PERE: Since Sumitomo Mitsui Banking Corp (SMBC) already has such a strong real estate lending platform in Japan, with $15 billion of loans, what’s the rationale for making equity investments?
Kai: Debt and equity have very different risk-return profiles, so whether or not we do equity depends on market conditions. When the debt market is good, it is usually not good timing for private equity. But, as a business, we can diversify our risk-return profile by doing both.
In equity, we have two types of investments: private, open-ended REITs and closed-ended real estate funds, with pre-specified assets at the beginning of the fund that function like direct investments. For the open-ended funds, we want income-generating assets, so usually the annual yield is 4 percent to 5 percent. For the closed-ended funds, we target higher returns, usually in the mid-teens, so the strategy will be more value-added or opportunistic. To achieve those kinds of returns, the asset would need some repositioning, refurbishment or re-leasing.
Since we have been investing for almost 10 years in the domestic market, we have a big information stock based on our past experience to carry out analysis and feasibility studies on whether these managers’ plans are feasible.
PERE: SMBC also is one of the few Japanese institutions investing in overseas real estate. Why was foreign property investment attractive to you, and what processes have you developed for such investments?
Kai: What we recognized in the global financial crisis was that we had been investing in just the Japanese market. So, as a result, our entire equity portfolio is very bound up in the Japanese real estate market cycle. For us, the basic motivation is to diversify our equity investment. Even within the Asia-Pacific region, there are many markets that have very different real estate cycles. Our basic idea was that, by investing in those different markets, we can enjoy the difference in the market cycles.
Our overseas strategy is a little different from our domestic one as we invest in blind-pool funds. That is a way for us to have more variety in our overseas exposure, since we only have a team of five professionals here in Tokyo to cover the whole world. It’s more a focus on manager selection. What we do first is analyze each property market and the sectors in each market, to determine which combination would be good timing for us to enter. Then, we identify a good manager in those sectors – that’s our basic strategy.
PERE:How do you overcome the limitations of such a small team?
Kai: We have banking branches in the various overseas markets, so we contacted them and asked them to introduce us to real estate managers they have contact with. We also go to various conferences to network. By doing that for a year or two, we now have a good contact base. We’ve made a few investments in overseas real estate so far, including one in ARA Asset Management’s Dragon Fund II and another in an Australian retail fund.
PERE: Is a banking relationship important to manager selection?
Kai: When we looked at those managers, we mainly considered two things. One was the manager’s stability and financials. For that purpose, we like to have a banking relationship with the managers, so we can easily identify their financial stability. The other thing we look into is whether the investment strategy is feasible or not. In due diligence, we meet with the manager and always ask them to show exact case studies of past investments. In some other cases, however, we just cannot believe in the stability of the managers in terms of their financials or their human resources. Some, for example, have very limited staff, so we are wary of those managers.
PERE: What are the milestones that SMBC hopes to achieve this year in your equity investing as well as real estate lending?
Kai: For domestic lending, competition is very tough and, in the past few years, our $15 billion loan portfolio has been shrinking as a whole. So what I want to do is reverse that trend and make our loan portfolio for real estate bigger than last year. For overseas, we only have been investing in the Asia-Pacific region so far. So, this year, we are looking at Europe and the US, and we hope to make our first investment in those two markets, either in a blind-pool fund or direct. I don’t really care which it will be but, as a first step, we would prefer core-type investment funds rather than opportunistic or value-added. Then, once we get comfortable with the market, maybe we can go into the higher-risk opportunities.
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