TOKYO The last time foreign funds jumped into the Japanese property market around 2006 they snapped up assets from office blocks to hotels, fuelled by highly leveraged bank loans. Then came the global financial crisis and many of them got burnt.
Their appetite is starting to return.
In Tokyo's posh Meguro neighborhood, the 14-storey Meguro Place Tower that went up in 2009 was never intended to be a landmark. But a fund partly owned by a unit of Aviva Plc (AV.L), Britain's second-largest insurer, saw something eye-catching in its concrete-and-glass -- a buy.
The fund, a joint venture with Japanese property investment firm Secured Capital, bought the office building in March for an undisclosed sum.
Big-name investors like Aviva are betting that the Tokyo property market has bottomed as office rents rise for the first time in more than four years.
Goldman Sachs (GS.N) has secured three properties alone so far this year for a real estate investment trust (REIT) that it will launch as soon as September. The assets include two office blocks.
Angelo Gordon & Co, the $24 billion New York-based asset manager, bought a stake in an office building in central Tokyo in March. Three months later, it acquired the 13-storey Aoyama Bell Commons in the chic shopping and dining district of Aoyama.
To be sure, skeptics say property investors may be too optimistic in expecting an easy supply of discounted properties, and caution there is scope for Tokyo rents to fall in the next few years.
But for now, the Tokyo market is outperforming Hong Kong, where office rents have dropped for three consecutive quarters. Singapore rents have also declined for two straight quarters, data from real estate service provider Jones Lang Lasalle shows.
The average rent for Tokyo's top-flight office properties rose 2.6 percent in the first quarter of 2012 from the previous three months, the first increase since the fourth quarter of 2007, according to data from real estate services provider CBRE Group (CBG.N).
Rental income from Tokyo buildings in prime districts has been pitched to Japanese pension fund investors as a source of stable returns at a time when stock markets remain volatile and yields on Japanese government bonds are punishingly low. The ultra-low yen interest rates also mean deals are cheap to finance.
Japan's biggest developers such as Nomura Real Estate Holdings (3231.T) and Mitsubishi Estate 8822.T are targeting a 4-percent yield for their pension fund investors. That would be four times more than what the funds can count on making from Japanese government bonds.
Demand for newly constructed properties with additional anti-quake features is also helping to bolster sentiment.
The Aviva-affiliate Tokyo Recovery Fund, which bought the three-year-old Meguro Place Tower, expects newer buildings in Tokyo to command a premium in rents after last year's massive earthquake in northern Japan.
"It's a flight to quality," said Ian Hally, chief executive officer for Aviva Investors' Asia Pacific real estate operations. "We are targeting newer office buildings with better earthquake resistance. We find tenants are demanding it."
Many of the property deals before 2008 relied on heavily leveraged financing that dried up with the global crisis triggered by the failure of Lehman Brothers that year.
Now, foreign investors and fund managers are taking a lower-risk approach by putting up more equity from pension funds.
With money from Japanese pension funds, Goldman is aiming to increase the asset size of its REIT by as much as 12-fold to 300 billion yen ($3.8 billion).
Investors are also counting on banks to release a stream of discounted properties into the market as they build up their financing muscle.
The Tokyo Recovery Fund, which expects to reach $250 million in size later this year, bought the Meguro property from lenders who gained control of the building after a previous owner defaulted on loans.
MGPA, an Australian property investment firm, purchased eight Japanese office buildings in June for around 12 billion yen through defaulted loans tied to commercial mortgage backed securities, or CMBS. Seven of them are in Tokyo.
Moody's Investors Service expects about 500 billion yen of loans, repackaged as CMBS, to mature this year.
In theory, more loan defaults would create more buying opportunities. But in many cases, Japanese banks are taking advantage of their own relatively strong balance sheets to refinance properties instead of putting them up for sale, expecting property prices to rise further.
That would set up a road block for investors looking to pick up marked-down assets.
"In the past two years, the expectation was that banks were going to sell a bunch of properties at a very cheap price because owners of the properties defaulted," said Jon Salyards, senior manager at property consulting firm Savills Japan. "But what we actually saw happening is that most banks agree to refinance or restructure or hold them by themselves."
One example was the refinancing for the 32-storey Shinagawa Grand Central Tower in March. In that case, German lender Deka Real Estate Lending and the Development Bank of Japan provided refinancing to keep one of the largest real estate loans in Japan, originally arranged for a Morgan Stanley (MS.N) fund, from going bad.
Skeptics are also saying Tokyo rents may come under pressure in the coming years because of new construction.
Tokyo office space increased 80 percent between 1990 and 2011, compared with a 3 percent decline in New York and a 26 percent increase in London, according to Goldman Sachs equity analyst Sachiko Okada.
"The long-term outlook for the Tokyo office market -- even for quality buildings -- is tough," said Tomohiro Araki, an equity analyst at Nomura Securities.
"Competition to secure tenants will continue as long as new buildings are added, and property owners will be under pressure to cut rents to attract new tenants."
(Reporting by Junko Fujita; Editing by Ryan Woo)