ASIA VIEW: Japan’s growing conservativism

The Bank of Japan has started tweaking the focus of its monetary policy, despite keeping negative interest rates unchanged at its September policy meeting. In a new attempt at quantitative easing to spur inflation and economic activity, the BOJ will now target ‘yield-control’ and look to anchor the 10-year bond yields around zero.

Since the beginning of the year, it has not been an easy task for the real estate industry to factor in the unpredictable macro environment in their investment decisions. After all, the outcome of some of the monetary maneuvers is not even in accordance with standard economic theory – the appreciation of the yen despite record low interest rates being a key example.

The likely outcome of the new yield control focus is also equally difficult to predict.
This uncertainty, coupled with continuing concerns about an imminent correction within the sector, is making some managers adopt a more conservative stance – a sentiment echoed at PERE’s Japan Forum 2016 in September.

Both data and anecdotal evidence point to this trend. For example, property transactions in the first half of this year totaled ¥2.3 trillion ($2.21 billion; €2 billion), a 26 percent drop from the volumes recorded in the first half of 2015, according to JLL.

This is largely due to inflated asset prices driven by excess demand, particularly from real estate investment trusts, and a limited supply of core assets in places like Tokyo. Most of the prime office deals this year, for instance, have traded at a cap rate of around 3.8 percent to 4 percent.

An analysis of the type of deals being closed this year also signals a cautious approach. JLL has estimated that the market is currently skewed more toward mid-sized deals in the $50 million to $100 million price range in comparison with bigger transactions of over $100 million. There are several possible reasons for this. For instance, Japanese REITs – responsible for 44 percent of the total transaction volumes in the first half of this year – generally prefer buying in this mid-priced range. And investment managers currently acquiring properties via closed-ended funds surely wouldn’t want to risk having to sell a huge asset at a discount should the impending correction extend until their fund’s termination period.

At the Japan Forum, a few opportunistic fund managers also discussed how they are no longer factoring in an exit cap rate compression from a valuation perspective. However, the firms told PERE that if they are buying right now on behalf of a fund, by the time they decide to exit the property in a couple of years, a 60 basis points compression in the cap rate can be expected from future rental growth.

“The investment committee now wants to see a conservative valuation on paper,” said one Tokyo-based manager.

Additionally, despite a cheaper cost of debt, both the listed REITs and private funds are making sure they maintain a conservative loan-to-value ratio. Fewer managers took on more than 70 percent leverage in 2015, compared with a year earlier, while there was a visible increase in the percentage of managers keeping leverage between 60 percent to 70 percent, according to the Association of Real Estate Securitization.

The perceived threat of a downturn underpinning some of these investment decisions is justified to an extent. Jefferies, for instance, recently downgraded its outlook for the Japanese property sector to underweight. Mortgage rates are expected to increase because of BOJ’s decision to push up yields, which could impact the residential sector.

Yoji Otani, a real estate analyst at Deutsche Bank AG, told Bloomberg in early October that Tokyo apartment prices could fall 20-30 percent by the end of 2018, adding further that the “collapse of this silent bubble has begun.”

That may not be the overarching sentiment within the property sector for now, but the growing restraint in investment strategies suggests that a correction is only a matter of when not if.