Global hedge funds and private equity firms are flocking to Japanese companies in hopes of unlocking up to ¥25 trillion (USD 165 billion) in undervalued real estate value.

Real estate's implicit value on corporate balance sheets has become the theme behind some of the large shareholder activist actions and M&A transactions in Japan this year. The latest case involves the U.S. company Elliott Investment Management announcing a 5.03% stake in Tokyo Gas. Last week, Elliott estimated the real estate portfolio value of the latter to be around ¥1.5 trillion, nearly equivalent to the utility company's entire market cap.

Due to a accounting practice where Japanese companies have long held office buildings, hotels, and country clubs, their real estate investments may have unrealized profits. Real estate is recorded on the balance sheet at acquisition or development cost minus annual depreciation, marking the book value. However, in recent years, real estate prices in Japan have soared, especially in metropolitan areas. This means that if these properties are sold, companies can make huge profits from the difference between book value and market value.

Investors who believe Japanese companies are undervalued are increasingly focusing on this strategy. It is evident in the $4 billion Fujifilm Holdings Corporation Unsponsored ADR acquisition, as well as the momentum behind activist investors such as Elliott, Palliser Capital, and 3D Investment Partners in private equity transactions.

"For decades, we knew the value of Japanese real estate was there, we just didn't have the key to unlock it — but now we do," said Bruce Kirk, Chief Japan Stock Strategist at Goldman Sachs. "This is exciting – now we are starting to see investors paying attention to it."

Goldman Sachs estimates that over 250 Japanese companies whose main business is not real estate could have at least ¥25 trillion in unrealized gains. Some of the largest companies holding include those in railroads, construction, and utilities industries.