Japan gains momentum as institutional property allocations recover

Japan’s logistics and residential markets hold the key to investor flows over the coming months, as the North Asian nation competes with Australia for the region’s recovering real estate allocations, advisors and asset managers in the region said.

“Whilst the positive carry is attractive, what is underpinning the interest in Japan real estate is asset fundamentals,"James Kemp, head of  Asia-Pacific real estate, Macquarie Asset Management, Sydney told AsianInvestor.

"Tenant demand across living and logistics is still strong and we see this supporting further investment  and development in these sectors. Outside of Japan multifamily, most living sectors in Asia-Pacific are very immature."

DEVELOPED MARKET DESIRE

Andrew Thompson, head of private equity, at KPMG Asia Pacific in Singapore told AsianInvestor that, in general, investors' preference for developed over developing Asia was pushing investors seeking a return to the property sector towards Japan and Australia.

“At the end of the day, real estate investor mandates favour lower risk-lower return; they’re not typically looking for private equity-type returns from this asset class,” he said.

James Kemp
Macquarie
Asset Management

Structurally, Japan remains the only key developed market that is characterised by positive leverage, where property capitalisation rates remain above debt financing costs, noted Macquarie AM's Kemp.

"More broadly, we continue to like Japan for its macro stability, size of its commercial real estate market and accommodative debt markets where leverage can boost returns,” he added.

Private equity funds focussed on Japan’s real estate sector have also shifted their operating models to broaden their appeal to investors, establishing operating platforms across several properties, as a way of sweating their assets, driving efficiencies, and creating value, according to Fumihiro Shichitani, associate partner, EY strategy and consulting in Japan.

“In the past, investment returns were highly dependent upon market conditions. But these days the actual initiatives undertaken by the real estate funds create the opportunities for investors to secure more stable returns,” Shichitani said.

Fumihiro Shichitani
EY

The model for Japanese private equity real estate of the last decade -- buy cheap, outsource management, and wait for asset prices to rise -- is no longer viable against a backdrop of increasing property prices and interest rates, he added.

A second trend is also emerging: an increasing number of real estate funds, which previously did not have asset management functions, are seeking to develop such capabilities in-house and have used an acquisition of  real estate investment trusts (REIT) to do so. 

"Additionally, through these REIT acquisitions, the real estate funds have also sought to expand their ability to execute a wider range of deal types,” Shichitani added.

CHALLENGES PERSIST

Following record-breaking flows in the first quarter of 2024, investors into Japan’s real estate sector deserted the sector in the second quarter, as investors pulled allocations in anticipation of the Bank of Japan’s July rate rise.

AsianInvestor previously reported that $6 billion flowed into the sector in the second quarter -- 39% lower than the same period one year earlier, according to MSCI’s Asia Pacific Capital Trends Q2 report.

Six month or half-year flows were 12% below a year earlier, according to the company.

Despite a recent drive by Japan’s government to lure foreign investors and asset managers to Japan, the obstacles posed by language, demographics and the BoJ’s interest rate increases this year – the first since 2007 – continue to concern investors pondering adding to their property allocations. 

Andrew Thompson
KPMG APAC

“Japan is a large market with willing banks lending large amounts on favourable terms; certainly, more capital will be allocated here compared to historical levels," said KPMG's Thompson.

"But if investors dont have a strong local presence or partners, it remains much harder to transact compared with Australia, the US or parts of Europe, given the cultural and linguistic differences. And when you talk about some real estate segments, you also can’t avoid demographic trends, which often aren’t good in Japan.”

The increase in policy rates and tight cap rates in Japan could make other developed markets in the region look more attractive, other experts said.

Alice Crowley
Knight Frank

"Australian commercial property, which has repriced the most in the region is a compelling alternative," pointed out Alice Crowley, director, international capital at Knight Frank in Singapore.

Distressed assets in Hong Kong could also be on the radar while core investors will like Singapore for its stability, she noted.

"These are viable markets to diversify into, but the case for including Japanese real estate in portfolios remains compelling."

The quotes in para 5 and 17 have been updated in this story.