Japan Excellent : Financial Results Material

Asset Management Report for the 32nd Period

(Semi-Annual Report for the 32nd Period)

From January 1, 2022, to June 30, 2022

Asset Management Report for the 32nd Period (Semi-Annual Report for the 32nd Period)

I. Greetings

To Our Unitholders

We would like to express our sincere gratitude for your continued support of Japan Excellent, Inc. (JEI) and Japan Excellent Asset Management Co., Ltd.

We hereby report the financial results of JEI for the 32nd period (from January 1, 2022, to June 30, 2022).

In the 32nd period, we decided in February to later sell Shintomicho Building, an old property, and decided that the gain on sale from this and also Kowa Shirokanedai Building, the sale of which was completed in June, will be utilized for future distribution stability to aim for stable management of distributions over the medium to long term. On the other hand, in May, we acquired ARK Hills Front Tower (49% equity interest in anonymous association) from our core sponsor, Nippon Steel Kowa Real Estate Co., Ltd., as a replacement property for these two sold properties, and obtained a first right of refusal to the property with the prospect of additional acquisition in the future.

On the leasing front, the period-end occupancy rate of the entire portfolio was 90.8% as a result of mainly (1) a slow start to leasing activities due to the impact of the Omicron variant after the turn of the year and (2) a lag in the period of accounting for contracts with large tenants, among other factors. Furthermore, rent revisions went well according to plan while conducting strategic rent revision negotiations for prevention of tenant departures and such.

On the financial front, we strived to enhance asset efficiency through acquisition of equity interest in an anonymous association entirely with funds on hand, buyback and cancellation of own investment units, and other means. In addition, we realized extension of borrowing periods and reduction of interest rates through refinancing of long-term loans.

As a result, in the 32nd period, JEI recorded operating revenue of 11,065 million yen, operating income of 4,711 million yen, net income of 4,101 million yen, and distribution per unit of 2,800 yen as initially planned (down 43 yen from the previous period).

In addition, after entering the current period (the 33rd period), we acquired Bizcore Shibuya as the third acquisition from the Bizcore series of medium-sized,high-grade office buildings developed by Nippon Steel Kowa Real Estate.

For ESG, we made progress in various initiatives, including reduction of CO2 emissions through a shift in electricity sources at another 19 properties and additional acquisition of environmental certification for properties in our portfolio. In terms of addressing climate change, we announced the recognition, policy, promotion system, etc. concerning climate change for each of the four items ("governance," "strategy," "risk management," and "metrics and targets") recommended by the Task Force on Climate-related Financial Disclosures (TCFD) based on the TCFD recommendations.

About Future Asset Management

In the real estate transaction market, while transaction prices are expected to remain steady for the time being backed by factors such as vigorous appetite for investment by market participants, JEI will continue to set the sponsor pipeline as the main source of property acquisition and advance talks with the sponsors. At the same time, JEI intends to earnestly work on acquisition from third parties as well.

In the office building leasing market, while trending toward inquiries and contracts for even large floor space, which had been sluggish thus far, gradually increasing due to the emergence of moves to review office functions with an eye to post-COVID and such, there continuing to be moves to consolidate and such among mainly large companies and an increase in supply of new office floors in central Tokyo from 2023 onwards lead to the forecast that the vacancy rate remaining range-bound for the time being and newly concluded rents still softening due to owners' priority stance for occupancy will continue.

Under such circumstances, JEI believes that, as indicated by the increasing number of relocations aimed at improving the location and building grade, large buildings with superior location, performance, etc. owned by JEI will easily fit into the new office strategy, and thus attract demand as core offices.

As to the policy on leasing activities for the time being, JEI will place upmost priority on "early refilling of vacated floors" and "prevention of departure" of existing tenants. Especially with the vacated floors, JEI will work to achieve early refilling of vacated floors by cooperating with the sponsors, setting flexible conditions taking into account the level of difficulty by property and other efforts.

As for rent renewal/revision, JEI will maintain the basic stance of prioritizing prevention of tenant departures.

In terms of finance, JEI will strive to conduct stable and sound financial management based on its basic policy of continuing to reduce financing interest rates, fixing the interest rates of loans, extending borrowing periods, and diversifying maturity dates. Furthermore, from the standpoint of maintaining and strengthening financing base through diversification of fund procurement means, JEI will work on environmentally conscious or new methods of funding including sustainability finance.

With regard to ESG, JEI intends to strive to further evolve and deepen its initiatives by taking on challenges in new areas, such as carbon neutrality and expansion of information disclosure in line with TCFD recommendations, in addition to previous efforts.

Finally, as always, JEI remains committed to strict adherence to the Financial Instruments and Exchange Act and other laws and regulations, and in addition to promoting compliance, we also disclose information on the status of our operations to our unitholders in an accurate and easy-to-understand manner.

We kindly ask for your continued understanding and support.

Asset Management Report for the 32nd Period (Semi-Annual Report for the 32nd Period)

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1. Asset Management Report

1. Outline of Asset Management Operation

1. Operating Results and Financial Position of the Investment Corporation

Fiscal period		28th Period	29th Period	30th Period	31st Period	32nd Period
	January 1, 2020, to	July 1, 2020, to	January 1, 2021, to	July 1, 2021, to	January 1, 2022, to
		June 30, 2020	December 31, 2020	June 30, 2021	December 31, 2021	June 30, 2022
Operating revenue	(Millions of yen)	12,717	11,043	10,567	10,666	11,065
(Rental revenues)	(Millions of yen)	(11,013)	(10,729)	(10,567)	(10,666)	(10,267)
Operating expenses	(Millions of yen)	6,426	6,119	5,977	6,180	6,353
(Property operating expenses) (Millions of yen)	(5,697)	(5,487)	(5,355)	(5,563)	(5,699)
Operating income	(Millions of yen)	6,290	4,924	4,590	4,485	4,711
Ordinary income	(Millions of yen)	5,631	4,291	3,976	3,846	4,102
Net income	(Millions of yen)	5,631	4,290	3,975	3,846	4,101
Total assets	(Millions of yen)	293,532	294,004	293,970	293,960	291,430
(Period-on-period change)	(%)	(1.6)	(0.2)	(-0.0)	(-0.0)	(-0.9)
Net assets	(Millions of yen)	152,133	152,418	152,335	152,206	150,461
(Period-on-period change)	(%)	(6.9)	(0.2)	(-0.1)	(-0.1)	(-1.1)
Unitholders' capital, net (Note 1) (Millions of yen)	147,907	147,907	147,907	147,907	145,907
Total outstanding investment units	(units)	1,353,000	1,353,000	1,353,000	1,353,000	1,337,598
Net assets per unit	(yen)	112,441	112,652	112,590	112,495	112,486
Net income per unit (Note 2)	(yen)	4,179	3,171	2,938	2,842	3,052
Total distribution	(Millions of yen)	4,004	4,059	3,975	3,846	3,745
Distribution per unit	(yen)	2,960	3,000	2,938	2,843	2,800
(Profit distribution per unit)	(yen)	(2,960)	(3,000)	(2,938)	(2,843)	(2,800)
(Distribution in excess of	(yen)	(－)	(－)	(－)	(－)	(－)
earnings per unit)
Return on assets (Note 3)	(%)	1.9	1.5	1.4	1.3	1.4
(Annualized rate)	(%)	(3.9)	(2.9)	(2.7)	(2.6)	(2.8)
Return on equity (Note 4)	(%)	3.8	2.8	2.6	2.5	2.7
(Annualized rate)	(%)	(7.7)	(5.6)	(5.3)	(5.0)	(5.5)
Capital ratio (Note 5)	(%)	51.8	51.8	51.8	51.8	51.6
(Period-on-period change)	(%)	(2.5)	(0.0)	(-0.0)	(-0.0)	(-0.1)
Payout ratio (Note 6)	(%)	71.1	94.6	100.0	100.0	91.3
Number of investment properties	(properties)	35	34	35	36	35
Number of tenants (Note 7)	(tenants)	193	191	187	587	585
Total leasable area (Note 8, 9)	(m2)	332,702	331,112	336,375	341,070	335,534
Occupancy rate	(%)	99.6	98.0	96.4	93.1	90.8
Depreciation	(Millions of yen)	1,946	1,824	1,847	1,891	1,937
Capital expenditure	(Millions of yen)	806	1,127	1,547	1,305	1,298
Net operating income (NOI)	(Millions of yen)	7,263	7,066	7,059	6,994	6,504
(Note 10)
Funds from operation (FFO)	(yen)	4,341	4,287	4,303	4,240	3,918
per unit (Note 11)
FFO multiples (Note 12)	(times)	14.4	15.0	18.3	15.8	15.5
Debt service coverage ratio	(times)	17.0	13.9	13.2	13.2	14.4
(DSCR) (Note 13)
Interest-bearing debt	(Millions of yen)	125,600	125,600	125,600	125,600	125,600
Loan-to-value (Note 14)	(%)	42.8	42.7	42.7	42.7	43.1
Number of days in operation	(days)	182	184	181	184	181

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(Note 1) The amount of unitholders' capital after subtracting any deduction from unitholders' capital is shown. This does not account for any deduction from unitholders' capital that is due to the implementation of distribution in excess of earnings related to the allowance for temporary difference adjustments.

(Note 2) Net income per unit is calculated by dividing the net income by the weighted-average number of units outstanding during the six months period.

(Note 3) Return on assets = Ordinary income / [(Period beginning total assets) + (Period end total assets) / 2] × 100 (Note 4) Return on equity = Net income / [(Period beginning net assets) + (Period end net assets)/ 2] × 100

(Note 5) Capital ratio = Period end net assets / Period end total assets × 100

(Note 6) Payout ratio = (Distribution per unit (not including distribution in excess of earnings per unit) / Net income per unit) × 100 (Figures are rounded to the first decimal place.)

For the 28th period and the 32nd period, as new investment units were issued in the former and buyback and cancellation of own investment units took place in the latter, the formula below was used to calculate the payout ratio.

Payout ratio ＝ (Total distributions (not including distribution in excess of earnings / Net income) × 100

For the 28th period, when accounting for reversal of allowance for temporary difference adjustments with the following formula, the payout ratio is 94.8%.

(Total distributions (not including distribution in excess of earnings) / (Net income － Reversal of allowance for temporary difference adjustments)) × 100

(Note 7) Number of tenants indicates the number of end tenants in each property as of the end of each period in principle, starting from the 31st period. When a tenant has multiple tenancies in the same property, it is counted as one tenant, and when in multiple properties, it is counted as multiple tenants. However, for properties in which the residential portion or the percentage of the interest owned by JEI is relatively low, the number of tenants indicates the number of master lease companies for the property, considering a master lease company as a tenant. In addition, for land with leasehold interest, the number of tenants is counted as one based on the lease agreement for the leased land.

(Note 8) For properties with joint ownership (including quasi co-ownership of trust beneficiary interest; the same applies hereinafter), the figure is obtained by taking the leasable area of the entire property and factoring in the percentage of the interest owned by JEI, regarding the figure as JEI's leasable area. The same applies hereinafter.

(Note 9) Spaces are rounded to the nearest specified unit. The same applies hereinafter. (Note 10) NOI = Rental revenues - Property operating expenses + Depreciation

(Note 11) FFO per unit = (Net income + Depreciation - Gain on sale of real estate + Loss on sale of real estate + Impairment loss) / Total number of outstanding investment units (the figure is rounded down to the whole number).

(Note 12) FFO multiples = Period end investment unit price / Annualized FFO per unit

(Note 13) DSCR = (Net income before interest and taxes + Depreciation (*)) / (Interest expenses + Interest expense on investment corporation bonds)

* Includes depreciation except for property operating expenses.

(Note 14) Loan-to-value = Period end interest-bearing debt / Period end total assets × 100

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(2) Asset Management Development

Japan Excellent, Inc. (JEI) was founded on February 20, 2006, under the Law Concerning Investment Trusts and Investment Corporations of Japan (Law No. 198 of 1951, as amended; hereinafter referred to as the "Investment Trust Law"). On March 15, 2006, it completed the corporate registration to the Kanto Finance Bureau (registration number 52, issued by the Head of the Kanto Local Finance Bureau) and listed on the Real Estate Investment Trust Section of the Tokyo Stock Exchange (Securities Code: 8987) on June 27, 2006.

Since the listing, JEI has continued investment management primarily in office buildings with the aim of maintaining sound corporate growth and stable revenues from the medium- to long-term perspectives. On June 30, 2022, JEI settled its 32nd period.

1) Business conditions and results

In the period under review (32nd period ended June 30, 2022), the world economy had been in a state in which economic and social activities were heading toward normalization, but then factors such as the rise in energy and raw material prices arising from the situation in Ukraine rapidly fueled inflation concerns that prompted major Western countries to make financial policy changes, turning into a state that called for close monitoring of such impact.

In the U.S., with the pace of interest rate hikes by the U.S. Federal Reserve Board (FRB) speeding up because of rapidly growing inflation concerns from the rise in the consumer price index and such, interest rates are bound to keep rising sharply, triggering concerns about a future recession.

In Japan, with the resurgence of COVID-19 infections due to variants, the rise in raw material prices arising from the situation in Ukraine and other factors, concerns about the impact on economic activities ahead make the outlook uncertain. Concerning the domestic finance market, although it has remained generally calm as the Bank of Japan has maintained the ongoing monetary easing stance, ultra-long-term interest rates are on the rise and so careful attention should be paid to future changes.

In the real estate transaction market, the acquisition appetite of investors within and outside of Japan is strong due to the favorable fund procurement environment continuing on the back of the Bank of Japan maintaining policies for monetary easing, differences in interest rates in Japan and abroad being maintained or widening, progress in depreciation of the yen in foreign exchange and such, making the acquisition environment still remaining severe with there being intense competition over prime properties on the market and such. Under such circumstances, JEI acquired equity interest in an anonymous association with ARK Hills Front Tower as the underlying asset (49%; acquisition price: 5,230 million yen) from a sponsor in May 2022.

In the office building leasing market, since 2020, market conditions have been worsening due to the strong effects of upward pressures on vacancy rates and downward pressures on rent from the floor space reductions, consolidations and such for expanding telework, reducing fixed costs, increasing efficiency and other purposes in the COVID-19 pandemic. Recently, office demand is gradually returning with an eye to post-COVID-19, but rent levels have yet to bottom out.

In addition, the vacancy rate in the five central wards of Tokyo continued to fluctuate up and down from the 6.3% at the end of December 2021 and stood at 6.4% at the end of June 2022 (published by Miki Shoji Co., Ltd.).

Under such circumstances, JEI additionally had the departure of a large tenant in their corporate group's consolidation moves accompanying relocation of the head office and refilling of vacated floors was delayed amid the severe leasing environment. As a result of these and other factors, the occupancy rate (Note 1) at the end of the period under review was 90.8%, down 2.3 points from the end of the previous period. The total number of properties owned and managed by JEI at the end of the period under review was 35 with a total acquisition price of 281.9 billion yen and total leasable area of 335,534.27 m2 (101,499.12 tsubos).

2) Fund procurement highlights

JEI will work on stable and sound financial operations over the medium to long term with a basic policy of procuring funds for the long term at fixed interest rates.

In the period under review, JEI conducted a buyback and cancellation of own investment units by utilizing funds on hand of 2.0 billion yen with a view to enhancing capital efficiency and unitholder value from a medium- to long-term perspective. In addition, JEI refinanced long-term loans that had matured with long-term loans (3.0 billion yen for borrowing period of 5 years in January and 2.0 billion yen for borrowing period of 9 years in June).

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