Slow-motion spinouts

Japan's corporate culture favors real estate investors who have patience for a glacial pace of change. By David Snow

A senior, Tokyo-based private equity real estate professional is quick to draw a distinction between the process of looking for deals in Japan versus China. In China, he says, “You get off the airplane and 48 hours later you have 24 deals in front of you, but 23 of them you'd never want to do.”

In Tokyo, the general partner continues, there are far more tantalizing deals to be done, but for the average Western investor, “you can drive around town all day and be confused. It's much more difficult to get things done here.”

As the world's second largest economy, home of the sprawling keiretsu, the promise of Japan's real estate market is, on paper, incredible. Among the most sought after assets are the significant non-core real estate holdings that populate the balance sheets of major conglomerates. Not only have these buildings often been greatly neglected as cash-flow generating properties, they tend to be managed by “salary men” who have zero incentive to unlock value or reposition assets.

Now that Japan is emerging from a protracted recession, it is witnessing the fruits of major economic reforms—some Western real estate investors are hoping this momentum will carry through to the corporate board rooms, where newfound enthusiasm for focus will cause companies to sell off real estate assets. Not so fast, says the long-time Tokyo GP.

“Management is very aware about the issues of the reallocation of capital,” he says. “But not all of them feel there's a sense of urgency to do it. You can go in and talk about all the good things that will happen if they sell off their real estate assets, about how they can take the money and focus on their most successful businesses. And they get all that, but they still won't do it.”

Leveraged buyout firms are well aware that Japan's low-hanging fruit is difficult to pluck. In a recent interview with sister publication Private Equity International, the head of one major LBO firm that recently opened an office in Japan described the disappointing message that closed many of his meetings with local CEOs: “We don't have any divisions to sell you.”

In Japan, the impediments to quick decisions are cultural as well as part of the legacy of guaranteed employment. The heads of the various real estate divisions within large corporations have usually been assigned to their position from the parent company, and the notion of selling off these divisions creates political problems for the keiretsu in question. The Tokyo GP says his firm is currently working on a deal to acquire the real estate assets that house switching stations for a major Japanese telecommunications company—assets that are worth roughly ¥800 billion ($8 billion). But the corporate parent has its hands tied with regard to the unionized employees in these buildings. “There is an understanding of lifetime employment,” he says. “If they sell the assets they have to deal with the people.”

“You can go in and talk about all the good things that will happen if they sell off their real estate assets, And they get all that, but they still won't do it.”

The GP says he expects the assets to go to auction eventually, but this event will probably be timed with the retirement of key individuals in the subsidiary. He says he has been working on this deal for three and a half years.

The investor complains that many top decision makers in Japan don't even own shares in their own companies, and therefore view their jobs as encompassing other priorities above enhancing shareholder value.

Two potential catalysts to change are on the horizon. The GP notes the arrival of so-called “activist” funds in Japan, such as Steel Partners, which have injected Japanese market dynamics with a distinctly Western style of rudeness. The hard-nosed tactics of these types of investors may play a role in pushing corporations to make painful changes, including the unloading of noncore real estate assets. The second potential catalyst may come as a result of the first—Japanese CEOs tend to act much more quickly if they see their competitors making similar moves. Shareholder value creation may not yet be pervasive, but the desire to compete against corporate rivals is deeply instilled. In a country that is sensitive to being taken advantage of by foreign investors, the GPs who create win-win real estate deals among the keiretsu will be doing the entire private equity real estate market a favor.

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