A leaked internal memo suggesting Goldman Sachs’ Real Estate Principal Investment Area (REPIA) was scaling back activities in Japan is a sign of a much-reduced competitive landscape in the country. Lured by potentially more lucrative distressed or discounted buying opportunities elsewhere – or by more attractive growth markets – some large beasts of private equity real estate investing have reduced their appetite for Japan or stepped back completely.
Tom Silecchia, managing partner at niche investment management and advisory firm Merchant Capital, said: “It is harder to achieve scale here now, which favours smaller groups looking for arbitrage on specific situations rather than bidding on large projects. For funds to deploy a large allocation of opportunistic capital in Japan, they would likely need to return to high leverage, rental growth assumptions and less liquid locations, none of which play too well with investors today.”
Goldman Sachs told REPIA staff and investors in the memo that Japan would take something of a backseat when investing the remaining capital from its Whitehall Street International 2008 fund, which closed on $2.3 billion. “In evaluating the markets and the pipeline, we have determined that Japan will no longer be an area of emphasis for Whitehall Street International 2008,” the memo stated.
REPIA’s deal pipeline in Japan was small going into 2011. Following the country’s earthquake and tsunami in March, the deal book became smaller still. Describing Japan as offering only “trading opportunities,” one real estate professional familiar with Goldman Sachs’ history in Japan said it is “hard to put out capital on scale” in the market, so REPIA decided to focus on others instead.
Even Dallas-based Lone Star Funds has reduced its typical allocation to Japanese real estate following the final closing of its $5.5 billion Lone Star Real Estate Fund II in June. It has downsized the allocation from around 33 percent to nearer 20 percent. While still maintaining a sizeable standing in the market, it is suspected that deal sizes will be smaller compared to the US, even though transactions in Japan could yet generate higher returns. The 20 percent allocation was not a ceiling and could be revised, according to a source. 
In evaluating the markets and the pipeline, we have determined that Japan will no longer be an area of emphasis for Whitehall Street International 2008
REPIA Memo
One obvious impact of the reduced competition is that certain smaller firms will feel they can fill the void. Scott Kelley, chief executive officer at Aetos Capital, is one principal that believes his firm will benefit from quieter auction rooms. “The competitive dynamics certainly have improved compared to where they were a couple of years ago,” he said. “The global funds have substantially de-emphasised their efforts, and that will be to our benefit.”
Indeed, Aetos already has benefited from REPIA’s withdrawal, picking up its stake in a joint venture investment into Simplex Investment Advisors, a Japan-focused fund management and development business with approximately $3 billion in assets under management.
That’s not to say private equity real estate’s largest players are completely neglecting Japan. With no sizeable presence before the global financial crisis started, The Blackstone Group and Fortress Investment Group both have ramped up their activities over the past couple of years, although their footprint is relatively smaller than in their own backyard.
According to research by property services firm Jones Lang LaSalle, transaction volumes in Japan dipped 74.6 percent in the second quarter as sellers remained cautious, evaluated their investments and avoided panic selling in the wake of March’s disaster. “It wouldn’t be too hard to have a fairly high percentage increase in transaction volume next quarter,” Silecchia said, suggesting a handful of deals would have a big impact.
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