Tuesday, November 6, 2012

Mitsui Fudosan and Shuwa Investments: Then and Now

Mitsui Building in Tokyo's Shinjuku district, Nov. 2, 2012

Some of us still remember a time, about a quarter of a century ago, when rules of valuation of office buildings were completely ignored in an ego-fueled Japanese buying binge.

The competition between Shuwa Investments Corporation and the real estate subsidiaries of Mitsui, Sumitomo and Mitsubishi in overpaying for real estate became insane. (“Mitsui Fudosan”, established in 1941, means “Mitsui Real Estate”)

For instance, the Exxon Building in New York was already listed for sale for $330 million when Mitsui came in and offered $610 million, or 85% above list price in 1986. When Mitsui representatives were later asked (after the deal closed) why they bid 85% above the list price, they said it was because Mitsui’s president wanted to be in the Guinness Book of World Records, and the previous high price for an office building had been $600 million [per Roger Simon Farrell, A Yen for Real Estate: Japanese Real Estate Investment Abroad – from Boom to Bust, 2000, Edward Elgar Publishing, Cheltenham, UK].

Not to be outdone, Shuwa Corporation acquired the Arco Plaza in downtown Los Angeles for $650 million in 1986, only to spend tens of millions more on asbestos abatement. Many of us who worked in L.A. in the late 1980s sat by our phones hoping for a call from Shuwa’s headhunter, because working for Shuwa meant being welcomed anywhere like a binge-shopping Arab sheik or Elizabeth Taylor at a jewelry store. 

By the end of the 1980s, though, Shuwa had lost its luster and even attracted local consternation in L.A. when local employees sued for being physically beaten at work. Finally, in 2002, the troubled loan from the Bank of Tokyo for all of Shuwa’s downtown L.A. office buildings was bought for $255 million.

"Yoshi-san just spent $650 million for Asbestos Plaza ! Hit him !"

[Disclaimer: Not an actual photo of employee beatings at Shuwa Corporation]

The causes

There was a perfect storm of causes that resulted in this legendary period of Japanese misinvestment:

a. The appreciation of the yen, starting in the mid-1980s. The Japanese manufacturing miracle suddenly elevated the yen to a status in which the rest of the world looked cheap.

b. Japan’s extraordinarily low cost of capital, which allowed borrowers to settle on lower returns from foreign real estate.

c. Japanese bank regulations which were favorable to real estate because real estate inflation was a fact of life at that time in Japan.

d. Rivalry for prestige among Japanese companies such as Mitsubishi, Shuwa, Mitsui and Sumitomo, which created a competitive haste to acquire trophy properties without adequate due diligence.

e. The Guinness Book of World Records.

f. The use of domestic investment criteria to evaluate overseas investments. In Japan at that time, real estate investors were being enriched by capital gains, and investors looking overseas were so convinced that capital gains would continue that they overlooked current financial performance. Japanese investors did not use DCF models or current rates of return in evaluating their foreign purchase decisions, as they assumed that capital gains would take care of everything.

Mitsui Fudosan today

As a publicly owned company, Mitsui Fudosan was forced to become run in a more sensible manner, and pursued a course as a savvy, diversified real estate developer involved in office, retail, and housing, with new initiatives in logistics facilities, solar power development and private REITs. It is not a J-REIT (Japanese REIT), but a development company focused on growth through value-added projects, and it had a good record in the last decade by increasing revenues by 21% and increasing the dividend from 14 yen per share in 2007 to 22 yen per share in 2009, where it has remained since, equivalent to a current dividend rate of 1.3%. The most recent annual report, however, indicated 4% slippage in revenues, down to 1.338 trillion yen, due mainly to the falloff in the property sales business.

One of Mitsui's most interesting recent projects has been DiverCity Tokyo Plaza, a grand mixed use project on Odaiba Island in Tokyo Bay with an office tower and 154store, "theater-oriented" retail center. Just as New York Harbor has the Statue of Liberty, Mitsui has now given Tokyo Bay a statue of Gundam, a popular Japanese anime character.

Both Jones Lang LaSalle and Cushman & Wakefield have recently published reports that Tokyo now ranks third in the world for new real estate investment, trailing only New York and London, and some of these Tokyo investments are of the "flight to safety" type that also define the New York and London markets.

Part of this "flight to safety", however, is a flight to seismic safety after last year's 9.0 earthquake, creating an interest in new, safer office structures and also causing more functional obsolescence for high-rise structures built before 1981, when seismic standards were considerably strengthened.  The above-depicted Mitsui Building in Shinjuku, for instance, was completed in 1974, although one can observe that the entire east-facing wall of the building is dominated by seismic cross-bracing.

Although the U.S. hasn't had a major destructive earthquake since 1994, there is currently a flight to building safety after Hurrican Sandy caused such unexpected destruction in New Jersey and New York. In this case, tenants are seeking buildings more resistant to wind and water damage. It is not a good time to sell a beach house.

Last year, Mitsui Fudosan had a 25th year anniversary celebration of their acquisition of the Exxon Building, now known as 1251 Avenue of the Americas, in the building lobby.

Shuwa Investments Corporation was dissolved some time during the turn of the century. Being a privately held corporation, they did not have angry shareholders to keep them in line.

Per Jones Lang LaSalle and Cushman & Wakefield, the Tokyo office vacancy rate was last measured at 8.9%, down from over 10% the year before.
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