Many investors see negative rates as a sign of panicking policy makers. Perhaps they’re right. Banks aren’t usually charged for the privilege of depositing funds with a central bank.
But where some see panic, we see opportunity. When a country’s 10-year government bond yields a big fat zero, a stable, predictable 3.5% return looks pretty good. That’s what Japan’s real estate investment trust sector is yielding right now. That figure is set to increase even further, not in spite of negative rates but because of them.
By the narrowest of margins, the Bank of Japan launched its negative interest rate policy in January. This was Japan’s ‘whatever it takes moment’, an echo of Mario Draghi’s famous 2012 comment, and proof that the bank would fight deflation and stimulate economic growth with ‘every available tool possible’.
Japan is not the first country to tread this path. Others are also hoping that negative interest rates will push banks to write more loans rather than sit on mountains of cash. We’ll see about that. The bigger question for investors is what impact negative interest rate policy will have on their real estate investments.
The answer is far less ambiguous than the likely impact of negative rates on bank lending. Whether it works or not, this policy is a very good thing for investors in the Japanese real estate investment trust (JREIT) market, and by implication APN Property Group’s Asian REIT Fund.
There are two principal reasons why. First, a fall in general interest rates will reduce the interest burden on real estate investment by lowering the cost of capital. Debt just became cheaper to service. Valuations in the sector should increase as a result.
Second, Japan’s central bank needs higher real estate prices to help it reach its all-important inflation target of 2% a year. So adamant is the bank about achieving this goal that it’s actually purchasing exchange traded funds and JREITs, to the tune of 3 trillion yen (A$35bn) and 90 billion yen (A$1.1bn) a year respectively.
When you own real estate assets and you have the central bank working to push up their prices, and indeed buying stock directly to do so, you have a powerful force on your side.
For investors seeking higher, stable returns, anything that increases the difference between the Japanese bond rate and the JREIT sector’s yield – the so-called spread – is a good thing.
Negative rates act favourably on both ends of the equation. On one they push down the cost of capital and work to increase valuations. At the other, dividend growth becomes more likely, making them even more attractive. Then, as more capital flows into the sector, the cost of capital falls further, permitting further portfolio expansion, potential to grow dividends and further valuation increases.
That’s the theory, anyway. Is it being borne out in practice?
Since the announcement of the negative interest rates policy, the performance of the Japanese REITs, our largest investment in APN’s Asian REIT Fund, has risen 13.1%. Of course, our investment case isn’t predicated on Japan’s central bank supporting the sector. Our performance track record of 16.6% per annum1 since the Fund’s inception in July 2011 is testament to that. But the policy certainly offers a happy tailwind.
What about the risks? Well, JREIT money managers might get carried away by their success, a possibility that Australian REIT investors might painfully recall. Before the Global Financial Crisis the AREIT sector, flush with higher valuations, rising asset prices and cash hoards, threw caution to the wind by purchasing mediocre shopping centres in the United States. They could have paid higher dividends but decided not to. A few years later the likes of Centro and General Property Trust returned home after burning through billions in shareholders’ funds.
That’s the major risk and one we’re watching closely. But it’s also an unlikely one. Japanese REIT managers are more risk averse than their Australian counterparts of a decade ago and 2016 is not 2006.
For investors looking for stable, predictable returns generated in the most Western of Asian cities, a key cog in the world’s fastest growing region to boot, Asian REITs have lots to recommend them. And the Bank of Japan seems to agree.