Japan's REIT Market
May Not Be a Bargain
Worried about high valuations for U.S. real-estate investment trusts, many Americans are going abroad seeking bargains on real estate. In Japan they may be late to the party.
The Japanese REIT market has grown rapidly since its birth a little more than three years ago and recently has tracked the U.S. market's hot performance. The Japanese market is still relatively small, with just 15 funds, valued at about $17 billion. By contrast, the U.S. market is roughly $300 billion.
But at least half a dozen new Japanese REITs are expected to open up in the fiscal year starting in April, as players from giant trading houses to regional real-estate companies jump into the business of putting investors' money in portfolios of properties.
Japan's REIT market surged last year, with the Tokyo Stock Exchange's REIT index rising 31.9%. That compares with a return of 31.5% for the U.S. market. The run-up has pushed down the yield on Japanese REITs to just under 4%, from a high of about 6% two years ago.
The decline reflects the higher costs of acquiring prime properties in Japan, as foreign and domestic REITs and private real-estate funds, their coffers stuffed with investors' cash, bid up prices.
"Some people are worried the [REIT] market's gone a bit too high, but there really aren't other alternatives," says Takayuki Kiura, head of the Japan office of Chicago real-estate investment adviser Heitman International LLC. "Demand is rock-solid." The 4% yield on REITs greatly exceeds the yield on the government's benchmark 10-year bond, now 1.4%. Japanese investors, from pension funds to regional banks to individual retirees, are desperate to park their assets in something -- anything -- that offers a decent return. So institutional investors look to REITs, among other vehicles, and mutual funds investing in REITs are popular with retirees, who count on the generous monthly dividends to supplement their pensions.
The prices of high-end properties in Tokyo and other big cities have rebounded from their depths recently, even as the nation's overall real-estate market remains on a downturn. Real estate bears say that to justify their current valuation, rents must rise.
While none of these REITs trade on U.S. stock exchanges, U.S. institutional investors are among the biggest holders of Japanese REITs. The trend is likely to continue. In a recent survey by the Association of Foreign Investors in Real Estate, a Washington-based lobby of global investors, Tokyo was named for the first time as one of the three top cities for real-estate investment.
The REIT run-up hasn't been without its bumps. REIT shares tumbled in November and December, but have rebounded strongly this year with some hitting record highs this month. A few of the funds trade at a premium of more than 40% of their net asset value, the value of the properties they own.
Experts believe the money will keep rolling into the REITs as long as the Bank of Japan maintains what is effectively a zero-interest-rate policy. Higher rates would hurt the funds, because they use borrowed money to boost their returns, and a rate increase would raise their funding costs, lowering their yields.
Some say Japan's REIT prices simply aren't sustainable, low interest rates or not. Among them is UBS Securities analyst Toshihiko Okino, who has a "neutral" rating on three of the four funds he rates -- Nippon Building Fund, Japan Real Estate and Orix JREIT -- and a "reduce" rating on Japan Retail Fund, which is trading at 863,000 yen ($8,157), compared with his target price of 750,000 yen.
Undeterred, several firms have disclosed plans to rollout new funds during the next fiscal year. Sumitomo Realty & Development Co. plans a fund with some 100 billion yen in assets to invest in office buildings. Two general trading houses, Mitsubishi Corp. and Mitsui & Co., are each preparing funds targeting distribution facilities. Fukuoka Jisho Co., a developer based on the southern island of Kyushu, plans a fund focusing on regional properties, the first of its kind in Japan.
With the influx, Japan's REIT market could nearly double in the next two to three years, to about four trillion yen in total value of properties owned, from 2.2 trillion yen currently, according to STB Research, a subsidiary of Sumitomo Trust Bank. The trust bank itself plans a new fund next year, with two partners.
Email your comments to rjeditor@dowjones.com.