In this interview for The Worldfolio, Mr. Tsuyoshi Komachi, President of Raysum, provides an insider’s perspective into the Japanese real estate market and explains the company’s unique “value creation” concept.
Sustained by low interest rates and the lifting of COVID restrictions, Japanese land prices surged at the fastest rate in 15 years leading into 2023. Attracted by the market's performance and the yen’s devaluation, total foreign investments in Japanese real estate saw a 45% uptick in the first half of 2023 (CBRE report). Considering the current global macroeconomic environment, what makes Japan so attractive to foreign investors?
There are two perspectives to consider in order to answer this question: ‘external factors’ and ‘internal factors.’
To exemplify these external factors, let me provide an interesting project that Raysum participated in. Last year, a large foreign insurance company sought to purchase a property in Japan. This company had specific investment criteria: they were exclusively interested in relatively new properties located in prime areas that could offer a certain level of return and potential for future value appreciation. Given the unique characteristics of the Japanese market, meeting their investment criteria was challenging.
Since none of our assets matched their requirements, we collaborated with our partners to adjust their investment parameters. Eventually, the advantages of Japan over other Asian markets persuaded the insurance representative to modify their investment criteria, leading them to engage in a project with us.
I have vivid memories of this experience, particularly of working with the company’s representative for real estate investments. The representative elucidated that the insurance company aimed to minimize risk by continually diversifying its portfolio. Pursuant to this strategy, a certain percentage of their capital had to be allocated to the US, Europe, and Asia, respectively.
For institutional investors currently deliberating on which Asian countries to invest in, the situation is complex. The region’s largest market, China, is currently undergoing a well-documented real estate downturn, presenting a considerable risk for investors. Additionally, the existing tensions between China and the U.S. have impacted capital flows into the region. Turning our attention to other Asian markets, various bottlenecks persist: Singapore generally tends to offer lower yields, while Australia’s tight supply translates into fewer investment opportunities compared to other countries.
Despite these challenges, institutional investors still need to allocate a portion of their funds to Asia, as concentrating their entire investment in the U.S. or Europe is not a viable diversification strategy.
In this environment, it is inevitable for institutional investors looking to allocate funds to the Asia region to consider Japan, a market where they can expect higher yields.
Another factor is the increasing interest of Taiwanese and Chinese investors in investing abroad, seeking to diversify their portfolios outside their home countries. For these investors, Japan represents a reliable option that is also culturally and geographically proximate compared to the U.S. or Europe. I assume that this attraction to Japan is particularly strong when looking at the Ginza area, as properties located there are frequently acquired by families and business groups from the greater China region. For example, we recently sold a property located in Ginza 8-chome to an Asian investor.
The second perspective for Japan’s attractiveness can be defined as ‘internal factors.’ I would like to introduce this point by noting that Japan is one of the few countries with a higher yield spread on real estate investments, a rarity for such a safe and stable market.
There are three factors to why I believe Japan’s high level of yield spread on real estate assets is, and will remain, high. First, there is concern that Japan’s interest rates will rise. Second, the regulatory framework for investing can be quite intricate. Third, there is the risk of natural disasters, such as earthquakes. These three elements combine to create a situation where Japan has a relatively higher yield spread on real estates.
Regarding speculations on the potential rise in interest rates, although there is a general expectation that they will increase, I do not believe that the increase will be as significant as what we witnessed in other countries such as Europe or the US.
In Japan, the overwhelming majority of real estate purchases depend on loans and mortgages with ultra-low interest rates. As such, my opinion is that if interest rates were to rise to 3%, 4%, or 5%, as is the case in America, then many would face bankruptcy.
When it comes to predicting how much interest rates will rise in the long term, those who had a background in financial industry, such as myself, see 3% as an unrealistic number. Honestly, my opinion and the general consensus seems to be that the maximum number we could see is around 2%. Even if we were to reach that number in the future, the rate of increase would be gradual. My feeling is that policymakers would set a target ten years in the future and raise interest rates in stages.
While this approach may seem unaligned with global market dynamics, if the population does not want to see an increase in interest rates, it would not likely to happen in Japan to override the public’s wishes to implement such changes.
Although adjustments are expected to be minimal, the Kishida administration appears to be nudging interest rates towards a more market-driven framework. However, for interest rates to rise even slightly, there needs to be an increase in income. As such, the government is attempting to bolster other economic pillars, including strengthening the investment environment and increasing wages.
Taking these factors into account, the government’s broader vision suggests a gradual increase in interest rates paralleled by an enhancement of the investment climate and an increase in incomes.
In January 2024, the tax incentives for individual investment through the new Nippon Individual Savings Account (NISA) were significantly adjusted. Since then, stock purchases through tax-exempt NISA accounts have already increased fivefold compared to previous periods.
On top of our positive business performance, this change is one of the reasons our stock price has seen another surge since new year. Given that our stock boasts one of the highest dividend yields in our category, it was seen as particularly attractive to new investors.
Considering the current environment, the buzzing stock market, and continuous efforts to boost investments in the country, I believe that even if interest rates were to rise, real estate prices would remain stable.
Furthermore, rents in central Tokyo remain significantly lower than those in New York, California, London, or Paris, and condominium prices are amongst the lowest in Asia. Combined with Japan’s high yield, I believe that these factors indicate the market’s undervalued status compared to other major hubs.
During the pandemic, there was a sharp increase in global money supply, and we are now seeing approximately 1.5 times more capital circulating around the globe than we did prior to the pandemic. Because part of this capital is to be allocated to Asia, Japan stands as an attractive destination boasting significant growth potential.
Under this momentum, Japan has been proactive in positioning itself as an attractive destination, so the next task is to increase wages and stimulate national compensation levels.
I do honestly feel that the Japanese mindset has been damaged by decades of deflation, with people finding satisfaction in small economic wins despite not experiencing wage increases. However, I believe that this mindset is changing, and one of our recent residential projects in central Tokyo proves that.
Tokyo’s residential market has seen interesting activity, with the price for new condominiums in central Tokyo doubling between March 2022 and March 2023. Furthermore, luxury housing is also experiencing a surge in demand as new projects targeted at high-net-worth individuals have started to become more prevalent. Based on your most recent project in the Tokyo area, how do you expect this segment of the market to evolve?
Before the pandemic, we acquired a newly constructed condominium building composed of 17 units, each measuring around 100 square meters.
In the Japanese residential property sector, such a scale belongs to the mass market. Historically, 70 square meters used to be considered the standard desirable size, but with more households now benefiting from dual incomes as both wife and husband work, the financial leeway for housing expenses has increased. Households have more capital to invest in larger homes (100 square meters class)or higher rents.
This shift is likely to lead to large amount of new supply as developers rush to meet demand. Anticipating this, we purchased the aforementioned condominium building, which is located nearby Meguro. Following a large-scale renovation, we converted the building into an exclusive residential property, turning those 17 condominiums into 7 units, each measuring around 200 to 300 square meters. We believed that while the demand for such large apartments was initially small, it would undoubtedly grow… and we were right.
In a short period of time, we leased all seven of these condominiums. Six of the seven units are occupied by people in their twenties and thirties, and the seventh was bought by an individual in his forties. We learned that this kind of large and luxurious apartment is clearly popular among younger generations of high-net-worth individuals.
In the past, Japan used to have a small wealth gap among social classes. However, the global rise of and entrepreneurship has made young generations realize that there are many business opportunities for them to grow their net worth and revenue. They have also begun to consider living in high-grade real estate as an investment in their own lives, which allows them to have a better workplace that is also used for better dwellings. Our project visibly proved and supported these assumptions. Moving forward, we plan to further cater to this emerging segment.
Today, RAYSUM offers two main businesses: Value Creation Services, where the company buys, upscales, and sells real estate assets; and Value-added services, providing rental and building management that optimize real estate value and rental yields. If we take each step of the value creation and value enhancement process (buy, enhance, sale), what are the strengths of RAYSUM?
Our strategy is always to be customer-oriented – we call it ‘customer-in’. When we purchase real estate, we not only determine and thoroughly understand the asset we are purchasing but also the type of client that we are targeting.
We start by envisioning the type of tenants the property will attract once developed. Our decision, therefore, hinges on understanding how much value we must add to make the property appealing both to potential tenants and investors.
It is part of our creed to fully understand our customers’ demands, goals, and aspirations. Once we have identified and thoroughly understood a client’s demand, we are then able to find the appropriate asset to take advantage of the opportunity, based on the asset’s intrinsic value.
This is precisely why we do not segment our teams into office, commercial, or residential divisions. Rather, we choose properties based on their holistic value and on the additional value we, as Raysum, can create. Consequently, we never limit our scope to just one asset class. Sometimes, this leads us to develop offices or residential properties. Other times, we might develop warehouses or high-graded medical facilities.
As such, our procurement strategy revolve around understanding the demand of specific customers and using these demands to determine what kind of modifications are needed on the property and what kind of value should be added.
The importance of understanding our customers’ desires is shared amongst all our employees. At Raysum, we hold the belief that if we can imagine a project that matches the vision of one customer, there must be, for instance, at least ten other customers willing to make the purchase.
When it comes to evaluating land, our first priority is to determine whether it should be developed for residential, office, healthcare, or other purposes, always seeking to find the best option for value creation. We usually have at least three plans simultaneously drawn out, and we keep our options open until the last minute, when we need to decide which would be the best fit to achieve maximum value for our customer.
Another credential that showcases our innovativeness has been the success of RAYEX, a scheme where we commercialize multiple properties in small lots and sell units to investors. This product has a low initial investment amount of 50 million yen per unit.
While other small-scale real estate investment products have struggled to acquire sales in the market, RAYEX has shown strong performance as clients have seen their ROI increase while holding the product. Under this scheme, customers purchase units that are continuously increasing in profitability. We previously rolled out two RAYEX series and have just launched the third one last December.
On top of its accessible initial cost, RAYEX also offers asset diversification, as units are spread across different properties. Regarding the first RAYEX series launched in December 2021, can you report on the performance and feedback from customers thus far?
Small-scale investments that do not focus on additional value creation but rely on the yield gap from acquisition to sales of assets are not well-sold.
In contrast, Raysum creates additional value by increasing Net Operating Income (NOI). As NOI increases, we can generate additional profits from the sales of the asset, even in a situation where we purchase the asset at a 4% cap rate and sell it at the same 4% to the customers.
Furthermore, we manage RAYEX with the same methodology as we do other assets, always focusing on value enhancement. This unique format has made customers really interested in this product since RAYEX investors can experience firsthand our value creation process, ultimately obtaining higher yields derived from our dedicated efforts to improve NOI.
The total value of the first RAYEX project totaled 6 billion yen, with each unit amounting to 200 million. The second one amounted to 10 billion with a 50 million yen unit price. After the completion of sales of these two series, we launched the third series in December with a total scale of 10 billion yen and a unit price of 50 million yen.
The reason we started with units of 50 million yen is because it is difficult to significantly experience the increase in profitability we achieve. Customers tend not to pay much attention to the performance if the investment size and P&L impact are not significant. Of course, investing 10,000 to 1 million yen per unit could be an option, but we believe 50 million is an appropriate volume for customers to truly experience our value creation process.
There are two purposes behind RAYEX. First, we want to act as an entry point for investors by starting with a ‘low’ minimum of 50 million yen. As they experience the positive returns that the product offers, we can then attract more of their investments, ultimately reaching 1 to 2 billion yen.
Second, we would like to use RAYEX to appeal to the market and show that a new type of solution is possible. We strongly believe that we are one of the very few players that can continuously upgrade and uplift the value of real estate assets across many years, even after we have sold the property.
The second quarter of FY 2024 was a strong one for RAYSUM. On top of the stock price reaching 3,500 yen, the company experienced a surge in revenue, expanding from 18.8 billion yen to nearly 39 billion yen. Simultaneously, operating profits increased by more than 200% to reach 9.6 billion yen, resulting in an operating profit margin of more than 24%. What were the reasons behind this performance?
Our stock price soared from 1,700 yen to around 3,500 yen due to several factors. First, we announced an upward revision of our mid-term business plan last May. The main points were that our operating profit forecast increased from 13.5 billion to 18 billion for FY24, and from 17 billion to 23 billion for FY25. Target ROE levels changed from 10-20% to 15-20%, and the dividend payout ratio was raised to 40%, with a floor of 175 yen per share.
We have historically been conservative when providing financial forecasts, always aiming for a 15% operating profit. However, today we are confident that we will achieve robust future growth thanks to the uniqueness of our business model. As such, we thought it would be appropriate to be more aggressive in driving our valuation, and we now forecast a 20% operating profit. The year-over-year performance in H1 FY23 proved our creativity in real estate assets and demonstrated our ability to achieve stable revenue creation and high liquidity. Furthermore, the unique business model we embraced allowed us to develop unique assets like RAYEX that have an impact on society. I believe these reasons sent our share price soaring.
Another aspect I would like to mention is that in recent times, a number of corporate customers, including large utility companies and other institutional investors, have purchased assets from us. Over the past years, we had mainly focused on mid-size assets in the 1 to 3 billion yen value range. However, we now have many opportunities to handle large-sized projects of 5 billion yen or more, both purchasing from and selling to large corporate customers. Our recent performance has made institutional investors aware of Raysum’s ability to break through the conundrum laid beneath the assets, such as complicated land rights issues.
We are now evolving into an ambitious publicly-listed company that is more active in terms of financing, investment, and valuation, making us attractive to investors. This attitude is creating a virtuous circle. Based on our strong performance, Japanese megabanks have started to give us more attention, and I think there will be more possibilities to collaborate with these large financial institutions.
Furthermore, we have been managing our balance sheet very cautiously, keeping our leverage level around 50%. With strong relationships and more financing options with financial institutions, I am confident that we will be able to conduct our business more actively while maintaining solid balance sheet management.
The most important element of Raysum’s robust performance is its employees. Excluding our executive directors, we only have 110 people. For any other real estate player, it would be impossible to achieve 100 billion yen in revenue with 100 billion yen in total assets by solely relying on an internal workforce. As such, I am proud to say that our employees are the elite few who can achieve these results. They are the very source of Raysum’s competitiveness.
To close this interview, we would like to get your opinion on the future of Raysum. What do you believe Raysum must achieve next to continue building upon its recent performance?
As our company is currently on a path towards continuous growth, we believe this is the perfect time to collaborate with more partners and financers that want to embark on this journey with us.
For more details about Raysum: https://www.raysum.co.jp/en/
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