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Growing assets for one of Japan's best managers

Interview - June 7, 2022

The COVID pandemic has had many lasting effects across many industries, one of them being real-estate. Even though regional markets have struggled throughout the last two years, Japan has proved more stabled and has recovered much quicker than most. In this interview, Daiwa House Asset Management's president & CEO, Koichi Tsuchida, explains how Japan has managed to rebound after COVID, in addition to the plans for the growth of his firm. 


Can you give us a brief introduction to your company?

Daiwa House Asset Management is the asset manager of Daiwa House REIT. Currently, a total of 61 J-REITs have been listed in the market, and we, Daiwa House REIT, can confidently say that our assets, equivalent to JPY 895 billion, place us as the fifth largest. I believe that our greatest strength stems from sponsor support of Daiwa House Industry. Annual sales of Daiwa House Industry amount to JPY 4 trillion and their business is strong across a wide range of areas from residential to commercial and logistics facilities. Daiwa House Industry has recently expanded their overseas business by investing in American residential companies and Asian logistics facilities through M&As. They have adopted the value chain business model, where they start with contemplating the best way to utilize a plot of land. Would it be for a residential facility, office, logistics facility or commercial facility? The diversity of their business leads to versatility of buildings to be constructed. Daiwa House Industry has a tenant leasing business where they can manage facilities and buildings on operation, but their mainstay business is construction contractor. To keep developing real estate assets in terms of cash flow, they plan to sell those assets at some point. By selling the developed assets to Daiwa House REIT, management of the assets will be kept within the group, which would otherwise be lost if they are sold to third parties. In the past three-year period, Daiwa House Industry has invested JPY 1 trillion in the real estate development business, in which JPY 650 billion was allocated to the logistics sector, according to their medium-term management plan. They develop logistics facilities that meet their clients’ needs. As I have mentioned, they do not mainly generate profit through the real estate market or stocks but through subcontracting or entrusted business. They prefer to sell them to improve their cash flow, and a total of JPY 670 billion was generated in the last three years, or about JPY 200 billion each year. As a real estate investment entity, we, Daiwa House REIT, have the right to start the negotiations, which means that we can specify what we want when we acquire properties. Utilizing our preferential negotiation rights, we have acquired about JPY 70 billion to 80 billion in assets every year in the past five years. Blackstone and other foreign companies have asked Daiwa House Industry to sell those assets through some kind of overseas funds; however, the sponsor's priority is to support Daiwa House REIT. Of course, Daiwa House Industry would make a significant amount of money if they sell all of those assets to third parties, but that is not what is important. Because those assets have been meticulously developed, they would want to manage those assets within their group. Daiwa House Industry is the top performer in the logistics business in Japan. Looking at the overview of the market, there have been so many companies that have started to take part in the logistics business, which has caused the increase in the land price for the past couple of years. Nevertheless, Daiwa House Industry has seen some opportunities in the acquisition of land. Their coverage extends across the country's archipelago, with a number of bases from Hokkaido to Okinawa, which enables them to gather specific information for their advantage. It is a noteworthy strength. Logistics facilities can be mainly categorized into two types: the build-to-suit and the multi-tenant type. For the build-to-suit type, the tenant has already chosen the area to build their facility, and Daiwa House Industry aims to cater to their needs. The duration of the contract for this type of logistics facility is typically about 20 years. 


Due to the shift of logistics facilities from company-owned to being acquired by J-REITs and democratized to be traded as financial assets, old logistics facilities outnumber financed modern logistics facilities that represent only some 10% of the overall available logistics facilities in Japan. How is your group capitalizing on that opportunity and the lack of new modern logistics facilities in Japan?

Many of the logistics facilities are so-called conventional warehouses.  Buildings and facilities built over 30 years ago account for more than half of the total floor area of logistics facilities. Renewing those facilities or building the facility on an already purchased land to achieve off-balance will be the kind of business that will emerge in the future. The multi-tenant facility has been flourishing particularly in three major regions of Tokyo, Osaka, and Nagoya. The tenants do not give specific requests at the beginning, but when the facility is completed, it will be offered to interested tenants to occupy and start the business. Because the market vacancy is currently about 2%, rents for logistics facilities are on an upward trend. In response to this, more players, including those who do not have in-depth expertise or knowhow in logistics can start participating in that market. In comparison to last year's supply of leasable floor area of 2.5 million square meters in the greater Tokyo area, it will be 3.5 million square meters in 2022, which is 1 million square meters more. We may expect the logistics vacancy rate to slightly increase going forward.


Are you looking to make further investments to acquire more properties in the logistics field, and if so, what are some Key Performance Indicators (KPIs) that you require from facilities that you plan to acquire or purchase in the future?

Last September and October, Daiwa House REIT has acquired four facilities amounting to JPY 72 billion through our global offering, and DPL Nagareyama III, a multi-tenant type logistics facility, is the biggest with a purchase cost of about JPY 32 billion. However, the main risk or concern for us in the future is the declining market cap rate. Our sponsor stands to support Daiwa House REIT. Daiwa House REIT acquired DPL Nagareyama III from our sponsor at appraisal NOI yield of 4.5 %, which I consider a REIT-friendly rate. Daiwa House Industry is developing four logistics facilities in Nagareyama in the greater Tokyo area. Daiwa House Industry tenaciously negotiated with municipalities with regards to land originally used for agricultural business for them to utilize. Daiwa House Industry successfully obtained those conditions and terms, which shows their strength.  That arrangement with municipalities could also contribute to ESG, particularly fostering more local employment, providing work opportunities to women, supporting child-rearing and securing evacuation locations for disasters. To achieve a win-win situation, they need to seal some supplies or stocks in logistics facilities. Even though working in cooperation with local municipalities takes longer, they help Daiwa House Industry acquire properties through negotiations. Last October, Daiwa House Industry constructed DPL Nagareyama IV with gross floor area of about 270,000 square meters. It is 2.5 times bigger than DPL Nagareyama III that Daiwa House REIT owns. The top floor can be used as a child-rearing support facility for working mothers, and it can accommodate 50 children with a rooftop area where children can play.

DPL Nagareyama III

Compared to regional Asian markets, in places like Melbourne or Hong Kong, Japan's market has proved more stable and recovered much quicker from the COVID-19 dip. How do you explain the resilience of Japan's real estate market?

The COVID-19 pandemic has definitely posed persisting challenges as Japan faces its sixth wave of infections. The tourism industry, including commercial facilities and hotels, has been the hardest hit sector; however, the government has set up certain countermeasures, such as specific border controls and a higher rate of vaccination in the population. I think these have helped in controlling the situation and enabling us to host the Olympics and Paralympics. I think that the COVID-19 will continue to evolve, and we cannot go back to how things were before the pandemic. Like the flu, we may need to coexist with these viruses in the future, but we really hope that the economy will recover quickly through strong governance.


In 2018 the ratio of foreign to domestic capital invested in Japan's market was around 21 %, but by 2021, foreign capital accounts for some 35 % of all transactions in the Japanese real estate market. Can you share with us why you believe these changes occurred? What is the importance of attracting foreign investors for your business?

I think one thing that attracts foreign investors to the Japanese real estate market is the low-interest rate. Also, considering the macroeconomic situation, real estate prices in Japan are relatively low for international investors because of the foreign exchange rate, and rent can be further raised in Japan's real estate market to improve expected cash flow. About 25 % of our investments come from international investors, and our transparency has been very well received by them. Daiwa House REIT discloses certain information to assure them that we are running a legitimate business with good governance, and we are putting forth ongoing efforts towards ESG. Most importantly, we emphasize providing data and information about our business and our business performance in English and Japanese.


The level of information disclosure of bilingual documents has considerably increased since 2018. What do you think can be done to further enhance transparency in the Japanese market? How much has transparency improved over the past four years? 

I think one thing that has changed over that period is governance in ESG, such as the increase of external and female directors in Japanese companies. Some people may claim that Japan has been falling behind environmental-related efforts, but that is an area that has been experiencing notable improvements over time. 


Japan's population is aging and declining, but in major urban centers like Tokyo and Osaka, the population is expected to continue to increase for many years to come which has led to many trends in the residential sector. For example, elderly people are selling their homes in rural or suburban areas in favor of mansion-type apartments in urban or metropolitan areas. How do you expect Japan's demographic situation to impact the metropolitan housing sector going forward?

Due to Japan's declining population, some people wonder if residential businesses will continue to grow as an industry. Housing starts in Japan peaked at about 1.8 million units but have declined to about 0.8 million units. Yes, people desire to go to urban areas for a better life; however, with the advent of the pandemic, people started to look at suburban or rural areas because they can work from home with much more space. I do not think it is going to be a serious problem for us. Real estate prices have increased, especially in urban areas. I saw on Nikkei news recently that there are roughly 30,000 mansion-type apartments in Tokyo under construction where the Olympics and Paralympics were held last year. Those mansion-type apartments will be completed in two to three years, especially in areas like Kachidoki, Harumi, or Tsukishima. We will have to wait and see if it will positively affect us or put us in a difficult situation. There are already nine million empty or unoccupied houses, mostly in the rural areas of Japan. It is another problem that we have to deal with. Furthermore, we have to figure out how to renovate the residential complex buildings built during Japan's high economic growth 50 years ago in order to attract more people. 


Besides Tokyo, Osaka, and Nagoya, other regional cities have been attracting more attention, such as Fukuoka because of its young population, growing business, and redevelopment around the metro station drawing in many startup companies. Outside of Tokyo, what do you think are the most interesting destinations for investment?

We are highly interested in areas that have growing and young populations. We are looking at Fukuoka as it is the biggest prefecture on Kyushu Island with a growing population and an increasing price of real estate. When the pandemic situation settles down, we can expect the recovery of inbound tourism from South Korea, China and Taiwan. Those tourists may be interested in Fukuoka and the hot springs in that area. Before the pandemic, we had a large-scale cruise passenger ship that accommodated many Chinese tourists who enjoyed exclusive purchases in the Japanese market. We are also remaining alert about the expo in Osaka scheduled for 2025. 


Your recent property sales include the Big Tower Minami Sanjo in Sapporo, and the Ohori Bay Tower in Fukuoka. Can you tell us what motivated you to relinquish all these properties, and what kind of strategy are those property sales a part of? 

Those recent sales slightly differ from the rest of our good properties because it has already been more than 10 years since they were completed. Since we were expecting large-scale renovations or repair work for those properties, we decided to sell them because it would have been difficult to cover the expenses required even by raising the rent.


Imagine we come to interview you again in five years. What objectives or vision would you like to have achieved by then?

My vision is to secure stable revenues for the midterm and long term as well as stable and satisfactory dividends for our investors. We need to determine the kind of real estate properties we can utilize in our business to attain that. As I said at the outset, our biggest strength is sponsor support. To further fortify that, we have to keep an eye out for the needs of the real estate market to have a starting point in our acquisition of properties. For now, the demand is in logistics facilities, but it may be data centers or nursing facilities in the future. We seek to acquire excellent assets for our stakeholders.