-Reits are cautious toward overseas investments, due mainly to perceived country risk and FX risk." He points to the listed property trusts in Australia that have recently found themselves mired in financial trouble thanks to rapid FX shifts and credit tightening in various countries. Anegawa believes that, just as Japan offers a wealth of different Reit structures to investors – from office specialists to residential Reits, retail property Reits and hotel-based Reits – the country should offer new Reitable structures that invest only in foreign real estate. Either way, Anegawa believes it will take a long time for J-Reits of any stripe to begin actively investing overseas. "I believe there exists no immediate demand [in overseas investment by J-Reit managers]," he concludes.
Attracting foreign buyers
The TSE and the MLIT had hoped that by encouraging Japanese J-Reit managers to invest in foreign assets, more overseas investors would be attracted. Foreign buyers, the thinking went, would be keen to use Japanese Reit structures to buy overseas, just as they have been via Reits in such countries as the US and Australia. But bankers in Tokyo threw cold water on this notion. "Why would foreign investors go out of their way to buy assets in, for example, their own country, via a Japanese Reit?" one queried. "It’s hard enough doing business in Japan as it is, given the language and culture problems and tax structure, for most corporations and investors. Why make it even harder for yourself?"
More pressing issues, however, confront the country’s floundering Reits. Japan’s economy performed strongly in the first quarter of 2008, but economists predict rockier times ahead, adversely affecting the property sector. Real estate projects have also been hobbled by the rising price of construction materials, notably steel, and stricter business codes.
Regulators and Reit managers meanwhile need to find some way to drag in greater retail investor participation. Retail buyers were expected to drive the market when it opened seven years ago but statistics from the TSE show that retail buyers made up just 8% of average daily turnover in Reit securities in March 2008, down from an average of 15% in 2007 and 10% in 2006. Those statistics stand in stark contrast to overseas investors, who comprised 44% of average daily turnover in 2006 and 55% a year later. Despite volatility in the J-Reit market since May 2007, foreign investors remain net buyers of Reit-related securities, according to CLSA.
One of the main problems with Japanese Reits lies in the scarcity of land. Domestic real estate trusts are unhealthily concentrated on Tokyo, with a few exceptions, such as Hankyu and Fukuoka Reits, and land in Japan’s capital remains both scarce and ludicrously expensive. Few new or existing properties come up for sale, so Reits are provided with limited scope to acquire and grow – and without expansion through property acquisition, yields slowly wither and Reits lose their lustre.
Take, for example, the decision by Daiwa House Industry to scrap its planned $562 million initial public offering because of weak investor demand. CLSA noted in a February 2008 report titled "J-Reit Bible: a reference guide for Japan property investors" that in terms of new IPOs there was "significant room for growth".
Yet Daiwa’s about-turn over its IPO casts doubt over this bullishness, and underlines the uncertainty that investors have about the long-term health of Japan’s stultifying Reit market. The company, Japan’s second-largest home builder, originally said it would list Daiwa House Reit Investment Corp by June 19, in what would have been the first Reit-related IPO by a Japanese firm in eight months. Investors became spooked by the continuing slough in domestic Reit stocks, which have shed more than 50% of their value over the past 12 months. Just two Japanese Reits were listed in the whole of 2007, while several were scrapped, including one by the insurer AIG.
Nonetheless, analysts are hopeful that retail investors can be lured back to the market. CLSA’s Schuster says the big hope for Japanese Reits is in individual investors becoming attracted to yields, now that prices are on the rise. "If you have inflation, you don’t want your savings in a Japanese government bond at 1.6%, particularly when the yield on a domestic office Reit is 4%, with up to 7% on a residential Reit."
It’s faint praise indeed, yet with the markets as they are, any straw seems worth clutching at. Besides, Schuster balances his brief moment of positivity by noting the historical ability of Japanese Reit managers to acquire any substandard property asset going. "The problem with Reits in Japan is that in the past the assets they bought weren’t always very good," he sighs.
