Legal and Regulatory Risks

Insider trading regulations designed to protect shareholders in non-J-REIT corporations do not protect unitholders of J-REITs

Listed J-REIT units are not subject to insider trading regulations, as stipulated in the FIEL. Although we and our asset manager maintain internal rules relating to insider trading, these rules are merely contractual obligations of our officers, employees and asset manager and cannot be enforced by unitholders, regulators or other third parties. Insider trading may damage the confidence of investors in our units and result in lower liquidity or decreases in the market price for our units.

Our ownership rights in some of our properties may be declared invalid or limited

Title registration does not guarantee absolute ownership under Japanese law. For example, if the former owner of one of our properties subsequently becomes subject to bankruptcy, corporate reorganization or civil rehabilitation proceedings, we could face a claim for avoidance or fraudulent conveyance. If, for example, we acquired the property while the seller or a former owner was insolvent, or if as a result of such a sale to us the seller or a former owner became insolvent, we may be required to return the property or the beneficiary interest in the property to the seller or former owner, or we may have to pay significant amounts to settle such claims. Further, if the former owner of one of our properties was or becomes unable to pay its debts at the time of our acquisition, the acquisition may be denied by the creditors of the former owner. We may also lose the beneficiary interest in a trust property if the seller or a former owner is found to have originally entrusted the property with a trustee to hide the property from its creditors. Although we do not believe that any of the properties we acquired are currently subject to significant risks of this type, these risks cannot be completely eliminated. As a result, future changes in the conditions of any former owners of our properties could jeopardize our ownership of the properties.

There is no title insurance available in Japan, which limits our ability to obtain protection from property ownership risks. Moreover, because the rights and obligations attached to some of our properties are complicated, due in part to the manner in which we expect to acquire and hold our properties, our ownership rights in some of our properties may be declared invalid, or the rights held by third parties may limit our rights in the properties. Any of these circumstances could have a material adverse effect on our business, financial condition and results of operations.

We may lose our rights in a property we own if the purchase of the property is recharacterized as a secured financing

Depending on the underlying facts and circumstances surrounding the purchase of a property, the purchase may not meet “true sale” requirements under Japanese law and may be recharacterized as a secured financing. In such a case, the relevant property would be deemed to be an asset of the seller, and we would lose our ownership interest in the property. We would instead hold only a security interest in the property. Recharacterization could occur when the seller becomes insolvent by way of bankruptcy, corporate reorganization or civil rehabilitation proceedings. Under Japanese law, whether a purchase may be recharacterized as a secured financing is determined through a consideration of various factors, including, without limitation, the intention of the seller and purchaser, whether the seller recorded the purchased property on its balance sheet, whether the seller transferred the economic risk to the purchaser, and whether the seller and purchaser contracted a buy-back arrangement permitting the seller to reacquire the property. Although we have no reason to believe that the acquisition of any of the nine properties we acquired would be recharacterized as a secured financing, any such acquisition may be so recharacterized following a legal or regulatory proceeding.

Our leasehold or subleasehold rights may be terminated or may not be asserted against a third party in some cases, or our leases with our tenants could be modified

Under Japanese law, buildings and the underlying land upon which they are built can be owned independently of each other. For example, the owner of a building may only hold a leasehold interest in the underlying land. See “Regulation—Laws and Regulations Relating to Japanese Real Estate”. To the extent that we hold leasehold or subleasehold interests in buildings or the underlying land upon which they are built, either individually or together, we may not be able to reclaim our deposit with the lessor of the building or the underlying land if the lessor of the underlying land were to become insolvent, and we may, in any bankruptcy or other such proceeding, become an unsecured creditor with respect to tenant leasehold and security deposits paid to the lessor.

Leasehold interests may also be terminated in certain events. Further, if a leasehold interest is not perfected, it may not be asserted against third parties, including any new owner of the building or the underlying land. While in the future we expect to hold leasehold interests in a manner customary for the Japanese real estate market and intend to take appropriate measures to prevent such events from occurring or to enable us to address such events should they occur, we cannot guarantee that such events will not occur. If our leasehold or subleasehold interest in a property is terminated, we may incur additional costs in purchasing the property, which may not be sold to us on favorable terms.

Some of our properties may be held in the form of a co-ownership interest (kyōyū-mochibun), and our rights relating to such properties may be affected by the intentions of other owners

We expect to hold an interest in some properties in the form of a co-ownership interest (kyōyū-mochibun)with third parties. Other properties that we acquire in the future may also be in the form of co-ownership interests. Under Japanese law, a co-owner of property has the right to sell its interest in the property without the consent of the other co-owners, unless there is an agreement between the co-owners that requires such consent or grants a right of first refusal. In general, a co-owner has the right to demand that such property be partitioned. Although special provisions may be included to contractually prohibit the exercise of such right of partition, such provisions are only valid for a period of five years. If a co-owner of one of our properties becomes subject to bankruptcy proceedings, corporate reorganization or civil rehabilitation proceedings, the trustees in the proceedings of such co-owner may have the right to demand that such property be partitioned. Although the other co-owners of the property may, if so agreed, have a right of first refusal to purchase the ownership interests of the defaulting or selling co-owner, we may not be able to exercise such rights on favorable terms. In addition, a sale of our co-ownership interests under such circumstances may result in liquidation proceeds that are less than the appraisal value of the property or interests being sold, which would have an adverse effect on our business, financial condition and results of operations.

A co-owner of a property may mortgage its interest in the property. However, such mortgage becomes applicable to the entire property when the co-owned property is partitioned. Accordingly, each of the co-owners in such case would be subject to such mortgage in proportion to its ownership interest. There is a risk that our interest in a property that was formerly owned through a co-ownership interest and owned by us independently following a partition may be subject to a mortgage that was placed on it by another co-owner.

Some of our properties may be in the form of stratified ownership interests (kubun shoyū-ken), and our rights relating to such properties may be materially and adversely affected by the intentions of other owners

We acquired ownership interests (kubun shoyū-ken) in some of our properties in our initial portfolio. In addition, other properties that we acquire in the future may also be in the form of stratified ownership interests. A stratified ownership interest in a property is not equal to a certain percentage interest in the whole property. Stratified ownership refers to a type of ownership recognized under the Stratified Ownership Law, whereby a property, such as a building, is divided into different portions by, for example, floors or apartments, which can be owned separately.

There are certain risks associated with stratified ownership interests. For example, each owner of a portion of a stratified building is entitled to transfer its stratified ownership interest at its own discretion, so there is a risk that such interest may be transferred to a third party. In some cases, where there are rules or contracts agreed upon by owners of a stratified building, the stratified owners may grant each other a right of first refusal with respect to any sale of their stratified ownership interest. In such a case, we would not be able to sell our interest without following the procedures prescribed by such rules.

Stratified owner meetings are held at least once a year, and approval by (i) a majority of all owners, and (ii) those owners who, in the aggregate, have a majority of the voting rights, is required to make any decision, unless otherwise provided in the Stratified Ownership Law or the rules agreed upon by the owners. Voting rights are granted to stratified owners in proportion to their interest in the stratified building unless otherwise provided in the rules agreed upon by the owners.

In addition, as described under “Regulation—Laws and Regulations Relating to Japanese Real Estate—Property Subject to Stratified Ownership”, certain supermajority votes are required for the administration of major matters, such as amendments to the rules agreed upon among the stratified owners or modifications that will significantly alter a common area, as well as any decision to rebuild the property. If we do not have the required majority interest, there is a possibility that our interests will not be reflected in the management of the building. We may also be involved in disputes regarding the rules or other interest conflicts among the stratified owners.

Moreover, a stratified owner must obtain the right to use the underlying land, which is typically achieved through ownership of the land among the stratified owners in proportion to each owner's percentage ownership of the building. To ensure that a stratified owner shall have the right to use the underlying land, the Stratified Ownership Law generally prohibits any disposal of these rights separate from the stratified interests. However, if the right to use the underlying land is not properly registered by a stratified owner with the real estate registry, then the subsequent purchase of the relevant interest by a bona fide third party would be effective, despite the breach by the seller of such general prohibition. In addition, if the underlying land is divided into several portions, which each stratified owner has a right to use independently and exclusively, each stratified owner can dispose of its portion of the underlying land despite such general prohibition on the separate disposition of rights in the underlying land. A stratified owner may also obtain the right to use the underlying land by entering into a lease agreement with the owner of such land. However, if ownership of the underlying land is transferred to a third party, the right to use such land under a free-charge lease agreement (shiyō-shaku-ken), as opposed to a charged lease agreement, may become invalid. This would complicate the contractual relationships surrounding the whole property. See “Regulation—Laws and Regulations Relating to Japanese Real Estate—Property Subject to Stratified Ownership”.

We expect to own most of our properties through trust beneficiary interests and may suffer losses as a trust beneficiary

We expect to own most of the properties in our portfolio in the form of beneficiary interests in Japanese trusts that hold or will hold those properties as title holders. Although we have entered into various contractual arrangements to reduce trust-related risks, we may suffer certain trust-related liabilities and losses that would not arise if we had direct ownership of these properties, including liabilities to third parties arising from the disposition of a trust property, compensation of the trustee, and property defects or losses due to unauthorized disposition or collateralization of a trust property by the trustee.