Seth Sulkin is the President and CEO of Pacifica Malls K.K., a Tokyo-based real estate asset manager specializing in commercial properties.
Looking at the increasing number of large-scale commercial property transactions recently, one might be excused for thinking that we are in the midst of a broad recovery in the Japanese real estate market.
A closer look at many of these transactions, however, raises several sticky questions: Do these deals fairly represent market sentiment? Is the increase in transactions sustainable? And does Japan have sufficient transparency and corporate governance in the real estate sector?
To be fair, some of the most notable recent transactions have been on an arm’s length basis. The largest office and retail transactions took place in December 2009, as Secured Capital Japan acquired the Pacific Century Place Marunouchi at a price said to be over 140 billion yen and SEB Asset Management of Germany bought a shopping center in Chiba for about 12 billion yen.
However, a large number of publicly announced transactions have been between related parties, raising issues about whether investors on both sides are getting a fair deal, and whether there is sufficient disclosure.
Since the public debt and equity markets opened up again to blue-chip Japanese real estate investment trusts (REITs) a few months ago, there have been many transactions between REITs and their “sponsors.”
During the first quarter of 2010, REITs acquired 229 billion yen of properties, the most since the third quarter of 2008 right before the Lehman Brothers shock. Many people in the industry have been puzzled by these deals. Not only have market watchers questioned the pricing, but they have challenged whether some of these acquisitions would have occurred at all if the sponsors did not control the asset managers of the REITs.
When queried about whether REIT managers sufficiently safeguard the interests of their shareholders, Japanese authorities say that it is the job of licensed appraisers to protect investors by making sure that REITs are buying properties at fair market value.
In the U.S., many mortgage lenders burned by the subprime crisis attribute a large portion of the blame to inflated valuations arranged by interested parties and hence no longer allow buyers to choose the appraisers.
Illustration by Phil Couzens
Many in the U.S. are also pointing fingers at the major credit rating agencies, which granted triple-A ratings on securities backed by sub-prime loans that later turned out to have little or no value, and whose fees were paid by the issuers of the securities.
With the Japanese economy still stuck in the doldrums, weighed by spiraling deflation and a continued rise in the vacancy rate despite falling rents, it is hard to make a case for investing in Japanese real estate based on the fundamentals alone.
Yet many major global institutions with allocations for Asia are looking for reasons to resume Japanese investment in 2010. If you ask what they like about Japan, they cite economic size, a high savings rate, political stability (believe it or not), clear laws and regulations and well-established financial institutions.
If you ask what they don’t like about the Japanese real estate market, they mention a lack of transparency in terms of transaction data, deflation, the lack of a simple pass-through vehicle to own property, the absence of a clear government policy to address Japan’s economic problems, a falling population and a general perception that major Japanese companies have special access to the best acquisition and financing opportunities.
Considering the glacial pace at which things change in Japan, one cannot expect the Japanese government to tackle all of these issues at once. Foreign investors were crucial to supporting the last boom in Japanese real estate prices, so the government should make greater efforts to address key issues such as transparency and corporate governance that could be handled relatively quickly.
Given the low prevailing cap rates (yields) on high quality Japanese property and limited availability of debt, Japan is becoming known as a country only suitable for so-called “core” investors. Typically, one associates core properties with high income stability and low risk, yet it is hard to attribute those features to the Japanese property market at the moment.
