REITs Are Learning to Speak Japanese

But they aren't likely to cure real estate's woes

It seems like an elegant solution to both Japan's banking crisis and its moribund real estate market. What if Japanese high-rises and shopping malls were bundled into investment companies whose shares were sold to local and global investors? A tsunami of incoming yen would halt a nine-year, 80% slide in Japan's property prices, give banks a way to unload collateral acquired when property-backed loans went bad, and help Corporate Japan turn unproductive land into much-needed cash.

That, at least, is the pitch from Western investment bankers, Japanese real estate players, and others lauding the arrival of a market for real estate investment trusts (REITs) in Japan. The government passed REIT legislation in November, and the Tokyo Stock Exchange will start trading them in March.

Major Japanese real estate players such as Mitsubishi Estate Co. and Mitsui Fudosan Co. are planning to roll out their own so-called J-REITs later this year. Meanwhile, UBS Asset Management and Mitsubishi Corp., the trading company, say they have set up an advisory group to scout out REIT opportunities and, they hope, pull down major fees. "It is not a magic wand," says Clem Salwin, an executive director at UBS. "But it could attract a new range of investors."

Since the mid-1990s, Japan has had a small market for repackaging such assets as auto loans and credit-card debt. And Sanwa Bank Ltd. last December sold off $240 million worth of home mortgages. But such asset-backed securities are aimed at institutional players, not your average Watanabe-san. REIT backers want to sell their securities at the retail level to small investors by offering better returns than Japanese companies' sinking stocks or government bonds, which yield 1.6% a year.

In theory, they could. A REIT bundles a collection of properties and pays investors the income they produce or profits from sales within the portfolio. Investors also make capital gains--or losses--when they sell their REIT shares, which trade like stock. With annual returns on top-class Tokyo office towers hovering around 5%, vs. interest rates of just 1%, a well-designed REIT could attract even the most risk-averse investors. "My guess is that they might give it a try," says Morgan Stanley Dean Witter equity strategist Alexander Kinmont.

Optimists expect the REIT market cap will hit $10 billion a year by 2003. The worry is that Japan's most troubled real estate companies, banks, and corporations will try to unload their most wretched properties into the REITs. Given the predatory practices of Japanese financial players in the past, that can't be ruled out.

The government and Tokyo Stock Exchange, however, are setting tough listing requirements and demanding that every REIT property be cash-flow positive. Standard & Poor's analyst Tomoyoshi Omuro, who has examined the books of some proposed J-REITs, thinks "it will be hard for real estate companies to put a lot of rubbish" inside the REITs.

The real issue is whether REITs can break the deep freeze in Japan's property market. Land typically is used as collateral for bank loans in Japan. As a result, even if the property is not being used productively, companies view it as a source of leverage with the banks. That makes real estate a powerful bargaining chip, not just another asset that may or may not deliver a return. On top of that, punitive capital gains taxes discourage buying and selling.

MORE DEMAND? Japanese Bankers Assn. Vice-Chairman Akira Kanno thinks REITs won't succeed unless investors believe land will actually appreciate. Nor will the REIT market mean immediate salvation for Japanese banks. The "special-purpose corporations" set up to buy real estate for the REITs wouldn't touch most of the real estate portfolio at a typical Japanese bank.

The hope, though, is that some liquidity might help revive the real estate market. Credit analyst Omuro believes there is pent-up demand for Tokyo's best office properties, and banks and companies could raise cash by selling headquarters, warehouses, and distribution facilities. Property that generates real income, he insists, will find a buyer.

Trouble is, shoddily constructed buildings that are virtually abandoned or vacant mar vast stretches of Tokyo and Osaka. They can't command enough income to cover costs. At some point, the banks and real estate companies that own them will have to bite the bullet, write the worst property off, and salvage what they can in a fire sale. REITs may get more money flowing into Japan's real estate market, but they can't fix the larger problem.

By Brian Bremner in Tokyo

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