ASIAVIEW: Abenomics rodeo

If you are a US investor and you bought a property in Japan eight months ago, the investment today could be showing a 30 percent drop in value. Not good on the face of it.

Still, that is the reality facing some US investors that engaged in Japanese real estate transactions towards the end of 2012 thanks largely to ‘Abenomics’, the popular moniker for prime minister Shinzo Abe’s economic stimulus measures that involve devaluing the yen to help reinvigorate the country’s export-driven economy.

Despite the paper loss in value, a devalued yen is not necessarily a good or bad thing for real estate investors. For direct investors, it depends on when they invested and what the holding horizon is. The exchange rate has risen from ¥78 to the US dollar in September, two months before president Abe’s second term started, to ¥103 at press time. Based on this currency swing alone, an investment made in September and sold today would crystallize a catastrophe for the investor. 

Few investments are held for such a short time, however, and there is a spread of views as to where the yen is going. Some institutions feel the yen is overshooting the dollar and the price parity point should be nearer ¥90. Conversely, others predict it will keep going to ¥120. Needless to say, for those having to exit in the second scenario, an already bad situation would be compounded.

For indirect investments made by dollar-denominated investors into discretionary real estate funds, the story might be different. These folks might want to check the currency and hedging policies of the vehicles they have backed to work out the ramifications of the wild currency swings being witnessed in Japan. 

For example, the capital outlays of the dollar-denominated funds of one Tokyo-based private equity real estate firm with whom PERE spoke are hedged on a deal-by-deal basis. Therefore, an investor whose capital is called at periodic intervals is able to ride out currency volatility during the vehicle’s investment period. 

How those hedges are arranged, either by a forward – a contract that locks in an exchange rate at which the transaction will occur in the future – or an option – a set rate at which the company may choose to exchange currencies (depending on whether the rate is more favorable at the time) – could have an outcome on the overall return. Each kind has a cost to the fund and, as you might expect, hedges made during volatile times usually are more expensive.

Another aspect for the indirect investor to consider is the currency denomination of the fund itself. On that point, one particular private equity real estate firm with a large platform in Tokyo springs to mind. This firm currently is producing excellent returns for its investors, but its funds are yen-denominated. The capital is called in yen and its distributions are made in yen. For the US investors in this fund – and there quite a few – the onus is on them to hedge appropriately. They also will need to make a sensible decision about when to convert the capital coming back into dollars. For groups like pension plans and insurance companies, which have time-sensitive liabilities to meet, an unfortunately priced yen versus the price originally paid might mean that, while the manager has done its job, the rewards from selecting it are eroded by macroeconomic forces messing with the yen.

The name of the game

While Japan’s stimulus measures arguably are bringing peripheral aspects of the investment decision into focus, it’s important not to ignore the positive effects that Abenomics (including aggressive fiscal spending and quantitative easing) is having on real estate fundamentals. For example, last month’s declaration by Japan’s cabinet office that the economy grew at an annualized pace of 3.5 percent in the first quarter has further buoyed already improving sentiment among office investors.

According to Tokyo-focused tenant rep firm Sanko Estate, office vacancy rates in the central five wards of the city fell in the five successive months to 7.24 percent in April. Jones Lang LaSalle (JLL), the global property services firm, reported there was 3.3 million square feet of net take-up by tenants last year across the city (an increase of 96 percent year-on-year). While this has yet to have a positive effect on office rents, about ¥12,200 per tsubo has been the average for a while now, further suggesting they’ve stopped falling. As the city’s remaining space runs out, rents are expected to rise accordingly. 

Meanwhile, capital values haven’t waited around. JLL also reported that values have increased 0.8 percent quarter-on-quarter and 3.6 percent year-on-year. 

Corporate Japan evidently is enthused by Abenomics, and that is expected to result in re-energised requirements for commercial real estate space from occupiers. What the occupier is doing should always be the name of the game for investors in private real estate, even if extreme currency swings occasionally upend an investment or two.