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Amid negative rates, Japan's REITs a big draw

TOKYO -- Real estate investment trusts, with their relatively generous returns, have been enjoying strong demand here as the Bank of Japan's negative interest rate policy drives funding costs to historic lows.

On the surface, there seems to be little to no drawbacks to buying the securities. While the Nikkei Stock Average is down more than 10% compared with the end of last year, the Tokyo Stock Exchange REIT index is up nearly 10%.

Whenever REIT prices drop, they immediately attract buying, said Naoki Fujiwara, chief fund manager at Shinkin Asset Management. REITs are being propped up by the exceedingly low interest rates and a favorable supply-demand balance, he added.

The newfound popularity of REITs started when the BOJ unveiled its minus rate policy in late January. The vehicles invest in real estate by using funds procured from bank loans and bond floats. Speculation quickly spread that negative rates would let REITs lift their dividend payouts.

"Each time interest on funds procured decreases by 10 basis points, dividends increase by 200 basis points," said Hiroshi Torii, senior analyst at SMBC Nikko Securities.

Foreign capital flowed into the Japanese REIT market during February and March. Overseas investors bought 116.7 billion yen ($1.09 billion) worth of the instruments in February on a net basis, the second-largest figure ever. Since April, regional banks and similar domestic players have apparently joined the feeding frenzy.

The average REIT dividend yield tops 3%, beating out the rate for first-section issues on the TSE, which is a hair over 2%. The yield on 10-year Japanese government bonds continues to hover in negative territory. Not only are the rates of return superior to other securities, REITs also carry no currency risk, said a fund manager at a trust bank.

There are also expectations that demand will gain even more steam. Analysts believe the BOJ will accelerate its current 90 billion yen annual pace of REIT buying in the event the central bank rolls out additional monetary easing. Others see the traditionally conservative Japan Post Bank parking funds in REITs starting this fiscal year.

Although many believe that REIT prices will remain stable amid high demand, some causes for concern have cropped up -- one being the growing rate of office vacancies. For five central Tokyo districts, buildings that are between 1 to 10 years old had a 2.36% vacancy rate in April, data from office leasing servicer Sanko Estate shows. Newer buildings used to be highly sought-after, but now the rate exceeds that for properties 11-20 years old and 21-30 years old.

Vacancy rates for buildings a decade old or less last surpassed those for older ones in June 2008.

There is also uncertainty surrounding REIT-held properties. It is becoming more difficult to acquire real estate in central Tokyo, to the point that purchases of older buildings and buildings outside the Tokyo area have become more pronounced, said Junichi Tazawa, senior analyst at UBS Securities. If the economy were to decelerate, there is a chance that demand for such buildings would plummet.  

"REIT prices appear to be overheated, but they are still more attractive than stocks," said an asset manager at a regional bank. Perhaps reflecting that, dividend yields for the largest REITs based on market capitalization have sunk below 3%, drawing closer to the rate of anticipated return afforded by first-section stocks.

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