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June 17, 2016

Japanese REITs (J-REITs) have become ‘silver linings’, according to the Wall Street Journal. While listed real estate in the Asia Pacific region has struggled, the year to date return for the Tokyo Stock Exchange J-REIT index has grown by around 8.5 percent.

J-REITs are currently trading at about 1.35 over their net asset values (NAV) which is high compared to most parts of the world including Hong Kong where listed real estate stocks have been trading at discounts to NAV. With the J-REIT index rising 36 percent in 2013 and another 25 percent in 2014 before falling 7.9 percent in 2015, however, some investors are understandably concerned about the sector’s current high valuation and according to Bloomberg J-REITs are now “the priciest in the world”.

With the recent IPO of another logistics focussed J-REIT, the LaSalle Logiport J-REIT, it is worth looking at the sector in more depth. The recent phenomenon of e-commerce is often used to justify the growing demand and sharp pricing for new high specification logistics facilities which are more often than not sold to J-REITs upon completion and stabilisation. But is e-commerce really generating that much more demand for high specification logistics space in the Japanese market, and should it really be the basis for the aggressive pricing which is currently being witnessed?

E-commerce has understandably brought the logistics real estate sector to the attention of investors, not just in Japan but all over the world – especially in the US. Many of the e-commerce groups in Japan, however, are end-users behind a 3PL which manages their warehousing, inventory & general supply chain needs – and it is these same 3PLs who have been the major source of rental income in the market ever since Prologis first set up shop in the country in 1999. We need to be reminded that consumers are not necessarily buying more goods these days due to e-commerce, they are merely shifting their buying patterns. What was once sold in a traditional retail setting is now being purchased online and, in both cases a 3PL is often between the landlord and the end user – whether it’s e-commerce or traditional.

There is no doubt that e-commerce is resulting in a higher number of SKUs needing to be managed in a distribution facility which is causing average ceiling heights in the U.S. warehouse market to increase by up to 25% – even on speculative buildings, but this has not been the case in Japan so far. The high specification logistics facilities being built in Japan today, and which also make up the bulk of the logistics properties held by the J-REITs, are generally no different from the ones pioneered by Prologis and AMB ten or so years ago. Many of the design features in these facilities such as ramp access; floor loading; and ceiling heights are fundamentally the same today as they were a decade ago.

Excluding the recently launched LaSalle Logiport J-REIT, the three existing logistics focussed J-REITs are currently trading at share price premiums of 1.1 to 1.4 over their respective per share NAVs. This premium is still lower than some non-logistics J-REITs which are trading around 1.7 over their NAVs. Their distribution yields of 3.3 to 3.6 percent for these logistics J-REITs are very attractive compared to the negative yield on 10 year Japanese Government bonds, as well as some non-logistics J-REITs whose distribution yields are now below 3.0 percent.

However, the NAVs behind these logistics focussed J-REITs are being supported by some of the most aggressive pricing ever seen in the direct real estate markets. Prime Tokyo logistics NOI cap rates are now sitting around 4.0 percent which is the lowest on record, and genuine rental growth prospects are limited primarily to the most prime logistics sub-markets in Tokyo and Osaka. Admittedly, however, prime yields for Tokyo logistics properties are still attractive compared to prime Tokyo office yields at circa. 2.5 percent. Nevertheless, the heat in the market has even prompted the outgoing President of Mitsui & Co. Logistics Partners Ltd., the manager of Japan’s first logistics J-REIT (Japan Logistics Fund), to refer to the current market as being in a state of “irrational exuberance”.

There is no question that Japan needs more high specification logistics space given the average age and quality of 90% of the nation’s warehouse stock, and there is also no doubt that occupier demand is fairly strong across the major logistics markets in Japan. However, pricing in the direct real estate markets needs to be kept in check, especially when this pricing is supporting the current NAVs behind many of the J-REITs which are already trading at premiums far above their global peers.

Pelham Higgins, Director, Asia Pacific Industrial, JLL
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