Japan Property News Digest

Friday, November 25, 2005

ANALYSIS: Property Funds Need To Diversify 'Exit' Options

November 25, 2005
ANALYSIS: Property Funds Need To Diversify 'Exit' Options

TOKYO (Nikkei)--If the success or failure of real estate investment trusts is determined by whether their opening prices stand above or below their initial public offering prices, only half of the REITs that listed during the current fiscal year so far would be considered winners.

The 50-50 chance of winning is mainly due to the fact that investors have grown selective in choosing REITs recently.

REITs set up by privately held property investment funds have found it particularly difficult to win, doing so at the rate of only 1 in 3 so far in fiscal 2005.

Trusts created by major funds like Creed Corp. (8888) , Asset Managers Co. (2337) and DaVinci Advisors KK (4314), have finished among the losers, sending a shock wave throughout the industry.

Citing the reason for their weak performance, an analyst at a second-tier securities firm said, "Speculation has spread among investors that the quality of the REITs managed by property investment funds -- new entrants into the market -- will deteriorate."

These funds, which are less popular than REITs affiliated with Mitsui Fudosan Co. (8801) and other major property developers, the first generation of REIT operators, tend to incorporate into their portfolios relatively old buildings whose value is only 1-4 billion yen each.

An increasing number of unlisted property investment funds have been established since around 2000, with their combined outstanding assets surging 150% to 3.3 trillion yen over the one and half years through June this year, according to a survey by STB Research Institute Co.

Because their maturity periods average from three to five years, many of them started to reach maturity around last year and are now trying to sell properties to recoup their investment.

Among the "exit" options that these funds use to recover their investment, the resale of property holdings to their own REITs has been the most common strategy to date.

Their REITs have mostly been lackluster this year partly because, as a property fund manager put it, they tend to purchase properties from the funds that set them up, degrading the overall value of their assets.

Pointing to the need to seek other exit alternatives, a leading analyst said, "If property investment funds fail to change their strategy, it will hamper the flow of money into them."

But the funds do not appear to feel a sense of crisis since overseas institutional investors are emerging as major property buyers.

Ryosuke Honma, president of leading property fund Kenedix Inc. (4321) , has recently been visited by a slew of executives from U.S. and European investment banks seeking his advice on real estate investment in Japan.

"Some of them now consider buying properties whose yields are a steady 3-4% per annum, rather than target handsomer returns," Honma said. Foreign players used to acquire a number of Japanese properties simultaneously at cheap prices to quickly earn capital gains from their sale.

In June, Japanese property fund Simplex Investment Advisors Inc. (8942) sold a building near JR Shinjuku Station to Babcock & Brown, an Australian investment bank, for about 3 billion yen. The building has shown it can maintain its occupancy rate, soon finding a new tenant to replace Sakuraya Co. when it moved out.

Babcock launched a REIT targeting Japanese properties in April and plans to quadruple its outstanding assets to 200 billion yen.

The Australian bank thinks there are many office buildings and commercial facilities in Japan that are potentially suitable for long-term investment now that the country's economic recovery will help to keep their occupancy rates stable.

In addition to relying on foreign buyers to recover their investment, funds are also trying to secure value-added properties. Asset Managers has set up a fund aiming to buy several office building sites in a prime location in Tokyo or Osaka and sell them to real estate firms wanting to redevelop a large area at one time. Iwao Aoki, the company's president, said, "We sometimes sell properties for five times the purchase price.

Other funds are opting not to quickly sell their properties but to extend their maturities. Creed is being asked by an investor in a fund with a high 18% yield to keep its quality assets under the fund's management, instead of selling them to an affiliated REIT.

Junji Inoue, a senior researcher at STB Research Institute, said, "Although the real estate market is unlikely to slump suddenly in the near future, funds should have a variety of exit strategies on tap."

-- Translated from an article written by Tadayoshi Ichimaru, Nikkei staff writer.

(The Nikkei Financial Daily Friday edition)