Company Reports

Mitsubishi Estate owns most of the land in the prime office area in front of Tokyo Station (Otemachi, Marunouchi, and Yurakucho), much of which was acquired from the government in 1890, with few transactions since. Leasing office space in these districts continues to generate most of the firm's profit today, though Mitsubishi Estate has expanded into retail and residential leasing, condominium developments, hotels, and related businesses.

We initiate coverage of Mitsubishi Estate, one of Japan's leading real estate developers and best known for its Marunouchi portfolio. The group operates across multiple asset classes and is vertically integrated with investment management, brokerage, and consulting services.

We will discontinue analyst coverage of Mitsubishi Estate on or about Feb. 7.

We raise our fair value estimates for Mitsui Fudosan by 6.7% to JPY 3,200 and for Sumitomo Realty by 2.5% to JPY 4,100 and maintain our JPY 2,000 fair value for Mitsubishi Estate after the Japanese developers’ earnings reports. The earnings growth outlook for the industry is brightening as the developers’ largest business—office leasing in Tokyo—appears to be reaching a cyclical turning point, while some secondary businesses such as hotel management are benefiting from a boom in inbound tourism into Japan. Meanwhile, the developers’ large office projects overseas—Mitsui Fudosan’s two Hudson Yards towers in Manhattan that opened in 2018 and 2022 and Mitsubishi Estate’s recently completed 8 Bishopsgate tower in the City of London—seem to be faring well in the postpandemic leasing environment despite the global work-from-home trend. Ongoing rises in construction costs in Japan have mixed effects, threatening to potentially reduce the profitability of future condo sales (which have done well until now as selling prices have risen robustly, particularly in central Tokyo) but at the same time potentially improving the supply/demand balance of new offices.

Mitsubishi Estate owns most of the land in the prime office area in front of Tokyo Station (Otemachi, Marunouchi, and Yurakucho), much of which acquired from the government in 1890 with few transactions since. Leasing office space in these districts continues to generate most of the firm's profit today, though Mitsubishi Estate has expanded into retail and residential leasing, condo development, hotels, and related businesses. More than 20% of profit comes from overseas, a proportion it aims to bring up to 30% by 2030.

We raise our fair value estimate for Mitsui Fudosan to JPY 3,000 from JPY 2,800 and maintain our fair value estimates of JPY 2,000 for Mitsubishi Estate and JPY 4,000 for Sumitomo Realty after the Japanese developers’ earnings reports. The main reason for our 7% increase in our fair value estimate for Mitsui Fudosan is our increasing optimism for its facility operations segment, which includes hotels and resorts as well as the Tokyo Dome stadium complex it purchased in 2021. There was also a stronger outlook for office leasing at Hudson Yards on the west side of Manhattan than we previously assumed. We think retail leasing and hotels for all the Japanese developers will benefit to some extent now that China is lifting its pandemic-era restrictions on tour groups traveling to Japan, with Mitsui being a larger beneficiary than peers as a result of its higher weighting in these areas.

We are revising the Morningstar Uncertainty Ratings for Japanese real estate developers in our coverage to Medium from High. We have maintained the High uncertainty rating since August 2020 due to the risks of secular destruction of demand for office leasing from the work-from-home trend, but after close to three years having assigned High ratings we now think visibility over future office demand is sufficient to revert them back to the Medium level. This lower Uncertainty level has the effect that the threshold for a four-star investment rating when our fair value estimates are above the current share prices becomes smaller.

Mitsubishi Estate owns most of the land in the prime office area in front of Tokyo Station (Otemachi, Marunouchi, and Yurakucho), much of which acquired from the government in 1890 with few transactions since. Leasing office space in these districts continues to generate most of the firm's profit today, though Mitsubishi Estate has expanded into retail and residential leasing, condo development, hotels, and related businesses. More than 20% of profit comes from overseas, a proportion it aims to bring up to 30% by 2030.

We maintain our fair value estimates of JPY 2,800 for Mitsui Fudosan and JPY 4,000 for Sumitomo Realty, equivalent to 0.53 times Mitsui Fudosan’s net asset value assuming 30% tax rate and 0.45 times Sumitomo Realty’s net asset value, and reduce our fair value estimate for Mitsubishi Estate to JPY 2,100 from JPY 2,200. Our new estimate for Mitsubishi Estate is 0.54 times net asset value, compared with 0.57 times previously. Earnings for the December quarter, the third quarter in the companies’ fiscal years ending March 2023, were in line with expectations for Mitsui and Sumitomo Realty, with annualized return on equity of 6.6% for Mitsui and 9.5% for Sumitomo Realty, near their averages and on track to at least meet company guidance for the year. Mitsubishi Estate’s annualized ROE of only 4.9%, however, was below its average of around 7% and the ROE implied by its guidance for this year of around 8%. Some of this was due to the timing of property sales, which always creates noise in the quarter-to-quarter results of the developers (a reason to focus instead on annual trends), but the slight weakness of Mitsubishi Estate’s results was broad enough to raise a bit of concern even though management maintained its overall profit guidance for the current year and expressed confidence for its prospects in the new fiscal year starting in April. Mitsubishi Estate’s investment management segment in particular seems vulnerable to declining market value of managed assets overseas as higher U.S. dollar interest rates lead to higher cap rates for properties. That said, we think current share prices already incorporate the risk. There is 30% upside to our new fair value for Mitsubishi Estate, versus 14% upside for Mitsui and 28% upside for Sumitomo Realty. If global interest rates stop going up, this could be a good time to buy the sector at relatively depressed valuations, in our view.

Mitsubishi Estate owns most of the land in the prime office area in front of Tokyo Station (Otemachi, Marunouchi, and Yurakucho), much of which acquired from the government in 1890 with few sale transactions since. Leasing office space in these districts continues to generate most of the firm's profit today, though Mitsubishi Estate has expanded into retail and residential leasing, condo development, hotels, and related businesses. More than 20% of profit comes from overseas, a proportion it aims to bring up to 30% by 2030.

We maintain our fair value estimates of JPY 2,800 for Mitsui Fudosan, JPY 2,200 for Mitsubishi Estate, and JPY 4,000 for Sumitomo Realty following the Japanese real estate developers’ results for the second quarter in their fiscal years ending March 2023. Our fair value estimates are equivalent to 0.54 times net asset value for Mitsui Fudosan, 0.57 times for Mitsubishi Estate, and 0.45 times for Sumitomo Realty, assuming 30% tax on unrealized gains, and represent 17% upside for Mitsubishi Estate, 11% upside for Sumitomo Realty, and 6% upside for Mitsui Fudosan from their current share prices.

Mitsubishi Estate owns most of the land in the prime office area in front of Tokyo Station (Otemachi, Marunouchi, and Yurakucho), much of which acquired from the government in 1890 with few sale transactions since. Leasing office space in these districts continues to generate most of the firm's profit today, though Mitsubishi Estate has expanded into retail and residential leasing, condo development, hotels, and related businesses. More than 20% of profit comes from overseas, a proportion it aims to bring up to 30% by 2030.

We maintain our fair value estimates of JPY 2,800 for Mitsui Fudosan, JPY 2,200 for Mitsubishi Estate, and JPY 4,000 for Sumitomo Realty after the Japanese real estate developers’ results for April-June, the first quarter in their fiscal years ending March 2023. Our fair value estimates are equivalent to 0.54 times net asset value for Mitsui Fudosan, 0.58 times for Mitsubishi Estate, and 0.46 times for Sumitomo Realty, assuming 30% tax on unrealized gains, and represent 17% upside for Mitsubishi Estate and 15% upside for Sumitomo Realty from their current share prices. Mitsui Fudosan’s current share price is near our fair value estimate.

In the five central wards that comprise Tokyo’s main business district, 6.39% of total office space was available for lease in June, up slightly from 6.37% a month earlier, according to real estate brokerage Miki Shoji. Tokyo’s office vacancy rate has thus stayed roughly flat in a range between 6.2% and 6.5% for a year now after having previously quickly deteriorated from a cycle low of 1.5% in March 2020 to reach its current range by mid-2021. Assuming the rate does not start to move higher again, the vacancy rate appears to be slightly more benign than what we had projected in May 2021, when we had forecast it might to peak around 8% or 9% by early 2023. Still, notwithstanding the slightly better-than-projected trend in the headline vacancy rate, we see the outlook for the Tokyo office leasing market as being in line with the base-case scenario we adopted at the beginning of the pandemic in March 2020 (see our March 25, 2020 note for details) for a downturn roughly half as deep as the one experienced after 2008.

We raise our fair value estimate for Mitsubishi Estate to JPY 2,200 from JPY 2,100, 29% above the previous closing share price. Mitsubishi Estate is our top pick at present among Japanese property developers.

Mitsubishi Estate owns most of the land in the prime office area in front of Tokyo Station (Otemachi, Marunouchi, and Yurakucho), much of which acquired from the Japanese government in 1890 with few sale transactions since. Leasing office space in these districts continues to generate most of the firm's profit today, though Mitsubishi Estate has expanded into retail and residential leasing, condo development, hotels, and related businesses. About 15% of profit comes from overseas, a proportion it aims to double by 2030.

We maintain our fair value estimate of JPY 2,100 for Mitsubishi Estate, which we calculate as equivalent to 0.61 times net asset value and 22% above the current share price. Mitsubishi Estate shares have underperformed those of its rivals since the start of this fiscal year in April and we think the company has less room to beat its March 2022 guidance than some of its peers. Halfway through the year, Mitsubishi Estate has achieved 46% of its full-year guidance for operating profit and 39% of its bottom-line guidance even though it has already realized 56% of its planned amount of capital gains for the year, in part reflecting a more-prolonged-than-expected impact from the pandemic on retail leasing and hotels. However, we expect operating profit to catch up in the second half of the year owing to seasonal dispersion in the residential segment. Mitsubishi Estate has already contracted 97% of its planned condo sales for the year as of Sept. 30 and this segment’s operating profit, which has only achieved 24% of full-year guidance in the first two quarters, could well top 100% for the full year.

Mitsubishi Estate owns most of the land in the prime office area in front of Tokyo Station (Otemachi, Marunouchi, and Yurakucho), much of which was acquired from the Japanese government in 1890 with few sale transactions since. Leasing office space in these districts continues to generate most of the firm's profit today, though Mitsubishi Estate has expanded into retail and residential leasing, condo development, hotels, and related businesses. About 15% of profit comes from overseas, a proportion it aims to double by 2030.

We maintain our fair value estimate of JPY 2,100 for Mitsubishi Estate, equivalent to 0.61 times net asset value and 22% above the current share price after it reported results for April-June, the first quarter in its fiscal year ending March 2022. Net profit for the quarter was JPY 35 billion, 24.4% of its full-year guidance of JPY 142 billion, and operating profit was JPY 63 billion, 25.5% of its full-year guidance of JPY 245 billion. By segment, commercial real estate was slightly ahead of 25% of guidance as office leasing has been resilient in 2021 for Mitsubishi Estate. The residential segment, meanwhile, was behind, despite the booking of JPY 5 billion in capital gains on the sale of a rental-apartment property.

Mitsubishi Estate owns most of the land in the prime office area in front of Tokyo Station (Otemachi, Marunouchi, and Yurakucho), much of which was acquired from the Japanese government in 1890 with few sale transactions since. Leasing office space in these districts continues to generate most of the firm's profit today, though Mitsubishi Estate has expanded into retail and residential leasing, condo development, hotels, and related businesses. About 15% of profit comes from overseas, a proportion it aims to double by 2030.