Global Economics

Yankee Woes Hit Japan's Real Estate


A key real estate index is down 30% from its February peak in what one manager called a "knee-jerk reaction" to subprime problems in the U.S.

After what has happened to Japanese stocks this year, the country's famously conservative investors could be forgiven for preferring to stash their cash in bank deposits. The Nikkei 225 index fell 2.2% on Sept. 1 and is down 8.5% so far this year, vs. a 5.2% gain for the Dow Jones industrial average, despite Japan's generally sound economy. While growth shrank an annualized 1.2% during the second quarter, the nation's gross domestic product still is expected to grow around 2.2% this year, thanks to buoyant corporate profits and an unemployment rate that has fallen to 3.6%, a seven-year low.

Investors in Japanese real estate stocks and funds probably feel the most aggrieved. Year to date, the Topix Real Estate Index has shed 13% and is down 30% from a February peak. Tokyo-listed real estate investment trusts have fared just as badly, shedding 29% since June.

The mood wasn't helped last week when Takeo Higuchi, chairman of Daiwa House, Japan's second-largest homebuilder, added insult to injury by claiming Japan's property sector was a bubble waiting to burst. "The property market has become dangerous," Higuchi told Bloomberg News on Sept. 5. "I wouldn't be surprised if the real estate bubble goes bust."

Baffled by Talk of a Bubble

Yet investors, including those involved in buying properties in prime locations, say the current malaise in real estate shares is an unfortunate reaction to the subprime problems in the U.S. rather than more deep-seated problems. Baffled by Higuchi's comments, they instead point to rising land prices and rents and low vacancy rates. "In Japan, there's been some kind of knee-jerk reaction," says Alfred Liu, an executive director at UBS Global Asset Management (UBS) in Tokyo. "We still see good fundamentals."

For sure, it's hard to characterize the market as a bubble. Land prices in some Tokyo hot spots have risen sharply in the last few years but the market performance as a whole is hardly stellar. Last year, land prices in Japan increased just 0.4%, ending 16 consecutive years of declines. In Tokyo, prices in a handful of upscale districts jumped as much as 40% last year, but the average hike was 14%. Rents are also rising but not at a great enough clip to spark concern. Office rents in prime Tokyo locations, for example, have increased to about $530 per 3.3 square meters. That's a lot, but it's still only 60% of the peak commercial rents in the late 1980s.

Just as important, for all the current liquidity concerns stemming from the subprime fallout, foreign investors in Japanese real estate still seem to like the market. On Sept 3, local media reported Goldman Sachs (GS) had bought Tiffany & Co.'s (TIF) main Japanese store for $340 million. And on Sept. 5, Pembroke Real Estate, real estate investment and development adviser to Fidelity Investments, announced the acquisition of Moto Azabu Grand Mansion, a high-end multifamily residential property in a swanky Tokyo district, for an unclosed sum.

Expats Like Central Tokyo

"The continued appreciation of land value in central Tokyo, increasing demand for high-quality residential housing from expatriates, and close proximity to leading international employers and schools are all factors that make this an attractive long-term investment, noted Mark Takeuchi, head of the branch office of Pembroke Real Estate Japan, in a statement. In April, before the current swoon began, Morgan Stanley (MS) said it was buying 13 hotels from Japanese carrier All Nippon Airways for $2.4 billion.

So what explains the sell-off? Clearly, much of the problem is a risk aversion globally to real estate stocks and equities in general caused by the fallout from subprime problems in the U.S., even though Japanese real estate companies have no direct exposure to American lenders or the homebuilding market. One concern: Foreign investors represent a high proportion of turnover on the Tokyo Stock Exchange, owning about 30% of stocks but accounting for almost 60% of trading volumes. That means that when the global appetite for risk weakens, Japan's market can be particularly volatile as foreign investors move out en masse.

In real estate, overseas investors led a surge when Japanese real estate stocks were considered cheap compared with global rivals, triggering a 56% rise in the Topix Real Estate Index in 2006 (BusinessWeek.com, 10/3/06). Now, with foreign investors selling, the market's fall is inevitable. "Japan's property prices had been driven up by foreign investors, but due to the fluctuations in the financial markets those investors are stopped buying and that's now being reflected in the stock market," says Masanobu Kaizu, head of Nomura Securities Financial & Economic Research Center.

Delaying Sales in Hopes of Higher Prices

Nonetheless, market watchers say it is not all doom and gloom. Liu at UBS says some of the factors weighing down real estate stocks are temporary. For instance, some Japanese REITs are suffering because other funds that invest in a range of REITs globally are having to sell because of losses elsewhere. He also expects office rents to continue to climb, particularly in metropolitan areas. "We're still a long way from the peak," Liu says.

There also seems to be healthy demand for new construction projects. Sony (SNE), for instance, said recently it will begin building a new 100,000-square-meter high-rise office in Tokyo's Osaki district in 2009, while demand for luxurious blocks in central Tokyo remains strong. Indeed, only a few weeks ago, Japanese media reported homebuilders were purposely delaying the sales of newly completed apartments because they expected prices to grow quickly.

And, after a weak July, house builders' order books suggest investors have become unnecessarily pessimistic, notes Nomura Securities. One homebuilder, Daito Trust Construction, saw its order book grow 44% year-over-year in August, while six others all posted rising orders.


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