Japan is having its moment – and Diamond Realty Management is looking to capitalize on the opportunity.
In the 1990s and 2000s, Asian real estate investing meant the exclusion of Japan, as the nation experienced a massive asset price bubble that contributed to its economic collapse and subsequent stagnation, also known as the ‘Lost 20 Years.’ Fast forward to today, however, and the Land of the Rising Sun has returned as a sought-after institutional real estate market of choice in the region, and seen as a more stable alternative to its more volatile neighboring countries.
Japan “has been ignored for the last 20 years to 30 years,” says Masanobu Fujita, managing director at Diamond Realty, speaking with PERE at the Hotel Majestic during last month’s MIPIM conference in Cannes, France. “In the last few years, Japan has been a hot market.”
With $26 billion in available capital, Japan ranked fourth among global real estate destinations, after the US, China and UK, according to The Great Wall of Money report released last month by property services firm Cushman & Wakefield. “We’re seeing a trend of new flows of capital trying to enter into the Japanese commercial real estate market,” says Fujita.
One recent example of Diamond Realty taking advantage of this influx in foreign capital was the launch last year of a $500 million core-plus logistics investment program with the sovereign pension fund, Employees Provident Fund of Malaysia (EPF). As part of the mandate, EPF acquired a seed portfolio that comprised five logistics properties located within Greater Tokyo and that had been previously owned by Diamond Realty’s parent company, Mitsubishi Corporation. The program represented EPF’s first real estate investment in Japan.
A unique opportunity
And while equity investments account for 90 percent of Diamond Realty’s assets under management, its real estate debt business also has benefited significantly from the return of overseas investors to Japan. In fact, almost 100 percent of the financing that Diamond Realty does through its debt platform is for non-Japanese equity investors.
The decision by Japan’s central bank, The Bank of Japan, in January to charge a -0.1 percent interest rate on all commercial deposits is expected to further enhance the attractiveness of the country’s real estate market. Negative interest rates would lower the cost of debt, and the lower financing costs are expected to in turn boost leveraged returns and potentially drive up bid prices on assets.
According to Fujita, Diamond Realty serves as an alternative lender in Japan. Foreign investors that are entering or reentering the Japanese real estate market will find it a challenge to obtain financing for property deals, since borrowers need to obtain an internal rating from Japanese banks – which use such ratings systems to determine the creditworthiness of borrowers – in order to secure loans from those lenders, he notes. The rating process, however, can be a complicated one for foreigners to navigate, which in turn makes it difficult for such sponsors to get a real estate transaction in the country off the ground.
“What’s unique is we do finance new equity sponsors coming into Japan,” he says. On behalf of these sponsors, the Tokyo-based real estate investment manager will both introduce the senior lenders into the transaction as well as provide mezzanine financing for the deal.
For example, last year, Diamond Realty helped to broker a real estate deal between a new group from Asia and a Japanese seller that was initially reluctant to sell to a foreign buyer. However, the seller agreed to the deal after Diamond Realty secured a mezzanine loan and partnered with a senior lender to help facilitate the transaction.
The financing challenges for new foreign sponsors represent a new type of gap in the market, for a company that has built its business on finding such gaps or skews. Indeed, the premise of Diamond Realty’s real estate mezzanine debt platform is offering gap financing to borrowers. After all, few financial institutions in Japan are able to make mezzanine loans – which are perceived to be riskier than the senior piece of the capital stack – following a large-scale bank restructuring in the 1990s.
However, while real estate borrowing in Japan has become cheaper, it also has become more complicated. Whereas financing costs previously were low, typically sub-1 percent, now Japanese banks are asking for floors on LIBOR, according to Fujita. “In the near future, we might do a fixed-term loan,” says Fujita.
But while Diamond Realty has raised and deployed capital on behalf of overseas investors in Japan, and is poised to do more such work amid the country’s negative interest rate environment, the investment manager also continues to attract and invest the capital of domestic institutions. Many of these local groups are seeking to make more property investments in anticipation of government bonds generating even lower yields in the face of the new interest rate policy, as discussed at a breakfast sponsored by Diamond Realty at MIPIM conference last month.
Just last month, Diamond Realty raised ¥20 billion (€160 million; $175 million) in equity for its fourth mezzanine real estate debt fund, DREAM Mezzanine Debt Fund IV, to be deployed in mezzanine loans backed by logistics development projects in Japan. Most of the capital in the vehicle came from 15 domestic Japanese institutional investors, including corporate pension funds, financial institutions, corporations and educational institutions.
Yet the new vehicle had a key distinction from its predecessors in the fund series, as Diamond Realty will be investing in development projects rather than finished assets, with aim of generating more attractive returns than what would otherwise be available under Japan’s increasingly competitive real estate investment market. Similarly, while Diamond Realty has traditionally focused on the country’s logistics and retail sectors, the investment manager is now considering expanding its investment scope to office and other alternative sectors. It also is looking at less competitive non-gateway markets in Japan such as the suburban area just outside of central Tokyo, where populations are growing, as well as regional cities where the number of inbound foreign visitors is on the rise, such as Hokkaido.
These domestic investors, meanwhile, also are looking to deploy capital overseas, which presents a new opportunity for Diamond Realty. The firm currently is contemplating, in partnership with Mitsubishi Corporation and its sister subsidiary companies, expanding its real estate portfolio through both equity and debt strategies into major property markets outside Japan, such as the US, UK or Australia.
At home or abroad, however, Diamond Realty’s investment mandate remains the same. “Our approach hasn’t changed. We still try to look for skews in the market,” says Fujita.