In the fairy tale, it is the big bad wolf who blows houses down. In real life, big bad wolves tend to take the form of lax lenders and easy credit, inflating prices rapidly so that a pop is inevitable. Alas for Japan, this time round there was barely enough time to say “bubble” before prices went into reverse. That is partly down to ripples from the global credit crunch, and partly down to over-zealous regulators.
Spooked by memories of the more protracted 1980s bubble and subsequent collapse, regulators were quick to nip any incipient signs of a bubble.
“We barely had the peak when we went over the side,” says Christian Mancini, chief executive officer of Savills Japan, the property services company. “So opportunistic groups are already steaming back into the market waiting for the blood on the streets.”
Some blood has already been spilt. This year has been marked by a string of bankruptcies, slews of empty apartment blocks, a bombed-out real estate investment trust market and the commercial mortgage backed securities (CMBS) market skidding to a virtual halt.
But the sense of crisis is tempered. Japan’s blue chip landlords are still sitting pretty, especially in prime central Tokyo where rents remain on the rise. “The major real estate companies – who seem to be immune from the credit crunch – and overseas funds continue to actively invest, particularly in A-class properties,” writes UBS real estate analyst Toshihiko Okino. “However, we note that the vast majority of transactions in the market are in B-class and C-class properties, and the liquidity of these properties is declining due to the credit crunch.”
The question, as Mr Mancini notes, is whether the would-be buyers can avail themselves of cash to do so. Most observers reckon cash will not be forthcoming in the immediate future. Tom Ito, co-head of investment banking at UBS says: “I don’t see additional liquidity coming into the real estate market in the form of debt. Banks are not lending. No way are foreign financial institutions going to lend either.”
However, there are glimpses of light. Lone Star, the US private equity firm that swooped on distressed assets after the bubble burst, acquiring golf courses and financial institutions, is now planning to extend loans for real estate. The plans, not yet publicly announced, entail extending mezzanine loans to property buyers – helping plug at least one gap in the market. However, senior debt remains an issue.
Encouraged by the Financial Services Authority, which was eager to avoid another bubble, banks have been retreating from real estate. They have been giving a particularly wide berth to real estate investment trusts (Reits) and small and medium-sized developers, bankers say.
Carnage on the $36bn J-Reit sector is even more pronounced – the market capitalisation has almost halved since the peak – and the chief salvation, consolidation, remains a distant hope. Consolidation, either through mergers and/or privatisations, would help improve economies of scale and weed out weaker companies.
However, companies cite three hurdles to be overcome before the sector can begin consolidation. First, regulators have no interest in seeing mergers: the Financial Services Agency wants to grow, not shrink, the market. Equally the Tokyo Stock Exchange wants to encourage more listings, not facilitate de-listings. Finally, tax benefits disappear under mergers.
Hitoshi Sumiya, a partner at Baker & McKenzie’s Tokyo office, says the way Reits are structured compounds the problem. J-Reits have external managers, meaning that any merger involves four parties – two managers and two funds. “So, in any acquisition, you must acquire shares in the J-Reit and the manager,” he says. Since the latter are not listed, it is easy for a reluctant manager to rebuff suitors. A buyer managing to tick all these boxes must still win over a majority of shareholders.
On the tax side, waivers that are part and parcel of the Reit structure are suspended once any shareholder owns more than 50 per cent. “These are quite big hurdles, and so there has been no precedent,” says Mr Sumiya. Reit operators argue that these hurdles are preventing Japan from responding to the downturn as would be the case in other markets. J-Reits are massively under-valued, trading steep discounts to net asset value, although dividend yields are upwards of 9 per cent, well above the 1.5 per cent or so available on 10-year Japanese government bonds.
Economies of scale would help: fixed costs of about $2m a year make it hard for smaller companies to operate, says Daniel Kerrigan, CEO at Prospect Asset Management. Until the issues of Reits consolidation and funding are resolved, prices are likely to trade sideways at best.
Optimists reckon the market is close to its trough. But with vast amounts of debt falling due and vacancy rates edging upwards, the chances are that more property is about to come on the market first. Would-be buyers are likely to wait a while before pouncing.