Japan
Real Estate
4 December 2008
Real Estate Sector
Underweight: Tokyo office vacancy
rates soar in 2009
Takeshi Fujita
Research Analyst
(+81) 3 5156-6765
takeshi.fujita@db.com
Deutsche Securities Inc.
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http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1.
Forecast change
Companies featured
Mitsui Fudosan (8801.T),¥1,348 Sell
2008A 2009E 2010E
EPS (¥) 99 101 97
P/E (x) 29.3 13.3 14.0
EV/EBITDA (x) 18.1 11.5 11.5
Mitsubishi Estate (8802.T),¥1,258 Hold
2008A 2009E 2010E
EPS (¥) 63 50 50
P/E (x) 48.9 25.0 25.3
EV/EBITDA (x) 24.2 13.9 13.9
Tokyo Tatemono (8804.T),¥275 Hold
2007A 2008E 2009E
EPS (¥) 69 34 21
P/E (x) 21.9 8.2 13.3
EV/EBITDA (x) 17.7 16.8 16.3
Tokyu Land (8815.T),¥250 Hold
2008A 2009E 2010E
EPS (¥) 54 20 36
P/E (x) 20.1 12.3 6.9
EV/EBITDA (x) 10.1 10.7 8.5
Sumitomo R&D (8830.T),¥1,255 Sell
2008A 2009E 2010E
EPS (¥) 133 118 124
P/E (x) 25.9 10.6 10.1
EV/EBITDA (x) 18.5 12.4 12.4
Global Markets Research Company
We revise down our sector view from Marketweight to Underweight
The main reasons for the downward revision are 1) we expect Tokyo office
vacancy rates to continue to rise for two more years, and we now think the degree
of deterioration in 2009 will be much worse than previously anticipated, 2) for the
major real estate firms the lack of visibility for the built-for-sale and rental
businesses is starting to penetrate and observers are starting to glimpse the
likelihood of an era of profit declines for major industry firms, and 3) the sector
seems somewhat overvalued based on the market cap weight of the three majors.
From FY3/09 RP of five majors to trend flat or decline
Following 2Q FY3/09 results, we revised down most earnings forecasts for the
major real estate companies. This is because we adopted a more conservative
stance, forecasting that earnings in the two mainstay businesses, built-for-sale
(sales business) and rental business (commercial buildings) would deteriorate. For
the built-for-sale business the main reason for our change in stance is to take
account of valuation losses on inventory in the condominium market, where the
correction is clearly dragging on, and other factors. In the rental business we take
account of the slowdown in rent hikes for existing buildings due to the faster
increase in vacancy rates. As a result we believe that from FY3/09 there is an
increasing lack of visibility for both OP and RP growth.
Target price basis switched to FY3/09 prospective NAV (after tax), no longer
taking account of enterprise value of non-rental businesses
We believe that in a climate where debt financing is becoming very difficult for
financial institutions, the valuations given to commercial real estate sales profit and
intermediary businesses are becoming smaller and smaller. Thus, while previously
we took account of the enterprise value of non-rental businesses, using adjusted
NAV to reflect the net asset value of real estate assets, we now exclude the
enterprise value of non-rental businesses from our target price calculations.
Since vacancy rates are increasing at a faster pace than we had previously
anticipated and because, according to the ‘Real Estate Investor Survey’ published
by the Japan Real Estate Institute on 19 November, expected investor yields are
generally rising, expect for the Marunouchi and Otemachi areas, we are increasing
the assumed cap rate by around 0.25ppt when we calculate NAV for the five major
real estate companies we cover. In addition, since the increase in Tokyo office
vacancies has risen faster than we previously anticipated, we have reduced the
premium applied to NAV when we calculate target prices. As a result, we
recommend the relatively strongly defensive Mitsubishi Estate.
Valuation and risks
We calculate target prices based on FY3/09 prospective NAV for the five real
estate majors we cover. We use a cap rate of between 4.25%-5.50%, based on
investor expectations for A-class Otemachi buildings, as reported by the Japan
Real Estate Institute (previously we used adjusted NAV to account for non-rental
business enterprise value, but we now exclude non-rental business value). Risks
include a sharp recovery in the economy or a halt in the rise of Tokyo office
vacancies or a slowdown in vacancy rates.

Valuations and target prices
Revisions to target prices and new ratings
We revise down our target prices on the real estate companies mainly involved in the rental
business, as shown in Figure 1. Accordingly we revise down our ratings on Mitsui Fudosan
and Sumitomo R&D from Hold to Sell and maintain our Hold ratings on the other three majors.
We revise our earnings forecasts for the five major real estate companies. Previously we
based our target price calculations on end-FY3/09 prospective adjusted NAV comprising, in
addition to the net asset value of rental assets, the enterprise value of condominium sales,
asset management and intermediary businesses. From now we are no longer factoring in any
value from capital-gain type businesses, since for the time being we do not expect the
market to evaluate these businesses highly, we simply use the net asset value derived from
rental businesses (FY3/09 prospective NAV) in our calculations.
We have increased our assumed cap rate and at the same time we have reduced the
premium we apply to NAV.
The assumed cap rate used for each company is as follows: Mitsui Fudosan: 4.50% →
4.75%, Mitsubishi Estate: 4.25%→4.50%, Sumitomo R&D: 4.50%→4.75%, Tokyu Land:
5.00%→5.00% (unchanged: increased substantially when forecasts were revised on 7
Nov), and Tokyo Tatemono: 5.50%→5.50% (unchanged: increased substantially when
forecasts were revised on 31 Oct).
We revise our target prices based on prospective FY3/09 adjusted NAV (after tax) as follows:
Mitsubishi Estate -30% (discount 30%), Mitsui Fudosan, Sumitomo R&D, Tokyu Land -
40% (discount 40%), Tokyo Tatemono -50% (discount 50%). Previously, Mitsubishi Estate
was -20%, Mitsui Fudosan, and Sumitomo R&D were -30%, Tokyu Land and Tokyo
Tatemono was -40% (for Tokyu Land, -30% prior to the earnings revision on 7 Nov; and for
Tokyo Tatemono, prior to the 31 Oct earnings revision the target price calculation was based
on a P/B of 1x).
The level of discount for Mitsubishi Estate continues to be relatively small, but this reflects its
high ratio of fixed rental contracts, particularly for Marunouchi office buildings. Rent declines
tend to lag those implemented by industry peers (Figure 2).