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Real Estate Industry Overview

11, 01. 2004

Current State

Land Prices Bottom Out; Cheerful Mood Returning for the First Time in Many Years

Skyscrapers under construction along Tokyo Bay
Skyscrapers under construction along Tokyo Bay

   Some time has passed since the Japanese myth of ever-escalating land prices came to an end with the collapse of the bubble economy. The ensuing fall in land prices, however, are now beginning to head towards conclusion, mainly in urban areas. Although real estate prices continue to fall as a national average, the bottoming out of land prices is beginning to be seen in urban areas such as Tokyo, Osaka and Nagoya. Land prices have even begun rising for the past few years in some of Tokyo's commercial districts and conveniently located residential districts.

   A "mini-bubble phenomena" whereby real estate is being snatched up ? without any concrete plans for its use ? in anticipation of the future appreciation of its value is beginning to be occasionally seen in urban centers.
   With the bottoming out of real estate prices, moves by various real estate companies to explore new growth strategies are beginning to surface.
   In August 2004, Mitsubishi Estate Co., Ltd. completed its Marunouchi 1-chome redevelopment project (the area in front of Tokyo Station). The company can now expect to add nearly 10 percent to its operating profit. With the completion of the first stage of its redevelopment project, Mitsubishi Estate announced its second stage redevelopment project in which it will invest a total of 450 billion yen to rebuild seven or eight commercial rental buildings located in the Marunouchi district in ten years beginning 2008.

A New Strategy: Earning Commissions through Development and Tenant Acquisition

   Companies such as Mitsui Fudosan, Co., Ltd. is striving to make a major shift through a new strategy in which investors will provide the necessary funds for development, and the company will make earnings through commissions for development and tenant acquisition.
   The consolidated results of all four majors in the real estate industry - Mitsui Fudosan, Mitsubishi Estate, Sumitomo Realty & Development Co., Ltd. and Tokyu Land Corporation - for the year ending March 2004 showed gains in current profits. All four companies are anticipating positive business performance for the year ending March 2005 as well, with increases in both sales and profit. Factors common to these companies are that the expansion of their profits are been driven by lowered tenant vacancy rates in their commercial rental buildings businesses, expansion of the number of condominium apartment rooms for sale, revitalization of their real estate brokerage businesses, and decreased interest payment expenses achieved through the refinancing of corporate debentures.


Land Prices Plunge after the Collapse of the Bubble Economy

   Japanese real estate companies were managing their businesses under a heavy debt load. During the bubble economy of the latter part of the 1980s when land value continued to soar, real estate companies could make a major profit through price appreciation by purchasing property using huge funds borrowed from financial institutions and then selling the property after its value increased. However, land prices plunged after the bursting of the economic bubble in the 1990s, creating a tragic situation in which the more they sold property, the more their losses swelled. One option was for companies to hold on to their property without selling it, but that would then result in a heavy financial burden in the form of interest payments.

   Furthermore, under circumstances where a reversal in the fall of land prices could not be expected, hanging on to property contained the future risk of greater losses on sale. They were in a catch-22 situation in which they could neither advance nor withdraw.

The Adoption of Current Value Accounting Accelerates Depreciation in Prices

   Furthermore, through the adoption of current value accounting, it became necessary for companies to automatically record appraisal loss if the current value of the shares or real estate it held became lower than book value. This causes an immediate direct hit on business performance. For this reason, a move to sell out real estate and shares began to become stronger among some listed companies, bringing about a vicious cycle that further accelerated the fall in share and real estate values.
   In this hopeless situation, even the repayment of loans became difficult, and the real estate industry saw bankruptcies among some small and medium sized enterprises with weak financial foundations as well as major companies with excessive debts.

Three Key Points towards the Future

Point 1
Will Land Prices in Urban Areas Rise Further?

The redevelopment rendering of the Yaesu entrance at JR Tokyo station. Twin skyscrapers are scheduled to open in 2007, and pedestrian decks connecting them will be completed later.
The redevelopment rendering of the Yaesu entrance at JR Tokyo station. Twin skyscrapers are scheduled to open in 2007, and pedestrian decks connecting them will be completed later.

   The first key point for forecasting the future of the real estate industry is whether land prices in urban areas will continue to rise.
   Central Tokyo is teeming with redevelopment projects right now. The large-scale redevelopment projects in Shiodome, Shinagawa and Roppongi have been completed, but there are other large-scale projects waiting in the wings, such as development on the Yaesu Exit side east of Tokyo Station. The Japanese government is also trying to boost the renewal of cities by setting up special measures laws and providing tax breaks, etc.

   Additionally, there is a continuing active trend among the baby-boom generation to return to Tokyo. They are selling off their houses in the suburbs and buying condominiums in central Tokyo. The children of these baby boomers are starting to enter their 30s, reaching an age for purchasing homes. This will also enhance demand in urban areas.
   Triggered by such factors, it is thought that the demand for both commercial and residential properties in cities will continue to remain strong.

Point 2
Will the Tenant Vacancy Rates at Commercial Rental Buildings Continue to Improve?

Amount of construction work orders received

   The headache for the real estate industry is the "2007 Issue." The baby boomers will start reaching the retirement age of 60 from 2007. There is concern that with a massive amount of retirees arising, the demand for office space will decline from that time, causing tenant vacancy rates to rise and resulting in a direct hit on the earnings of real estate companies. Redevelopment projects will continue on a high level, so there is a possibility that supply will exceed demand. However, those that will be directly hit with the negative effects are inconveniently located small and medium-sized commercial rental buildings with cramped office spaces. There is possibility that the tenant vacancy rates of the large-scale high-rise buildings owned by major real estate companies will fall even further as the economy picks up.

Point 3
Will New Products Help Expand Real Estate Company Earnings?

   Companies such as Mitsui Fudosan are moving towards the adoption of a strategy whereby they have investors, such as those from overseas, provide the funding, and the companies make earnings from commissions on development and tenant acquisition. A recent hot topic is the Real Estate Investment Trust (REIT). REIT is a financial product in which funds are collected from multiple investors and used to purchase property. Investors receive dividends from the rent or the profit on sale that is generated by the property. Real estate companies are trying to make REIT a new source of income by becoming REIT placement entities.
   There are also an increasing number of companies that have their eyes on the liquidation of real estate. In this business, they buy real estate sold in the course of disposing nonperforming loans, attach added-value, and resell it to investors. It is not as lucrative as it once was since the number of companies involved in this businesses has gradually increased, but it looks like there will still be room for growth over the next few years.
   The sources of income for real estate companies will probably be expanding as they take on new real estate related products.

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