Urban Design System files for bankruptcy

Today the announcement was made that on August 29 2008, developer URBAN DESIGN SYSTEM announced that it had filed for bankruptcy. The company filed for protection from its creditors under the Civil Rehabilitation Law and the Tokyo District Court accepted its application.  The company’s liabilities totaled 20.38 billion yen (US $180 million).

Urban Design System started as an collaboration of a group of upcoming architects and bloomed into an innovative designer/developer producing some unique work over the past few years.  They began with the cooperative house concept bringing end users and architects together to plan and develop condominiums together, moved into other residential products and then branched into larger projects including retail and hotels.  See pictures of some works here.

In the hotel arena we were very impressed, as were others, with the renovation of a Meguro warehouse into the unique and boutique hotel CLASKA.  The Granbell Hotel in Shibuya is not quite so exciting, more like your standard contemporary Japanese urban look, although fitting to its Shibuya clientele.  But they really upped the ante with the plan for Sezoko Island, a 5-star contemporary beach resort hotel on the secluded north side of Okinawa.

Unfortunately, this huge undertaking has probably become the downfall of UDS, as is the case with many other upcoming developers that have moved quickly to catch up with a fastmoving market through 2007 but now the liquidity rug has been pulled out from underneath.

It will be interesting to see who raises their hands to sponsor the group now, as fundamentals for Okinawa tourism are very good and the UDS projects were good, although those undertaken in 2007 were probably pricey.  Domestic tourists have steadily grown from 2.6 million 20 years ago to an expected surpass of the 6 million mark this year!  That has resulted in direct tourism revenues over $4 billion USD and estimated economic effect over $22 billion.  The perceived `summit effect` of increased tourism after the 2000 G8 Summit held in Okinawa was actually well underway beforehand and since then Okinawa has become the default domestic beach resort destination.

While this has led to an overdevelopment the last few years, leading some companies getting a bit out of control like Zephyr to their recent demise also, the fundamentals are still good and the very well done, truly 5-star hotels are still far and few between.  We`ll be watching to see what eager parties come to the plate this time.

residential zone

The Japan residential sector has been hit hard the last half year:

1) Smaller J-REITs with a market cap under JPY 30 billion initially have had trouble from the start convincing the market they could grow and boost liquidity so received a discount to the other sectors.

2) This year even the larger resi J-REITs got pushed down over the higher rent growth seen in office and retail, continued emersion of assets with questionable earthquake resistance remant from the Aneha incident last year, and rising construction costs.

3) The overall market has been pushed down on global credit concerns but coincidentally regulators began to cut the money supply to real estate on concerns over an asset bubble… strange timing!

4) The result is that the sector has dropped 50%, some are discounted to near 50% of NAV, sector yield is averaging 8% with some over 10% and average implied cap rates are now at 6% – that`s about 5% over the 10 yr bond yield folks.

So there is a big discount for residential, is it justified?  Well, we would think otherwise…

1) Rents and occupancy in the central cities have not moved, but actually trended upwards.  Virtually 100% occupancy when accounting for normal turnover – how does that compare with other major global cities!  Even as some weakness is being seen in the overall Japan economy, if it continues urban residential rents will be the very last sector to suffer and it will take several years of a serious recession to have an impact.  So this is not the problem.

2) Architectural worries, economic worries and issues with developers have cut consumer demand so strata sales have declined.  Overregulation after the Aneha scandal and increased construction costs has  nearly halved new supply just this year, and new construction start figures show the supply will continue downward.   With the urbanization to central areas continuing to move population up and the drop in supply, rents (and prices) should theoretically go up in the coming years.

So what is the big issue, and is it sustainable?

Debt financing has dried up, J-REITS can`t buy, so developers with projects in the works and funds with refinancing terms pressing must cut prices to create liquidity or they are out of luck like Urban and Zephyr, Sohken Homes, Sebon falling the last few weeks and more in the pipeline.

The solution comes down when will financing become readily available again, which is unforeseeable at this point but the pressure for policy change and deregulation is coming on very strong now.  Meanwhile, those willing to buy at conservative LTVs will enjoy a very nice yield indeed…

Where else in the developing world, yet a major city, can you find yield spreads at 5% and above?  It was about this level in Tokyo when the foreign investment banks and `vulture` funds started looking at Japan last and spurred development of the securitization market reaping huge profits on low borrowing rates and normalization of the spread over several years.

Do I hear hovering?