Japanese Property: Fear Has Overcome Greed

As we outlined last week, domestic and foreign investors are already running "what-if" scenarios assuming a recession in the US. Ironically, while avoiding the auto and electronic sectors with the most exposure to the US would be the obvious choice, domestic retail and real estate (including REITs) are being dumped on the fear that Japan's economy will also slow.

As some Japanese industry insiders talking about a property "bubble", and banks are becoming more cautious on real estate financing because of the BOJ/FSA regulators snooping around in recently rapidly growing non-recourse loans and special purpose real estate company-related financing (i.e., structured finance) for any signs of excess, some domestic and foreign investors are beginning to suspect that Japan's real estate boom may be ending.

Specifically, the US subprime crisis has caused changes in perceived yield gaps, i.e., the difference between the cap rate on the earnings generated by real estate and the interest rate on loans. The higher yield gap in Japan has meant that returns on Japanese property have been more attractive than New York or London. Given a recession, the fear is that this gap will shrink and foreign investors will begin to back away from Japanese property.

But direct real estate investors like Morgan Stanley and Goldman say that talk of a "bubble" is hogwash and continue to aggressively bid for prime property. We believe that a clear distinction needs to be made between the dynamics of the property market itself, and the valuation dynamics of the stocks of real estate companies and J-REITs.

There was already a clear shift to quality and size from the sell-off in June of last year, as investors abandoned small caps for large caps and individual investors dropped small caps in favor of forex margin trading and chasing yield in overseas funds. The recent stampede out of Japanese equities by foreigners only exacerbated this trend.

With real estate stocks (and to a lesser extent REITs) now heavily oversold while earnings fundamentals are largely intact, we would now be looking to pick up selected real estate majors like Mitsubishi Estate (MITEY.PK)and Daibiru Corp. (DIBUY.PK), as the worst fears of investors already seem to be discounted.

Comments

[WFlorid:]

Thanks for the specific recommendations. What makes Mitsubishi Estate and Daibiru more attractive than other real estate firms?

2007 Sep 10 07:53 AM

[Darrel Whitten:]

Bill;
Mitsubishi Estate and Daibiru were mentioned because of Seeking Alpha's requirement to mention stocks that are traded in the US, which these two are in ADR (OTC) form. Personally, I like Sumitomo Realty (TSE Code: 8830) better because of its higher Beta to bull runs in real estate-related stocks. Mitsubishi Estate is the Cadillac (or Mercedes S550) of the Japanese real estate companies, being landlord of the some of the best commercial properties in Japan, such as the Marunouchi central business district around Tokyo station.

2007 Sep 11 05:16 AM