World’s best REIT hands Fortress 700% gain on Japan bets after tsunami

Fortress Investment Group LLC is betting that one of the real estate industry’s greatest contrarian wagers has more room to run.

The manager of $70.5 billion, which piled into Japanese property after a tsunami and nuclear meltdown battered valuations in 2011, has seen its investments surge after Prime Minister Shinzo Abe’s stimulus revitalized the industry. Invincible Investment Corp., a hotel-focused real estate investment trust managed by Fortress, has returned eight-fold in the past five years, the biggest gain among REITs worldwide. Two of the firm’s Japan-focused private equity funds have climbed near the top of their peer rankings.

Now, as slowing Asian growth and a stronger yen cast fresh doubts on prospects for Japan’s hospitality industry, Fortress is adding to its wager. The money manager plans to invest the majority of its third $1.1 billion Japan fund in hotels, saying that regional tourism will prove resilient and that record-low interest rates will increase the appeal of real estate investments.

“Asia is getting wealthier and the economic mobility associated with that is hitting a critical mass,” Tom Pulley, the chief investment officer for Japan at Fortress, said in an interview at their high-rise offices in Tokyo’s Roppongi Hills overlooking the city. Real estate is “a more and more compelling asset class in Japan because of the stability of income and the relative yields to costs,” he said.

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The bet wasn’t so obvious when Fortress jumped in five years ago. Its plan to invest in Invincible was first announced just a week after the March 11, 2011, tsunami that devastated Japan’s eastern coast, caused a nuclear disaster at the Fukushima Daiichi power plant and pummeled the nation’s tourism industry. The deal was completed in mid-July that year, giving Fortress a 45% stake and control of the REIT’s asset manager.

Invincible has since become an integral part of Fortress’s real estate strategy in Japan. The money manager has been buying hotels — mostly via distressed-debt transactions — for its first two Japan funds, which eventually offer to sell them to the REIT. Invincible has an agreement with Fortress giving it the first right to bid on the funds’ hotels, an arrangement that includes external advisers to help protect against conflicts of interest. While Fortress has a stake in both sides of the transactions, it’s a structure common in Japan and other countries in Asia, said Yosuke Ohata, a Tokyo-based analyst at Mizuho Securities Co. who has a buy rating on Invincible.
Returns Surge

The deals have worked out well for Fortress’s funds and Invincible shareholders. Invincible, which invests a majority of its assets in hotels, has returned about 700 percent in Tokyo trading including dividends since the Fortress purchase was finalized in July 2011, the best performance among more than 400 REITs worldwide with a market value of at least $10 million.

Invincible went from being the worst-performing property trust in the Tokyo Stock Exchange’s REIT index in 2011 and 2012 to being the best for each of the following three years as Abe and BOJ Governor Haruhiko Kuroda pumped stimulus into the economy. The REIT has brought investors a more than 1,200% gain since the start of 2013.

Abenomics has had a lot to do with the rally. Since becoming prime minister in December 2012, Mr. Abe has pushed for both a weaker yen and lower borrowing costs — a profitable combination for the hotel industry because it encourages tourism and makes debt financing cheaper. The government also relaxed visa rules for tourists from China, India, Indonesia, the Philippines and Vietnam under Mr. Abe, fueling a surge in Asian visitors. A record 19.7 million tourists visited Japan in 2015, with China accounting for the largest proportion, according to Japan National Tourism Organization.

BUDGET FOCUS

“We see more convenient, more affordable and a greater array of travel choices to support the growing number of people wanting to come to Japan,” Mr. Pulley said. “At the same time, you have a hotel-supply base that has really not seen a lot of investments in the past 20 years. Many of the Japanese hotel companies borrowed too much during the bubble and they are still yet to really recover.”

Fortress, which now owns 90 hotels with 17,500 rooms in Japan, boosted revenue from available rooms by 24% last year, according to Pulley. He said the firm’s focus on tour-bus groups with budget room rates, at about 9,000 yen ($79) per night, have sheltered its hotel business from the adverse effects of China’s stock-market selloff on wealthier tourists.

Of course, not all of Fortress’s investments have worked out so well. The U.S.-listed firm, among the first alternative managers to go public in 2007, shuttered a $2.3 billion macro hedge fund ran by Michael Novogratz in 2015 after almost two years of losses and investor redemptions. Fortress’s share price has slumped about 43% over the past year.

FALLING YIELDS

The Japan hotel bets also have risks. For one, property prices have become more expensive after the economy recovered from the 2011 tsunami and more institutional investors entered the market. Hotels in central Tokyo offered an expected yield of 5.05 percent as of January, the lowest since at least 2009, according to an investor survey published last month by CBRE Group Inc., the world’s largest property services company.

At the same time, the hospitality industry faces headwinds from a resurgent yen, which has strengthened about 10% from a 13-year low against the dollar in June and makes the country more expensive for overseas visitors. The weakest economic growth in a quarter century in China may act as another drag on tourist spending.

“The hotel sector will probably underperform this year,” said Yoji Otani, a Tokyo-based real estate analyst at Deutsche Bank AG. The Bank of Japan’s negative interest rate policy adopted in January will make banks less willing to lend to the property sector and weigh on Tokyo real estate prices this year, he said.

For Mr. Pulley, returns from Japanese hotels are still compelling as the nation’s falling yields boost the real estate industry. Japanese firms can borrow in the bond market at an average rate of 0.2%, less than a third of when Mr. Abe came to power.

Japan’s fast-speed bullet train, or shinkansen, will link the northern island of Hokkaido with Tokyo for the first time later this month, and the government is planning to add slots at Haneda airport in Tokyo to improve access from overseas.

“One of the bright spots of Abenomics is the investments in infrastructure, the shinkansen, the airports, more people coming here,” he said. “These things matter for someone who sits on a portfolio of 90 hotels.”