Reits Gain Valuation and Shareholder Approval

By Charles Keenan

REIT corporate governance is among the best in the United States and boards across the industry remain highly focused on corporate performance and strategy. In fact, REITs have historically fared much better in corporate governance than almost every other industry.

“REITs have been head and shoulders above almost everyone else,” says Paul Wanner, director of ratings at Institutional Shareholder Services, a research firm that monitors corporate governance practices. In fact, ISS rates REITs second to only utilities.

However, REITs and other publicly traded real estate companies are grappling with a few issues that are on the minds of shareholders. Topics such as de-staggered boards, executive compensation and majority voting are front and center.

In a corporate world filled with acquisitions and executive compensation issues, how does the REIT industry fare on shareholder concerns and what can they do to build upon the corporate structure?

M&A Shapes Governance

In the last two years, mergers and acquisitions have played a larger role in shaping corporate governance policies. The heated climate of private equity firms and acquisitive REITs looking for sellers has prompted boards to consider how to position themselves to get the best valuation, says Larry Portal, a partner at Schonbraun McCann Group, a consulting firm. “Many REIT boards are spending a lot of time ensuring that deals are in the best interests of the shareholders,” Portal says.

For example, observers cite the recent buyout of Equity Office Properties Trust by the private equity firm The Blackstone Group as an example of the benefits of strong corporate governance.

“That deal is a great argument to why clean corporate governance does a great job,” says Barry Vinocur, editor of REIT Zone Publications. “Sam Zell always said, ‘We’re here, we have the transparency. There was no staggered board, no poison pill.” He also says that even if Zell objected to the takeover, the deal probably would have been completed because of the favorable corporate governance for its shareholders.

However, Mike Kirby, director of research at Green Street Advisors, says that M&A activity is impacting boardroom behavior. “If the rumor mill is correct, a number of REITs have received offers and have not responded. Sometimes it is perfectly fine to pass on an offer, but that’s not always the case. Some companies may have been approached with reasonable offers and the management team doesn’t take it. That’s not an answer shareholders want to hear.”

He also says that this is an issue of the integrity of the board rather than looking at past practices. “Shareholders should pay attention to the boards and encourage them to strongly consider these offers,” Kirby says.

Strengthening the Board

There are a few topics dominating boardroom discussions recently. For example, institutional investors are pressuring companies to eliminate staggered board terms, which make it much harder for shareholders to take action, such as removing a majority of the board for poor company performance.

		How do REITs Compare to other Corporate Governance? In early April, luminaries from corporate America, Wall Street and regulatory agencies met in Washington, D.C.

Generally, corporate governance proponents prefer directors to be elected each year, making it easier to remove them. These setups are also known as “classified boards,” which are divided into three classes, each with three-year terms. That means changing the board’s majority would only take two elections.

“De-staggered boards should be a priority.” Kirby says, “REITs generally stack up well in this category, but there are still plenty of companies that have entrenchment devices available to management teams.”

Majority voting is another hot issue. The policy means that all directors are elected by a majority of the votes cast. If they haven’t done so already, many companies are implementing this policy, either on their own or by pressure from investors.

“Shareholders are using their influence by majority voting because they can voice their dissatisfaction with the board,” says Michael Friedman, a partner at Pepper Hamilton.

Executive Compensation

Executive compensation is another element in the governance mix making recent headlines. Last year, the Securities and Exchange Commission (SEC) said that public companies in the 2007 proxy season must precisely disclose what they pay to executives, including perks and benefits. Companies are required to disclose the information in a Compensation Discussion and Analysis section in their proxy filing.

So far, reviews are mixed. In early returns of filings, the SEC was less than satisfied. The section “isn’t anywhere close to plain English,” said SEC Chairman Christopher Cox in a March speech. “Most of it’s as tough to read as a PhD dissertation.” In fact, executive pay disclosures averaged almost 5,500 words in length, about 1,000 more words that the U.S. Constitution, Cox noted.

However, Green Street has found that REITs paid their executive teams a lot less then corporate America, Kirby says. “The range of pay is enormous. For example, corporate compensation packages across America are $50 to $70 million compared to $8 million in the REIT industry.”

He also says that the private side may have some lure for executives. “There are very lucrative offers in the private world, because they can afford great prices for good managers without having to report to the SEC. That’s something to keep in consideration when thinking about public versus private.”

Reaching the Limit

Still, despite work to improve corporate governance, REIT chief executives warn that too much of it might not be such a good thing. “You can have all the corporate governance practices in the world that you want,” says Hamid Moghadam, chairman and chief executive officer at AMB Property Corporation (NYSE: AMB). “However, if a management team operates in a less than transparent way, a company can’t legislate that by incorporating corporate governance practices.”

Last year, the Securities and Exchange Commission (SEC) said that public companies in the 2007 proxy season must precisely disclose what they pay to executives, including perks and benefits.

Moghadam’s words carry weight since AMB stands as one of the leaders in corporate governance practices. ISS gives the company a corporate governance quotient of 94.7 when comparing AMB with its peers. At the time of the REIT’s IPO in 1997, it had put in place policies of directors serving annual rather than staggered terms and language preventing enactment of poison pill and other anti-takeover provisions.

Since then, it has added several other enhancements, including becoming an early adopter of expensing employee stock options and requiring a majority vote standard in uncontested director elections.

Yet there is a limit to good corporate governance, Moghadam warns. By extending corporate governance too far, investors may drive public companies off the market. “There is a risk to going overboard. Some companies may go private where there is no transparency into the company’s practices,” he says.

Top Shareholder-Friendly REITs of 2007 In March 2007, Institutional Investor asked portfolio managers and sell-side analysts to choose the most shareholder-friendly companies in their domain. The following are the highest-scoring REITs. Host Hotels & Resorts  (NYSE: HST) AvalonBay  (NYSE: AVB) Simon Property Group (NYSE: SPG) AMB Property Corporation (NYSE: AMB) ProLogis (NYSE: PLD) Source: Institutional Investor

At times, certain corporate governance practices deemed as “bad” may actually be a blessing. For example, poison pills are generally scorned by investors. However, they might aid a company fighting hostile takeover attempts and proxy contexts. “It’s important to have adequate defenses against both of these tactics to give the board sufficient time to consider a proposed change of control and determine whether to pursue it or remain independent,” says Jim Hanks, partner at Venable LLP law firm.

He points out that corporate governance measures are not easily applied the same to each REIT. “Corporate governance is not a one-size-fits-all proposition,” he says. “The governance structure and practices of each REIT should be tailored to that company. Some structures and practices are appropriate for some companies, but not necessarily for REITs.”

Given REITs’ stellar performance in recent years, the industry’s relatively good standing in corporate governance may have lent a helping hand in the uplift. “REIT corporate governance is generally good,” Vinocur says. “It has worked well for investors.”