Land and Buildings collectively with Scot Sellers – the leader of
Archstone-Smith Trust for over 15 years, culminating with the sale of
the company for $22 billion near the peak of the market in 2007 – are
shareholders of approximately 2.8% of the common shares of Associated
Estates Realty Corporation (NYSE: AEC) (“AEC”, “Associated Estates”, or
the “Company”). Land and Buildings sent a letter to shareholders of AEC
announcing that today it is distributing definitive proxy materials in
support of electing Land and Buildings’ three independent, highly
qualified, nominees to the Board of AEC to effect necessary and
immediate change.
The full text of the letter is as follows:
April 8, 2015
Dear Fellow Associated Estates Realty Shareholder:
Land and Buildings is an investment firm founded in 2008 that invests in
publicly traded real estate companies. Collectively with Scot Sellers,
who has overseen the creation of significant value in the apartment
business as the leader of Archstone-Smith Trust for over 15 years, our
group owns approximately 2.8% of the outstanding Associated Estates
Realty Corporation common stock.
We are seeking your support to elect three independent, highly-qualified
individuals to the Board of Associated Estates—Charles Elson, Jonathan
Litt and Scot Sellers. We believe that these candidates, given their
collective range of deep experience across the multifamily and real
estate industries, as well as their commitment to best practices in
corporate governance, are ideally suited to maximize shareholder value
at Associated Estates. We urge you to vote the enclosed GOLD
proxy card TODAY by telephone, over the Internet, or by signing,
dating and returning your GOLD proxy card in the postage-paid
envelope provided.
The Land and Buildings team has a deep history as global real estate
investors and analysts in both public real estate securities and direct
property. I, personally, have been closely involved with management
teams of many of the public REITs since 1992 as a former top-ranked
sell-side property equity analyst and have known Jeff Friedman since the
early 1990s, during his over 20 year tenure as Chairman and CEO of
Associated Estates.
IT IS TIME TO END THE COMPANY’S LONG-STANDING RECORD
OF
DISAPPOINTING FINANCIAL PERFORMANCE
We believe that Associated Estates’ 20-plus year history of material
underperformance and shareholder value destruction can be traced back to
one central issue: an entrenched, intertwined and stale Board of
Directors. The Company’s Board lacks what we view as true independence
and relevant experience and has not, in our view, exerted effective
oversight over a management team led by the Company’s Chairman of the
Board and CEO Jeff Friedman that has acted against shareholder interests
for far too long.
Persistent Undervaluation and Fundamental
Underperformance
AEC has traded at average 23%, 20%, and 28% discounts to net asset
value, or NAV (i.e. private real estate value), over the trailing three,
five, and ten years respectively1 while the Company’s proxy
peers have on average traded near NAV over the same time periods.2
Over the trailing 20 years, AEC has the lowest total return of its proxy
peers and has lagged the proxy peer total return average by nearly 700%.3
AEC shares prior to investor activism were 33% below its November 1993
IPO price of $22.4
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AEC IPO’d at $22 and closed at $14.65 the day prior to KKR - a private
equity firm whose specializations include real estate - initially
disclosing a material stake in the Company on November 14th,
2013.
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In contrast, apartment REIT proxy peers that had initial public
offerings in 1993 and 1994 (8 out of 9) had an offering price
averaging $21.28 and closed at $72.88 on November 14th,
2013.
AEC annual earnings results failed to beat the management team’s initial
guidance in five of the past six years.5 Shareholders should
ask themselves how many of them would continue to hold their jobs if
they failed to hit or exceed their targets over 83% of the time? 2014
was a "miss and lower" year as funds from operations (“FFO”) per share
and core same-store growth guidance were both lowered despite national
apartment rental growth being stronger than in any other post-recession
year.6
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Total Shareholder Returns
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Company
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Trailing 20 Years (Jeff Friedman CEO/Chairman Since
1993)
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Since Investor Activism
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Associated Estates
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244%
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79%
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AEC Underperformance vs. Proxy Peer Average
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|
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-697%
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34%
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Potential Upside for Shareholders
We believe the net asset value of Associated Estates is $31 per share,
indicating an approximately 25%
further upside to intrinsic value above and beyond the 79% rise in the
stock since investor activism began. Given the Company’s high quality
apartment assets and what we view as the potential for significant
improvements in operations, financial controls, capital allocation and
corporate governance, further upside is within reach with the informed
guidance from an active and highly-qualified Board. We believe that a
well-regarded management team and Board could recapture a significant
amount of the net operating income underperformance (AEC has
cumulatively underperformed its public peers' net operating income
growth by ~900bps since 2011 in overlapping geographies) and cause the
stock to trade at a premium to real estate value, leading to
approximately 50% upside in the
stock compared to today.
A Failure in Corporate Governance
Prior to Land and Building’s involvement, the three member Executive
Committee was comprised of Jeff Friedman, his brother-in-law, and AEC’s
long-time lawyer. This Executive Committee “…possesse[d] the power of
the Board of Directors in the management of the business and affairs of
the Company…”.7 Given the clear lack of independence, in our
view, it is no wonder that shareholder value has not been maximized.
Indeed, we believe the Board has lacked applicable skills, is
over-tenured and is incredibly insular.
Before our engagement with the Company, none of the external directors
had experience in high-quality apartment operations. The average tenure
was over 14 years and Jeff Friedman has been combined Chairman of the
Board and CEO since 1993. All seven incumbent directors were based in
Cleveland, which only provides a narrow view of the relevant market
given that ~90% of AEC’s net operating income is generated outside
Cleveland. In our view, this is not how a public company should be run
on behalf of shareholders.
It is apparent to us that the incumbent Board has been incapable of
checking Jeff Friedman’s toxic self-interest – for example, a
shareholder lawsuit forcing Friedman to relinquish 63,714 stock options
due to breaches of its fiduciary duty is only further proof of the
Board’s lack of control.
The Friedman Family has been putting their own interests ahead of the
shareholders for too long. Jason Friedman, CEO Jeff Friedman’s son,
has served as Senior Vice President, Acquisitions and Development while
Matthew Friedman (Jeff’s son and Jason's brother) has earned millions of
dollars under Jason's watch as a real estate broker for AEC real estate
transactions in a clear conflict of interest. Jeff and his sons, Jason
and Matthew, received $5.9 million in combined compensation from AEC in
2013. At the 2013 run-rate, the Friedmans
could make more money in ~3 years running the company than Jeff’s entire
stake in the Company is currently worth. In fact, Jeff
Friedman has been a consistent seller of AEC stock with his ownership of
AEC decreasing from 6.75% in 2004 to 1.4% of shares outstanding today.8
Since August 2004, Jeff has sold or disposed of the equivalent of over
1.2 million shares of AEC, or approximately 2% of the outstanding
shares. Ask yourself – is this company being run in the best interest of
shareholders or the Friedman family?
Lack of Expense Control and Capital Allocation Discipline
The incumbent Board is either unwilling to control costs and deploy
capital in an optimal fashion or does not understand how to do so. AEC’s
general and administrative (“G&A”) expense as a percent of revenue is
11% compared to a 4% proxy peer average. It is no surprise to us that as
G&A expenses have increased, so has Mr. Friedman’s compensation. His
compensation equals 2.1% of revenue and is more than 4 times larger than
the proxy peer average and more than 50% higher than similarly sized
REITs on average across all sectors.9 This may be acceptable
if Mr. Friedman’s team had the wherewithal to allocate capital
efficiently on behalf of shareholders, but they have not demonstrated
that they do. Earnings (FFO – Funds From Operations) per share has
fallen 5% since 2008 as AEC more than tripled its share count through
five massively dilutive equity issuances at significant discounts to
real estate value totaling over $500 million; meanwhile AEC's proxy
peers saw FFO per share increase 26% over the same time period.10
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AEC: Over $500 Million of Dilutive Equity Issuances Since 2010
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Issuance Date
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Shares Issued (000's)
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Price
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Amount
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Discount to NAV
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January 12, 2010
|
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5,175
|
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$11.10
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$57 million
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-31%
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May 6, 2010
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9,200
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$13.00
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$120 million
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-15%
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September 28, 2010
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9,200
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$13.60
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$125 million
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-15%
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June 22, 2012
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6,325
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$14.40
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$91 million
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-33%
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May 29, 2013
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7,048
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$17.25
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$122 million
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-23%
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Total/Weighted Average
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$515 million
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-22%
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L&B Board Nominees: Highly-Qualified and
Independent
The Land and Buildings slate of directors would be able to provide fresh
perspectives and significant value-add across all facets of Associated
Estates. Their sole motivation is, in our view, to enhance shareholder
value. Scot Sellers ran what we view as the highest quality
apartment company in the REIT universe and maximized value by selling
the company twice. Charles Elson is a leading corporate
governance expert and would provide AEC with much needed counsel on how
to run a company for the benefit of all shareholders. Jonathan Litt is
the Founder and Chief Investment Officer of Land and Buildings and was a
top-ranked sell-side REIT analyst on Wall Street for well over a decade
when he was involved in the initial public offerings of many of the
largest public REITs operating today.
These three individuals will represent a minority of the Board (which
has 7 members and, if the Company's proposal is approved by shareholders
at the annual meeting, will be expanded to 8). They will seek to restore
accountability to shareholders and effectively oversee management, while
working closely and constructively with existing directors, such as
Douglas Crocker II and Jon A. Fosheim, to change the culture of
underperformance.
Reactions to Land and Buildings’ Nominees Have Been Very Favorable11
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“…highly-reputable independent directors…Scot Sellers’ presence is
noteworthy as he is regarded as one of the top apartment executives in
the country.”
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Green Street Advisors Research Note (11/17/14)
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“…we do believe L&B’s slate would be well received by investors…We
are impressed with the proposed Board slate and believe that their
public company, operational, capital allocation, and corporate
governance experience would benefit AEC shareholders. We believe that
the proposed Board would be able to help close the persistent discount
to NAV.”
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Citigroup Research Note (11/17/14)
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“We believe AEC shareholders will elect the proposed Board given
the candidates are highly qualified and have ample public market and
REIT experience…notable nominees include Scot Sellers (former ASN
CEO)…highly regarded within the REIT world.”
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Sandler O’Neil Research Note (12/10/14)
In contrast, the Company’s slate of incumbent-dominated nominees appears
to be the same AEC board with the window dressing of a few new
independents, who we believe are incapable of effecting any real change
unless the old regime of incumbent directors, led by Jeff Friedman,
concur.
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Five of the Company’s seven nominees are still long-time,
Cleveland-based directors who have overseen the company’s long-running
underperformance. Associated Estates’ recent and (we believe)
desperate changes to the composition of the Board and enhancements to
corporate governance in response to our actions have been too little,
too late and appear designed to maintain the status quo, not spur real
fundamental change.
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Associated Estates’ changes have been half-measures such as replacing
only two out of seven board members and, in our view, only the most
egregious, indefensible corporate governance standards have changed
such as eliminating the Executive Committee of the Board and redeeming
the Company’s shareholder rights plan.
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Bottom line: Without implementing
additional change by electing Land and Buildings' nominees on the GOLD
proxy card, AEC will be left with an incumbent-dominated board. The
same incumbents who have overseen the Company’s significant
underperformance, poor capital allocation and egregious self-dealing.
Significant Operational and Strategic Change
Required
Land and Buildings has nominated the type of Board candidates we believe
would lead Associated Estates to becoming a best in class REIT that
trades at a premium to net asset value. Land and Buildings believes
numerous changes need to be made across the company to right the ship
and turn AEC into the next world-class apartment REIT.
Operational Improvements
Our nominees will roll up their sleeves and work for shareholders by
delving deep into the Company’s operations. They would engage in a full
operational review to maximize rental revenue in line with the best
practices of Class A apartment REITs that Board nominee Scot Sellers
helped pioneer at Archstone-Smith Trust. We would further endeavor to
clean up filthy and neglected properties, improve customer service
training and instill a culture of excellence at the corporate level and
down to the property-level, while eliminating unnecessary property
operating expenses and reducing bloated G&A expense that has been
amplified by the multiple Friedman family members on the dole. We
believe the 9% underperformance of same-store NOI growth over the past 4
years relative to public peers in similar geographies can be recouped,
translating into an additional $3.00-plus in value per share.
Capital Allocation Optimization
In order to optimize capital allocation to drive shareholder value, our
nominees would start by reassessing all current and future development,
acquisition and capital spending activity given the Company’s current
inferior cost of capital. They would seek to narrow and refine the
poorly planned geographical focus of the Associated Estates portfolio.
Value needs to be preserved by halting further equity issuances below
NAV except in the most extenuating of circumstances. Buying back stock
and selling assets as long as the Company continues to trade materially
below real estate value will only serve to drive value higher still,
which the Company should be doing at the current market price. There is
almost always an arbitrage available in the public markets either by
buying back a company’s undervalued stock or issuing it a premium to buy
and build assets.
Instill Best in Class Governance
By electing our nominees in place of the targeted directors,
shareholders will take a first step in revitalizing AEC as a public
company. Our nominees will re-align senior management compensation more
closely with shareholder total returns, particularly relative to AEC's
peers, and enforce greater insider ownership to align themselves with
shareholders. They would seek to ensure no onerous or unnecessary stock
ownership limits existed. Our nominees would also review any and all
strategic alternatives, including a sale of the Company, as the most
expedient avenue to maximize shareholder value. A REIT run for the
benefit of shareholders, as we believe AEC has not been historically,
should be for sale every day. With improved
capital allocation decision-making and best in class corporate
governance standards in place, we believe AEC could garner a premium to
NAV in the public markets as other blue-chip REITs have been able to, adding
an additional $3.00-plus in value per share.
Vote FOR our Nominees on the GOLD Proxy Card
Today
As detailed above, we view AEC as a case study in how not
to maximize value at a REIT. Numerous operational, financial and
strategic changes need to be made to reverse course, improve earnings
growth and have AEC shares trade at or above real estate value,
unlocking as much as ~50% upside. And we believe strongly that our three
candidates would help comprise the Board to do it, for the benefit of
all our fellow shareholders.
Sincerely,
Jonathan Litt
Founder & CIO
Land and Buildings
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REMEMBER:
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You can vote your shares by telephone or via the
Internet.
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Please follow the easy instructions on the enclosed proxy card.
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If you have any questions or need assistance in voting
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your shares, please call our proxy solicitor,
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INNISFREE M&A INCORPORATED
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TOLL-FREE, at 1-888-750-5834.
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LAND & BUILDINGS CAPITAL GROWTH FUND, L.P., LAND & BUILDINGS INVESTMENT
MANAGEMENT, LLC AND JONATHAN LITT (COLLECTIVELY, "LAND & BUILDINGS") AND
CHARLES M. ELSON AND R. SCOT SELLERS (TOGETHER WITH LAND & BUILDINGS,
THE "PARTICIPANTS") FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
(THE "SEC") ON APRIL 6, 2015 A DEFINITIVE PROXY STATEMENT AND
ACCOMPANYING FORM OF PROXY CARD TO BE USED IN CONNECTION WITH THE
PARTICIPANTS' SOLICITATION OF PROXIES FROM THE STOCKHOLDERS OF
ASSOCIATED ESTATES REALTY CORPORATION (THE "COMPANY") FOR USE AT THE
COMPANY'S 2015 ANNUAL MEETING OF STOCKHOLDERS (THE "PROXY
SOLICITATION"). ALL STOCKHOLDERS OF THE COMPANY ARE ADVISED TO READ THE
DEFINITIVE PROXY STATEMENT AND OTHER DOCUMENTS RELATED TO THE PROXY
SOLICITATION BECAUSE THEY CONTAIN IMPORTANT INFORMATION, INCLUDING
ADDITIONAL INFORMATION RELATED TO THE PARTICIPANTS. THE DEFINITIVE PROXY
STATEMENT AND AN ACCOMPANYING PROXY CARD HAVE BEEN FURNISHED TO SOME OR
ALL OF THE COMPANY'S STOCKHOLDERS AND ARE, ALONG WITH OTHER RELEVANT
DOCUMENTS, AVAILABLE AT NO CHARGE ON THE SEC'S WEBSITE AT HTTP://WWW.SEC.GOV/.
IN ADDITION, INNISFREE M&A INCORPORATED, LAND & BUILDING'S PROXY
SOLICITOR, WILL PROVIDE COPIES OF THE DEFINITIVE PROXY STATEMENT AND
ACCOMPANYING PROXY CARD WITHOUT CHARGE UPON REQUEST.
___________________________
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1 Trailing 10 years defined as October 8, 2004 – October
3, 2014, trailing 5 years defined as October 9, 2009 – October 3,
2014, and trailing 3 years defined as October 3, 2011 – October 3,
2014; share prices relative to historical net asset values
calculated by Land and Buildings using data provided by Green Street
Advisors; Green Street Advisors has been an industry leader in real
estate and REIT research for over 25 years and Greenwich Associates
rated Green Street Advisors #1 in five categories including first
place in Best Industry Knowledge and Best Original Research for the
last six years in a row.
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2 Peer group represents the proxy peer group for the
2014 annual meeting of shareholders excluding two companies that
are no longer separate publically traded companies: Apartment
Investment and Management Company (NYSE: AIV), Avalon Bay
Communities, Inc. (NYSE: AVB), Camden Property Trust (NYSE: CPT),
Equity Residential (NYSE: EQR), Essex Property Trust, Inc. (NYSE:
ESS), Home Properties, Inc. (NYSE: HME), Mid-America Apartment
Communities, Inc. (NYSE: MAA), Post Properties, Inc. (NYSE: PPS),
and UDR, Inc. (NYSE UDR); the company’s proxy peers traded at a
3.4% discount, 3.1% premium, 3.4% discount over the trailing
three, five, and ten year periods; the trailing 10 year period
excludes HME and MAA as data was not readily available; share
prices relative to historical net asset values calculated by Land
and Buildings using data provided by Green Street Advisors.
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3 Bloomberg; Trailing 20 years defined as July 29, 1994
–November 14, 2013 to reflect a start date to capture the completion
of several proxy peer IPOs; Trailing 10 years defined as November
14, 2003 –November 14, 2013; Trailing 5 years defined as November
14, 2008 –November 14, 2013; Trailing 3 years defined as November
14, 2010 –November 14, 2013; Trailing 1 year defined as November 14,
2012 –November 14, 2013; Since investor activism defined as November
14, 2013 through April 2, 2015.
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4 Prior to the Kohlberg Kravis Roberts & Co (“KKR”) stake
disclosure, AEC closed at $14.65 on November 14th, 2013; as of April
2nd, 2015 AEC closed at $24.78 (used as the current date
throughout the letter).
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5 Company reports; 6 year time period defined as full
year 2009 through full year 2014.
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6 Axiometrics.
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7 AEC 2013 Definitive Proxy Statement: “The Executive
Committee, which consists of Messrs. Adams, Friedman (Chairman) and
Milstein, possesses the power of the Board of Directors in the
management of the business and affairs of the Company (other than
filling vacancies on the Board of Directors or any of the Board of
Directors’ committees) during intervals between meetings of the
Board of Directors.”
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8 As of March 13, 2015, as disclosed in the Company's
Proxy Statement.
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9 Bloomberg; Data based on 2013 results and compensation;
Similarly sized REITs defined as those US REITs between $1.5 to $2.5
billion in enterprise value as of December 31, 2013.
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10 Time period defined as full year 2008 through full
year 2014.
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11 Analyst quotes were prior to Land and Buildings’
shortening the proposed slate of nominees from seven candidates to
three.
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