Brought down to earth

Akira Mori, Japan's richest man, spent a record 231 billion yen ($2.3 billion) buying Tokyo's Toranomon Pastoral Hotel last September. He now says it's worth closer to 200 billion yen.

"The boom we've enjoyed for the past few years is over," says the 71-year-old CEO of Mori Trust Co, who teamed with KK DaVinci Advisors, a 1.2 trillion yen Tokyo-based property fund, for the acquisition. "Investors were convinced that prices would keep rising, so in about six months, they'll probably rush to get out regardless of price."

Global real estate financing has evaporated as defaults by US homeowners saddled banks and securities firms with $232 billion of losses and asset write-downs. Mitsubishi UFJ Financial Group Inc, Japan's biggest bank, reduced property loans by 7.7 percent as of September 30 from a year earlier. Regulators have sought to prevent a bubble like the one that burst in 1991, leading to 15 years of falling land values.

"People who bought properties last year at a very high price, they're in trouble," says Toshio Masui, president of Japan operations for Los Angeles-based buyout firm Colony Capital LLC. "Everybody was overpaying. People with a bunch of stuff in their portfolio are now running around trying to get refinancing, and they won't get it."

Cracks are emerging in a market that generated annual returns averaging 14 percent since 2003. The Tokyo Stock Exchange REIT Index dropped 16 percent this year and 40 percent from its peak in May. Twenty-six of 42 property trusts are trading below their initial public offering price, according to data complied by Bloomberg.

Lone star

The purchase price for the Pastoral in Tokyo's central Minato ward was the highest paid anywhere in the world for a hotel last year, according to New York-based research firm Real Capital Analytics Inc. The 313-room hotel now is worth about 13 percent less, Mori said in a March 24 interview. The buyers plan to redevelop the site, which is close to nine other buildings owned by Mori Trust.

Lone Star Funds, the Dallas-based buyout firm led by John Grayken, scrapped plans last month to sell a group of Japan hotels after bidders reduced their offers by as much as 25 percent between December and March as financing conditions deteriorated, say two people with direct knowledge of the matter.

"We should be prepared for another round of real estate deflation that may last for some time," says Akiyoshi Inoue, president of Tokyo-based Sanyu Appraisal Corp.

Financing costs

Reicof Co, an Osaka-based real estate investor, filed for court protection from creditors last month, saying it was struggling to obtain bank loans and selling properties because of contagion from the US subprime collapse.

Funding costs for investment banks climbed at least 2 percentage points in the past six months, says Yukio Egawa, head of Japan securitization research at Deutsche Bank AG in Tokyo.

"The credit market started demanding a substantial credit premium from US investment banks," Egawa says. "It doesn't make economic sense for them to extend new loans for real estate investment funds when funding costs have risen substantially."

Morgan Stanley, the biggest issuer of commercial mortgage- backed securities in Japan, plans to cut as many as 40 employees in its securitization unit. Merrill Lynch & Co, the largest US brokerage, closed its Japan property funding unit, eliminating 11 jobs. Both Morgan Stanley and Merrill are based in New York.

"There are now fewer lenders providing higher-leverage loans," says Douglas Smith, managing director of commercial real estate at Deutsche Bank in Tokyo. "Not because they necessarily are taking any particular view on the prospects for the Japanese real estate market, but because of events outside this market affecting their ability or willingness to provide lending."

Condominium slump

While total returns for real estate investments in Japan, including capital gains and rental income, have been positive since 2002, according to the MTB-IKOMA Real Estate Index produced by K.K. Ikoma Data Service System and Mitsubishi UFJ, the housing market has been showing signs of strain.

Condominium sales are set to fall for a third year in 2008 after a new building code slowed project approvals and construction costs soared. Total condo sales dropped 14 percent to 133,000 units in 2007, according to the Tokyo-based Real Estate Economic Research Institute.

Commercial property has held up better. Prime office rents in Tokyo rose 16 percent last year, and have almost doubled since 2004, according to real estate broker Jones Lang LaSalle Inc. Prices for commercial buildings in the center of the city jumped 20 percent in 2007, helping swell Mori's wealth to $7.5 billion, the most among Japan's 24 billionaires, according to Forbes magazine.

Agencies

(China Daily 04/14/2008 page11)