Fortress Finds Bargain in Non-Office Assets and Debt in Japan

Fortress Investment Group LLC, which raised $1.65 billion last month for its second Japan fund, plans to buy real estate debt backed by rental apartments, retail space and business hotels in the nation’s metropolitan areas.

Fortress, which oversees more than $50 billion, has so far invested 30 billion yen ($344 million) in debt and assets consisting of more than 300 buildings through its second fund, said Thomas Pulley, chief investment officer of Fortress Real Estate (Asia) GK in Tokyo. New York-based Fortress sees bargains in medium to small non-office buildings that range in size from 500 million yen to 5 billion yen, he said.

The manager, which entered the Japanese market in 2009, is seeking to profit from investing in real estate debt and assets in a country where the property market has been stuck with loans borrowed prior to the global financial crisis in 2008. A record 700 billion yen of commercial buildings are set to be sold over the next two years to repay debt, according to Moody’s Investors Service.

“We continue to find attractive investment opportunities that are created in part because of the deleveraging process that is occurring after the 2006, 2007 bubble,” Pulley said in a telephone interview yesterday. “That deleveraging and asset-cleansing process has occurred more at the mid-size than the larger properties. That’s an area where we see a lot of activity.”

Post Lehman

Bonds backed by commercial mortgages linked to everything from shopping malls to office towers were used to finance $66 billion of property acquisitions in the three years ended 2007, according to data compiled by Deutsche Bank AG. The annual volume dropped about 70 percent in 2008 after Lehman Brothers Holdings Inc. filed for bankruptcy that year and investors shunned securities that bundle property debt.

Fortress’s strategy of focusing on smaller assets is in contrast with other real estate investors, such as Morgan Stanley Real Estate funds and K.K. DaVinci Holdings, which bought larger office properties in Japan, including the headquarters of Citigroup Inc. and Shinsei Bank Ltd., and Pacific Century Place prior to the 2008 global financial crisis. In 2010, Fortress bought loans made to Tokyo-based K.K. DaVinci, which ran Japan’s biggest private real estate fund.

The second Japan Opportunity Fund has made 10 investments in Japan so far and will be fully invested in two years, according to Fortress. The first fund, which started in 2009, provided 34 percent return as of Sept. 30. The second fund targets an internal rate of return of more than 20 percent and seeks to buy residential, retail assets and business hotels that provide stable income, Pulley said.

Higher Yield

“If there was one consistent theme to the assets we’ve acquired, it is assets with good stability to the cash flow in the future, so therefore can provide a relatively high current yield to us,” he said.

Offices, which were popular among larger funds prior to the global financial crisis, returned 2.5 percent on average for the year ended August 2012, less than half the 5.4 percent return generated for retail properties and 6.3 percent return for rental apartments, according to London-based Investment Property Databank Ltd.

The office vacancy rate, a measurement of unoccupied space, rose to a record high in June in Tokyo’s five central wards, pushing rents to a record low, according to Miki Shoji Co., a Japanese office brokerage company.

“We are somewhat underweight offices because we think that the differential between rent in place relative to market rent is more severe,” said Pulley.