Last exit to Tokyo

Will J-REITs be viable acquirers of opportunity fund assets?

When Japanese real estate investment trusts, commonly referred to as J-REITs, were first listed on the Tokyo Stock Exchange in late 2001, they provided a convenient investment vehicle for many domestic institutions and individuals who wanted to diversify into real estate. Four years, ¥2 trillion and an annualized return more than five times the Tokyo stock market later, J-REITs are now opening up opportunities for a whole new set of investors: private equity real estate firms.

Although the nascent J-REIT industry is but a fraction of the US market, many opportunity funds in the world's second largest economy are hoping these publicly traded vehicles will provide, much like their US counterparts, a profitable exit route. Given the robust activity seen in the market recently, they may in fact get their wish.

Since the beginning of the year, the composite Tokyo Stock Exchange REIT index is up by more than twelve percent. On the back of that performance, consulting firm BRRI is reportedly estimating that J-REIT acquisition volume will increase by more than 50 percent to ¥3.6 trillion ($32.6 billion; €27.0 billion) in the fiscal year ending March 2006. And as many as ten new J-REITs could go public in the next nine months, including a fund started by MHS Capital Partners which invests exclusively in “love hotels” (see story p. 34).

Yet for such a relatively young asset class, the industry's rapid growth is causing some observers to get nervous. In the US, for example, it wasn't until 1992 – more than 20 years after the launch of the NAREIT index – that the NAREIT's market cap was comparable to the Japanese market. Additionally, the Tokyo property market, where many JREIT investments are concentrated, is heating up.

Last month, the rating agency Standard and Poor's noted: “While REITs currently enjoy strong credit ratings and booming growth, more challenging days may lie ahead. Competition among the funds is intensifying, especially as they rush to acquire office property in the Tokyo market, driving up land prices.”

Nevertheless, for the time being, J-REITs are well-capitalized and looking for assets to buy. Opportunity funds are hoping it stays that way.