CommonWealth Clash Spotlights Uncommon Management System

CommonWealth REIT’s clash with shareholders over a stock sale is putting a spotlight on the company that manages it and four other real estate investment trusts after investors complained the structure erodes value.

CommonWealth’s manager, Reit Management & Research LLC, is at the center of objections by investors including Corvex Management LP and Related Cos. who tried to block the stock sale, which was completed yesterday. CommonWealth sold 34.5 million shares at $19 each, resulting in net proceeds of about $628 million, the REIT said in a statement.

RMR receives fees from the companies it runs and its owners, Barry Portnoy and his son Adam, serve on the boards of the REITs, according to data compiled by Bloomberg. More investors may follow the lead of Corvex and Related and push for changes at other REITs that Newton, Massachusetts-based RMR manages, said Jim Sullivan, a managing director at Green Street Advisors Inc., a Newport Beach, California-based company that focuses on REIT research.

“The Portnoy empire is a large one,” he said in a telephone interview. “Tipping one domino here, that is CommonWealth, could tip the others as well.”

RMR, the biggest company that manages publicly traded property REITs, also operates Select Income REIT, Government Properties Income Trust, Hospitality Properties Trust and Senior Housing Properties Trust. Most publicly traded REITs that own real estate are internally managed, making RMR and the firms it runs uncommon in the industry, Sullivan said.

Management Incentives

Keith Meister’s Corvex and Related, led by Chief Executive Officer Jeff Blau, projected that CommonWealth’s real estate assets are worth about $40 a share, according to a Feb. 26 letter to the board. The “misalignment of incentives” between the REIT and its external management has driven down the value of the stock, the New York-based investors said. They sought to stop the stock sale because of the dilution to shareholders.

Corvex and Related, which together own 9.8 percent of Newton-based CommonWealth, had offered to acquire the company for $27 a share before the stock was priced and said they may seek to replace the five-member board with independent trustees.

The REIT’s board, “controlled by external manager RMR, is in the unique position of blatantly acting in the best interest of RMR rather than as a fiduciary” to CommonWealth shareholders, John Guinee, an analyst at Stifel Nicolaus & Co. in Baltimore, wrote in a March 4 note to clients.

CommonWealth amended its corporate bylaws last week to make it harder for shareholders to push for changes, “indicating RMR is already hard at work buttressing its castle,” Guinee wrote.

Share Decline

Tim Bonang, head of investor relations at CommonWealth and the other RMR-managed REITs, didn’t return a call seeking comment.

CommonWealth fell 3.3 percent to $23.12 in New York trading yesterday. The shares dropped 17 percent in the 12 months through Feb. 25, the day before Meister and Related began agitating for change. That compared with an 11 percent advance in the Bloomberg REIT Index of 129 companies.

Shares of the other companies operated by RMR rose during the period, with a 12 percent gain for Senior Housing Properties Trust, 5 percent for Government Properties Income Trust and 3.8 percent for Hospitality Properties Trust. Select Income REIT jumped 18 percent since its initial public offering last March.

CommonWealth, with a market value of $2.74 billion, is the third-largest of the REITs managed by RMR. The biggest is Senior Housing Properties Trust, at $4.8 billion. The smallest is Select Income REIT, with a value of $1.08 billion.

‘Fundamental Difference’

Having an outside manager is standard among nonlisted REITs, which aren’t traded on stock exchanges and sell shares primarily to individual investors through brokers. For publicly traded property REITs, managers, executives and employees tend to work for just that company, Sullivan said.

The outside management arrangement creates a “fundamental difference in the alignment of interests of shareholders and those that manage the REIT,” Sullivan said. “In the case of RMR, the guys that run the REITs don’t own much of the REITs.”

Another issue for investors is that RMR divides its management efforts among its five companies rather than focusing attention on an individual REIT, Sullivan said.

CommonWealth benefits from being operated by RMR because of the company’s depth of management and experience in the real estate industry, according to the REIT’s website. The fees paid to RMR, which was founded in 1986, have historically been lower than the average corporate expenses for many office REITs, CommonWealth said.

REIT Requirements

REITs, whose primary income streams are from real estate, are required by the Internal Revenue Service to distribute at least 90 percent of their taxable earnings to shareholders as dividends. In exchange, they pay little or no income tax.

A hostile bid “has never been successful in REIT land,” Rich Moore, an analyst at RBC Capital Markets, wrote in a March 4 report to investors.

To fend off Corvex and Related, CommonWealth changed its bylaws on March 1 to make it harder for an investor to replace board members. A shareholder or group of investors now must own 3 percent of the company for at least three years before taking action to remove a trustee, according to a filing with the Securities and Exchange Commission.

Investor Lawsuits

The investors said in a lawsuit that CommonWealth’s trustees disseminated false and misleading statements and defrauded the landlord’s investors. The trustees were using the equity offering to place large blocks of stock in “friendly hands” and disenfranchise existing shareholders, according to the complaint filed March 1 in federal court in Boston.

At a court hearing on March 4, Corvex and Related “affirmed their desire to seek to replace all of the members” of CommonWealth’s board, according to regulatory filing yesterday.

Joanna Rose, a spokeswoman for Corvex and Related, didn’t return a call seeking comment on their plans.

Another CommonWealth shareholder, Delaware County Employees Retirement Fund, also sought to stop the share sale. The fund sued CommonWealth founder Barry Portnoy and members of the board, saying the trustees are using CommonWealth’s equity “to entrench themselves and discourage any proposal to acquire,” according to that complaint, filed Feb. 28 in federal court in Boston.

Lawyers for the trustees said in court papers that CommonWealth was raising equity and cutting debt to maintain an investment-grade credit rating.

The case is Corvex Management LP v. CommonWealth REIT, 13-cv-10475, U.S. District Court, District of Massachusetts (Boston). The Delaware fund’s case is Delaware County Employees Retirement Fund v. Portnoy, 13-cv-10405, U.S. District Court, District of Massachusetts (Boston).

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