Tougher Times for Japanese Real Estate Trusts
Are Japanese real estate investment trusts about to turn a page? Since their creation nearly five years ago, the trusts, which buy big properties like office buildings and shopping malls and distribute rental income to investors, have thrived in the low- interest-rate environment of Japan by giving individuals in search of income a cash-yielding investment. The recent decision by the Bank of Japan to abandon its ultra-loose, zero-interest-rate monetary policy has raised the specter of higher rates and, with them, the end of the party for the J-REIT market and a possible shakeout of the real estate investment industry. Higher interest rates mean tougher times in general for the underlying real estate investments that make up the trusts: higher cost of capital for development, higher cost of borrowing for purchase and higher operating costs for landlords until rents start rising. In Japan, higher interest rates will mean higher yields on government bonds and other yen-denominated instruments, which means competition for investors' attention.
All of this, analysts say, means that the Japanese REIT market 32 trusts with a combined 3 trillion, or $25.5 billion, in capitalization may be facing a shakeout and consolidation. "If interest rates start to grow 25 to 50 basis points over the next year, that would start putting some pressure on the share prices" of Japanese REITs, said Sam Lieber, chief executive of Alpine Woods Investments in New York, which runs global real estate investment funds.
Real estate investment trusts typically thrive after an economic bust, as a crash in real estate prices allows investors with cash to invest their money in big properties like office buildings and shopping centers through a listed vehicle. The fact that REITs must distribute all their income in the form of dividends is also an attraction for investors, since interest rates are often held low after an economic bust. That is what happened in Japan after the collapse of the real estate bubble in the early 1990s and in the United States after the savings and loan crisis of the 1980s. When the economy recovers, though, share prices of real estate investment trusts can suffer, highlighting the quality of the individual trusts.
While the real estate market was booming, many companies created REITs as a way of maximizing the return on their properties. Initial public offerings of REITs traded on average 40 percent and as high as 70 percent above their net asset value. The sponsors, usually developers or other companies with large real estate holdings, are the originators of the REITs, which also create the management firms and transfer their holdings into the REIT.
"Some companies are utilizing REITs as a sort of a dust bin" for properties they want to unload, said Daisuke Fukushima, a real estate analyst at Nomura Securities in Tokyo. He added that because the properties in some REITs "tend not to be so competitive in the market," the ability of the property owners to raise rents to cover the higher interest costs will be limited. Takashi Ishizawa, chief real estate analyst at Mizuho Securities, said that the Japanese real estate trusts have been preparing for higher interest rates by readjusting their debt portfolios. "On average 70 percent of their debts have been repackaged into long-term debt," which is less sensitive to short-term movements in interest rates, he said. And at many of the trusts, "cash flow is 10 times their annual debt servicing levels," he added.
Yosuke Koi, chief financial officer at Tokyo Real Estate Investment Management, which manages office and retail properties in the Tokyo area, said that 77 percent of his trust's debt load was now at fixed rates and with an average duration of more than four years.
"In September 2003, when we went public, virtually all of our debts were short term," Koi said.
Other analysts point to the fact that the yield on Japanese REITs, close to 4 percent on average, is still comfortably higher than the 1.7 percent yield on 10-year Japanese government bonds. Nevertheless, the prospect of higher obstacles to profit, Lieber said, will spur the managers of the real estate trusts to seek new strategies to keep investor money coming in. Here, the experience of REITs in the United States and Australia, both mature markets, might be instructive. Top REITs sponsors like Westfield Holdings, an Australian operator of shopping malls, and Prologis of the United States, which owns industrial facilities, have cultivated strengths in niches. For Japanese REITs to follow in their footsteps, two things may have to happen, analysts said. First, the law governing real estate investment trusts will need to change to allow the trusts to develop property. Currently, Japanese REITs are exempt from corporate tax so long as they pass more than 90 percent of its net profits along to investors and refrain from development activities to reduce risks. These rules, which have applied to virtually all REIT markets in their initial phase of development, generally are loosened as the market matures and investors and regulators grow more comfortable with risk. Next, they said, Japanese REITs need to shed their current structure, in which all functions, including the management of assets, are handled by outside providers in exchange for fees. That structure, which was designed to keep costs low, has also kept dividend payouts low because "compensation does not come from the performance of the underlying company," Lieber said. An internally managed structure, similar to the way REITs in other countries are managed, would have the trusts hire directors and managers, who report to shareholders. An internally managed REIT, where directors' pay is directly monitored by shareholders, may be more eager to show increases in dividend payouts, Lieber said. "The goal of the internal management is to get the managers aligned with the interests of the shareholders," Lieber said. "And it is best to do that."
All of this, analysts say, means that the Japanese REIT market 32 trusts with a combined 3 trillion, or $25.5 billion, in capitalization may be facing a shakeout and consolidation. "If interest rates start to grow 25 to 50 basis points over the next year, that would start putting some pressure on the share prices" of Japanese REITs, said Sam Lieber, chief executive of Alpine Woods Investments in New York, which runs global real estate investment funds.
Real estate investment trusts typically thrive after an economic bust, as a crash in real estate prices allows investors with cash to invest their money in big properties like office buildings and shopping centers through a listed vehicle. The fact that REITs must distribute all their income in the form of dividends is also an attraction for investors, since interest rates are often held low after an economic bust. That is what happened in Japan after the collapse of the real estate bubble in the early 1990s and in the United States after the savings and loan crisis of the 1980s. When the economy recovers, though, share prices of real estate investment trusts can suffer, highlighting the quality of the individual trusts.
While the real estate market was booming, many companies created REITs as a way of maximizing the return on their properties. Initial public offerings of REITs traded on average 40 percent and as high as 70 percent above their net asset value. The sponsors, usually developers or other companies with large real estate holdings, are the originators of the REITs, which also create the management firms and transfer their holdings into the REIT.
"Some companies are utilizing REITs as a sort of a dust bin" for properties they want to unload, said Daisuke Fukushima, a real estate analyst at Nomura Securities in Tokyo. He added that because the properties in some REITs "tend not to be so competitive in the market," the ability of the property owners to raise rents to cover the higher interest costs will be limited. Takashi Ishizawa, chief real estate analyst at Mizuho Securities, said that the Japanese real estate trusts have been preparing for higher interest rates by readjusting their debt portfolios. "On average 70 percent of their debts have been repackaged into long-term debt," which is less sensitive to short-term movements in interest rates, he said. And at many of the trusts, "cash flow is 10 times their annual debt servicing levels," he added.
Yosuke Koi, chief financial officer at Tokyo Real Estate Investment Management, which manages office and retail properties in the Tokyo area, said that 77 percent of his trust's debt load was now at fixed rates and with an average duration of more than four years.
"In September 2003, when we went public, virtually all of our debts were short term," Koi said.
Other analysts point to the fact that the yield on Japanese REITs, close to 4 percent on average, is still comfortably higher than the 1.7 percent yield on 10-year Japanese government bonds. Nevertheless, the prospect of higher obstacles to profit, Lieber said, will spur the managers of the real estate trusts to seek new strategies to keep investor money coming in. Here, the experience of REITs in the United States and Australia, both mature markets, might be instructive. Top REITs sponsors like Westfield Holdings, an Australian operator of shopping malls, and Prologis of the United States, which owns industrial facilities, have cultivated strengths in niches. For Japanese REITs to follow in their footsteps, two things may have to happen, analysts said. First, the law governing real estate investment trusts will need to change to allow the trusts to develop property. Currently, Japanese REITs are exempt from corporate tax so long as they pass more than 90 percent of its net profits along to investors and refrain from development activities to reduce risks. These rules, which have applied to virtually all REIT markets in their initial phase of development, generally are loosened as the market matures and investors and regulators grow more comfortable with risk. Next, they said, Japanese REITs need to shed their current structure, in which all functions, including the management of assets, are handled by outside providers in exchange for fees. That structure, which was designed to keep costs low, has also kept dividend payouts low because "compensation does not come from the performance of the underlying company," Lieber said. An internally managed structure, similar to the way REITs in other countries are managed, would have the trusts hire directors and managers, who report to shareholders. An internally managed REIT, where directors' pay is directly monitored by shareholders, may be more eager to show increases in dividend payouts, Lieber said. "The goal of the internal management is to get the managers aligned with the interests of the shareholders," Lieber said. "And it is best to do that."
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