Mergers of Private REITs in Japan

Overview of Merger Process

The following table lists the major items related to investment corporation merger procedures and notes issues and considerations relevant to private REIT mergers (noting that this is not exhaustive and covers only selected issues).※4

Calculation of Merger Ratios

In listed REIT mergers, a common valuation approach is valuation analysis methods based on unit prices formed in the J-REIT market, and merger ratios are calculated based on such results. However, since such unit prices do not exist for private REITs, merger ratios would typically be calculated based on net asset value (based on appraisal values).

In connection with this point, in investment corporation mergers, when the consideration paid (total amount of surviving corporation units delivered to merged corporation unitholders) is lower than the merged corporation’s net asset value, the difference is recorded as “negative goodwill.” In the case of private REIT mergers, since valuations are conducted on a net asset value basis, “negative goodwill” would likely remain at a substantially lower amount compared to listed REIT cases. In any event, since mergers involving private REITs are unprecedented, detailed confirmation of accounting treatment from accounting counsel is necessary.

Sounding Out Major Unitholders and Acquisition of Units

Unlike listed REITs, private REITs are not subject to insider trading regulations, making it possible to directly explain mergers to major unitholders and conduct vote counting.

Additionally, since tender offer regulations do not apply, if vote counting results indicate that the necessary votes for a special resolution at the unitholder meeting cannot be gathered (or there is risk of being unable to obtain the necessary votes), it is possible to acquire units directly from the unitholders indicating opposition. However, in such cases, careful consideration is required regarding whether it is appropriate to conduct acquisitions at amounts with premiums added to net asset value, given fairness issues with other unitholders.

Handling Redemption Requests

Since private REITs are structured as so-called open-end investment corporations that allow redemptions under certain conditions, it is necessary to consider in advance not only how to handle statutory unit purchase demands from opposing unitholders, but also how to respond when redemption requests are made during the merger process.

In this regard, investment corporations may suspend unit redemptions for the purpose of conducting merger negotiations and mergers pursuant to Article 146, Paragraph 1 of the Investment Trust and Investment Corporation Act (the “Investment Trust Act”), but such redemption suspension cannot exceed three months (Paragraph 2 of the same Article), and public notice or notification must be provided at least one month before the redemption suspension period. Therefore, when conducting redemption suspensions pursuant to the Investment Trust Act, the related parties should consider how to incorporate such procedures into the merger schedule.

Additionally, because merger ratios are mandatory items to be stipulated in merger agreements, the effect of any redemption requests on merger ratios should also be discussed. If redemptions cannot be avoided through redemption suspension, it may become necessary to secure cash for such redemptions.

Treatment of Fractional Units

When fractional units arise from investment corporation mergers, it is necessary to sell units equivalent to the total number of such fractions at a “fair value” and deliver the sale proceeds to the relevant merged corporation unitholders according to their fractional amounts (Article 149-17, Paragraph 1 of the Investment Trust Act).

In the case of listed REITs, fractional units are sold in the market and the sale proceeds are delivered (Article 199, Item 1 of the Regulation for Enforcement of Investment Trust and Investment Corporation Act), but since private REITs cannot be sold in markets, “sales at fair and reasonable amounts in light of the net asset value of the investment corporation issuing such units” must be conducted (Item 3 of the same Article). Since no precedents exist for this point either, consideration is required regarding how to determine both the “fair and reasonable amount” mentioned above and the identity of the purchaser. For private REITs, fractional units may also be processed through redemptions (Article 88, Paragraph 2 of the Investment Trust Act as applied mutatis mutandis pursuant to Article 149-17, Paragraph 2 of the same Act).

Sponsor Acquisition of Certain Properties

While not limited to private REIT mergers, there may be cases where, due to sponsor intentions or because certain properties do not meet the surviving corporation’s portfolio criteria, sponsor acquisition of certain properties from the merged corporation becomes a condition for the merger.

Such acquisitions constitute transactions with interested parties, requiring compliance with Articles 201-2 and 203, Paragraph 2 of the Investment Trust Act, as well as with conditions determined by certain standards set forth in the asset management company’s internal rules (interested party transaction rules, etc.). Typically, sales at or above the most recent appraisal value are required.※5