Japan Apartment Real Estate Proving Best: Riskless Return

Investing in Tokyo apartments beat putting money into office buildings, malls and the domestic stock and bond markets over the past five years as a housing shortage cushioned rental incomes from years of deflation.

Apartment real estate investment trusts produced the best returns, adjusted for price swings, of Japanese REITs in the five years through March, the BLOOMBERG RISKLESS RETURN RANKING shows. Daiwahouse Residential Investment Corp. (8984) led all REITs with a 5.5 percent risk-adjusted return, followed by Advance Residence Investment (3269) with a 5.4 percent gain.

REITs that buy apartments benefited from a shortage of new supply and a stable number of tenants in a nation where less than half of Japanese under the age of 40 own their own home. Japan has accelerated efforts under Prime Minister Shinzo Abe to end deflation and boost the world’s third-largest economy, including measures to revive the property industry, which has been struggling since an asset bubble burst two decades ago. The government has a target to increase assets owned by REITs by 40 percent by 2020.

“It’s all about stability,” said Hideyuki Shinkai, who helps oversees 51.4 trillion yen ($528 billion) in assets at Norinchukin Trust & Banking Co. in Tokyo and owns residential REITs he declined to name. “If you are looking for mid- to long-term investments, residential REITs are your best bet because they provide a stable yield.”

Property Revival

REITs pool investor money to buy real estate and are publicly traded like stocks. Japanese apartment REITs gained a risk-adjusted 3.2 percent in the five-year period, followed by offices at 0.9 percent and retail REITs at 2.3 percent.

The gains compared with declines of 1.7 percent for 10-year Japanese government bonds and 0.2 percent by the Topix (TPX) index, a benchmark for domestic stocks.

The risk-adjusted return, which isn’t annualized, is calculated by dividing the total return by the volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.

The ranking compared 39 members of the Tokyo Stock Exchange (1345) REIT index, 44 publicly traded property companies, the stock benchmark and the 10-year JGBs. The 44 companies had an average 0.7 percent risk-adjusted return in the past five years.

Six of the top 10 performers in the ranking were REITS that invest in residential real estate. Daiwahouse had the best total return, with a cumulative gain of 275 percent over the five-year period, before adjusting for price swings. Advance Residence had the fourth-highest total return, at 129 percent, and the fourth- lowest volatility.

Tokyo Apartments

The supply of new apartments in Tokyo this year will reach the highest level since 2007 because of expectations of an economic recovery, according to an estimate by Real Estate Economic Institute Co. in December. The inventory will rise 9.6 percent in 2013 to about 50,000 units, according the Tokyo-based industry researcher.

“The supply of rental apartments is extremely low at the moment,” said Tokyo-based Tomoyuki Kimura, director and general manager of the corporate management department at Advance Residence, Japan’s biggest residential REIT by market value. “A lack of supply in Tokyo has boosted our occupancy rate.”

Advance Residence manages 16,127 apartments across 190 buildings and had an occupancy rate of 96 percent as of July 31, according to the company.

REITs get most of their profit from rental income, paying the majority of it as dividends. While investors receive a yield that is competitive with bonds, they can also benefit should the value of the underlying properties rise.

Supply Shortage

Residential REITs have an average yield of 4.6 percent, compared with 3.4 percent for office REITs and 4.4 percent for retail REITs that hold shopping malls and retail stores, according to Nomura Securities Co.

In a weak market, rents at residential REITs tend to decline less than office REITs and are less likely to suffer from sharp declines in occupancy rates, according to Kimura. Commercial REITs tend to be directly affected by the revenue of tenants, he said.

Housing rents in Tokyo’s 23 wards rose or fell as much as five percentage points since 2008 on average, according to Recruit Co., a housing-data provider. Office rents had more than 10 percentage points of fluctuation, according to data compiled by broker CBRE Group Inc.

The supply of new apartments in the city’s metropolitan area averaged less than 43,000 a year since the global financial crisis in 2008. That was about half of the more than 81,000 units in the 10 years to 2007, according to the institute.

Market Rally

REITs still outperformed stocks and bonds in the first three months of this year, as Abe’s push to revive the economy prompted the Bank of Japan (8301) to introduce unprecedented asset purchases that fueled a stock market rally. The Tokyo Stock Exchange REIT Index gained a risk-adjusted 2.1 percent in the first quarter, compared with a 1 percent increase for the Topix and a 0.7 percent decline for 10-year government bonds.

Nippon Prologis REIT Inc. (3283), which invests in distribution centers and warehouses, and started trading in the first quarter, was the best performer in the period with a risk- adjusted return of 2.5 percent. Activia Properties Inc. (3279), which invests mainly in commercial and office buildings in the Tokyo metropolitan area, ranked number two, with 2.2 percent.

“Office REITs are likely to outperform because they are the only type of asset that tends to benefit when the economy enters into an inflationary stage,” said Tomohiro Araki, a Tokyo-based senior analyst at Nomura. “Having said that, as time goes by, when office rents fail to rise and large tenants continue to move out, people will rediscover the attractiveness of residential REITs.”

First REITs

About 61 percent of Japanese own their own home, based on a survey by the statistics bureau. About 46 percent of people between 35 years and 39 years have their own home, while home ownership for people between 30 years and 34 years is at 30 percent, the data shows.

Japan started the REIT market in September 2001 when Nippon Building Fund Inc. (8951) and Japan Real Estate Investment Corp. (8952), which both invest in offices, were first listed. The securities were pioneered in the U.S. in the 1960s.

Nippon Residential Investment Corp., listed in 2004, was the first residential REIT to go public and was merged with Advance Residence in March 2010, according to the Association for Real Estate Securitization.

An index of residential land prices has slid by half from its 1991 peak, according to Japan Real Estate Institute. The Nikkei 225 Stock Average is about one-third of its peak in 1989, while the 10-year Japanese government bond yield is 0.62 percent compared with 8.685 percent in 1990.

High Occupancy

Housing starts fell 23 percent in the 10 years to the end of 2012 from the previous decade, according to land ministry data. They gained for a third year in 2012, up 5.8 percent, the fastest pace since 1996.

REITs that hold housing properties have 20 tenants on average per building, almost double the average 12 for an office building, according to Nomura. The average occupancy rate of residential REITs was 96 percent as of December, according to Japan’s Investment Trusts Association. It was 95 percent for office buildings.

“The risk of residential REITs not being able to pay their dividend as promised is extremely low because of stable income,” said Nomura’s Araki, who favors residential REITs over all other real estate investments. “So from that angle, the risk of investing in residential REITs is the same as investing in JGBs.”

Tokyo’s Growth

Starts Proceed (8979) Investment Corp., a Tokyo-based residential REIT that focuses on cheaper apartments mainly for singles, had an occupancy rate of 97 percent as of October, according to company material. The valuation of the REIT’s properties has increased for two years because rental income helped boost the value of its assets.

A lack of new apartments in Tokyo as the population grows will continue to support residential REITs, said Yoji Otani, an analyst at Deutsche Bank AG in Tokyo. The population in the capital has increased 6 percent to 13.1 million in the past decade, while the number of households has risen 17 percent to about 6.6 million, according to the Tokyo Metropolitan Government.

“Even though residential REITs may underperform in the early stage of an economic recovery, they are likely to pick up speed by boosting dividends when the economic growth accelerates,” Otani said.

To contact the reporters on this story: Kathleen Chu in Tokyo at kchu2@bloomberg.net; Katsuyo Kuwako in Tokyo at kkuwako@bloomberg.net

To contact the editor responsible for this story: Andreea Papuc at apapuc1@bloomberg.net

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