CEO and board succession in the real estate industry, particularly the graying REIT C-suite was raised by Alex Avery, managing director of Institutional Equities at CIBC World Markets in 2016 as a major issue for REIT and REOC investors. (Part one of this article CIBC’s Avery a pessimist on Calgary office market
Avery, speaking at a meeting of the Commercial Real Estate Lenders Association (CRELA) in Toronto last week, referenced his March report on the aging C-suites of most real estate investment trusts. Canadian REITs were started up by relatively young executives two decades ago and up to 70% of them are expected to retire in the next five years or so, the CIBC analyst estimated.
“When we went to measure how big a risk this was in the REIT sector, it is pretty huge, it is quite enormous.”
Avery drew up an index of the average tenure of the board, the average age of the board members and the average age of the CEOs. “Publishing this made me very popular with management teams.”
He expects the CEO exodus will be matched by a wave of departures by board contemporaries with a significant loss of institutional memory.
“That can be a particularly challenging thing if you think for instance you have a CEO change of March and 2008 and the board walks out at the same time and a year later the world has gone to hell and you are trying to figure out how to solve a big problem. Trying to remember why you bought that property, what the story was, what the development plan was, who the key was in the relationships you had around that property.
“So I think that is a big, big issue.”
Worse, Avery analyzed the independence of Canadian REIT boards. “The majority are not independent.” Loading REIT boards with family and friends could make the potential institutional memory loss worse, he said.
Avery used the example of Cominar REIT to illustrate the issue of board turnover and CEO succession.
Founded by Jules Dallaire in 1965, it became a dominant force in the Quebec real estate market and was characterized by shrewd operations.
“He bought at really high cap rates and low prices per square foot and when the market got ahead of him (he switched to developing properties). So it was a mixture of one-off acquisitions and one-off developments.”
A market darling, Cominar enjoyed a huge premium to net asset value compared to other REITs. Dallaire eventually handed over control of the company to his son and that cautious and conservative approach was abandoned.
“In a very short order after that you can see that leverage started to move up pretty aggressively, EBITDA interest coverage came down, Michel (Dallaire) undertook a number of very aggressive hostile takeovers which…have not actually paid off for shareholders.”
Cominar is a stock market darling no longer. “I guess the best measure of how this evolution of the strategy has worked is that 10 years ago Cominar stock was $20 and today it is $15. Ten years ago interest rates were probably 400 or 500 basis points higher than they are now. Everything in the real estate world has improved in the last 10 years and Cominar stock has really not.”
REIT management teams may have not appreciated having their ages discussed among investors and financial media, but the report had the desired effect, Avery concluded.
“Talking to management teams they weren’t particularly concerned about it until we published this report and now everyone has got a plan which is a good thing but there are still some challenges that go along with that.”
Rates stay friendly
A “big issue” for real estate is the potential of an interest rate hike, something Avery is “not concerned” about.
To illustrate how rates can stay low for a long time, the analyst showed a chart of U.S. 10 Year Treasury rates floating between 2 and 4% between 1925 and 1960. “We have probably got another 20 years of very low interest rates. That doesn’t necessarily mean that it is not going to be a bumpy ride.”
What does it mean for REIT investors?
“I would say that if you are a REIT investor today you can probably count on your income and three or four years from now you might have slightly higher share prices but the lion’s share of the return is going to be the income and if the Fed does hike, expect a short term bump in the road. But beyond that, I’m not all that concerned.”
In a Q&A session after his presentation, the CIBC analyst shared his outlook for the Canadian economy and near-term interest rate action by the Bank of Canada.
Avery described the Canadian economy as “weak” compared to international peers, citing very high personal debt levels, rising government debt, a “very inflated housing market” and a commodity cycle on the downside. On the plus side Canadians enjoy a robust social safety net, lessening the negative impact of high debt loads when compared to a market such as the U.S. “We forget that they have to pay for their own health care, they have to pay for all sorts of other things that Canadians get through government.”
So what’s the outlook for the country’s economy? “It is probably not going to be a robust economy but it is probably going to be a sideways economy, slightly up over the next number of years and I think relatively speaking, not compared to the U.S. but compared to a lot of other markets, that is going to be a pretty attractive place to hang out.
“I don’t know that we will see negative interest rates but I will say that if I had to push between (Bank of Canada Governor Stephen) Poloz hiking or cutting next, I would say that he is going to cut next.”
Crowdfunding needs bank brands
Avery’s “State of REITs” presentation ended with a question from Amar Nijjar, JLL’s vice-president and practice lead of debt capital markets on the future of real estate crowdfunding in Canada.
The analyst said crowdfunding’s growth will be slow until big players get involved.
“As a guy who works in a bank I’m not particularly concerned about it right now. I think that it is going to take some time and I think the critical ingredient that needs to be added to the mix is credibility. So you need to have mainstream players participate in that type of technology and as they do and they get more and more comfortable with that I think the largely unregulated nature of it today lends itself to more risk.
“If you look at the mutual fund business for instance, banks are continuing to consolidate mutual fund management in Canada and it is the trust factor …The shift towards banks I think is almost exclusively a trust factor.”
For crowdfunding to grow therefore, financial names that small investors trust will be key. “It’s a question of credibility and bringing in brands, you need to bring brands into that business.”