Download The Outlook for Real Estate Markets in Japan

RREEF Research
September 2007
The Outlook for Real Estate Markets in Japan
Table of Contents
1.
1. Introduction………………….1
2. Economic Fundamentals…..2
3. The Case for Real Estate in
Japan…………………………6
4. Investment Strategy……….14
5. Market Sector Outlook:
Office………………………..18
6. Market Sector Outlook:
Retail………………………..24
7. Market Sector Outlook:
Industrial/Logistics………...27
8. Market Sector Outlook:
Hotel………………………...30
9. Conclusions………………..33
Authors:
Tan Yen Keng
+852 2203 8062
[email protected]
Koichiro Obu
Introduction
Over recent years there has been a surge of interest from both domestic and
foreign investors in Japanese real estate markets. Investment transactions in
Tokyo’s commercial real estate market have increased over 13-fold in four years
to circa US$30 billion in 20061. As allocations to real estate have risen, investors
have responded favourably to the broad-based recovery of the Japanese market.
The maturation of real estate markets in Japan has increased the options
available for investors.
Within this context, this paper explores the opportunities associated with the
recovery of real estate markets in Japan and the attractiveness of these markets
to institutional investors. Because the drivers of real estate performance move in
tandem with the Japanese economy, this paper begins first by exploring the
sustainability of economic growth and the recovery of real estate and land prices.
Second, the paper examines the opportunities presented by cyclical and
structural drivers for investing in Japanese real estate. Third, the paper explores
the relative attractiveness of various investment strategies. Finally, the paper
outlines the opportunities and outlook for each of the four investible real estate
sectors in Japan.
The attractiveness of the Japanese real estate market is underscored by a large
investible stock coupled with increasing demand from both domestic and foreign
investors. Both of these trends are well-entrenched and are set to continue over
the longer term. Clearly, Japan remains a highly attractive market, not just in
terms of its performance but also for its liquidity and relatively low economic,
political, and financial market risks. The options for investors appear ample for
both the shorter and longer terms. With that in mind, this paper attempts to
provide useful insights for investors seeking to participate in the Japanese real
estate market.
+81 3 5156 6000
[email protected]
Peter Hobbs
+44 (0)20 7547 4855
[email protected]
Henry Chin
+44 (0)20 7545 6611
[email protected]
IMPORTANT: PLEASE SEE
IMPORTANT DISCLOSURES AND
ANALYST CERTIFICATION
IMMEDIATELY AT THE END OF THE
TEXT OF THIS REPORT
1
RREEF (2007) Global Real Estate Investment and Performance 2006 and 2007, March. JLL.
RREEF Research
1
2. Economic Fundamentals
Japan is well into a broadbased economic recovery
that includes real GDP
growth…
Japan, the second largest industrialized economy in the world, has largely recovered
from a slump that lasted for more than a decade. After the short-lived recovery in the
early 2000s, Japan’s economy has resumed expansion at an average growth rate of
2% per annum since 2004. Going forward, real GDP growth is expected to average
2% p.a. for the next three years2, led by a steady expansion in consumption, exports,
capital investment, and improvements in labour productivity.
Chart 1: Japan’s Real GDP and Growth Rates 1995-2010F
Total Real GDP (LHS)
Tr n Yen
GDP Growth (RHS)
700
7%
F o r e c a st
600
6%
500
5%
400
4%
300
3%
200
2%
100
1%
0%
0
95
96
97
98
99
00
01
02
03
04
05
06
07F
08F
09F
10F
- 100
- 1%
- 200
- 2%
- 300
- 3%
Source: DB Global Markets Research
…consumer spending,
exports…
Domestic private and composite consumption has been on the rise since 2003, at a
CAGR of 2.4%, indicating the recovery and expansion of the domestic market.
Exports have also climbed, with an increasing amount going to Asia, where economic
growth exceeds that of the US. In 2006, China, South Korea, Taiwan, and Hong Kong
together accounted for 34.5% of Japan’s total exports, compared to 22.5% to the US3.
2
3
RREEF Research
Deutsche Bank Global Markets Research’s forecast
Economist Intelligence Unit
2
Chart 2: Japan’s Private Consumption and Composite Consumption Indices and
Customs-Cleared Export Volumes by Destination
(2000=100)
Private Consumption Index
105
Composite Consumption Index
(2000=100)
(sa, 3M m o v. avg.)
104
160
103
150
All Destinations
U.S.
Asia
140
102
130
101
120
100
110
99
100
98
90
97
80
96
70
95
Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07
60
Jan
95
Jan
96
Jan
97
Jan
98
Jan
99
Jan
00
Jan
01
Jan
02
Jan
03
Jan
04
Jan
05
Jan
06
Jan
07
Note: Private and Composite Consumption Indices are seasonally adjusted
Source: Nikkei NEEDS, Japan Cabinet Office, Japan Ministry of Finance, DB Global Markets
Research
…capital investment…
Capital investment has expanded to meet the rising demand. The ratio of capital
investment to gross capital increased from 5.9% to 7.1% between 2002 and 2007.
Labour productivity rose by an average of 1.8% between 2000 and 2007. This
spurred new economic growth which in turn stimulated job creation. The rate of
unemployment fell from the peak of 5.4% in 2002 down to 4.1% in 2006, and is
forecast to decrease further going forward.
Chart 3: Japan Labour Productivity and Unemployment Rate
(%)
10
GDP Growth (LHS)
Labor Productivity Growth (RHS)
(%)
2
(%)
6
5
1.5
5
4
1
3
2
0
0.5
1
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
95 96 97 98 99 00 01 02 03 04 05 06 07
0
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07F
08F
09F
10F
0
-5
Source: Japan Cabinet Office, Japan Ministry of Internal Affairs and Communication, Japan Ministry
of Health, Labour, and Welfare, DB Global Markets Research
Although the short and medium term economic outlook remains strong, there remain a
series of risks and structural challenges facing the Japanese economy. At a global
level, the recent financial turmoil caused by the US sub-prime loan crisis poses the
most immediate risk, with Japan’s exports being susceptible to a potential slowdown
in US economic growth and consumption, as well as the rising Yen due to the
RREEF Research
3
unwinding of carry-trade positions4. Domestically, Japan faces structural challenges
associated with a declining population that will pose difficulties for sustaining stronger
growth over the longer term. Despite these risks and weaknesses, the economic
outlook remains positive, at least for the remainder of the decade.
…and, finally, real estate.
The economic recovery has also begun to impact property markets. Property and
land prices in Japan fell into a severe and prolonged downturn following the collapse
of the bubble economy in the early 1990s. The subsequent period was characterized
by distressed debt restructuring in the nation’s banking sector accompanied by
prolonged price deflation5. The stable recovery of the economy since the early 2000s
has helped turn around the real estate market. Real estate returns trended positive in
2002 and have increased 40.5% since then. Land prices also have shown signs of
upturn since 2004, most notably in the major cities.
Chart 4: Japan GDP Growth, Land Price Index, and Property Total Return
Japan Re al Es tate M ark e t Ove rvie w
All-Property Total Returns (RHS)
(1994 = 100)
Land Price Index (LHS)
GDP Growth (RHS)
120
10.0%
8.0%
100
6.0%
4.0%
80
2.0%
60
0.0%
-2.0%
40
-4.0%
-6.0%
20
-8.0%
0
-10.0%
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Source: Nikkei NEEDS, DB Global Markets Research, IPD, RREEF Research
The commercial land price index for Tokyo and the other five major cities bottomed
out in 2004 after 14 years of decline. The commercial land price index for these six
major cities has since risen over 30%. Boosted by positive overall economic growth,
the recovery of real estate markets in the six major cities is now spilling over to more
peripheral markets. The result is a nationwide commercial land price index that at last
shows signs of bottoming.
4
Deutsche Bank (2007), Risk of sub-prime contagion to the Japanese economy, August
Deutsche Bank Global Markets Research (2007), Japan Economics Weekly – Macroeconomic
Conditions for Rise in Japanese Property Price, April
5
RREEF Research
4
Chart 5: Japan Commercial Land Price Indices
(2000.3.31=100)
600
Nationwide: Commercial
Six Large Cities: Commercial
Tokyo 23 Wards: Commercial
500
400
300
200
100
0
Source: Nikkei NEEDS, DB Global Markets Research
RREEF Research
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3.
After a prolonged decline, the
Japanese real estate market
has now moved well into a
new growth phase.
The Case for Real Estate in Japan
Japan’s investible commercial real estate stock is estimated to be around US$1.8
trillion6, making it the largest in Asia and the second largest in the world. The sheer
size of the Japanese real estate market accentuates the significance of Japan in the
regional and global portfolio. The major participants in the market include listed real
estate companies, J-REITs, private funds, foreign investors, and financial institutions.
Large listed real estate companies, which are called ‘developers’, have strong
positions in the Japanese market, and the market capitalisation of some of the
companies’ amount to US$20 billion to US$40 billion.
The lacklustre performance of the Japanese real estate market during the decadelong economic recession deterred investors, and new construction starts have
declined since the early 1990s7. When the Japanese economy resumed steady
recovery in 2003, the low levels of new good quality real estate supply during the prior
period resulted in a structural shortage of quality modern space in contrast to newly
rising demand. As vacancies declined and rents started to rise, the Japanese real
estate market began moving out of contraction into the growth phase of its cycle.
Compared with other real estate markets in the UK, US, and several dynamic markets
in Asia, Japan is currently well into the sweet spot of this cycle (Chart 6). In addition
to the structural shortage of quality modern space, several other structural changes
are currently underway that provide significant opportunities. The J-REIT market has
been successfully expanding and currently 41 REITs are listed. This helps to increase
the market transparency significantly. As the Japanese market has matured, the
opportunities available to investors have increased to include the less risky core-type
and value-added investment strategies.
Chart 6: Position of Office Market Fundamentals through the Cycle
USA
Czech Rp
Hong Kong
UK
China
Singapore
Hungary/
Romania
Japan
Portugal
Thailand
S.Korea
Taiwan/
Malaysia
Source: RREEF Research
6
7
RREEF Research
RREEF Research (2007) The Future Size of the Global Real Estate Market, July
Japan Ministry of Land, Infrastructure, and Transportation
6
Japan accounts for half of the
Asia Pacific region’s
commercial real estate stock
With over US$1.8 trillion of investible commercial real estate stock, Japan accounts
for 11% of the global commercial real estate stock and dominates half of the Asia
Pacific market. Despite the enormous stock, the level of owner occupation remains
high relative to other mature real estate markets such as Hong Kong, and Singapore
in the region (Chart 7), and the US and UK globally.
and 11% of the worldwide
market.
Chart 7: “Invested” and “Investible” Real Estate Stocks
(US$ Bn)
2000
Invested (LHS)
Difference btw Investible and Invested Stock
Owner-Occupation Ratio(RHS)
1800
1600
100%
90%
511
80%
1400
70%
1200
60%
1000
50%
800
40%
600
30%
535
400
20%
77
200
134
100
0
Japan
China
Australia
S.Korea
India
11
11
Hong Kong
Singapore
10%
0%
Source: RREEF Research
Note: As of year-end 2006
A number of factors converge to underpin Japan’s market opportunities. These
include:
•
increased maturity of lease legislation8;
•
pressure to improve capital and operational efficiencies;
•
a high owner-occupation ratio; and
•
over US$500 billion investible commercial real estate that is currently
available in the market.
With these structural changes in progress, prospects exist for significant sale and
leaseback activity. There are opportunities for institutionalising and securitising real
estate within Japan’s large investment market. This process should gain momentum
as assets are transferred from owner occupation to the more professionally managed
institutional market (Chart 8).
8
Japan’s lease law was revised in March 2002 to allow for fixed-term lease contracts. Because a
landlord is not required to renew a fixed-term lease contract at expiry, this equalizes the legal standing
of landlords and tenants. In the conventional lease contract, landlords are required to renew tenancy
contracts in the absence of ‘reasonable’ reasons for not doing so.
RREEF Research
7
Chart 8: “Investible” Market, Owner Occupation Ratios, and Recent Transaction
Activity
Owner-Occupation Ratio (%)
100
China
India
Substantial potential for sale
and leaseback deals as market
matures
South Korea
80
Emergent Group
Japan
60
Australia
40
Hong Kong
20
Small size of the
investment market, but
large investment
transaction volume
Mature Group
Singapore
0
0
500
1000
1500
2000
2500
Investible market size ($bn)
Notes: Size of bubble represents total transaction activities in 2006.
Source: RREEF Research, JLL
The recent strong performance of real estate has led to increased interest in the asset
class from a wide range of investors9. Across the world, both institutional and retail
investors have sought to increase the real estate allocation of their investment
portfolios.10 This evolving shift toward real estate has been driven by structural factors
such as:
Foreign investors are
showing renewed interest in
Japanese real estate.
•
aging populations;
•
higher dependency ratios;
•
greater exposure to “alternatives”; and
•
ongoing maturity of the real estate asset class (i.e., broader options for
investors seeking to invest in real estate)11.
Investor intention surveys by INREV12 and IREI/Kingsley Associates13 demonstrate
that demand for foreign real estate by European and US investors continues, and
Japan tends to come at the top of the buying list. These surveys partly explain the
ongoing strong capital flow into the Asia Pacific region, where investment activity has
increased each year since the 2003, reaching US$63 billion in 2006. The scale of the
market means that Japan represents close to 50% of all investment activity in the
region14 (Chart 9).
Since the burst of the bubble economy, Japanese pension funds have been very
cautious and resistant to real estate exposure. The current average allocation ratio of
real estate to total assets by pension funds is only 1.6% in Japan, compared to 5.0%
in the UK, 7.0% in Australia and 8.3% in the US. However, the ratio is expected to
increase steadily over the coming years in accordance with the rapidly growing
transparency of the Japanese market.
9
RREEF Research (2007), Global Real Estate Investment and Performance 2006 and 2007, March
RREEF Research (2007), Global Real Estate Securities, January
11
McKinsey (2006), The Asset Management Industry in 2010
12
INREV (2007), Investment Intention Survey
13
IREI/Kingsley Associates (2007), 2007 Plan Sponsor Survey, January
14
JLL Jones Lang LaSalle, REIS Services
10
RREEF Research
8
Chart 9: Real Estate Investment Activity, by Destination of Investment
(US$ Bn)
70
Australia
China
Hong Kong
Japan
Singapore
S Korea
India
Others
60
Singapore
50
Singapore
40
Singapore
30
20
Japan
Japan
Hong Kong
10
Japan
Japan
Hong Kong
Hong Kong
China
Australia
Australia
Australia
Australia
2003
2004
2005
2006
China
0
Source: RREEF Research, JLL
The steady, ongoing maturity
of the Japanese real estate
market spurs confidence
among investors.
The weight of capital to real estate continues to grow with an increasing number of
domestic, regional, and international investors seeking to access the market. The
robust level of investment activity in Japan is highlighted by two key indicators. First,
the growing scale and sophistication of the listed real estate market (and J-REITs in
particular) has blossomed. And second, the unlisted markets have grown as well. In
2006, the J-REIT market cap rose by 40%, and the unlisted market cap soared 60%.15
The announcement in August of the Pension Fund Association in Tokyo to allocate
5% or ¥650 billion (US$5.6 billion)16 to Japanese real estate investments further
strengthens the confidence in Japan’s recovering real estate market17.
Although domestic transactions dominate with about 80% of all investment, crossborder investment in Tokyo’s commercial real estate market increased 23-fold in four
years to around US$6.3 billion in 2006. The significant increase in investment activity
occurred not only in Tokyo, but also in many regional cities such as Yokohama,
Osaka, and Nagoya, where domestic (J-REITs and domestic funds) and foreign
(Australian LPTs, some US REITs, and international funds) institutions are also
investing. This strong weight of capital coupled with the expansion of J-REIT, CMBS
and non-recourse bank finance have helped the Japanese real estate market to
mature by increasing the scale and liquidity of the market.
15
STB Research Institute (2007), 2006 Market Survey Results, January
US$ 1 = ¥116, as at 31 August 2007. This exchange rate is used throughout the report.
17
Nikkei Business Daily, 15 August 2007
16
RREEF Research
9
Chart 10: Investment Activities in Tokyo (Office and Retail)
(US$ Mn)
35,000
Domestic
Foreign
30,000
25,000
20,000
15,000
10,000
5,000
0
2002
2003
2004
2005
2006
Source: RREEF Research, JLL
The office sector remains a
favourite choice of investors
in Japanese real estate.
According to the actual investment transactions compiled by JLL and DTZ, office
remains the favourite sector in Japan, and it accounts for over 50% of investment
activities. The office sector has traditionally been followed by retail and residential as
an investment preference (Chart 11). By 2006, however, the share of industrial
investments had grown to represent 20% of total activity. This increase is due to the
structural changes underway in this sector (which will be discussed in detail in the
subsequent Industrial/Logistics section).
Chart 11: Real Estate Investment Activity in Japan, by Sector
Office
Retail
Industrial
Residential
100%
90%
80%
Industrial
70%
60%
50%
40%
30%
Office
Office
Office
2003
2004
Office
20%
10%
0%
2005
2006
Source: RREEF Research, JLL, DTZ
RREEF Research
10
Strong appetite for real estate has also led to significant cap rate compression in
recent years (Chart 12). Falling cap rates and rising bond yields have squeezed the
spreads. In Japan, these tight spreads are supported by the recovery in rental levels
and the strong weight of capital from an increasingly broad-based set of investors.
Cap rate compression has
characterised many global
financial centres in recent
years, but spreads in Tokyo
still remain attractive.
Cap rates for Grade A office in Tokyo have compressed 150 bps to 3% since 2003.
Although the current cap rate is low on a nominal basis, the positive spreads of 110
bps are attractive compared to other major global markets (Chart 12). The upward
pressure of rising interest rates on the cap rate is more muted in Japan than in other
markets. In the US and the UK, by contrast, the narrowness of spreads means there
is an increasing risk of an upward movement in cap rates.
Chart 12: Cap Rates and Bond Rates for Key Global Markets (%)
%
Bond Rates
8
Cap Rates
7
6
5
4
3
2
1
0
2003 2004 2005 2007*
London City
2003 2004 2005 2007*
Paris
2003 2004 2005 2007*
Frankfurt
2003 2004 2005 2007*
New York
2003 2004 2005 2007*
Tokyo
Note: Year end data points except 2007 where Q2 cap rates and June 29th bond yields
Source: RREEF Research; CBRE; JLL; NREI; Deutsche Bank Global Markets
Japanese real estate
provides diversification
benefits for foreign investors.
One of the main reasons behind the rise in cross-border investment relates to the
potential diversification benefits from investing in overseas markets. Although there
are diversification benefits from investing across property sectors, the advantages are
greater still when exploiting the differences in market behaviour across the global
markets18. Differences persist across a range of economic, financial, and particularly,
real estate factors such as planning regimes and leasing practices. This means that
real estate markets remain very local and display significantly different patterns of
performance, and this results in low cross-correlations in real estate total returns
(Chart 13).
Cross-border investment strategies, therefore, can reduce risk
significantly. The lower the correlation, the greater the benefits of cross-border
diversification. Japan’s particularly beneficial regional pairings are shown in bold (low
correlation) with Western Europe and North America. Even within the Asia Pacific
region, the inclusion of Japan in the pan-Asian portfolio will yield some diversification
benefit.
18
Webb, J., Curcio, R., and Rubens, J. (1988), Diversification Gains from Including Real Estate in
Mixed-Asset Portfolios, Decision Sciences; Stevenson, S. (1999), Real Estate's Role in an
International Multi-Asset Portfolio: Empirical Evidence Using Irish Data, Journal of Property Research;
Conover, M., Friday, S. and Sirmans, G. (2002), Diversification Benefits from Foreign Real Estate
Investments, Journal of Real Estate Portfolio Management; Hoesli, M., Lekander, J. and Witkeiwicz,
W. (2004), International Evidence on Real Estate as a Portfolio Diversifier, Journal of Real Estate
Research
RREEF Research
11
Chart 13: Correlation Matrix for Direct Real Estate Total Returns of Japan, Western
Europe, North America and Asia-ex-Japan (1997-2006)
North
America
Western
Europe
Asia ex
Japan
North America
1
Western Europe
0.68
1
Asia ex Japan
0.35
0.41
1
Japan
0.43
0.44
0.80
Japan
1
Source: Datastream, RREEF Research 2007
The significance of these diversification benefits is demonstrated by optimisation
analysis. The inclusion of Japan in a global real estate portfolio improves the riskreturn profile of the global portfolio. The new efficient frontier is shifted upward
generating around 40 bps of additional return for the same level of risk as a
predominantly ex-Japan portfolio.
Chart 14: Efficient Frontiers for Global Real Estate Portfolio with and without
Japan
9.0%
Global Portfolio including Japan
Portfolio Diversification
Benefit
Portfolio Return
8.5%
8.0%
Global Portfolio ex-Japan
7.5%
7.0%
6.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
Portfolio Risk
Note: The portfolios are based on the historical risk and covariance for the 1997-2006 period and
the average expected return for 2007-2011. The average expected return is based on RREEF
Research forecast
Source REEF Research
RREEF Research
12
The still-emerging maturity of many Asia Pacific markets means that alongside their
strong growth prospects are significant risks associated with investment (Chart 15).
Japan is one of the few exceptions in the region, given its relatively low risk compared
with other major Asian markets. Japanese real estate markets have matured
markedly in recent years, reducing the risks associated with investing. The revision of
the Japanese lease law in 2002 has been followed by the introduction of the Financial
Instrument Exchange Law (effective September 2007) to regulate the real estate fund
business under Japan’s Financial Supervisory Agency. Both of these legal changes
have contributed to the maturity of the market, and this maturation has, in turn,
increased the options available for investors (as well as their confidence in the asset
class).
Chart 15: Risk Analysis, By City
5
Transparency
Liquidity
Economic Risk
Tenancy/Income Risk
Political Risk
Country Risk
Asia
Average
Risk Score
1= The Lowest Risk
4
3
Global
Average
2
1
Shanghai
Bangkok
Dehli
Taipei
Seoul
Kuala
Lumpur
Auckland
Tokyo
Hong Kong
Singapore
Melbourne
Sydney
0
Source: RREEF Research
Despite rising maturity, risks
associated with transparency
and liquidity remain an issue.
Despite these improvements, the risks associated with relatively low liquidity and poor
transparency remains significant from the international perspective. For instance,
although these markets have improved in transparency in terms of data reliability and
availability, the limited availability of robust performance measures19 and lack of
widespread reporting of transactions increases market risks.
19
RREEF Research
IPD Japan real estate performance data is only available from 2003.
13
4.
The risk-return spectrum
offers a number of
investment strategies.
Investment Strategy
Real estate investment strategies may vary significantly according to the objectives of
investors, where selection and allocation decisions have to be made within a broader
portfolio context. The range of real estate investment strategies are summarized in
Chart 16 in the conventional risk-return spectrum. On the one hand, core/core+
strategies are generally lower risk with an emphasis on delivering a long-term stable
income stream. Such strategies tend to track broader market risk and mirror the
construct of the market in terms of geography and sector. In contrast, opportunistic
strategies tend to have the highest proportion of return coming from non-rental income
sources and, due to their high leverage and focus on more volatile and emergent
markets/sectors, are much riskier than core-type strategies.
Falling in between these two extremes are REITs and value-added strategies. Both
REITs and value-added strategies aim to enhance total returns through active asset
management. Value-added strategies seek to enhance returns by identifying and
anticipating cyclical change; exploiting structural change; and through the possession
of a deep understanding of real estate assets in the context of such change, adding
real value through asset management strategies that anticipate rather than respond to
market change20. In contrast, REITs are bound by regulations on exposure to nonincome-producing investments, debt-to-equity ratios, and payout ratios. This places
REITs on a lower risk spectrum than a value-added strategy. It should be noted,
however, that due to the listed nature of REITs, they can be exposed to far higher
volatility, especially over the short term21.
Chart 16: Schematic Representation of Real Estate Investment Styles
Potential return
Opportunistic
„ High risk
„ High return requirement
Value Added
„ Moderate risk
„ Enhanced return requirement
J-REIT
„ Medium risk
„ Moderate return requirement
Core/Core+
„ Low risk
„ Low return requirement
Note: for illustrative purposes only
Source: RREEF Research
20
RREEF Research (2007), European Value Added Investing: Leveraging structural and cyclical real
estate opportunities, March
21
Liang, Y. and McIntosh, W. (1998), REIT Style and Performance, Journal of Real Estate Portfolio
Management; Seiler, M., Webb, J. and Myer, F. (1999), Are EREITs Real Estate? Journal of Real
Estate Portfolio Management; Ling, D. and Naranjo, A. (1999), The Integration of Commercial Real
Estate Markets and Stock Markets, Real Estate Economics; Newell, G. (2001), Listed Property Trusts:
A Matter of Style, Property Australia; Chau, K. W., Wong, S. K. and Newell, G. (2003), Performance
of Property Companies in Hong Kong: A Style Analysis Approach, Journal of Real Estate Portfolio
Management
RREEF Research
14
Japan’s interest rate
differential allows foreign
investors to boost returns by
200 bps through hedging
In general, the return (IRR) expectation for a core strategy is high single digits with a
relatively high income component. This compares with value-added (low teen returns
and 30-70% gearing) or opportunistic (18%+ return, most of which is value growth,
and 60-100% gearing)22. In a relatively low-interest environment (Chart 17), the
expected return in Japan is generally lower. Expected returns in Japan range from 45% (core strategy) to 10-12% (value-added) to 15%+ (opportunistic). However, the
interest rate differential between Japan and other countries allows foreign investors to
boost returns over 200 bps through hedging23.
Chart 17: 10-Year Bond Yields in Major Global Economies
Le nding Rate s in M ajor Global Economie s
%
Japan
12
Euroland
UK
Australia
US
Germany
10
8
6
4
2
2007 2Q
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
0
Source: DB Global Markets Research, Datastream
Given the range of real estate investment strategies, a systematic framework is
necessary to help identify different types of opportunities and strategies in the
Japanese real estate markets. Appropriate strategies can be determined along the
two dimensions of performance drivers and real estate risks (Chart 18).
22
INREV (2007), Investment Intentions Survey
Based on the assumption that the exchange rate between the Japanese yen and foreign currencies
remains stable
23
RREEF Research
15
Chart 18: Real Estate Performance Drivers and Risks Determining Market
Attractiveness
Performance
Drivers
Market
Attractiveness
Emerging
Geographies
Structural
Drivers
Cyclical
Drivers
Opportunistic
Emerging
Products
Demand,
Supply, Rents
Cap Rates &
Performance
Sale and
Leaseback
Value
Added
Market
Fundamentals
Core
Performance
& Pricing
Real Estate
Risks
Country &
Economic
Liquidity,
Transparency
Market
Volatility
Institutional
Risks
Note: for illustrative purposes only
Source: RREEF Research
Structural and cyclical factors
drive performance…
Performance is driven by two distinct factors, structural and cyclical. Structural drivers
are normally associated with the emergence of real estate markets, such as new real
estate products, new geographic markets, or sale and leaseback opportunities. As
presented in the earlier sections, Japanese real estate markets have matured with
accumulated stocks of older and lower quality products. Through refurbishment,
redevelopment, repositioning, and effective asset management, the return
performance of the older sub-standard products can be enhanced. According to
CBRE’s estimate, only 17% of the office stock in Tokyo is Grade A space. The
remaining 83% is of lower quality. This provides a window for asset-enhancement
opportunities. With high owner-occupancy ratios and over US$500 billion in privately
owned commercial real estate, the structural drivers point toward opportunistic and
value-added investment strategies.
Real estate markets are highly cyclical. Cyclical factors are important in determining
the changing attractiveness of markets at various points within their market cycles. As
pointed out in the earlier section, the Japanese commercial real estate market is in its
growth cycle. Demand for quality space from both local and foreign companies is
supported by the steady economic recovery. Vacancy rates are declining and rents
are rising in Tokyo (recovering in regional markets). Cap rates for Grade A office
buildings in Tokyo have compressed significantly since 2000 to the current level of
3%. Despite cap rate compression, the spread between 10-year government bond
yields and cap rates remains positive24 making Japan one of the few major markets in
the world where real estate yields are clearly above the cost of borrowing. The
positive spread not only cushions marginal interest rate hikes, but also enables higher
leverage to enhance total return.
…but investors must also
consider the associated risks.
Beyond the structural and cyclical drivers of performance, investors need to consider
the risks associated with investing in different markets and product types. As
discussed in the previous section, these risks involve the volatility of market
performance and institutional risks. Institutional risks involve the economic maturity of
24
RREEF Research
About 110 bps as at the end of July 2007
16
a country, as well as more real estate-specific factors such as transparency, liquidity,
and income security25.
Japan offers opportunities for
enhancing a global real
estate investment strategy.
Coupled with structural and cyclical factors, the recovery of the Japanese economy
offers a range of real estate return enhancement opportunities that can be exploited.
The major challenge to this investment strategy is to capitalise on these opportunities
to deliver true value-added returns.
The following sections provide an overview of the office, retail, industrial/logistics, and
hotel sectors in Japan. For each market sector, the performance drivers, the
opportunities, and the market outlooks are discussed in detail.
25
RREEF Research (2007), The Case for Europe: Issues and Options for UK Investors Considering
the European Property Market, April
RREEF Research
17
5.
Tokyo’s robust office demand
has not yet diffused to
Japan’s more peripheral
markets.
New office construction in
Tokyo is largely committed
and office shortages are
anticipated.
Market Sector Outlook: Office
After a prolonged economic slump since the early 1990s, the Japanese labour market
began to show signs of turnaround in 2003 with an expansion of part-time jobs, and a
strong recovery in full-time employment in 2006. Office demand has finally regained
momentum – first in Tokyo and now in other major cities. Further economic growth is
still underway, pushing the unemployment rate down to 4.1% at the end of 2006 from
a peak of 5.4% in 2002. According to the Miki Office Report (July 2007) , the vacancy
rate in Central Tokyo fell to 2.9% for all offices and 0.9% for grade A offices in 2Q
2007. The outlook for office demand is supported by an uptick in private-sector hiring.
Employment for new graduates hit a 10-year high in 2006 with no sign of slowing in
the near future. Although this robust recovery is clearly apparent in Tokyo and other
major cities, it has yet to be become visible in smaller regional cities due to the lagging
effect of improving demand.
After the collapse of land prices in the early 1990s there was a stagnation of
development activity with a sharp fall-off in the level of new construction that persisted
for more than a decade. Although Tokyo experienced a surge of new supply in 2003
(the “2003 problem”), net completions were only half of the peak in the early 1990s.
Tokyo is also currently in the midst of a major development boom, with a large number
of Grade A office projects completing in 2007. Despite this, most of the new space
has already been fully occupied (or committed), and the current pent-up market
demand has yet to be thoroughly satisfied. This is evident by the improving
employment figures and the low replacement rate26 (circa 2%) in recent years
compared to 6-8% during the early 1990s. Furthermore, there will only be limited
uncommitted new supply in 2008 and 2009 in the pipeline, so the office shortage is
not expected to be resolved in the foreseeable future.
Chart 19: New Office Supply and Replacement Rate in Tokyo
(Million sqm)
8.0%
5.0
Grade A Office Completion (LHS)
4.5
Grade B and Other Offices Completion (LHS)
Replacement Rate (RHS)
4.0
6.0%
3.5
3.0
4.0%
2.5
2.0
1.5
2.0%
1.0
0.5
10E
09E
08E
06
07E
05
04
03
02
01
00
99
98
97
96
95
94
93
92
91
0.0%
90
-
Source: ‘Tokyo no Tochi’ by Tokyo Metropolitan Government, JLL, RREEF Research
Because of strong demand and lack of office space, rents have been recovering
strongly in Tokyo. According to Miki, average rents increased by 8.8% in 2006 and
continued to accelerate in 1H 2007 (see Chart 20). The most significant increase
observed was for large new buildings, where rents surged over 20% in the first six
26
RREEF Research
Defined as the percentage of new completion to total stock
18
months to June 2007. Given the structural shortage of quality stock and limited new
supply, we expect further rental growth for large floor-plate buildings, which include
Grade A and higher quality Grade B offices, of 6%-9% p.a. in the next five years
(Chart 20).
The rental differential
between Grade A and nonGrade A space in Tokyo has
widened.
Small and mid-size floor-plate office rents were relatively stable in the past two years
while large office rents rallied. The rental differential between large and mid-size
space has widened substantially and is becoming more attractive to cost-conscious
tenants. With large floor-plate (Grade A) office rents expected to continue rising, the
better quality mid-size floor-plate offices (especially better quality Grade B office
between 50-100 tsubo) will benefit the most from the spill over demand and low-rent
advantage. Similarly, upside potential exists for other major cities, including Osaka
and Nagoya, where yields have not compressed as much as in Tokyo. These cities
could become targets for yield-accretive investment. Currently yields in Osaka and
Nagoya are 110 to 120 bps higher than that in Tokyo as shown in Chart 21.
Chart 20: Rent Trends by Building’s Floor Plate Size in Central Tokyo
(Yen/tsubo/month)
(1 tsubo = 3.3 sqm)
Large, Newly-built
Large (over 100 tsubo)
Mid-Size (over 50 tsubo)
Small (under 50 tsubo)
30,000
20,000
10,000
98
99
00
01
02
03
04
05
06
07
08F
09F
10F
Source: Miki Office Report (historical), RREEF Research (forecast)
Chart 21: Cap Rates of Offices in Major Cities
Sapporo
Fukuoka
Nagoya
Osaka
Tokyo
9%
8%
7%
6%
5%
4%
3%
2%
2H 02
1H 03
2H 03
1H 04
2H 04
1H 05
2H 05
1H 06
2H 06
1H 07
Source: Japan Real Estate Institute
RREEF Research
19
The recovery first observed in
Tokyo is now showing signs of
spreading to other major cities
like Osaka and Nagoya.
The office market recovery was first observed in Tokyo. Other major cities are
following suit, but with several years of delay behind the trend in Tokyo. In Osaka and
Nagoya, vacancy rates dropped to 6% in 2006 with office rents picking up slightly by
0.2% and 1.9%, respectively – the first increase in either city in 15 years (see Chart
22). We expect these upward trends to persist going forward due to the growing
demand and structural shortage of quality stock. Grade A rental growth in both cities
should average 3-5% p.a. over the medium term.
As this trend broadens
geographically, other regional office markets are expected to recover as well.
Chart 22: Office Rents and Vacancy Rates in Major Cities in Japan
0
10,000
5,000
-
Vac ancy Rate (% )
15,000
Yokohama
Vacancy
18,000
12
15,000
10
12,000
8
9,000
6
6,000
4
3,000
2
-
0
Vacancy Rate (%)
Average Rent
96
97
98
99
00
01
02
03
04
05
06
07
08 F
09 F
10 F
Avg. Rent (Yen/tsubo/month)
Osaka
20,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
-
A verage Rent
V acancy
14
12
10
8
6
4
2
Vacancy Rate (%)
2
9
8
7
6
5
4
3
2
1
0
25,000
96
97
98
99
00
01
02
03
04
05
06
07
08 F
09 F
10 F
4
V acancy
0
96
97
98
99
00
01
02
03
04
05
06
07
08 F
09 F
10 F
6
Avg. Rent (Yen/tsubo/month)
8
Average Rent
Avg. Rent (Yen/tsubo/month)
14,000
12,000
10,000
8,000
6,000
4,000
2,000
-
Tokyo
V acancy
10
Vacancy Rate (%)
A verage Rent
96
97
98
99
00
01
02
03
04
05
06
07
08 F
09 F
10 F
Avg. Rent
(Yen/tsubo/month)
Nagoya
Source: Miki Office Report (historical), RREEF Research (forecast)
After years of restrained
construction levels, Tokyo’s
stock of Grade A office space
is relatively limited.
RREEF Research
Despite its position as the world’s largest office stock, Tokyo is also characterized by a
scarcity of quality buildings. According to CBRE, aggregate floor space of Grade A
buildings in Central Tokyo accounts only for 17% of the total stock in the region,
compared to 50-80% in both Central London and Manhattan.
20
Chart 23: Share of Tokyo Office Stock by Quality
Grade A
17%
Grade B and C
83%
Source: CBRE 2007
Owners of existing Grade A
office properties tend to be
reluctant sellers.
Due to the structural shortage of quality office buildings, it is very difficult to acquire
Grade A buildings in prime locations in Tokyo. This limited stock of quality buildings is
held almost exclusively by major property developers who have no incentive to sell
their prime investment properties. Therefore, real estate investors tend to have to pay
a premium for acquiring from a very limited pool of prime property.
Recently, an increasing number of companies have tried to shift their real estate
assets “off-balance sheet,” not only to focus on their core business activities but also
to improve their capital structures. This movement has been streamlined by rapid
structural changes in the property sector, such as the growth of the real estate fund
market and the growing popularity of non-recourse finance in Japan. According to
STB Research Institute, the Japanese real estate fund market expanded to ¥12.8
trillion, or US$110 billion, in 1H 2007 (see Chart 24). This is a 28% increase from the
previous year or over four times the size of three years ago. The amount is even
larger, ¥16.3 trillion or US$141 billion, if identifiable foreign funds investing in Japan
are included.
RREEF Research
21
Chart 24: Size of Real Estate Fund Market
(Bn Yen)
J-REITs
Private Placement
Foreign Funds in Japan
6,000
4,000
2,000
0
1H03
2H03
1H04
2H04
1H05
2H05
1H06
2H06
1H07
Note: No data available for the size of foreign funds investing into Japan in 2H 2006 or before.
Source: STB Research Institute
Foreign investors have
responded to Japan’s
increasing transparency as
well as the successful
expansion of the J-REIT
market.
RREEF Research
Japan’s relatively wide yield spreads and the structural and cyclical opportunities
discussed in the previous sections have increasingly attracted foreign investors since
2004. This trend was further fuelled by the successful expansion of the J-REIT
market as well as by the growing transparency of the Japanese real estate market in
general. As a consequence, significant capital growth was observed in Japanese
properties in the last two years, with total returns jumping from 6.4% to 15.8% in 2006
(Chart 25) according to Ikoma. The relatively stable income return means the surge in
returns was driven by rental growth and cap rate compression.
22
Chart 25: Performance of Office Properties in Japan
(%)
20
Total Return
Income Return
Capital Growth
10
0
-10
-20
-30
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: MTB Ikoma
RREEF Research
23
6.
The Japanese retail market
has been relatively slow to
recover.
Market Sector Outlook: Retail
After Japanese consumer spending peaked in 1992, the retail market faced general
downward pressure for more than a decade, as shown on Chart 26. This led to a
string of bankruptcies among retailers, along with major restructurings and mergers
and acquisitions. However, the recent economic recovery, record profits in the private
sector, and generally strong business sentiments led the Bank of Japan to end its
zero-interest rate policy in July 2006. This was a symbolic gesture, indicating that the
threat of deflation may finally have lifted and that the economy has entered a growth
cycle.
Yet the long erosion of consumer confidence has been slow to reverse, with Japanese
consumers taking a long time to change their restrictive spending habits. Although
retail sales have been growing for four consecutive years, the volume is up only 2.2%
from the trough in 2002. This contrasts with GDP growth of 8.5% in the same period.
In the longer term, growth in the Japanese retail sector should gradually align with
broader economic growth. One perceived obstacle has been the income disparity
between the rich and the poor – a gap that has widened since the 1990s. This
polarisation has resulted in a ‘working poor’ class, which has become a widely
discussed political issue in Japan.
Chart 26: Retail Sales in Japan and Share of Shopping Centres
(Yen Mn)
DISPOSABLE INCOME
350,000,000
300,000,000
250,000,000
200,000,000
150,000,000
100,000,000
50,000,000
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
0
Source: Ministry of Economy, Trade, and Industry; Japan Council of Shopping Centres
Japan is inching toward
larger scale retailing, but the
market is still more
fragmented than Western
Europe and North America.
RREEF Research
The Japanese retail market has been very fragmented, with the market share of the
top three retailers (Ito-Yokado, Aeon, and Daiei) accounting for only 9% of the total
retail food sales in Japan, compared to 53% in France (Carrefour, Intermarche, and
E.Leclere) and 27% in the US (Kroger, Wal-Mart, and Albertsons) in 2003 (see Chart
27). The latest trend in the sector, however, is the growing popularity of large-scale
shopping centres, with the leading retailers increasing their market shares through
organic growth and M&A activities. The sales share of shopping centres against the
retail market in Japan has almost doubled in the last 15 years according to Japan
Council of Shopping Centres. Their market share rose from only 11.4% in 1991 to
20.6% in 2005 (see Chart 26) while sales of department stores and traditional
independent mom-and-pops steadily declined. In the last decade, 70-80% of new
24
shopping centres were developed in suburban areas, typically alongside major
roads. This trend coincided with the depopulation of city centres and the rapid
development of suburbs.
Competition has pushed
Japan’s department store
chains toward consolidation.
Department store sales fell 0.7% to ¥7.8 trillion, or US$67 billion, in 2006, making it
the ninth straight year of decline, according to the Japan Department Stores
Association. In order to stay competitive, consolidation is rapidly taking place among
major department stores. Seibu Department Store and Sogo joined forces in 2003 to
create Millennium Retailing, now part of Seven & I Holdings. Daimaru has agreed to
take over Matsuzakaya to create the largest department store in the country.
Furthermore, Mitsukoshi and Isetan are also in talks to create an even bigger chain.
Chart 27: Share of Top 3 Retailers in National Food Retail Markets
(Share %)
60
53
51
47
41
40
27
21
20
14
9
Japan
Italy
Korea
US
Germany
UK
Canada
France
0
Source: IGD, Global Retailing
Note: As of 2003
Chart 28: New Completion of Shopping Centres
Town Centre
Number of new SC
160
Fringe of Town
Suburb
New regulation enacted in June
2000
120
80
40
0
94
95
96
97
98
99
00
01
02
03
04
05
06
Source: Japan Council of Shopping Centres
Due partly to the polarisation of rich and poor, sales of luxury goods in Japan were not
battered – even during sluggish economic conditions. Leading European and
RREEF Research
25
domestic retailers opened flagship stores in Ginza and Omotesando (both in Tokyo)
and in Shinsai-bashi (Osaka) in order to increase brand prestige and market share.
Accordingly, investment in retail properties expanded, with the Japan Real Estate
Investor Survey (by Japan Real Estate Institute) reporting the expected cap rate for
high-street retail properties at just 4% in Central Tokyo in 3Q 2006, a level where it
has since stabilized (see Chart 29).
Chart 29: Expected Cap Rates of Retail Properties in Japan
(%)
11
10
9
Urban Speciality Stores
(%)
Tokyo Ginza
Tokyo Omotesando
Sapporo
Sendai
12
Yokohama
Osaka
Nagoya
Fukuoka
11
Suburban
Suburban Shopping
Shopping Centre
Centers
Within 1hr to Cent. Tokyo
Sendai
Nagoya
Fukuoka
Sapporo
Yokohama
Osaka
10
8
9
7
8
6
7
5
6
4
5
4
3
Apr-02 Oct- Apr-03 Oct- Apr-04 Oct- Apr-05 Oct- Apr-06 Oct- Apr-07
Oct-02 Apr-03 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07
02
03
04
05
06
Source: Japan Real Estate Institute
New national planning laws
adopted in 2006 discourage
shopping centre development
in greenfield suburban areas.
Amendments to Japan’s City Planning Law, adopted in May 2006, will regulate
development of large-scale commercial facilities such as shopping centres, outlet
malls, and cinema complexes in suburban areas. This is the second major regulatory
change in seven years. In June 2000, the Large-Scale Retail Store Location Law was
enacted with many local governments implementing additional requirements on
retailers that opened large-scale stores. When the new law adopted in 2006 comes
into effect by the fall 2007, opening new shopping centres will be limited within city
centres. This change has made existing store portfolios in the suburbs extremely
valuable, and shopping centres have become a popular asset class for developers,
private funds, and J-REITs to acquire. Owner occupation is being gradually replaced
by sale-and-leaseback, which also helps strengthen the balance sheets of debt-laden
retailers27. The introduction of the impairment valuation rule on fixed assets in March
2006 also accelerated leaseback transactions.
As a result, investment opportunities for foreign and domestic investors in the
Japanese retail sector are gradually increasing. However, it should also be noted that
a single key tenant (usually a large-scale supermarket) that has a master lease
contract with the owner of the shopping centre tends to control the sub-letting process
for the in-line tenants rather than the shopping centre owner. Lease contracts are still
very rare for department stores. Currently, there are several J-REITs dedicated to
investing in retail properties. The expected cap rates for assets in suburban Tokyo fell
from 9% in 2002 to 5.5% in April 2007 (see Chart 29). Relatively little difference is
observed between expected cap rates for shopping centres in the Tokyo area and
other major cities. Because of the relatively short history of the retail property
investment market in Japan, retail market coverage by consultants is limited, and
there are no established data or statistics for fundamentals such as rents or vacancy
rates. As Japan’s retail investment market matures, data availability and transparency
should follow.
27
A recent sale-and-leaseback case is the restructuring of Daiei Inc., one of the largest retailers in
Japan.
RREEF Research
26
7.
Japan’s industrial/logistics
sector has only recently
emerged as an investmentgrade property type.
Market Sector Outlook: Industrial/Logistics
Since the beginning of 2000, Japan’s industrial/logistics market has undergone a
series of structural changes. Previously, industrial/logistics property was not regarded
as an investment grade property type, so coverage by property consultants lagged.
Investment and lease markets were undeveloped because the majority of the logistics
facilities were owner-occupied. Most of the existing properties were old, small, and
not well-suited for modern logistics purposes.
The collapse of the Japanese property market in the 1990s was followed by increased
competitive pressure to improve distribution efficiency and flexibility. During this
transition process, domestic corporations started to adopt new, for-lease logistics
facilities. Because the revision of the lease law in 2002 equalised the legal standing
of landlord and tenant, it contributed to the development of the lease market in Japan.
More Japanese corporations are shifting to modern logistics facilities and sale and
leaseback is becoming a popular option. Developers – both domestic and foreign –
are actively delivering modern, build-to-suit distribution properties28. New construction
of large facilities has been concentrated in Japan’s largest metropolitan areas —
Tokyo, Osaka, and Nagoya.
The industrial land price index for the six major cities bottomed out in 2006 after
continuous decline since 1991. The industrial land price index for the six major cities
edged up 2.5% in 2007, whilst the nationwide industrial land price index is now
showing signs of bottoming.
Chart 30: Industrial Land Price Index
Nationwide Industrial
250
6 Large Cities Industrial
200
150
100
50
0
1985
1990
1995
2000
2003
2004
2005
2006
2007
Note: The interval of the index between 1985 and 2000 is 5-year
Source: Japan Real Estate Research Institute
Significant pent-up demand
exists for modern, efficient
logistics facilities.
New warehouse construction has picked up since 2004, though it is still relatively tepid
compared to the early and mid 1990s (see Chart 31). Since 2000, about 7.7 million
sqm of modern warehouse space has been added to Japan’s total stock annually.
Although this new supply is far below the 10-year annual average of 12.1 million sqm
in the 1990s, construction of quality warehouses with large floor plates and high
specifications is becoming extremely popular. According to a survey conducted by
Japan’s Ministry of Land, Infrastructure, and Transport, the average size of new
28
RREEF Research
CBRE Research (2007), Asian Industrial Property Market Flash, Q1
27
logistics properties increased as much as 72% between 2002 and 2006. This
increase is driven by construction of multi-tenant facilities, typically with over 100,000
sqm, which are often developed by firms with expertise in industrial warehouse
construction. Obsolescence of existing logistics properties has produced pent-up
demand for modern and efficient facilities, so there is currently ample demand for
more new space. According to ProLogis29, at the current pace of new warehouse
construction, it will take at least 20 years to replace the existing obsolete stock with
modern facilities.
Chart 31: Warehouse Construction Starts in Japan
(Ths sqm)
20,000
15,000
10,000
5,000
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: Japan Ministry of Land, Infrastructure, and Transportation
Asking rents are trending
upward again in Tokyo and
Nagoya.
In line with the broader market recovery, asking rents for warehouse space in the
major metropolitan areas has begun to recover. In Tokyo, warehouse rents bottomed
out in the first half of 2004 and rose 10% to ¥6,590 per tsubo per month, or US$207
per sqm per year, in 2006. A similar recovery trend has been observed in Nagoya
where asking rents rose 11% over the same period. However, the asking rent in
Osaka slipped slightly after levelling off in 2004.
29
ProLogis (2007), Global Property Market Review-Asian Distribution and Warehouse Markets,
Winter-Spring
RREEF Research
28
Chart 32: Average Asking Rents for Warehouses in Tokyo, Osaka and Nagoya
(Yen/tsubo/month)
Tokyo 23 Wards
Osaka Prefecture
Nagoya Region
9,000
7,000
5,000
3,000
1,000
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Source: CBRE
With the structural changes underway and with Japanese companies striving for
greater efficiency and flexibility, the industrial/logistics market will continue to evolve
and mature along with the recovering economy. The industrial market has ample
room to absorb steady construction of new, modern, and efficient logistics properties
as the older and more obsolete products are gradually replaced.
RREEF Research
29
8.
Investors have shown keen
interest in Japan’s hotel
market since 2001.
Market Sector Outlook: Hotel
Japan has been the focus of hotel investment activity in Asia since 2001 and
continues to attract high levels of investor interest from abroad (mainly US opportunity
funds) as well as from domestic sources (opportunity funds and J-REITs). Japan’s
recovering economy and its low-interest-rate environment continues to offer attractive
leveraged investment opportunities despite narrowing yield spreads. The growth of
hotel J-REITs has generally fallen behind office REITs so far. This is because of the
limited scope for rental increases due to long-term fixed price contracts and due to the
volatility and seasonality of the hotel business. However, the introduction of an
impairment valuation rule on fixed assets in March 2006 is expected to trigger more
non-core assets to be released into the market by Japanese companies and we can
expect a high level of investment activity going forward.
Chart 33: Number of Hotels and Rooms Sold in Japan 1999-2006
Number of Hotels Sold
No. of Rooms Sold (RHS)
16,000
70
14,000
60
12,000
50
10,000
40
8,000
30
6,000
20
4,000
10
2,000
0
Number of Rooms Sold
No. of Hotels Sold (LHS)
80
0
1999
2000
2001
2002
2003
2004
2005
2006
Source: JLL Hotels
Note: based on publicly available data
The Japanese government
has launched a targeted
campaign to attract
international tourists.
The travel and tourism industry in Japan, which is the underlying demand driver for
the hotel market, is improving due to government initiatives and the sustained
recovery of the domestic economy. To promote inbound tourism, the Japanese
government initiated a ‘Visit Japan’ campaign that targets 12 countries30 (including
many high-growth Asian markets). The campaign target is for ten million international
arrivals by 2010 (CAGR 9% p.a.).
30
South Korea, Taiwan, China, Hong Kong, US, UK, Germany, France, Singapore, Australia,
Thailand, and Canada
RREEF Research
30
Chart 34: Composition of Travellers Visiting Japan
Inte rnational
Trave lle r
100%
Bus ine s s
Trave lle r
90%
80%
70%
60%
50%
Dom e s tic
Trave lle r
40%
30%
20%
10%
2016F
2014F
2012F
2010F
2008F
2006
2004
2002
2000
1998
1996
1994
1992
1990
0%
Source: World Travel & Tourism Council 2007
Note: F: Forecast
Future demand growth is anticipated to comprise domestic, business, and
international travellers. Historically, the travel and tourism industry in Japan is
dominated by domestic and business travellers (over 95%).
Through the
government’s initiatives, the low value of the yen and the rising wealth of neighbouring
countries, inbound visitors in Japan have already been boosted.
According to the World Travel and Tourism Council (WTTC), spending by international
travellers is projected to grow at 7.2% p.a. over the next ten years, compared to 2.6%
p.a. for domestic and business travellers. However, the possibility of the continued
strengthening of the Yen could reduce the scope for Japan to attract international
visitors at the rate projected by the WTCC.
Two-thirds of the international
tourists visiting Japan come
from within the increasingly
affluent Asia Pacific region.
The fast-growing number of international travellers (66% of which come from Asia) is
expected to improve the trading performance of high-end (4 and 5-star) hotels
because 20% to 50% of the hotel clientele are international travellers. Cities that will
benefit from an increase in inbound international travel include Tokyo, Osaka, Kyoto,
Nagoya, Yokohama, Fukuoka, Nagasaki, Sapporo, Hiroshima, Okinawa, Narita,
Chiba, Kobe, Hakone, and Nara. These cities feature a concentration of tourist
attractions, efficient transportation, and accommodation facilities that are convenient
for foreigners31. Though Tokyo was historically under-represented by foreign hoteliers,
an influx of world-class luxury chains has been witnessed in the city since 2002. This
includes the Four Seasons Marunouchi (2002), Grand Hyatt Tokyo (2003), Conrad
Tokyo and Mandarin Oriental Tokyo (2005), and Ritz-Carlton and Peninsula Tokyo
(2007). The aggregate number of rooms of these hotels is about 1,600 – which
effectively doubled the room stock held by foreign luxury hotels in Tokyo. On top of
this, InterContinental Hotels Group agreed to join forces with ANA Hotels under an
operating joint venture agreement in 2006.
31
RREEF Research
Euromonitor International (2006), The Market for Travel and Tourism in Japan, October
31
Occupancy rates for high-end hotels in Tokyo were sluggish between 2000 and 2005
due to the surge of new supply during the period. Nonetheless, occupancy levels
have improved in recent years and they are expected to grow further to about 80% in
2007. This is due to an improving economy and anticipated growth of inbound
arrivals. With only two major new hotel developments expected to complete between
2008 and 2010, the delivery of new supply will be limited32.
Chart 35: ADR, RevPAR and Occupancy for High-End Hotels in Japan
Yen
ADR (LHS)
RevPAR (LHS)
Occupancy (RHS)
25000
82%
80%
20000
78%
15000
76%
10000
74%
5000
72%
0
70%
2000
2001
2002
2003
2004
2005
2006
Source: JLL Hotels, RREEF Research 2007
RevPAR has improved since 2004 on the heels of three consecutive years of rising
occupancy levels. Though the average daily room rate (ADR) has remained flat over
the same period, it appears to have bottomed out. Going forward, we anticipate that
the ADR will remain flat (or improve slightly given that many hotels are undergoing
renovation). RevPAR is expected to grow modestly on the back of sustained
occupancy levels.
Renovation and
refurbishment will emerge as
a necessary strategy to
remain competitive.
Renovation will play a key role for the future trading potential of older hotels. The
appearance of new modern hotels and recently renovated hotels in the market is
expected to exert downward pressure on the trading performance of the older hotels
that do not undertake renovation or refurbishment.
32
RREEF Research
The number of new rooms will only account for about 4% of total hotel room stock in Tokyo.
32
9.
Conclusions
After a prolonged economic recession since the early 1990s, Japan has finally
emerged to enjoy gradual but sustainable economic growth that is supported by rising
levels of capital investment, consumption, exports, and labour productivity. This
positive trend has been followed by the more recent recovery in the real estate
market. During the past few years, the property market has experienced dynamic
structural changes as well as a cyclical recovery in major cities, especially in Tokyo.
The optimal combination of performance, size, liquidity, and relative risk make Japan
an attractive investment option. With half of the investible real estate assets in Asia, it
is too big to be ignored in a global or regional portfolio. Moreover, the market is
rapidly maturing with structural changes that have stimulated greater liquidity and
transparency while increasing investment options and vehicles. The timing of
structural and cyclical changes has positioned Japan in a “sweet spot” of positive
developments relative to other markets. Some of these converging factors include:
•
A structural shortage of quality stock (following years of limited construction);
•
A string of investor-friendly regulatory changes affecting lease contracts, city
planning, and real estate funds;
•
A large investible stock with sale-and-leaseback activity, securitisation, and
institutionalisation;
•
A positive yield spread and interest rate differential that compares favourably
against other major global cities;
•
Low cross-correlations with Western Europe and the U.S. (indicating
substantial portfolio diversification benefits);
•
A limited supply pipeline that is expected to lag demand for the next five
years; and
•
Relatively low economic, political, and financial risk.
Traditionally a somewhat opaque market for real estate investors, transparency is now
improving in Japan, although it is not yet comparable to most Western European or
North American investment markets. A robust history of fundamentals, performance,
and transaction data that is widely accessible to investors will emerge only as the
various property sectors transition toward greater liquidity and efficiency. Again, that
is a trend that is in process that will not fully develop for some time to come.
For investors who wish to include Japanese property in their global strategies, the
current cyclical and structural position of the market points toward a value-added
strategy, at least for the intermediate term. Across the major property types, there are
key points for investors to consider:
•
•
RREEF Research
In the office market, vacancies are declining and rents are recovering in the
major urban markets as corporations are once again hiring and expanding
operations in Japan. Solid fundamentals of steady demand and a limited
supply of high-quality space will allow office rents in Tokyo to maintain
upward momentum. Small Grade A properties and relatively old office stocks
provide opportunity for asset-enhancement strategies. The limited supply of
Grade A office stock in Tokyo will encourage spill over to Grade B (with a
pull-effect on rents) and a ripple effect across regional Japanese cities as
office-users rationalise the increasing costs of occupancy.
The retail market will benefit from a growing consumer preference for
shopping centres that coincides with restrictive new planning laws for
33
•
•
suburban commercial development. Retail sales growth should eventually
align with Japan’s economic growth.
Structural changes in the industrial/logistics market are spurring demand
for modern, efficient facilities to replace obsolete distribution buildings.
The hotel market benefits from the steady economic recovery, but even
more so from the Japanese government’s successful targeting of international
tourists. New openings of luxury chains stimulate domestic demand as well.
Japan is well-positioned in a converging “sweet spot” of both cyclical and structural
change. Foreign investors in Japan will find a range of options – across property
sectors and investment vehicles – that may fit with their global or regional
diversification strategies.
RREEF Research
34
ANALYST CERTIFICATION
The views expressed in this report accurately reflect the personal views of the undersigned
lead analyst. In addition, the undersigned lead analyst has not and will not receive any
compensation for providing a specific recommendation or view in this report.
(Signed) Peter Hobbs
RREEF Research
35
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