Executive summary

Business overview

First Brothers (FB) is a real estate investment management and investment banking company. It was founded in February 2004 by Tomoki Yoshihara, who had previously worked at Mitsui Trust and Banking Company (currently Sumitomo Mitsui Trust Bank). Two former colleagues of Mr. Yoshihara joined the management team as directors not long after the company was established. Many of the company’s employees have a background in the financial industry, and are professionals in related fields (attorneys, certified public accountants, real estate appraisers, and class-1 architects). According to the company, FB has carved out a unique position as an investment bank that is also a real estate company.

At its Investment Management segment, which drove much of FB’s initial growth, the company manages client assets through private funds that mainly invest in real estate and real estate trust beneficiary rights. The balance of assets under management (AUM) in this segment as of end-FY11/20 was JPY11.8bn and the business accounted for 4.2% of total revenue and 9.6% of operating profit in FY11/20. Around the period of its listing in February 2015, FB refocused its operations, positioning as its core business the Investment Banking segment where the company uses its own capital to make investments, primarily in real estate. The balance of FB’s proprietary assets in this segment as of end-FY11/20 was JPY55.6bn (55 properties). The Investment Banking segment accounted for 94.9% of total revenue and 89.8% of operating profit in FY11/20. As of end-FY11/20, the AUM and proprietary assets of the two segments combined stood at JPY67.4bn.

Under the Investment Banking segment, FB owns a portfolio of properties for lease (end-FY11/20 breakdown by asset type: commercial 36.8%, office 40.9%, hotels 19.5%, residential 2.8%; Greater Tokyo area 57.4%), through which it projects to generate stable income over the medium to long term. FB applies strict valuation (appraisal) criteria to acquire real estate that has unrealized value stemming from its location and other attributes. Many of the properties the company targets are owned by individuals rather than real estate companies, and FB explains that there is often room to raise their rent and occupancy. The company sources properties through various channels ranging from referrals from financial companies to real estate brokers, and conducts due diligence to select and acquire one or two properties per month from several hundred offered. FB maintains that because it can rapidly appraise properties (in one to three days) and raise capital, it receives offers on good deals ahead of many competitors.

The main sources of revenue at the Investment Banking segment are capital gains (mainly gains from property sale; 50.6% of total gross profit in FY11/20) and investment income centering on rental income (48.6%). The company achieves a relatively high return on properties with its capital gains ratio trending at over 1.0 regardless of the trend in the market (at end-FY11/20, sales prices exceeded acquisition prices by 26%). The properties FB purchases are generally small to mid-sized (around JPY1.0bn per property); the company also develops new properties if it feels it can generate sufficient returns. FB would opportunistically sell its properties to realize capital gains (at end-FY11/20, the market value of its properties exceeded their book value by 15%). The company says it mainly focuses on maximizing property values before sale and tends not to confine itself to metrics such as days in inventory (739–1,823 days in FY11/17–20). Thanks to further expansion of FB’s real estate portfolio in FY11/20, gross profit from property lease exceeded the corresponding SG&A expenses, raising the SG&A coverage ratio (gross profit from property lease divided by SG&A expenses) to 137%. OPM in the Investment Banking segment has trended steadily at over 20% since FY11/14.

FB’s real estate portfolio has continued to expand, aided in part by the addition of Higashinihon Fudosan Co., Ltd. as a consolidated subsidiary in April 2019. Higashinihon Fudosan owns a large number of quality properties in Japan’s Tohoku region with their total asset value standing at JPY12.7bn, or 29.3% of FB’s proprietary assets as of end-FY11/19. Properties include office buildings near stations and in business districts, as well as roadside and other commercial facilities. According to the company, these properties had an average NOI yield (net operating income [NOI] divided by acquisition price) of 8.0%, whereas the average for FB’s properties at end-FY11/19 was 6.6%.

Because FB uses debt to fund property acquisitions, its loan balance tends to expand in tandem with growth in investment (loan balance of JPY46.0bn at end-FY11/20). Leverage, calculated as the loan balance divided by the book value of FB’s properties, was 81.8% at end-FY11/20. The company generally tries to borrow long-term with ten-year or longer loans and uses interest rate swaps to maintain a fixed interest rate for certain portions of its loan balance (44.3% at end-FY11/20). The weighted average interest rate before the fixation of interest rates is around 0.8%. This shows FB is enjoying extremely low preferential interest rates compared to its peers, where interest rates tend to be over 1%.

Trends and outlook

For FY11/20, the company reported full-year consolidated revenue of JPY15.6bn (-21.2% YoY), operating profit JPY2.5bn (-26.6% YoY), recurring profit JPY1.8bn (-35.4% YoY), and net income of JPY2.3bn (+5.9% YoY). Revenue, operating profit, and recurring profit fell due to lower property sales in connection with refreshing the portfolio of properties for lease. Meanwhile, net income increased due to the recognition of negative goodwill (JPY1.2bn) in the consolidated financial statement at the time of consolidating Fuji Facility Service.

For FY11/21, the company initially projected full-year consolidated revenue of JPY30.1bn (+92.4% YoY), operating profit of JPY4.7bn (+86.1% YoY), recurring profit of JPY4.0bn (+120.8% YoY), and net income of JPY2.6bn (+10.2% YoY). The sharp jump projected for both the top- and bottom-line reflected plans for additional property sales in connection with the makeover of its leasing property portfolio.

The company revised its full-year guidance on November 26, 2021, lowering its top-line estimate while raising its estimates for earnings at all levels. Under its revised forecast, the company now sees full-year consolidated revenue coming in at JPY26.7bn (-JPY3.4bn or 11.4% less than its initial estimate), operating profit of JPY4.9bn (+JPY160mn or 3.4% more than its initial estimate), recurring profit of JPY4.3bn (+JPY290mn or 7.2% more than its initial estimate), and net income of JPY2.6bn (+JPY83mn or 3.3% more than its initial estimate). Explaining the revisions, the company said it had replaced the properties it planned to sell at the beginning of the term with properties with higher gross profit margins, so revenue fell short of the initial plan, but gross profit from property sales exceeded the plan.

The company does not publicly disclose a medium-term business plan. Although its policy is to increase profit and shareholders’ equity while expanding its real estate portfolio, property sale currently accounts for a relatively large portion of its profit, which means annual earnings may be subject to short-term fluctuations driven by property sale trends. However, FB thinks gross profit (= gross profit from property lease + gross profit from property sale + other) will remain in an uptrend over the medium to long term provided its shareholders’ equity and investment portfolio continue to expand.

FB aims to pay a stable dividend (year-end only) irrespective of fluctuations in short-term earnings. It looks to increase the dividend over the medium to long term in line with company growth, and targets a dividend on equity ratio (DOE) of 2.0%.

Strengths and weaknesses

First Brothers’ strengths are 1) due diligence and value-add capabilities that underpin the property investment cycle from purchase to sale; 2) a strong credit that enables financing through long-term borrowings at low interest rates; and 3) a growing real estate portfolio centering on properties with high NOI yield. Its weaknesses are 1) a governance system that needs further development; 2) uncertainties surrounding capital gains-reliant earnings structure; and 3) the company’s inability to date to fully recoup the investments in renewable energy and startup companies.

Definition of terms

Key financial data

Recent updates

Revision to full-year consolidated earnings forecast for FY11/21

On November 26, 2021, First Brother Co., Ltd. announced a revision to its full-year consolidated earnings forecast for FY11/21.

The company revised its full-year guidance on November 26, 2021, lowering its top-line estimate while raising its estimates for earnings at all levels. Under its revised forecast, the company now sees full-year consolidated revenue coming in at JPY26.7bn (-JPY3.4bn or 11.4% less than its initial estimate), operating profit of JPY4.9bn (+JPY160mn or 3.4% more than its initial estimate), recurring profit of JPY4.3bn (+JPY290mn or 7.2% more than its initial estimate), and net income of JPY2.6bn (+JPY83mn or 3.3% more than its initial estimate). Explaining the revisions, the company said it had replaced the properties it planned to sell at the beginning of the term with properties with higher gross profit margins, so revenue fell short of the initial plan, but profits from property sales exceeded the plan. The company also reduced SG&A expenses and non-operating expenses compared to its initial forecasts. The company considers gross profit from property sales and lease to be more important than the level of revenue.

Trends and outlook

Quarterly trends and results

Cumulative Q3 FY11/21 results

Summary

• Revenue: JPY15.8bn (+57.8% YoY); achieved 52.5% of the full-year plan
• Gross profit: JPY4.5bn (+35.7% YoY)
• Operating profit: JPY3.1bn (+57.2% YoY); 65.8%
• Recurring profit: JPY2.7bn (+88.2% YoY); 66.6%
• Net income attributable to owners of the parent: JPY1.8bn (-11.3% YoY); 70.9%
  
  

In cumulative Q3 FY11/21, both rental revenue and gross profit from property lease increased as the company made progress in expanding its portfolio of rental properties. Gross profit margin for cumulative Q3 FY11/21 was 28.2% (27.4% in FY11/20; 26.6% in Q2 FY11/21). Both the selling price and gains from property sales increased due to the sale of several properties. On the other hand, net income declined YoY as the impact of a gain on negative goodwill booked in the previous year dropped out. 

First Brothers acquired new properties for lease during cumulative Q3 FY11/21. The company continued to focus on investment in lease properties, and its property portfolio grew 20.5% from end-FY11/20 to JPY67.7bn on a book value basis. Gross profit from property lease rose 16.8% YoY due to the expansion of the lease property portfolio. In addition, unrealized gains through value enhancement of lease properties expanded to JPY12.3bn, up 48.5% from end-FY11/20. The company have also continued to realize these paper profits through property sales. Rental income from the lease property portfolio has been secured at a level exceeding the sum of SG&A expenses and interest expenses.

Segment results

Investment Management segment

• Revenue: JPY842mn (+189.1% YoY)
• Gross profit: JPY194mn (-7.6% YoY)
• Operating profit: JPY155mn (-17.2% YoY)
  

During cumulative Q3 FY11/21, the company refrained from investing in relatively large properties, which funds target as investments. On the other hand, due to the new asset management business contracted during Q2, the balance of assets under management as of end-August 2021 reached JPY23.4bn, up from JPY11.8bn at end-FY11/20. Segment profit declined partly due to the high cost ratio of the real estate management business of Fuji Facility Service, which First Brothers acquired in FY11/20.

Investment Banking segment

• Revenue: JPY14.9bn (+52.1% YoY)
• Gross profit: JPY4.2bn (+37.7% YoY)
• Operating profit: JPY3.6bn (+51.8% YoY)
  

As of end-August 2021, the balance of the company's lease property portfolio was JPY66.8bn (+JPY11.2bn from end-FY11/20), and the number of properties was 90 (up 35 from end-FY11/20). The portfolio has unrealized gains of JPY12.3bn (+JPY4.0bn, or 48.5%, from end-Q2 FY11/21), and the assumed NOI yield is 6.4% (-0.2 pp from 6.6% at end-Q2 FY11/21) if the company's value enhancement scenario is executed. During Q3 FY11/21, the company added 27 properties with a value of JPY9.3bn in its lease property portfolio.

The geographical distribution of the lease portfolio as of end-Q3 FY11/21 was as follows: Greater Tokyo area 55.0% (-2.4 pp from end-FY11/20) and other major cities 45.0% (+2.4pp). The breakdown by asset type (breakdown of balance based on acquisition price) was as follows: offices 30.6% (-10.3pp from end-FY11/20), commercial 29.9% (-6.9pp), hotels 26.2% (+6.7pp), and residential 13.2% (+10.4pp). In Q3 FY11/21, the company bought properties in bulk, including relatively small residential properties. This resulted in an increase in the proportion of the lease portfolio accounted for by residential properties.  

The company manages properties for lease while improving their value and sells them when appropriate from the perspective of portfolio rotation. During cumulative Q3 FY11/21, the company sold JPY11.5bn of properties for lease (JPY171mn during standalone Q3 FY11/21), acquired JPY8.9bn of properties for lease, earned JPY2.6bn in gross profit on sales, and had a capital gains yield (sales amount divided by acquisition amount) of 1.30 times. It appears that transfer of most properties will take place in Q4 FY11/21.

Gross profit from property lease and SG&A coverage ratio

The company has a policy of expanding both quality and volume of its lease portfolio to generate growth in gross profit from property lease (net income from property lease, calculated as NOI [excluding special factors] minus depreciation). For cumulative Q3 FY11/21, gross profit from property lease was JPY1.8bn, and SG&A coverage ratio (gross profit from property lease divided by SG&A expenses [excluding special factors]) was 134%. This is higher than the 133% coverage ratio for cumulative Q3 FY11/20, and the company continues to increase the depth of its gross profit from property lease by expanding its lease property portfolio.

Financing

The company raises funds on a project-by-project basis when it acquires individual properties for lease. Currently, in principle, the company uses ultra-long-term basis loans (10 years and longer, variable interest rate loans), combined with interest rate swaps to convert the majority of the outstanding loans into fixed payments. The balance of outstanding loans at end-Q3 FY11/21 stood at JPY55.7bn (up JPY9.7bn from end-FY11/20), the average interest rate on loans was 0.94% (+0.19pp), the average remaining period of loans was 10.0 years (+2.1), and the fixed interest rate ratio was 31.7% (44.3% at end-FY11/20). The JPY9.7bn increase in loans from end-FY11/20 was in line with lease portfolio expansion, and the leverage ratio at end-August 2021 was 82.3%, up 0.5pp from 81.8% at end-FY11/20. Interest rates on loans have risen, but this is likely because increased assets included hotel properties, which have become subjected to stricter screening by financial institutions. The fixed interest rate ratio decreased by 12.6pp from end-FY11/20, partly due to the expiration of interest rate swaps contracts.

Company forecast for FY11/21

Initial forecast

For FY11/21, the company initially projected full-year consolidated revenue of JPY30.1bn (+92.4% YoY), operating profit of JPY4.7bn (+86.1% YoY), recurring profit of JPY4.0bn (+120.8% YoY), and net income of JPY2.6bn (+10.2% YoY). The sharp jump projected for both the top- and bottom-line reflected plans for additional property sales in connection with the makeover of its leasing property portfolio.

Revenue in the Investment Banking segment consists of income from property sales and leases (rental income). The increase in revenue projected by the company comes primarily from property sales since no major increase in rental income is anticipated. The revenue forecast reflects the capital gains from property sales carried over from the previous fiscal year due to transaction delays, as well as those from deals originally anticipated for FY11/21.

The company revised its full-year guidance on November 26, 2021, lowering its top-line estimate while raising its estimates for earnings at all levels. Under its revised forecast, the company now sees full-year consolidated revenue coming in at JPY26.7bn (-JPY3.4bn or 11.4% less than its initial estimate), operating profit of JPY4.9bn (+JPY160mn or 3.4% more than its initial estimate), recurring profit of JPY4.3bn (+JPY290mn or 7.2% more than its initial estimate), and net income of JPY2.6bn (+JPY83mn or 3.3% more than its initial estimate). Explaining the revisions, the company said it had replaced the properties it planned to sell at the beginning of the term with properties with higher gross profit margins, so revenue fell short of the initial plan, but profits from property sales exceeded the plan. The company also reduced SG&A expenses and non-operating expenses compared to its initial forecasts. The company considers gross profit from property sales and lease to be more important than the level of revenue.

Medium-term outlook 

FB does not disclose medium-term business plans for two reasons. First, the company faces many uncertainties in its target markets, which are the real estate and financial markets. Second, it focuses on flexible management that can adapt to any market conditions. In the following section, we present our views on the medium-term outlook for the company while reflecting on the events that led to the company’s establishment, the business climate at the time of its founding, and its growth trajectory. 

Company establishment and business climate at the time

FB was established in February 2004 during a period when schemes to liquidize and securitize real estate gained traction, as exemplified by the successive J-REIT listings at the time. In the early 1990s, the real estate market was bogged down by disposals of non-performing loans following the collapse of a bubble fueled by excess investment in real estate. From 1991 to 2001, a period commonly referred to as Japan’s lost decade, a number of financial institutions successively filed for bankruptcy. Following the launch of the first two J-REITs in September 2001, the J-REIT industry embarked on an expansion phase that was ultimately followed by periods of stagnation, realignment, and renewed growth. As of December 2020, J-REITs had a market value of JPY14.4tn (62 entities) (Source: Association for Real Estate Securitization’s “JREIT.jp”). 
FB’s founder, Tomoki Yoshihara, had previously worked at Mitsui Trust and Banking Company (currently Sumitomo Mitsui Trust Bank) and Morgan Stanley Properties Japan (currently Morgan Stanley Capital), where he had witnessed the emergence of the real estate securitization market. Mr. Yoshihara says his original intention when founding the company was to make contributions to the domestic markets leveraging the experience he had accumulated while working at trust banks and foreign financial institutions during Japan’s lost decade.

Focus on fund management to ride out financial crisis

From its inception through 2005, FB rapidly acquired properties, incorporated these into funds, and mainly focused on the Investment Management segment. By FY11/05, it had acquired over JPY100.0bn in real estate holdings. From 2006, however, the company refrained from chasing high-priced properties and instead pivoted to an approach of carefully selecting acquisitions as property prices were approaching a peak. At the same time, it started progressively selling off previously acquired properties. In 2004–2005, large numbers of properties valued at several tens of billions of yen circulated on the market. From late 2006, the supply of large properties worth over JPY10.0bn dwindled, pushing down yields. In September 2008, just as FB was selling off its properties and building up cash reserves, the collapse of Lehman Brothers sent shockwaves through the world. The company managed to ride out the subsequent financial crisis without adverse impact by focusing on fee-based management of real estate funds and abstaining from proprietary investments in real estate.

Initiatives related to rescue cases

As uncertainties prevailed in the financial industry following the global financial crisis, liquidity declined in the real estate market. During this period (2008 to 2013), FB expanded its AUM by undertaking management of properties rescued from troubled funds. This involved asset management for funds originally managed by another company at the request of fund investors or lenders (such as banks) due to loan defaults or other reasons. According to the company, as real estate prices plummeted in the aftermath of the global financial crisis, FB leveraged its trustworthiness—based on the fact that none of the properties under its management had ever defaulted—to undertake management of a large number of rescued assets. However, this sharply pushed down gross profit in the Investment Management segment because asset management fee rates for rescue cases were low, compared with the fee rates of projects that begin with property acquisition. As of 2020, all rescued assets under the company’s management had been sold. 

High returns through combination of capital gains and investment income 

According to the company, FB’s management team of financial industry veterans enables it to flexibly transition between the fee-based business and the proprietary investment operations. From FY11/13, the supply of large properties worth over JPY10.0bn dwindled, pushing up corresponding prices. As a result, FB reoriented its efforts toward proprietary investment in small and mid-sized properties of around JPY1.0bn. The company applies strict valuation (appraisal) criteria to acquire real estate that has unrealized value attributed to its location and other features. Its capital gains yield (ratio of selling price to acquisition price) nearly consistently trends above 1.0 irrespective of market trends. In the case of total returns in real estate funds, investment income generated throughout the asset management period is added to the capital gains (difference between acquisition price and selling price), and leverage is also factored. Accordingly, FB has largely avoided losses in its property deals, and its returns have been higher than implied by its capital gains yield.

Envisioned growth trajectory over medium to long term 

FB has positioned the expansion of its portfolio of properties for lease as its core growth strategy. It intends to continue acquiring and managing real estate with room for value improvements, engaging in new property development, and realizing sustainable growth with surrounding regions by promoting coexistence with the local communities. In the process of growing its portfolio, it refreshes its holdings to generate unrealized gains, enabling further investment and growth. Its group policy is to enhance its real estate portfolio while increasing profits and shareholders’ equity. That said, because its share of profit from the sale of real estate (one-time revenue) is relatively high at present, fiscal year profit or losses may fluctuate depending on property sale trends. 

FB thinks its gross profit (GP from property lease + GP from property sale + other GP) will remain in an uptrend over the medium to long term provided its shareholders’ equity and investment portfolio continue to expand. It has thus far categorized large properties (several billions to several tens of billions of yen) as target assets for its funds (off-balance-sheet investment) and small to mid-sized properties (around JPY1.0bn) as those for proprietary investment (on-balance-sheet investment). However, FB’s financial condition has improved to the extent it is now capable of purchasing properties worth JPY10.0bn using its own capital, so the dividing line between fund-owned and proprietary assets may become blurred in the future. The decision on when to refocus on its fund business and based on what criteria remains a pending issue for FB’s management.

In an effort to secure earnings streams that are relatively unaffected by conditions in the real estate market, FB engaged in other investment and management businesses (such as renewable energy, venture capital funds, bonds, and private equity), but it has yet to report notable achievements or earnings contributions from these initiatives.

FB has been highly reliant on its one-time revenue business (property sale), but in FY11/20, its reliance on one-time revenue measured as percentage of total gross profit fell to 50.6% from 72% in FY11/19. The drop was attributable to delays in sales transactions (deals carried over from FY11/19 to FY11/20) and the addition of a commissioned asset management assignment in the Investment Management segment. Competitor Ichigo Inc. (TSE1: 2337) has achieved a near 50–50 balance between one-time and recurring revenue operations.

Because recurring revenue businesses generate comparatively higher margins, FB’s GPM (27.4% in FY11/20) has also lagged Ichigo’s (39.5% in FY02/20). In FY11/14–16, when the company’s recurring-revenue business (the real estate asset management operations) accounted for the bulk of its earnings, FB’s GPM exceeded that of Ichigo. However, Ichigo has since increased its revenue from solar power electricity sales (from 3.5% of gross profit in FY02/18 to 4.3% in FY02/20), which has also contributed to a balance between its one-time and recurring revenue businesses. 

Compared with Ichigo, which has found success in the solar power electricity business, FB has yet to effectively leverage its strengths in fields other than real estate, and Shared Research understands this is another challenge that will need to be addressed by its management team. 

Business

Business overview

Core business

Since its inception in February 2004, First Brothers (FB) has achieved growth by setting up and managing real estate funds targeting institutional investors. Around the time of its listing in February 2015, the company overhauled its operations and currently focuses on the management of its own assets, securing stable income from the mainstay real estate investments, while also investing in a range of peripheral fields. 

The company’s businesses divide into the Investment Management segment and the Investment Banking segment. In FY11/20, Investment Management accounted for 4.2% of total revenue and 9.6% of operating profit, and Investment Banking 94.9% and 89.8%, respectively. In Investment Management, FB sets up and manages private funds that invest client capital in real estate. In Investment Banking, the company conducts various types of investments using its own capital, and also provides corporate advisory. The Investment Management segment comprises asset management and real estate advisory. The Investment Banking segment spans real estate investment, skin-in-the game investing in funds, other investment, and corporate advisory.

Asset Management segment

Asset management operations (fund business)

FB sets up and manages funds that mainly cater to institutional investors. These funds invest in relatively large real estate properties (several billions to several tens of billions of yen each) and are operated with the intent of securing both investment income and capital gains. FB says it aims to offer investment services that put client satisfaction first and accordingly times the sale of fund properties so that they can generate the most profit. This means assets under management (AUM) fluctuate significantly in tandem with swings in the real estate market. In addition, the company provides asset management services for other real estate investments undertaken independently by investors. The balance of FB’s AUM exceeded JPY300.0bn in FY11/09 due in part to the rise in assets rescued from funds of other asset managers amid worsening market conditions following the global financial crisis. However, the AUM contracted sharply as FB continued to sell off properties. From FY11/13, the supply of large properties (over JPY10.0bn) in the market dwindled, pushing up corresponding prices. Consequently, FB refrained from new acquisitions for funds in which it was investing as a principal. At end-FY11/20, the balance of FB’s AUM stood at JPY11.8bn (down from JPY1.8bn at end-FY11/19 = JPY21.6bn increase during the term + JPY23.3bn decrease during the term). The increases and decreases are attributable to asset management services commissioned and completed for other property investments undertaken independently by investors.

Investment Banking segment

Real estate investment and skin-in-the-game investing in funds

FB owns a portfolio of properties for lease, through which it expects to generate stable income over the medium to long term. Small to mid-sized properties (around JPY1.0bn each) that tend to have high market liquidity make up the company’s real estate portfolio. While managing these assets, FB applies various measures to enhance their property value, and also develops new properties if it feels it can generate sufficient returns. The company refreshes the portfolio as necessary to secure capital gains from the value-added properties.

Real estate investment can be classified into four strategies: core, core plus, value-add, and opportunistic. Core investments mainly target returns from rental income (investment income). These investments are characterized by low yields, but also carry low risk by virtue of their focus on properties in prime locations. Core plus investments mainly target returns from investment income, but also look to resell properties at higher prices (capital gains). Value-add investments involve the acquisition of undervalued properties, which are enhanced to add value for sale at a higher price. These investments seek investment income as well. Opportunistic investments refer to acquisitions of high-risk properties (including auctioned properties and properties vacated through forced relocations). The aim is to add value to such properties and resell them at a higher price. We understand FB’s real estate investment and management style falls into the value-add category.

Many of the properties FB targets (real estate worth around JPY1.0bn each) are owned by individuals rather than real estate companies. These assets have yet to realize their full potential and often have room for rent and occupancy improvement. FB sources properties through various channels ranging from referrals from financial companies to real estate brokers, and conducts due diligence to select and acquire one or two properties per month. FB maintains that because it can rapidly appraise properties (in one to three days) and raise capital, it receives offers on good deals ahead of many competitors.

The company records its proprietary investment assets as real estate for sale, not as fixed assets. To ensure sound financial health, it uses a conservative accounting method that depreciates real estate for sale, which is uncommon in the industry. In addition, if an opportunity arises to invest in large properties, the company also co-invests in funds with other institutional investors. The balance of FB’s proprietary investment assets has continued to increase from FY11/13 alongside a corresponding decline in the balance of its fund-managed assets, rising to JPY55.6bn by end-FY11/20.

Other investment: private equity

In addition to real estate, the company invests in non-performing loans, venture capital, shares of unlisted companies, and other assets. In FY11/16, it booked valuation losses on its entire investment in biotech startup Genaris and its subsidiary Genaris Omics after both went bankrupt. In the subsequent years, the company has not reported notable achievements or earnings contributions from this business.

Other investment: renewable energy

In December 2016, the company set up a new department to promote renewable energy operations, and began developing business in the geothermal energy sector through its consolidated subsidiary First Brothers Development Co., Ltd. Although it will take several years to develop full-fledged businesses in this field, FB plans to utilize hot water from power generation in peripheral businesses such as agriculture and the development of hot spring facilities, leveraging its expertise to contribute to society. Developing geothermal power stations presents a number of challenges including difficulties in securing favorable locations and the lengthy development period. This means that even if the company starts a development project, it will take years until the project can contribute to earnings. In August 2015, FB invested in FSK K.K. (formerly BPC Fukushima K.K.), a company established to build a biomass fuel factory. Although constructions began, operations never got off the ground and FB ultimately sold its stake.

Segments

Investment Management segment (FY11/20: 4.2% of total revenue, 9.6% of operating profit)

In this segment, the company manages assets for clients through private funds that mainly invest in real estate and real estate trust beneficiary rights. It provides a range of services including investment strategy planning and proposals, property acquisitions, property management during the investment period, and property disposition (sales). This business was the original growth engine of the company. However, as the company refocused its operations, the impact of this segment on overall performance weakened. The segment accounted for only 4.2% of total revenue and 9.6% of operating profit in FY11/20 in contrast to 58.3% and 63.8%, respectively, in FY11/15.

The principal revenue streams of the segment are acquisition fees associated with the funds’ property purchases, asset management fees obtained during the asset management period, disposition fees generated when selling properties, and incentive fees obtained when the selling price exceeds a certain amount. The business maintains a recurring-revenue model distinguished by high profitability and an extremely high marginal profit ratio. Segment OPM stood at 65.2% in FY11/14, 82.3% in FY11/15, and 74.6% in FY11/16. A sharp revenue decline in FY11/17 pushed the figure down to 12.8%, but it has since risen to 34.0% in FY11/19 and 50.0% in FY11/20.

Investment Banking segment (94.9% of total revenue, 89.8% of operating profit)

In this segment, FB invests as the principal, concentrating on investments in real estate for lease, through which it expects to generate stable income. The company also conducts private equity investment applying the platform and strengths of the company’s existing businesses, investments in renewable energy and other social infrastructure, and skin-in-the-game investing (co-investment) in the private funds it originates. These investment activities are the driving force behind the company’s growth. In FY11/20, the segment accounted for 94.9% of total revenue and 89.8% of operating profit. The main revenue streams of the segment are capital gains (mainly gains on property sale: 50.6% of gross profit in FY11/20) and investment income (mainly rental income from real estate: 48.6%). Segment OPM has held steady at around 20% since FY11/14 (with the exception of FY11/15, when OPM jumped to 62.1%).

Proprietary investment

Real estate investment: FB invests in properties for lease that are not large enough to include in its funds but are expected to deliver high yields in the future. The purpose of such investments is to secure stable income. After acquiring properties, the company works to maximize the cash flows provided by these assets by applying various measures to add value. It takes a flexible approach toward sales, disposing of properties at the opportune time (for example, when a buyer offering favorable terms or a more lucrative investment opportunity appears) and refreshing its portfolio accordingly.

Other investment: To diversify its business portfolio and expand earnings opportunities, the company invests in a range of fields where it can use its existing strengths. Examples of such fields are private equity and renewable energy. However, these investments have yet to deliver notable earnings contributions.

Advisory business

Based on its experience to date in moving assets off balance sheet, setting up real estate securitization schemes, and arranging financing, the company provides a range of advisory services tailored to client needs, including corporate rehabilitation support and M&A-related advice.

Group companies

The FB group comprises the company (First Brothers Co., Ltd.),five main consolidated subsidiaries (including First Brothers Capital Co., Ltd., First Brothers Asset Management Co., Ltd., Higashinihon Fudosan Co., Ltd., First Brothers Development Co., Ltd., and The Fuji Facility Service, Inc.) and one equity-method affiliate (Credit Guarantee No. 2 LLC, silent partnership investment ratio: 45.0%) among others. The group operates in the Investment Management and Investment Banking segments.

First Brothers Capital generated over 10% of consolidated revenue (after excluding internal transactions among consolidated companies) in FY11/19, when it reported revenue of JPY16.5bn, recurring profit of JPY3.2bn, net income of JPY1.1bn, net assets of JPY1.2bn, and total assets of JPY40.3bn.

Acquisition of Higashinihon Fudosan fuels growth

FB acquired shares in Higashinihon Fudosan (99.6% of voting rights) on April 26, 2019, making it a subsidiary. Established on December 23, 1983, Higashinihon Fudosan had operated stably for 35 years and enjoyed sound financial health underpinned by a portfolio of many quality assets located near railway stations or in business districts. After leading the firm for many years, the owner had been looking for a business successor, which was the main reason behind the share transfer to FB. The total acquisition cost was JPY4.2bn (includes share acquisition, funding for Higashinihon Fudosan’s share buyback, and advisory fees). FB borrowed JPY6.9bn from a financial institution, part of which was used to repay a portion of Higashinihon Fudosan’s loans.

Higashinihon Fudosan owns a large number of properties in the Tohoku region with the total asset value standing at JPY12.7bn, or 29.3% of FB’s proprietary assets (investments) at end-FY11/19. The portfolio comprised 25 properties with an average value of JPY508mn (less than half the average value of JPY1.3bn for FB’s properties). Properties include office buildings near stations and in business districts, and roadside and other commercial facilities with an average NOI yield (net operating income [NOI] divided by acquisition price) of 7.9%. FB explains that expansion from the Greater Tokyo area into the Tohoku region has boosted its flexibility in terms of both business continuity and opportunities to acquire high-NOI properties such as office buildings near railway stations.