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We have observed a decoupling of real estate capital values and rental cash flows, with capital values flat or rising amid a decline in rental cash flows for some types of real estate, such as offices. In this report, we discuss cross-border real estate investment fund inflows potentially causing the decoupling, and how this might impact the industry structure. Our analysis uses our own formulas for dividend per share (DPS) accretive hurdle rates for J-REITs' property acquisitions, ÃÛ¶¹ÊÓƵ Evidence Lab, and data from a private equity fund survey company.

A rise in capital values without a corresponding rise in rental cash flows, or asset inflation driven by declining cap rates, lowers investment yield when a real estate investor buys a property, and the resulting decline in return on investment capital (ROIC) erodes return on assets (ROA) and return on equity (ROE). In particular, high capital costs for developers means that the share price discount to net asset value (NAV) increases due to a reverse divergence between ROE and cost of equity while NAV grows. In this situation, it is therefore more beneficial from the perspective of total returns to crystallise capital gains from real estate divestments.

Some developers have accelerated commercial real estate divestments and used some of the proceeds to buy back shares, while Japanese (J-REITs) have continued to raise equity to buy such properties. However, divestment gains are taxed when a property is transferred from a developer to a REIT. We see UPREITs as a possible solution to this issue. It would be worthwhile to implement a similar system to UPREIT and aim to improve ROE and lower the cost of equity before developers with share prices languishing well below NAV become a target for delisting by private equity funds which have built up large amounts of capital. We also see an urgent need to work on initiatives for environment-related assets that are likely to be appealing to funds that have been increasing capital based on ESG policies.