J-Reits will help recapitalise the real estate markets, while it could provide a route into Japan for international investors
For more than a decade Japan’s economy has been in recession. The real estate market has been particularly hit with property values having fallen to around 50% to 70% of levels of 10 years ago. One instrument aimed at recapitalising the property market is the real estate investment trust known as the J-Reit. With the legal framework set up last November, several Japanese real estate groups are busy working to get the first of the new real estate companies listed this autumn.
This new breed of listed property companies is structured differently from their cousins in the US. J-Reits are asset ownership companies which will be advised and managed by an asset management company. Investors can expect yields between 3% and 6% pa. This compares to the 1.3% being offered on 10-year government bonds.
J-Reits are aimed at both the retail investors as well as the institutional market. Many Japanese have retirement capital tucked away in postal savings schemes earning low interest so the sponsors of J-Reits are confident about attracting attention for the new product.
Though generally welcomed by the real estate industry and the investors’ community, a number of issues concerning the J-Reits have yet to be resolved. “Most of these are related to transparency and governance issues,” says Jack Chandler, regional chief executive officer for LaSalle Investment Management, Asia Pacific. “Many of the features investors are looking for may not be there for the first few issues. To find solutions will be particularly important if offshore capital is to support the J-Reit market.”
This includes disclosure of tenant information. The financial sector wanted full disclosure of tenant information and lease terms for each building, something that was strongly objected to by potential sponsors.
Lease legislation in Japan is tenant friendly. Lease agreements run for two years with the tenant having the right to terminate the lease at any time with six or 12 months notice. In addition, when the quoted rents in the neighbourhood change markedly, the rents can be adjusted accordingly. It was decided disclosure would occur when the space a tenant leased exceeded 10% of the total space.
The J-Reit is an asset owning vehicle. A J-Reit has no employees and is outside-managed by an asset management company which recommends the purchase and the price level. This points to a potential conflict of interest for the Reit sponsor – usually the larger Japanese property groups who may find themselves in a position of having to serve two masters. J-Reits provide the sponsors with an opportunity to increase their fee income, thereby improving the return to shareholders. However, one issue is whether J-Reits will award all property management contracts and advisory work to an affiliated company of the sponsor. Unless there are covenants in place to ensure that this is done at market rates such arrangements could be to the detriment of J-Reit investors.
Another issue potential investors are focusing on is the capital structure of the J-Reits as the level of leverage and the type of loans have an important impact on the earnings potential for the shareholders. Though it is expected that the market will not accept Reits with debt to total capitalisation ratio of more than 50%, floating rate loans can easily eat into the profits in times of rising interest rates.
Nevertheless, none of these issues are considered to constitute fatal flaws for the J-Reit market. The comparatively high dividend yield is considered to offer sufficient incentive for investors. Takashi Uematsu, director of Nomura Real Estate, says: “I am not a pessimist. Japanese companies are improving the disclosure level and governance. I believe that this trend should be accelerated once the J-Reits are actually listed in the market.”
The launch of the J-Reit market also opens a door to foreign investors to take a stake in the Japanese property market, an opportunity which is currently hard to find. Even though there are many publicly listed real estate companies in Japan, the lack of disclosure and uncertainties about the valuations used in the accounts make it hard, if not impossible, to assess the value of such an investment.
J-Reits will be launched in the context of a fairly strong trading market in Tokyo. In addition to acquisitions by foreign investors, domestic capital has come back into the market and the number of investment transactions has risen sharply. The strong investment activity continued in the first three months of 2001. Many of the listed companies are trimming their balance sheets due to the economic slump.
The strong demand has driven initial yields down to around 4%. While some analysts have termed this “the fund bubble”, others see it as a reflection of property values bouncing back. Chandler expects international investors to provide some initial liquidity and help to reframe the real estate market to focus more on the needs of investors and occupants. It has to be noted, however, that the share of foreign capital compared to the overall size of the market is fairly small.
According to research by Jones Lang LaSalle (JLL), the vacancy rate in all grade offices in Tokyo’s CBD was down to 3.1% at the end of March 2001. Rents have been flat for the past two to three years; prime rents increased slightly over the past 15 to 18 months. News about the recession of the Japanese economy is causing worries for the real estate sector. There are concerns that there will be bankruptcies followed by rising vacancies which will cause rent levels to come under pressure again.
One obstacle hampering the restructuring is the non-performing loans, many of which are related to property. The government is putting pressure on the banks to sort out the problem by writing off all their non-performing loans within a few years.
Japan is not the only country in Asia with an evolving Reit market. As of the beginning of July Korea passed legislation to introduce K-Reits and in India the prospect of introducing Reits is being studied.
“A number of the markets in the region are recognising that it is in their interest to have international markets where offshore capital can come and invest,” says Chandler. “But there are also some very practical considerations for the needs that international capital has, and the market is struggling with them. Having said this we are moving in what, from our perspective, is a very positive direction as issues such as arm’s length valuations, disclosure of information and alignment of interest are some of the concepts that are slowly working their way into the Asian real estate markets.”
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Asian property indicators |
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City |
Vacancy rate in % |
Rental movements Yr on Yr Local currency changes in % |
Prime investment yields |
|
Hong Kong Central |
7.4 |
29.8 |
4.57 |
|
Shanghai |
20.6 |
n/a |
5.55 |
|
Beijing |
14.4 |
n/a |
n/a |
|
Tokyo CBD |
3.1 |
4.1 |
5.30 |
|
Makati CBD & Fringe |
20.1 |
-21.0 |
10 |
|
Singapore CBD |
6.3 |
28 |
4.25 |
|
Kuala Lumpur CBD |
17.8 |
4.6 |
6.75 |
|
Bangkok CBD |
27.4 |
-2.3 |
7.61 |
|
Jakarta CBD |
24 |
26.1 |
9 |
|
Mumbai CBD |
11.3 |
0.0 |
– |
|
Sydney CBD |
4.3 |
13.2 |
6.50 |
|
Melbourne CBD |
6.8 |
25.5 |
5.00 |
|
Auckland CBD |
13.6 |
-5.3 |
8.50 |
|
Source: Jones Lang LaSalle |
Figures as at 31 March 2001 |
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Life after 1997 – the crisis abates |
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After the financial crisis hit Asian markets in 1997, most countries resumed the pursuit of economic growth and in the years 1999 and 2000 some countries achieved double digit growth rates. Although last year the export-led economic recovery broadened into a stronger intra-regional trade, Asia is exposed to a slowdown in the world economy. Most at risk are countries with a high percentage of their GDP being tied to technology products such as Malaysia, the Philippines, Taiwan and South Korea. However, according to the Asian Development Bank the economic downturn is now also spreading to other sectors. Looking at the real estate markets the strong demand in the first quarter of this year has caused rents to rise. In eight of the major 13 markets covered by JLL’s research, rents rose in the first quarter of the year. Vacancy rates are generally stable albeit with a wide spread. At the lower end Tokyo and Sydney report a vacancy rate of 3.1% and 4.3% respectively. At the top end Bangkok still has 27.4% of its offices vacant, followed by Jakarta CBD with 24%. Other cities with a vacancy rate of more than 20% are Manila and Shanghai. Turning to the investment markets, initial yields for prime offices range from 4.25% in Singapore to 10% in Manila’s Makati CBD. Due to the worsening global economic outlook, investment activity is driven by domestic players with overseas investors continuing to stay on the sidelines for the time being. Exceptions were Tokyo CBD, Sydney and Melbourne. For some observers the current economic plight of lower growth may also lead to renewed efforts for structural reform. Due to the swift economic recovery the pressure on governments to proceed on a strict reform course somewhat lifted. Asset management companies set up for the purpose of sorting out these problems have only begun their work. As the companies are restructuring they may want to make productive use of capital tied up in property assets and the number of sale-and-leaseback transactions and prime asset disposals are likely to rise. For instance, the bank mergers in Japan could result in new space for sale or lease being put on the market. In Singapore it is also the banking sector that is likely to help the investment market. In an attempt to make the local banks internationally competitive the government has directed them to divest their real estate assets over the next five years. As these are important institutional investors in the property market, this will lead to an increase in first class assets being put on the market. In the first quarter of this year DBS Bank sold its DBS Securities Building for S$51m as part of its divestment strategy. |
