ASIAVIEW: An elixir for J-REITs

When PERE visited Tokyo late in July, it was plain to see the popularity of Toyota’s third generation Prius car. The streets of the Japanese capital were adorned with the fuel efficient model. The Prius, made by ailing Toyota, took orders for 245,000 as of July, despite only launching in May. Auto industry analysts say this is one result of the government’s stimulus package.

At press time, Japan’s Liberal Democratic Party (LDP), the country’s entrenched ruler for most of a half century, was set to be uprooted by a coalition led by the Democratic Party of Japan (DPJ) in the 30 August general elections. In any case, DPJ is championing the restoration of 2 percent growth for the country by March 2011.

And just as Toyota’s government-stimulated resurgence has started to take effect, conversations with real estate leaders in Japan suggest that the country’s young but troubled J-REIT sector will receive similar stimulating treatment.

While the government has not been forthcoming on detail, we do know its ¥300 billion to ¥500 billion stimulus initiative is inked to go live from this month and run for the next two and half years to March 2012, a period when many of the 41 J-REITs in existence will face debt deadlines.

According to research by Moody’s, as of the end of September 2008, loans amounting to ¥3.09 trillion were outstanding, with about ¥700 billion scheduled to mature in 2009. While everybody owes, the package is expected to prioritise those J-REITs with the strongest sponsors and those that manage portfolios bought between late 2001, the year the sector launched, and midway through 2004.

This is intended to lead to consolidation in the sector and as one PERE firm told us, opportunistic and value-added fund managers should welcome the capital boost as it will revitalize an exit route for their funds. The recent investment inactivity of the sector has meant that many firms have been unable to offload their investments despite great effort. Public markets commentator Seeking Alpha reported just 92 acquisitions by J-REITs in 2008 against 501 in 2007.

It will be important to ensure the sector does not become a 'dumping ground' for fund managers

While optimistic of the effects of government stimulus, a professional at another Tokyo property investment firm warned that once boosted, it will be important to ensure the sector does not become a “dumping ground” for fund managers. During the boom, poor quality assets were sometimes bought by J-REIT managers who also managed the fund selling the asset. Not surprisingly this has led to a dip in confidence.

Coupled with a general malaise in Japanese stock prices – the Tokyo Stock Exchange’s J-REIT index  plummeted more than 70 percent from its high in May 2007 – it’s no surprise lenders lost the will to commit to all but the healthiest J-REITs. And note that only five of the 41 J-REITs saw unrealized gains between August 2008 and March 2009.

One lender told PERE it would lend only to J-REITs with “significant mass and standing” and, like the government, hoped for consolidation between the healthier J-REITS. “We would not be inclined to provide financing to little companies that merge with each other,” he insisted.

His eyes, like many others, will be fixed on what happens with Lone Star Japan’s proposed takeover of Japan’s first failed J

We would not be inclined to provide financing to little companies that merge with each other.

REIT, New City Residence Investment Corporation, a  J-REIT with 105residential assets comprising approximately three million square feet. The offer from the Dallas-based private equity giant, agreed in the Spring, has hit the skids as New City’s lenders question the viability of the firm’s $120 million plan to rescue the J-REIT by taking it private and relisting it in five years. The firm has exclusivity until 9 September when the lenders will convene to consider the bills fate. Rival offers from Daiwa House and Oaktree to merge New City with their own smaller, and some say weaker, J-REITs wait in the wings.

Impartial sources don’t care which route the J-REIT takes, so long as one party is successful and it is not broken up and sold off.

A healthier future for New City and the wider J-REIT market is not carved in stone, but the early signs are promising and this should be just the tonic for PERE firms wanting to see a favoured exit route return. With the government and lending community facing in the same direction also, perhaps the sector will once again see its order book grow just like sightings of the Toyota Prius.