From the colossal Government Pension Investment Fund to far smaller wealth management arms of individual companies, there is an increasingly widespread acceptance that portfolios must diversify away from a bias towards domestic bonds and stocks. So it comes as no surprise real estate investment managers are preparing vehicles to hoover up as much of this capital as possible.
The expected windfall has led to the emergence of the private Japanese REIT. Structured similarly to the more widely recognised private open-ended fund, these vehicles have gathered momentum since Nomura Real Estate Holdings introduced its maiden effort in November 2010. The devastating Tohoku earthquake and tsunami in March 2011 caused temporary disruption, but since then others have entered this swelling arena including the development businesses of Mitsubishi Estate and Mitsui Fudosan as well as Goldman Sachs.
Since Nomura’s early launch, approximately ¥206.5 billion (€1.94 billion; $2.5 billion) has been collected in these vehicles, and, last month saw a fifth entrant in the form of Mitsubishi Corporation subsidiary Diamond Realty Management (DREAM). This latest example has added another ¥31.7 billion through its DREAM Private REIT. Initially wrapped around three assets, the firm expects the REIT to grow to ¥150 billion in three years and ¥250 billion – more than the entire capital value of the sector currently – in five years. Though it is the fifth to hit the market, it is the first focused on retail and logistics properties, a departure from the residential appetites of the prior four.
“This alternative financial product is geared towards pension funds or institutional investors that seek stability with a long-term horizon,” DREAM said in its announcement on the REIT launch. Its strategy is set around long leases typically offered for Japanese retail and logistics properties of 10 years or more. From these, DREAM expects core-like returns of between 4 percent and 4.5 percent with capital repatriated twice a year.
“Private REITs should continue to grow in popularity,” commented Tom Silecchia, managing partner of real estate investment management firm, Merchant Capital. But despite offering greater liquidity than closed-ended private equity real estate funds, he argued the benefit to investors when compared to publically listed J-REITs is less clear: “They are expected to have similar target assets and leverage restrictions but have less liquidity,” he said. Redemptions for the DREAM Private REIT are available just twice a year, for example.
One counterargument is that private REITs are not adversely affected by a correlation with the wider stock market. But recent performances by the J-REITs do not support that argument. According to the Asia Pacific Real Estate Association (APREA), J-REITs have returned on average 8.4 percent between June 2009 and April 2012 – since the global financial crisis – whereas stocks returned just 3.7 percent. Since J-REITs were established in 2001 they have outperformed stocks to the tune of 5.6 percent versus 0.2 percent, APREA said.
“But J-REITs can be volatile,” argued one manager of a private REIT who declined to be named, “Maybe on average they have returned 5.6 percent but next year it might drop to 3 percent depending on how the stock market is doing.”
Why should institutional investors choose Japanese private REITs over private real estate funds? The private REIT manager said Japanese real estate as an asset class is intrinsically better suited to core products given its mature, low-growth environment. “And leverage use is low,” he said. “When you do private funds you play the financial engineering game.” Private equity real estate platforms of Fortress Investment Group and Secured Capital Investment Management might disagree as both have raised capital from institutional investors for opportunistic, distressed real estate debt strategies. Nonetheless, for more vanilla direct real estate investments, private REITs have institutional support as evidenced by five successful capital raisings.
Silecchia admitted the private REIT market was too young for conclusions as to which vehicle style is most appropriate for Japan’s institutions. But given they are allocating more to the asset class than before, each style could find itself benefitting anyway.
Either way, as Silecchia argues, the focus should really be on the quality of the manager and its strategy.