ASIA NEWS ANALYSIS: Securing distress

More than $1 billion was raised against distressed real estate debt strategies in Japan last month. But exactly what is the opportunity? PERE Magazine July/August 2010 issue

Last month, PERE reported on more than $1 billion of equity raised for distressed real estate debt strategies for Japan.
Fortress grabbed much of the attention after meeting the $800 million fundraising target for its first fund in Asia, the Fortress Japan Opportunity Domestic Fund. But Secured Capital Japan (SCJ), the Tokyo based private equity real estate firm with approximately $6.3 billion in assets under management, also attracted capital for such a strategy.

The firm raised the first $155 million of a targeted $200 million for its SCJREP Loan Fund, a side vehicle spawned by demand from investors in its fourth opportunity fund, SCJREP IV, after LPs asked for more exposure to debt investments than the 25 percent allocation could cater for.

With so much money raised for Japanese distressed debt, PERE caught up with SCJ’s J-P Toppino to ask exactly what he regarded the opportunity to be. His answer was threefold.

“Firstly, you have historical loans from the Japanese banks,” he said. “These are real estate-related loans that have become overleveraged and in some cases have matured or defaulted. They are corporate in nature and are recourse so there is a guarantee behind them.” Toppino estimated the size of this part of Japan’s debt market to be $10 billion, “although it hasn’t really started to trade in large volumes yet”.

The second debt opportunity, Toppino said, was in hung loans. “These are loans originated by investment banks from Japan and overseas that were raised with the anticipation of being securitised, but it never happened.” Owners of such loans are large securitisation lenders, like some of the large Wall Street banks. Toppino said many of these loans were raised at the end of 2007 and the beginning of 2008. This market in Japan could be up to $3 billion in size, he said.

The third opportunity comes from maturing CMBS. The amount of CMBS tied to Japanese-real estate expected to mature over the next three years is approximately $40 billion. Here, Toppino drew a comparison with the CMBS market in the US. He said: “In the US, the special servicer can extend the loan on its own – the well-coined ‘extend and pretend’ exercise. In Japan it’s different. You need bond holder approval and because Japanese AAA-bond holders aren’t generally impaired its really difficult to get an extension done.”

He said this sort of debt investment is currently showing lots of potential although large sales have not materialised yet. Furthermore, Toppino believes an improving market could push such debt into the “sub-performing” category and, as such, could become less likely to trade.

SCJ is unlikely to follow Fortress into raising a larger dedicated Japanese distressed debt fund after closing the SCJREP Loan Fund. Instead, the firm is more likely to set a higher hard cap for the follow-up to SCJREP IV and increase its exposure to distressed debt to closer to 40 percent. That is some way off though as SCJ still has plenty of dry powder at its disposal having only invested one third of the opportunity fund and about $20 million from the debt vehicle.