Slim pickings in the J-REIT market

The $120 billion Japanese real estate investment trust market has recorded a series of firsts in recent years. The market saw its first hostile takeover in 2019 and its first successful privatization in 2022, sparking hopes that the future may hold more corporate activity and more opportunities for private equity investment.

J-REIT performance during the pandemic was volatile to say the least; the Tokyo Stock Exchange REIT index lost nearly half its value in a month between February and March 2020, but by July 2021 had recovered almost of all those losses.

Since then, however, the index has been falling and has lost more than 13 percent of its value as the equity market factors in expectations of rising interest rates and a rise in property cap rates. This fall means that, on average, J-REITs are now trading at a slight discount to net asset value.

REITs that trade at a discount to NAV are vulnerable to takeover bids, as investors see the opportunity to acquire assets at a discount to their appraised value. However, M&A is rarely straightforward, and even less so in Japan. So far, the market has seen only one J-REIT privatization, when Dallas-based manager Invesco Real Estate acquired Invesco Office J-REIT in 2022, staving off a hostile bid from Starwood Capital Group.

There has also been just one successful hostile takeover in the J-REIT sector thus far, when Star Asia REIT acquired Sakura REIT in a $300 million transaction. Star Asia began by acquiring a large enough stake in Sakura to convene a special meeting of unit holders in 2019, and then by proposing at that meeting to dismiss Sakura’s executive director and asset manager and install itself as the successor to both. Then in 2020, it merged the two REITs.

The conservatism of the nation’s investors and the often sizable (above 10 percent) stakes held by J-REIT external managers both act as barriers to M&A. In the wider Japanese stock markets, cross-shareholdings by major domestic corporations also act as a barrier to corporate action. A series of corporate governance reforms have led to more transparency and activism, although nothing like that is regularly seen in other stock markets.

At present the main obstacle to a raft of M&A transactions in the J-REIT sector is that discounts are not wide enough. As of March 15 of this year, just nine J-REITs were trading at a discount of 20 percent or more, and only two trading at a discount of more than 30 percent.

Calvin Chou, head of Asia-Pacific at Invesco Real Estate, says: “Privatizations are complex transactions and the discounts to NAV in the J-REIT sector are not wide enough to encourage investors to make the effort required. If the market fell further and discounts widened substantially, that might change. However, the Japanese market has been uniquely resilient amongst developed markets and we do not expect dramatic change.”

While the overall J-REIT market is not expected to see dramatic falls, some individual trusts could become more vulnerable due to declining performance.

David Cheong, a managing director in manager KKR’s real estate team, says: “The longer a J-REIT trades at a discount to NAV, the more difficult it is to issue equity and grow, which impacts their ability to retain management and can impede performance and hurt the unit price. It becomes a vicious cycle. Under those circumstances a J-REIT manager might look to privatization or a takeover as a solution for it and for unitholders.”

Should any such privatizations take place, they are unlikely to be the result of hostile bids. Nonetheless, some REIT managers, especially smaller players, might find privatization preferable to slow decline.

“Smaller REITs don’t get the economies of scale which larger managers have. There is a lot of fragmentation in both the private and public J-REIT markets; there are a lot of J-REIT managers with $300 million to $500 million in AUM which have faced more challenges to achieve growth,” Cheong says.

“The Japanese market has been uniquely resilient amongst developed markets”

Calvin Chou
Invesco Real Estate

Transactions in the J-REIT space need not necessarily be sparked by discounts or distress. In 2022, KKR acquired J-REIT manager Mitsubishi Corp-UBS Realty from Mitsubishi and UBS AM for $2 billion. The manager, now rebranded as KJR Management, has two J-REITs in its stable with ¥1.7 trillion ($12.9 billion; €11.8 billion) of assets under management.

Successfully closing such deals requires a favorable relationship with sellers as much as offering the right price. Mitsubishi and UBS are understood to have preferred KKR because the fit and culture would work for the management and staff at KJRM while Invesco’s privatization bid was favored because, as well as being the incumbent manager, the firm’s long history in Japan was seen as more ‘local’ than Starwood.

Looking ahead

A falling J-REIT market is unlikely to throw up many asset sales, says Invesco’s Chou: “J-REITs are not in a good position to issue units and buy assets, so they will focus on asset management. There is not much incentive for them to sell assets unless to fund an acquisition, so the likelihood is that we will see little activity this year.”

This hiatus will itself influence the wider Japanese real estate market, as J-REITs have been one of the largest sources of core capital since they were introduced in 2000. Chou says: “This is a mixed blessing for other investors in Japan: there is less competition from J-REITs when buying assets, but there is also less of a market to sell into.”

The stability that overseas investors prize in Japan militates against J-REIT privatizations and takeovers, but should the J-REIT index fall further than is expected, opportunities could still arise. The few transactions that have occurred set a precedent, meaning that moving forward, more transactions can be closed by managers with the capital and an understanding of Japan’s business culture.