By Christopher M. Wright

NAME: Jack Foster TITLE: Managing Director, Head of Global Real Estate, Franklin Templeton Real Estate Advisors BORN: 1957 Experience: Foster earned a B.A. from Columbia University and began his career in residential housing development in Maryland and Virginia. He later worked as a commercial real estate broker in New York City, then joined Franklin Templeton Real Estate Advisors in 1987. He serves on the advisory boards for several private property funds around the world and for various real estate organizations.

Since their inception in 2000, Japanese REITs have brought transparency to Japan's commercial real estate market and helped to revive the Japanese economy. But does that make them a good investment in today's market? Some say yes—things are looking up in the world's second largest economy. Jack Foster, managing director of Franklin Templeton Real Estate Advisors, oversees $4.5 billion in global real estate investments and has his eye on possible legislative changes that could propel J-REIT shares upward.

However, he also sees risks that could bring them down. What return expectations does he have for Japan, and how do they stack up against other countries? Portfolio recently sat down with Foster to find out his views on the J-REIT market.

Portfolio: There are a lot of international real estate funds and money managers now. What is your firm's competitive advantage?

Foster: I have been involved in both publicly listed stocks and private deals in international real estate investing for more than 20 years. The most senior members of our group have been investing globally in property for 10 years on average. Our team is very deep in terms of experience.

Additionally, we have 20 people in our group, only two of whom are Americans. We have employees from Belgium, China, Japan and the Netherlands, among other countries.

We've worked very hard to build a truly global team for one big reason: real estate is priced locally. Unlike other commodities, you need to have local perspective on culture and current events. Additionally, we invest in private equity real estate funds on a global basis. This gives us some of the most cutting edge perspectives on property markets. All of this helps us find the best values out there as we pursue our high income and low volatility strategy.

Portfolio: What is your outlook for J-REIT investing for the next two years?

Foster: We are looking for strong returns from J-REITs in the next two years. Our overall return expectation is 10 percent to 15 percent, with approximately half of that coming from income.

Shorter term, the prospects for high returns are not as good—the yields on Japanese REITs are low at the moment. However, I would argue they will be able to deliver the type of performance I mentioned over the next two years.

Portfolio: How does that stack up against other countries and regions?

Foster: The J-REIT market is weaker than the rest of the market for the next 6 to 12 months. Comparatively, Australia, Singapore, and the United States—which is poised for recovery and some healthy returns—will likely perform better than Japan in the next 12 months.

However, Europe looks a little pricey. We're watching it very closely, because the U.K. market has had such a decline. Yet, it could turn around fairly quickly and may offer some strong returns.

Portfolio: Some argue that investment in Japanese real estate is a good idea because of its ongoing economic recovery and the fact that Japan has the world's second largest economy. Is that true?

Foster: We like Japan for long-term fundamental trends, such as economic prospects and continuing securitization of the market. However, things can get confused if there's too much construction, if capital flows are weak or if there are financing issues.

The subprime situation and credit crisis in much of the Western world affects many real estate markets and will continue to do so for the foreseeable future. The Japanese and Asian markets are affected less, but Japan has seen an increase in the cost of financing.

There's huge interest in J-REITs from domestic investors, because yields are still two or three times what they can get from a savings account. Additionally, the Japanese market is substantially impacted by capital flows from foreign investors. However, recently, we've seen foreign capital flows pull back.

Portfolio: What are the most compelling J-REIT investment themes going forward?

Foster: There are five themes to look for in the Japanese real estate market. The office sector is very positive. We're coming off a 15-year decline in property values, and it's currently recovering. The fact that land values are turning positive is a very important theme. In Japan, most of the value in a property is in the land, unlike the United States.

Securitization is another big theme. In the last five years, we've seen huge growth in the amount of property being securitized, and that trend will continue.

Japanese REITs are externally managed, and we like companies that have strong sponsors like a big insurance or property company partnered with them. Then, the opportunity for the J-REIT to buy more assets is substantially greater.

Low interest rates are an important theme. Of all the developed markets, Japan has the widest spread of property company yields above government treasuries. That yield spread will continue to be important.

Lastly, the government is focused on supporting this asset class, and strong demand for J-REIT shares from pension funds will continue.

Portfolio: There is a debate about whether investors should look at Tokyo or elsewhere in the country. What is your take?

Foster: Tokyo is a strong market. The country's population and financial activity are concentrated there. The Tokyo office market might be the largest in the world, easily 30 percent to 50 percent larger than New York City.

We think most of the growth in the office sector for the short-term will be in the Tokyo market. Long-term, the population is aging and there will be more demographic concentration in the cities that will help other urban centers across Japan.

Portfolio: Currently, J-REITs can't invest outside Japan. What are the prospects for changing the law and what effect would it have on the J-REIT sector and share prices?

Foster: The governing body reviewing this has received substantial feedback from J-REIT managers. This is likely to change and it will be a major catalyst for returns. There are other reforms—such as allowing J-REITs to get into development activity—that may also occur.

I'm confident the Japanese REIT structure is going to evolve over time. The country has a history of importing ideas from abroad and the government will eventually adopt what is normal REIT practice elsewhere. However, this will take time and it's hard to forecast exactly when it will happen.

Portfolio: What are the biggest risks in J-REIT investing?

Foster: There are several risks involved. One is a possible rise in interest rates which could put downward pressure on J-REIT valuations. Also, higher capital flows from foreign investors have increased volatility in the sector. There could be sponsor risk if a sponsor is too passive in supporting the REIT.

However, another property bubble could occur. The REIT structure has given greater transparency to the Japanese property market and there are a lot of regulatory restrictions on property companies because of Japan's history of bubbles. But it's a small market, so never say never.

Portfolio: What other country or real estate investments do you think will outperform in the next 12 to 24 months?

Foster: The residential sector will be very positive in the developing Asian markets. We're suffering in the West from overbuilding and generally weaker housing markets. However, there are two demographic shifts in Asia—a growing middle class and the movement from rural to urban living. These will continue to drive housing. In the West, the office sector will continue to do well and it's not overbuilt in most countries.

Another country to look at is Australia. According to the government, it has the third largest pension system in the world and is expected to move to number two in the next five years. The economic wealth that's being created in Australia will result in very strong, long-term property trends in Melbourne, Sydney and the other cities. Amazingly, 70 percent to 80 percent of all commercial property in Australia is owned by publicly listed companies. It's a great REIT market.