J-REIT Consolidation and M&A Opportunities

When property markets turn downward (or upward) investors tend to lump REITs, physical real estate and stocks in real estate companies all in the same basket, i.e., real estate plays, and avoid the lot. The Tokyo Stock Exchange J-REIT Index is now down a whopping 52% from a mid-2007 peak, and up to 90% of the 42 listed REITs are trading at a discount to NAV.

There is no denying that credit has dried up for real estate developers and the number of property transactions has dropped off sharply. This is a double whammy for newly emerged real estate developers whose business model was dependent on a) readily available credit and equity, and b) active trading in real estate properties. As a result, many are failing and will continue to fail.

The J-REITs with the highest discounts to NAV are those whose sponsors are also the designated management company, and investors are leery that a failure in the management company/sponsor will negatively affect the J-REIT. However, some discounts to NAV more than account for what is actually limited risk to J-REIT holders from such an occurrence.

On the other hand, the deep discounts to NAV are attracting foreign value investors looking for ways to acquire or consolidate deep discount REITs to obtain their properties for less than current market values. Despite the recent plunge in J-REIT unit prices, foreign investors and domestic J-REIT fans believe there is still a lot of REIT secular growth potential in Japan. Japan's J-REIT market is still miniscule relative to Japan's property market, and to Topix market cap at under 1%. In Australia, REITs are equal to 9% of the ASX, and they are 2.8% of the S&P 500 in the U.S.

Where else in the developing world, much less a major city, can you find yield spreads at 5% and above? It was this level of yield spreads which first attracted foreign investors to Tokyo before the mini property bubble, when the foreign investment banks and `vulture` funds last started looking at Japan and spurred development of real estate securitization. Thus to value investors, J-REITs are looking pretty good.

Stock position: none.