August 24 Tokyo Tokyo real estate offers attractive yields and opportunity for recovery play The Economy 1 Office Sector (recovery play with attractive yield) 2 Retail Sector (buy) 5 Residential Sector (selective buy) 6 JREIT Review 9 The Japanese economy is recovering with real GDP expected to grow at a strong 4.2% this year on the back of a robust Chinese economy and recovery in the US economy. It is projected to average 1.8% pa over the coming 1 years (source : Consensus Economics). The latest Tankan survey in June revealed that Japanese businesses are at their most optimistic since the property and stock bubble burst more than a decade ago. -5 Buyer/Tenant Quadrant SPACE Seller/Tenant Quadrant +5 The Economy 2Q4 1Q4 2Q3 Real GDP Growth 4.3%(e) 5.6% 2.1% (yoy) Unemployment Rate 4.6%(e) 4.7% 5.3% CPI (yoy) -.2%(e) -.1% -.4% Exchange Rate 18.77 14.22 119.8 Long term 1.79% 1.45%.85% Government Bond Yield Cost of Borrowing 1 2.93% 2.74% 2.4% 1 5-year swap rate plus 2bps MARKET M A R K E T -5 C A P I T A L Buyer/Landlord Quadrant +5 Seller/Landlord Quadrant Office (-2,2) Retail (1,2) Residential (-4,2) August 24 8 6 4 2-2 -4-6 Page 1 of 1 Mar-85 Sep-85 Mar-86 Tankan Survey on Sentiment Index of Large Manufacturers and Non- Manufacturers Sep-86 Mar-87 4.5% 4.% 3.5% 3.% 2.5% 2.% 1.5% 1.%.5%.% -.5% -1.% Sep-87 Mar-88 Sep-88 Source : Consensus Economics Inc Mar-89 Sep-89 Mar-9 Sep-9 Mar-91 Sep-91 Mar-92 Sep-92 Mar-93 Sep-93 Mar-94 Sep-94 JNTLMFG Index PX_LAST Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98 Mar-99 JNTLNMFG Index PX_LAST Japan Real GDP Growth pa 2 21 22 23 24F 25F Average Forecast for 24-214 A significant recent development is the shrinking GDP gap. Japan GDP growth has been below its potential growth since 1993. As the economy rebound, the gap started narrowing since last year. With a shrinking GDP gap, there is strong likelihood that Japan is finally coming out of its deflationary malaise. Sep-99 Mar- Sep- Mar-1 Sep-1 Mar-2 Sep-2 Mar-3 Sep-3 Mar-4
Office Sector (recovery play with attractive yield) Space Market Review The average vacancy rate of office buildings in Tokyo s five main wards has been falling since it peaked at 8.6% a year ago. It stood at 7.2% in Jun this year (source : Miki Shoji). Grade A buildings did better with vacancy rate at 4.3% in Jun (source : IDSS). The improvement in occupancy has resulted in the bottoming of office rental. The Bank of Japan is likely to continue its quantitative credit easing that would advance the shrinking trend of the GDP gap. The resurgence of inflation should support higher real estate prices, especially in the key cities like Tokyo. With inflation coming back, the lowering of real interest rates should also augur well for asset pricing. Japan CPI YOY % Change 1.%.8%.6%.4%.2%.% -.2% -.4% -.6% -.8% -1.% -1.2% 2 21 22 23 24F 25F Average Forecast for 24-214 Source : Consensus Economics Inc Having seen the peak in supply of new office buildings in 23, projected supply in 24 to 27 is at about historical average. With real GDP growth projected to average about 2.5% per annum, we expect demand for office space in central Tokyo to grow an average of 4% per annum over the next 3 years. Office building vacancy is projected to fall to around 6% by end of the year and towards 4% by 26. Rentals, which generally lag the improvement in occupancy, are expected to start growing by the end of the year. Page 2 of 1
Capital Market Review Since the burst of the Japanese property bubble in 1991, commercial property prices have declined by more than 7%. Trend of Land Value Indices in Tokyo 23 Wards Capital Value of Offices in Tokyo 3 Main Wards Commercial Residential Industrial Source : Tokyo Metropolitan Government We believe the correction in prices have overshot on the downside as indicated by the extreme low level of total land value to nominal GDP measurement. Prices have stopped declining since 3Q23 and have rose by about 1% as at 2Q24. With prices having declined more severely than rentals since the early 9s, yields of office buildings rose to an all time high of above 6% in 1999. Since then, there had been a deluge of capital into the Tokyo real estate market. Initially, there were the 2, 1,8 1,6 1,4 1,2 1, 8 6 4 2 1996 1997 1998 Source : JLL REIS 1999 1Q 2Q 3Q 4Q 1Q1 2Q1 foreign opportunistic funds looking for leverage play that the high yield and low interest rate environment offered. This was followed by the 3Q1 4Q1 1Q2 2Q2 3Q2 4Q2 CAPITAL VALUE (' JPY psm) (LHS) 1Q3 2Q3 3Q3 4Q3 1Q4 2Q4 Page 3 of 1
JREITs when they came into being in 21 and more recently, core plus funds looking for income on the back of a recovery play. A recent survey by the Japan Real Estate Institute among institutional real estate investors reveals that more than 8% of these investors were planning to invest aggressively in real estate in the next 12 months. The flood of capital has resulted in the compression of yields. Respondents in the Japan Real Estate Institute survey expected the yield of investment grade properties in Tokyo to continue declining. The simple average yield of office buildings acquired by JREITs in 22 was 6.1%. It fell to 5.5% in 23. These are simple averages as office buildings in Tokyo have diverse profiles. Investors expected yield on grade A office buildings in the Marunouchi/Otemachi area to be around 5.25% after adjusting for the deal structure. Also in June, Nippon Building Fund acquired the Alliance Building in Minato Ward from Mitsui Fudosan at a price that reflected a 4.8% yield. However, it should also be noted that some transactions were done at yields that are above 6%. Foreign investors have also been active in the Japanese real estate market recently. GIC Real Estate purchased two office cum hotel buildings in June the Shinagawa Seaside East Tower and Shinagawa Seaside West Tower for JPY 42.5 bn. Morgan Stanley Group acquired the Koicho No. 26 Building, an office and residential development, in June, and Shuwa Toranomon Building No. 3 in Jan. Recently, Lone Star beat AIG, Morgan Stanley and Colony Capital to buy three Tokyo buildings from Kokusai Motorcars Co. for about JPY 117 bio. The three buildings are the 19-storey Kokusai Akasaka Building, the 18-storey Kokusai Shin-Akasaka Building West Tower and the 24-storey Kokusai Shin-Akasaka East Tower. This is the largest single transaction done by a foreign investor in Japan since the property market peaked in the early 199s. Despite the fall in yields over the last few years, valuation remains attractive in view of the low interest rate environment and the growth prospect from the expected recovery in rentals : Investment Yield 4.5% to 5.5% Carry 2 2.1% Risk Premium 3 3.2% As at 3 th June, the three pure office JREITs (Nippon Building Fund, Japan Real Estate Investment and Nomura Real Estate Office Fund) were trading at prices that reflect average implied property yields of 5.%. Recommendation Yields are still attractive. With occupancy improving and rental expected to bottom out soon, the opportunity for leverage and recovery play is attractive. As interest rates are also likely to have bottomed, we would recommend locking in longer term borrowing costs. So far this year, a couple of office transactions were done at close to 5% yield. Nomura Real Estate Office Fund acquired the Isuzu Shiba Building in Minato-ku at expected NOI of 5.2%. In June, Japan Prime Realty acquired Shinjuku Square Tower at a headline yield of 4.25%. The effective yield is said In view of the generally under-developed stage of asset management in Tokyo, there is potential for active asset management to enhance value, especially in grade B buildings of 5 to 1 years old. 2 Investment yield less borrowing cost 3 Investment yield less long-term government bond yield Page 4 of 1
Retail Sector (buy) -1-2 -3-4 Space Market Review Judging from the improving sentiments of Japanese retailers, we expect the demand for leasing of retail space to grow. Overseas luxury brand retailers (Chanel, Gucci and Tiffany) are also opening outlets and investing in shops in prime retail locations such as Ginza and Omotesando. 1 Tankan Survey on Sentiment Index of Retailers 16 14 12 1 8 6 4 2 Number of new shopping centres in Japan 1994 1995 1996 1997 1998 1999 2 21 22 Source : Japan Council of Shopping Centers The supply of retail space in Japan is relatively tight. The retail space per capital at 1.5 sm is much lower than the 2.5 sm and 4.5 sm in Australia and the US, respectively. -5-6 Dec-98 Mar-99 Jun-99 Sep-99 Dec-99 Mar- Jun- Sep- Dec- Mar-1 Jun-1 Sep-1 Dec-1 Mar-2 Jun-2 Sep-2 Dec-2 Mar-3 Jun-3 Large Retailers Medium Retailers Small Retailers Sep-3 Dec-3 Mar-4 Jun-4 With few new shopping centers coming into the market, we expect occupancy to remain high and rental to grow in line with the strong demand; especially in locations that have a niche in high-end branded products (such as in Aoyama and Omotesando), and suburban malls around the vicinity of subway and train stations. Recent years have seen increasing retail activities at shopping centers. The share of sales in multi-tenant shopping centers to total retail sales have increased from 12% in 1988 to 19% in 22. Sales and Market Share of Shopping Centers 2 3 18 16 25 14 2 12 1 15 8 6 1 4 5 2 1988 1991 1994 1997 1999 22 As % of total retail sales (LHS) Sales of Shopping Centers (billion Yen) (RHS) Source : Japan Council of Shopping Centers There was a boom in shopping center development in the 9s when the Large-Scale Retail Store Law was changed but the supply of new centers in the last few years have fallen off considerably. Capital Market Review Institutional demand for retail properties, especially from JREITs, is even stronger than that for office buildings. This is partly due to the attractive yield as well as the currently low institutional ownership of retail properties. Less than 1% of retail spacein Page 5 of 1
Japan are owned by institutional investors compared to almost 5% in the US and Australia. investments. They also offer prospect for capital gain from recovery as well as further yield compression. We recommend buying into good quality urban and suburban shopping malls, preferring those in the vicinity of subway or train stations and with strong tenants. Japan Retail Fund Investment Corporation acquired the IVY Jingumae Building, a 3-storey plus 1 basement retail building, in April this year at a yield of 6.3%. Pacific Management Corporation acquired the Plaza246, a retail and office building in Minami- Aoyama, in March. ORIX JREIT acquired the CUBE Daikanyama, a 5-storey retail building, in March at 5.4% yield. In January, Japan Retail Fund has also acquired the Harajuku FACE Building, a 6- storey retail and office building, in Jingumae. Foreign investors were also active in Tokyo retail properties recently. In July, Deka Immobilien bought Don Quijote, a 9-storey retail building of 8,3 sm in Chiyoda for about USD91 mio. The German fund has previously paid a total of USD166.4 mio for three other buildings in Tokyo over the last 2 years. In June, LaSalle Investment Management purchased the Haimanten Shibuya Building and Asia Pacific Land Group acquired the Sun Street Building. Residential Sector (selective buy) Space Market Review The supply-demand balance of new condominiums in Tokyo metropolitan area has been improving since early last year, though at a slow pace. The inventory of unsold condominiums as at May 24 stood at 7,675 units (down from 9,625 units a year ago). Inventory has now stayed below the 1, psychological level that indicate a healthy market for more than 12 months. Income yield is attractive : Investment Yield 5.% to 6.% Carry 2.6% Risk Premium 3.7% As at 3 th June, Japan Retail Fund (the only pure retail JREIT at the moment) was trading at prices that implied property yields of about 4.4%. Recommendation With attractive positive carry and expectations that rent will improve with growth in retail activities, we can expect stable and growing cash flow from retail The contract ratio, the percentage of condominium sold the same month they were launched, improved to about 8% after hitting a low of 7% in Jan. The ratio for high-rise developments is at an impressive 95%; reflecting the preference for high-rise living. Page 6 of 1
2. 18. 16. 14. 12. 1. 8. 6. 4. 2.. Tokyo Housing Affordability (by distance from central Tokyo) 1986 1987 1988 1989 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 The improved supply-demand situation is showing in the bottoming of prices. The average price per tsubo has been hovering between JPY1.7-1.9 mio per tsubo in the last four years. ~1km 1~2km 2~3km 3~4km 4~5km Source : Urban Developers Association of Japan, CSFB Affordability Ratio = Housing Price/White-collar Annual Income With prices having declined by more than 5% from its pre-bubble peak in 199, housing in Tokyo is becoming more affordable. The differences in affordability between housing in central Tokyo and suburban locations have narrowed significantly in recent years. As housing becomes affordable, more and more Japanese households are moving to stay in the city. We believe this will be an important demand driver in the Tokyo residential market in the coming years. The leasing market is not as healthy as the sale market. The vacancy rate of high-grade apartments (with monthly rent above 3, and area of 1 square meters or more) in Tokyo s three main wards has been climbing in the past 4 years. It recorded 11.2% in 1Q4; up from around 9% a year ago. The average contracted rent has declined to 15,48. Page 7 of 1
per tsubo. In March, Premier Investment Company, another listed JREIT, acquired the Mita Keiodai Mae Residence in Minato-ku (under construction and scheduled to be completed in November) at JPY 2.96 mio per tsubo and a yield of 5.8%. Foreign funds are also interested in Tokyo residential properties. In February, CBRE Investors acquired three residential properties in Tokyo metropolitan area and Kawasaki-shi. It is rumored that CBREI plans to use these properties to launch a REIT fund. At the price of JPY 554,, the implied property yield of Nippon Residential Investment Corporation is under 5%. With yield in the direct market above 5%, it is yield accretive for JREITs to acquire more properties. This could result in further yield compression. Investment Yield 5.% to 5.5% Carry 2.3% Risk Premium 3.5% Recommendation We believe the leasing market would improve along with the sale market as employment growth picks up momentum. With foreign financial institutions, especially the securities firms, increase hiring in light of the resurgent stock market, we also expect a pick up in demand from expatriate renters. Yield is attractive vis-à-vis the low borrowing cost. The residential sector also offers the opportunity to participate in the recovery of the Japanese economy. We recommend buying into exclusive high-grade apartments in Tokyo s three main wards. Such apartments have good demand from both institutional buyers and tenants. We see value in these properties, as we believe their prices would recover with the economy. Capital Market Review Institutional demand for Tokyo real estate is also seen in the residential sector. In May and June, Nippon Residential Investment Corporation, the first pure residential JREIT, bought 4 residential properties the J-PARK Nagatacho Building, the Suidouko Mansion, the Excellent Tower Nogizaka and the Pacific Residence Akasaka, at prices that reflect yields of between 5.% to 5.6%. The price paid for J-PARK Nagatacho was about JPY2.59 mio Page 8 of 1
JREIT Review As at 3 June 24, there were 13 public listed JREITs on the Tokyo Stock Exchange with combined market capitalization of about JPY 1.3 bio. Year to date, the JREIT Index provided 15.3% in total return; underperforming the broad market where the TOPIX Index provided 43.5% in total return. US REITs The price of the JREIT Index rose by about 2% from a year ago. With the run-up, most of the JREITs are currently traded at between 2% to 5% premium to their NAVs. The spread of most JREITs dividend yields to 1-year JGB yield are at their lowest since listing between 2% to 3%. For comparison, the average premium to NAV of US REITs and Australian LPTs are between -2% to 3%, and between 5% to 5%, respectively. The average spread of dividend yield against long-term government bond yield for US REITs is about 1%, and that for Australian LPTs is between 1% to 2%. Given the high liquidity in the Japanese market and the improving real estate fundamentals, we expect the dividend/bond yields spread to narrow further with more upside in prices. The risk is that the Japanese economic recovery falters or the BOJ raise interest rate aggressively, both of which may have an adverse impact on JREIT pricing. It is noted that at the current price levels, the cost of equity for most JREITs are lower than the property yield in the direct market. This is a condition for JREITs to expand their capitalization through yield accretive acquisition. Hence, we expect JREITs would continue to be active buyers in the Japanese real estate market. UBSW Page 9 of 1
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