Safe from subprime?

Japan, Inc., May-June, 2008 by Brad Frischkorn

With the break of the subprime mortgage crisis in the summer of 2007 and the global scale of its spread, the parade of negative real estate related news has been relentless as financial institutions fall, central banks launch massive credit-easing campaigns, and home foreclosures put many on the street--all with shocking swiftness. After experiencing its own real estate market collapse through the 1990s, Japan is certainly no stranger to this kind of pain. Should the country brace itself for another round of carnage?

"The way real estate is now packaged and repackaged, it is not really real estate like we used to know it," cautions Kentaro Sato, a securitization analyst with a foreign investment bank. "In many places, it's just another financial product." As such, he says, real estate has become just as subject to speculative buying and selling, fear and hubris routinely seen in the stock, commodities, options and futures markets.

The Spread of Securitization

The meteoric growth of so called asset backed securities (ABS) in recent years has illustrated this trend. ABSs are debt securities based on pools of diversified assets made from a receivable--from credit card payments and auto loans to more exotic cash flows. Globally, MBSs (mortgage backed ABSs) have gotten an increasing share of bank and lender attention, particularly as US and European markets have rapidly expanded with rising asset prices.

While Merrill Lynch, Morgan Stanley, Citigroup and others have announced large losses on mortgage and securitized mortgage-based investments in recent months, the subprime meltdown spelled the veritable end for 86-year-old Bear Stearns, one of the largest underwriters and traders of mortgage bonds in the US, and for Countrywide Financial, that nation's largest home lender and subprime debt collector. On April 1, Swiss-based UBS AG announced forecast losses and write-downs of US$19 billion in the first quarter; its $37.4 billion loss total for the past nine months tops all banks to date.

Japan has embraced the MBS trend, especially in residential mortgage backed securities (RMBS), where the Government Housing Loan Corporation (GHLC) is the largest player. From 2000 to 2006, the market grew from virtually nil to some 160 trillion in issuance, with GHLC alone behind around 40% of that total. Many experts point to continued aggressive growth as Japan shifts to a rising interest rate environment.

But even so, the scale of the residential mortgage market against GDP is only about 30% in Japan, less than half that of the US and comparatively low among developed countries. And while the value of real estate in overseas markets has soared over the last decade, Japan's residential mortgage market has been substantially hit by prolonged economic slowdown and asset deflation, writes Koyo Ozeki, executive VP at PIMCO in his March 2007 report Japan Credit Perspectives.

As in the US, residential mortgage remains a burden for Japan's household budgets, where the mortgage-to-disposable income ratio is currently around 132%. But with the virtual disappearance of the high-risk market in the 1990s, Japan really has no equivalent to the US high-risk subprime market, Ozeki says. Outside the US, Canada, Australia, and the Netherlands, MBS instruments are actually not very widespread.

Different financial animals

Japan's real estate market is a study of contrasts in many respects, especially when viewed from the perspectives of large urban versus regional areas, and for residential versus industrial and commercial space. Industry location, demographics, logistics, foreign investment and other factors all come to bear in the comparison. But the most intense interest in Japanese real estate has traditionally been centered on Tokyo, where some bellwether transactions have recently been reported.

Last summer, Goldman Sachs Group acquired the property and the building of US jewelry retailer Tiffany & Co's main Japanese outlet in glitzy Ginza. The 37 billion price tag made it the nation's most expensive piece of real estate; Goldman's bid was also substantially higher than the 16.5 billion Tiffany's paid for the facilities in 2003. Separately last February, Morgan Stanley agreed to sell The Westin Tokyo, an upscale foreign hotel in Meguro, for 77 billion to the Government of Singapore Investment Corp (GIC).

The two deals, done during the heat of the ongoing subprime meltdown, may illustrate several impressions about Tokyo land: 1) some areas, while expensive, may still be seen as value investments, and 2) the sub-prime problem is not seen as having major fallout. Goldman's purchase was actually its second in Ginza last year, while GIG, with more than $200 billion in assets under management, is one of the biggest sovereign wealth funds in the world, and known for identifying stable investments.

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"The attractiveness of the Tokyo market is the thinking that prices have to bottom out some time," says Gordon Hatton, Executive Officer at Bovis Lend Lease Japan.