Ask any global real estate investment professional which country is most under-invested in non-domestic property and you will get only one answer: Japan.
Ask them which organisations are most glaringly absent from the global real estate market and you get two answers – Government Pension Investment Fund of Japan and Japan Post.
There are myriad reasons for this including the low and conservative nature of investors in the country, the large domestic market in which they can play and the fact that the Japanese were burnt badly by poor timing in the 1990s.
But that is all about to change.
The £1tn public pension fund GPIF is on the brink of appointing fund managers to take a fiduciary advisory role. These managers will advise on the global and strategy-specific funds that GPIF should invest in, which will mean billions pumped into the market.
On the hunt
The £2tn conglomerate Japan Post is already on the hunt to invest in real estate funds and has held preliminary talks with the managers of the £2.8bn Royal London UK Real Estate Fund.
A decades-long intention to invest is finally coming to fruition, nudged along by the low-return global investment environment and the relative attractiveness of property. This is illustrated by Japanese two, five and 10-year government bond yields sitting at 0.1%.
Some trailblazing Japanese investors, such as Mitsubishi Real Estate, have long been in the UK and European market but a sea change is now expected.
“There are lots of smaller financial institutions, corporate and public pension funds watching what those two do and, once they appoint gatekeepers, others will start to do the same. They need leaders to follow,” says Laurent Jacquemin, head of Asia at AXA IM – Real Assets. Jacquemin was previously head of transactions in Europe but moved eastward at the end of last year when the company transferred its Asia hub from Singapore to Tokyo in order to capitalise on the trend.
Others to follow
The two big beasts are the names everyone is talking about but they will not be alone. There is a sense that once they have shown the way that major regional banks and corporate and public sector pension funds will follow. Some are already prepping for this phenomenon, such as Nomura Real Estate Asset Management, which purchased 75% of Lothbury Investment Management so it can now better channel such capital into the UK.
“Some more confident corporates have already started and gone ahead of governmental ones. It is very much a case of trickling it into the market with tickets of around €25m and it is presumed that, assuming there aren’t any performance hiccups, these will continue to flow and be topped up,” says Jeremy Plummer, chief executive of CBRE Global Investment Partners.
When you move to talk to some of the important regional investors in Kyoto, Osaka and Nagoya, your ability to have meetings comfortably in a language other than Japanese is much diminished
Investment from the country is likely to flow through in many forms (see box below) but typically it is anticipated that investors will take a conservative attitude to begin with, focusing on deploying capital into core global funds with low leverage, targeting returns in the region of 7%.
Japanese investors are often tagged as some of the most difficult to deal with for western advisers and fund managers, owing to cultural differences, but for those that strike and maintain the right relationships, there is potential for the future of individuals and companies to be transformed as seismic amounts of capital begin to flow.
Getting a foot in the door
How will the money flow in? There are a variety of ways in which Japanese capital does and will increasingly flow into overseas real estate and these depend upon the size and risk characteristics of each individual investor.
■ Fiduciary mandates. Many Japanese investors will appoint a local or global fiduciary that will in turn take on a role to invest for them into a variety of funds and take on reporting responsibilities. Locally this would typically be the likes of Tokyo Marine or Nomura Asset Management and globally those taking such roles would be large managers such as Aberdeen Standard or CBRE Global Investment Partners.
■ Directly as a limited partner within funds. Some more experienced investors will allocate and invest into funds themselves. Typically they invest in global, low-risk, core funds but the more experienced they become the more they will employ specific and localised strategies to invest in funds.
■ Direct investment in standing assets. This is relatively rare and will be undertaken only by more sophisticated and most likely large investors, but they will not take more than 49% of investments for tax reasons (see below).
■ Segregated mandates. Wholescale segregated mandates are relatively rare but some large-scale, sophisticated investors team up with fund managers to find them opportunities where they can buy 49% of assets. This can involve the manager buying the other 51% on balance sheet or with a co-mingled fund it manages.
■ Direct development. This is undertaken only by very experienced specialist real estate companies such as Mitsubishi Real Estate. They can avoid double taxation on profits overseas as they are trading companies (see box).
The Japanese way
One universal comment from western fund managers with experience in Japan is that doing business there is culturally unlike in any other country and each has stories of investor idiosyncrasies and misunderstandings that they have found bizarre or amusing.
These are the best tips and advice from those that have been there and done it:
■ Detail. Every fund manager EG spoke to was implored to stress the level of detail and highly forensic nature of Japanese analysis regarding opportunities, meaning the volume and intelligence of the queries that it is necessary to answer is unrivalled.
“Be aware that cell AA101 of your spreadsheet will get looked at in the same way as A1 and the link will be followed through and you will be questioned on every single aspect of the market,” says one manager with experience in the region.
■ Language. It is completely normal for some meetings to be conducted predominantly in Japanese even if there are participants that speak only English. As a result it is imperative to have a Japanese team to work with.
“When you move to talk to some of the important regional investors in Kyoto, Osaka and Nagoya, your ability to have meetings comfortably in a language other than Japanese is much diminished and having an experienced Japanese team and colleagues certainly helps,” says Richard Johnson, global head of business development at UBS Real Estate & Private Markets, which co-manages three Japanese REITs alongside Mitsubishi Corporation.
■ Building a relationship. The importance of relationship building in business is something of a truism but it is no more important and harder than it is in Japan. It takes a large number of meetings in order to gain trust and a willingness to visit regularly, at least once a quarter, or better still build a local presence.
“They want to see over a series of meetings whether they are seeing a senior person once or whether they are going to see the same senior person consistently over a period of time,” adds Johnson.
■ Alignment. For many investors there is a desire for financial alignment with fund managers who want to see “hurt money” or “skin in the game”.
“Those investors that are investing directly with managers, in their funds or alongside them buying assets, want to see alignment. That is tied in with expectations around integrity, which is partly to do with what has happened in the past when Japanese investors have been hurt investing overseas,” says Duncan Owen, head of property at Schroders, which is understood to have a strategic partnership to co-invest with Mitsubishi Estate and a mandate to invest in direct assets in Europe with Norinchukin Bank.
■ Constant change. It is not uncommon for entire teams to change in one fell swoop on a relatively regular basis and relationships made to become near worthless overnight.
“You need to get in with a new team because relationships in Japan are like a burning platform. Staff stay within organisations for a long time but teams change about once every three years and move to a completely different parts of the business. It beggars belief but it happens a lot. There is a culture of wanting things looked at with a fresh set of eyes and a reassurance that if something is going wrong it doesn’t go wrong for longer than three years,” says one manager.
■ A (very) slow pace. Japanese decision-making is famously slow, so much so that investors are often accused of missing whole cycles. In dealing with Japanese investors, patience is king.
“It is all about being patient. You are most certainly not going to fly in and come back out of your first meeting with a big cheque,” says Laurent Jacquemin, head of Asia at AXA IM – Real Assets.
■ The magic 49%. Japanese investors are commonly seen to be buying, or looking at buying, 49% stakes. This is due to anti-tax haven regulations in Japan. As of last year, in any country where corporation tax is less than 30%, Japanese companies cannot own a controlling stake or they will also be subject to a 33% tax on profits in Japan. This applies in countries including the UK where the corporate tax rate is 19% and the US where it is 21%.
“The current rules do mean that the UK has become slightly less attractive across the board for Japanese investors,” says Joachim Stobbs, partner in international tax services at EY. “It colours any analysis for Japanese corporates of non-domestic investments and it makes it harder for them to compete outside Japan.”
It is not possible to avoid this through a series of fractional Japanese ownerships that are less than 49%. (In an example where three Japanese companies owned a third of a company each, they would all still be subject to tax back home.)
Fund managers must also be careful to ensure for their Japanese clients that there is not more than 49% of them in any one structure and to consider this as more Japanese investment comes into a fund over time.
And capping investment at 49% may still not be enough. Even if Japanese investors own less than half of an investment, if they are seen to be controlling it or making the majority of the decisions in relation to it, they could be hit by double taxation.
One saving grace is that the regulations relate only to companies that make passive investments, such as those that buy standing property, but not trading companies, such as those actively involved in development.
Rosy outlook in the land of the rising sun
Hideki Ota, head of capital markets and investment services, Japan, Colliers International
The Japan property market maintains its positive momentum owing to strong investor confidence and a significant demand and supply delta. The extremely low cost of borrowing in Japan has resulted in an attractive yield spread, drawing both domestic and foreign capital flows into the Japanese real estate market. The recent headline transaction of Shinagawa Sea Side Hitachi Tower B by Morgan Stanley to overseas Korean investors for $350m is a highlight of the trend.
Yields continue to compress to below 3% for Grade A office buildings in Tokyo as strong market fundamentals, such as corporates’ healthy financial performance and low unemployment, contribute to robust pricing in the office sector. Leasing activities across office, residential and logistics sectors remain strong and rents have started to rise in the Tokyo residential sector.
An upswing in inbound tourism is also boosting the performance of the hotel and urban retail sector. This growth, coupled with recent regulation affecting Airbnb and guest houses, which is expected to accelerate hotel development throughout Japan is, however, fuelling concern about oversupply in the hotel sector. Meanwhile, with stagnant employee wage growth and lacklustre consumer sentiment, we are seeing a slowdown in residential condominium sales.
The logistics sector is enjoying strong demand. Logistics in highly populated areas are very competitive, while those in low-populated areas struggle with leasing owing to workforce limitations and, as a result, asset location is the primary and differentiating factor.
We expect to see increased activity in development projects across most sectors, in the coming quarters, driven in part by forward commitments by investors and low leasing risks.
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