Japan Reit sector may halve due to M&As

Consolidation is the way to go given tighter credit markets, falling property prices, says one seller

Japan’s real estate investment trusts will accelerate takeovers in the US$32 billion industry as banks pressure them to consolidate amid a tighter credit market and falling property prices, said Curtis Freeze, who agreed to sell his Reit to a unit of Oaktree Capital Management LLC.

The number of Japanese Reits may fall by half to about 20 in the next year as the funds seek merger partners to counter falling demand and tighter loan terms, Mr Freeze, chairman of Honolulu-based Prospect Asset Management Inc, said.

Japan’s 37-member TSE Reit Index has lost 58 per cent from its peak in May 2007 as the global credit crisis made it harder for them to refinance loans and acquire capital to purchase properties. Mr Freeze, faced with refinancing problems, last week agreed to sell Prospect Reit Investment Corp to Japan Rental Housing Investment Inc, controlled by Oaktree Capital, marking the fifth Reit takeover in Japan since September.

‘Japanese Reit merger and acquisitions are just getting started,’ Mr Freeze said in an interview in Tokyo yesterday. ‘There is a clear divide between the winners and losers, and by agreeing to merge, Prospect went from the losing camp into the winning camp.’

Property acquisitions by Japan’s 41 publicly traded real estate investment trusts before some trusts merged, surged to 66.4 billion yen (S$1.04 billion) in the three months ended December, from 3.6 billion yen in the previous quarter, according to Urban Research Institute Corp. The pick-up came after the government started a fund to support Reits, which derive most of their profit from rental income and pay out the majority of it as dividends.

Prospect Reit rose 2.6 per cent to close at 87,400 yen on the Tokyo Stock Exchange, compared with a 0.5 per cent gain for the broader TSE Reit Index. Japan Rental Housing rose 1.2 per cent to 128,000 yen.

Japan opened the Reit market in September 2001, with its first two Reits – Nippon Building Fund Inc and Japan Real Estate Investment Corp – playing catch-up in developing the securities pioneered by the US in the 1960s.

The benchmark TSE Reit Index had a record market value of about 6.79 trillion yen in May 2007, compared with about 2.84 trillion yen today. The decline came as the collapse of Lehman Brothers Holdings Inc in September tightened credit conditions.

Japanese bank lending dropped 1.7 per cent in January from a year earlier, the largest decline since September 2005, the Bank of Japan said last month. The drop, amid a five-year low in demand for loans, compares with a 1.2 per cent contraction in December.

Shareholders will receive 0.75 of a share in Japan Rental Housing for each Prospect share they own, the two companies said on Feb 26. Japan Rental Housing will be the surviving entity. The takeover, which is expected to be completed in July, will create a trust with assets of about 184 billion yen.

The takeover of Prospect follows four other combinations of Japanese Reits. Advance Resident Investment Corp merged with Nippon Residential Investment Corp on March 1, and Japan Retail Investment Corp and Lasalle Japan Reit Inc combined on the same day.

Out of the five mergers, only two funds have announced plans to raise capital as part of the deal, according to data compiled by IB Research and Consulting Inc. Japan Rental Housing said that it would issue five billion yen worth of shares through private placement, while Daiwa Housing Industry Co bought six billion yen in new shares in failed New City Resident Investment Corp after it merged with Daiwa’s Reit.

‘There will be more J-Reit mergers on the back of declining credit worthiness and difficulty in refinancing,’ said Mikio Namiki, an analyst at Mizuho Securities Co. ‘The key to success would be finding a financially sound partner rather than how big the funds would become, so that they can improve their creditworthiness.’

Rating and Investment Information, a Japanese rating company, in a note dated March 1 said that the fund-raising environment for Prospect is not ‘favourable’ even after the merger plan announcement. Mr Freeze said that refinancing of his bonds worth 24.8 billion yen due in March should not be a problem.

‘Every merger in Japan has to win banks’ support and Reits are no exception. We agreed to merge because the credit quality is much better for Japan Rental. There is no problem with our refinancing due in March.’

Mr Freeze said that by exiting the day-to-day management of his own Reit, he plans to help Oaktree find trusts to buy, declining to identify any targets. He began buying Tokyo properties in 2002, when Japan was emerging from its third recession in a decade, and invests in 14 Japanese Reits, according to Bloomberg data.

Source : Business Times – 4 Mar 2010