Japan Logistics Fund Inc. Semi Annual Report

Transcription

1 Japan Fund Inc. Semi Annual Report The 21 st Period (From August 1, to January 31, 2016) May 24, 2016

2 Management Discussion and Analysis Background of JLF Japan Fund, Inc. (JLF) is Japan s first dedicated logistics REIT, founded with the aim of contributing to the Japanese economy by converging the flow of money (finance) with the flow of goods (logistics), which is the lifeblood of the economy. To that end, we leverage the history and experience of Mitsui & Co., Ltd., which as a general trading company has worked in logistics operations for more than 100 years. Based on the Act on Investment Trusts and Investment s of Japan (Act No. 198 of 1951; including revisions enforced thereafter) (AITIC), JLF was founded on February 22, 2005 by Mitsui & Co., Partners Ltd. (MLP) as the asset management company, and was listed on the REIT section of the Tokyo Stock Exchange on May 9 of the same year (security code: 8967). Since JLF s initial public offering, we have applied a discerning eye for logistics sites, building specifications, tenant needs and other factors to investment decisions that are tied to real demand. In the process, we have built a portfolio that can be expected to deliver stable earnings over the mid to longterm. As Japan s first dedicated logistics REIT entering a market of REITs invested mainly in office and residential assets, JLF became a pioneer and has since demonstrated to the market a track record of the logistics sector s ability to deliver stable cash distributions to its investors. Basic Policy As the pioneer of JREIT dedicated to logistics properties, we aspire to provide stability and growth of dividends in the midtolongterm by leveraging its unparalleled experience and expertise in logistics business and in financial markets. is a series of economic activities, such as transportation, storage, loading/unloading, packaging, labeling, sorting, or information integration, which connect manufacturers and consumers directly. We believe logistics is a vital function supporting the foundations of industry and people s life in Japan. As a consequence, demand for logistics properties is likely to be stable in the long term. These days, supply chain management which optimizes the entire logistics process is becoming widespread. It is imperative to construct logistics system that can be flexibly adjusted based on consumers various needs. Therefore, logistics business providers now actively seek highly versatile logistics facilities in order to build elastic logistics systems. Furthermore, consolidation of logistics functions to improve efficiency, as well as separation of ownership and use of logistics facilities to reinforce balance sheets, are growing trends in the logistics business. Given the current environment, we see great investment opportunities in this area. Investment Policy Acquisition of new properties Compared with other asset types, logistics properties tend to have less liquidity in the acquisition market. We believe, therefore, that collecting a broad range of information and making precise investment decisions based on the information gathered is the only way to achieve high quality property acquisitions. In order to avoid unnecessary price competition, we strive to gain early access to property information and promote negotiated transactions by leveraging our extensive networks of sponsors and the information sourcing channels of MLP. When acquiring properties, we make investment decisions focusing on the location and versatility of properties, which are essential factors in pursuing longterm stability in managing logistics properties. As a general rule, we avoid acquiring properties with unique structural features that suit only certain types of tenants in certain industries. Instead, we prefer properties with specifications that meet broad logistical demand. To minimize fluctuations in revenue arising from factors such as rent reduction request from tenants or unexpected tenants departure, we acquire properties that will help reduce the risk of overconcentration of tenants by avoiding excessive dependency on a single tenant or industry, and will help diversify lease period expirations. 2

3 Portfolio Management In renewing existing lease contracts, we prefer the way to ensure generating stable revenue flow, such as urging the existing tenant to renew the lease with longer term. In case that a tenant decides to move out, we conduct leasing activities based on this policy so that leases are maintained without any discontinuity and that revenues are secured, by leveraging our sponsor network, intermediary companies well versed in logistics properties and tenant information, and the network of the asset management company. We promote the improvement of the overall satisfaction level of tenants by maintaining close contact with them. Specifically, we respond to tenants needs with respect to expanding rental space, making functional improvements in line with tenant and industry needs, and implementing renewal of the properties. We conduct repairs and renovations of properties by keeping related costs below a certain level. In addition, we strive to maintain an optimal level of maintenance management for the properties by selecting appropriate property management companies that can provide efficient management in line with the characteristics of each property, by improving the quality of the property management control at the asset management company, and by standardizing various procedures. Furthermore, we will make additional investments in properties with locational advantage in term of leasing and properties with OBR (Own Book Redevelopment) potential, taking into consideration tenant requests, the leasing needs of facilities, floor area ratios and other factors. Financial strategy We set the highest priority on stability and growth of dividends while maintaining relatively conservative LTV (Loan to Value) in financing. When pursuing debt financing, we diversify funding sources and repayment due dates. In addition, with regard to tenant leasehold and security deposits, we may use such deposits to partially fund property acquisitions for efficient cash management purpose. Strategic and Financial Review of the 21 st Period (The Period Ended January 31, 2016) During the 21 st fiscal period under review, the Japanese economy as a whole continued to recover moderately, primarily as a result of the gradual increase in capital expenditure based on growth in corporate earnings and strong consumer spending in response to steady improvement in employment and personal income, despite some impact of slower growth in emerging economies on exports and production. In the logistics properties leasing market, growth in demand for large logistics properties was driven by the establishment and expansion of distribution centers by ecommerce businesses, retailers strengthening logistics functions, and thirdparty logistics (3PL) providers. In the Tokyo metropolitan area, however, the gap between asking rent level and the actual rent level demanded by tenants widened in some areas as a result of the continued supply of large new facilities over the last few years, and cases were observed in which lease terms for new properties were relaxed and there was a fall in the contract rate of tenants at the time of completion. In the logistics properties acquisition market, investors both in Japan and abroad were even more eager to invest in logistics properties, which would yield higher returns than those on other types of investments, as investment opportunities were decreasing due to the monetary easing worldwide. Under these circumstances, JLF promoted the acquisition of property at appropriate prices based on the characteristics of individual pieces of property, such as the location and building specifications through offmarket transactions, rather than competitive bidding. It purchased four properties, namely Chiba Kita Center, Chiba Kita Center II, Urayasu Chidori Center III, and Zama Center (total acquisition price 8,848 million yen, total appraisal value 10,110 million yen, average discount from appraisal value of 12.5%). In association with the acquisition of these properties, JLF executed a public offering for the first time in two years. JLF announced the mediumterm business plan stable + Growth in March 2013 and has been managing investment, aiming for stable distribution and sustainable growth. As a result of the acquisition of the four properties and the public offering, JLF was able to achieve the target dividends per unit of 4,000 yen set in stable + Growth six months ahead of schedule. As an effort for continuous internal growth, JLF has also decided to implement the redevelopment of Kiyosu Center, which will be the third round of OBR (Own Book Redevelopment, which means the redevelopment of properties held by JLF on its own). 3

4 Results of Operations The following table illustrates the financial results of the 20 th /21 st Period: The 20 th Period The 21 st Period Ended July 31, Ended January 31, 2016 Operating revenue 7,074 million 7,554 million Operating expenses 3,473 million 3,563 million Operating income 3,601 million 3,991 million Ordinary income 3,210 million 3,549 million Net income 3,209 million 3,548 million Distributions in excess of earnings per Unit 0 0 Dividends per Unit 3,866 4,033 In the 21 st Period, operating revenue rose to 7,554 million, a 6.8% increase compared to the 20 th Period. The major factors contributing to the increase were new acquisitions (four properties) and fullperiod contribution from fully occupied Yachiyo Center. On the other hand, factors such as tenant turnovers, increase of repair expenses and expenses from new investment units issuance negatively impacted to the net income. Net income rose to 3,548 million, a 10.6% increase from the previous period, and earnings per unit (= dividends per unit) increased to 4,033 at the 21 st period, a 4.3% increase even after the issuance of new investment units. Business Outlook Recognition of the Environment The Japanese economy is expected to continue on a mild recovery trend due to strong domestic demand based largely on a gradual increase in capital expenditure, backed by growth in domestic corporate earnings, and strong consumer spending associated with steady improvement in employment and personal income. The quantitative and qualitative monetary easing policy with a negative interest rate implemented by the Bank of Japan is expected to stimulate the economy in terms of capital expenditure and other aspects. However, risks that significantly affect the Japanese economy, such as economic trends in emerging countries, the development of refugee crisis in Europe, the pace of the U.S. economy recovery, and geopolitical risks in the Middle East and East Asia need to be continuously monitored. In the logistics facilities market, development projects have been continuously announced even in the environment where land prices and construction expenses are rising against the backdrop of the strong willingness of investors in Japan and abroad to invest, and development areas are also expanding. JLF believes that recent new properties have an aspect whereby they will be forced to set a relatively high asking rent even in emerging areas, as the developers need to recover high development costs. Meanwhile, as the potential demand of tenants, which was accumulated in the environment where new supply was limited after the Great Financial Crisis, has been absorbed by the rise in supply in the last few years, the supplydemand balance is being relaxed. As the number of properties that take time to decide on tenants and that are forced to ease the lease terms is increasing in some areas, given that tenants have strengthened the tendency of carefully evaluating the location, building specifications and rent, JLF believes that properties could be unable to be sold at a price based on the rent level assumed by developers. In the financial market, JLF also considers that it is necessary to pay attention to the possibility that the expected yield of logistics facilities will rise significantly (the price will fall) associated with a rise in interest rates due to the termination of monetary easing in the future. In this environment, JLF will maintain the existing policy of realizing stable distribution per unit and sustainable growth and will make efforts to build a framework that will enable it to respond accurately to future changes in the financial and real markets, in order to achieve a new mediumterm business plan stable + Growth 2.0, following the last plan stable + Growth. 4

5 Strategies & Challenges JLF is the only JREIT to have announced a midterm business plan that sets forth quantitative DPU targets and a timeline for reaching those targets. In March 2013, we have launched our current midterm business plan stable + Growth. The original DPU target of the plan was to achieve 4,000 (4.0% CAGR) by the Period Ending July 31, Through property acquisitions and OBR completion, however, we expect that we can achieve the plan stable + Growth a halfyear early. As a result, actual CAGR reached to 5.8%. This time, we have announced our new midterm business plan stable + Growth 2.0 with a quantitative DPU target ( 4,280 or 2.0% CAGR) and timeline for reaching the target (by January 2019 or the 27 th Fiscal Period.) amid an uncertain outlook for financial and property markets. We may be able to achieve higher growth rate if market turns (i.e. falling real price) by leveraging our expertise of contrarian investing. Thanks to QE, low cost capital is abundant. The situation makes logistics property developments accelerate even in high construction costs and expensive land price environments. Thanks to QE, again, yield is scarce. Compared to other asset class, real developments, especially logistics property developments, still have better profitability, so we see more new entrants in the sector. As a result of these, developable site is running out in the metropolitan areas. Now developers seek the vacant land in exterior edge of the metropolitan areas. As long as the developers can find tenants, it may have no problem. However, we concern this overextension of location once logistics property market trend turn arounds. Many of these developers exit their developed properties to their own REITs. So it is getting harder to identify investment opportunity in open market. Also, we see more real investors enter into logistics property investments (not only developments but investing logistics properties as core assets), with fundamental assumption that rent will drastically rise. It is natural the prices rise irrational price level to us. As long as things go according to this scenario, acquiring properties at those level could be a better option under current low interest rate environment. We fear, however, significant downside impact to the logistics property price may happen if rent may not rise as high as developers have expected. In reality, several tenants keep cautious attitude to rent level, reflecting uncertainty in global economy. Even though developers assume rent to rise and set relatively high asking rent, many of the tenants cannot afford that rent. For newly developed properties, we see longer leasing period (taking longer time to fill vacancy of those properties) and longer rentfree period (if normalized over the entire leasing period, real rent is significantly lower than the asking rent.) We concluded that developers are too aggressive in developing properties, and investors are too careless in logistics property pricing. We will not follow current overheated market. 5

6 Current favorable market environment enables JREITs to raise equity at a premium to NAV. Low capital cost situation accelerates pace of property acquisitions by JREITs, and they often pay too much for those acquisitions. Still, in the shortterm, DPU grows and unit price rises nonetheless. It works as long as the trend continues, but once market turns down JREITs that relies on the market environment too much may fall into vicious cycle; e.g. DPU growth is halted or even falls, risk of unrealized valuation losses increases, funding becomes more difficult, etc. For many JREITs, property support from sponsors are regarded as driver of external growth. In return, sponsor controls everything and capitalizes its position, that creates corporate governance issues; e.g. the sponsor decides the what / when / how much of property to acquire in what price, development profit from OBRs goes to the sponsor, decisionmaking at the asset management company leans toward sponsor, etc. At this moment, many sponsors (tend to be developers) are eager to develop new properties, even under current severely escalated construction cost situation. Sooner or later, JREITs may be forced to buy some of these highcost properties (nearly equal to compressed cap rate properties). We fear sometime in near future, we may see conflictofinterest issue once again. We see signs of change in the market environment, and believe it will become much important to have independent growth strategy that does not rely solely on financial markets and sponsors. 6

7 In our new midterm business plan stable + Growth 2.0, we continue to employ our unique strategy that seeks independent DPU growth that is not swayed away by market changes. 7

8 JLF s Unique Strategy 1) Acquisition Strategy Market is always cyclical, and thus we have stuck to acquisition strategy aligned with the market environment. Under booming market we acquired properties at appropriate prices according to location, building specs and individual property characteristics. Once the market bursts, we employed contrarian investing approach to seize acquisition opportunities. Especially for contrarian investing, we have enough track records since our IPO. According to a real investors survey conducted by CBRE, Inc., a global real services provider, those investors current anticipated return on multitenant logistics center exceeds that of the preglobal Financial Crisis time (the price higher, the yield lower). We believe the current market is in irrational exuberance. Actions we have to take under this market environment are, therefore, staying away from fever covering the market and making every effort to purchase properties at appropriate prices. At the same time, securing borrowing capacity to position JLF for future acquisition opportunities is imperative in case the market trend should turn around. We are not saying we will not buy in this market, but saying we buy at appropriate prices. Of course it is not easy task, but we have made every effort and uncovered acquisition opportunities even in difficult market environments by combining sponsor support and the asset manager s knowhow. As a result of our initiatives, we purchased properties 8.3% discount from appraisal value at the time of acquisition, versus our competitors purchased only 1.9% discount. We will continue to work to uncover acquisition opportunities at appropriate prices. 8

9 2) Unrealized gain We have consistently accumulated unrealized gain through a) purchasing properties at appropriate prices, b) contrarian investing, and c) OBRs. Combined with current favorable real market, our portfolio appraisal value keeps rising. Unrealized gain of our portfolio now reached 66.0 billion and unrealized gain as % of book value 33.2%, the highest level among JREITs. We believe we can absorb negative impacts on our business such as sudden tenant departure, rent reduction, and recognition of nonrecurring one time losses by effectively utilizing our unrealized gain. We see our unrealized gain as risk buffer for sudden market environment changes. 9

10 3) Borrowing capacity JLF has employed contrarian investing as one of our basic acquisition strategies. Under the current real market, we believe now is the time to secure borrowing capacity to position JLF for a future turn in real market. As of the end of fiscal period ended January our LTV is as low as 27.1%, the lowest level of LTV among JREITs. Our conservative LTV policy enables us to keep the highest issuer credit rating. Under main scenario of stable + Growth 2.0, expected LTV ceiling is 35.0%. If we find contrarian investing opportunity in market turn scenario, we may leverage up beyond 35.0% threshold. We have borrowing capacity to an LTV of 35% of about 32.0 billion (the size of our portfolio will grow 15.2%), and to 40% of about 57.0 billion (the size of our portfolio will grow 26.8%). We will continue to control LTV at conservative level for the time being to secure borrowing capacity, and enhance ability to withstand unforeseen events to position JLF to seize contrarian investment opportunity. 4) Stable Earning Base and Financial Standing Stable cash in and stable cash out create stable earning. In order to enhance DPU stability, therefore, we strived to lengthen leases and leveled out the leasing ladder as well as strived to lengthen debt maturities at fixed rate and leveled out the maturity (redemption) ladder. On earnings base, our average remaining life of leases is 7.0 years. On finance side, our average remaining life of debt maturities is 5.9 years. We believe we could build stable portfolio that will endure future potential rent and interest rate fluctuations in the market. 10

11 5) OBR (Own Book Redevelopment) JLF intends to continue OBR as a major driver for organic growth. On September 1,, we announced the launch of OBR#3 Kiyosu Center. Kiyosu Center is a landonly asset, and thus we can carry out redevelopment without recognizing temporary loss resulting from tearing down the existing building. We believe the project enables us to achieve future organic growth through the redevelopment while maintaining stability in the level of DPU. Leasing activities of the property are under way so as to be fully operational upon completion of construction. JLF sees the following four points as the standards for implementing OBR; a) good location, b) better profitability than if bought from market, c) small writedown on fixed assets due to building age, and d) significant untapped floortoarea ratio. Among our portfolio, we identified about 45 OBR candidates, including Kiyosu Center. Assuming we conduct all of these 45 OBRs, we can potentially add about 200,000 m 2 to our total gross floor area, or 18% increase. As we have explained, we intend to conduct one OBR in every 23 years, and it will take close to 10 years to complete those 45 OBRs. 11

12 6) Change in Ownership Structure of the Asset Manager Our main sponsor, Mitsui & Co., is bolstering its real asset management business. In order to concentrate human resources and expertise, funds, and information, it decided to establish a strategic holding company, Mitsui & Co. Asset management Holdings, Ltd. (MAH). These changes create a new structure, which JLF become MAH s subsidiary company by transferring the shares of JLF. Mitsui & Co. still continues in its capacity under the sponsor support agreement signed with JLF. 12

13 Message from President Let me tell you about the two sources of my pride. First, the employees of Mitsui & Co., Partners. Please come visit our company. Our employees will greet you with smiles and impress you with their abundance of expertise and motivation for work. Frankly, I think it is the greatest place to work in Japan. Second, the quality of Japan Fund. Please take a good, hard look at JLF. You will find JLF is of the highest quality in every respect, from LTV to tenant profile and asset quality, to name a few. Without a doubt, JLF is Japan s most reliable REIT. Workplace reforms aimed at improving worklife balance make it easier to get work done. This makes it a more rewarding and satisfying place to work for all employees. Because our employees enjoy a high level of satisfaction, they are able to manage the REIT with a singular focus on the longterm view. The result is stable DPU growth. In other words, shareholder value grows in proportion to employee satisfaction. JLF is the only JREIT to release a midterm management plan that sets forth numerical targets and a timeline for achieving those targets. And JLF reached those targets a halfyear early. The two sources of My Pride described above enable the creation of a followon midterm plan. To date, we have condensed the essence of our management principles into a keyword: stable + Growth (March 2013); Reborn (September 2013); V=D/(rg) (March 2014); Muscular REIT (September 2014); Independent REIT (March ); and Integrity (September ). And now I pass on the baton to my successor, who will carry forward the new midterm management plan, stable + Growth 2.0, and both sources of My Pride. I believe firmly you will find the fruits of his efforts rewarding and I ask for your continued support and kindness. Takayuki Kawashima President Mitsui & Co., Partners Ltd. 13

14 Risks Risk Profiles The principal risks with respect to investment in JLF are as follows: (i) Risks related to the marketability of the investment securities or the investment corporation bonds Risk associated with the fluctuation of market prices of the investment units or investment corporation bonds of JLF Risk associated with the distribution of cash Risk associated with the fluctuation of income and expenses Risk due to the fact that the rights of unitholders and the rights of shareholders are not always identical Risk associated with JLF s investment units transactions in the market Risk associated with the redemption and coupon payment of the investment corporation bonds of JLF (ii) Risks related to the management policy of the investment corporation Risk due to the fact that the investment target is limited to logistics properties Risk associated with the dependency on a small number of tenants Risk associated with single tenant properties Risk of not being able to purchase properties from Mitsui & Co., Ltd., Trust Bank, Limited and Kenedix, Inc. as planned Risk of not being able to acquire or transfer of real Risk associated with funding through issuance of new investment units, borrowings and issuance of investment corporation bonds Risk associated with the dilution of value when new investment units are issued Risk associated with redevelopment projects (OBR) (iii) Risks related to parties concerned and framework of the investment corporation Risk associated with the dependency on Mitsui & Co., Ltd., Mitsui & Co. Asset Management Holdings Ltd., Trust Bank, Limited and Kenedix, Inc., and with conflicts of interest Risk associated with the dependency on interested parties of JLF and with conflicts of interest Risk of dependency on executive officers of JLF and personnel of MLP Risk associated with changes in the investment policy of JLF Risk of bankruptcy or deregistration of JLF Risk associated with deposits and guarantees (iv) Legal risks related to beneficial interests of real and trusts Risk associated with defects of real Risk associated with lease contracts Risk that accompanies damage, loss and deterioration of real due to disasters, and degradation of the surrounding environment Risk associated with owner liability and repair/maintenance costs related to real Risk associated with administrative laws and regulations related to real Risk associated with the establishment or amendment of laws Risk of being affected by bankruptcy, etc. of the seller Risk associated with the master lease company Risk associated with subleasing Risk associated with the use of real by tenants, etc. Risk associated with jointownership of properties Risk associated with sectional ownership buildings 14

15 Risk associated with properties with leased land Risk associated with properties with leased building Risk associated with properties with limited proprietary right of land Risk associated with development properties, etc. Risk associated with detrimental substances Risk associated with specific facilities under the Water Pollution Prevention Act Risk associated with reserve land Specific risk when owning real in the form of trust beneficiary rights Risk associated with jointownership, etc. of trust beneficiary rights Risk related to forward commitment, etc. Risk related to landfill (v) Risks related to a taxation system Risk associated with requirements for dividend deductibility Risk of dividend deductibility requirements not being fulfilled expost facto due to corrections following tax inquiries, etc. Risk of reduced tax system accompanying the acquisition of real not being applied Risk associated with changes in the general tax system (vi) Other Risk associated with expert reports, etc. Risk associated with the dependency on market reports Risk associated with the application of impairment accounting Risk of increased tax burden due to discrepancy between accounting and taxation Risk associated with investment in silent partnership equity interests The current risk profile of the JLF and the risk management systems employed by the MLP to manage those risks; The appropriateness and effectiveness of the risk management structure are regularly evaluated and enhanced by the MLP. Deposits are exposed to risks of bankruptcy of the financial institutions which hold the deposit, and other credit risks. Such risks are, however, managed by limiting shortterm deposits and depositing financial institutions with high credit ratings. Loans and investment corporation bonds are mainly used for asset acquisition or debt repayment, etc. While loans and bonds are exposed to liquidity risk at the time of due date and maturity date, such risk is controlled by diversifying lenders and maturity and due dates, diversifying financing means, establishing commitment lines to secure liquidity as well as monitoring cash flows periodically. JLF has 13 billion yen of commitment lines; no amount has been drawn down as of March 31, Debt with a floating interest rate is exposed to interest rate fluctuation risks. JLF will manage the risk by maintaining conservative level of LTV and by increasing fixedrate debt ratio. Circumstances in which the JLF may use leverage; JLF may take out loans or issue longterm or shortterm investment corporation bonds for the purpose of acquiring assets, repair of properties, payment for dividends, payment for working capital of JLF, or repayment of obligations (including repayment of tenant leasehold or security deposits, and obligations related to loans or longterm or shortterm corporate bonds) and other activities. 15

16 The types and sources of leverage permitted and associated risks; JLF may raise funds through loans and issuance of investment corporation bonds. Associated risks are; There are risks of delinquency in payment of principal or interest, or insolvency with regard to investment corporation bonds due to deterioration of JLF s credit status or other reasons. There is no guarantee that monetary debt and issuance of investment corporation bonds can be made at a timing or on terms that JLF desires since the possibility and terms of monetary debt and issuance of investment corporation bonds are affected by JLF s economic credibility, interest rate environment and other factors. As a result, there is a possibility that JLF will not be able to purchase assets that it had planned to purchase, forced to sell assets that it had not planned to sell, or face cashflow issues. In cases where JLF makes loans or issues investment corporation bonds, financial covenants such as restricting monetary distribution to unitholders (including distribution in excess of earnings) may be imposed, collateral may be set to assets under management, or changes to articles of incorporation may be restricted. Such restrictions may affect the operation of JFL or may have a negative influence over the amount of monetary distribution, etc. to unitholders. All of JLF s debt as of the date of this document are unsecured; however, financial covenants have been imposed prescribing that a certain level of financial indicator figures must be maintained based on assets and liabilities, etc. The interest rate of loans and investment corporation bonds depends on the market trend at the time of the loan or issuance of the investment corporation bond, and will be influenced by subsequent market trends if the interest rate is variable. If the interest rate of the loan and investment corporation bond rise or if the amount of JLF s loan and investment corporation bond issuance increase, the amount of JLF s interest payment will increase. Such increase may have a negative impact on the amount of monetary distribution, etc. to unitholders. Any restrictions on leverage; The borrowing of funds will be limited to borrowings from qualified institutional investors that are prescribed in Article2, Paragraph 3, Item 1 of the Financial Instruments and Exchange Act (only institutional investors prescribed in Article 6715 of the Act on Special Measures concerning Taxation). The amount limit of the borrowings and investment corporation bond issuance shall be 1 trillion yen, respectively, and the sum of the two shall not exceed 1 trillion yen. Any restrictions on collateral and asset reuse arrangements; When borrowing funds or issuing investment corporation bonds, JLF may offer assets under management as collateral. Maximum level of leverage which the MLP is entitled to employ on behalf of the JLF; The upper limit of the percentage of the balance of borrowings and investment corporation bonds to JLF s total assets (hereinafter referred to as the Percentage of Liabilities ) will be 60%. However, the Percentage may temporarily exceed 60% due to acquisitions of new assets, etc. In order to secure the financial health and future margin for growth, JLF will maintain a lower Percentage of Liabilities and pursue conservative management for the time being. 16

17 Asset Management Report 1. Outline of Asset Management Operation (1) Changes in Key Indicators Fiscal period Management period The 17 th Period (from August 1, 2013 to January 31, 2014) The 18 th Period (from February 1, 2014 to July 31, 2014) The 19 th Period (from August 1, 2014 to January 31, ) The 20 th Period (from February 1, to July 31, ) The 21 st Period (from August 1, to January 31, 2016) Operating Revenue (Millions of yen) 6,645 6,972 9,416 7,074 7,544 of which real leasing business revenue (Millions of yen) 6,645 6,971 6,795 7,068 7,544 Operating Expenses (Millions of yen) 3,199 3,437 3,554 3,473 3,563 of which real leasing business expenses (Millions of yen) 2,544 2,758 2,833 2,776 2,850 Operating Income (Millions of yen) 3,446 3,534 5,862 3,601 3,991 Ordinary Income (Millions of yen) 3,021 3,108 5,456 3,210 3,549 Net Income (Millions of yen) 3,020 3,106 5,456 3,209 3,548 Total assets (Millions of yen) 193, , , , ,459 (Periodonperiod change) (%) (+12.5) (+3.7) (1.3) (+0.7) (+5.2) Net assets (Millions of yen) 116, , , , ,592 (Periodonperiod change) (%) (+16.9) (+0.1) (+2.0) (0.0) (+8.1) Unitholders capital (Millions of yen) 113, , , , ,823 The number of investment units outstanding Net Assets per Unit (Units) (Yen) 166, , , , , ,457 (Note 9) 140, , , ,127 Total Dividends (Millions of yen) 3,020 3,106 3,237 3,208 3,549 Dividends per Unit (Yen) 18,196 3,743 3,900 3,866 4,033 of which earnings Distribution per Unit (Yen) of which Distributions in excess of earnings per Unit (Yen) Ordinary Income to total assets (Annualized) (Note 1) (%) Net income to Net Assets (Annualized) (%) 18,196 3,743 3,900 3,866 4, (3.3) 1.6(3.2) 2.7(5.4) 1.6(3.3) 1.7(3.4) 2.8(5.5) 2.7(5.4) 4.6(9.2) 2.7(5.4) 2.9(5.7) Capital adequacy ratio (Note 3) (%) (Periodonperiod change) (%) (+2.3) (2.1) (+2.0) (0.5) (+1.6) Number of days under management (Days) Payout Ratio (Note 4) (%)

18 Number of properties held at end of period (Bldgs) Total leasable area at end of period (m 2 ) 974, ,015, , ,055, ,099, Number of tenants at end of period (Tenants) Occupancy rate at end of period (%) Depreciation and amortization (Millions of yen) 1,519 1,614 1,583 1,668 1,717 Capital expenditure (Millions of yen) NOI (Net Operating Income) from leasing business (Note 5) (Millions of yen) FFO (Funds From Operation) (Note 6) (Millions of yen) 5,642 5,839 5,627 5,992 6,420 4,562 4,733 7,121 4,909 5,274 FFO per unit (Note 7) (Yen) 27,484 5,703 8,580 5,915 5,993 (Note 1) Ordinary Income to Total assets = Ordinary income / {(Total assets at the beginning of the period + Total assets at the end of the period) / 2} x 100 (Figures are rounded off to the nearest one decimal place.) Net Income to Net assets = Net Income / {(Net assets at the beginning of the period + Net assets at the end of the period) / 2} x 100 (Figures are rounded off to the nearest one decimal place.) (Note 3) Capital adequacy ratio = Net assets at the end of the period / Total assets at the end of the period x 100 (Figures are rounded off to the nearest one decimal place.) (Note 4) Payout Ratio = Total Dividends / Net Income x 100 (Figures are rounded down to one decimal place.) (Note 5) NOI from leasing business = Real leasing business revenue Real leasing business expenses + Depreciation and amortization + Loss on retirement of noncurrent assets. (Note 6) FFO = Net Income + Depreciation and amortization + Loss on retirement of noncurrent assets (including extraordinary loss) (Note 7) FFO per Unit = FFO / The number of investment units outstanding (Figures are rounded off to the nearest integral number.) (Note 8) For amounts in units of millions of yen, figures are rounded down to the nearest million yen. (Note 9) JLF has conducted 5for1 investment unit split, as record date of January 31, 2014 and as effective date of February 1, For comparison purpose, figures of Net Assets per Unit above are calculated assuming the split has occurred at the beginning of the Period ended January 31, 2014 (the 17 th Period). (2) Status of Capital Increase, etc. Investment Units Issued and Outstanding and Changes of the Unitholders capital are as follows. Date Summary Total number of investment units issued Unitholders capital (Millions of yen) Change Balance Change Balance Remarks February 22, 2005 Private placement offering 1,000 1, (Note 1) May 6, 2005 June 1, 2005 February 8, 2006 March 8, 2006 August 31, 2007 February 23, 2010 March 25, 2010 August 30, 2010 Capital increase through public offering Capital increase through thirdparty allotment Capital increase through public offering Capital increase through thirdparty allotment Capital increase through public offering Capital increase through public offering Capital increase through thirdparty allotment Capital increase through public offering 55,700 56,700 29,562 30,062 2,800 59,500 1,486 31,548 (Note 3) 46, ,000 35,668 67,217 (Note 4) 2, ,800 2,147 69,365 (Note 5) 13, ,300 12,656 82,021 (Note 6) 8, ,800 5,123 87,145 (Note 7) , ,446 (Note 8) 16, ,300 9,689 97,136 (Note 9) 18

19 September 24, 2010 September 13,2013 October 2,2013 October 28,2013 Capital increase through thirdparty allotment Distribution in Excess of Earnings Capital increase through public offering Capital increase through thirdparty allotment , ,559 (Note 10) 148, ,095 (Note 11) 16, ,000 14, ,729 (Note 12) 2, ,000 1, ,559 (Note 13) February 1,2014 Investment Unit Split 664, , ,559 (Note 14) September 16, Capital increase through public offering 47, ,500 8, ,360 (Note 15) Capital increase through October 15, 2, , ,823 (Note 16) thirdparty allotment (Note 1) Upon establishment of JLF, investment units were issued at the price of 500,000 yen per unit. Investment units were newly issued at the price of 550,000 yen per unit (net proceeds of 530,750 yen) for new properties acquisition. (Note 3) Investment units were newly issued through thirdparty allotment at the price of 530,750 yen per unit for new properties acquisition. (Note 4) Investment units were newly issued at the price of 793,800 yen per unit (net proceeds of 767,070 yen) for new properties acquisition. (Note 5) Investment units were newly issued through thirdparty allotment at the price of 767,070 yen per unit for new properties acquisition. (Note 6) Investment units were newly issued at the price of 971,180 yen per unit (net proceeds of 937,486 yen) for new properties acquisition. (Note 7) Investment units were newly issued at the price of 624,680 yen per unit (net proceeds of 602,784 yen) for a new property acquisition. (Note 8) Investment units were newly issued through thirdparty allotment at the price of 602,784 yen per unit for partial repayment of bank loans. (Note 9) Investment units were newly issued at the price of 627,590 yen per unit (net proceeds of 605,592 yen) for a new property acquisition. (Note 10) Investment units were newly issued through thirdparty allotment at the price of 605,592 yen per unit for partial repayment of bank loans. (Note 11) Distribution in Excess of Earnings was resolved at the price of 3,138 yen per unit in order to level out the loss associated with OBR. (Note 12) Investment units were newly issued at the price of 947,700 yen per unit (net proceeds of 914,652 yen) for new properties acquisition and partial repayment of bank loans. (Note 13) Investment units were newly issued through thirdparty allotment at the price of 914,652 yen per unit for partial repayment of bank loans. (Note 14) JLF has implemented a 5 for 1 investment unit split. (Note 15) Investment units were newly issued at the price of 191,782 yen per unit (net proceeds of 185,290 yen) for partial new properties acquisition and repayment of borrowings with respect to the acquisition of new properties. (Note 16) Investment units were newly issued through thirdparty allotment at the price of 185,290 yen per unit for financing future acquisition of specified assets, partial repayment of the borrowings or partial redemption of the investment corporation bond. Changes in market price of investment securities The market price of JLF s investment securities listed on the Tokyo Stock Exchange REIT Market changed during each fiscal period as follows: Fiscal period The 17 th Period The 18 th Period The 19 th Period The 20 th Period The 21 st Period For the six months ended January 31, 2014 July 31, 2014 January 31, July 31, January 31, 2016 Highest 1,150,000 yen 245,900 yen 278,600 yen 261,900 yen 241,300 yen Lowest 861,000 yen 212,100 yen 231,100 yen 227,100 yen 193,300 yen 19

20 (3) Distributions, etc. Concerning Taxation; Act No. 26 of 1957; including revisions enforced thereafter) (hereafter, the Special Taxation Measures Act ) that allows the maximum amount of distribution of earnings to be treated as a taxdeductible expense, JLF decided to distribute to unitholders the full amount of net income excluding fractions below one yen of the amount of dividends per investment unit. As a result, JLF s dividend per investment unit was 4,033 yen. Fiscal period Total amount of unappropriated retained earnings Accumulated earnings Total amount of cash distributions Thousands of yen Thousands of yen Thousands of yen The 17 th Period (from August 1, 2013 to January 31, 2014) The 18 th Period (from February 1, 2014 to July 31, 2014) The 19 th Period (from August 1, 2014 to January 31, ) The 20 th Period (from February 1, to July 31, ) The 21 st Period (from August 1, to January 31, 2016) 3,020,567 3,107,029 5,456,363 3,209,318 3,549, ,219, ,020,536 3,106,690 3,237,000 3,208,780 3,549,040 Dividends per unit Yen 18,196 3,743 3,900 3,866 4,033 of which total amount of earnings distributions Earnings distribution per unit of which total amount of capital refunds Thousands of yen 3,020,536 3,106,690 3,237,000 3,208,780 3,549,040 Yen 18,196 3,743 3,900 3,866 4,033 Thousands of yen Capital refunds per unit Yen Portion of total amount of capital refunds that is total amount of distributions from reserve for adjustment of temporary differences, etc. (Portion of capital refunds per unit that is distribution from reserve for adjustment of temporary differences, etc. per unit ) Portion of total amount of capital refunds that is total amount of distributions from distribution of reduction in capital, etc. under the tax law (Portion of capital refunds per units that is distribution from distribution of reduction in capital, etc. under the tax law) Thousands of yen Yen Thousands of yen (4) Significant Subsequent Events Not applicable to the 21 st Period (from August 1, to January 31, 2016). Yen 20

21 [Reference Information] < Issuance of Investment Bond > JLF issued the following investment corporation bond after the end of the fiscal period and before the date of this Financial Report. Name of the bond Japan Fund, Inc. #4th Unsecured Bond (private offering to qualified institutional investors) Total amount of the bond issue 1.7 billion yen Coupon 0.535% Subscription date February 4, 2016 Payment date February 8, 2016 Collateral Redemption method and date Use of proceeds There is no secured mortgage or guarantee on the bond. There are no assets reserved as security for the bond. The entire amount will be redeemed on February 8, The bonds may be repurchased at any time upon notifying the investors by document prior to the repurchase. In case JLF repurchases, JLF will pay accrued interest as well as break funding cost (if any) to the investors on the date of repurchase. Repayment of an existing longterm loan 21

22 2. Outline of JLF (1) Status of Unitholders Capital The 17 th Period The 18 th Period The 19 th Period The 20 th Period The 21 st Period Fiscal period (as of January 31, 2014) (as of July 31, 2014) (as of January 31, ) (as of July 31, ) (as of January 31, 2016) Total number of investment units authorized (Units) 2,000,000 10,000,000 10,000,000 10,000,000 10,000,000 Total number of investment units issued (Units) 166, , , , ,000 Unitholders capital (Millions of yen) 113, , , , ,823 Number of unitholders (Persons) 6,721 7,266 7,804 8,382 9,626 (2) Matters Concerning Investment Units Major unitholders as of January 31, 2016 are as follows: Name Japan Trustee Services Bank, Ltd. (Trust Account) The Master Trust Bank of Japan, Ltd. (Trust Account) Trust & Custody Services Bank, Ltd. (Securities Investment Trust Account) The Nomura Trust and Banking Co., Ltd. (Investment Trust Account) Address Number of investment units owned (Units) Portion in the total number of investment units issued (%) 1811 Harumi, Chuoku, Tokyo 182, Hamamatsucho, Minatoku, Tokyo 87, Harumi Island Triton Square Office Tower Z, 1812 Harumi, Chuoku, Tokyo 66, Otemachi, Chiyodaku, Tokyo 36, The Chugoku Bank, Ltd , Marunouchi, Kitaku, Okayama 17, Metlife Inc. 413 Taihei, Sumidaku, Tokyo 17, The Fuji Fire and Marine Insurance Company, Limited Trust & Custody Services Bank, Ltd.(Cash in Trust Taxable Account) STATE STREET BANKWEST PENSION FUND CLIENTSEXEMPT State Street Bank And Trust Company Minamisenba, Chuoku, Osaka 14, Harumi Island Triton Square Office Tower Z, 1812 Harumi, Chuoku, Tokyo 1776 HERITAGE DRIVE, NORTH QUINCY, MA 02171, U. S. A. P.O.BOX 351 BOSTON MASSACHUSETTS U.S.A. 12, , , Total 454, (Note ) The Portion in the total number of investment units issued is indicated with figures rounded down to two decimal places. 22

23 (3) Matters Concerning Officers, etc. A. The executive director, supervisory directors and accounting auditor in The 21 st Period are as follows: Total compensation or Title Name Major concurrent posts outside JLF fee for The 21 st Period Executive Director Takayuki President, Mitsui & Co., Partners Ltd. (Note 1) Kawashima President and CEO, Daiichi Appraisal Co., Ltd. Supervisory Director Takachiyo Suto President and CEO, Daiichi Kousan Co., Ltd. (Note 1) Chairman and CEO, Appraisal Firm A Square Ltd. 1,800 Supervisory Director Lawyer, Mahoroba Law Office Toshima Aaraki (Note 1) Corporate Auditor, SAZABY LEAGUE, Ltd. 1,800 Supervisory Director (Note 1) Tetsuya Azuma Azuma Certified Public Accountant Office Certified public accountant and licensed tax accountant Representative Liquidator, Melco Metecs Co., Ltd. Accounting auditor Ernst & Young (Note 3) (Note 4) ShinNihon LLC 15,700 (Note 1) The executive director and supervisory directors do not own investment units of JLF under their own or other names. The supervisory directors might serve as directors or auditors of entities other than the above, but there are no mutual business interests between JLF and such entities, including those above. Takayuki Kawashima is to leave on June 21, 2016, and Keita Tanahashi is to take office on the same day. (Note 3) The audit contract with an accounting auditor is renewed every fiscal period. The renewal requires deliberation about reappointment or nonreappointment at a meeting of the Board of Directors. (Note 4) Fees to accounting audit include fees associated with audit of English financial statement and comfort letter. Fee on comfort letter were 3,200 thousand yen. B. Imposition of regulatory penalty (suspension) on Accounting Auditor On December 22,, the Financial Services Agency suspended the Accounting Auditor, Ernst & Young ShinNihon LLC, from taking new contracts for three months (from January 1 to March 31, 2016). (4) Asset Management Company, Custodian and Administrative agent Asset management company, custodian and administrative agent as of January 31, 2016 are as follows: Business Asset management company Custodian of assets Administrative agent Mitsui & Co., Partners Ltd. Trust Bank, Limited Trust Bank, Limited Name 1,800 23