Japan housing & real estate sector - First fall in inbound hotel demand in 43 months

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Some companies now cautious about hiking room rates

On 7 October the Japan Tourism Agency published data from its accommodation survey (second set of preliminary data for July, first set of preliminary data for August). According to these figures, the number of guests in accommodation facilities was down 0.4% y-y in July (with Japanese guests down 2% and foreign guests up 8.9%) and down 1% in August (Japanese guests down 0.9% and foreign guests down 1.8%). This was the first time in 43 months that the number of foreign guests had fallen y-y, which is a potential negative for hotel operators, which constitute an inbound tourism-related sector. The view among stock market participants has been that accommodation demand would rise despite the end of so-called bulk buying by tourists, which has cast a cloud over spending in Japan by foreigners. With demand from Japanese people weakening too, some hotel operators that had been focusing on hiking room rates through the previous fiscal year have started to rein in rate hikes as they factor in occupancy as well, and hiking room rates will become increasingly difficult if demand from inbound tourists pegs level or even falls. At this juncture it is not clear why the number of foreign guests fell in August, and as we only have the first set of preliminary data, we will be watching to see if the second set of preliminary figures, due for release on 31 October, will have any revisions.

Japan construction and real estate market - Record gap for Mitsui Fudosan, Mitsubishi Estate

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Mitsui Fudosan's implied cap rate at 6.5% 
Looking at the spread between the implied cap rates (based on our calculations) for Mitsui Fudosan [8801] and Mitsubishi Estate [8802] since 2003, we see that while the spread between the two companies' implied cap rates has narrowed from 2.6ppt in late August, it is still at an unprecedentedly high level of 1.9ppt based on 8 September closing prices. Except for the brief time when real estate stocks dropped sharply in the wake of the global financial crisis in 2008, Mitsui Fudosan's implied cap rate has been consistently higher than Mitsubishi Estate's, and the spread between the two companies cap rates has generally been around 0-1ppt. Even in September 2014, when Mitsui Fudosan's market cap was temporarily higher than Mitsubishi Estate's due to increased expectations for Mitsui Fudosan's profit growth following its capital increase in June 2014, the spread was still only 0.4-0.5ppt. We believe this is because real estate in the Marunouchi area (the focus of Mitsubishi Estate’s portfolio) is valued higher than real estate in Nihonbashi (the focus of Mitsui Fudosan's portfolio), which results in a lower cap rate.

NOMURA JAPAN DAILY SUMMARY & RESEARCH - REITS

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Near-term earnings likely to depend on real estate sales and condo business 
Tokyu Fudosan Holdings has no major projects under development for long-term holding and rental until the planned completion of the Shibuya Dogenzaka 1-chome and Shibuya Nanpeidai projects in 20/3 and the Takeshiba and Shibuya Station Sakuragaoka Exit projects in 21/3. We expect the company to sell Yokohama Minatomirai 21-32, which is being developed near condominiums and slated for completion in 18/3. After completion, we expect a stable contribution to profit growth from the sale of the Higashi Ikebukuro 1-chome Cinema Complex, a project in which the company disclosed its involvement on 9 August 2016, as well as retail stores, restaurants, and business hotels in Futako Tamagawa, Ginza 1-chome, Shimbashi 3-chome, and Osaka Shinsaibashi 2-chome. Our views are unchanged, and we maintain our forecasts, target price, and Buy rating. Our target price is based on NAV calculated from a cap rate of 4.3%, and the shares look undervalued considering the implied cap rate of 5.3% based on the 8 September closing price.

NOMURA - Japan housing & real estate sector - Office demand down for third straight month

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Daisuke Fukushima
Vacancy rate continues to improve on multiple demolitions, rent upside strengthens

According to major real estate brokerage Miki Shoji, the office vacancy rate in Tokyo’s five central wards improved 4bp m-m to 3.90% in August 2016. Growth in advertised rents remained weak, up only 4.75% y-y, but this nevertheless represents a gradual improvement on 3.98% in January 2016, the weakest recent month. Office demand, a key indicator, fell 5,794 tsubo (3.3m²) m-m, thereby registering its third consecutive monthly decline. However, the vacancy rate improved because eight office buildings were demolished and therefore removed from the survey/statistics, which are now based on 2,591 office buildings, with the result that leasable office floor space fell 9,430 tsubo m-m to 7.28mn tsubo while vacant space fell 3,636 tsubo to 283,896 tsubo. While three straight months of falling demand for office space will warrant ongoing attention as it constitutes the first such move since end-2009/early 2010, the summer is not a particularly strong season for office demand to start with, and we therefore think it would be premature to say that demand has moved into a sustained downtrend along the lines of 2008, when the global financial crisis occurred. We think it would be prudent to maintain a wait-and-see attitude for now. We continue to recommend Mitsui Fudosan [8801] and Tokyo Tatemono [8804] for rising rents and low P/NAV ratios.

STIFEL: Office/Industrial REITs - Conference Call 9/7/16 - Value Creation or Destruction and Lease Economics Analysis. SLIDES ATTACHED. Dial-in Info Below.

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Conference Call 9/7/16 - Value Creation or Destruction and Lease Economics Analysis. SLIDES ATTACHED. Dial-in Info Below.

• We are hosting a conference call on Wednesday, September 7 at 11AM ET. Dial in numbers are as follows: (888) 267-2848 (Domestic); (973) 413-6103 (International); Conference ID: 987648;

• A replay of this conference call will be available through September 21, 2016 - Replay dial in numbers are as follows: (800) 332-6854 (Domestic); (973) 528-0005 (International); Conference ID: 987648

• We believe the best way to determine a company's ability to create (or destroy) value is to 1) review its Net Asset Value at a static cap rate, 2) adjust for dividends paid, 3) evaluate the lease economics and then 4) overlay projected property market conditions, portfolio expectations and development-driven value creation.

• The body of this report reviews each company under our coverage and its Net Asset Value plus dividends paid during (in most cases) 2006-1H2016. In our summary of each company, we also provided a projection given the current strategy, development pipeline and lease economics.

• Additionally, we have compared and contrasted the Lease Economics Analysis for the Office & Industrial REITs under coverage. We recently started this analysis to provide a forward look at expected portfolio performance based on the re-leasing spreads combined with the re-leasing costs. Evaluating one without the other is similar to a PB&J without either the PB or the J.

Pricing as of 9/6/16

• Our primary conclusions: 1) creating value without the benefit of cap rate compression is not easy, 2) asset re-cycling and portfolio re-positioning appear to be working, 3) the dividend is vital over the long term, 4) quality development worked, while commodity development, plus high land inventories, proved disastrous, 5) the 2009 re-equifications were painful, 6) prudent, proactive equity raises were helpful, 7) quality assets and submarkets usually ruled the day, 8) high re-leasing costs and marginal re-leasing spreads result in value erosion

METHODOLOGY -- No Cap Rate Geniuses

• Our methodology was to hold the cap rate fixed for the time period reviewed to determine share value creation or destruction absent cap rate fluctuations (no "cap rate geniuses" allowed), and add the dividend paid in order to determine portfolio value created or destroyed and total shareholder return.

• For some companies with major portfolio re-positioning strategies, we adjusted the underlying cap rate.

• This captures, from a valuation perspective, hard-to-detect nuances such as 1) excess capex and re-tenanting costs, 2) cash costs for balance sheet management, which were real costs in spite of being excluded from FFO, 3) real re-development returns, 4) the importance of the dividend in total return to shareholders, and 5) stock based compensation.

• Note that we usually annualized our NAV estimates as quarterly estimates have often been volatile historically.

NOMURA: Japan REIT sector - Ongoing property sales by REITs

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Property sales constitute viable option even if pros and cons are not immediately apparent

On 31 August Sekisui House SI Residential Investment [8973] (Buy) announced the sale of b-town Minamiaoyama, an urban retail facility. It has been selling off commercial facilities since June 2014 in order to turn itself into a specialist residential REIT, and to date had sold six properties. It had hitherto decided not to sell b-town Minamiaoyama because it was carrying unrealized losses, with appraisal value of ¥1.17bn at end-16/3 versus book value of ¥1.49bn. However, it has now managed to sell it to a third party based in Japan that made an offer of ¥1.56bn, well above the property's appraisal value and also higher than its book value. Sekisui House SI Residential Investment said that it received an offer for the property in excess of its book value because the real estate market has been buoyant recently.

Japan REIT sector - REITs up despite ex-dividend date for 11 REITs

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Stocks should benefit from BOJ buying, REITs seem also to be in favor

TOPIX rose 2% on 29 August from the previous trading day. The main factor was likely the yen's retreat following the Fed chairwoman's lecture and comments by BOJ Governor Haruhiko Kuroda at the symposium at Jackson Hole, Wyoming, on 26 August. Amid these conditions the TSE REIT index rose 0.5% on 29 August despite it being the ex-dividend date for REITs with August-ending fiscal periods (ie, 11 of the 54 REITs). After nearly doubling its annual ETF buying target to roughly ¥6trn (from ¥3.3trn) at the 29 July Monetary Policy Meeting, the BOJ bought ¥71.9bn in ETFs on both 25 and 26 August, roughly double the daily amount of BOJ ETF buying up to 3 August. Even so, TOPIX continued to fall d-d on 25 and 26 August. On the other hand, the BOJ did not buy REITs on 25 or 26 August, but the TSE REIT index rose each day nonetheless. Judging from these market conditions, our view is that market participants feel safer in REITs than stocks.

NOMURA - Sanki Engineering (1961 JP) (Neutral) Effect of suspension not clear yet

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Real estate business also warrants attention

In Apr-Jun 2016, operating losses narrowed to ¥0.3bn, from ¥0.6bn the year earlier, although Apr-Jun results make only a small contribution to full-year results owing to seasonal factors. Losses narrowed owing to an increase in revenues in the machinery systems business, offsetting an increase in provisions against construction losses in the facilities construction business, which includes the HVAC systems for buildings business. As announced by the company on 23 June, the government suspended the company from participating in bids and contracts for 30 days, from 8 July to 6 August, in connection with antitrust law violations. We will be paying close attention to the effect of the suspension on earnings in Jul-Sep and beyond. Peers that were similarly suspended in 15/3 saw earnings adversely affected in cases where the companies also refrained from actively taking on work in the private sector. We make no change to our operating profit forecasts, but we lower our target price as we cut our target P/E to 11-12x, from 16-17x previously, to reflect trends in the benchmark P/E and other factors.

 

NOMURA - Maeda (1824 JP) (Buy) Focus on sales growth, concessions

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Pulling away from rivals by ending its dependence on contracting work

Maeda performed well in 17/3 Q1, generating a gross margin of 9.9% on building construction projects and overall operating profit growth of 26% y-y. We raise our profit forecasts, having lifted our outlook for the gross margin on building construction projects. While some investors may be concerned that the gross margin on building construction projects is high in historical terms and offers only limited scope for improvement from 18/3 onwards, we note that the order book has been rising and that sales growth from 18/3 onwards is likely to lend further impetus to profit growth. Maeda has also established a subsidiary to operate a toll road concession in Aichi Prefecture, and it will be interesting to see how it contributes to earnings. We have raised our target price to reflect upward revisions to our profit forecasts and a rise in the benchmark P/E.