Industry fears a Japanese sell-off may be looming.

Tokyo stock market, L.A. real estate values stay soft

If Japanese stock market values and demand for Los Angeles office and hotel space do not pick up, Japanese investors who own billions of dollars worth of Los Angeles real estate could be forced to start selling assets at up to 50 percent discounts by 1994, industry sources warned.

That dire scenario is looming because of strict new loan-loss-reserve requirements called for under the Federal Deposit Insurance Corp. Improvement Act of 1991.

Japanese lenders financed the Japanese partnerships' acquisition of millions of square feet of Los Angeles building space during the 1980s. But the 1991 law requires that, by March 1993, all lenders must maintain loan-loss reserves equal to 8 percent of all loans secured by commercial real estate. And that more-stringent reserve requirement could have dire consequences for Japanese investors with L.A. commercial property holdings. Presently, California banks must have a 7.2 percent loan-loss reserve.

"They (commercial real estate lenders) have to shrink their asset base, or increase the capital levels," pointed out Ron Greenspan, director of restructuring services at the Los Angeles office of Big Six accounting firm Price Waterhouse. "The hidden cushion created for them when real estate and stock prices were rising has evaporated."

Some Japanese banks, in order to avoid the strict examinations (and tougher capital requirements), have sold their U.S. commercial real estate loans back to their non-bank subsidiaries in Japan, Greenspan said.

"There is over $100 billion in convertible debt (debt that can be converted to stock) owed by Japanese banks and insurance companies that sold corporate bonds to finance U.S. real estate developments. They face similar problems," Greenspan said.

Many of the bonds must be paid off in 1994, said Greenspan. Unless the companies that issued those bonds can sell more bonds to pay off the original bonds, they may be forced to sell off the L.A. real estate at very soft prices, he said.

The Japanese investors have become victims of their own unfortunate timing, having purchased most of their L.A. properties for top dollar in the bullish 1980s.

Those top-dollar prices were paid based on Japanese investors' overly optimistic projections about commercial occupancy rates and effective lease rates, said Greenspan and other Los Angeles experts on Japanese U.S. real estate holdings.

Many Japanese companies that own Los Angeles commercial real estate probably have the staying power to survive the trying times, industry experts added. But if even a few large properties sell at big discounts, it could further soften the overall Los Angeles office market, Greenspan said.

For now, September and October rallies on the Nikkei Stock Exchange have helped Japanese corporations with Los Angeles real estate holdings, Greenspan said. The rebounding stock prices restored equity lost earlier this year, and has made things look better for now. But another drop in stock prices in late 1993 or early 1994, just as the more-stringent capital requirements kick in, could spell trouble for them.

Harry D. Hartnett, director of research for the Century City office of real estate accounting firm kenneth Leventhal & Co., said one of the largest Japanese investors in Los Angeles real estate, Shuwa Investment Corp., has been particularly hard hit by recent decreases in the Japanese stock market and L.A. real estate values.

"It has been reported that Shuwa Investment Corp. has lost over $1 billion because of the falling value of the Nikkei," Hartnett said. "It's possible that they may have to part with some assets, but I don't see any wholesale liquidation."

Shuwa officials in Los Angeles did not return phone calls.

"The Japanese invest for the long haul, and they haven't been in this market that long," Hartnett pointed out. "The credit crunch will eventually shore up lease rates and property values because nobody else is building new office buildings."

Taking a more moderate perspective was Andrew S. Kane, a partner and western regional director for real estate services at Big Six accounting firm Arthur Andersen & Co. Kane said he sees a prolonged office market flaccidity.

"We could be in for a three- to five-year hold pattern until we see Los Angeles real estate values go back up," he said.

"I have seen a lot of Japanese investors who want to sell their Los Angeles real estate, but they aren't willing to sell at a discount," Kane concluded.

Del Mar-based real estate consultant Sanford Goodkin said the Japanese investors still active in Southern California, such as Haseko (California) Inc., are investing in residential construction financing. They make short-term loans to home-builders, who use the money to pay for materials and labor. As soon as the homes sell, usually nine to 18 months after the builder gets the construction loan, the lender is repaid.

Although a few Japanese investors remain active, they are largely being replaced by investors from other Asian countries.

"I feel the Japanese have been replaced in the California real estate capital markets by the Chinese," Goodkin asserted. "There is a lot of money from Hong Kong, the Peoples Republic of China, Taiwan and Singapore. They believe in California. But the players in the marketplace today are third-tier players. They want to buy buildings in the $2 million-to-$5 million price range."

The Japanese still love Los Angeles, Goodkin continued. But he added that they are more cautious now than ever.

"They're asking themselves what they have learned from their mistakes in the (Southern California market)," he said. "If they want to put up less of their own money and still stay in the game, they'll have to give up some of the control they have historically had on their developments."

Major Japanese-owned Los Angeles commercial properties include:

* Mitsui Fudosan  USA's 1.4 million square feet of offices in Los Angeles, including the 950,000-square-foot Sanwa Plaza at 601 Figueroa St. in downtown L.A.

* Shuwa's twin-tower Arco Plaza at 515/555 S. Flower St. and Chase Plaza at 801 S. Grand Ave. in downtown L.A.

* And Oybayashi America Corp.'s 1.5 million square feet of projects in various stages of planning and completion throughout Los Angeles County, including the 565,000-square-foot tower at 550 Hope St. in downtown L.A.