Distress Real Estate Sales - Foreign Funds Handing Back Keys

Shinsei Bank's headquarters in Tokyo is an impressive structure, with its multi-storey, glass-encased entrance hall and offices overlooking Tokyo’s lush Hibiya Park. But the building is attracting interest not so much for aesthetic reasons as doubts over its future.

A sharp fall in Tokyo property values over the past two years is raising questions in the market over whether a fund managed by Morgan Stanley, which acquired the building for Y118bn ($1.4bn) in early 2008, could end up handing the keys over to its creditors if it is unable to refinance its loans when they come due early next year.

The Shinsei Bank building, soon to be vacated by its sole tenant, is just one of the most prominent among a clutch of properties in Japan that investors believe could end up on the market

In the wake of the global financial crisis, a renewed plunge in property prices in Japan has fuelled expectations of a new era of distressed asset fire sales, an opportunity specialist funds have been hungrily eyeing.

Bankers to a fund managed by Goldman Sachs are believed to be looking to sell the Tiffany Building after the fund, which bought the building for Y38bn at what is now seen to be a peak price, chose to walk away when its loan came due this year, leaving the property under the control of its lenders. “Japan will be the first to pass through this ordeal because the lending terms for non-recourse loans made for real estate investments are short, at three years,” says Tetsuji Takenouchi, who heads the commercial mortgage-backed securities team at Moody’s in Tokyo.

SCJ Investment Management, which has since March bought about Y20bn of loans made during the peak years of 2006 and 2007, believes about Y200bn of such loans, excluding those held by the former Lehman Brothers, could be sold between 2009 and 2011.

“The distressed market is beginning to come to the fore in Japan right now,” says J-P Toppino, SCJ president, which is raising up to $350m to invest specifically in distressed debt.

Fortress, the alternative investment group, has invested Y20bn of its Y75bn Japan Opportunity Domestic Fund, which targets real estate-related debt.

Capmark formerly known as GMAC, the financing arm of General Motors, which is currently in liquidation, is expected to sell its portfolio of real estate loans, believed to be in the range of $1bn-$2bn.

Japan was a treasure trove of lucrative investment opportunities after the asset bubble burst in the early 1990s, with funds managed by Goldman Sachs and Morgan Stanley among many believed to have booked handsome profits.

But while this year was expected to be one of the biggest years since for distressed asset sales as loans made in 2006-07 come due, activity has not been nearly as high as anticipated.

Many of the distressed asset sales have been by funds that have borrowed from foreign financial institutions that are unwilling or unable to refinance troubled deals.

“At this point, what you have is mostly foreign institutions selling positions” that were originally intended to be securitised, says Mr Toppino.

But Japanese lenders have been reluctant to foreclose on their loans, as they would have to book their losses.

“Japanese banks are relatively healthy, so rather than sell their distressed assets to allow distressed asset funds to make money, they are holding on to them and refinancing,” says a senior Japanese regulator.

Furthermore, many players are convinced that “if we are not at the bottom of the market, we are not very far from it, so why don’t we refinance for one or two years,” says Michael Bowles, national director, Asia Capital Markets, at Jones Lang LaSalle in Tokyo.

The question is whether there is any justification for that optimism.

With uncertainty clouding the global economy, a recovery in Japanese asset prices is hardly assured.

The property slump has become entrenched. With the exception of 2006 to 2008, commercial real estate prices in Tokyo have fallen every year since 1991.

The reluctance of the domestic banks to foreclose on their loans could risk “[dragging] the pain on for another two to three years” and slowing the recovery in real estate in Japan, says Mr Bowles

http://www.ft.com/cms/s/0/c6a82202-d61e-11df-81f0-00144feabdc0.html