JAPAN: An Introduction to Capital Markets: Domestic: J-REITs
Current Trends in the J-REIT Market
Based on the performance of the Tokyo Stock Exchange REIT Index, the market for Japanese real estate investment trusts (J-REITs) has been on a downward trend since mid-2021, falling 8.34% in 2022, 4.60% in 2023, and 6.92% in 2024 (as of 12 March 2024). Particularly with regard to its recent performance, the REIT Index has been affected by the Japanese stock market’s performance (represented by Nikkei 225), which encouraged domestic and foreign institutional investors, including financial institutions, to shift their funds towards investing in the stock market.
Against this backdrop, as of 12 March 2024, J-REITs have not conducted any IPOs since June 2021. New entrants generally prefer private REITs, and the amounts procured in the follow-on public offerings of existing J-REITs in 2022 and 2023 continued to be relatively small.
However, since the market price for J-REITs has declined, the expected average dividend yield of J-REITs has increased to 4.67% as of the end of February 2024, which is higher than the yields of most high-dividend stocks. Furthermore, the underlying real estate market continues to boom despite several negative factors, such as the expected massive oversupply of large office buildings in Tokyo. The Japanese economy is now experiencing inflation for the first time in many years and, in March 2024, the Bank of Japan exited from the negative interest policies it introduced in February 2016. These factors may positively affect the J-REIT market going forward.
Reflecting the general increase in awareness of environment, social, and governance (ESG) issues, the ESG movement (especially the environment element) has become a trend for portfolio assets and equity/debt financings. More and more portfolio assets have various environmental certificates and some J-REITs have introduced renewable energy to their portfolio of assets. Green and sustainability financings (both equity and debt) are increasing as well.
Boom in private REITs
As mentioned above, it seems that there is a recent trend where the establishment of private REITs are preferred to listed J-REITs. From 2018 to 2023, eight J-REITs were listed while nearly 31 private REITs commenced operations. In 2022 and 2023, 15 private REITs commenced operations, while no J-REIT was newly listed (as of the end of 2023).
The industry type of private REIT sponsors has diversified to include railways, electricity, gas, construction, and regional banking. There are several small private REITs in the market, but none of the private REITs have experienced ordeals, such as reorganisation and consolidation, because, unlike J-REITs, they appeared after the financial crisis in 2008. Therefore, for private REITs that have yet to undergo any business integration or restructuring, there is a possibility that they will move towards these in the future.
Recent noteworthy capital market transactions
In recent J-REIT offerings, even if the J-REIT makes placements of investment units to foreign investors, it has become less common for issuers to conduct Rule 144A offerings or prepare an English offering memorandum, mainly because of costs considerations.
However, in large-scale offerings, Rule 144A transactions are still being conducted. For example, Industrial & Infrastructure Fund Investment Corporation (IIF) recently completed a very large Rule 144A offering to purchase logistics properties from Logisteed, which had received investments from KKR, IIF’s new sponsor. The total offering size was approximately JPY50 billion (approximately USD330 million). One noteworthy feature is that some properties were acquired by IIF in a joint investment with a Japanese real estate company, which is a new investment style for a J-REIT.
J-REITs meeting certain requirements can rely on the guidelines of the Financial Services Agency (FSA) to shorten the period between the announcement date and the pricing date of their offerings. A number of J-REITs that conducted follow-on offerings relied on this rule. Shortening the period reduces the risk of fluctuations in the price of the investment units after the announcement date.
Corporations can also rely on these guidelines, but J-REITs can benefit more than corporations because J-REITs are not subject to the waiting requirement under the Companies Act. If there is no solicitation to investors in Japan, the “accelerated bookbuilding” method may be used to determine the price on the day following the announcement date. GLP J-REIT used this method in 2020.
Increasing numbers of J-REITs are delivering their prospectus electronically rather than on paper, which promotes environmental protection.
Some types of offering that were once uncommon for J-REITs have also been used in recent years.
Daiwa House REIT Investment Corporation recently completed the first sponsor-initiated secondary offering in the J-REIT market. In this transaction, the sponsor, Daiwa House Industry Co., Ltd., sold part of its stake in the form of a secondary offering. With the announcement of this transaction, it became clear that the J-REIT market is open to sponsor-led secondary offerings. This transaction will serve as a guidepost for future secondary offerings in the J-REIT market.
Some issuers (such as Ichigo Hotel REIT Investment Corporation and Tosei REIT Investment Corporation) have made a third-party allotment to their sponsors to fund the acquisition of properties.
Recent noteworthy corporate actions in the REIT sector
The Japanese REIT sector has recently witnessed a hostile unitholder proposal for merger and a hostile takeover attempt being made against listed J-REITs (in 2019 and 2021), which were previously unseen in this market. Regarding the latter, Starwood commenced a tender offer for the units of Invesco Office REIT, Inc (IOJ) without the prior consent of IOJ. Starwood’s tender offer failed, but Invesco, the sponsor of IOJ, launched and succeeded in making a counter tender offer as a “white knight”. Consequently, IOJ completed a squeeze-out and delisted in November 2021 - the first delisting in J-REIT history.
In the listed infrastructure fund market, a neighbouring market of the J-REIT market, there were two cases of a buy-out takeover and squeeze-out conducted by the sponsor of the fund (in 2022 and 2023).
In 2023, a unitholder proposal was made to one J-REIT (Ichigo Office) requiring, among other things, the modification of asset management fees and appointment of additional directors. The proposal was opposed by the board and was not approved in the extraordinary unitholders’ meeting held in June 2023.
These cases sparked discussion over the corporate governance of REITs. In particular, the deemed consent scheme in unitholders’ general meetings and consolidation of REIT units to squeeze out unitholders are hot topics.
Also noteworthy are recent changes in the ownership of asset management companies and mergers of J-REITs. For example, in 2022, Mitsubishi Corporation and UBS sold their entire interest in their joint venture asset management company managing J-REITs to the KKR Group.
As for mergers of J-REITs, in 2022 MORI TRUST Sogo REIT, Inc. and Mori Trust Hotel REIT, Inc, which were managed by the same asset management company, announced a merger, which was completed as planned in 2023. In 2023, Kenedix Office Investment Corporation, Kenedix Residential Next Investment Corporation, and Kenedix Retail REIT Corporation, which were also managed by the same asset management company, announced a merger, which was completed as planned in the same year.
Strengthened supervision of J-REIT asset management companies
Stricter supervision of J-REIT asset management companies followed after administrative actions were taken in July 2022 against ES-CON ASSET MANAGEMENT, a J-REIT asset management company. It received a business suspension order and a business improvement order from the FSA after it was established that the following violations of its duty of loyalty to the J-REIT were committed:
• undermining the independence of the real estate appraiser, where the appraised value of real estate acquired from the parent company was raised; and
• tampering with the real estate appraiser selection process, where several appraisers were asked to provide estimates, and the appraiser who calculated the highest estimated value was requested to quote the lowest fee.
Based on the administrative actions taken, the FSA is thought to have enhanced its supervision of the conflict of interest management systems of J-REIT asset management companies, which may enhance good governance and the transparency of the market, thus making it more attractive for investors.