Investing in J-REITs

Sumitomo Mitsui Trust Asset Management (SuMi TRUST), one of Japan’s largest asset managers, manages over US$646 billion as of the end of March 2023. The company has been recognised in multiple categories in the Asia Asset Management (AAM) Best of the Best 2023 Awards.

Notably, SuMi TRUST won the award for Best REITs Manager (Japan) for the second time, in recognition of its Japan Quality REIT Strategy (JQR).

Managed by Chief Portfolio Manager Shigemitsu Kurihara, who has been engaged in real estate investment and portfolio management for over 20 years, the strategy aims to generate stable returns by investing in listed Japanese REIT (J-REIT), whose market size is the second largest globally after the US. The strategy values the quality of the real estate owned by J-REIT and the property management capabilities of the asset management company based on the assumption that the greatest source of return in J-REIT investment is the quality of the property to generate cash flow. 

Market Overview

With a track record of over two decades, J-REITs were first established in 2001. Today, with a market capitalisation of over 15 trillion yen (US$113 billion), it is the second largest REIT market globally after the US, and with a trading volume of 30-50 billion yen per day, is a liquid asset class. Currently, there are 60 listed J-REITs, made up not only diversified REITs that own multiple types of properties, but also those that only own specific properties such as offices, residences, logistics, commercial facilities, and hotels.

“One of the attractiveness of the J-REIT market is the wide yield spread,” notes Shigemitsu, pointing to the gap between J-REIT yields and 10Y JGB interest rates. 

“Due to the continuing monetary easing policy by the Bank of Japan, the yield spread between J-REITs and 10-year government bonds has reached an attractive level when compared to other countries,” he adds.

In addition, he also highlights the advantages of differences in interest rates between the US and Japan that allow foreign investors to earn a foreign exchange premium in the short term through an interest rate gap, and the fact that the generally accommodative lending attitude of financial institutions under ultra-low interest rates makes it easier for J-REITs to raise funds.

Moreover, he stresses that the properties held by J-REITs are located in large cities with population inflows despite the shrinking population in Japan as a whole country. Indeed, in terms of metropolitan areas, Tokyo has the world’s largest population of approximately 38 million people, and is projected to remain one of the world’s most populous cities by 2035. Approximately 50% of the properties owned by J-REITs are located in the 23 wards of Tokyo, and around 90% are situated in the two major metropolitan areas of Kanto (the Greater Tokyo Area) and Kinki, the southern-central region of Japan’s main island, the second-most populated in Japan after the Greater Tokyo Area. Shigemitsu anticipates that the inflow of population into urban areas to lead to increased demand for offices and residences, as well as increased sales of commercial facilities, which should provide a boost to the J-REIT market. He also expects an improvement in the hotel sector due to the increasing number of foreign visitors to Japan thanks to the lifting of the border restrictions.

ESG engagement

ESG engagement is another important characteristic of the J-REIT investment market, according to Shigemitsu. Moves to actively incorporate external evaluation standards, such as an increase in the number of J-REITs participating in GRESB Real Estate, an international ESG evaluation designed for the real estate sector, have resulted in 57 of the 61 listed J-REITs now participating. 

Here, he points to the advantages for each J-REIT to conduct environmentally friendly operations, for example by switching to LED lighting fixtures, reducing greenhouse gas emissions, and installing solar power generation systems on roofs to reduce utility costs and other expenses. “In addition, by attracting tenants such as companies and financial institutions that place importance on ESG investment that are willing to move into such environmentally responsible properties, it is expected that the occupancy rate of the properties will increase and rents will rise,” explains Shigemitsu, citing a report from Sumitomo Mitsui Trust Research Institute, a Sumitomo Mitsui Trust Group company, which states properties that have acquired environmental certification can command around 4.6% higher rental prices than those at properties without such certification.

Investment Strategy Overview

Shigemitsu acknowledges that the greatest source of return in J-REIT management is the ability of REITs to generate cash flow from the properties they own. 

“Based on the investment philosophy that the ability of real estate to generate cash flow depends on the quality of properties held by J-REITs and the property management capabilities, we place importance on the quality of properties held by J-REITs and the property management capabilities. Given our valuation analysis by referring to indicators such as dividend yield and Price to Net Asset Value (P/NAV), we manage our portfolio to ensure stable dividend income and to earn excess returns over the medium to long term,” he adds. 

The investment strategy is centred around a unique investment process that leverages the rich resources of the Sumitomo Mitsui Trust Group under an investment structure that brings together the full power of the Group. First, in assessing the quality of individual properties held by J-REITs, SuMi TRUST utilises the property valuation capabilities of Sumitomo Mitsui Trust Bank (SuMi TB). SuMi TB then rates each J-REIT on a six-point scale for quality evaluation for underlying properties. Second, in assessing the property management capabilities of each J-REIT, Shigemitsu utilises the assessment capability of Sumitomo Mitsui Trust Research Institute (SuMi TRI), which specialises in the fields of real estate markets and real estate finance. SuMi TRI evaluates J-REIT managers in terms of their real estate management capabilities, financial management capabilities, and operational reliability and stability. In addition to the data collected from SuMi TB and SuMi TRI, Shigemitsu then evaluates the valuation of each J-REIT and constructs a portfolio. 

The strategy also focuses on environmental considerations and sustainability in property management and incorporates into the investment process for each J-REIT the confirmation and evaluation of the status of initiatives and acquisition of environmental certifications such as CASBEE, GRESB, and DBJ Green Building.

ESG Assessment Framework

ESG ratings of J-REITs owned by the JQR are evaluated both quantitatively and qualitatively. Shigemitsu’s evaluation framework is designed to work collaboratively with SuMi TRI, which quantitively evaluates individual J-REIT names based on environmental, societal and governance elements. SuMi TRUST also examines initiatives to enhance ESG activities based on 80-100 items for assessment and reviews them as needed. 

Meanwhile, to ensure effectiveness of the qualitative assessment, and to confirm the location and condition of J-REIT properties, since April 2022 Shigemitsu has visited 260 properties owned by J-REITS throughout Japan. 

“Seeing is believing, and I believe it is critical to visit properties to see if they include LED lighting and other environmentally friendly measures, and to confirm the location and condition of J-REIT properties,” he says. He has also met with the management teams of all 60 listed J-REITs, not only to discuss their financial performance but also to discuss management focus as well as their progress on ESG-related issues. 

Heading into 2023, Shigemitsu intends to incorporate ESG qualitative assessment to a deeper level by leveraging the property assessment capabilities of the SuMi TRUST Group, one of the major players in the Japanese real estate market.

SuMi TRUST was also recognised by AAM with awards for Best Performing Large Cap Equity (3 Years), Best Equity Manager (Japan) and Best Impacting Investing Manager (Japan).