Investment Risks

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As of July 30, 2019

Ⅰ Risk Factors

The following lists are general risk factors possibly associated with investment in securities of Kenedix Office Investment Corporation ("KDO"). The risks outlined below are not all encompassing. KDO attempts to hedge and/or eliminate the occurrence of such risks as much as possible and to implement a policy to counter these risks in the event that they occur. However, KDO does not guarantee that avoidance and countering of risks will be adequate. If the risks outlined below materialize, the market prices of the investment units or bonds of KDO may decline and fall below the issue prices. The decline in market prices may potentially lead to financial losses for the unitholders or creditors. In addition, a decrease in KDO's net assets and deterioration of its other financial conditions may lead to a reduction in distribution.
The followings are the risks described herein:

A. Risk pertaining to Commercial Value of KDO Investment Units or Investment Corporation Bonds

B. KDO Management Policy Risk

C. KDO Structure and Interested Party Risk

D. Real Estate and Trust Beneficiary Interests Risk

E. Tax Risk

F. Other Risks

A. Risk pertaining to Commercial Value of KDO Investment Units or Investment Corporation Bonds

(1) Risk concerning Changes in Market Value of Investment Units or Investment Corporation Bonds

As investment units are closed-end securities, investment units are not refunded at the demand of unitholders and conversion of investment units into cash is restricted to sale to third parties.

The market value of investment units or investment corporation bonds is affected by the supply/demand balance on the stock exchange, and sharp decreases in value are possible when massive selling of these units occur within a set period. Furthermore, market values may fluctuate due to various factors including interest rates, the economic climate, real estate market and other market-related factors. Decreases in the market value of investment units or investment corporation bonds may also result from administrative measures recommended or conducted by regulatory authorities as they affect KDO or KDO's asset manager, Kenedix Real Estate Fund Management, Inc. (“KFM”), or also other investment corporations or asset managers.

In cases when KDO's market value declines, unitholders or creditors may not be able to sell investment units or investment corporation bonds at the price they acquired them and losses may be incurred as a result.

(2) Risk concerning Cash Distributions

KDO plans to allocate cash distributions to unitholders in accordance with the distribution policy; however, the payment and size of distributions are not guaranteed. Profits and losses during fiscal periods fluctuate due to rental conditions, profits and losses from the sale of assets, impairment losses and losses from reconstruction efforts, and the like related to real estate and assets backed by real estate that KDO has acquired. These factors may cause fluctuations in the cash amount of distributions to unitholders.

(3) Risk concerning Fluctuations in Income and Expenditures

KDO income is primarily dependent on rental revenues from real estate. Rental revenues derived from real estate may decrease greatly based on factors such as a decrease in the occupancy rate of properties, rent decreases as a result of negotiations with lessees or when rent increases previously agreed upon with tenants in rental contracts are not realized, etc. Furthermore, past income and expenditures and total rents for owned assets are not necessarily indicators or guarantees of future income and expenditures and total rents for the same assets. Additionally, it may not always be the case that the rents based on rental agreements concluded regarding the concerned real estate will be at an appropriate level compared to ordinary rent levels.

On the other hand, a reduction in income is not the only risk. There is also the possibility that cash flows will decrease due to a number of factors including the refunding of deposits and guarantees to departing tenants, expenditures needed for major repairs and maintenance, large capital expenditures, expenses necessary to acquire real estate and the increase of other expenses related to real estate.

Therefore, there is the possibility that income from real estate will decrease and expenditures related to real estate will increase. When one or both of these two events occurs, there may be cases where distributions to unitholders decrease and market values of the investment units drop.

(4) Risk concerning Dilution of Value per Unit after New Offerings

KDO plans new offerings of new investment units as necessary and such new offerings will reduce the investment unit shares owned by existing unitholders. Furthermore, if investment units of new offerings during KDO's fiscal period are offered at the same cash distribution amount as previously existing investment units, the investment unit share of existing unitholders may be affected negatively compared with the situation where no new issuances are offered.

Furthermore, new offerings may also affect KDO's value per investment unit and the supply/demand balance in the market.

(5) Risk concerning Redemption and Interest Payments for Investment Corporation Bonds

Risk concerning the delayed payment of principal and interest on investment corporation bonds and insolvency may emerge as a result of a worsening in KDO's credit standing or other reasons.

(6) Risk concerning Trading of Investment Units in the Market

The investment units are listed on the Tokyo Stock Exchange. If there is a violation of the listing requirements for real estate investment trust securities specified in the Securities Listing Regulations of the Tokyo Stock Exchange, such as a decrease in the total assets of KDO or a decrease in the trading volume of the investment units, the investment units will be delisted.
If the investment units are delisted, the unitholders will have no means for cashing out the investment units they hold other than transferring them on a negotiation basis. In addition, there will be cases where the unitholders are forced to transfer the investment units they hold at considerably low prices compared to the net asset value of KDO, or where the actual transfer of the investment units becomes impossible in practice. As a result, the unitholders may suffer from losses.

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B. KDO Management Policy Risk

(1) Risk that Properties being Acquired Based on Support Line Memorandum Cannot be Acquired as Assumed

KDO and KFM concluded a support line Memorandum of Understanding (“MOU”) with Kenedix, Inc. ("KDX") and Kenedix Investment Partners, Inc. ("KIP"), the wholly owned subsidiary of KDX.
However, this MOU is just an agreement regarding provision of information to KDO and KFM concerning particular real estate and does not represent an obligation by KDX and KIP to sell said real estate at a value desired by KDO. In other words, according to the MOU, KDO is not always guaranteed acquisition of real estate it judges as appropriate or at an appropriate price.

As a result, there may be cases when KDO is neither able to construct an optimal portfolio nor amend the portfolio in a timely manner based on KDO's returns or stabilizing profits.

(2) Risk concerning Regional Biases

KDO plans to invest over 70% of its funds based on acquisition price in real estate, etc. in the Tokyo Metropolitan Area. Consequently, this real estate investment target may experience regional biases, and KDO's returns may suffer a material negative impact due to such factors as changes in the regional economy and real estate market, natural disasters such as earthquakes or typhoons and particular demographic shifts and other unique phenomena occurring in the Tokyo Metropolitan Area.

(3) Risk that Real Estate Cannot be Acquired or Sold

Since each piece of real estate is quite unique, cannot be "replaced" and generally has low liquidity, there is a possibility that a property that is desired cannot be acquired or sold at the desired time. It is not necessarily the case that KDO will be able to complete the acquisition of desired real estate as well as acquisition of securities backed by real estate. Even if acquisition is possible, it may be unwise to do so from the perspective of the investment's profitability. Moreover, in cases where KDO sells previously acquired real estate or securities backed by real estate, it may not fulfill profitability expectations from the perspective of investment profitability such as the desired price or timing of a sale.

As a result, there may be cases where KDO is neither able to construct an optimal portfolio nor amend the portfolio in a timely manner based on KDO's returns or stabilizing profits.

(4) Risk concerning Fund Procurement with regard to New Offerings, Borrowings and Investment Corporation Bonds

The possibility and conditions of new offerings of investment units, capital borrowings and issuances of investment corporation bonds may be affected by KDO's economic standing, interest rates and other factors. Therefore, their execution at the timing and under the conditions desired by KDO is not guaranteed in the future. As a result, the planned acquisition of assets may become impossible, unforeseen sale of assets may become unavoidable and fundraising may become difficult to manage.

In addition, when KDO seeks to borrow funds or float investment corporation bonds, there is a possibility that new financial restrictions such as to maintain certain values in accordance with a financial index based on assets, liabilities and others, to maintain KDO's credit standing at a certain level and to limit cash distributions to unitholders may be established as well as the new or additional placement of managed assets as collateral and the restriction of amendments to the Articles of Incorporation. These limitations may obstruct KDO's management activities or have a negative influence on the cash amount of distributions to unitholders. In cases where these restrictions are violated, the additional placement of managed assets as collateral as well as the assumption of cost burdens may be required, which could possibly have significantly adverse effects on KDO's business operations.

In addition, with all of its lenders, KDO has entered into a Basic Loan Agreement related to its fund borrowings, and such Agreement includes a financial covenant to maintain figures at a certain level relative to a financial index based on assets and liabilities, etc.

Furthermore, conditions placed on interest rates for borrowings or investment corporation bonds and related costs may change due to market trends and ratings on investment corporation bonds at the time of the borrowings or issuance of investment corporation bonds, and variable interest rates will be affected by the subsequent market trends. In Japan, interest rates have remained low for over 10 years. However, this situation may not necessarily continue into the future, and market interest rates could increase significantly. In cases where interest rates for borrowings or investment corporation bonds increase or when the amount of borrowings or investment corporation bonds increases, KDO's interest payments will also increase. This type of increase in interest payments may have a negative effect on the distributions to unitholders.

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C. KDO Structure and Interested Party Risk

(1) Risk concerning Dependence on and Conflicts of Interest with KDX and its Group Companies

KDX owns 100% of the shares of KFM and is the primary provider of KFM's fulltime employees as of the date of this document. Additionally, KDO and KFM have concluded a support line memorandum of understanding with KDX and KIP. Furthermore, KDO has consigned real estate property management business to Kenedix Property Management, Inc. (“KPM”), the wholly owned subsidiary of KDX, with regards to all properties owned by KDO with the exception of ARK Mori Building and Shinjuku 6chome Building (Land), land properties with leasehold, as of the date of this document.

Thus KDO and KFM maintain close relationships with KDX, KIP and KPM that significantly affect the securing of stable earnings and growth potential of KDO.

Therefore, if relationships equivalent to the present relationships are no longer able to be maintained, this may have a negative impact on KDO.

Furthermore, in the event that KDO or KFM conducts a transaction with one of the funds that KDX or KIP manages or advises through asset management activities or the like, conflicts with the profit of KDO's unitholders or creditors may occur in order to secure profit for one of the funds that KDX or KIP manages or advises. In such a case, the interests of KDO's unitholders or creditors may be damaged.

(2) Risk concerning KFM being Entrusted with Asset Management of Multiple Investment Corporations

An asset management company is not prohibited from being entrusted with asset management of multiple investment corporations, etc. under the Financial Instruments and Exchange Act, and KFM is being entrusted with the asset management of Kenedix Residential Next Investment Corporation, Kenedix Retail REIT Corporation and Kenedix Private Investment Corporation in addition to KDO.

As KDO targets investment in office buildings, central urban retail properties, etc., the investment targets are in competition with the respective investment corporations.

Therefore, KFM has established a Pipeline Meeting and adopted rules on "preferential rights to study property information" along with prohibiting concurrently holding positions as a Head of Departments that manage the respective investment corporations as of the date of this document. This was done to establish rules to decide which investment corporations shall preferentially consider an acquisition when information on the sale of real estate, etc., is obtained by KFM and has stipulated that it shall conduct management in accordance with the concerned rules.

KDO and KFM expect that there will be only limited instances of competition actually arising over requests for property acquisitions due to the difference in scale of main investment targets between KDO and the respective investment corporations as well as the differences in nature of fund procurement, financial strategies and investment return sought by the investors. However, in cases when competition actually arises over requests for property acquisitions beyond such expectations, the respective investment corporations may preferentially consider property acquisitions according to the abovementioned rules. In addition, the possibility of considering property acquisitions that go against such rules cannot be denied. Furthermore, such rules are subject to change and KDO may not be able to secure the same property acquisition opportunities as of the date of this document due to the concerned changes. In that case, there is a possibility that the building of a portfolio that is considered to be desirable for KDO may be difficult to be realized due to a decrease in its property acquisition opportunities and other factors, and, as a result, this may adversely impact profitability or the asset status of KDO.

(3) Risk concerning Dependence on and Conflicts of Interest with Interested Parties of KDO

KDO decides on important business matters through its Board of Directors comprised of an executive director and supervisory directors in accordance with the Act on Investment Trusts and Investment Corporations. The management of assets is outsourced to KFM, the custodianship of assets to an asset custodian and administrative affairs to an administrator. KDO depends to a large degree on the capabilities, experience and expertise of these parties to conduct business smoothly. However, there is no guarantee that these parties can maintain the personnel and financial standing needed to execute these services. In addition, the Act on Investment Trusts and Investment Corporations assigns duties and responsibilities to executive directors and supervisory directors of investment corporations and related parties, but the interests of KDO's unitholders and creditors may be damaged if the parties related to KDO violate the Act on Investment Trusts and Investment Corporations or other laws or no legal measures are taken.

The continued existence, earnings or the like of KDO may be negatively impacted and the interests of unitholders and creditors damaged should KFM, asset custodian and administrator fail to execute their duties as good managers, fail to execute their duties with integrity for KDO or violate the duty to not harm KDO's interests when there is a conflict of interest.

Furthermore, some KFM directors or employees have acquired stocks or share warrants of KDX and will continue to acquire stocks or share warrants according to KDX's stock option plan or Employee Stock Ownership Plan (J-ESOP). Consequently, conflicts of interest may arise between KDO and those directors or employees at KFM who have acquired such stocks or share warrants.

KDO, KFM and the company holding in trust the beneficiary interests in trust for the portfolio also outsource duties to property managers (hereinafter, referred to as "PM companies" in some cases) that are entrusted with property management business, building managers and the like. The improvement of profitability at KDO greatly depends on the capabilities, experience and expertise of these parties but there is no guarantee that these parties will necessarily be able to maintain the necessary people and financial foundation to execute their duties. Consequently, KDO's continued existence, earnings and the like may be negatively impacted if these parties neglect their duties, violate their obligations in some other manner, lose the ability to execute their duties.

Before November 1, 2018, the asset management business of real estate private placement funds was included in the business of KFM in addition to the asset management business of investment corporations. Therefore, there are the risks on business such as burden of the contractual obligations for compensation which may be borne as a manager of a real estate private placement funds regarding KFM's past business. If such risks on business become a reality, the base and capability necessary for KFM to perform the business as an asset management company of KDO will be damaged, and as a result, may have an impact on the operations of KDO.

(4) Risk concerning Dependence on KDO's Executive Director and the Personnel of KFM

KDO operations rely heavily on the executive director at KDO and personnel at KFM. The loss of these officers and staff might result in a negative impact on the operations of KDO.

(5) Risk concerning Changes to KDO's Investment Policy

Any change to basic matters related to the asset management targets, policy, etc. in KDO's Articles of Incorporation requires the approval of the General Meeting of unitholders, but it is possible to change the more detailed investment policy, portfolio development policy, management guidelines and the like that were designated by the Board of Directors without obtaining the approval of the General Meeting of unitholders. Therefore, there is the possibility that these changes may not reflect the wishes of KDO's unitholders.

Furthermore, in the event of an acquisition for a controlling stake, etc. of KDO's listed units, KDO's management policy, structure or other matters may be changed in a direction that other unitholders don't assume as a result of a resolution of the General Meeting of unitholders and the like.

(6) Risk concerning Bankruptcy or the Cancellation of KDO's Registration

There is the possibility that KDO will fall under the bankruptcy proceedings of the Bankruptcy Act (Law No. 75 of 2004 and ensuing revisions), organizational proceedings of the Civil Rehabilitation Act (Law No. 225 of 1999 and ensuing revisions) and special liquidation proceedings under the Act on Investment Trusts and Investment Corporations (Article 164).

KDO is registered as an investment corporation based on the Act on Investment Trusts and Investment Corporations and its registration may be cancelled in accordance with the Act on Investment Trusts and Investment Corporations due to certain reasons (Article 216). Those cases will result in the abolishment of the listing of these investment units, the dissolution of KDO and the commencement of liquidation proceedings.

In the event that KDO is liquidated, unitholders will only be able to collect back their investment from distributions of the remaining property after all creditors have been repaid (including repayment of investment corporation bonds). Therefore, unitholders may not be able to collect back all or part of their investment.

(7) Risk concerning Deposits and Guarantee Money

KDO may use deposits or guarantee money deposited at no or low interest by tenants of managed assets as a part of the capital to acquire investment assets. However, the deposits and guarantee money from tenants may fall under the amount placed on deposit or have a shorter period in deposit than assumed by KDO as a result of rental market trends, tenant negotiations, etc. In these cases, the necessary funds will have to be secured through loans or other means. Additionally, in exchange for KDO being able to use deposits or guarantee money, KDO bears an obligation to repay the deposits or guarantees and may have to procure the necessary funds through loans or other means to cover said repayment obligations when they occur which may impact KDO's earnings negatively.

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D. Real Estate and Trust Beneficiary Interests Risk

KDO's primary managed assets are the specified assets such as real estate, and KDO owns real estates and real estate beneficiary interests in trust. Owners of real estate beneficiary interests in trust and other assets backed by real estate acquire essentially the same profit conditions economically as if they directly owned the real estate that is the trust property or the real estate that backs the securities. Therefore, the risks related to real estate that are described below are essentially the same for real estate beneficiary interests in trust and assets backed by real estate.

Furthermore, plese refer to "(20) Risk unique to owning real estate as beneficiary interests in trust" about unique risks of trust beneficiary interests.

(1) Risk concerning Real Estate Defects and Boundaries

Real estate may have defects and problems (including hidden defects and problems) related to its rights, ground, and soil quality. There may also be defects and problems related to piles, beams, and other structural components of a building, or building design and construction. These defects and problems may not become evident until after the corresponding property is acquired. In addition, there are cases in which KDO acquires a property whose boundaries are not officially set after considering matters such as the possibility of a dispute and the impact on the management of the property. However, circumstances unexpected by KDO may arise, such as a dispute with adjacent land. There may also be a case in which a certain portion of the acquired land is found to belong to the owner of the adjacent land or be limited to a smaller area. If this portion is essential to the management of the assets (including land necessary for complying with regulations imposed by laws, rules, etc.), it may have an adverse effect on the management of the property and earnings, etc. of KDO.

There are cases where KDO may, depending on the conditions, demand a representation and warranty concerning certain matters from the previous owner or make the previous owner liable for defects. However, even if the representations and warranties are found not to be true while liability for damages and defects is pursued, the liability period and amount are normally restricted to a certain limit and there are cases where liability can't be enforced because the previous owner has dissolved or has no capital.

Depending on the degree of the defect, problem, etc. in these cases, KDO, the buyer of the property, may incur a significant amount of unscheduled costs to repair the defect, problem, etc., reconstruct the defective building, or take other response measures in an effort to prevent a decline in the asset value of the property. KDO may have to shoulder these expenses in such cases. This may result in damage to the unitholders or creditors.

Additionally, there may be cases where the buyer may be unable to obtain the rights to the real estate because the transaction has been completed in good faith based only on the records in the real estate registry. Furthermore, there may be times when items pertaining not only to rights but also to the real estate as indicated in the registry do not reflect actual circumstances. As in the preceding cases, KDO will pursue the liability of the seller to the extent permitted by law and the contract; however, the effectiveness of such efforts is not guaranteed.

(2) Risk concerning Responsibility in the Sale of Real Estate

KDO is registered as a real estate broker under the Real Estate Brokerage Act (Law No. 176 in 1952 and ensuing revisions) when it sells real estate. Therefore, excluding when the counterparty in the sale is a real estate broker, there are restrictions on placing riders in the sale and purchase agreement for real estate that would be disadvantageous to the buyer with regards to liability for covering defects. Therefore, when KDO sells real estate, there is the possibility that it will damage the interests of unitholders and creditors by having to cover unforeseen expenses incurred to correct defects, reconstruct the defective building or take other response measures in the sold property.

There is also the possibility that the complexity of obligations regarding rights related to real estate will later lead to the revelation that the rights are limited by the rights of a third party, the rights are restricted by law or that the property is violating the rights of a third party. This may have a negative impact on KDO's returns or other interests. In addition, depending on the shape or status of the use of real estate, there is a possibility of an unexpected violation of the rights of a third party due to the existence or status of the use of the real estate.

Furthermore, in the sale of lease properties, the new owner shall be deemed to be the successor to such responsibilities as the repayment of deposits to the lessees, and actual business shall follow this rule. However, in the event that the previous owner did not obtain consent from the lessees for the exemption of relevant liabilities, the previous owner may be deemed to shoulder such liabilities together with the new owner, and, therefore, may undertake unexpected liabilities or responsibilities.

(3) Risk concerning Rental Agreements

a. Risk concerning the Cancellation and Renewal of Rental Agreements

When the lessee reserves the right to terminate a rental agreement, the rental agreement may be concluded during the contracted period or the contract may not be renewed upon expiration of the rental agreement period which may lead to a decrease in occupancy and rental revenues. When the right to terminate a rental agreement during the contracted period is limited with termination prohibition articles and termination penalty articles, and the renewal charge is set, there still remains the possibility that the court will reduce the predetermined amount of payment or reject the validity of the concerned article.

As a result, there is the possibility that the interests of KDO's unitholders and creditors will be damaged due to a negative impact on earnings from the drop in rental revenues etc.

b. Risk concerning Rent Delinquency

In cases where the tenant's financial standing has worsened, or the tenant has filed for bankruptcy, reorganization proceedings under the Civil Rehabilitation Act, corporate reorganization proceedings under the Corporate Reorganization Act (Law No. 154 in 2002 and ensuing revisions) or other bankruptcy proceedings, the tenant may become delinquent in the paying of rents based on the rental agreement and the interests of KDO's unitholders or creditors may be damaged if the amount of delinquent rent surpasses the amount of deposit and guarantee money taken as collateral.

c. Risk concerning Revisions to Rent

When the length of the rental agreement with the tenant is relatively long, the rent and other content in the rental agreement are often reviewed on a periodic basis.

In addition, ordinary building rental agreements occupy a high percentage among rental agreements concluded with the end tenants who are housed in the office buildings owned by KDO, and most of them have a contracted period of 3 years or less. Accordingly, opportunities in which rents can be revised through negotiations with the end tenants on contract revisions arise relatively frequently with an interval of approximately two years. Because of this, trends in market rent may have a significant impact on KDO's earnings, etc.

Therefore, there is no guarantee that the rent as of the date stated here will be maintained. A reduction in the rent when it is revised may adversely affect the earnings, etc. of KDO and cause damage to unitholders and creditors.

In addition, even when the rental agreement includes provisions for the periodic increase in rent, etc., depending of negotiations with the lessee, the rent may not necessarily be raised as provided for in the agreement.

d. Risk concerning the Lessee's Right to Demand Rent Reductions

Excluding when the lessee of a building establishes a special contract that relinquishes the right to demand a rent decrease based on Article 32 of the Act on Land and Building Leases in a fixed term building lease agreement, the lessee is able to make such a demand based on the provisions of this Law. If the demand is satisfied, the rental income from said real estate will decline and this may negatively impact KDO's earnings and damage the interests of its unitholders or creditors. Also, under the provisions of the Act on Land and Building Leases, a special contract that rules out the right to demand a reduction of rent based on Article 32 of the Act may be established only in a fixed term building lease agreement. In order for a fixed term building lease agreement to take effect, the requirements set forth in Article 38 of the Act need to be satisfied. If these requirements are not met (including cases where satisfaction of these requirements is not proved), the fixed term building lease agreement does not take effect, nor does the special contract that rules out the right to demand a reduction of rent. This may result in damage to the unitholders or creditors.

(4) Risk concerning Building Damage, Loss and Deterioration due to Disasters

It is possible that the value of real estate will be impacted by its destruction, deterioration or damage as a result of fires, earthquakes, tsunami, severe rainstorms, floods, lightning, tornadoes, liquefaction, war, riots, terrorism and other circumstances. This may damage the interests of unitholders or creditors because repair of locations that have been destroyed, deteriorated or damaged will require the building to be vacant for a certain period and thus reduce rental revenues or the value of said property. There is also the possibility that the interests of unitholders or creditors will be damaged due to the negative impact on earnings, etc. of KDO caused by insurance policies not being concluded due to unique circumstances of the property, the occurrence of damages that exceed the payment ceiling established in the insurance policy, the occurrence of disasters not covered by the insurance policy, payments not being made by the insurer based on the insurance policy or payments being reduced or delayed.

Furthermore, the possibility that earthquakes and following tsunamis of the same scale as or larger than the Great East Japan Earthquake occurred on March 11, 2011 might occur or that other natural disasters or accidents might occur cannot be ruled out hereafter. If such are to occur, there is the possibility that KDO's owned properties or properties to be acquired may be destroyed, deteriorated or damaged as well as the possibility that the surrounding regions or the Japanese economy as a whole may be negatively affected, and KDO's earnings and asset value, etc. relating to owned properties by KDO may be negatively affected as a result.

(5) Risk concerning Ownership Liabilities, Repair and Maintenance Expenses, etc. Related to Real Estate

In the event that the life, body, property, etc. of a third party is violated as a result of a managed asset, there may be an obligation for liability and unforeseen damages may be incurred by KDO in the end. In particular, there are cases where the owner of a structure on land bears no-fault liability according to the Civil Code. When an insurance policy hasn't been executed due to unique circumstances of the property, there is the possibility as with (4) above that KDO will be negatively impacted.

Also, when the real estate is destroyed, damaged, deteriorates or the like and repairs are necessary, the repairs and countermeasures may require enormous expenses. In the event that such repairs or countermeasures are difficult or impossible to carry out, the price of the real estate may drop because of decreased rental income obtainable from the real estate.

(6) Risk concerning Laws and Regulations Related to Real Estate

As a rule, when the Building Standards Act, the orders or ordinances based on it and the City Planning Act are revised, a new law is passed, or regulations concerning expropriation, redevelopment, rezoning and other such administrative acts are executed or applied, existing buildings (including those under construction) and their lots that do not satisfy these regulations are exempted from their application (so-called existing non-conformed). However, when these existing non-conformed buildings are to be rebuilt, the regulations are applied and so there is a need to make changes so that the regulations are satisfied. Consequently, additional expenses may be needed and there is also a possibility that buildings of the same scale cannot be constructed.

Additionally, various administrative laws and regulations and local regulations may be applied to real estate managed by KDO. Examples of these include City Planning Act, regulations of ordinances by local self-governing bodies concerning architectural regulations, etc. in landscape area, restrictions on the building of structures in river conservation areas based on the River Act (Law No. 167 of 1964 and ensuing revisions), the obligation for excavation based on the Act on Protection of Cultural Properties (Law No. 214 of 1950 and ensuing revisions), the obligation to provide residences up to a certain ratio, the obligation to provide space for a parking lot, the obligation to install welfare-friendly facilities, the obligation to promote greenery and the obligation to install facilities that suppress rainwater flow off. With these types of obligations in place, it is possible that disposal and rebuilding of the concerned real estate will in fact become difficult or that an additional expense will be incurred by the owner to comply with these obligations. Furthermore, when the managed asset is in an area that includes city planning aspects such as road construction, building restrictions may be placed on areas covered by the city planning ordinance which reduce the building lot area and in turn the earnings. There is also the possibility that a building of the same scale as present cannot be rebuilt in the event of building reconstruction.

(7) Risk concerning Establishment / Change of Laws

Laws and ordinances may be established and enforced with the objective of protecting the environment such as the Soil Contamination Countermeasures Act (Law No. 53 of 2002 and ensuing revisions), and these laws may impose investigatory, removal and compensatory obligations on the real estate regarding air, soil, subterranean water and other pollution regardless of the presence of any negligence.

There is also the possibility that real estate management costs will increase due to the revision of the Fire Service Act (Law No. 186 in 1948 and ensuing revisions) and other related laws and ordinances that can impact real estate management. In addition, there is the possibility that additional costs or burdens will be incurred in the event of the establishment, application and amendment of laws and ordinances that are for the purpose of reducing energy use and greenhouse gas emissions. Real estate rights may also be restricted due to revisions to the Building Standards Act and City Planning Act, the passage of new laws, and administrative acts including expropriation, redevelopment and rezoning. There is the possibility that these laws, ordinances and administrative acts and their changes may negatively impact KDO's earnings.

(8) Risk concerning Bankruptcy, etc. of the Seller

If KDO acquires real estate from a seller recognized or suspected to be in substantive fiscal crisis due to excessive debt or other financial factors, then the seller's creditors may cancel the transaction concerning this real estate (cancellation as a prejudicial act). Also, if the seller commences bankruptcy proceedings after acquisition of the real estate by KDO, the bankruptcy custodian, supervising member or custodian may reject the transaction concerning this real estate.

Also, when KDO acquires real estate from a party that acquired real estate from a certain party (hereafter, purchaser in this article only), there is the possibility that the transaction between the seller and purchaser will be rejected and that the results of that transaction will be contested if KDO is aware of information that could lead to the real estate transaction between the seller and purchaser being cancelled or rejected as a prejudicial act.

KDO will carefully consider the various circumstances concerning the risk that the custodian will reject or cancel the transaction and take practical steps to remove any risk that the transaction will be rejected or cancelled by the custodian as much as possible. However, it is difficult to completely eliminate this risk.

There is also the possibility that the embodiment of the transaction will lead to the judgment that the real estate transaction between the seller and KDO is a collateral transaction and that the concerned real estate comprises a part of the bankrupt property owned by the bankrupt party or that it is a part of the property of the seller who is legally reorganizing (that is, the risk that it is not considered a true sale).

(9) Risk concerning Master Lease Companies

KDO may acquire properties in the form of master lease, a style of business involving the subletting of property to sublessees based on a master lease drawn up between the master lessee and KDO or the trustee.

In the event of the deterioration of the master lessee’s financial condition as it pertains to properties that are subject to the master lease, there is the possibility that lease payments from the master lessee to KDO or the trustee may fall behind, even if the sub-lessee has made lease payments to the master lessee. This is a consequence of creditors' garnishing the rent received from the sub-lessee.

(10) Risk concerning Subleasing

When the right to sublet all or part of the property is given to the lessee (including sub-lessee), KDO may lose the right to select or remove at its own discretion tenants occupying the property. In addition, when the rent of the lessee is linked to that of the sub-lessee, the credit status of the sub-lessee may have a negative impact on KDO's earnings.

Furthermore, if an agreement is finalized to cancel the rental agreement or rescind said agreement due to the default of obligations, the obligation to refund deposits may be inherited by the lessor even when the rental agreement stipulates that the lessor inherits the obligation to refund deposits to the sub-lessee when the contract ends. In this case the cash for the deposit and such to be refunded may become the burden of the lessor and thus have a negative impact on KDO's earnings.

(11) Risk concerning Tenant Use, etc. of Real Estate

There are cases where the use or management condition of the real estate by the tenant may have a negative impact on the asset value of said real estate or KDO's earnings. There is also the possibility that the attributes of the sub-lessee or the successor of the leasehold rights deteriorate the tenant attributes of the real estate that is a managed asset and cause the rent levels of the entire building to decrease.

(12) Risk concerning Co-owned Properties

In cases where the managed asset is a property that co-owned with a third party, various risks exist regarding its preservation, use, disposal, etc. that are absent when it is owned by a single owner.

First, regarding the management of co-owned properties, Civil Code Article 252 states that management is to be conducted by the party with a majority of ownership based on the equity price unless there is a separate agreement between the co-owners. When KDO does not own the majority interest, the intents and wishes of KDO may not be reflected in the management and operation of said real estate. In addition, since the co-owner according to Civil Code Article 249 can use all of said co-owned property according to the ratio of ownership, the ownership or use of said real estate of KDO may be hindered by the exercise of rights by other co-owners.

Other possible risks include the co-owner exercising the right to demand that the entire co-owned property be subdivided (Civil Code Article 256), the possibility that the court may order an auction of the entire co-owned property (Civil Code Article 258, Paragraph 2) or that the entire co-owned property be sold by a co-owner who is exercising the right to subdivide the property and goes against the wishes of another co-owner.

Although a rider among co-owners concerning the abrogation of the right to demand subdivision of the property is valid, it loses validity after five years. In addition, even when there is a registered rider prohibiting subdivision, if one of the parties to the rider files for bankruptcy, the custodian can demand subdivision of the property for said ownership portion to secure the right to convert this ownership into cash. However, a co-owner can purchase the portion owned by the co-owner that has filed for bankruptcy at an equivalent price (Bankruptcy Act Article 52, Corporate Reorganization Act Article 60 and Civil Rehabilitation Act Article 48).

When the co-ownership interest of other owners has been mortgaged, it is believed that subdivision of the co-owned property will lead to effectiveness of said mortgage being applied to the entire property that had been co-owned in accordance with the ratio of said co-owner's (the party that took out the mortgage) ownership interest. Therefore, even if the co-owned interest of an asset under management is not mortgaged, when another co-owner's portion has been mortgaged then the division of said property will lead to the risk that said mortgage will remain in effect regarding the subdivided managed asset in accordance with the owned interest of other co-ownership parties.

The general interpretation is that a co-owned portion of real estate can be disposed of freely in the same manner as independently owned real estate, but there are cases where the co-owner bears an obligation to provide other co-owners with a preferential right to purchase its share when selling the share to a third party. This is done by agreeing to a preferential purchase right for the co-owned portion to be disposed among the other co-owners.

When a co-owner of real estate becomes a lessee of a property, it is generally considered that the rent obligation becomes an indivisible credit and that the obligation to return deposits becomes an indivisible obligation. Therefore, other co-owners are subject to possible impact from the credit risk of the co-owner who is the lessee.

Since co-owned real estate faces the above restrictions and risks compared to independently owned real estate, more time and expenses are required for their acquisition and sale. In turn, these restrictions and risks may increase factors which lower the property's value.

(13) Risk concerning Compartmentalized Ownership of Properties

A compartmentally-owned building falls under the jurisdiction of the Act on Building Unit Ownership, etc. (Law No. 69 of 1962 and its ensuing revisions) and is a building that is comprised of an exclusive area (residences, etc.) that is subject to independent ownership, a common area that is co-owned (entrance, etc.) and the building's lot area. Under the Act on Building Unit Ownership, etc., the management of compartmentally-owned buildings is determined by legal management methods and management bylaws (when there are such). When attempting to pass a resolution to rebuild, a vote must be held on the resolution and at least 80% of the compartmental owners and voting rights (the ratio of the exclusive area to the floor area unless the management bylaws stipulate otherwise) must pass the resolution (Act on Building Unit Ownership, etc. Article 62). In this way, there are management restrictions as opposed to independently owned properties that don't fall under the Act on Building Unit Ownership, etc..

Although the exclusive area of a compartmentally-owned building can be freely sold, it is similar to a co-owned property in that there are cases where compartmental owners agree to preferential purchasing rights among themselves.

The following risks exist regarding the relationship between compartmentally-owned buildings and their lots.

Regarding the lot owned by a compartmental owner, the rights to own an exclusive area of a compartmentally-owned building are known as land use rights. In compartmentally-owned buildings, the separation and disposal of the exclusive area and its related land use rights is as a rule legally prohibited to maintain a sense of unity between the exclusive area and the land use rights (Act on Building Unit Ownership, etc. Article 22). However, when the land use rights haven't been registered, it is impossible to oppose a third party regarding this prohibition and the separation and disposal of the property following subdivision becomes possible (Act on Building Unit Ownership, etc. Article 23). When the lot of a compartmentally-owned building is divided into several parts and when the compartmental owners respectively own one or several parts of the land independently as fee simple or land use rights in the form of leasehold rights (land use rights in the form of partial ownership), the lot can be separated and sold. When the exclusive area and related land use rights are disposed of separately, compartmental owners who don't own land use rights may appear.
When the land use rights are either use rent rights or a similar right and said lot is sold, auctioned or transferred to a third party in some other way, the compartmental owner may not be able to oppose the third party regarding existing land use rights.

In the case of compartmentally-owned buildings that reflect this relationship between compartmentally-owned buildings and lots, significant time and expenses are needed to acquire or sell such properties and this may lead to a number of factors which cause the asset's value to decline.

(14) Risk concerning Leasehold Land Properties

There are unique risks to owning buildings on leasehold land compared to owning buildings on land that you already own. Leasehold is not a permanent right to use the land unlike fee simple ownership, and the contract ends naturally upon expiration of the leasehold period (fixed term leasehold right) or when the owner of the leased land upon expiration of the term refuses to extend the leasehold agreement and has an appropriate reason for doing so (ordinary leasehold right). A leasehold right may also end when a party fails to pay land rents or ends the right for another reason. When the leasehold right ends, excluding cases where the building owner can demand purchase of the building at market price as stipulated in the Act on Land and Building Leases Articles 13 and the Land Lease Act Articles 4, the land must be returned after tearing down the building on the leasehold land. In the case of an ordinary leasehold right, it is impossible for KDO to accurately forecast whether or not the owner of the leased land will reject an extension at the end of the leasehold period for a proper reason. Therefore, even when there is a right to demand acquisition of the building, there is no guarantee that the price will be equal to or greater than the price desired by KDO.

Ownership of the land for which KDO has leasehold rights may also be sold to another party or transferred to a third party due to the execution of a mortgage, etc. on the land that existed at the time the leasehold rights were set. In this case, when no requirements for opposition are in place concerning the third party in accordance with the laws and ordinances applicable to leasehold rights, KDO cannot oppose the new owner and may have an obligation to hand over said land.

Furthermore, if the leasehold rights are lease rights, the approval of the owner of the leased land is necessary when transferring the leasehold rights as a rule. When transferring ownership of the building on the leased land, the leasehold right for said land will also be transferred. As a general rule, it is then necessary to obtain the approval of the owner of the leased land at that time. Regarding this approval, the payment of approval fees to the owner of the leased land may be determined in advance and there are also cases where the owner invoices for such as a business customer (it must be noted that the right of the owner of the leased land to demand an approval fee is not guaranteed under the law).

In addition, the deterioration of the financial condition, bankruptcy, etc. of the owner of the leased land will cause all or a portion of the deposits, guarantees and such normally paid to the owner of the leased land to not be refunded. Traditionally there is no collateral set or guarantee for the right to demand a refund of the deposit, guarantee or like from the owner of the leased land.

Unlike the case where the land and building are owned by the same party, leasehold land and a building built on this leasehold land incurs the above restrictions and risks. Therefore, it may require more time and expenses to acquire or sell such property or may increase factors that lower the property's value.

(15) Risk concerning Leased Properties

KDO occasionally sublets buildings (including co-ownership and compartmental ownership) that it has leased from a third party or to the trustee, either independently or together with a building it owns, directly or through a trustee to tenants.

In this case, as was the case with the above (14), the financial deterioration, bankruptcy, etc. of the building lessor may lead to all or a portion of the deposits or guarantees paid to the building lessor not being refunded.

Additionally, under the Civil Code, when a rental agreement concluded by KDO directly or through the trustee with a third party terminates for any reason, there is the potential that compensation will be sought by the tenant upon termination of the sublease agreement since KDO or the trustee must also then end the sublease agreement with the tenant.

(16) Risk concerning Land Properties with Leasehold

KDO may acquire what is called land with leasehold, which is land leased to a third party which owns buildings on the land. Land properties with leasehold have risks specific to such properties. In the case of fixed-term leasehold, the leasehold rights will automatically be extinguished upon the arrival of the term stipulated in the land lease agreement (however, the efficacy of a fixed-term leasehold establishment agreement may not be recognized if the requirements designated in the Act on Land and Building Leases are not satisfied (including the case when it cannot be proven that the requirements are satisfied), as it is necessary to satisfy those requirements for such an agreement to become effective). In the case of an ordinary leasehold, the rights will be extinguished only if KDO rejects renewal of the leasehold upon the expiration of the agreement with proper reasons to reject the renewal. If the leasehold is extinguished, the land lease right holders may demand KDO to purchase buildings on the said land at their prevailing market prices (Article 13 of the Act on Land and Building Leases and Article 4 of the Land Leases Act.) There is no guarantee that, when the land lease right holders demand for KDO to purchase buildings on the said land at their prevailing market prices, the purchase prices will be equal to or lower than the prices desired by KDO.

In addition, when the land lease rights are rights to lease, the land lease right holders must in principle obtain consent from KDO when they transfer the land lease rights. However, the land lease rights will be transferred without any consent from KDO if the court provides permission in place of the consent (Article 19 of the Act on Land and Building Leases) or if KDO had consented to the transfer of the land lease rights within a certain degree before the land lease agreement was concluded. As a result, the land lease rights may be transferred to parties not desired by KDO, such as those having trouble in their financial conditions. This may consequently damage the interests of KDO's unitholders.

Moreover, if payment of rent on the land based on the land lease agreement becomes delinquent and the total amount of rent in arrears exceeds the amount covered by the deposits and guarantees, KDO's unitholders may suffer losses. On top of this, rental income from the said land with leasehold may be reduced as a result of revision of rent on the land or the request for reduction of rent on lease of the land by the land lease right holders pursuant to Article 11 of the Act on Land and Building Leases, damaging the interests of KDO's unitholders.

(17) Risk concerning Development Properties

KDO may conclude a sale and purchase agreement at the development stage to acquire properties after they are completed in accordance with the investment policy designated in KDO's Articles of Incorporation. Unlike acquisition of already completed properties after concluding sale and purchase agreements, such a case presents a variety of reasons why the property may not be handed over according to the sale and purchase agreement including delays, changes or suspension of development. As a result, earnings from the development property may fall far below the forecast, their attainment may be delayed past the scheduled time, or such earnings may not be attained at all. Additionally, KDO may need to bear unanticipated costs, damages or losses. These factors may negatively impact on KDO's earnings.

(18) Risk concerning Forward Commitments, etc.

When KDO acquires real estate or trust beneficiary interests in real estate, it may conclude a so-called forward commitment. In the case that a real estate purchase and sale agreement is cancelled for reasons attributable to the buyer, the buyer is required to bear responsibility to compensate for damages should a nonfulfillment of an obligation occur. Furthermore, many agreements have provisions for a penalty for cancellation which amounts to a certain ratio of the acquisition price of the real estate or trust beneficiary interests in real estate, regardless of whether or not the amount of damages, etc. were confirmed. Since there is a certain time period between the conclusion of agreements, such as the forward commitment, until the settlement and delivery of property, it is possible that KDO may not be able to procure funds for acquiring the real estate during that time period, due to changes in market environment, etc. Should KDO be forced to terminate the purchase and sale agreement, it could have a negative impact on its financial conditions, etc. as a result of having to pay penalty for cancellation, etc.

(19) Risk concerning Toxic Substances

There is the possibility that industrial waste, radioactive material and other toxic substances will be buried or present in land when KDO acquires land, land leasehold rights, superficies and beneficiary interests in trust for these assets and the value of said land may plummet as a result in cases where said toxic substances are buried or present in land. Unforeseen costs and time may also be required if the soil must be replaced, washed or decontaminated to remove said toxic substances. There is also the risk that a third party may suffer damages due to these toxic substances and that KDO will be held liable to compensate for said damages either directly or indirectly through the trustee. In addition, the value of the real estate may decline due to the existence of these toxic substances. According to the Soil Contamination Countermeasures Act, there are cases where the land owner, manager or occupant are ordered to investigate and report findings to the prefectural governor about land contamination by specific toxic substances including lead, arsenic, trichloroethylene and other toxic substances. When the pollution from the specific toxic substances harm the health of people or may potentially do so, the prefectural governor may order pollution removal and other measures to be taken to prevent injuries and damages.

In this event, there is a possibility of an enormous financial burden being placed on KDO and there is no guarantee that the party that was the cause or other parties will always compensate KDO for the expenses it was forced to incur.

In addition, when KDO acquires a building or beneficiary interests in trust where a building is placed in trust, the value of the building may plummet if the building's materials are found to contain asbestos or some other toxic substance or that the building is storing PCB waste. In addition, unforeseen costs and time may be required when it becomes necessary to replace all or part of the materials to remove these toxic substances or when it is necessary to dispose of or store these toxic substances. If a third party suffers damages from said toxic substances, there is the possibility that KDO will be required to compensate for those damages directly or indirectly through the trustee.

Future laws and ordinances may be established and enforced to protect the environment, and responsibility to investigate, remove and compensate for damages regardless of the cause may be incurred concerning real estate air, soil, subterranean water and other pollution. Also, changes in the accounting standards concerning toxic substances and other related factors may negatively impact KDO's earnings.

(20) Risk Unique to Owning Real Estate as Beneficiary Interests in Trust

KDO often acquires real estate in the form of beneficiary interests in trust.

The trustee owns and manages the real estate, real estate leasehold rights, superficies or easements as trust property for the beneficiary interest holder and all of the economic profit and loss in the end is ascribed to the beneficiary interest holder. Therefore, in owning beneficiary interests in trust, KDO will effectively bear the same risks via the trustee as when the managed asset is real estate.

When attempting to transfer beneficiary interests in trust under a trust agreement, it is common to demand approval of the trustee. Furthermore, unless such beneficiary interests in trust are beneficiary certificate of beneficiary certificate issuing trust, the beneficiary interests in trust that have real estate, real estate leasehold rights, superficies or easements placed in trust do not have the same character as investment securities which are transferred in the same way. Thus, when such beneficiary interests in trust are transferred in the same way as the transfer of debt, they also do not possess the same liquidity as securities.

Under the Trust Act (Law No. 62 of 1922 and ensuing revisions before revisions of Act for Establishment of Laws and Regulations Related to the Trust Act (Law No. 109 of 2006)) and the Trust Act (Law No. 108 of 2006 and ensuing revisions), it is essential that the trust is registered with the real estate placed in trust in case a trustee becomes subject to bankruptcy proceedings. This is to counter bankruptcy custodians and other third parties with the position that the real estate that is the subject of the beneficiary interests in trust is a trust property. If, for example, this registration has not been completed, KDO may not be able to argue to the third party that said real estate is the subject of the beneficiary interests in trust.

Also, in the event that the trustee of the trust property sells the trust property contrary to the objective of the trust or incurs some sort of debt with the real estate that is trust property as the allowance, KDO, as the owner of the beneficiary interests in trust of the real estate placed in trust, may suffer contingent damages.

In addition, when the initial settlor bears a certain degree of liability for defects regarding the trustee of the trust property in relation to defects of the trust property that already existed at the commencement of the trust and based on the trust agreement, KDO may suffer contingent damages and harm the interests of unitholders or creditors because the trustee of the trust property fails to appropriately demand the defect liability or is unable to demand such liability appropriately.

(21) Risk concerning Quasi Co-ownership of Beneficiary Interests in Trust

In cases where the investment assets are real estate beneficiary interests in trusts that are owned under quasi co-ownership with third parties, there may arise various problems regarding their preservation, use and disposal, etc. that are absent when they are owned independently.

First, management of quasi co-owned interests shall be conducted by a majority of the quasi co-owners in accordance with the value of the interests they own, except if otherwise agreed among such quasi co-owners (Article 252 and 264 of the Civil Code). Therefore, in cases where KDO does not own a majority of the quasi co-ownership interests, KDO may not be able to reflect its intentions in the directions by the trust beneficiaries with regard to the management and operations of the real estate. Such other quasi co-owners may possibly be investment corporations or other funds for which KDX, KIP or KFM conducts asset management or provides advice. Even so, if such investment corporations or other funds have different intentions (including management policies) from KDO regarding management and operation of the real estate, KDX, KIP or KFM may be influenced in effect by such intentions or bound by contractual or legal obligations in terms of the relationship with such other investment corporations or funds. As a result, there is a possibility that KDO's intentions cannot be reflected in the directions by the trust beneficiaries with regard to the management and operation of the relevant real estate.

Moreover, the general interpretation is that quasi co-ownership can be disposed of freely in the same manner as solely owned real estate but there are cases where quasi co-owners bear an obligation to provide other quasi co-owners with preferential rights to purchase its quasi co-ownership interest when selling it to a third party. This is done by agreeing to a preferential purchase right for the quasi co-owned portion to be disposed among the quasi co-owners.

Furthermore, the general interpretation is that the right to demand the trust's principal of the quasi co-owners of trust beneficiary interests in real estate over the real estate trustees is an indivisible credit and that their obligation to pay trust expenses, etc. to the real estate trustees is an indivisible obligation. Therefore, a quasi co-owner is subject to possible impact from the credit risk of other quasi co-owners.

In addition, among the quasi co-owners, there are cases where protocols, etc. are concluded among them, agreement is reached among them on the preferential purchase right of quasi co-ownership interests, agreement is reached that the right to demand for sale or purchase will arise under certain conditions, or agreement is reached on the method to make decisions, etc. (content of such is varied) as beneficiaries. In cases when these agreements are made, there is a possibility that disposal of the quasi co-ownership interests owned by KDO is restricted, that KDO is forced to acquire or transfer quasi co-ownership interests at an unexpected time, or that, regardless of the percentage of its interests, KDO's intentions cannot be reflected in the directions by the trust beneficiaries with regard to management and operation of the real estate.

Such restrictions and risks as stated above exist when real estate beneficiary interests in trust are quasi co-owned with third parties, in contrast to cases where they are owned independently. Accordingly, there is a possibility that more time and expenses are required for acquisition and sale of such interests or that factors causing a decrease in prices will increase.

As stated above, even when other quasi co-owners are investment corporations or other funds for which KDX, KIP or KFM conducts asset management or provides advice, if investment corporations or other funds have intentions that are different from KDO's, KDX, KIP or KFM may be influenced in effect by such intentions or bound by contractual or legal obligations in terms of the relationship with such other investment corporation or fund. Therefore, such restrictions and risks as stated above that exist when the real estate beneficiary interests in trust are quasi co-owned with third parties cannot necessarily be dissolved or mitigated.

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E. Tax Risk

(1) Risk concerning Conduit Requirements

Under the Tax Code, a special regulation regarding taxation of investment corporations stipulates that investment corporations meeting certain requirements (hereafter, conduit requirements) are exempt from double taxation at KDO and unitholder level, and thus investment corporations are allowed to record profit dividends (distributions), etc. as deductible expenses.

Major Conduit Requirements of Investment Corporations
Dividend Payment Requirement The distributions paid shall be more than 90% of the distributable profit (if distribution of cash exceeds distributable profit, the amount of cash distributed shall be more than 90% of distributable profits)
More than 50% Domestic Offering Requirement for Investment Units The ratio of the total issue price of investment units offered in Japan to the total issue price of investment units issued by KDO shall exceed 50% and shall be presented or recorded in the Articles of Incorporation
Lender Requirements Debt financing shall not be conducted with anyone other than institutional investors (referring to what is stipulated in Article 67-15 Paragraph 1, 1-(b)-(2) of the Special Taxation Measures Law. The same applies to the owner requirements which follow.)
Owner Requirements By the end of the fiscal year the investment units issued and outstanding shall be owned by either 50 people or more or only by institutional investors
Non-Family Corporation Requirements By the end of the fiscal year KDO shall not fall under the family corporation, of which a unitholder and special persons concerned hold more than 50% of the total number of investment units issued and outstanding or the total number of voting rights
Prohibition of Controlling Company Requirement 50% or more of another corporation's shares or investments shall not be owned (including investment in tokumei-kumiai and excluding certain overseas subsidiaries)

KDO endeavors to meet the conduit requirements, but there remains a possibility that the conduit requirements cannot be met in the future due to an occurrence of a large amount of income taxes for prior years that may be levied due to tax reassessment as corrective measures, a change in unitholders, restrictions on underlying capital to pay distributions, a lack of such capital, fund source, opacity concerning definitions of borrowings, differences in the perspectives of tax authorities and KDO, revisions to laws, a rise in percentage of investment in other corporations by KDO due to reasons uncontrollable for KDO and other factors. If KDO were unable to meet the conduit requirements, it would be unable to record profit distributions, etc. as deductible expenses and KDO's tax burden will increase. This would negatively affect distributions paid to unitholders.

(2) Risk that Conduit Requirements Will be Unfulfilled due to Corrective Measures from Tax Audits, etc.

There may be a case where conduit requirements in previous business years will be deemed to have not been met ex post facto in the event that a tax investigation is conducted and a difference in interpretation between KDO and the tax authorities regarding the treatment of conduit requirements leads to corrective measures. In this case, the denial of filed tax returns for distributions recorded as expenses in previous business years may lead to an increased tax burden for KDO and could have a negative impact on distributions paid to unitholders.

(3) Risk that Tax Mitigation Measures Related to Real Estate Acquisitions Cannot be Applied

The investment policy in KDO's Articles of Incorporation stipulates that the portfolio will be managed so that the value of specified real estate (real estate, real estate leasehold rights, superficies, or beneficiary interests in trust where ownership of real estate, land lease rights or superficies are placed in trust) versus the total value of specified assets owned by KDO will be at least 75% of all assets (Paragraph 3 of "Investment Policies, Asset Management Target and Policies", Attachment 1 of the Articles of Incorporation). KDO's line of thinking is that by satisfying the investment policy stipulated in the Articles of Incorporation and other tax requirements it will receive tax mitigation measures for the real estate transaction taxes (registration license tax and real estate acquisition tax) when it directly acquires real estate. However, KDO may not be able to receive the tax mitigation benefits if it doesn't meet the tax mitigation requirements or the mitigation requirements change.

(4) Risk concerning Changes in the General Tax System

There is the possibility that taxes and public charges will increase and that this will impact KDO negatively if there are changes to the tax system regarding KDO and the interpretation, management and treatment of the tax system regarding real estate, real estate beneficiary interests in trusts and other assets of KDO. In addition, the amount of net income of unitholders may decrease in the event of ownership or sale of KDO's investment units or a burden on unitholders for tax filings and other tax procedures may arise due to changes in the tax system concerning distributions paid on profits from investment units, refunding of investments and the transfer of investments and changes to the interpretation, management and treatment of the related tax system.

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F. Other Risks

(1) Risk concerning Appraisal Reports, etc.

Valuations indicated in real estate appraisal reports and real estate pricing investigations are no more than opinions concerning evaluations at the time of the analysis that are based on the analyses of individual real estate appraisers, etc. and objectively do not automatically match the suitable real estate price. There is the possibility that appraisals, studies and the like of the same property could lead to different appraisal values and study valuations depending on which appraiser conducted the appraisal, the valuation and study methods used and their timing. In addition, the appraisal reports are not a guarantee or promise of the possibility of buying or selling said property at the valuation in the appraisal or study presently or in the future.

The results of building engineering reports and earthquake PML valuation reports are recorded when a specialist verifies design drawings, visually inspects present conditions, interviews facility managers, etc. of buildings being appraised to determine present defects and forecast future defects, necessary repairs and renovations and to calculate the cost for doing such, cost of replacing the building, the anti-seismic performance of the building and the risk of loss from earthquakes. However, these reports do not guarantee that there are no real estate defects, etc.

In addition, the PML values calculated for properties are no more than forecasts based on the analyses of individual specialists. The PML values are indicated by the ratio of the foreseen damage recovery costs to the replacement cost of the building (%), but there is the possibility that a future earthquake may result in recovery costs that are greater than expected.

(2) Risk concerning the Application of Asset Impairment Accounting

As a result of the compulsory application of accounting standards relating to the impairment of fixed assets (Statement Concerning the Establishment of Accounting Standards for the Impairment of Fixed Assets, (Business Accounting Council, August 9, 2002) and Guidelines for the Application of Accounting Standards for the Impairment of Fixed Assets) (Business Accounting Council Application Guidelines No. 6, October 31, 2003) from the fiscal year starting April 1, 2005 onwards, KDO has applied asset impairment accounting.
Asset impairment accounting refers to the accounting procedure whereby the book value of commercial real estate, mainly land and buildings, is reduced in order to reflect the likelihood of recovering investment under certain conditions in the event that there is no prospect of securing a return on the relevant investment due to a decline in profitability. The application of asset impairment accounting means that factors such as trends in land prices and profits from invested assets could result in accounting impairment losses and could potentially have an adverse effect on the KDO's performance.

There may be impairment losses due to the substantial devaluation of KDO property due to the fluctuations in economic conditions and real estate prices, and other factors.

(3) Risk concerning Investment in Tokumei-kumiai

In accordance with its Articles of Incorporation, KDO may invest in a real estate-related tokumei-kumiai (Japanese silent partnerships). In such tokumei-kumiai, KDO invests in real estate, etc. However, in the event of deterioration in income from and the value of the relevant real estate or unintended taxes occurring, the amount of distribution and redemption of principal that KDO can recover as a party to such a tokumei-kumiai may decrease. Accordingly, there is the possibility that KDO will not be able to collect funds invested via its TK Operator, causing damage on KDO. In addition, the assignment of interests in a real estate-related tokumei-kumiai are often prohibited or limited in accordance with the agreement, and there is no established secondary market. The liquidity of such interests in a real estate-related tokumei-kumiai is therefore low and it may be difficult to assign such interests in a timely manner and at an appropriate price at the time that KDO intends to assign the interests or may be forced to buy and sell at prices lower than planned.

(4) Risk concerning Investment in Preferred Equity Securities

In accordance with its Articles of Incorporation, KDO may invest in preferred equity securities issued by the TMK as set forth by the Act on Securitization of Assets. Such TMK, which KDO invests in, uses KDO's funds to invest in real estate, etc. However, in the event of deterioration in income from and the value of the relevant real estate or unintended taxes occurring at the TMK which is a conduit, the amount of dividends and residual assets to be distributed that KDO will gain from such preferred equity securities may decrease. Accordingly, there is the possibility that KDO will not be able to collect funds invested via the TMK, causing damage on KDO. In addition, the assignment of interests in the preferred equity securities are often prohibited or limited in accordance with the agreement among investors in the TMK, and there is no established secondary market. The liquidity of such interests in preferred equity securities is therefore low, and it may be difficult to assign such interests in a timely manner and at an appropriate price at the time that KDO intends to assign the interests, or may be forced to buy and sell at prices lower than planned.

Ⅱ Investment Risk Management System

Based on the understanding that risks such as those mentioned above are the investment risks, KDO and KFM have established risk management systems to address these risks at the maximum possible level.

However, the concerned risk management systems are not guaranteed to have sufficient effect, and there are fears that damages may extend to unitholders or creditors of KDO in the case that risk management systems do not function appropriately.

1. System of KDO

(1) Board of Directors

KDO is striving to ensure that the Board of Directors sufficiently functions as a decision-making body for the execution of operations and a supervising body for the Executive Director, and that the Executive Director faithfully executes duties for KDO. Regular meetings of the Board of Directors are held at least once every three months, and the Executive Director is to report on the operation execution status, etc. of KFM, administrative agents and asset custodians at the regular meetings of the Board of Directors. In addition, basic policies concerning compliance with laws, regulations, etc. are to be decided and matters concerning compliance with laws, regulations, etc. are to be periodically discussed at the regular meetings of the Board of Directors.

(2) Check-and-Balance of KFM

In the asset management agreement concluded between KDO and KFM, it is stipulated that KFM shall formulate management guidelines in accordance with standards set forth in the Articles of Incorporation and execute entrusted operations in accordance with the Act on Investment Trusts and Investment Corporations, the Articles of Incorporation, management guidelines and other various internal rules of KFM. Furthermore, approval of KDO is required for the asset management plans and annual business plans, etc. established by KFM and KFM is obligated to report to KDO. Thus, KDO controls the investment risks.

(3) Management Rules on Insider Trading, etc.

KDO strives to prevent insider trading or similar trading by its directors through establishing management rules on insider trading, etc. Furthermore, in principle, the sale and purchase of KDO's investment units, etc. by KDO's directors (including those who were directors for less than the past one (1) year) are prohibited. However, in special cases in which the executive directors of KDO concurrently serve as the directors and staff of KFM, they may sell and purchase the investment units in accordance with the Management Rules on Insider Trading, etc. of KFM. (Please refer to "(4) Management Rules on Insider Trading, etc., 2. System of KFM" below.)

2. System of KFM

KFM invests in properties and manages them in accordance with strict rules while striving to sufficiently ascertain the existence and scale of risks such as mentioned above, and has structured measures to avoid these risks as described below.

(1) Establishment of and Compliance with Management Guidelines and Risk Management Regulations

KFM formulates management guidelines in accordance with the Articles of Incorporation as an asset management company which is entrusted with asset management by KDO, and sets forth the investment policy, distribution policy, disclosure policy and other basic policies concerning investment management. KFM strives to manage risks concerning investment management by complying with the management guidelines.

KDO also laid out the risk management policies, departments responsible for risk management, risk management methods, etc. in its risk management regulations, and defined the investment management risk, real estate management risk, financial risk, compliance risk, administrative risk, system risk, and business continuation risk as major risks. It also instructed the individual departments that manage each risk to engage in the review of items, details, and response policies, etc. for each risk once every two years in principle.

(2) Organization System

KFM is required to adhere to strict procedures concerning certain important matters including transactions with related parties. The procedures are to be assessed by the Compliance Officer, granted authorization by the Compliance Committee and Asset Management Committee following deliberation at each committee. KFM sufficiently ascertains the existence and scale of risks through consideration from various points of view at such multiple committees.

(3) Office REIT Department Related-party Transaction Rules

KFM establishes self-regulatory rules for self-transactions or transactions with related parties (the Office REIT Department Related-party Transaction Rules) for transactions concerning KDO's asset management. The Office REIT Department Related-party Transaction Rules provide for the terms and conditions of transactions between related parties or KFM and KDO. In verifying the terms and conditions of transactions, the Compliance Committee shall adequately conduct verification in compliance with the standards specified under laws and regulations so as not to be disadvantageous to KDO, just as is normally done in other similar transactions.

(4) Management Rules on Insider Trading, etc.

KFM establishes the Management Rules on Insider Trading, etc. and endeavors to prevent insider trading, etc. by its directors and staff, etc. In addition, the said rules generally prohibit the sale and purchase of KDO's investment units by the directors and staff (including those who were directors or staff for less than the past one (1) year) of KFM. However, in special cases in which insider trading is not prohibited under law, the directors and staff of KFM may acquire KDO's investment units only when the acquisition is made under the accumulated investment agreement.

(5) Forward Commitments, etc.

The properties subject to forward commitments, etc. which mainly consist of off-balance sheet items, are not recorded on the balance sheet of KDO until settlement. However, the risk of price fluctuations related to these properties for the period will be attributed to KDO. Therefore, when engaging in forward commitments, etc., KFM establishes the rules for the acquisition price for properties, such as the maximum period from execution of the agreement to the delivery of the properties and the means for procuring funds for payment, and controls the aforementioned risk.