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June 2010
Taisuke Miyajima
Executive Director
Kenedix Realty Investment Corporation
CEO & President
Kenedix REIT Management, Inc.

Delivering Unitholder Profit and Value
and Achieving Stable Growth

The curtain is about to go up on the second act of the J-REIT market growth story, a follow up on the first act, which opened with the 2001 launch of the J-REIT market and closed with the onset of the recent global financial crisis. I would like to explain our approach toward becoming a “self-sustaining J-REIT” through growth strategies aimed at always staying half a step ahead of our competitors.

The Resurgent J-REIT Market Growth Story

Over the past year—a period in which the global financial market has witnessed efforts aimed at stabilization—I believe that the real estate market has for the most part been cruising with the wind at its back. Cash flows in the real estate leasing market, however, have not shown any substantial recovery due to the significant contraction in demand. Still, in the fourth quarter of 2009 property prices seemed to bottom out, while the environment for debt financing improved substantially. This and other conditions are giving us reason to believe that the real estate market has entered into a possibly long-lasting recovery phase.

In the wake of the recent financial crisis triggered by the Lehman shock, the J-REIT market entered into an adaptive selection and restructuring phase. Now that this phase, and its accompanying air of stagnation, appears to be drawing to a close, I believe that the J-REIT market will soon embark on the second act of its growth story. In support of this belief is the fact that although the real estate leasing market is currently looking weak, real estate liquidity has recovered to a level sufficient to provide the impetus to kick-start the second act. I strongly believe that the J-REIT market will begin growing again in the not-so-distant future through both equity and debt financing.

Six Months Later—Still on the Offensive

We must admit that the recent financial crisis has significantly strained our financial standing. However, our November 2009 execution of a public offering was a breakthrough in that, with this move, we declared the end of our restructuring. In fact, it was a significant turning point for us as we started anew toward our renewed growth.

The average NOI yield for the five office buildings that we have acquired since last November stands at 5.9%. This figure is actually higher that the 5.1% average for our portfolio prior to those acquisitions. Recognizing that the current trend of declining rent levels presents an advantageous investment opportunity, we will focus on the acquisition of properties that have high potential for profitability.

Focusing on Medium-Sized Office Buildings

We are the only J-REIT to clearly focus on medium-sized office buildings. The scale of the medium-sized office building markets in the Tokyo Metropolitan and other major urban areas is significant; these markets offer a large number of potential tenants, and these tenants are diversified in terms of their respective industries. Also, medium-sized office buildings in these markets tend to accommodate large numbers of smaller tenants compared with large-scale office buildings in comparable areas. Due to such characteristics, occupancy rates and rent levels in these markets are relatively immune to economic fluctuations. By concentrating on these markets, we aim to stabilize our rental business profit.

Our portfolio currently includes more than 60 medium-sized office buildings. For these buildings, we are working to maximize the benefits of scale by grouping them in order to facilitate comprehensive management. Specifically, we are enjoying benefits in terms of service quality and costs by outsourcing repair and maintenance work for several buildings as a unit, rather than for each building.

At present, the spread between the cap rates for large-scale prime office buildings and medium-sized office buildings ranges between 1.0% and 1.5%. While enjoying the 1.0% to 1.5% cap rate difference, we are working to diversify risks and taking advantage of holding and managing an extensive portfolio. This is how Kenedix Realty Investment Corporation ("the Investment Corporation") is creating added value for its unitholders.

Adding Value by Enhancing Property Management Capabilities

Despite the stagnant real estate leasing market, our portfolio saw the occupancy ratio bottom out at 92.4% in July 2009 and recover steadily since then to 94.4% as of April 30, 2010.

Our unique strength in managing medium-sized office buildings lies in the structure under which Kenedix REIT Management, Inc., ("the Asset Management Company") as the asset management company of the Investment Corporation, takes full responsibility for wide-ranging property management functions. In addition, the Asset Management Company plays an important role in operations related to tenant leasing and property management for all its portfolio properties. In fact, our direct involvement with tenant attraction, building maintenance company arrangements and tenant satisfaction surveys ensures efficient and effective communications with market players, which, in turn, enables us to obtain real-time, immediate knowledge of market trends and movements. Based on such strategic activities, we have strengthened our tenant relations and, ultimately, accumulated know-how with regard to stabilizing our cash flows.

July 2010 will see the implementation of Japan’s revised Energy Saving Act. As our portfolio is mostly composed of medium-sized office buildings, none of our portfolio properties will be subject to the stipulations of the act. Still, recognizing energy-saving measures for our portfolio as an integral part of our property management strategy, we are implementing necessary initiatives proactively. In the future, we plan to undertake proactive renovation and refurbishment, particularly of air-conditioning systems, and, as a publicly traded J-REIT, we will continue to advance environmental efforts throughout our portfolio and thereby trigger a major environmental movement in the medium-sized office building market. Such an approach will also help to differentiate our portfolio.

Adhering to an Unwavering Financial Policy

As a going concern, a REIT must be simultaneously aggressive and defensive to achieve steady growth. From around the time of our establishment, we have tackled financing activities in a way that avoids placing excessive stress on our financial standing in any operating environment. Specifically, we have prioritized the use of long-term loans with diversified maturities and lenders. Even after the subprime loan crisis in the United States, we accelerated the reshuffling of our portfolio by selling off minority portfolio properties, such as those for residential use or located in regional cities, and by buying office buildings. Through such portfolio reshuffling, we were almost always able to keep cash inflows and outflows nearly at par. Moreover, we have been able to build a competitive portfolio mainly consisting of medium-sized office buildings while maintaining our LTV ratio at around 41%. Also, our prioritization of long-term loans with diverse maturities has allowed us to keep our semiannual refinancing at a manageable level.

Such financial strategy has long been the foundation for our operations. Particularly over the past five years, we have been able to accumulate invaluable experience and a solid track record in investment management thanks to this unwavering strategy.

A Paramount Issue: Stable Cash Distribution

To achieve growth backed by public offerings, we must sustain stable cash distributions to our unitholders and thereby encourage them to hold our investment units over the long term. Unfortunately, overall rent levels are persistently declining. However, as we continue to acquire new properties by leveraging our extra acquisition capacity as shown by our relatively low LTV ratio, we have been able to maintain our rental business profit at a satisfactory level.

As a general principle, public offerings can cause dilution in unitholder interest and value. Therefore, when we consider any future public offering, we give due consideration to the unit prices, distribution yields and NOI yields of our new properties.

Aiming to Develop into a Self-Sustaining J-REIT

The most distinctive characteristic of the Investment Corporation is its strong drive toward developing into a self-sustaining J-REIT. This has not changed since the time of its IPO. Also, we take pride in the fact that our investment strategies since our IPO have all been our own.

The Asset Management Company welcomed ITOCHU Corporation as a major shareholder in 2008. Also, MAX-REALTY—a joint venture capitalized by Sumitomo Mitsui Banking Corporation and XYMAX Corporation—joined the list of major shareholders of the Asset Management Company in December 2009. Having won the support of a general trading house, a powerful bank and a building maintenance company, and leveraging its extensive know-how and pipeline, the Asset Management Company has made great strides toward becoming a truly self-sustaining asset manager.

Taking full advantage of the flexibility and agility that they boast, self-sustaining the Investment Corporation and the Asset Management Company are joining forces to maximize the appeal of medium-sized office buildings and thereby take the lead in the second act of the J-REIT market growth story.