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With another developer down last week and another JREIT taking losses on acquisition cancellation penalties, the Japan real estate markets may be starting down a vicious spiral into perilous waters – and investors with `dry powder` are watching the situation closely.

The sentiment at the Real Estate Investment Japan conference last week was decidedly negative and nearly sarcastic regarding the state of JREIT regulation and liquidity, with no quick solutions in sight.  But amid the gloom a theme is emerging that Japan, in particular Tokyo, is in better shape fundamentally than the rest of the world, and investors that are still in the game will be making higher allocations and high expectations for opportunities here in 2009.   Sonny Kalsi of MS underlined that Tokyo IS THE MOST ATTRACTIVE RE MARKET IN THE WORLD, amid the global chaos.

Currently the ask/bid spread is very wide though, freezing the market.  Theoretically a deleveraging of 20-30% on securitized assets up for refi should bring prices down 20-30%, but the scarcity of debt capital and increase in target IRR has pushed expected cap rates to a level above this in the name of `opportunistic` investment.  Indeed, many investors need to double up on returns (and risk) to make up for other losses to date this year.

Beside the refi assets though, there is a pool of bankruptcy and rehabilitation situations, defaulted debt including JREIT debt, etc. arising and some percentage where lenders are willing or forced to cut exposure to shore up balance sheets.  We would suggest this is not the general trend and probably not going to be – for the prime assets everyone is after.  The majority of investors in the game are looking for class A assets, and lender discounts on prime underlying assets are going to be on the frugal side.   Assets with issues, no income or yet stabilized, not finished, etc. will be first to come up for quick sale solutions.  But distress processing takes a long time and if banks do not have a strategic prerogative to do otherwise, they are better off to hold on to the underlying if cashflow is good or assets are prime.   There is always a risk/return tradeoff and when dealing in property, prime assets are lower risk so the returns even in a distress situation will be lower.

One thing is sure, the political risk of delay to action is great and the longer no effort is made to stabilize the JREIT market and bring some liquidity back into the market, the ask/bid spread will continue at a standstill and more distressed situations will arise, feeding the expectation and possibly the need for lenders and syndicates to deal swiftly with more situations.  An interesting year is ahead.

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