Four independent directors share their thoughts on joining the REIT industry, making the time commitment and dealing with stricter governance standards.

By Steve Bergsman

Publicly traded real estate companies continue to make great strides in terms of governance and board practices. As part of this effort, many REITs, both large cap and small cap, have made concerted efforts to increase the independence of their boards.

Lance R. Primis

The clamor for companies to have independent boards centers on limiting possible conflicts of interest, as investors seek reassurance that members of a board of directors have no personal financial interests that would conflict with being on the board. However, there are other advantages to having independent members on a board in addition to meeting SEC and NYSE requirements; independent board members bring objectivity, diversity, accomplishments and new skill sets.

But for an industry with a relatively low profile, how does a REIT, particularly a smaller company, attract a qualified independent director who will be willing to meet the time demands of board service, manage the regulatory pressures and learn the idiosyncrasies of the industry.

“It is a commitment you sign up for and if you cannot meet the commitment you should not participate because it is an important job and one that you have to take seriously,” notes Lance Primis, who was recently named lead independent director for AvalonBay Communities Inc. (NYSE: AVB). Primis had been president and general manager of The New York Times Co., and now runs a management consulting firm called Lance R. Primis & Partners.

Several real estate companies have been able to attract highly qualified outsiders to their boards. Real Estate Portfolio recently spoke with four of these independent directors to learn their views on the key issues facing REIT boards today and what role they see themselves playing.

Taking the Lead

When AvalonBay, the Alexandria, VA-based apartment REIT, established the position of lead independent director earlier this year, it chose Lance Primis, a long-time director to serve in that role. Primis joined AvalonBay’s board in 1998 and currently chairs the compensation committee, while also serving on the nominating and corporate governance committees. (In the near future, the board may decide its lead independent director should not be on any committees as an additional step to avoid conflicts of interest, according to the company.)

Richard Ellwood

“I don’t have a deep experience in real estate, but the board said it needed expertise in public company corporate debt and I filled the bill,” Primis says.

For the last five years, Primis has been the chair of the compensation committee and has had compensation experience throughout his career. “In addition, having been on the boards of The New York Times and a Canadian-based publicly traded company, I bring a good deal of governance experience,” he adds.

However, there was a learning curve regarding the industry that he says he had to manage. “I have had to learn how to take the long view on determining investment and development issues. Given the long cycle for creating a first-class apartment community, I have learned to examine factors and trends in each potential market (projecting return targets, etc.),” he says. “AvalonBay’s management provides the board with a significant amount of information permitting us to properly evaluate each opportunity. Many other industries make investment decisions based on shorter-term data as the projects are completed in a more rapid time frame with return performance evident more quickly.”

One of the attractions of the position for Primis was that the AvalonBay board had a high commitment to corporate governance.

“AvalonBay has a strong eight-person board, seven of which are independent,” Primis says. “The board has a wonderful mix of real estate and non-real estate experience, it is well rounded and the management team trusts the board. Therefore, a lot of issues are dealt with collaboratively.”

When first nominated, Primis met with the management team and the board. “The quality of the company’s performance, the team and the product made the decision to join easy,” he says. “There are not many times in your career when you can work with top individuals who run organizations that produce top-line products. It was an easy choice for me.”

Susan Williams

Before Primis joined AvalonBay’s board, the company was already committed to fostering a predominantly independent board.

“The good news at AvalonBay is that independent directors have always held six or seven seats and their commitment to corporate guidelines and communications has always been very strong,” Primis says. “AvalonBay has been on the leading edge of the independent director standards, well in advance of stock exchange or SEC requirements.”

A strong board will be helpful to AvalonBay as it and the industry confronts a number of problems. AvalonBay, which owns an interest in 149 apartment communities containing 43,608 units, faces an uncertain economy and changing nature of the residential market.

“We have issues to try to work through,” Primis says, but adds, “The REIT industry is relatively young and many problems are quite specific to the industry.”

Making the Time

Another REIT board member who came from outside the real estate industry is Susan Williams, a five-year board member of Rockville, MD-based Washington Real Estate Investment Trust (NYSE: WRE), which owns a diversified portfolio of 60 properties consisting of 11 retail centers, 24 offices, 16 industrial/flex buildings and nine multifamily projects.

Like the REIT she helps oversee, Williams, too, boasts a diversified background. She was formerly the assistant secretary of transportation for the federal government, and also played a founding role in Project Head Start, is a former chairperson of the Greater Washington Board of Trade and remains chief executive officer of consulting firm William Aron & Associates.

Robert Gidel

Williams has served on several non-corporate boards, but Washington REIT was her first publicly traded company board and the only one involved in real estate. “Although I had no direct involvement with real estate, Edmund Cronin, chairman, president and CEO of Washington REIT, who I knew, invited me to join the board,” Williams says. “I thought it would be a learning experience since it was very different from what my every day business was. I’ve found serving on this board very challenging.”

She currently serves on the board’s nominating committee and earlier in her tenure worked on the audit committee. Of the latter service she says, “working on the audit committee is a wonderful way to understand what is going on in the company. It is a good place for a board member to start.”

That committee served as her introduction into the inner-workings of the company and the industry—knowledge that she says she needed to evolve quickly in her role on the board.

“I had to learn about the real estate market in the region. I had represented REITs on a national level concerning tax issues, but never got into the nitty-gritty of visiting the properties like I’ve done since I’ve been on the board,” she says. “For the properties that Washington REIT wants to acquire, we go and visit prior to the purchase. It’s been a real education. What you learn about are the current market conditions, what properties are more attractive than others, and what is expected to happen to the different communities in the future.”

While serving as chair of the Greater Washington Board of Trade, Williams was frequently briefed on the economics of the region, but for the real estate market she says she has learned it really depends on where the property is located and what is projected for the future.

What Williams brings to the board is an understanding of government processes and the importance of managing people, two skills learned from her days at the Department of Transportation. As a public affairs consultant, she knows the players and the systems extremely well.

“On this board we are almost all outside directors,” Williams explains. “None of us are directly involved in commercial real estate. As a result, we bring skill sets and experience a company of this size usually would not be able to get. Since we all have experience managing much larger public and not-for-profit organizations, we bring strong governance and oversight.”

Although she was already a busy person, of the time demanded by the board she says, “If you are interested, you make the time.”

Knowing the Line

While Williams had no professional experience related to real estate prior to joining Washington REIT’s board, other independent directors have a more related background. Richard Ellwood, who had been an investment banker on Wall Street for more than 30 years and is currently president of R.S. Ellwood & Co. Inc., a New Jersey-based real estate investment banking firm, definitely has an interest in property companies. He even serves on the board of three: Florida East Coast Industries Inc., and two REITs, Apartment Investment & Management Co. (NYSE: AIV) and FelCor Lodging Trust Incorporated (NYSE: FCH).

While still an independent director with no direct ties to either REIT, Ellwood did have past professional experiences with both AIMCO and FelCor. “In both cases, I had business relationships predating the formation of the REITs. I had worked with some of the AIMCO people where one of the corporate attorneys also represented one of my investment banking clients, and in the case of FelCor, I had done business with Primus Corp., who was the owner and operator of Embassy Suites, of which FelCor owns many.”

At FelCor, Ellwood is chairman of its corporate governance and nominating committees and has been a director since 1994. He has a few interesting points to make about being an independent board member. First, he says board members should talk to each other on an informal basis from time to time—which surprisingly doesn’t happen all that much, he adds.

Secondly, board members need to stay “in line.” “The biggest problem with getting very good, tough-minded, independent directors is getting them to stay in the policy and strategy area and not stray over into the line of management,” Ellwood says. As an example, he has witnessed an independent director chew out one of the corporate managers at a board meeting. “He might be right, but he was out of order. The director needs to wait and talk to a fellow director or the CEO about the problem, but he shouldn’t chew out the ‘sergeant’ in front of the troops.”

To which Ellwood adds, “you become a board member if you enjoy the people and enjoy the business. And to do it you have to trust the other directors and the company. It can not be enjoyable if you do not trust the people you are working with.”

Enjoying the job of being a director is even more critical now, Ellwood says, since increased regulatory pressure has expanded the time commitment involved. “[The biggest difference] is that I now allow longer time for board meetings—particularly audit committee meetings.”

Independent But Knowledgeable

Another former investment banker who has sat on a number of REIT boards is Robert Gidel. He has a long history in the REIT world, first as president and chief operating officer of Paragon Group Inc., a Dallas multifamily REIT (sold to Camden Property Trusthttp://www.camdenliving.com) and then as president and CEO of Meridian Point VIII, an industrial REIT sold to EastGroup Properties Inc. Gidel is currently managing partner of Dallas-based Liberty Partners LP, an investment partnership, and also sits on the board of U.S. Restaurant Properties Inc.

Since 1999, Gidel could be counted on as a director of Developers Diversified Realty Corporation (NYSE: DDR), a shopping center REIT that owns and manages over 400 retail operating and development properties.

Gidel came on board at the request of DDR’s chairman and CEO Scott Wolstein, who knew Gidel from his days as managing director of Alex Brown Realty Advisors.

Since Gidel has a wide range of experience in regard to investment banking and REITs, he has developed some set ideas about independent board members, some of which are a bit controversial.

“I have been around independent board members who exercised very, very poor judgment,” he says. “I don’t think independent is always the answer. If you have a board comprised entirely of independent people that don’t have intimate knowledge of the business that the companies are in, that cannot be helpful.”

He adds, “What a CEO should seek when adding board members are people who know a good deal about the industry, can be critical about strategic planning and sometimes even be critical of the internal planning.”

Gidel adds that directors with “skin in the game” are also beneficial to the company and its shareholders. “I am more comfortable around people who I know have an investment in the company,” he says. “People who have something to lose make better decisions. How much (of a stake) is meaningful differs by individual.”

For an old hand such as himself, Gidel says, sometimes the biggest struggle is to be in a room where someone else is running the company. “I really have to move back, get into the bleachers so as to give the CEO a different perspective. You have to be confident and comfortable in a supporting role and not everyone is suited for that.”

Gidel says the added requirements and regulations placed on board members have, to varying degrees, had an impact on board activity.

“In regard to the companies with which I’m involved, there are an awful lot of financially knowledgeable people sitting around the table so the regulatory pressure hasn’t had a substantive effect,” he says. “With a board where there is not a lot of financially savvy people or an investment by board members in the company then there probably will be a lot of change.”

Even after many years in the REIT industry, Gidel still says he receives something important by being on a board such as DDR. “The retail business has always fascinated me, and I have risen exponentially up the learning curve relative to the business of retail. Frankly, it has helped me become a better investor—and shopper.”

Price Of Independence Since Congress passed the Sarbanes-Oxley Act of 2002, REITs and other companies have been focused on restructuring independent director’s pay. The restructuring is generally resulting in increased compensation and a change in the components of compensation, according to Bruce Schonbraun, managing partner of Schonbraun Safris McCann Bekritsky & Co., a consulting and accounting firm specializing in the real estate industry. “Independent director fees have and will continue to increase as REITs attempt to attract and retain top quality independent directors who are likely to work harder, work longer and assume greater risk,” Schonbraun says. Robert Gidel, who has sat on a number of REIT boards, says there is no question that board compensation must increase. “The time commitment and liability exposure have gone up, so directors should be compensated commensurately,” Gidel says. “In my view this isn’t a substantive amount, but could be as much as a $50,000 increase per year if the director is chairman of the audit, compensation or governance committees. In my view, part of the total comp paid to directors should be in restricted stock vested over a few years, so once again they are invested in the decisions they make.” The increase in independent director fees must be accomplished giving appropriate sensitivity to the possible concern of shareholders who will not want to see the fees rise to a level approaching a part-time executive job, he adds. From an actual and perception viewpoint, the independence of directors cannot be compromised. The structure of the independent director compensation is similarly undergoing a revamping with the goal to more closely align the long-term interests of independent directors with that of company shareholders. “In particular, stock options, which have been criticized for encouraging a short-term focus and face expensing, are increasingly being replaced by restricted stock and other forms of equity which typically incorporate long-term vesting features and in some cases carry restrictions regarding when they can be sold,” Schonbraun says. Cash, as an element of director compensation, remains important as opposed to providing all equity. Many companies are also providing additional cash compensation for certain committee chairmen (in particular the audit committee chairman) whose individual roles and responsibilities have been greatly expanded.”