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In response to the rapid collapse of the asset bubble in the late 1980s, many companies holding real estate went bankrupt as a result of various factors including poor business decisions and drastic, reactive government policies. Thereafter, a number of Laws were enacted to create avenues for turning around the market and protecting investors with little knowledge.

The Real Estate Syndication Act

Generally agreed to be the first of these Laws, the Real Estate Syndication Act (RSA) was implemented in 1995 and created a permit system whereby parties to transactions of real estate assets that involve distribution of dividends to investors had to have a minimum amount of paid-in capital, a realtor's license and proven knowledge about the real estate market. The RSA also required a certain level of disclosure to investors and established distinct structures for these companies including Nin'i Kumiai (Voluntary Partnerships) and Tokumei Kumiai (Special Partnerships) with the latter almost exclusively adopted due to tax and other considerations. Revisions to the RSA in May 1997 expanded the range of qualified investors in real estate assets to include banks, trust companies, insurers, and publicly-traded corporations with at least 500 million yen in paid-in capital and demonstrated knowledge of the real estate market.

Asset Monetization Law

Triggered by the crisis in the Asian financial markets and the large amount of non-performing loans (NPL) released into the Japanese economy in the late 1990s, the Law on Specific Asset Monetization by Special Purpose Companies (SPC Law), also known as the Asset Monetization Law, was enacted in September 1998 and revised in May 2000. In addition to creating an effective mechanism to dispose of NPLs, the SPC Law also enabled companies managing assets to procure funds from the capital market based on the value of the asset to be acquired as opposed to the creditworthiness of the company itself. The SPC Law authorized two structures for ownership of qualified assets, special purpose companies (SPC) and special purpose trusts (SPT) of which the former is adopted almost exclusively. SPCs are able to procure funds by issuing securities for owned assets backed by the appraised value of said assets and anticipated cash flow from those assets (rental revenues in the case of real estate).

Investment Trusts and Investment Corporation Law

With the enactment of the Investment Trusts and Investment Corporation Law (ITIC Law) in November 2000, the legal platform for the Japanese real estate investment trust (J-REIT) market was complete. In addition to previously permissible negotiable securities, the ITIC Law also allowed for management of real estate and other assets through authorization of entities known as investment corporations. The ITIC Law also created regulations to enhance disclosure and stipulate responsibilities to investors, relax borrowing for such entities and more strictly monitor acts which create potential conflicts of interest. Investment trusts were also provided for in the ITIC Law although their use has been minimal in the J-REIT market compared with that of investment corporations.

According to the stipulations of the ITIC Law, investment trusts and investment corporations can be established as open-end funds where investors can request redemption of their assets or closed-end funds where they cannot. However, due to the illiquid nature of real estate, the latter structure is most commonly used for J-REITs as investors still benefit from the liquidity of these investment units through market trades of their investment units. As the investment corporation structure also provides for stricter corporate governance and disclosure to investors, the closed-end investment corporation fund has been almost exclusively used as the structure for publicly-listed J-REITs.

The Structure of Investment Corporations

Although the investment corporation has a legal standing as an actual corporation, according to the provisions of the ITIC Law it may only manage the assets in its portfolio and is not allowed to engage in any other form of business. Furthermore, management of its assets and execution of its operations must be entrusted to a separate asset manager which among other duties makes investment decisions for the investment corporation, ensures compliance with regulatory authorities and conducts the investment corporation's general operations including the assignment of leasing and property management of its properties. Although essentially functioning only as vessels for the assets they own, investment corporations also provide additional security for investors that investment trusts cannot offer, including a governing board of directors and investor meetings where investors possess the same voting rights as stockholders of corporations.

Establishing an investment corporation involves the preparation and filing of bylaws with the Prime Minister and the raising of at least 100 million yen through investment unit offerings whose price, amount and date of offering are approved by the board of directors before the investment corporation can be established as a corporation. The investment corporation must then complete further registration with the Prime Minister as an investment corporation to begin asset management transactions.

In addition to investment unit offerings, investment corporations may also float investment corporation bonds although management of these bonds must be outsourced. Investment corporations may also secure borrowings from financial institutions. No legal ceilings are placed on the amount of these borrowings although ceilings are generally stipulated in an investment corporation's bylaws. In order for distributions to investors to qualify as accounting expenses, investment corporations must distribute more than 90% of taxable income to investors to qualify for this tax exemption.

Asset managers play an integral role in the J-REIT structure as they are responsible for management of the J-REIT's assets and execution of its operations. Asset managers must obtain approval from the Ministry of Land, Infrastructure, Transport and Tourism to act as a discretionary transaction agent based on the Building Lots and Buildings Transaction Law and obtain approval from the Financial Services Agency (FSA) as an investment trust manager. Asset managers are also required to meet certain financial and personnel requirements and obtain a real estate brokerage license. Asset managers have a fiduciary duty to J-REITs and are required to act with professional diligence and knowledge in the best interests of the J-REITs' beneficiaries and investors.

In addition to the outsourcing of asset management of its assets, the J-REIT also contracts with an asset custodian, usually a trust bank, to hold the J-REIT's assets in a segregated account. A J-REIT bond manager handles duties associated with the floating of bonds and must possess either a banking license or a trust license. A separate administrative affairs manager handles any business that falls outside the scope of the abovementioned entities including clerical matters associated with investment unit offerings. The asset manager may outsource the day-to-day management of the actual properties to a property manager or may take on those duties itself.

The J-REIT Market of the Tokyo Stock Exchange

In March 2001, the Tokyo Stock Exchange (TSE) established the J-REIT market separate from the First and Second Section markets of the Exchange. TSE also instituted listing and de-listing requirements for the J-REIT market and established disclosure standards for all listed J-REITs. The main requirements for listing on the TSE J-REIT market are as follows:

1. 1) At least 75% of the J-REIT's assets must be invested in real estate or real estate backed securities;
2. 2) At least half of all assets must be currently generating rental revenues or projected to do so in the future;
3. 3) Non real estate assets must be cash or cash equivalents; and
4. 4) Total assets must be more than 5 billion yen.

The TSE places these restrictions and others on listed J-REITs to ensure that they focus on real estate that generates stable income and possess sufficient liquidity through adequate asset size and number of investors. The TSE also requires the timely disclosure of material information by the investment corporation and the asset manager to enhance transparency of all J-REITs.

Related Legislation

Other recently enacted legislation with direct consequence to the J-REIT market includes the December 2004 revision to the Trust Law (first enacted in 1922). The revision to the Trust Law expanded the range of assets able to be entrusted as well as the nature of entities wishing to become trust companies (the previous law limited such entities to financial institutions). The revisions also enabled clerical work of trust businesses to be outsourced to third parties if the work is stipulated as trust business.

The Financial Instruments and Exchange Law (FIEL), enacted in the fall of 2007, regulates a wider range of financial products more closely in an effort to close loopholes in previous legislation such as the Securities and Exchange Law. FIEL stipulates requirements for registration as a financial instruments trader and regulates asset management and investment unit transactions.

The preceding is a general overview of information regarding legal regulations concerning J-REITs and is provided as a service to promote understanding of the J-REIT system. Please note that, due to the ever-changing legal environment surrounding J-REITs, Kenedix Realty Investment Corporation does not guarantee the accuracy of this information.