REITs are dealing with growing shareholder activism.
11/3/2015 | By Dawn Wotapka
REIT magazine: November/December 2015
For years, the REIT industry has been relatively untouched by shareholder activists, who were focsed on other industries and higher-profile companies. However, as the industry’s size and profile has increased, activist investors have become more vocal. They’re demanding meetings with executives and seeking board changes. In the most dramatic cases, they’re pushing for companies to be broken up or sold, snapping up stocks as leverage. This increased attention is spurring proactive changes as companies work to effectively manage and respond to such challenges.
“REITs used to be kind of a sleepy sector that was viewed as not really attractive for activists because of REITs’ organizational and ownership structures,” says Paul Adornato, a managing director and longtime REIT analyst with BMO. “Shareholder activism has been alive and well in other sectors forever. It’s only now starting to trickle down into the real estate space.”
Earlier this year, law firm Goodwin Procter LLP reported on the trend in an alert titled in part “Barbarians at the (REIT) Gates: REITs Should Be Prepared for a New World Order.” The firm suggested REITs undertake thorough reviews of corporate governance profiles to make sure that the company and board can navigate possible hostile activity. It also recommends that REITs should know the stockholders and how they view the business plan and growth prospects.
“No public REIT should assume that it is immune from the forces at work in the current marketplace,” the firm wrote.
Friend or Foe?
Some industry watchers accuse activists of looking for a quick profit. Others point out that companies can benefit from additional points of view, particularly if they come from shareholders.
“Given that it is incumbent upon management teams to maximize shareholder value and that real estate prices are at all-time highs, companies should expect their real estate to be considered fair game, and management teams shouldn’t be surprised to see an activist show up if management falls asleep at the wheel,” says Phillip Owens, a senior vice president with Green Street Advisors, a real estate research and advisory firm. “I’m not saying that all activist activities are desirable, but if the goal is to maximize shareholder value, they do play an important role as it relates to price discovery.”
In this new world order, Jonathan Litt is considered a trailblazer. Litt was a well-known sell-side analyst. During the worst stretch of the most recent downturn in 2008, he founded Connecticut-based investment firm Land and Buildings to take advantage of the opportunities uncovered by the bursting of the global property bubble.
Litt describes his mission in simple terms. “We still view ourselves as an advocate for shareholders,” he says.
REIT industry experts point to numerous explanations for the change brought on by activists such as Litt. In allowing everyday investors to own a piece of a major landlord, the unique REIT model faces numerous tax rules and governance mandates. Investors are generally prevented from owning more than about 10 percent of a company’s shares, preventing the Hollywood-style snapping up of large ownership stakes.
However, REITs are now better understood by many investors, helped by increased media coverage. Meanwhile, the industry has long since recovered from the despair that lured Litt to start a new company. Some property values have surpassed peak values and don’t show any signs of falling, earning widespread attention.
This comes as private money is looking to pour funds into real estate. Earlier this year, Fitch Ratings estimated that capital raising could reach between $103 billion and $117 billion. Sovereign wealth funds are particularly active; with some $6.3 trillion in assets under management – and growing – they are snapping up properties coast to coast and reshaping the space.
Perhaps the most important driver is a company’s historic share price relative to its net asset value (NAV). A company whose stock has exhibited an on-going trend of share price underperformance and is trading at a deep discount to its NAV is most likely to draw interest from activists.
Figuring out the NAV discount and the potential upside have become big business. Some analysts and large investors update their estimates quarterly and share the information. Companies pay close attention to the numbers.
“We review and monitor all executive compensation, board governance ratings, total shareholder return charts and NAV models that are published on the company and, if necessary, will point out errors or inaccuracies based on what information the company has publicly disclosed,” says David Bujnicki, Kimco Realty Corp.’s (NYSE: KIM) vice president of investor relations and corporate relations. “Analysts have so many companies they prepare models for that it can be a challenge for them to accurately update in a short timeframe.”
For some companies, the debate over NAV and other shareholder suggestions can be cumbersome and a distraction, says Jeremy Banoff, senior managing director with FPL Advisory Group. FPL has worked with numerous REITs, including several facing activists.
“Part of the issue is that you have outsiders speculating on what really the true NAV is and making certain claims,” he says. “Without running the company and knowing all the finite details, it’s difficult to assess at what precise value the true value ultimately is.”
To be sure, few complaints arise if the stock trades at a premium to NAV. Those operators frequently issue shares. A closer look at the governance practices includes exploring everything from a company’s total shareholder return and executive compensation levels compared to peers, and its NAV. A discount doesn’t immediately mean raiders are on the way: It could be that the particular business cycle is in a downturn, or a market is just taking a beating.
“Just because a company’s trading at a discount doesn’t mean that an activist shareholder should step up and make something happen,” says Tim Pire, a managing director with real estate investment management firm Heitman. “You have to look at it on a case-by-case basis.”
Meanwhile, a company’s format could be beyond repair. Litt says his company avoids getting involved with a “bad corporate structure that an activist can’t change” and firms “that are in really difficult businesses and you don’t know where the bottom is.”
One might ask why REITs can’t just sell less desirable buildings and/or exit weaker markets to appease any concerns. The primary issue there, says Green Street’s Owens, is that selling buildings may trigger capital gains taxes. A building that has been owned for a long time may have a low basis, so high sales prices may mean even greater capital gains tax concerns. “The strategy to sell real estate to monetize value may not achieve the goal of creating value for shareholders once taxes are paid,” Owens says.
Companies At Risk?
By the time activists deem their involvement with a company is necessary, the demands for change are typically meaningful. They often include replacing board members or even the CEO.
Kimco hasn’t faced any major activism issues, but the shopping center REIT periodically performs an informal vulnerability assessment to identify potential issues that may leave the company ripe for activism. The company focuses on knowing its shareholder base and having regular ongoing dialogues with them. Shareholders will tell companies what is important for them as investors and what good governance practices they want to see from an organization, according to Bujnicki. As an example, Kimco expanded its sustainability reporting and issued its initial corporate responsibility report last year.
Litt says breaking up companies isn’t his primary goal, and he points out that if a company is broken up, it can take longer for shareholders to see a strong return.
“We’re not bad guys,” he says. “The last resort is to be public in a spat. We always try to work collaboratively and constructively with the board and with management to figure things out. Most of the time it works.”
Industry watchers are staying tuned to see if the activism trend continues. Some think it even could accelerate. “As long as there are significant discounts to perceived value, that will be the fodder for activists,” says Adornato of BMO.
Dawn Wotapka is a former real estate writer for The Wall Street Journal.