Wednesday, August 27, 2008 2 comments ++[ CLICK TO COMMENT ]++

Japanese Real Estate Developer Declares Bankruptcy

If you though that only American, British, Spanish, and Irish homebuilders were having bankruptcy problems, well, add Japan to the mix.

Shares of Japan's Sohken Homes Co. were suspended from trading Wednesday after the home builder filed for court-led rehabilitation with the Tokyo District Court, becoming the latest Japanese developer to enter into bankruptcy protection...

The move comes in the wake of Urban Corp.'s filing for court protection earlier this month.

July saw similar moves by condominium developer Zephyr Co., with debts of around 95 billion yen, and construction firm Suruga Corp. with debts of 62 billion yen.

I'm not sure if this is the start of a trend or if it is just a few weak homebuilders falling by the wayside. I have been mildly bullish on Japanese real estate but it looks like it is starting to face some issues. The bullish case (from a contrarian point of view) for real estate in Japan lies with its massive decade+ bear market. The bearish case lies primarily with the poor demographics (declining population.) At some point Japanese real estate will be a good investment. One strategy is to follow Martin Whitman and invest in top-rated class-A buildings, which are cheaper than in many other parts of the world.

(Astute readers of this blog may recognize Suruga in that quoted news story. It was a company I was following for almost an year, only to discover that it was entangled with the organized criminals in Japan. The lesson for all newbies is to pay attention to why Buffett and Munger never invested in gambling companies. I think it was Munger who said that the gambling industry is dirty. I think it is prudent to apply the same thinking if you are looking at small-caps. A lot of people trip over themselves for the small-cap Chinese companies (many of them incorporated in Cayman Islands and listed in Hong Kong or NASDAQ) but I wonder how many of them are fronts for the Triad.)

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2 Response to Japanese Real Estate Developer Declares Bankruptcy

August 28, 2008 at 4:29 AM

Hi Sivaram

Thanks for yet another great post. I have been subscribed and reading along even if I do not have much time to respond.

As you may recall, I am living in Tokyo and have some inside perspective from my vantage point to what is happening. It is very true that the yakuza (mafia) are involved in money loans, equity investments and sometimes even legitimate companies. Real estate in Japan is known to be a very dirty business.

That being said, the main problem right now is the softening in the market place with land prices falling or starting to fall. Central tokyo especially 2nd tier neighbourhoods for office properties like in Shinjuku and Shinagawa have already falled 5-10%. 2nd tier cities outside Tokyo especially Nagoya have been said to have the most serious price concerns. New condo prices are being discounted 10-15% off published prices and even more is possible for buyers bringing cash to the closing by desperate property developers.

The banks are refusing to refinance any debt of the real estate companies as they are being mandated by the MOF to be cautious. They are supposedly coming down hard on the mega-banks to restrict lending to the good companies compared to the bad / yakuza linked ones. Urban Corp as an example was one that I was told by some knowledgeable Japanese real estate analysts as tightly linked with yakuza interests. The MOF is really concerned about the worldwide fall in real estate prices and they seem to be quite involved in the credit and lending policies of the Japanese banks.

GE Real Estate finance has come in to be one of the largest non-bank lenders to many REITS which have to refinance their short-term loans. GE is outside of Basel II and thus not constricted with as many regulations as the banks. However GE has raised the rates at which this debt can be financed, which is hampering the viability and returns which can be generated by the REITs.

Every property developer whether residential condos, homes or commercial buildings is now sitting on land whose price is falling, loans which they are having problems refinancing and excess inventory which they are having trouble selling at a profit or even selling at a loss.

The Japanese REITs are the most interesting in my opinion. Many are now yielding over 10% and prices have already come down very much from their highs in 2005/2006. Some are now trading at around 0.2 of price to book value or even less.

Also interesting are the real estate consulting and asset management companies which operate the REITs.

I have not done extensive research in this area yet, but recently have noticed a few things worth sharing.

1.) Hedge funds are moving into the sector, many with sizable purchases of 10-40% of the company. They seem to be targeting the REITs and Real Estate asset management/advisory companies. Ichigo AM is one that has bought into Asset Managers Holdings (2237), Creed Office Investment REIT (8983), and Creed Corporation (8888) Both Asset Mgrs and Creed Corp are actually real estate asset management firms who are doing the consulting and some direct investing in real estate. Tower Investment is another Japanese hedge fund with many similar positions while the global investment banks Goldman Sachs and Morgan Stanley in particular have been pretty active in purchasing stakes this year. Many of the largest purchases have literally just happened in the past 2 weeks, which we can fortunately get access to quickly due to MOF filing requirements which are not quarterly like in the US.

I am interested to hear what you might think about these ideas. Hopefully we can come up with different perspectives. The main thing that seems to be lacking at this point is any sort of catalyst that will actually change the current situation for real estate firms in Japan. Until that point, things are expected to get worse and there will be more bankruptcies among those highly levered real estate sector companies.

The risk reward is pretty good on many of these firms, because the upside is a multiple of your investment whether 500% or 1000% return over a few years, but unfortunately that comes with 100% capital loss as a strong possibility! This is why I am most others who are interested in this sector are treading VERY carefully.

It will likely get much worse before it gets any better.

August 28, 2008 at 12:06 PM

Interesting ideas Craig. Like yourself, I'm very cautious with Japanese real estate. On top of falling prices (which may be temporary,) the concern I can't overcome is the declining population. If we are investing for the medium or long term, it is absolutely imperative that we have an idea of what can happen. Maybe the catalyst you mention will come from a better understanding of the longer term outlook for Japan.

One of the theories (I can't remember if it was you that mentioned this possibility before) is for urban real estate to recover and do well, while rural real estate declines due to the declining population (as it has been over the years.) But how likely is that?

What is your sense of availability versus demand? In the American real estate bubble, one of the big problems right now is the huge inventory hangover. Way too many houses with demand that continues to drop. What is your impression of the number of units of condominium/houses/etc versus demand? I know there was a building code change that impacted the numbers last year (things may have appeared tighter than they really were) but not sure about the situation right now. I personally need to get a better sense of the supply & demand.

I like your REIT idea (not sure how tax-efficient they are though.) I looked at some random ones last year but need to re-visit them. I think the ideal ones are ones that not only manage properties in Japan but are also looking at other parts of Asia.

I may do more research on Japanese real estate... on another note, what are your thoughts on Japanese industrial cyclicals? As Jean-Marie Eveillard has said many times, you have many world-class companies being sold off due to weakening economies. Ranging from the auto manufacturers, all the way to industrial product suppliers, these companies seem to be getting attractive. But if the Yen strengthens, it will hurt these companies...

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