Mortgage-backed securitization as the remedy to Japan's weak real estate sector was a recurring theme at last month's Fabozzi/IMN Conference on Real Estate Finance and Securitization in Japan. The prospect of a growing number of Japanese companies securitizing their real estate holdings was a topic that drew nearly 500 originators and arrangers of asset-backed deals to the Tokyo event.

But despite the huge potential of Japan's real estate market, significant obstacles remain before a liquid secondary market can be established. Falling commercial property prices, an undeveloped domestic investor base, and a banking sector unwilling to sell assets at a discount were some of the challenges outlined at the conference.

CMBS: Market-Clearing Prices Needed

One of the biggest problems for commercial mortgage-backed securitization is the falling value of commercial real estate. Tokyo real estate prices have dropped to half of their peak values in 1991, but the market has yet to hit bottom, speakers agreed.

"This year, the government began using public funds to support the real estate market and ease the credit crunch. But this positive impact will fade and the downward trend in land prices is likely to linger on," commented Yoshihiro Hashimoto, a real estate analyst at Merrill Lynch. And as more developers and financial institutions look to shed their assets and restructure their balance sheets, the supply of real estate on the market will only increase, noted Shuji Tomikawa, vice president of Mitsui Fudosan Investment Advisors.

Several CMBS deals were completed in the first quarter, which will pave the way for more issuance. And more private sector players are using market-driven, cashflow-based real estate pricing methods, as opposed to the so-called comparative approach, which is based on the price of neighboring properties.

But until Japan's banks aggressively sell off their distressed assets, land prices will not stabilize, and many investors will not be convinced by values in CMBS deals. "The U.S. RTC established clearing prices for distressed assets, which was extremely important because it created momentum in the market and made people realize what real estate was really worth," commented T. Timothy Ryan, managing director at J.P. Morgan. "Japan's government also needs to play a key role in setting market-clearing prices, since the problem here is that no one knows what real estate is really worth."

Residential MBS: Much Brighter Future

The prospect for residential mortgage-backed securitization looks much brighter, owing to the creditworthiness of Japanese consumers in general.

"Credit problems in Japan are so low as to be non-existent. If you look at the payment behavior of domestic borrowers, you're looking at one of the lowest-risk assets in the world," commented Robert Sheehy, senior managing director at Bear Stearns, which recently closed Japan's first mortgage-backed securitization from Sanwa Bank. A twice-yearly bonus payout system and aversion to default are other factors behind the high performance of mortgage payments, added John Speaks, vice president of structured finance at Moody's Investors Service.

Getting originators to invest in technology required for securitization, enlisting support from more rating agencies, and educating investors about the merits of MBS deals are still needed to deepen the market, said Anthony Dixon, head of securitzation at Nikko Salomon Smith Barney.

Yet home mortgages are one of Japan's strongest asset classes left for securitization. "Mortgages are very easy to work with in Japan," Sheehy concluded. "We anticipate it will rapidly move towards a very deep and liquid market."

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