tokio property week

Dallas Four Season Hotel

2009-11-08T21:38:00.001+09:00

I sometimes read the blog named as WSJ's Development at http://blogs.wsj.com/developments and recently found an intersting article on Dallas Four Seasons Hotel. You can soon see how a sharp decline in operating cash flow has led to the default on its mortgage debt.

In a nutshell, the Four Seasons Resort and Club near Dallas has gone delinquent on its $175 million securitized mortgage. The hotel's owner acquired it in 2006, when the appraisal value was $229 mil. Since the hotel additionally carries $39 million in debt. The LTV ratio was set at approximately 93%, based upon the appraisal value, which I believe is significantly high then, because this investment looks like hotel investment instead of property investment. The blog says that the it likely is worth now from $68 million to $117 million.

This is the reality many hotel investment has been faced with. In the above case, the hotel owner was not abke to pay the latest interest on its mortgage debt, because the hotel’s annual cash flow went down to $6.8 million this year, substantially below its annual interest payments of $10.9 million.

My first surprise came from the very high level of LTV on the above transaction. Again, this deal does not have a fixed-rate rent scheme. This is a definitely investment in operational assets. I could imagine how available such easy money was in the US market. Another surprise came from the fact that the above mortgage debt was securitized and sold to investors as CMBS. I was amazed how blind investors who bought this CMBS were to potential risks. I guess that the credit rating must have mistified many of investors.

The story of Dallas Four Season Hotel has just reminded me that Go-Go days were definitely over.

Opportunistic Investment and Core Investment

2009-11-07T21:11:00.002+09:00

I had a chance to speak to a certain asset management specialist of a Japanese property investment house last week and asked him how the demand for core investments from non-Japanese investors looked like. He finds it difficult to identifty such a demand among overseas investors.

Certainly, I saw the newspaer's article saying that AXA teamed up with Sumitomo Trust to launch JPY 100 bil. of core office fund; however, I also heard that the fund launch is still at the blueprint stage.

The situation behind it looks like 10 to 15% of IRR can be reached by loan particiaption in the US. If this is the case, there is little good reason that overseas investors shall allocate their funds into a core investment in Japanese properties. In fact, I heard that some private equity real estate funds are looking at around 20% of IRR when they make an investment in Japanese real estate. Then, one obvious question here is how easy it is to seek for such a propety, given 20% of IRR target. My gut feeling is Japanese lenders are still holding their foreclosed properties, because they know ery well if they can protect the loan principal when they sell them into the market. It is dificult to identify a non-Japanese core investor who is interested in Japanese properties, while it is also hard for opportunistic investors to identify the properties which yield 20% of IRR after the leverage here in Japan.

Debt Restructuring of Blackstone's Hilton Deal

2009-11-03T21:56:00.001+09:00

I read the article on WSJ.com about Blackstone's discussions with lenders on Hilton's deal. This article clearly illustrates how Blackstone has dealt with its debt restructuring with lenders. Blackstone still has cash on hand; that's why they can make a new equity infusion combined with the extension of the debt maturity date, debt-equity swap, buyback of outstanding debts at a discount etc. I guess loan covenants such as LTV and/or DSCR has been already hit; therefore, Blackstone is forced to restructure its debts before the maturity of loans come due.

I could easily imagine that Hilton's operations are heavily hit by the global recession. Hotel's ADR can be defined as the rent set forth for the "one-day" lease agreement, judging from the viewpoint of the property business, so it is can be much more impacted by the economy than the rent of office and residential properties, which is usually defined as a long-term contract.

Getting back to the Hilton's case, it is not so easy for other real estate private equity managers which run the comingled property funds to follow the suit with Blackstone, I believe. It is mainly because they can hardly get an OK from all equity investors on additional equity commitments. Challengeｓ and difficulties will continue with property investment managers.

Global Mandate In Case Of Property Investments

2009-11-01T14:45:00.006+09:00

A global mandate is what investment managers for bonds and stocks have seen as a major trend of investment style among pension funds. Certainly, a gobal mandate approach has a merit. In portfolio construction, the wider the index coverage is, the better the risk-return profile is because it is more diversified. On top that, as long as the Japanese equity investment is concerned as a signle country mandate, it looks like the Japan is lack of upside potential as compared with China and India. That's why a portfolio construction nowadays is going global. Global equity and bond mandates are booming relative to a single country manadte or a regional mandate. In fact, a Japanese equity mandate has only 0.5% of breakdown in the US instituional equity manadtes, while a global equity mandate shows [20]%.

How about a proprty investment? Certainly, we have seen a global real estate private equity products and global REIT mandate so far. Goldman's Whitehall Fund is one of good examples and they have looked for a global opportunit to invest properties which produce a return of double digit percentatge after the leverage. However, such a global player is limited and decreseing in number under the current market conditions. Surely, the size of property investment per trade is big; therefore, a global portfolio construction is challenging. That's why a country and sector allocation is fairly important. I have got know the reason many Japanese property managers have difficulty rasing equities for their planned Japanese office or residential funds. It is primarily because the demand for Japanese properties is not so strong as they expected. Moving global or demonstrate the relative attractiveness of Japanese properties in a clear way looks like a solution.

Different Views on The Property Market

2009-11-01T13:37:00.003+09:00

I am now back to write my comments in this Blog after a 'short break'.

Mitsui Fudosan's residential J-REIT announced a follow-on equity offering and this is the first equity offering over the past 15 months! I heard other J-REITs were considering a similar equity financing. It looks like it has been warmly received among the community of investment community which manages J-REITs in their equity portfolios. They seem that they are looking at the capability to realize an external growth by acquiring properties.

Conversely, there are a few property managers, if any, which view the worst is over in the property market. A major driver for negative thinking lies in the continuing increase in vacancy rate and decline in rents. There is a good reason to believe so. It is partly because the demand for a space is really weak, and partly because many tenants are still asking property owners to consider a decrease in rent; otherwise, they will leave it for a cheaper place.

It is obvious that the equity market is a leading indicator and that the market is looking for something positive. However, on thing for sure is that the increased stock price will not last unless the J-REIT's NOI and divided go up.

An Increasing Risk of Commercial Mortgage

2009-03-28T09:12:00.005+09:00

What I more frequently saw in US and Europe is an increasing rate of delinquency of commercial mortgage. Originally, the problem started with a sub-prime loan, but now the issue has been surely widespread into the commercial mortgage side. Here in Tokyo, this bad problem has been already outstanding. Because of a credit crunch, everybody can hardly borrow the money from lenders; that's why he or she cannot but office properties at a discount, even though the decent deal comes into the market.

I certainly understand that banks are not ready to make a new loan to the deal. This is partly because their risk capital can be hardly allocated to non-recourse loan due to a decline in their held Japanese stocks and increasing non-performing loans. And this is partly because they are busy with their maintenance towards outstanding loans, including a huge volume of refinancing deals, where a majority of loans are underwater.

The stock prices have been globally on the rise in March and they showed us the best monthly return; however, the real estate sector have been lagging substantially behind. What we will see in 2009 includes a loan restructuring, foreclosure and administration etc. A wave of negative events will come to the commercial real estate market later this year.

Mezz Burst!

2009-02-22T20:39:00.003+09:00

There is no sign at all that the economy has been bottomed out. This is true of the propert industry. What we have seen is the news of insovent developers and construction firms.

Now, turning to the commercial real estate, WSJ.com recently mentioned that many of mezzanine loans went to the toilet. or at least are in the situation of so-called "unerwater". Mezz. finanicing has played a big part in leveraged equity investments into properties. It worked well like a magic when lenders asked us for more equity contributions.

Sadly, the current market turmoil looks to have wiped out not only the equity, but also all or a substantial part of mezz. in the leveraged equity investments here. For example, let's take a look at residential properties in Tokyo. Many Private funds here had bought them at a cap rate of 4-5.5% over the past few years. Now, if we try to sell them in the current market, we will definitely have challenges and difficulties identifying a prospective buyer. There is no demand for them in the market; therefore, we need to increase a cap rate to lure buyers into the deal. I would say 8 to 10% for a good area is needed. Having said that, the cap rate for the next buyer is almost twice as high as that at the time of acquisitions. Given the current market conditions, all equities, mezz. and probably a substantial part of loans are gone, regardless of the level of LTV.

The market is now turning on to the commercial real estate from residential one in the US. We need to stop this vicious circle anyhow, but we do not know how, quite frankly.

Westbrook

2009-02-11T20:19:00.003+09:00

After a couple of months interval, I have decided to resume my blog anyhow. The last blog was traced back to the end of Sept., 2008 and since then, the property market has gone to the toilet.

However, I have found an interesting article on Westbrook on WSJ.com. It says Westbrook completed the eighth fund last year and raised an equity commitment of USD 2.5 bil. from pension funds and institutional accounts. Though the fund-raising itself was a great thing under the current market conditions, the core part of the article is that Westbrook let its investors shrink forward commitments by 10% without paying any penalty. This action certainly reflects what the market participants have seen i.e. default of LPs. Default of LPs means that LPs cannot fulfil their commitment to invest in the deals, which might cause the fund itself to cancel the deal. This phenomenon has been seen in the private equity funds. In fact, it has been heard that some LPs are selling their stakes in the secondary market at a discount to unload their commitment. This is a serious blow to the fund, partly because the funds may lose the confidence among the lender's community and partly because sellers are concerned about the capability of the funds. Something negatives has yet to be finished in the market.

The Resignation of Minister of LITT

2008-09-28T23:18:00.006+09:00

I was totally disappointed with the resignation of Minister of Land, Infrastructure, Transport ans Tourism. Given the fact that many developers have been insolvent or filed a chapter 11-type of application, I believe there should have been many things for him to do immediately, before he made a personal comment on Naita International Airport, unified and single people and Japan's teachers' union. What he had to do is to help bank loans be available to developers and real estate asset managers. It is because the current credit turmoil has had a very serious influence upon the real estate industry. I need to say that Prime Minister Aso should have looked at abilities and qualifications in appointing ministers.

The Higher The Mountain, The Greater The Descent

2008-09-15T09:10:00.003+09:00

This is my exact feeling towards the recent event involved with bailout of Lehman Brothers for this weekend. I personally thought Lehman was able to survive this difficult situations somehow; however, the situation out there seems to be much more challenging and difficult, based upon the news. Lehman's exposure to commercial real estate is huge and it said to be "toxic" from time to time. I am wondering if it is really true. My guess is, yes, it might be overvalued, based upon the current market conditions, but looking at the property itself, there must be a lot of quality assets.

If Lehman is forced to conduct a fire sale of its properties, it will definitely have another rippling effect upon the commercial real estate markets across the globe. The latest WSJ.com said that Bank of America is in merger talks with Merrill Lynch. Unprecedented deals might happen one after another under the current chaotic market environment. It appears to me that the market is still looking for another victim.

A Winner of CRE

2008-09-14T11:02:00.002+09:00

It is said that CRE, corporate real estate, has been often discussed in the Japanese market and some developers seem to use the concept of CRE as a business tool to win the property business. To be sure, Japanese business corporation has been historically a net buyer of lands, first because the land had been a good collateral for bank borrowing and second because this had been a sort of market practice among well-reputed firms. Over the past 10 years, some Japanese firms conducted a balance sheet restructuring via its outright sales of unused lands and sales-& leaseback of their headquarters; however, a few firms, if any, have considered which properties to be owned or leased from a perspective of CRE. CRE is a mixture of many elements such as business utility, facilities, tax and accounting, market reception if firms are listed, credit etc. I am wondering who can be a winner of CRE business. Developers, real estate services firms, consulting, trust banks, investment banks and property funds are among prime candidates as winner. For listed firms, more important is the market perception and impact upon a credit rating. My gut feeling is real estate background is a certainly plus, but with it only, brokers and developers might not dominate such interesting business.

A Fate of House of Lehman

2008-09-10T08:40:00.002+09:00

The share price of Lehman has plummeted by more than 40 % on the NYSE yetserday on concern about Lehman's capital raising abilities. The share price was now below $10 and S&P has issued a possible downgrade of Lehman's credit rating by more than one notch. It has just reminded me of Yamaichi's failure almost 10 years ago. However, I do believe that Lehman is neither Yamaichi nor Bear Stearns. Today, Lehman will announce its third quarter earnings and key initiatives today, a week earl er than it was originally planned.

On the other hand, it is getting much clearer to me that the asset quality is still deteriorating around the globe. This is true of real estates. During the go-go days, acquisition guys has created a phantom story so that the underlying property may hit a high-teen IRR after the leverage; however, asset managers have, in reality, had difficulties and challenges to meet the initial business plan. At early days, it was OK, because a cap rate had been on the decrease. To put it another way, when the property hits DSCR covenant, funds were able to end up with its exit with a decent profit. Many potential issues in terms of asset management have yet to be made clearly outstanding.

Now, the market has seen a sharp increase in cap rate and credit crunch; so liquidation is not anymore a wide card for the troubled properties.

Bottom Fishing Opportunity

2008-09-08T19:02:00.004+09:00

Look at Orix's move into Joint Corp. today! Orix announced that it will make an equity contribution and debt arrangement into Joint Corp., a Tokyo-based beleaguered developer and asset manager. Orix said that this investment is Orix's principal one. The share price of Joint has sharply fallen down over the past year and is rumored to be faced up with financial difficulties.

This is a definitely bold move; however, Orix is well-known as savvy investor and surely views that the bottom in the market is coming near or that the worst was over. Joint is a good firm with its development and asset management functions. I also believe that Orix must have assessed the assets under Joint's management in a positive manner. With these arrangement to kick in, Joint may survive the current difficult market conditions and move forwards.

Logistics

2008-09-07T20:10:00.003+09:00

Some market participants say that logistics properties are still supported by a strong demand in the market. That is at least a good news. Think of logistics properties, the owner usually enters into a long-term lease with tenants, which are viewed as stable and similar to credit investments. On the front of macro economics, I think economic activities have certainly an impact upon the demand for logistic properties. Corporate Japan has tried to increase its productivity over the past years, and its effort to reduce an inventory volume of goods also has an impact upon the demand for warehouses. To look at the distribution stream carefully, companies like Toyota has tried to reduce an inventory of parts via its "Kanban" method; in reality, parts makers might need to make such parts ready for Toyota. If this logic is right, the overall demand for logistics properties might be stronger that I thought.

Chance After Pinch

2008-08-31T20:17:00.002+09:00

In Japan, there is a phrase that a good chance will come after pinch. Look at the current real estate market, where we have seen so much blood shed in the battle field. What we see evey week is bankruptcy and insolvency of developers, construction companies and property fund managers.

There is no doubt that the job of asset management will not gone, because so many properties have been securitized. Some funds went to the toilet, but others did not. The property prices have been way down, where there must be a good opportunity to buy them at a resonably cheap price.

The real estate business is the business combined with gut, energy and creativity. We need to survive this difficult markt and be prepared for the good opportunity to come.

Skill Sets: REF

2008-08-25T23:42:00.003+09:00

As the real estate market has been in a worse shape, we have often heard lay-offs and hiring freeze anywhere. To be sure, many real estate funds have difficulties increasing assets; instead, major jobs are now shifted to the re-finance or liquidation.

However, it is also true that there is a gap between what employers are looking for and what employees are providing in capabilities. Thinking again what kind of skill sets are sought by real estate funds in market, I can raise three important skill sets: REF. R stands for real estate, which is our underlying asset class. F stands for finance, for we are a leveraged equity player. Last, E is E for English. Global players have heavily invested in Japan's properties and what counts is to communicate our asset management highlights with foreign investors in English.

Looking around, we soon see a limited number of professionals can meet REF criteria. English-speaking real estate professionals are small in number; therefore, sort of scarcity value is added to such qualified people in the market.

Relationship with Commercial Banks

2008-08-24T20:27:00.004+09:00

It is often heard that many J-REITs have had difficulty rolling over the debts. In a sense, the debt availability had been given for J-REITs; therefore, they had believed that they would hold real properties for long. If they cannot refinance outstanding debts, they will be forced to liquidate real properties, because it is almost impossible to raise funds via issuance of new equities under the current market conditions. However, it is not necessarily easy to sell them. It is primarily because financial buyers, driving forces of acquisition machines, now hardly borrow the money in the market.

There are several reasons for that: first, the global credit crunch has had a big impact upon the Japanese loan market as well and second, there are a diminished number of balance sheet lenders after many conduit lenders are gone. There are only three so-called "mega" banks. Retrospectively looking, we can say some J-REITs, which heavily have relied on the finance from the capital market, should have maintained a better relationship with commercial banks, for such J-REITs can hardly issue debt instruments in the capital market.

Infrastructure Fund

2008-08-23T19:05:00.004+09:00

Another interesting article on infrastructure funds is seen on WSJ.com. To put it short, infrastructure funds have been faced up with the liquidity crunch and remarkably bad share performance. Infrastructure funds remind us of Babcock & Brown and Macquarie, which have bought infrastructure facilities from electric power plants to airports to toll roads globally. A success in these business model is based upon publicly listed funds, where funds are not worried about the redemption of equities "as long as they can roll over their debts." This is true of J-REIT and J-REIT has a similar problems now.

Nobody had predicted such a large-scaled credit turmoil would come to the market; instead, the business model of such listed infrastructure funds had attracted many investors around the globe. Now, everyone understands that such a business model is weak under the current market environment. Whatever people call, leveraged equity business itself can work, only when the debt finance is readily available. Otherwise, it enters into a vicious circle.

Ups & Downs

2008-08-21T22:35:00.005+09:00

Shares of Japanese developers and property fund management firms listed on the exchanges here in Japan have remarkably declined; in fact, share prices are traded at around one-tenth of prices a year ago.

In a sense, a series of actions such as to buy lands, construct properties and sell them need to be repeated as long as developers run their operations, no matter how good or bad the property market is. Therefore, it is so obvious that this business model can work only when we feel bullish on the market. Developers knows this simple logic, but they cannot take a rest, unfortunately. This is a saga for them.

I myself thought of this model's delinquency many times and one possible solution is to diversify the business lines to mitigate a business risk. For example, when the market goes well, the business model is OK. When not, the business line is shifted to a brokerage business, a fee business. However, this shift can make it in an idealistic environment. In the real business, a shift from development to brokerage does not make sense, because a skill set for each business is rather different.

Embedded Value

2008-08-17T19:26:00.008+09:00

Did you hear Pershing Square Capital Management LP hired Blackstone as advisor on Friday to help Pershing Square drive up the purchase price for Longs Drug Stores Corp.?

Longs Drugs Stores agreed on Tuesday to be acquired by CVS Caremark Corp. for about $2.6 bil., or $71.50 a share, a 32% premium to the closing price on the NYSE that day. There is a good reason for the above hedge fund to retain Blackstone. According to WSJ.com, "CVS said this week that it was attracted to Longs's real estate, which would give CVS a presence in markets where it has been weak, especially northern California and Hawaii. The 521 retail locations CVS will acquire also include stores in Nevada and Arizona. Longs owns 200 of its store locations and three office facilities. CVS said it has valued the real-estate holdings at more than $1 billion and indicated it plans to monetize assets over time."

Now, it is an easy story for property-savvy guys. Pershing Square thought that CVS's bid is not high enough when paying a great attention on the property value Longs Drug owns. Property is a unique asset different from equities and fixed income. Longs Drug's retail locations are certainly a precious value, first because of its size, say, 200 retails, and second because of its uniqueness.

WSJ.com said that there is a possibility that to team up with Walgreen could give Pershing Square a higher value than to do so with CVS. This is a definitely hard-charging tactics to increase the bid price. The above news has reminded me that properties sometimes have an embedded value, which is underestimated in some cases.

Continuing Credit Crunch

2008-08-16T17:35:00.004+09:00

Since the spring, more and more developers and construction have became insolvent or bankrupted. It was rumored that banks accepted an extension of loan terms at the end of March; however, it has now become clear that the extension was set at less than 6 months.

It is remarkable that the size of debt payable has got bigger. In case of Urban Corp., it was ballooned to approximately JPY 260 bil., though it was said to have been further increased to JPY 400 bil. on a consolidated basis. I cannot say all of such firms were linked to organized crime groups, but it appeared that it was true of many of them. To be sure, we have been faced up with worsened credit crunch. This is no doubt about it. However, there is clearly another reason for that.

Property prices have substantially declined; therefore, there must be a decent acquisition chance out there. Some Japanese developers mentioned that a large chunk of money would be invested in office properties for the next two to three years. One of concerns lie in the downturn trend in the Japanese economy. A rule of thumb in the real estate business is the property business is largely linked with the cycle of the economy. A dip on property prices has certainly given us a chance to buy properties cheaply, but I am wondering if it is a good enough reason for purchasing them.

New Trial

2008-08-09T19:39:00.002+09:00

It is clear that credit crunch have been prevailed here in the Japanese market. On the other hand, there are a few interesting trials out there.

Quite frankly, it is now very difficult for real estate funds to borrow non-recourse loans on JPY 1 to 3 bil. of assets outside of Tokyo from Tokyo-based banks. Having said that, some funds have tried to borrow non-recourse loans from regional banks on the properties where such banks run their banking operations. So far, even though property funds bought one-room studio apartment in Sapporo or shopping mall in Fukuoka, equities and loans of funds, in most cases, came from Tokyo or offshore for equities. To think again, we can say that regional banks have missed good opportunity to lend their loans towards acquisitions in regional real estate.

This business model may show us a win-win situation for both financial buyers and regional banks.

New Comers

2008-08-02T19:16:00.006+09:00

Since the property market has been on a declining trend here in Japan, there has been a change in market players. On the front of investors, financial buyer's presence is now getting much smaller, because a financial buyer feel it substantially hard to borrow non-recourse loans from banks. Instead, non-Japanese long-term investors such as sovereign wealth fund and pension accounts are dominant in the market. On the lending side, conduit lenders are virtually gone and a few German balance sheet lenders are active in the market. Interestingly, one of German lenders so far acquired non-recourse loans in the secondary market. To put it another way, it has not originated loans, but it has bought them in the market.

This Is The Road We Have Seen Before.

2008-08-01T15:21:00.002+09:00

There are increasing opportunities in which we have seen condo developers and construction companies have filed a kind of "Chapter 11" these days. Worse credit crunch, stagnant condo sales and a decline in property prices are cited as major reasons for the increased insolvency and bankruptcy in our industry. I am, however, wondering if we have seen such situations before.

Our industry felt a great pain when we saw a burst of the bubble in 1990s; however, it looks like the history of pain have repeated.

Here in the Japanese market, the FSA's strict policy towards loans to real estate business is another major reason for that. Now, lenders are very concerned about the violation of Building Code and Fire Defense Code, because the FSA has pointed such a violation as accepted in their regular inspection towards banks.

The real estate business is certainly a cyclical business. Our industry needs to be well-prepared for the downturn period; therefore, it is a risky business to rely too much upon development works. However, regardless of ups and downs in the economic activities, condo developers have continued to buy land in order to create re venue. This is the way condo developers have run their business.

Linked with Organized Crime Group

2008-08-01T14:37:00.004+09:00

There are many rumours that real estate developers and funds are linked with organized crime groups. In fact, its is sure that real estate business have been historically linked with such a group. It is partly because real estate business transactions are, in most cases, private deals and lack of transparency and partly because a transaction fee is way high, as compared with brokerage fees for other financial instruments.

The Tokyo Stock Exchange and Japan Securities Dealers' Association now has a very strict stance towards any involvements of listed firms with organized crime groups and it is well said that the FSA, a Japan's financial watch dog is now keeping a keen eye on such a linkage. Furthermore, it is also confirmed that the Individual Information Code does NOT apply to the investigation by SRO into any linkage with organized crime group.

In fact, investment banks and commercial lenders have already stopped doing the business with listed firms which are said to have a connection with organized crime group. For example, it is virtually imposable to borrow a non-recourse loan from lenders order to buy an even class-A building from such listed firms. This is true of the case where real properties are bought with brokers linked with such a group. Interestingly, it is today when amened law of Counter-Measure with Organized Crime Group is enacted.

An Increase in the Productivity of the Japanese Agricultural Industry

2008-05-27T21:09:00.001+09:00

It is well said that the Japanese agricultural industry is way behind the US and European counterparts in terms of productivity. Here is a good instructor for the Japanese one: a real estate expert. Why? If he or she put on a farmer's shoe, he or she will bring his or her interesting ideas to the farm. FAR is among them. Given the advanced technologies in the agricultural industry, a sunbeam is not necessarily a must have, and an artificial light is good enough. What about soil? Water-cultivation technique has changed the objective of soil substantially. Having said that, four-story non-soil vegetation plants with temperature and precipitation controlled by computeres on a 24-hour & 365-day basis are a key to success.

Property Derivatives

2008-05-21T08:46:00.003+09:00

I have yet to hear further development of property derivatives in the Japanese market. Certainly, listed options on some liquid J-REITs are now available on the OSE. That is a good start. How about the futures on the TSE REIT Index? that is another interesting tool, I think.

But what I really want to see is a total return swap with a certain index as reference. Previous discussions here in Japan have centered upon the lack of a quality property index. IPD's efforts are great, but it still takes time.

The development of property derivatives must come with the intensive discussions with the tax authorities on tax treatment; otherwise, it will lose the real hedging function at all. Japan needs to learn the past which the London already experienced.

Ways of Taking A Real Estate Risk

2008-05-19T21:48:00.005+09:00

It is needless to say that there are several ways of taking a real estate risk even in the Japanese market. The easiest way is to buy the real property. When the investment money is not big enough to buy offices or apartments, to buy J-REITs is another good way. How about buying J-REITs and selling Topix-linked ETFs short? It is probably more directly linked to property risk exposures.

Are there any other ways of being exposed to the real estate risk exposure? How about sub-lease? Let's think about the following case: you may enter a lease agreement with the owner of the real property at Yen 20,000 per tsubo and provide a sub-lease contract for end tenants at Yen 23,000 per tsubo. As long as sub-lessees pay a rent of Yen 23,000 per tsubo, you can enjoy Yen 3,000 of margin. You may be required to put a deposit equivalent with 6-month monthly rents; however, you do not have to acquire the real property for this purpose.

It sounds interesting, doesn't it?

Conduit Lenders

2008-05-11T20:39:00.004+09:00

The US sub-prime issues have had a big and negative impact upon the Japanese financial market as well. In particular, many conduit lenders have withdrawn themselves from or scaled back their lending business here in Tokyo. So far, conduit lenders had played a major role as driver for the leveraged equity investments in Japanese real estates; therefore, it is natural for many asset managers to face the challenge in borrowing a non-recourse loan.

Some market professionals are wondering if there will be a timing gap between the resumption of lending and the increase in lending. It is partially because many bankers were already let go by conduit lenders and partially because it will take some time for many of conduit lenders to build up their lending platform again.

Nobody knows when the liquidity will be back in the Japanese market.

Interested in Operational Assets?

2008-05-04T20:54:00.005+09:00

As you know, office and residential properties are generally viewed as "commodity" ones. It is because there are a reasonably good number of property managers which can take care of those assets. The quality of property management certainly varies with property managers, but it is also true that any property manager can get at least "B+" grade on the performance.

On the other hand, retail, hotel, nursing home etc. are classified as operational assets. It is because dedicated operators usually act as lessee and run the professional business out there. Sounds interesting?

It is, in a sense, quite natural that some people in our industry shift their interest to operational assets from commodity ones. Sooner or later, they recognize that operational assets are a totally different animal. The business run by operators are real business. A cash flow is not stable and we are dealing with individual people as customers. It is interesting and a great fun, but it is completely different from a typical real estate business, unless operators of a quality credit enter into a long-termed lease agreement with a fixed rent fee as tenant. A life is not always easy.

Real Estate or Real Estate Company? (part 2)

2008-05-03T18:05:00.004+09:00

As you have seen, some property funds have started to invest in stocks of common shares in real estate companies in Japan. This is a natural course of action, I think.

Let's think about what kind of risks they are taking. In case of real estate investments, you expect such investments to carry a profile of middle risk/middle return. However, this is, practically speaking, the case if you can see the property before your investment gets started. In fact, if you invest in blind-pool type of real estate funds, you are supposed to make a bet on the management capabilities of an asset manger. On top of that, you now recognize that the risk/return profile has substantially changed if a financial leverage scheme is applied to property investments.

On the front of real estate company investments, you as shareholders are, to a large extent, separated from a day-to-day responsibility for running the firm and your return on investment mainly depends on the company's management abilities and general stock market fundamentals.

As you see two different types of property investments, it seems there should not be a major difference between the two. Instead, you may see a kind of similarity, because the two approaches to property investments rest with investors' bet on the capabilities of asset managers or real estate firm's executives.

The Fate of J-REITs

2008-05-03T09:00:00.003+09:00

Recently, there have been active discussions as to what's going on with the J-REITs.Surely, the J-REIT market had steadily grown before the US sub-prime issue had a big impact upon the global capital markets.Since then, many probelems have been outstanding and more market participants have been concerned about the future of J-REITs.

On the front of equities, it is clear that unit prices of J-REITs have been more volatile than it was originally thought an that they have been down substantially. As a result of this, many J-REITs have difficulty in equity financing.

How about debt financing? As you know, the credit crunch has made it difficult for J-REITs to borrwow money from the lender or the capital market. This is true of re-financing for J-REITs. Though J-REITs are viewed as long-termed investment viehcle, the business continuity is becoming a real issue to some J-REITs.

In addition, the difficult in financing creats another headache. More and more offshore investors have played a major role in the J-REIT market, an external growth has been an imporatnt valuation factor. To put it another way, it is an acquisition capability. Some J-REITs enters into a forward commitment with SPCs where real properties are being developed. In good days, nobody has believed such a bad credit crunch came to us. Now, though the real properties are near its completion, J-REITs cannot arrange the financing for them. Eventually, J-REITs might need to pay a cancellation fee to SPCs or SPCs need to look for another buyer in order to pay off their non-recourse loans. This is always the case with us, but once assumed scinario is gone, there are few back-up plans, if any.

In order to avoid the worst case, some market participants have been working hard. The change in sponsors and a capital increase via a new unit issue to a strategic investor are among many solutions I have seen.

Real Estate or Real Estate Company? (part 1)

2008-05-03T05:40:00.008+09:00

Is is remarkable how big offshore investors poured funds into the Japanese real estate market. Among them are real estate funds run by Morgan Stanley, Goldman Sachs and AIG etc. European major players such as ING and AXA already set up their offices in Tokyo and have invested in Japanese properties. Principal accounts like Lehman Brothers and GE Real Estate also have shown their strong presence here in Japan.

Interestingly, what they have mainly invested in is real properties. I from time to time hear that waht they need neither real estate companies nor people working out there, but properties.

Let's think about the difference in risk/return profile between real estate and real estate company.

Traditionally, real estate investments are characterized as a middle risk with a middle return sustained by a steady cash flow from tenants. Conversely, public real estate firms like developers have been, to a greater extent, affected by the economic cycle as macro factors and development skills as micro ones and are volatile.

Real estate funds including REITs have brought to the market a different view from such a conventional risk/return profile. Many real estate funds use a financial leverage via bank borrowings in order to increase a return on investments. LTV varies from fund to fund, but over 80% of LTV has been seen in the funds looking for at least 15% of targeted return. In many cases, such funds assume a capital appreciation at the time of exit. The result? So far, so good. A yield compression has explained such a fabulous performance.

However, what if a terminal cap rate rises? Because of a high LTV, it is clear that a return on investment will be substantially lowered or there is a good possibility that the principal itself will not be secured at all. I am wondering who can reasonably accurately predict a terminal cap rate in five to seven years.

Having said that, I can say structured property investments have brought a high risk/high return characteristic to us.

(To be continued...)

You Still Like Exotic Assets, Don't You?

2008-05-02T08:37:00.005+09:00

Approximately 10 years have passed since the securitization techniques were brought to the Japanese property market. The underlying asset classes have been accordingly diversified into office, residential, retail, hotel and nursing home. Some real estate funds already bought hospital and infrastructure facilities. Among further interesting asset classes are "leisure hotel", where men and women enjoys sex and "social" building, where host clubs and hostess clubs are typical tenants.

The recent credit squeeze has had a big impact upon such exotic assets as well. In good days, lenders made a non-recourse loan to SPCs with exotic assets as collateral. However, the situation has now completely changed.

The credit has dried up and the liquidity of such assets have substantially dropped in the property market. Certainly, they can still bring a decent return to investors, but there is virtually no exit.

　

Vicious Circle?

2008-04-30T22:06:00.006+09:00

Is there anything wrong with financial buyers? In fact, it is remarkable how hard it has been for financial buyers to secure the debt financing. On a flip side, it does also means that financial buyers have been faced up with the challenge in disposing their assets. Interestingly, the maturity date of such debts is approaching, but a re-financing is not an easy task right now in the Japanese market.

I heard from some brokers that they wish they could bring the deal to financial buyers, because financial buyers have had difficulty in closing the deal due to their struggle to secure a commitment from lenders. Brokers have shifted their attention to the buyers who can buy properties via their own balance sheet in looking for buyers.

All in all, properties prices have been under a downward pressure. Is this really a vicious circle? Or is it the beginning of the end?

A good thing with us is the cash flow from exisiting properties, mainly officies located in the CBD is still strong, while a vacancy rate of Grade A buildings in Tokyo is still low.

What we are seeing here is a shift of investor's profiles from financial buyers to long-termed institutional accounts. In fact, some asset managers are seriously thinking of the scheme where quaility assets can be held for a long duration of period, to put the J-REIT aside.

What's going on in the property market?

2008-04-29T21:23:00.011+09:00

Who could have felt so bearish on the property market in Japan six months ago? Who could have predicted US sub-prime issues would be so widespread to the Tokyo property market six months ago? I certainly feel nobody has a crystal ball to predict the future.

It is remarkable how lenders have got so conservative towards their lending to the property business now. Look at the non-recourse loan market. The spread over the Yen libor has been substantially wide to 300 to 400 bps on an all-in cost basis and lenders are now getting very picky. Conduit lenders are virtually gone from the market and balance sheet lenders can select the quality deals under the current market conditions. Lenders seem more and more concerned about the quality of asset managers. I heard that some lenders are asking asset mangers even for a back-up asset manager. Surely, some lenders in the past called asset managers for back-up operators when the underlying assets were either hotels or nursing homes. It is for my first time since I joined the real estate business that I heard "a back-up asset manager".

Now, I am wondering when banks' lending activity will be back to a normal course of business. More and more market participants get to feel that the market turmoil will continue at least until the third quarter of 2008 (calender year). As I read the comment from John Mack of Morgan Stanley to the effect that he has never ever experienced such a bad credit market turmoil since he joined the Wall Street, it is with no doubt that the current lending market is dysfunctional.

I hear that many SPCs have been faced up with the difficulty in refinancing and that some properties are now virtually under the lenders' control. This is certainly due to the credit crunch triggered by US sub-prime issues; however, I am wondering if there is any responsibility on the side of asset mangers themselves. I do think the refinancing challenges have been, to a greater extent, brought by asset managers' optimistic forecast on NOI, ultra-aggressive cap rate and easy policy towards issues under the Building Code at the time of underwriting.