Leading REIT CEOs discuss the opportunities and challenges that lie ahead

By Christopher M. Wright

Step into the shoes of a REIT CEO. Sure, you get the corner office with the gorgeous view and the usual perks of upper management. However, your job also includes navigating rapidly changing market conditions and juggling multiple demands, such as satisfying relentless pressure to maximize shareholder return, determining where your company is on the acquisition food chain, finding and utilizing capital under less than favorable business conditions and steering through the shoals of inevitable globalization.

Portfolio asked nine real estate CEOs to share their outlook and how they handle the multiple challenges that came with the title CEO. Participants included: Jon Bortz, president and CEO of LaSalle Hotel Properties (NYSE: LHO); Debra Cafaro, president, chairman and CEO of Ventas, Inc. (NYSE: VTR); Gordon DuGan, president, co-CEO and director of W.P. Carey & Co. LLC (NYSE: WPC ); Jay Flaherty, chairman and CEO of Health Care Property Investors, Inc. (NYSE: HCP); Phil Hawkins, CEO of DCT Industrial Trust, Inc. (NYSE: DCT); Edward Linde, president and CEO of Boston Properties, Inc. (NYSE: BXP); Peter Lowy, managing director and CEO of U.S. properties of The Westfield Group (ASX: WDC); Connie Moore, president and CEO of BRE Properties, Inc. (NYSE: BRE); and Donald Wood, president and CEO of Federal Realty Investment Trust (NYSE: FRT).

PORTFOLIO: Let's start with some general observations. What REIT industry trend will have the greatest impact on your company through 2008, and why?

The trend that will have the largest impact on our company is globalization of real estate markets. We have seen some convergence in worldwide cap rates but we might see more. —GORDON DUGAN, W.P. CAREY & CO. LLC

Phil Hawkins: The abundance of capital from a variety of sources and the corresponding reduction in return expectations requires all of us to think much differently about how we grow our business and deploy capital. As a result, I believe that we will see an acceleration of international expansion, continued growth in the amount of private capital managed by REITs and continued public-to-public and public-to-private transactions.

Jon Bortz: The trend with the largest potential impact on any individual company is an offer to purchase it, either by private equity or with another public company. With so much private equity looking for direct investments in real estate, we've seen an increasing number of private equity buyouts. If a company's desire is to stay independent and public, the best defense is to perform at a high level.

Debra Cafaro: In the same vein of M&A activity, the health care REIT sector should continue to consolidate to provide shareholders with the benefits of scale, liquidity, risk pooling, lower costs of capital and improved profit margins. That trend picked up steam in 2006, and we think it will continue. We have completed one acquisition by merger every year since 2004, and we expect to continue to participate actively in this trend because it makes money for our shareholders.

Gordon DuGan: The trend that will have the largest impact on our company is globalization of real estate markets. We have seen some convergence in worldwide cap rates but we might see more. Furthermore, since we are internationally active, we expect continued global activity to create global competition. There are, of course, impediments to this globalization process such as local tax laws, restrictions on foreign ownership, etc. However, the process has started and we believe it will continue strongly.

The health care REIT sector should continue to consolidate to provide shareholders with the benefits of scale, liquidity, risk pooling, lower costs of capital and improved profit margins. —DEBRA CAFARO, VENTAS, INC.

Peter Lowy: Decreasing cap rates and high property values have significantly impacted the calculation of returns on purchasing individual assets, portfolios or companies. It is more difficult to increase both income and value through acquisitions. International expansion by U.S. REITs means companies must compete not only locally in the United States but also abroad.

PORTFOLIO: Several of you referenced the flow of capital, which is always a primary consideration. What steps will your company take in the next few years in terms of acquiring capital?

Lowy: It is extremely important to access many forms of capital in both private and public equity markets as well as the public debt market. Westfield seeks equity capital through joint ventures with institutional partners, institutional wholesale funds and/or hybrid equity.

On the debt side, we look to the United States, the United Kingdom and European public debt markets to issue unsecured debt on a corporate level versus commercial mortgage-backed securities (CMBS) or mezzanine financing.

DuGan: We continue to find very attractive capital from the mortgage markets in Europe and the United States. The flip side of the concern: there is too much capital chasing deals, and this is a great time to finance and refinance assets.

Cafaro: Our goal is to maintain access to many forms of capital through all different cycles to take advantage of opportunities that arise. We have become an investment-grade credit, which has included unsecured bonds, CMBS and other mortgage debt, convertible debt and asset sale proceeds. We will also consider joint ventures—with pension funds and/or international capital sources—as a way to acquire high quality assets in the current environment.

Ed Linde: Capital of all kinds is available in large amounts and at extremely attractive rates. We would like to have more debt on our balance sheet, but it makes no sense to raise money we can't invest.

Connie Moore: BRE has a very strong balance sheet that provides the flexibility to attractively access the capital markets when necessary. There are many options available, including long-term debt, preferred stock and common equity. We are very stingy with issuing common equity; it's been over three years since we've accessed this source of capital.

The important thing is not to get into a capital box. We have a very large development pipeline to fund, so we must remain flexible and take care of our stakeholders.

Bortz: We will continue to raise capital in the public markets, focusing on common, perpetual preferred and CMBS debts, tied only to a need for additional capital as new acquisitions are made. In other words, effective match funding.

We need to earn the confidence of public market investors every day through continuing relative outperformance, and assuming we continue to succeed, public capital will continue to be available for opportunities that will add to shareholder value.

PORTFOLIO: Mergers and acquisitions have come up in several of your comments already, and obviously M&A is still a big topic in our industry. What is the most important factor for completing a successful transaction?

Donald Wood: Mergers are only successful when the acquirer's business plan is truly enhanced. The reality is that an acquisition creates zero value for the acquirer since a purchase or merger at market value merely represents the exchange of one asset, usually cash or stock, for another property or a platform. Value can only be created by what is done with the acquired assets or platform.

Going bigger for "bigger's sake" doesn't work, and the envisioned "synergies" used to justify the strategic value are often far more theoretical than practical.

Photo by Jim Spirakis

My biggest concern is identifying opportunities. Boston Properties has a development orientation, so securing and entitling the best sites is a signficant challenge. —ED LINDE, BOSTON PROPERTIES, INC.

Jay Flaherty: Since HCP announced its $5.3 billion acquisition of CNL Retirement Properties, our enterprise value has increased by $8.5 billion to $15 billion, our stock price has increased 50 percent and we have lowered the average age of our portfolio by five years and significantly increased the growth of our dividend. While it is far too early to declare "victory," I would say that the strategic fit of an acquisition is the most important factor in M&A success.

PORTFOLIO: Even in the best of markets, a successful leader has to plan for the worst-case scenario. What are some of your biggest concerns about the challenges facing your company and the REIT industry as a whole?

Wood: I'm always looking for signs of a broad-based pullback, whether in the form of dramatically reduced consumer spending for a sustained period of time, reallocation of the huge storehouse of capital away from real estate or specific sectors within it, or our national government's overspending habits that serve to weaken our dollar and drive up the cost of money. We've seen only sporadic signals in each of these categories, but the cyclical nature of our business constantly weighs on my mind.

Bortz: Our biggest concern is the inevitability of capital withdrawal from the REIT industry and how that will impact valuations in both the private and public sector. We've seen large capital flows into REITs over the last few years that have driven values to record levels. Some of that capital will eventually migrate to other investment classes that are perceived to have a better risk/return equation.

Lowy: A major concern is the lack of coherent U.S. policy on terrorism insurance and the need for a clear, predictable policy and long-term solution (The Terrorism Risk Insurance Extension Act [TRIEA] is slated to expire at the end of the year). The real estate industry is concerned with how to secure enough capacity in the insurance markets to obtain reasonable coverage at an affordable price. Our shareholders are taking most of the risk, hence influencing decision-making in terms of where and how much we invest.

Cafaro: There is a war for talent among healthcare REITs. My overriding objective is to retain and motivate our very skilled and committed executive management team and other professionals we have recruited to Ventas that have made the company successful.

Linde: My biggest concern is identifying opportunities. Boston Properties has a development orientation, so securing and entitling the best sites is a significant challenge.

The industry is vulnerable to changes in the capital markets. REITs will feel the impact if there is a significant increase in interest rates or if the market for high quality real estate runs out of steam and reverses.

Moore: It's all about execution. The repositioning of BRE's portfolio is complete and puts us in a terrific position to deliver on the promise of our platform. However, it takes people with the drive to outperform to make it happen. We are in the middle of a good three to five year run for all our markets, so it's up to us to make it happen.

DuGan: My biggest concern for the industry is that we have been in such a strong position for so many years that people forget there is something called "risk." Values for properties can decline, debt financing can become more restrictive and economies can have shockwaves.

PORTFOLIO: With both property valuations and construction costs at high levels, what is your answer to the development-versus-acquisition growth strategy conundrum?

Moore: The continued liquidity for well-located real estate makes it difficult for us to source property acquisitions that meet our hurdle rates. Access to capital and the relative low return expectations for many institutional investors continues to make the external growth equation difficult. We find a much better risk/reward balance with development.

Linde: Boston Properties consistently leveraged its development capacity to achieve higher returns on equity than what could be earned in an acquisition, especially with the bidding up of prices that has occurred. The real challenge is finding the right sites, accurately assessing the market demand and building a quality project.

Bortz: At LaSalle, we generally avoid development due to returns that are not commensurate with the risk involved. As a result, we have sought acquisitions at below-replacement cost, and existing properties with great locations in the major primary markets that can be significantly renovated and repositioned.

Hawkins: We expect to invest a higher share of capital in value-add acquisitions and development to generate higher risk-adjusted returns and growth. We will also continue to expand our co-investment or capital management activities so we can increase relatively low real estate returns on core assets with additional fees and promoted interests.

Lowy: From our perspective, returns from development and redevelopment exceed those from purchasing assets and create significant income growth and value within the company. Although cash-on-cash returns vary in different markets, all tend to generate extremely high internal rates of return (12 percent to 14 percent range over a 10-year period), which far surpass returns from acquisitions.

REITs have demonstrated an ability to leverage their real estate operating, acquisition and development expertise into very successful money management ventures. —PHIL HAWKINS, DCT INDUSTRIAL TRUST, INC.

PORTFOLIO: Joint ventures with institutional investors were supposed to give REITs higher returns and allow them to control more properties with less of their own capital at stake. Does this still hold true?

Hawkins: Very much so. REITs have demonstrated an ability to leverage their real estate operating, acquisition and development expertise into very successful money management ventures. This is certainly an important element of our business plan to increase investment returns and FFO growth. It is important in this environment to have access to a variety of different capital sources, both public and private.

The advent of closed-end funds, private and publicly traded, have been an important development in recent years, which translates into more stable capital and fees for the sponsoring REITs.

Moore: JVs are here to stay as many REITs offer attractive operating platforms to enhance returns for their JV partners. Many JVs are still in the formative stages so time will tell if the story turns out as advertised.

PORTFOLIO: Another frequent topic of discussion is the globalization of the REIT approach to real estate investment. REITs are becoming prevalent across the globe. What do you envision for the future of the global commercial property market?

Cafaro: I see large-scale globalization. This outcome might depend upon the creation and rationalization of tax treaties to ensure consistent tax treatment among countries. It is possible that we will see global real estate companies with assets exceeding $100 billion within the next decade.

Lowy: I also see continued globalization of securitized REIT markets. Large-scale globalization and free flow of capital in commercial real estate markets continues to occur. The movement toward REIT vehicles around the world is a major factor, giving investors the ability to invest efficiently in a global marketplace. Diverse economies, currencies, tax jurisdictions, accounting rules, interest rates and market characteristics, among other factors, certainly add complexity to global operations. Handled correctly, it can be rewarding.

DuGan: I envision that there will be not just one model, but a number of very large global players in the real estate investment management business. At the same time, there will continue to be a role for local players in various markets as they will still have access to inexpensive capital and may have certain advantages in their local presence.

It's better to be ahead of the "green" curve than to play catch-up. —DONALD WOOD, FEDERAL REALTY INVESTMENT TRUST

PORTFOLIO: Energy usage and efficiency has increasingly been in the news, whether it is green building initiatives, plug-in hybrid vehicles or lawmakers taking up global warming. What is the most significant opportunity for REITs arising from renewed emphasis on environmentalism?

Wood: It's better to be ahead of the "green" curve than to play catch-up. A proactive program to modify your development methods clearly represents an opportunity to increase competitive advantage in civic development projects. This is the case for Federal Realty where Leadership in Energy and Environmental Design (LEED) certified buildings and other environmentally based requirements are mandated by a number of jurisdictions in charge of civic projects.

Linde: REIT management will make a mistake if it views environmentalism as a threat. Government officials, tenants and investors will expect us to behave responsibly and the incremental cost involved is manageable.

Moore: The opportunities are two-fold. One, our prospective residents/customers in Generation Y place a large emphasis on eco-friendly products, including their homes. Our developments need to meet the customers' desires, and eco-design is one of them.

Secondly, many communities are placing a strong emphasis on eco-development. Incorporating eco-friendly design elements into the building(s) can accelerate the entitlement process.

PORTFOLIO: REITs have received high marks in recent years for good governance practices. To the extent that governance measures were adopted to attract capital, will the industry remain a leader in governance issues now that REITs have won mainstream acceptance and capital is abundant? If so, who will make it happen?

Linde: Good governance practices were not created to attract capital. Some of the regulations are onerous and address form rather than substance. Many good governance measures just formalized what was already considered good practice. I don't see that changing, and our board will not allow us to fall behind the curve.

Over the last several years, BRE has focused on operational excellence, and we’re beginning to see the results. This is an ongoing pursuit to build a great company. —CONNIE MOORE, BRE PROPERTIES, INC.

Hawkins: Plenty of attention will remain on corporate governance practices so that we run very little risk of companies taking their eyes off this ball in the foreseeable future.

Flaherty: I certainly hope—and expect—that the REIT industry will remain one of THE leading sectors in terms of best-practice corporate governance. Ultimately, that is the function of the board of directors for each of the publicly traded REITs. If history is a guide, the biggest threat to best-in-class corporate governance is corporate arrogance. It is everyone's responsibility to remain vigilant to that potential development.

Moore: I believe the industry will continue its leadership position when it comes to governance. Today's boards are more focused on it. I can't envision an environment where governance practices would be relaxed just because we're now an accepted asset class. We all stand to benefit from good governance practices.

PORTFOLIO: What is the most important quality for an effective leader, and how does that play a role in the REIT industry today?

Flaherty: The most important quality of a leader is to identify, recruit, retain and reward an exceptional leadership team.

Moore: The capacity to share a vision and get others to build something great. Over the last several years, BRE has focused on operational excellence, and we're beginning to see the results. This is not a static endeavor, but rather an ongoing pursuit to build a great company. It takes leadership across our entire company to remain focused on the goal by entwining passion with vision.

I certainly hope—and expect—that the REIT industry will remain one of THE leading sectors in terms of best-practice corporate governance. —JAY FLAHERTY, HEALTH CARE PROPERTY INVESTORS, INC.

Hawkins: To continue to attract, inspire and motivate people in the face of rapid organization, business and industry change. In the case of DCT Industrial, it is very important to our board, our employees and me that we retain a creative, results-based, entrepreneurial culture as we continue our growth and expansion, which has made us successful as a relatively young startup company.

Cafaro: Developing strategies that position the company for long-term success and also create near-term value; being nimble and adaptable; and welcoming accountability from key constituencies, including the board, shareholders, creditors, press, employees and customers, are essential leadership qualities.

My priority is to ensure our team is motivated and cohesive, and that each person is contributing at his or her highest level.

DuGan: I think it has been a relatively easy time to be a REIT industry leader, given the favorable environment we have recently weathered. We will all be tested to a greater degree if our industry suffers a reversal of fortune, which I hope is many years away.