Almost three years ago, the world’s biggest pension fund, Japan’s Government Pension Investment Fund, kickstarted the re-entry process of Japanese institutional investors into global real estate investing by starting to look for alternative investment professionals.
That eventually resulted in Hideto Yamada being appointed as director of real estate last February. And it was only last December the investor hired Mitsubishi UFJ Trust and Banking Corporation as funds of funds managers to implement its Japan core real estate strategy.
Last year was an active one for GPIF and peers like the $185 billion Pension Fund Association for Local Government Officials, known as Chikyoren, in terms of finalizing their managers ahead of a big push into the marketplace. The next step – the one the global real estate industry has long been waiting for – is the push itself. When, where and how much equity these investors end up deploying is front of mind for senior industry figures the world over, including the four executives sitting at PERE’s annual Japan roundtable.
That these debut investments have been a long time in the making does not come as a surprise to the participants.
Shusaku Watanabe, director of capital transactions for Asia at the global real estate fund manager TH Real Estate, says many of these investors still have a relatively small and new investment team, and often don’t find it easy to evaluate the real estate investment opportunities including site visits.
“Institutional investors in Japan have not recognized real estate as a core asset class in the past and have been under allocated due to the speculative investments made in the late 80s and early 90s in overseas real estate. But it is different now. Japanese institutional investors today are more sophisticated and strategic, seeking to appropriately allocate capital in the real estate space to diversify its portfolio blending. Further, international real estate markets are recognizing this dynamic shift. This is happening at a much faster and sophisticated way than what the market initially anticipated from Japanese investors,” he says. “They have hired people who are experienced and knowledgeable in the global real estate market with aspirations to make good investments and rebalance their large portfolios.”
But the bigger question on everyone’s mind is how these investors and their managers will access core deals – both in domestic and overseas markets – at the current point in the cycle, where even seasoned real estate investors are having to think of creative ways to deploy their dry powder in markets like Tokyo which is awash with liquidity. What compounds the deployment challenge is the distinct investment style of some of these Japanese investors.
Hidetoshi Ono, managing director for Japan real estate at the Canadian insurer Manulife Insurance, says the two tiers within the Japanese institutional investor universe have different investment theses. He says the bigger and more sophisticated groups like GPIF and Japan Post, generally have a ticket size of $50 million-$100 million and are interested in club deals, while the smaller investors want to invest around $5 million-$10 million per deal.
“Japanese institutional investors hate the blind-pool model,” Ono says. “They want to see the property first and then make the investment decision, which becomes particularly difficult when you are investing overseas. And then underwriting the property rather than the strategy is also difficult.”
Amelie Delaunay, director of research and professional standards at the industry body Association for Investors in Non-Listed Real Estate Vehicles, says she has anecdotally heard of cases where Japanese investors have asked US core managers to show them the underwriting of all properties in one real estate fund.
“The real estate market is competitive,” adds Isabella Lo, managing director, investments for Hong Kong-based private equity real estate firm Gaw Capital Partners. “And one needs to be fast. If an investor takes too long to go through its approval process, the opportunity may no longer be there.”
Another challenge is the cost these investors will incur while investing overseas. Explaining the trade-off situation, Ono says major gateway cities in the US, including New York, will typically be the first pick for Japanese investors, but then the asset prices and other costs would reduce the total returns, making such outlays less attractive.
“If they hedge back to the Japanese Yen, along with other taxes and structuring losses, the expected net return would end up being the same, if not lower, than investing within Japan. That is why investors have not been as fast as they wished in deploying capital,” he says.
As returns for core assets in the US fall, some Japanese institutions are turning their attention to Asia-Pacific. According to last year’s annual ANREV index, non-listed real estate funds in Asia-Pacific returned an average of 10.6 percent in 2016, more than the 8.49 percent returns in their US counterparts and just above 6 percent in the European vehicles.
The Australian core funds were listed as the best performers, with 13.5 percent returns. Delaunay says investors are starting to look at open-ended fund investments in Australia as well as investments in South Korea, Hong Kong and Singapore.
Dilemma of domestic investing
Some of these investors, especially the ‘two whales,’ Japan Post and GPIF, as Watanabe calls them, are also eyeing domestic deals.
However, even then it is hard for such a magnitude of capital as held by Japanese investors to find an investment outlet domestically, creating a chicken-and-egg situation.
“Traditionally, they have been investing in private REITs, which now give a 4 percent distribution yield. But even private REITs are finding it hard to buy in the current domestic market, which is why they are pushed out to explore foreign investments,” Ono explains.
This investing dilemma is not limited to Japanese investors. Manulife and other roundtable participants are also grappling with similar deployment challenges.
“We are optimistic about exits, but not so sure about acquisitions,” says Lo. “Exits are not a problem given the large amount of capital chasing deals. We hope we will outperform underwriting.”
Ono says he has not closed any acquisition since he joined Manulife about three years ago and blames today’s ultracompetitive marketplace.
He says even the opportunistic funds have now become competitors for core assets, given their ability to take on leverage. On the exit side, the firm sold three assets in the past year. Ono adds that some of these assets were in fact sold at over a 40 percent higher price than the appraised value. “As a long-term investor looking for a long-term return, the current total return is not enough to meet the long term target,” he says.
“So, there is a trade-off – either buy now or wait for a few years to get better pricing. But then, one ends up losing that yield during the waiting period.”
He acknowledges there is pressure to invest, but at the same time he says Manulife’s investment horizon is regional, so a 3 percent cap rate in Tokyo may not be as attractive as a 5 percent cap rate in Sydney. This is why Manulife, as of last year, has moved toward investing from a regional capital pool to build a diversified Asia portfolio, instead of a country-by-country allocation. As part of this plan, the insurer is looking to invest about $2.5 billion in Asia-Pacific over the next couple of years. The firm is also planning to consider indirectly investing via pan-Asia core funds.
Meanwhile, TH Real Estate made its debut Japan investment in late 2016 with an $82 million Tokyo commercial property buy, but has since not made any new investment. Watanabe agrees that Japan has not been an easy market to unravel for quality core assets, with offshore investors like GIC and Norges Bank Investment Management, two more whales, becoming more active making landmark investments in Japan in 2017.
He sees potential investment opportunities arising from off-market deals or other deals related to corporate restructuring. He has been seeing some interesting deals from corporates beginning to offload their quality assets to focus on their main businesses or through M&A or restructuring this year.
TH Real Estate is currently in the process of closing such an off-market deal of around $200 million.
“The theme in Japan is different from China or Australia, where there is more growth and high inflation,” says Watanabe. “Japan is more of a stable income play for us, especially with its attractive yield gap relative to risk free, especially for core assets underpinned by high credit tenants as both corporates and individuals are financially sound and reliable. We focus our investments on key cities based on a long-term basis and see Tokyo as one of the key core markets globally.
As an investment person on the ground in Asia, if I can invest in a quality, well-located asset in central Tokyo, I can count on a long and durable income flow so I can sleep well at night.”
Quoting data from Real Capital Analytics, Delaunay says around 33 percent of the overall property transactions in Japan were done by offshore capital last year. While the country received the largest volume of cross-border capital in absolute dollar volumes across Asia-Pacific last year, the market is still dominated by local Japanese institutions and real estate investment trusts.
Lo says her firm therefore also strategically builds relationships with local players – by using trust banks as property managers or getting dealflow from them – to gain access to some of the off-market investment opportunities.
Agreeing with the other participants on the constraints of deploying capital, she says: “As an opportunistic investor, we are good at finding and turning around distressed assets.
But the market is so fundamentally healthy and there is so much institutional capital chasing assets here that we have not found any distressed opportunity in the past 12-18 months.”
Blackstone is one example of an opportunistic manager using a creative approach to finding deals in Japan. The New York-headquartered manager completed two privatization deals in Japan last year, Croesus Retail Trust and a takeover of Astro Japan Property Group.
On whether the trend of a REITs takeover will become more popular this year, Lo says the execution process is hard: “There are a few undervalued REITs that we are eyeing. But J-REITs are difficult to privatize because they are heavily regulated. Hostile takeovers will be near impossible. Friendly deals, maybe.”
Japan continues to be one of the key investment spots in the region. Like ANREV’s Delaunay says, it has nearly always featured in the top three investment destinations in its annual Asia-Pacific investor intentions survey for the last 11 years.
What is less certain is how foreign managers and domestic investors will deploy their capital in the current cycle.