The rising role of private J-REITs

Japanese private real estate investment trusts have boomed since the covid-19 pandemic, providing secure returns for risk-averse domestic institutional investors and fund management income for a range of sponsors.

For overseas investors in Japan, private REITs act as both potential competitor and customer; however, few overseas managers have managed to tap this domestic pool of capital.

Meanwhile, savvy international players have tapped into the demand from wealthy Japanese retail investors for core real estate returns which are higher than those on offer in the domestic market.

Private REITs, operating on behalf of domestic institutional investors and with a low cost of capital, have been active players in the Japanese real estate market in recent years. Since the end of 2019, their assets under management have nearly doubled to ¥5.87 trillion ($39.7 billion; €36.4 billion) and the number of REITs has grown to 54, from 32. Over the same period, the number of listed J-REITs has fallen to 60, from 64.

A private REIT is created under the same REIT regime as J-REITs, but is usually structured as open-end, usually with restrictions on the timing and volume of redemptions. Private REITs vary in size from ¥20 billion-¥500 billion of AUM. The first was created by Nomura in 2010; the latest private REIT was the Dai-ichi Life Sogo REIT Investment Corporation, launched in January, with ¥32 billion of office and logistics AUM. The sponsor said it would also invest in other commercial property types and grow to ¥100 billion of AUM.

“It is harder for sponsors to acquire assets at a price which can generate a 4 percent dividend yield”

Koichiro Obu
DWS

The strength of domestic capital is something of a double-edged sword for overseas investors. David Fassbender, head of Japan at PGIM Real Estate, says: “A challenge in Japan across all sectors, but in office in particular at the moment, is that domestic investors have continued to be very aggressive.

“Private J-REITs are part of this competition, with a lower cost of capital. At the same time, they are adding liquidity to the market, and the depth and liquidity of the Japanese real estate market is a real positive.”

Japanese private REITs source capital from domestic institutional investors, mainly regional banks and pension funds, which are looking for low-risk core returns.

Kiyotaka Maeda, senior consultant and deputy general manager, private fund advisory department, at Sumitomo Mitsui Trust Research Institute, says: “Private REITs are very popular in Japan because they are not exposed to the equity market and the value is based on appraisal value. Japanese investors like this stability and are happy with total returns of 5-6 percent a year, mainly from income. This would be too low for overseas investors.”

The sponsors for private REITs tend to be domestic developers or investment managers, also often linked to big developers, although the peculiar circumstances of the pandemic led to one particular type of active sponsor.

Koichiro Obu, head of real estate research, Asia-Pacific, and head of real estate, Japan, at DWS, says: “One of the reasons for the increasing number of private J-REITs in recent years was that, during covid, these vehicles were a source of profit for railway companies who were suffering in the main transportation business due to lower travel.

“They used private J-REITs to monetize the commercial assets they own alongside tracks and railway stations.”

Picking a partner

The sponsor of a private REIT is as important a factor as the asset it owns. A February report from Japanese law firm Atsumi & Sakai suggests that, although private REITs distribute property income, the vehicles are more of an investment in the sponsor than the assets.

“In the case of a private REIT scheme, the emphasis is placed not on the specific property but on the sector focus of the sponsor company, the criteria the sponsor is expected to apply to property acquisition and the capabilities of the asset management company,” says the report.

As with listed REITs, private REITs need to maintain their dividends to retain and attract investors, something which becomes more and more difficult if market yields are compressing and the REITs maintain typical gearing of 40-45 percent.

Obu says: “There is room for further growth in the sector as it continues to mature, but we believe that any expansion will be more challenging than before. It is harder for sponsors to acquire assets at a price which can generate a 4 percent dividend yield under the current tight market conditions.”

Maeda adds: “It is hard for private REITs to maintain returns with new acquisitions, so they rely on their sponsors for a pipeline of new assets.” He also notes that growth is likely to be slower because “the office market is weaker, which means investor appetite is a little lower. However, existing REITs will not be selling assets and will keep growing.”

The world of private Japan REITs is almost entirely domestic. In 2012, Goldman Sachs Japan bucked the trend when it launched Japan Private REIT Inc, which holds a 40-asset portfolio, purchased for ¥198.8 billion. The portfolio is composed mainly of offices but also includes residential and retail properties, with a focus on central Tokyo.

Obu says: “So far, the sponsors have mainly been domestic companies and we have seen only two foreign investment managers launching such vehicles to date, out of 54 existing private J-REITs in the country as of December 2023.”

Indeed, overseas private equity groups have so far been more involved in the listed J-REIT market than in the private space. Prologis, GLP and LaSalle Investment Management all manage J-REITs in the logistics space, with a total of nearly ¥2.2 trillion of AUM.

Singapore-based SC Capital is the majority shareholder of Japan Hotel REIT. Meanwhile, KKR acquired J-REIT manager Mitsubishi Corp-UBS Realty in 2022, bringing it two listed J-REITs. The same year, Dallas-based Invesco Real Estate took its J-REIT private in the face of a hostile takeover attempt from Starwood Capital Group.

With a potentially more difficult market ahead for private J-REITs, it may seem unlikely that many foreign investment managers will become active in the market. “The key challenge for the foreign managers to establish private J-REITs is the relationship with the domestic institutional investors, who are the majority group of investors of private J-REITs,” explains Obu.

However, foreign real estate investment managers have been active in Japan for a good while, and a growing number have domestic Japanese businesses.
With the huge pool of domestic institutional and retail capital as a lure, private REITs remain an option for overseas businesses to entrench themselves as particpants in Asia’s largest developed market.

Foreign managers open private REITs to Japanese investors

Overseas private REITs are proving attractive to Japanese individual investors, and global managers are taking note.

Overseas private real estate investment trusts are proving attractive to Japanese individual investors, and global managers are taking note. In 2022, Blackstone partnered with Nomura to launch Japan’s first public offering of an offshore private REIT, Blackstone Real Estate Income Trust. Meanwhile, in March, Brookfield teamed up with SMBC Nikko Securities to offer the Brookfield REIT to Japanese investors.

The Brookfield REIT is relatively large compared with Japanese private REITs, with $2.2 billion of assets under management. Meanwhile, Blackstone’s BREIT’s $114 billion in AUM makes it larger than the entire Japanese private REIT sector.

Overseas private REITs offer Japanese investors the prospect of higher income returns than the equivalent in Japan, with typical dividend returns of 7-8 percent.

Jeremy Hall, head of Asia-Pacific for Brookfield Oaktree Wealth Solutions, says: “When speaking with our distribution partners in Asia and in more recent years in Japan, we are seeing alternative allocations rapidly picking up for individual investors. We are also seeing a significant ramp-up and adoption of semi-liquids in the Japanese marketplace as investors look for attractive income and lower correlation to equity and bond markets.

“Institutions have been allocating to alternatives – including private real estate – for many years, and the opportunity for individual investors to follow suit has a long runway.”

Daisuke Kitta, head of real estate, Japan, at Blackstone, says: “We believe private real estate has the potential to provide investors portfolio diversification, steady income and lower volatility than public markets, while also acting as a hedge against inflation.”

Japan has a total of more than $14 trillion in household financial assets, most of which are held as savings in very low interest accounts. The Japanese government is trying to encourage a move from “savings to investments,” in order to boost post-retirement incomes for citizens.

Last year, prime minister Fumio Kishida said this would “contribute to sustainable growth not only in Japan, but also on a global scale.”

Such a huge pool of savings means potential for other private equity real estate managers to open access to low-risk investments such as private REITs in the future.