In a situation where Japanese stocks are plummeting, listed real estate investment trusts (REITs) have begun to strike back. While sharp fluctuations in the foreign exchange market have rocked the stock market, the stability of rental income, which is less susceptible to exchange rate movements, is being reevaluated. Office REITs, which have been buoyed by the market recovery, is particularly strong. It is likely to be a driving force in the REIT market, which has been stagnant for a long time and lagged behind the stock market.

“If the REIT continues to perform well, we would like to purchase additional shares. Now we are waiting for the right time.” A female individual investor in her 50s is looking to add REIT into her portfolio, which has been showing solid price movements beside a sharp decline in the stock market.

The Tokyo Stock Exchange REIT Index, which indicates the overall REITs price movement in the Tokyo market on 8th, closed at 1,700.24, up 5.05 points (0.3%) from the previous day. On 5th, the market was caught up in a sharp decline in the stock market, the REIT Index hit a four-year and two-month low, but quickly recovered. It regained its pre-tumble level on 5th on 7th, ahead of the Nikkei 225.

Masahisa Oshima, Lead Portfolio Manager at Nissay Asset Management, noted, “Rental income of REITs is less sensitive to foreign exchange rates. It is stable and is easily preferred compared to equities in this phase.” To date, the REIT market has lagged far behind Japanese equities, where corporate reforms aimed at improving capital efficiency and expectations of earnings growth due to the weak yen have been bullish factors. The investment environment has changed dramatically, and REITs are gaining momentum for recovery.

The expected dividend yield of REITs, which corresponds to the projected dividend yield of stocks, showed that the weighted average of listed REITs was 5.022% on 5th and 4.804% on 8th. The weighted average of all TSE Prime stock is 2.51% on 8th, which also shows a relative investment opportunity.

Office REITs have been particularly strong. Many office REITs were among the top performers in terms of increase in investment unit price (equivalent to share price) compared to the end of June. Nippon Building Fund, the largest, temporarily reached a nearly three-month high on 7th and was up 2% from the previous day on 8th.

One clue is that the office market is picking up. According to Miki Shoji, a leading office brokerage firm, the average office vacancy rate in central Tokyo’s five wards (Chiyoda-ku, Chuo-ku, Minato-ku, Shinjuku-ku, Shibuya-ku) in July was 5.00%, down 0.15 points from the previous month. This is the lowest level since January 2021 (4.82%). As economic activity recovers from the COVID-19 pandemic, there is strong demand for office space from companies that are actively seeking to acquire human resources.

The monthly change in demand area (Net Absorption, 6-month moving average) calculated by Morgan Stanley MUFG Securities from Miki Shoji’s data has been stable in positive territory since March 2023.

Yasuyuki Kuroki, Mitsubishi UFJ Asset Management’s chief fund manager, says, “We had skepticism about office demand, but as it turned out, we were misguided. The trend of returning to offices in Japan is a positive surprise.” The REIT fund under his management, Nippon Building Fund Japan is the highest weighted REIT in the portfolio. At the end of July, the inclusion ratio increased by 0.2 percentage points from the end of June to 7.8%.

Office REIT buildings are also competitive. According to Estie, the real estate data service company, the average year of completion of office buildings (standard floor area of 50 tsubo or more, 1 tsubo is approximately 3.3 square meters) owned by the seven office-specialized REITs within the five central wards of Tokyo is October 1998. It is nearly a decade “younger” than the market as a whole (February 1989).

The percentage of office buildings completed between 2001-2010 and 2011-2020 is 28% and 14%, respectively, higher than the overall market (12% and 7%). Estie says, “REITs specializing in office buildings are selling older properties and acquiring newer properties in order to improve the performance of their entire portfolio” .

However, this does not mean that concerns about future price movements have been completely dispelled. Daisuke Seki, a representative of IB Research & Consulting who is familiar with market trends, noted, “Foreign investors are reluctant to reach out to Japanese office REITs concerning the poor office market conditions in the US.”

In the Japanese REIT market, office buildings account for about 40% of the market capitalization, and the valuation of office REITs could determine the future of the REIT market in Japan. It is essential for the REIT market to strike back by demonstrating to investors that market conditions are improving, and steady earnings growth is being achieved under the solid office demand in Japan.