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A new phase: with the dramatic ups and downs of U.S. real estate, Japan has begun a period of 'disinvestment.'

Institutional investors are aggressively pursuing opportunities to acquire real estate assets from Japanese owners and lenders in what may be the next wave of commercial-property sales in the United States.

In recent years, pension funds, real estate investment trusts, corporations, credit companies, foreign buyers, and funds sponsored by investment bankers and real estate companies have allocated billions of dollars for the acquisition of portfolios of real estate assets or individual properties. The sellers have mainly been the Resolution Trust Corporation, individual owners, and life insurance companies and banks that have restructured and sold portfolios of performing and nonperforming assets and real estate owned. * Now that the RTC and many private owners have nearly completed their restructuring programs, there could be fewer chances to acquire assets. With many well-capitalized investors still in the market, however, the competition for assets has intensified. In this environment, investors re looking for new opportunities in the acquisition of Japanese-owned assets. * Many Japanese owners, including trading, real estate, construction, insurance, and investment companies, are actively marketing their U.S. properties. So are many Japanese banks and other lenders that took back properties from Japanese or American borrowers (those who had difficulty repaying their mortgage loans and are cooperating with the banks in selling the underlying properties). This year, the Japanese are expected to dispose of between $5 billion and $ 10 billion of properties.

Before approaching Japanese owners and attempting to negotiate deals, however, U.S. investors need to do their homework. They need to understand the evolution of Japanese investment in U.S. real estate, the motivations and expectations of the Japanese in owning U.S. properties, and their strategies for holding or selling these assets.

Ten years ago, the Japanese were generally considered novices in the U.S. real estate market. Now they are seasoned veterans, with total investments of more than $77 billion. Their history in the U.S. market can be divided into two phases: investment and "disinvestment." From 1985 to 1991, the Japanese were major investors in U.S. real estate. In 1988, during the U.S. real estate boom, they invested a record &16.54 billion. Subsequently, the U.S. economy fell into a recession, U.S. property values declined, and Japan's "bubble" economy collapsed. By 1992, Japanese investment had fallen to only $810 million.

In 1993, the Japanese entered the disinvestment phase. By the end of that watershed year, they had:

* Sold $2.6 billion of properties.

* Contracted to sell another $800 million of properties.

* Deeded $1.4 billion of properties back to lenders.

* Restructured $12.7 billion of problem assets.

All told, the Japanese sold. contracted to sell, or restructured $17.5 billion of assets in 1993. By contrast, their new investments totaled only $710 million.

During 1994, the Japanese finished restructuring the bulk of their troubled assets and focused on sales of assets they had targeted for disinvestment. According, to an analysis by the E&Y Kenneth Leventhal Real Estate Group, which has been tracking Japanese investment activity for the past 10 years, by the end of last year they had sold $2.2 billion of assets, contracted to sell $1.4 billion worth, and were actively marketing another $2.8 billion. The three categories of 1994 disinvestment--sale, under contract for sale, and marketed for sale--totaled $6.4 billion. While the Japanese were actively selling assets in 1994, they practically stopped making new investments in U.S. real estate.

In 1994, Japanese disinvestment activity was concentrated in two categories of properties: hotels/resorts and office. The first category accounted for $2.8 billion, or 44 percent of such activity, and the second for $1.7 billion, 27 percent. California, Hawaii, and New York, the leading states for Japanese investment, were also the leaders in disinvestment.


In managing their U.S. real estate assets, Japanese owners and lenders have been following three basic strategies:

* hold and wait;

* sell and liquidate; or

* hold and sell (hybrid).

The particular strategy adopted by individual owners and lenders is determined by a number of considerations, including the economic outlook and property market conditions in both Japan and the United States, the strength of the yen, and the prices that the Japanese expect to receive for U.S. properties.

Japan's Economy

Since Japan's "bubble" collapsed in the early 1990s, its economy has had little or no growth. In 1994, Gross Domestic Product increased only about one percent, and that was achieved primarily by government stimulus in the form of a midyear tax cut. The strong yen, economic losses from the Kobe earthquake, corporate downsizings, slumping stock and real estate markets, deflation, and general consumer pessimism point to another year of sluggish growth in 1995.

Over time, however, rebuilding from January's earthquake will help to boost growth. Public expenditures of an estimated 3.7 trillion yen ($44 billion) will be required to replace or repair earthquake-damaged freeways, roads, bridges, and other infrastructure as well as commercial buildings and housing. In addition, the government plans to spend as much as 63 trillion yen ($741 billion) over a 10-year period to retrofit or rebuild infrastructure throughout Japan.

Financial System

In January of this year, Sumitomo Bank announced that it would write down $8 billion in bad loans and take a $2.8 billion pretax loss for the fiscal year ended March 3 1. Sumitomo's loss was the first by a major Japanese bank since World War II. Until Sumitomo's action, Japanese banks had always covered losses by selling off their stock portfolios as the end of the fiscal year approached. The government had pressured banks not to report tax-deductible losses because such losses could undermine public confidence in the financial system. Sumitomo's announcement as the most candid admission yet of loan-quality problems in Japan. Sumitomo presumably took its action in close consultation with the Finance Ministry and the Bank of Japan. This may signal a change in government policy to allow banks to disclose such losses. In the near term, however, most banks are not likely to follow Sumitomo. Few have the capital to withstand massive writedowns in a single fiscal year. But with government support, banks will gradually implement programs for taking writedowns, reporting losses, and disposing of problem loans.

U.S. Market

The economic and regulatory climate at home has had an effect on Japanese owners and lenders in the United States. Japanese banks and other lenders have been the most aggressive in selling their U.S. real estate assets, accounting for $3.7 billion, or 58 percent of 1994's disinvestment activity. Two banks completed sales of three major portfolios of real estate assets totaling more than $600 million in book value. Japanese banks are expected to remain very active this year, selling properties individually or in bulk through a competitive bidding process that has proven highly successful. Through such sales, the Japanese are trying to free capital for other purposes and devote their resources to concerns other than problem real estate.

Japanese owners accounted for $2.7 billion, or 42 percent of 1994's disinvestment activity. Compared with the lenders, owners have tended to hold their investments, although some contractors have begun to liquidate their holdings in order to free capital for private investment in Japan's rebuilding programs.

In 1993, when commercial-property values were generally at their cyclical lows, some Japanese owners and lenders elected to sell their properties. Most, however, decided to continue holding them. By following this strategy, they benefited from an increase in commercial-property values in 1994. Japanese-owned properties sold at an average of 56 percent of book value in 1994, while properties listed for sale or under contract for sale were expected to sell for 60 to 65 percent of book value. By comparison, Japanese-owned properties sold for an average of 50 percent of book value in 1993.

In 1994, the gap between the prices the Japanese wanted for their properties, and those prices U.S. buyers were willing to pay, narrowed significantly. In mid- 1994, the E&Y Kenneth Leventhal Real Estate Group conducted a survey in Tokyo of senior executives of leading Japanese banks and insurance, financing, and leasing companies, as well as real estate and construction companies. The survey found that companies would sell their U.S. investments if they could realize 70 to 80 percent of the original book value. Based on actual sales transactions in 1994, many agreed to accept substantially less than 70 percent, which helped to increase sales last year.


Many Japanese owners and lenders would like to sell their U.S. real estate assets and repatriate the cash to Japan. But they would not be able to recover the full value of investments typically made in the late 1980s at the peak of the U.S. real estate market. Another consideration is the strong yen. For nearly 10 years, the yen has been strengthening against the dollar. In recent years, it has grown even stronger. Since the beginning of 1995, it has increased more than 20 percent in value. Thus, when converting the proceeds from U.S. real estate sales from "cheap" dollars to "expensive" yen, Japanese owners and lenders would take less money back to Japan than five years ago when the yen was weaker.

This point is illustrated in the accompanying chart. Assume that a Japanese investor purchased a U.S. office building in 1990 for $100 million, or 14.5 billion yen, based on an exchange rate of 145 yen to the dollar. In 1995, the investor sells this property for $50 million. or a 50 percent loss. In converting the sales proceeds to yen, the investor realized 4.25 billion yen. or a currency exchange loss of 71 percent. Thus, Japanese owners and lenders take a double hit in disposing of U.S. properties: first, selling them for less than they paid for them, and, second, converting the dollar sales proceeds to yen. As previously noted, however, Japanese owners and lenders are expected to continue selling assets in 1995. There are a number of reasons:

* Uncertainty over whether the yen will continue to strengthen against the dollar.

* The need to repatriate capital to Japan.

* The continuing recovery of U.S. real estate markets.

* The opportunity to sell properties at higher prices than last year.

* Increased demand from U.S. buyers for Japanese-owned properties.

Japanese owners and lenders must address the important question of how long the window of opportunity for selling assets will remain open. As U.S. property values have continued to increase, yields have continued to decline. If this trend persists, real estate investors may elect to pull out of the market to seek higher yields in other types of investments. Fewer buyers may be in the market in 1996 than in 1995.

For their part, U.S. investors have opportunities to buy three types of assets from the Japanese: properties, loans secured by real estate, and real estate loans in which Japanese banks have participating interests. At least for the present, there is strong competition for Japanese assets, and investors may need to move quickly.

In the market for Japanese-owned U.S. real estate, this could be a good year for the Japanese to sell and for U.S. investors to buy. Jack R. Rodman and Date Strickland are members of the E&Y Kenneth Leventhal Real Estate Group, Los Angeles, CA, (310) 277-0880.

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