Subject: Adler Kawa Fourth Quarter 2014 Letter
From: "Matthew Adler" <[email-masked]>
To: "Hunter Biden" <[email-masked]>
Date: Wed, 12 Feb 2014 05:05:25 +1100

Download a PDF of this Letter [http://adlerkawa.com/newsletters/2013-12-Adler_Kawa_Letter.pdf]                                  Quarterly Letter February 2014

Dear Friends and Clients,

Adler Kawa is off to a busy and productive start in 2014.  We have officially closed Fund II for capital subscriptions. Total capital commitments for Adler Kawa Real Estate Fund II are $56 million, which is a number we are  pleased with. We are initiating a quarterly distribution for Fund II. Our primary focus remains on deploying capital and  managing  our portfolio properties.

Investment opportunities: We closed Fund II's third acquisition in December, Vista Point North. Following this purchase, the fund  is left with $37.4 million of discretionary capital for investment.  We continue to operate according to our investment plan and have a three building light industrial park under contract in Houston.

We are enthusiastic about the acquisition of Vista Point North (Vista). Vista is a four building office/industrial park located in the Lewisville/Denton submarket of Dallas, Texas, approximately 10 minutes north of DFW International Airport. The complex which fronts the Sam Rayburn Tollway was built in 2000 and includes one 2-story office building and three single story flex buildings.  The property is currently 91% occupied and has strong tenants including Regus, CareView Communications and Dematic. We secured a 5 year fixed rate loan with a life insurance company paying an interest rate of 3.85% for 70% of the purchase price. The property was acquired at a strong cap rate of over 8.5%. As the spread between the cap rate and the interest rate is significant the annual cash yield is very high.  This is our first property in Dallas and we believe there is significant opportunity to continue to grow in the market.

As mentioned above, we are also under contract and have completed due diligence on a three building light industrial asset in Houston called The Business Center at Park 10 (Park 10).  The property is institutional quality and located in the Energy Corridor, which is a strong submarket.  Park 10 has  tenants such as Lloyds Register Drilling, Petroleum Geo-Services and Reel Group.  The property is 92% occupied and will be purchased at a cap rate  in excess of 8%.  Similar to Vista, we have procured attractive debt and the spread between cap rate and interest rate will be high.  We anticipate generating strong cash flow.  Park 10 is scheduled to close in late February.

Market Conditions: We continue to see significant opportunities within our investment strategy of multi-tenant business parks in the eastern and southern US. The strategy is based on the management expertise required to operate the asset class and a focus on mid market transactions between $5 - $15 million of equity.  In our experience, there is less competition within this category and often few bidders with discretionary capital.

A topic that we spend a lot of time thinking and talking about is cap rates. A cap rate is effectively the unlevered return one can expect to generate on a property upon acquisition.  It is an industry standard and is often a barometer for the validity of a transaction, as exemplified in the preceding paragraphs.  That being said, it is an imperfect measurement and is a drastically different calculation between asset class and even properties. As an example, when we purchase a property we look at no less than five cap rates:  in-place; trailing 12-months; year 1; market (stabilized occupancy and market rents); and capital + lease-up.  While these are all important indicators, they are merely data points that tell us information about the potential investment.  We never start the analysis of a property based solely on an in-place cap rate.

Additionally, many factors can alter the interpretation of a cap rate. For instance, in multi-family residential, the industry standard is to include leasing expense as part of Net Operating Income (NOI). In the case of office and industrial assets, leasing expense is considered a "below the line" item and not included in NOI.  Leasing expense and capital items can greatly impact the significance of a cap rate.  When analyzing cap rates items that need to be considered are lease term, market rent increases/decreases, tenant improvement expense, leasing commissions and occupancy.  We have been working on a methodology to balance cap rates between properties and asset classes.  An interesting example as to why such a methodology is important is that, in terms of projected cash-on-cash return and IRR, an 8% cap rate on the Park 10 deal is effectively equivalent to an 8.5% cap rate on Vista, as illustrated in the table below.

The above table displays our conservative projections of minimal NOI growth at both Park 10 and Vista.  Park 10 starts out at an in-place cap rate of 8%, and the cap rate then increases to an average of 8.6% throughout the 5-yr hold period.  Vista starts out at a relatively higher in-place cap rate of 8.5%, but the average cap rate over the 5-year hold increases only marginally to 8.7%.  In general, NOI at Park 10 is expected to grow at a faster rate than at Vista due to a combination of stronger contractual rent growth, market rental rate growth and tenant rollover schedule.  Another important factor which has an impact on the projected deal returns is leasing costs.  Vista has a higher average office build-out (94%) as compared to Park 10 (50%), as well as a disproportionate amount of tenant rollover which results in a higher proportion of NOI being spent on leasing costs at Vista (25.7%) than at Park 10 (17.7%) during the hold period.  Relatively stronger NOI growth and lower leasing costs at Park 10 are two of the most significant factors that explain why we could target a similar overall rate of return on both deals despite acquiring Park 10 at a lower in-place cap rate.

The larger point is that while cap rates are an important measurement, they can also be misleading. We believe it is important to look at cap rates from all angles and furthermore be able to understand why cap rates for each deal are higher or lower than others that we are valuing.  Additionally, the different cap rates we look at are effectively used to tell a story of the investment and become guidelines for proving out the property's business plan, risks and mitigants.  Most importantly, the chart illustrates how both Park 10 and Vista fit our yield oriented strategy.  We believe, by locking in cash flow of approximately 11% we are well on our way to achieving strong risk adjusted returns.

Summary: Our pipeline for future transactions remains strong. Looking forward, we plan to continue to focus on asset management, devise strategies to add value to the existing portfolio and increase cash flow.  We anticipate securing more acquisitions that fit our investment strategy and closing Park 10.  We thank you for your time and attention and should you have any questions, comments or concerns please don't hesitate to contact us.

Sincerely,

Matthew L. Adler

President & C.E.O.

Fund II Investments   Property Details Project Returns Investment Thesis

Vista Point North

Dallas, Tx Price: $16,000,000 ($111.26 psf) 143,810 square feet 90.8% Occupied 8.48% Acquisition cap rate

Average Cash on Cash: 10.9%

IRR:17.42%

Equity Multiple:2.0x

Wide spread between cap rate and interest rate creates strong yield and the oppurtunity for good risk adjusted returns.

Well leased to a strong base of local and multinational tenants representing a diverse mix of industries and uses at the property.

Business Center at Park Ten

Houston, TX Price: $12,150,000 ($105.47 psf) 115,200 square feet 91.7% Occupied 8.03% Acquisition cap rate

Average Cash on Cash:11.4%

IRR:17.11%

Equity Multiple:1.9x

Consistent NOI provides for strong cash on cash and the opportunity for good rick adjusted returns.

High occupancy with minimal historical lease rollover and a diverse roster of local, international and publicly-traded tenants.

Fund II refers to Adler Kawa Real Estate Fund II together with the off-shore parallel vehicle Adler Kawa U.S. Property Partners Ltd.

Past performance is not indicative of future results. This is not an offer to sell or distribute any product or service. This letter is made only for informational purpose, and the information contained in this summary is fully set forth in the Confidential Explanatory Memorandum and Subscription Agreement, which will be made available upon expression of interest by an accredited investor. In the case of any inconsistency between the descriptions or terms in this summary and the Confidential Explanatory Memorandum, the Confidential Explanatory Memorandum shall control. Admission as a shareholder in the fund is not open to the general public, and any investment or consideration should be first made in consultation with your financial advisor. This Letter is the property of Adler Kawa Real Estate Advisors and may only be used by parties approved by Adler Kawa Real Estate Advisors. This Letter and its contents are of a confidential nature and shall be treated as confidential and proprietary to Adler Kawa Real Estate Advisors. No portion of this Letter may be copied, reproduced or otherwise disclosed to any party without the prior written consent of Adler Kawa Real Estate Advisors.

AdlerKawa © 2014. All Rights Reserved.

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