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Direct Effect - NAREIT Real Estate Portfolio
By Steve Bergsman - NAREIT Real Estate Portfolio
November/December 2002
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As the spotlight on corporate governance intensifies, the role of a company's board of directors has become more important than ever. Are real estate boards up to the challenge?
Analyst commentary scrutinizing corporate board activity instead of profits still is relatively rare, but in the post-
Enron, post-WorldCom environment, anything and everything is grist for review. As the focus on corporate governance issues intensifies, real estate companies will need to ensure that board composition and practices keep pace with rapid changes at all publicly traded companies.
Over the years, REIT boards have evolved from entrepreneurial clans into strong management groups that now often mirror the boards of Fortune 500 companies. However, it hasn't been a consistent process, and there still are some REIT boards that lack independence, activism and diversity. The discrepancies now are becoming apparent to investors, analysts and securities firms.
"The REITs of today emerged out of entrepreneurial private companies," explains Anthony LoPinto, managing director and chief executive officer of Equinox Partners, an executive search firm that has conducted a number of board searches for REITs. "Private-side business practices were ingrained, but as the companies transitioned to the public market, they began to address the fact that the game had changed. Governance and the way companies are managed are very different animals for a public board as opposed to a private board."
A View From Within
How far have REIT boards come over the past two decades? It depends on whom you ask. The most insightful comments concerning REIT boards generally emanate from those closest to the situation: current chief executives and chairmen of real estate companies.
There is a common view that REIT boards actively are taking strides to eliminate any past perceptions of impropriety and move toward respectability. Among the optimists is Christopher Nassetta, president and chief executive of Host Marriott Corporation (NYSE: HMT). "There is recognition that proper governance in a public company format is not only important but a critical component of managing a company and maximizing the value of a company," Nassetta says. "As a result of this recognition, we have seen a positive evolution where boards and management teams are taking a much more sophisticated approach to running a public company."
That view is shared by Richard Campo, chairman and chief executive officer of Camden Property Trust (NYSE: CPT). "REIT boards definitely have evolved to be more active and to include more outside directors," Campo says. "REIT management boards have an increased awareness of governance issues and due diligence."
For example, Duke Realty Corporation (NYSE: DRE) announced several corporate governance initiatives in August that were applauded by analysts. Among them was increasing the minimum number of independent board members to 75 percent of the total and removing staggered board terms.
However, other executives acknowledge that progress has been made, but point out that, overall, there still is a lot of ground to cover.
John McMahan runs his own real estate consulting firm, The McMahan Group in San Francisco, and also is chairman of the board of BRE Properties, Inc. (NYSE: BRE). Becoming BRE chairman in 1996 (after joining the board in 1993), McMahan has been around long enough to see how other REIT boards operate, and he has not been impressed.
"Members of REIT boards are either internal members of management, close associates of management, or friends of the CEO. There are not too many independent boards out there in the REIT world," he says. "Boards are getting more independent, but I would say they have lagged other types of public companies in terms of independence and governance."
Hamid Moghadam, chairman and chief executive officer of AMB Property Corporation (NYSE: AMB) and member of the board of Plum Creek Timber Co., Inc. (NYSE: PCL), agrees that one of the major concerns over many boards is a lack of independent members. "Just knowing a little bit about other boards, it looks to me that in the early days of REITs [the boards of directors] consisted mostly of insiders, related parties and real estate people," he says. "REIT boards basically nominated friends and long-term contacts of the entrepreneur/founder. Over time, there appears to be [the inclusion of] more outside directors."
Two Key Ingredients: Active and Independent
Initially after becoming public, the boards of many REITs reflected the entrepreneurial nature on which the companies were founded rather than the skill sets needed to manage a publicly traded company. However, over the years REIT boards have become more independent and much more active.
Host Marriott maintains a relatively modest-sized board. It never has been more than nine members and recently was down to six directors following some retirements. "As a result of having that size board, we really have an ability to fully engage [the board members] in everything that is going on in the business," Nassetta says. "We just finished a couple of days of meetings with our board, and they are actively contributing to what is going on with the major issues that we are dealing with as a company."
The BRE board consists of 10 members, eight of which are considered independent. "Boards like BRE are very active," notes McMahan, but he cautions that not all "activity" by board members is helpful.
"If they are trying to duplicate the [roles of] management then it is not a very healthy thing. That is not the role of the board," McMahan says. "The board should be involved in setting the strategy and direction of the company. Also, a board should be involved in governance activities and audit-those are primary areas. It also should make sure there is a succession plan in place."
One indication of a well-managed company, says Moghadam, is if its board of directors is independent. He also suggests a well-managed company usually can tout an active board -something that had not been particularly common in the publicly traded real estate world. "REIT boards are becoming more active, but historically they have been reasonably passive," Moghadam says. "That is all going to change because of the legislation that is coming out of Washington."
Moghadam suggests new regulations stemming from the rash of corporate scandals will necessitate that audit, compensation and maybe even nominating committee members will have to consist of independent directors or trustees. What that is going to mean for a lot of real estate companies, he says, "is that they are going to have to scrutinize their boards and basically figure out how many directors or trustees meet the definition of independent. A number of these boards are going to have to go out and find people that meet these criteria."
Building the Perfect Board
While the perfect board member for one REIT may not be right for another, most boards now seek someone who is, by definition, independent of the company, has needed skill sets and is willing to make the commitment of time and energy.
Camden's board consists of eight members, five of which are independent. The most important criteria the company looks for is a person that has knowledge related to the intrinsic business of the company, Campo says. "Part of the problem you have with some other REIT boards is that the business has become so complicated that some members don't have a clue what's going on because they don't have the business background," Campo says.
Campo says more important than having someone on the board with a "name" or a chief executive from another company is finding someone who will put in the time, and "can understand the business and then make sure the company is executing the business plan in accordance with best practices in the industry."
Some corporations have looked to fill their boards with well-known chief executives or maybe even a "celebrity" with little actual business experience. That has not been the tradition in the publicly traded real estate industry, not only because it is a smaller industry but also because REITs traditionally have been small businesses without the net revenues to attract those kinds of high-profile individuals. As real estate companies have grown in size, the general trend has been one of practicality, trying to bring people onto the board who have the expertise and business acumen to help with expansion, bring sense to finances or set strategy.
"To the extent that you can get a board that is dominated by CEOs of other companies can be a very good thing because they bring a breadth of experience in having been there and done that," says Eric Bolton, president and CEO of Mid -America Apartment Communities, Inc. (NYSE: MAA). "Because of their background, not only do they become a good advocate for owners and shareholders, but they can be a real support to the chief executive and the issues that person faces."
Mid -America elected a number of current and former executives from diverse business sectors for its board, including the former CEO and current chairman of First Tennessee National Corporation, the CEO of a large trucking and distribution company, the chief executive of a real estate construction company and the chief financial officer of Federal Express in Memphis.
As it looks to fill an opening on its board, Host Marriott has been very conscious of finding an individual that would bring diversity to its board, Nassetta says. "Even though we are in the real estate business, we are driven by consumers so we a re looking to find somebody who has a broader background than real estate or finance, someone who has a consumer-oriented background," he says.
That type of diversity is what REIT boards need, says Anthony Paolone, a REIT analyst at CIBC World Markets Corporation. "It's not necessary to have a celebrity board, but it is necessary to have a good balance of members that bring something to the table, people from different industries that can bring unique experiences and quality advice to the management team."
Measuring Up
Are REITs behind other industries when it comes to board independence? One company that has analyzed the composition of boards of directors in numerous public industries is investor services firm Institutional Shareholders Services (ISS). Using a 2001 database of REITs, ISS found that REITs performed reasonably well compared to companies in the Russell 3000. ISS gleaned that 3 percent of REITs had no company insiders as members of their board, while less than 1 percent of companies in the Russell 3000 had no insiders on their board. In addition, a slightly higher percentage (8.7 percent to 8 percent) of companies in the Russell 3000 had four to six insiders on the board.
ISS also learned that 70 percent of the almost 200 publicly traded real estate companies it analyzed boasted boards with a majority of independent outsiders, while only 26 percent had boards where half or a majority of members were insiders or affiliated outsiders. Meanwhile, 82.3 percent of Russell 3000 companies ran boards with a majority of independent outsiders, and 26.9 percent had boards where half or a majority of members were insiders or affiliated outsiders.
In addition, ISS explored the composition of the various board committees and found that 69 percent of REITs had all independent outsiders on the audit committee, 57 percent had all independent outsiders on the compensation committee and just 11 percent had all independent outsiders on the nominating committee. In comparison, the Russell 3000 posted slightly higher results in these categories. ISS found that 74.5 percent of Russell 3000 companies had all independent outsiders on the audit committee, 58.6 percent had all independent outsiders on compensation committee and just 13.3 percent had all independent outsiders on nominating committee.
Fortunately, there have been no major corporate scandals in the REIT world, but "this is not to say there may not be things under the surface," says Shirley Westcott, chief policy advisor at ISS. "But I don't think they are doing any worse jobs overall than at other firms."
A Growing Priority
Generally, an analyst report looks pretty dry with a running list of corporate data and accompanying commentary. While the subject of management occasionally enters into these reports, it is rare that composition of the board ever is considered. Nevertheless, CIBC's Paolone says, "it certainly factors into our investment decisions." However, it may become more than just a contributing factor. Over the last year, with the scandals plaguing corporate America and the lack of oversight concerning chief executives who have run amuck, corporate boards have received more scrutiny, and governance is a subject that everyone is trying to address, from individual companies to Congress.
Fortunately for REITs, external oversight is not a stranger to this sector. "One thing that REITs have had to their advantage in this environment is a lot of outside scrutiny," Paolone says. "When you think about the folks who are running REITs, they historically have been before the public dealing with pension funds, insurance companies and large financial institutions, all of whom need for the REITs to be above board. Pension funds were often REIT partners before they went public. Just think about the kind of scrutiny pension funds put their partners under."
Due to the volatility in the public equities markets, a lot of capital is flowing into real estate stocks because the asset class is viewed as having more stability than the broader equity market.
"When you have a lot of capital coming into the business," Moghadam says, "you have more sophisticated investors as part of that capital flow. And they are going to bring to the REIT world the same type of scrutiny that they have applied to IBM."
As the businesses of individual REITs have grown, the boards of these same companies have had to evolve to meet the new demands of larger corporations. Of course, not all REITs have risen to the task of expansion and growth, and some have not improved to meet the other challenges of the times. However, this all will change as new governance regulations stemming from recent corporate scandals come into effect. Going forward, all corporate boards will have to meet certain minimum standards.
Steve Bergsman is a veteran real estate writer based in Mesa, AZ.
© 2002 - NAREIT Real Estate Portfolio, all rights reserved.
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