Friday Letter Developer distress

Though property sales are healthy in Japan, the balance sheets of many Japanese developers are not. 

Quite an irony is facing property developers in Japan at the moment. At the same time that property values are soaring – with Tokyo this month overtaking London and New York as the most active office sales market in the world – developers are having a very difficult time getting credit, and this has led a number of them into bankruptcy.

Last week Japanese real estate developer Urban Corp., a widely recognized name, filed for bankruptcy with debt of 255.8 billion yen, making it the largest bankruptcy among listed companies in Japan this year. The company is not alone in this situation among Japanese developers, who are facing difficulties getting funding to buy new properties and refinance existing ones in the face of the credit crunch.

According to Tokyo Shoko Research, 60 Japanese property companies went bust this July, more than double the 27 that declared bankruptcy in July of 2007. And the second quarter marked the fourth straight quarterly decline for lending to Japan’s real estate industry, according to the Bank of Japan. Some of the larger property firms in Japan to declare bankruptcy last month included Tokyo-based condominium builder Zephyr and construction company Tada.

This week reports were circulating that Urban Corp. is about to become the target of a bidding war between as many as ten international financial firms, including Merrill Lynch. Officials involved in the talks told Bloomberg that competition for the asset is going to be very intense.

The up to ten foreign suitors are likely eyeing the company’s $4.4 billion real estate portfolio, which could be broken up and sold off for a tidy profit. Observers will be watching the bidding process for Urban closely to see how overseas investors value these properties being sold in distress, particularly in light of Japan’s ongoing property sale boom. The country saw office property sales rise 103 percent between the first half of 2007 and 2008, with $12.6 billion (€8.5 billion) in sales at the end of June 2008, according to a recent report from Real Capital Analytics.

Sell-offs from distressed sellers may not be the only opportunity opening up here. With the development companies badly in need of assistance, foreign firms may be able to step in as debt investors as well. Japanese banks such as Mizuho Financial Group, Mitsubishi UFJ Financial Group have reportedly cut their exposure to senior loans after being hit by the subprime loan crisis. Lone Star is one of the firms likely eyeing the vacuum this has created. Last month it was reported that the firm has decided to start extending loans for real estate deals in Japan.

In a statement this week Urban said the Tokyo District Court will select a buyer for the company by November, and the company has named Deutsche Bank’s Japanese unit as the financial adviser for the bidding process. It will be an interesting bidding war to watch as foreign firms eye the developer distress occurring in Japan.