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Is Japan's latest REIT boom overheating?

Orix JREIT acquired Hamamatsu Act Tower, a 47-story office building complex, in April.

TOKYO -- Investment money is flowing into Japan's booming real estate investment trusts. Japanese REIT managers have been scrambling to acquire properties away from the Tokyo metropolitan area, while non-Japanese players are betting on the market's future demand, thanks to Japan's continued ultralow interest rates, which should help achieve relatively high returns. Amid the growing momentum, concerns are growing that the market may be overheating.

In early April, about 50 retail investors attended a seminar on REITs in Tokyo. They were interested in the market's growth potential, while being concerned about overheating of the market. Retail investors have begun increasingly interested in REITs, due to the Bank of Japan's negative interest rate policy, which took effect in mid-February, said Daisuke Seki, head of IB Research & Consulting that hosted the seminar.

In April, Orix JREIT acquired Hamamatsu Act Tower, a 47-story office building complex that opened in 1994, for 11.8 billion yen ($105 million). This news became a hot topic of conversation among local market insiders.

The rate of return, calculated by dividing rental income from the building by the price tag, is 9%, a relatively high level. The number goes into the 6% range after depreciation. Connected to Hamamatsu Station, the 212-meter skyscraper stands tall at the center of the city of Hamamatsu, Shizuoka Prefecture, southwest of Tokyo. With a vacancy rate of 1% or so, its tenants include a hotel and roughly 140 companies. Japan's communications giant KDDI has a branch office in the building.

During the same month, Orix JREIT also spent 5.2 billion yen to buy an office building in Sapporo, the capital of Hokkaido, Japan's northernmost prefecture.

Likewise, Japan Hotel REIT Investment in April bought a hotel in Hakata, Fukuoka Prefecture, on the island of Kyushu in southwest Japan. Industrial & Infrastructure Fund Investment the same month acquired a manufacturing center, and land with leasehold interest in the city of Kakegawa, Shizuoka Prefecture.

But it would be wise to remember that the higher the return, the higher the risk will be, when it comes to properties outside of the nation's biggest cities. It is highly likely that the vacancy rate rises sharply in an economic downturn, due to the weak economic base.

Actually, Hamamatsu Act Tower was partially owned by Mitsubishi Estate. After taking a heavy blow from the collapse of Japan's economic bubble, in 2003 one of the country's largest property company finally had to unload the building at a loss due to its persistently high vacancy rate.

Driving force

What is whetting their appetite for risk?

One answer lies in lower returns from properties in central Tokyo.

In Tokyo's 23 wards, returns on investment in properties acquired by REIT managers since the beginning of this year have been in the high-3% range on average, down 0.5 percentage point from an annual average last year, according to a survey by Tokyo-based securities brokerage SMBC Nikko Securities.

On the back of overheating real estate investment, rents still cannot catch up with the property price increases.

The vacancy rate for office buildings in central Tokyo will play a key role in predicting the REIT market, because such buildings usually occupy a large portion of asset holdings of REIT investors. If the rate goes down, it will provide a tailwind for the market. In March, however, the average office vacancy rate in Tokyo's Chiyoda, Chuo, Minato, Shinjuku and Shibuya wards stood at 4.34%, for the second straight month of rise, according to office-space broker Miki Shoji. Until recently, the rate was declining after peaking in June 2012 at 9.43%. The figure is now approaching its limit.

In the same Tokyo's five central wards, however, rents for office buildings averaged 17,973 yen per 3.3 sq. meters in March, marking the 27th straight monthly increase. One lingering concern is that slower improvements in the vacancy rate could also put the brakes on rising rents.

Asset managers are also starting to come up with various measures to acquire more properties. For example, Daiwa House Residential Investment and Daiwa House REIT Investment, announced on Apr. 15 that the two asset managers will merge their operations with the effective date being Sept. 1. Both of them are wholly owned subsidiaries of Daiwa House Industry. The asset size of the surviving company is seen to exceed 500 billion yen in total, likely taking the seventh spot in the industry. The duo has so far invested in houses, logistics and commercial facilities. But the new REIT manager intends to diversify its portfolio, by including office buildings and hotels.

Eating into future?

The Tokyo Stock Exchange REIT Index has largely been moving above the 1,900 line since late March, though it briefly dropped to nearly 1,500 last September. The current trend is supported by buyers abroad.

According to data released by the TSE, overseas investors were net buyers of Japanese REITs, with purchases exceeding sales by 116.7 billion yen in February to hit the highest since February 2007, and by 83.2 billion yen in March.

An official at a domestic securities company said that overseas players poured money into Japan's REIT market on expectations that Japanese regional banks will start adding to their REIT purchases in early fiscal 2016, which kicked off on April 1, given that they are having difficulties managing profitable portfolios.

Meanwhile, Japanese investors, including individuals, banks and investment trusts, were strong net sellers of the country's REITs for the two months through March. Yet, they are expected to become net buyers in April and beyond. If the numbers fail to meet such market expectation, overseas players could generate strong selling pressure in one go, said Kohei Omura of Daiwa Securities.


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