Changing of the Guard

For chief executives, choosing the right time to leave is almost never easy. Just ask Keith Guericke, who stepped down as chief executive officer of Essex Property Trust Inc. (NYSE: ESS) at the end of 2010 to assume the role of vice chairman with the company.

Guericke, 62 at the time, could have served much longer, despite his tenure at the company of more than three decades. But that would have taken away from his colleague Michael Schall, who was 53 at the time. If Guericke stayed another five years, Schall would have been 58, diminishing the successor’s chances of a lengthy stay at the helm. Essex also was in a good spot for a transition, beyond the financial crisis and enjoying a robust market for multifamily housing.

“You have to give the successor the right amount of time,” Guericke says. “Sometimes that means the current CEO has to maybe step down a little bit earlier than he wanted to in order to do the right thing for the company.”

While CEO succession is a tough task for all companies, REITs that do it best benefit from stable management and, in turn, better valuations in the eyes of investors. A company’s management team is an essential factor investors and analysts use in evaluating a company, and they want the reassurance that the company’s strategic plan can continue and grow after the current leadership has left. Successful companies in this regard generally focus on building a nucleus of talent at the top level. They also place a high priority on finding future leaders in the middle ranks.

In the grooming of potential successors, they make sure executives get exposure to the board. Additionally, they often rotate managers to different departments to round out resumes. Focus on personal growth is another key.

“The senior leadership team continues to focus greater energy on human resources and people as opposed to real estate projects, of what we might be buying, building or redeveloping,” Schall says. “People are your greatest assets. Focusing more time on your greatest assets is really important in the short run and critical in the long run.”

More Than “Picking the Right Horse”

When lining up a succession plan, REIT boards and incumbent CEOs must select someone adept at balance-sheet management and capital allocation, says Michael Knott, an analyst with Green Street Advisors. Those skills go hand in hand with the right leader. “Not enough REITs get those two areas right,” Knott says. “Picking the right horse is the most important factor.”

Having a good succession plan not only makes any transition easier, it’s also good business, says Merrie Frankel, vice president and senior credit officer at Moody’s Investors Service. Investors factor in bench strength. “Clearly they look at who is running the show and how strong the overall management team is,” Frankel says. “That is why certain companies have a better rating, and you can see it in their stock prices as well.”

Often, companies that receive the highest valuation have strong balance sheet management and capital allocation, but these REITs have also tended to have smooth transitions at the top. For example, AvalonBay Communities Inc. (NYSE: AVB), Essex Property Trust and BRE Properties Inc. (NYSE: BRE) all had forward-looking estimated 2012 FFO multiples greater than 20 as of Nov. 30, ahead of most REIT peers in the residential sector. Among mall owners, and Taubman Centers Inc. (NYSE: TCO) is a leader in the sector, and Vornado Realty Trust (NYSE: VNO) is a leader in the diversified category. All of these REITs are widely considered to have had smooth management transitions and deep talent in their ranks.

“There needs to be an individual there capable of assuming that position should that other individual leave,” says Tom Bohjalian, senior vice president and portfolio manager at Cohen & Steers. “That is not always the case. Companies are going outside more often than not to fill roles.”

Often though, outsiders don’t come into a company with the same loyalty as long-time lieutenants, or they don’t fit well culturally. Sunstone Hotel Investors Inc. (NYSE: SHO) recruited Steven Goldman from Hyatt Hotels Corp. (NYSE: H) to succeed founder Robert Alter in March 2007. Yet, Goldman left at end of March 2008 to serve as Hilton Hotels Corp.’s president of global real estate and development. Alter stepped back into the chief executive role, and recruited Arthur Buser in July from the Hotels Americas division of Jones Lang LaSalle (NYSE: JLL) to serve as Sunstone’s president, then chief executive a year later. Yet, Buser and the company parted ways at the end of 2010.

Before Buser left, Sunstone’s directors re-evaluated the situation. “The board took a step back and said, ‘Hold on, we have got to figure out the right formulation in a team that is aligned, cohesive and committed to the future of the company,’” says Ken Cruse, current Sunstone president and chief executive officer. In December 2010, Cruse, then chief financial officer, assumed the role of president. At the time, Alter and Cruse agreed to jointly run the company, with no official timeline given to Wall Street as to when Cruse would assume the chief executive role. Cruse was promoted to CEO after nine months, in August 2011. “The board appropriately wanted to manage expectations with the Street,” Cruse says. “We didn’t want to go back and revisit the CEO process again.”

Simply put, good succession plans are well thought out. For potential successors, a chief executive needs to identify strengths and weaknesses of each candidate, and a road map should be developed to fill in the gaps.

Companies need to have in essence two plans: One for a situation where the chief executive gets hit by the proverbial bus. Who could step in today, at a moment’s notice? The other plan is more long-term in nature, focused on grooming candidates. Even so, this latter approach needs to be refreshed and will change over time, executives say. A REIT’s needs in 2009, in the wake of the financial crisis, would have tended to demand a stronger person in finance than operations, given the capital-raising needs of the industry, notes Connie Moore, president and chief executive officer of BRE.

Corporate Office Properties spent two years before announcing Roger Waesche (left) as
Rand Griffin’s successor as CEO.

“It depends on what is going on in the organization and what skill sets you need, not only for the short term but long term,” Moore says.

Developing and Recruiting Talent

To be prepared for long-term plans, companies need to make sure they have strong bench strength.

“Ensuring that you have high-caliber individuals on the ‘bench’ should always be the goal; therefore, grooming people for a future position starts many years in advance,” says Rand Griffin, who is slated to retire as CEO of Corporate Office Properties Trust (NYSE: OFC) at the end of March. Corporate Office’s effort to identify a successor to Griffin actually began two years before its announcement in September 2011 that the company’s president, Roger Waesche, would be taking over.

For Sunstone, work had to be done rebuilding the foundation before transition plans could be laid. Sunstone had cut back on management in 2009 due to the fallout from the financial crisis, so Cruse set about rebuilding the ranks in the first half of 2011, tapping long-term contacts.

Cruse recruited John Arabia from Green Street Advisors to fill the CFO spot he vacated. Cruse tapped David Horowitz to run Sunstone’s convention hotels. Horowitz had been general manager at Sunstone’s Hyatt Regency Century Plaza in Los Angeles. Cruse brought on Cormac O’Modhrain as group vice president of asset management; O’Modhrain was president of hotel management at CIM Group. Cruse also hired Robert Springer as senior vice president of acquisitions; Springer had worked in Goldman, Sachs & Co.’s merchant banking division.

“It is a team that is highly aligned in its focus and very passionate about the future of the company,” Cruse says. “Essentially, everybody knows what the goal is, what the purpose is and what the vision of the company is.”

REITs have also taken a grassroots approach to finding future talent. By the time Schall succeeded Guericke at Essex on Jan. 1, 2011, the two had had the luxury of working together for more than two decades. They were part of a team of core veterans within the company. As a result, Schall set about expanding the ranks of potential successors for the future—at all levels. Each manager now asks the question; “Is a direct report capable of replacing me?”

Schall also started a program where managers mentor someone other than a direct report. “It gives the mid-level executive a different perspective on the company, on what is required to grow with the company and realize its opportunities for advancement,” Schall says. “At the same time, it also provides a different perspective on the capabilities of mid-level executives, allowing greater insight in planning their career.”

Schall also implemented a computerized system that ranks the workforce by skill level. This helps management get a better sense of the talent, from managers to maintenance supervisors, spread out over 140 properties. He also put in place a more formal system for annual performance reviews. “As you get larger, you become more specialized and process oriented, hopefully without being excessively bureaucratic,” he says. “The goal is to look for talented people at all levels, having a process to indentify them, and moving them into more advanced positions. If this process does not function properly, you will lose your potential future leaders.”

“The best succession plan really involves bringing people up from within the company and trying not to go outside,” Guericke adds. “Again, it’s the issue of ‘Do you understand the company? Do you have the respect of the personnel within the company?’ And that is always hard for a new person stepping in, trying to take the reigns of a company.”

Holding on to What You Have

REITs are also mindful to ensure the people they are grooming will stick around. Companies that might have a CEO destined to stay in the position a while longer face the question of how to retain aspiring executives looking for career advancement.

AvalonBay announced last June that Bryce Blair, who now serves as chairman, would hand over the CEO reins to Timothy Naughton at the end of 2011. Blair emphasizes the importance of identifying talented employees within the company ranks.

“It comes back to career development progression, in terms of compensation and recognition programs to make sure that you’re not having a flight of talent,” Blair says. “If you are going to spend money to hire and train them, make sure you are retaining them as well.”

To be sure, cash and equity compensation must be competitive with other real estate companies. But recognition in other ways is also important, executives say. AvalonBay puts together specific career development plans for each individual, identifying strengths and weaknesses. Outside courses at executive programs at Harvard Business School and Wharton School help fill in gaps. The company also conducts “360 feedbacks,” where employees receive anonymous reviews from above and below in the hierarchy.

Rotation into new positions is another key ingredient toward development. Cruse arrived at Sunstone in 2005, after having worked in corporate finance at Host Marriott Corp., the predecessor of Host Hotels & Resorts Inc. (NYSE: HST). At Sunstone, he first served in the post of senior vice president of asset management and corporate transactions, then assumed the role of chief financial officer in 2007, rounding out his background before being promoted to chief executive officer in 2010.

Expose Future Leaders to Key Constituents

Companies also need to focus on getting potential future leaders acquainted with the board. BRE’s Moore makes sure senior vice presidents and vice presidents frequent the board meetings. For example, for BRE’s review of its 2012 budget, two employees who worked on the budget for John Schissel, chief financial officer, sat in on the meeting. “They can hear the kinds of questions the board is asking, to see where there is pushback,” Moore says.

It also never hurts to get future talent exposed to investors as well. A lot of REITs will take the CEO and CFO to investor meetings such as the one-on-ones held during REITWeek: NAREIT’s Investor Forum, but that’s not enough for Essex, which takes teams of executives and managers. “The process shows shareholders the strength of Essex’s entire executive team,” Schall says.

That same kind of visibility was key to smoothing his transition into the CEO chair, according to Naughton. AvalonBay announced that he would succeed Blair as chief executive right before REITWeek 2011, one of the REIT industry’s high-profile annual events. At the convention, Naughton had the opportunity to meet with major investors, analysts and bankers in his new capacity.

“We had a formal transition time of seven months,” Naughton says. “It was intentional that we announced it right before REITWeek. That was a good time to sit down with investors and let them get to know me a bit better.”

Communicate on All Fronts

Good succession plans also have good communication, both during the grooming process and when there’s an announcement. Executives must be kept in the loop as to whether they’re in the running, and who are other potential successors, experts say. After a move, communication is also critical, Blair says.

In March of last year, three months before the transition to Naughton would be made official, Blair and his staff had to figure out how to get the word out internally and externally when the time came. For the announcement, AvalonBay offered an exclusive to the Wall Street Journal, with press releases going out later that same day. Internally, management announced the decision via emails and held conference calls in a town meeting style.

In light of his new responsibilities, Naughton says maintaining those lines of communication both inside and outside the company has proved to be a bigger challenge than he expected.

“It’s hard to fully appreciate the demands on your time until you’re in the role,” he says. “There’s a certain level of communication that is required across all constituencies at all levels. It has been something that has taken a lot more of my time than I would have guessed.”

Waesche also points out that communication and setting expectations also help ease the transition process.

“A transition plan is extremely important, outlining expectations and roles for both the outgoing and incoming executive,” Waesche says. “The transition timeframe should be carefully outlined based on the business needs, and the expectations during that timeframe need to be clearly communicated throughout the company.”

In essence, CEOs should think of themselves as stewards working on behalf of others, standing in for a period of time representing the good of the company as a whole, much like the president of the United States, notes Moore. “You are just passing through,” she says. “You hope you leave a good mark, and you hope you can leave somehow on your terms, as opposed to being ousted for not performing. That is your job as CEO.”

What REITs Should Seek in a CEO

While REIT boards tend to rely on inside talent for the next chief executive officer, they often must look elsewhere to fill the position. Bill Ferguson, co-chairman and co-CEO of FPL Advisory Group, an executive recruiting and consulting firm, says boards need to emphasize a few specific traits in their searches:

Leadership Skills. The industry does a good job of finding people on the deal-making side of the business. Yet, management skills often receive less emphasis, which can end up backfiring down the road. Good dealmakers ultimately must also manage executive
staff well.

“The industry rewards very capable deal people,” Ferguson says. “It doesn’t do as good of a job in mentoring and developing leaders and managers.”

Varied Experience. Candidates should also have had experience across the real estate spectrum, such as operations, capital markets and investments.

“The more breadth of experience they can get in managing the various functional disciplines, the easier it is for them to ultimately integrate everything and step up and run the business,” Ferguson says.

CEO Experience. This is not a prerequisite, but it helps,
Ferguson says.

“A lot of newly-minted CEOs underestimate the requirement with interfacing with the board,” he says. “They’ve had some exposure to sitting in on board meetings, but they have never been beholden to one. For someone who hasn’t been a CEO before, it can be a little bit of a rough road.”

Vision. CEOs must lead the company in terms of growth, which means positioning it for the future. That could involve embarking on geographical expansion, moving into other property types, launching an investment-management business, or weighing whether to emphasize development or acquisition.

Having that strategic vision to build the business is the key to growth, Ferguson says: “It’s that kind of creativity that really moves the needle and gives investors a comfort level.”