Morningstar | Sumitomo Has Near-Term Earnings Growth, but Long-Term Headwinds Persist
Sumitomo Realty & Development, Mitsubishi Estate, and Mitsui Fudosan are the leading Japanese real estate developers. All three share similar profiles, including an office-leasing portfolio concentrated in Tokyo, residential trading of condominiums, and easy financing through their respective zaibatsu banks. What sets Sumitomo apart is its heavy use of debt financing to sustain an asset-heavy business model.The company has reaped the most benefits from the low-interest-rate environment through its high leverage. Its borrowing cost averaged below 1% over the past five years, and is expected to remain there for the near future. Further, the Bank of Japan, or BoJ, has pushed down the yield by buying JREIT units. This has expanded the universe of yield-accretive targets in the Japanese commercial real estate space, leading to the rise of capital value across the board. As Sumitomo does not dispose of its assets through affiliated REITs, it benefits fully from the cap-rate compression. We take some comfort that the management has secured almost all funding at fixed rates for the next 10 years.Sumitomo has been in an expansionary phase over the past three years, with capital expenditure funded by bank borrowing. The spending pace should moderate as projects come to completion. With its unique ability to source larger land bank through multiple midscale acquisitions, SRD’s high asset concentration within the Tokyo Central Businesses Districts has allowed the company to build new supply in a more efficient manner than its peers. SRD also can adopt to a variety of strict zoning laws and town planning restrictions while maintaining good relationship with the Tokyo metropolitan government over multiple decades. However, these projects are entering a market with mismatched supply and demand dynamics. Office supply is projected to be plentiful on the back of easy financing, accommodative land-use policies, and rising competition among prestige developments among large developers. On the demand side, despite some tailwinds from migration into the Tokyo metropolitan area, demand for office space will soon peak as white-collar employment may decline more quickly than expected.Sumitomo Realty & Development is mainly engaged in the real estate business. Co.'s principal business segments are real estate leasing, real estate sale, construction, brokerage, and others. It is engaged in the development, direct leasing and management of office buildings and condominiums, the sublease of properties leased from special purpose companies, the provision of hotel business and the operation of event halls and conference rooms; the development and sale of condominiums, buildings, detached houses, housing land and other properties; the construction and remodeling of houses; the brokerage and sale of real estate; and the operation of fitness clubs and restaurants.
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