Japanese REITs

Regarding J-REITs

Number of J-REITs
Japan’s real estate investment trust (J-REIT) market premiered in September 2001, when two J-REITs publicly listed their investment units for the very first time. The number of J-REITs increased steadily thereafter, reaching 42 through October 2007.

By April 2012, however, this number had dropped to 33; one J-REIT went bankrupt in October 2008, following a global financial crisis, and eight other J-REITs merged or had been acquired by others.
Market prices eventually recovered, and the first new report on a J-REIT since October 2007 took place in April 2012. Additional J-REITs followed suit, and as of June 2014 a complete of 46 J-REITs were operating. All J-REITs are listed about the Tokyo Stock Exchange.

Institutional Features
The only operating format permitted for J-REIT is definitely an external management format, in which the investment corporation is operate by an asset management company. This is because the law requires that the asset management company operate the investment corporation in which investments are created.

A J-REIT is essentially established by the shareholder (sponsor) of the asset management company. If the sponsor invests in various asset classes of property, it can establish multiple investment corporations that are operated with a single asset management company.
No real estate company has converted itself for an investment corporation, because there are no tax incentives that might make such conversions advantageous.
Requirements for Dividend Deductibility
To be exempt from paying corporate tax during any given business year, a J-REIT must satisfy 4 main requirements:

(1) Its payout must exceed 90% of earnings readily available for dividends.
(2) Its largest shareholder must hold less than 50% of its investment units.
(3) Its largest shareholder mustn’t hold more than 50% of the shares of another organization.
(4) If it borrows funds, these must originate from an institutional investor.

Sector
The primary asset classes of J-REIT opportunities include office, residential and commercial facilities. In addition to these types of, the share of logistics facilities has increased recently. Some J-REITs commit also in hotels, housing for the elderly and infrastructure amenities.

The categories of J-REIT in terms of investment focus include the focused type (purchasing a specific asset class), the complex type (investing within two asset classes), and the diversified type (purchasing multiple asset classes).
As of May 31, 2014, J-REITs experienced limited their investment area exclusively to Japan. Accordingly, J-REIT earnings happen to be denominated in yen. However, the law permits J-REITs to purchase properties located outside Japan, and one J-REIT announced its investment inside a commercial facility located in Malaysia. As a result, in the future chances are that additional J-REITs will invest in properties located outside associated with Japan.

Characteristics as an Investment Instrument
With one exception, J-REITs report their financial results on the semiannual basis. The fiscal periods of J-REITs differ, including, for instance, January/July, February/August, March/September, April/October, May/November and June/December.

J-REITs are necessary to distribute more than 90% of their profits as a situation for dividend deductibility, but a majority of J-REITs have a payout ratio near to 100%. Only two J-REITs regularly use depreciation to fund dividends (that’s, to make distributions in excess of profits).

Investors as well as Japanese REITS: A Love Story

TOKYO-Japanese real-estate investment trusts have become among the silver linings in the cloud of concern hovering over the actual Pacific Rim’s real-estate sector.

Overall, shares of listed property companies in the area have been dragged down this year by the cooling from the Chinese economy. But the Tokyo Stock Exchange REIT index offers gained 8. 5% in 2016.

Shares of Japanese REITs, referred to as J-REITs, are trading at a 35% premium over their internet asset values, according to the Association for Real Estate Securitization associated with Japan. In many other parts of the world, including the actual U. S., property stocks have been trading at discounts in order to asset values.

The current love story between investors and J-REITs is partly because of strength of the Japanese real-estate business. A surge of foreign travelers to Japan may be boosting revenue for hotels and retail stores. Growing e-commerce is actually creating new demand for logistics facilities.

Meanwhile, an economic recovery may be helping rents at apartments and offices. Japanese land prices rose last year for the very first time in eight years, led by strong demand for commercial qualities in big cities, according to government data.

J-REITs also are becoming a big boost from the Bank of Japan’s decision in January to maneuver to negative interest rates. Their dividends, which typically run close to 3%, are very attractive to investors when 10-year Japanese federal government bonds are yielding about minus-0. 1%.

“That story of growth of dividend is essential for Japanese REITs, ” said Svitlana Gubriy, manager of the $1 billion global real-estate securities portfolio held by Edinburgh-based Regular Life Investments Ltd.

Since the Bank of Japan action, Regular Life has bought more J-REIT shares in its global real-estate profile. The firm likes the hotel and office sectors. “We observe opportunities there, ” Ms. Gubriy said.

Foreign investors put the net ¥117 billion ($1. 05 billion) into Japoneses REITs in February, the biggest amount since February 2007, based on Tokyo Stock Exchange data compiled by the Association for Property Securitization, or ARES. They bought an additional ¥83 billion within March and ¥62 billion in April.

The J-REIT market offers kept growing, attracting several new issuers a year. Its marketplace capitalization amounts to ¥12 trillion, now roughly 90% of the entire market value of the developers and other real-estate businesses listed about the first tier of the Tokyo Stock Exchange, according to ARES. With regard to yield-seeking investors, J-REITs can be an ideal alternative to bond investments because J-REIT dividends are usually stable, backed by rents of leased properties. J-REITs typically don’t create buildings.

Star Asia Investment Corp. became the latest to debut like a J-REIT in April. Taro Masuyama, managing partner of Star Asia’s recruit, said the group plans to help the REIT assets grow to ¥200 billion within the next several years, compared with ¥61 billion at the time associated with listing.

Support for the market also comes from the Financial institution of Japan, which now owns more than 5% of the shares inside a dozen J-REITs-the result of the BOJ’s unconventional asset-purchase program.

J-REITs are taking advantage of sharply lower borrowing costs. The average rate for three- in order to seven-year interest-bearing debt at J-REITs is 0. 5%, the cheapest ever, according to Morgan Stanley Research. At Japan Retail Account Investment Corp., the largest retail-focused J-REIT, interest expenses are projected to be reduced by ¥71 million in the year to February due to the drop in interest rates, according to officials at the fund’s resource manager.

Still, some investors are becoming cautious about J-REITs for their hefty valuations.

Consider Macquarie Investment Management, which bought J-REITs within late 2012, anticipating the start of a big BOJ quantitative-easing program that could drive down interest rates, make J-REIT dividends look more appealing and boost their share prices. It was a good phone, as the REIT index rose 36% in 2013 and 25% within 2014, before falling 7. 9% in 2015.

Macquarie has since cut the J-REIT exposure in its $825 million global real-estate portfolio and it is focusing more on Japanese developers, which are still benefiting from the strong real-estate businesses in the united kingdom. “I think we are probably due for a correction in J-REIT at some time, ” said Bob Zenouzi, Macquarie’s U. S. -based chief expense officer for real-estate securities.

Some investors in the retail sector are worried about the sustainability of growth driven by foreign travel in order to Japan. Wilson Magee, portfolio manager for $1 billion of worldwide real-estate securities at Franklin Templeton Institutional LLC, said his team sold some shares in the retail sector as they observed growth of tourist sales slowing recently.

Meanwhile, Takashi Iwamoto, chief investment officer for Frontier Real Property Investment Corp. ’s asset manager, said uncertainty remains over sustained growth of merchandise sales which some Chinese visitors are shifting their pattern of spending toward experiences instead of buying goods.

On the other hand, Mr. Iwamoto, who just returned from the five-year stay in Shanghai, said China’s decent economic growth and people’s wage increases will probably continue to prompt them to travel abroad. “I believe the broader trend of inbound [tourism] will continue moving forward, ” he said.

Franklin Templeton’s Mr. Magee said his associates are concerned about expensive pricing of J-REITs, but they will most likely maintain their key positions such as hotel and office until they visit a dramatic change. “We don’t believe we’ll see significant changes in the manner they are priced, until some of the support from quantitative easing and direct purchasing of J-REIT shares [by the central bank] abates significantly or disappears entirely, ” he said.

These Japanese REITs Are Hot

Key Takeaway

We met with investors in Asia over the final week. Our key discussions were centered on a) negative rate of interest policy (NIRP), b) asset reallocation to higher yield securities including JREITs, c) margin improvements of building companies, d) lack of catalysts for major developers in spite of cheap valuations. Stocks in focus were Obayashi, Taisei, JR Eastern, NBF and Mitsui Fudosan.

Impact of negative interest rates: Theoretically, the negative interest rate policy (NIRP) implemented in February this season by the BOJ should encourage real estate investments. Lower financing costs should make leveraged investments in real estate more attractive and therefore should lower cap rates. However, investors were skeptical about the effectiveness (can you rush to buy real estate just because you get 15 foundation point savings on borrowing? )#), especially considering macro headwinds through China, etc.

Shifting to high yield securities: Although investments into hard assets for example real estate may take time, investors agree JREITs with steady cash flows and high yields are attractive investments. The JREITs’ typical dividend yield is 3. 1% (vs -0. 02% for that 10 yr JGB yield), and it is based on stable income from rents and JREITs have tax advantages with a 100% payment ratio. We believe large, liquid names such as NBF (8951. JP, MAINTAIN, PT: JPY600, 000) will benefit from asset reallocation, and also the continuous purchases by the BOJ should also provide support for that sector. Our most preferred names are the logistics JREITs: Nippon Prologis REIT (3283. JP, PURCHASE, PT: JPY270, 000) and GLP J-REIT (3281. JP, PURCHASE, PT: JPY150, 000) for growth in e-Commerce and the actual scarcity of modern logistics facilities in Japan.

Margin improvements For construction companies: Although the strong demand for construction was popular to investors, the construction cost stabilization was a surprise with a investors. The shortage of construction labor has improved, which has resulted in a stabilization of labor costs since October 2014, and falling material costs were the primary reasons for margin improvements at construction companies. Near term catalysts consist of strong 4Q numbers and we expect upward revisions to companies’ assistance. Our most preferred names are Obayashi (1802. JP, PURCHASE, PT: JPY1, 400) and TaStability of earnings from JRs – safety heaven: isei (1801. JP, PURCHASE, PT: JPY900), while our least preferred is Kajima (1812. JP, MAINTAIN, PT: JPY700).

Stability of earnings from JRs – safety heaven: For those investors looking for cash flow stability, all of us recommended JRs. JR East generates approximately 70% of its operating income from its transportation segment where we expect stable income. Its real estate exposure centered around Tokyo also provides stable rental income and it has a lot of unrealized gains of JPY1. 35 trillion (US$11 billion). It’s currently trading at 8. 2x FY3/17E EV/EBITDA, well below the actual pre-Lehman level (11x), despite record high profits. Investors also appreciated an overall total payout of 70% for Sekisui House, whose dividend yields is actually 3. 5%.

Lack of clear catalysts for developers: Despite inexpensive valuations and improving market fundamentals, there were no clear catalysts with regard to major developers in Japan. The office vacancy rate reached four. 0% level this year, the lowest level since August 08, while rents, albeit at a lower rate, are improving through c. 5% YoY. Mitsui Fudosan (8801. JP, BUY, REHABILITATION: JPY3, 700) was the most discussed stock among designers. It is trading at a c. 30% discount to it’s net asset value (NAV) estimate (JPY4, two hundred), but is relatively expensive compared to others with property exposure such as construction companies and JRs.

Pecking order: We received probably the most requests/follow up on constructors (Obayashi/ Taisei) especially on the margin improvements, followed by JREITs, then JR East and homebuilders. Developers were from the least interest to the investors we met in Asia.