It should be noted that in this retail property market overview section, the data presented and overall history of the retail property sector is as of January 2006.

Overview

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Japan's retail property market has experienced a number of changes in recent years, including an increase in per store floor space. As a result of the increased number of larger stores, as well as the increasing propensity of Japanese consumers to shop at large-scale shopping centers, there has been a corresponding decline in the overall number of retail establishments. In addition, amendments were made to certain zoning laws, which will come into effect in 2007 and are intended to decelerate the development of large-scale commercial centers in suburban areas and preserve and promote the efficient use of urban infrastructure. However, we believe that, given the recent preferences of Japanese consumers, sales at large-scale shopping centers as a percentage of total retail industry sales will continue to grow.

Retail Store Trends in Japan

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Increase in annual sales per retail store.
The retail industry has recently experienced improved performance. However, according to data in the second table below from the Ministry of Economy, Trade and Industry, which publishes data relating to Japan's retail industry, retail price declines and weak demand for retail products resulted in decreases in total annual sales in the retail industry from JPY 147,743 billion for the year ended March 31, 1997 to JPY 133,279 billion for the year ended March 31, 2004. Despite these conditions in the retail sector, because of the reduction in the number of stores, announced sales per store increased 2.0% from 1999 to 2002 and 3.8% between 2002 and 2004, the last year for which such data has been published.

The following table sets forth annual sales per retail store by sector.



Reduction in number of retail stores and total annual sales. According to data from the Ministry of Economy, Trade and Industry, there were approximately 1.2 million retail establishments in Japan as of June 2004, the latest month for which such data has been published. During Japan's post-war period of long-term economic growth, the number of retail stores peaked in the early 1980s. However, since the mid-1980s, the number of retail stores has consistently declined. The following table illustrates trends regarding the number of retail stores in Japan and total annual sales.



Renewed growth in certain retail sectors. Although the overall number of retail stores in Japan declined through 2004, there were significant variances in the numbers of retail stores and rates of growth by retail sector, as shown in the following table. In particular, specialty superstores and convenience stores have experienced relatively strong growth. The number of specialty superstores grew from 25,171 in 1994 to 36,220 in 2004, and the number of convenience stores grew from 28,226 in 1994 to 42,738 in 2004. Grocery superstores also exhibited relatively strong growth between 2002 and 2004, while the number of clothing superstores declined.



The data presented above also shows that both the absolute number and the rate of growth of the number of retail stores has declined in many segments of the Japanese retail industry, especially with respect to department stores. We believe, however, that more recent empirical data indicate that the supply of space in department stores and supermarkets may be increasing. For example, the following table shows that the aggregate floor area of department stores steadily increased from the year ended October 31, 1989 to the year ended October 31, 2005.



Increase in per-store sales and floor space. While the number of retail stores in Japan has been declining, there has been a gradual increase in per-store sales and the per-store sales floor area of retail stores in recent decades, as reflected in the table below. This trend is due to several factors, including a decline in the number of smaller shops, which generate more than 50% of sales in Japan's retail market, the deregulation of the Large Retail Store Law and increased consumer preference for shopping at larger stores. The number of specialty shops, many of which are small shops in local shopping areas, declined by nearly 200,000, or more than 20%, between 1999 and 2004. In addition, large global retailers, many of which utilize a large format structure emphasizing bulk procurement, cost efficiency and low prices, have been expanding their operations into Japan.



Intensified competition and consolidation. The adverse economic conditions in the Japanese retail industry, which have only recently improved, the increased efficiency and services offered by larger operators of retail stores and the recent entry of global retailers into Japan have contributed to the increased consolidation in the Japanese retail industry. Between 1997 and 1999, retail sales declined for the first time, after gradually increasing throughout Japan's post-war period of economic growth. The resulting decline in revenues and increased competition contributed to an increase in the number of bankruptcies of retail store operators. As a result, many stores and assets of insolvent operators were acquired by larger, more efficient operators, including large global retailers. Additionally, retail store operators seeking to integrate procurement, supply and distribution functions have increasingly invested in or acquired companies specializing in these functions, while diversifying the types of retail stores they operate. These and other factors have contributed to consolidation in the retail industry in Japan and intensified competition among larger, more efficient groups of integrated retail store operators.



Shopping Center Trends in Japan

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According to the Japan Council of Shopping Centers, a “shopping center” in Japan is defined as a group of commercial service facilities that are planned, developed and managed by a developer as one unit:

• that has collective commercial facilities with total retail floor space of greater than 1,500 m²;
• in which the number of retail stores, excluding the key tenant or tenants, is greater than 10;
• in which the floor space of the key tenant or tenants does not exceed 80% of the total leasable floor space or in which the total retail floor space, excluding the floor space of the key tenants, is greater than 1,500 m²; and
• in which the tenant association cooperatively conducts activities such as marketing and events.

The following table provides an overview of certain attributes of shopping centers in Japan.



In the early 1990s, the Japanese government relaxed the restrictions under the Large Retail Store Law, which had imposed limitations on the development of large retail properties. This change contributed to an increase in the number of shopping center developments as well as a rise in the number of large-scale shopping centers.

In the period of slower economic growth that followed the collapse of Japan's so-called “bubble economy” in the early 1990s, earnings of major retailers declined, and many retailers accordingly revised their store opening plans and selectively disposed their existing stores in an effort to restructure their operations. Despite the recent closing of a number of shopping centers and a slowdown in the growth of new shopping center openings, there were 2,704 shopping centers in Japan at the end of 2005. However, as illustrated in the following table, the number of shopping centers opened each year dropped considerably between 2000 and 2005, partly due to the June 2000 introduction of the Large Retail Store Location Law. As enforced, this law has generally served to lessen restrictions on the opening of new stores. However, uncertainty as to the application of this law contributed to a decrease in new large store openings in the years immediately following its passage, as developers considered its potential effect.



While the number of shopping centers constructed in Japan per year has decreased over the past few years, the size of individual shopping centers has, on average, increased, with the average sales area per shopping center rising gradually in recent years to 15,935 m² as of December 31, 2005. This increase in the size of shopping centers is due in part to the increase in the size of many retail stores, as well as an increase in the number of large-scale shopping centers, particularly in suburban areas.

The geographic distribution of new shopping center construction has also changed in recent years. As shown by the table below, recently a majority of new shopping centers were built in suburban areas, with a relatively even distribution of new construction in central urban and peripheral areas.



Japanese shopping centers increasingly account for a greater portion of consumer spending. As shown in the following table, the market share of large-scale shopping centers as a percentage of total retail industry sales increased from 11% in 1991 to 21% in 2005, reflecting the increasing propensity of Japanese consumers to shop at large-scale shopping centers.



Beginning in 2007, amendments to the City Planning Law and the Building Standards Law will come into effect in Japan. These laws are intended to decelerate large-scale commercial development in suburban areas, including retail shopping centers, and preserve and promote the efficient use of urban infrastructure. See “Regulation - Laws and Regulations Relating to Japanese Real Estate - City Planning Law and Building Standards Law”. As a result, it will become more difficult to develop new large-scale shopping centers in suburban areas. However, we believe that given the recent preferences of Japanese consumers, sales at large-scale shopping centers, including existing suburban shopping centers, will continue to increase both in the aggregate and as a percentage of total retail sales.

In terms of other retail property trends, it has traditionally been common practice in Japan at the commencement of a retail development project for the tenants to provide significant amounts of tenant leasehold and security deposits, which generally exceed those in other property sectors in Japan and around the world. Retail leases may also be distinguished from those in other property sectors in Japan by their relatively long terms. However, the receipt of large tenant deposits as a means of helping to finance the development of new shopping centers has become less common in recent years, as larger tenants have become less willing to commit such up-front funds. Additionally, operators of retail stores are increasingly moving away from direct ownership of the retail properties they operate.



Our prognosis for the retail sector.

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We believe the retail sector in Japan is undergoing a number of dramatic changes, many of which we anticipate being able to capitalize on within our Fund. The following summarizes certain of these changes we currently see emerging in the retail sector:

Increasing Separation of Retail Store Operations from Retail Property Ownership
We believe continued structural changes in the retail sector will lead to an increasing separation of retail operations from retail store ownership, with existing retailers and property owners seeking to engage in either sales or long-term retail property sales and leasebacks. Other contributing factors making it increasingly difficult for many retail companies and property owners to continue to hold a large number of retail properties include the potential introduction of new accounting standards for impairment of long-lived assets, as well as growing concerns with their leverage levels and profitability, including the impact of depreciation on retailer earnings.

Fundamental Changes in Historically Sizeable Tenant Deposit Requirements
Where new retail project developments do occur, we would anticipate fundamental changes to occur in the methods traditionally utilized to finance such projects. Historically, retailers have been required to provide large and long-term low or no cost tenant deposits to developers, which is unique in its complexion to the retail property class (and which we have been able to benefit from in our Fund by way of the assumption of such deposits in the financing of our acquisitions using such low or no cost monies as a form of financing property acquisitions).

Increasing Emergence of Rents Tied to Tenant Revenues
We believe that 'percentage rent' provisions, wherein rents are calculated in whole or in part based upon a tenant's respective sales level, may become increasingly common in Japan's retail leases and there may be opportunities for our Fund to selectively capitalize on a sharing in the upside of particular tenant's retail operations. In such lease arrangements, both we as the retailer property owner as well as the retail property tenant may seek to achieve a common goal of increased store sales performance.

Accordingly, we may over time, in accordance with emerging sales performance based rental trends, employ percentage rent structures within certain of our properties; such as that employed at our Hakata Riverain, Abiko Shopping Plaza and Nara Family properties.

Increased Investor Education of the Retail Property Class
Understanding of retail properties in the institutional community, while increasing considerably, is still relatively low, although we believe the sector is becoming better known not only through our publicly-traded Fund, but also through such developments as broader research coverage of the retail property sector.

In a general sense, Japanese shopping centers have developed utilizing American shopping centers as models, with a broad array of retail focuses within the retail spectrum, including the GMS (general merchandise store) segment, the department store segment, the 'category killer' segment, and high-end luxury goods segment, each of which are undergoing their own distinctive sector industry forces of challenges and opportunities. For example, while consumers exhibit increasing price sensitivity relating to the pricing of necessity items, we believe a number of 'super or luxury brands' (e.g. Chanel, Gucci, etc.) will continue to perform well in Japan. Moreover, at the other end of the retail spectrum, certain economy-oriented shopping centers, including outlet centers and power centers will likely be able to continue to attract customers with appealing prices.

Our Asset Manager continues to monitor, as well as anticipate such emerging retail sector trends in carefully selecting properties for acquisition on an ongoing basis.