The recent spurt in global bond yields needs to be carefully watched because it has the potential to create another inflation scare that could trigger yet another global sell-off in equities. Shifting perceptions about interest rates are a short-term risk for Japan's real estate stocks and REITs, because of the very strong rallies seen to date and over the past two years.
This notwithstanding, we believe Japan’s property market is now in a strong secular rebound after 15-plus years of secular decline, and that the secular bull market in Japanese real estate plays will not be easily derailed, despite periodic spurts in bond yields. Property prices in the commercial districts of Tokyo rose an average of 9.4% on the year as of January 1, 2007 and in some cases have surged 3%~40% in what some fear might be a bit “bubblish”. However, the gains reflect strong capital flows into the market from domestic and overseas investors via real estate investment trusts (REITs) and privately-placed funds, and calculated yields based on future rental income discounted to future value using risk premiums and discount rates based on bond yield forecasts.
So how does one make money in Japanese property? If you are an entrepreneur, you can bet on finding neglected property near great skiing or other natural assets and develop an international tourist enclave. Or, you could establish a fund, attract some investment capital, go out and buy yourself rental properties and create a REIT, and cash in by listing either in Japan or even Australia. Thirdly, you could invest in the major developers who were early to list their REITs and who own the choicest properties in central Tokyo. Fourthly, you could buy a listed Japanese REIT, preferably one of the original listed 14. Investments in established real estate stocks and REITs have been extremely profitable over the past year.
However, we are cautious on the junior property developers that were doing so well before the Livedoor scandal. For one, they have been tarred with “small cap syndrome”. Secondly, investors are beginning to suspect a bit of a shake-out will come as these companies grow outside their respective niches.