Pre-emptive voting rights are protecting or hindering the real estate industry, depending on whom you talk to. Maha Khan Phillips reports

Last year, US real estate manager Cohen & Steers raised eyebrows when it published the first in a series of three research papers on pre-emptive voting rights in Europe. The firm, and its president and CIO, Joe Harvey, argued that pre-emptive voting rights, which force European companies seeking to raise equity capital to first approach existing shareholders via a rights issue, needed to be reassessed.

"I believe that pre-emptive rights make the companies we own less valuable. It impedes the cost of capital and ironically creates bad company decision-making and bad governance. I'm interested in increasing the value of our company and I'd like to see the European listed market get bigger and thrive," says Harvey.

The firm believes that its holdings in the UK and continental Europe would trade at higher valuations if companies were free from pre-emptive rights. It would like to see a larger listed real estate universe in Europe, with more real estate companies accessing the public market and growing through securitisation of private real estate. It also believes that companies should focus on the cost of their equity capital, as pre-emptive rights have obscured this fundamental discipline, it believes.

"We want to raise awareness that pre-emptive rights do not adequately meet the financing needs of capital-intensive real estate companies, especially REITs that are further constrained by their requirement to distribute nearly all of their earnings," the Cohen & Steers report stated. The firm argues that the pre-emptive rights structure, which is applied broadly across many industries, particularly in banking, has been a contributing factor to too much leverage being adopted by the industry. "By liberating capital-raising practices we believe the value of our holdings will increase by far more than any ‘alpha' we can create by buying follow-on stock offerings," it said.

So do pre-emptive rights need to be abolished? Harvey is quick to point out that he is not suggesting shareholder rights be scrapped but rather there needs to be a more flexible framework. Raising equity can take up to six weeks in Europe, in contrast with the US where earlier this year Simon Property Group announced an agreement to purchase a 28.7% stake in Klepierre, a $21bn (€16.8bn) pan-European shopping centre company. Simon Property was able to execute the funding of the acquisition within 24 hours from the announcement of the transaction, through $1.3bn of common stock priced at $137 per share and $1.75bn of unsecured debt.

And it is not just about individual transaction times, argues Harvey. "As we are finding out every day from reading the papers, Europe, like other places in the world including the US, needs to deleverage. The way to do this is to grow out of it, or inflate your way out of it, or to cut spending in the case of a sovereign, or to raise equity or a combination of those things. But the European banking sector is tied to the sovereign through the system. While a sovereign can't raise equity, a bank can, and commercial and residential real estate sectors are very much tied to the banking sectors, and you have a system that is all connected."

A mixed response
Cohen & Steers' argument has received a mixed response. Unsurprisingly, investor groups such as the UK's National Association of Pension Funds and the Association of British Insurers have argued that the current structure protects shareholders and should be preserved. Investors are concerned about share dilution, and about losing control.
Hans op't Veld, head of listed real estate at Dutch pension provider PGGM, says that it should be up to equity owners to decide on equity issuance. "This is why our voting policy, and the policy of most of our peers, reflects the fact that we are wary of providing companies with extensive authorities to issue equity," he says. "Now, in some cases this is more opportune than in other cases. Defensive equity issuance, as we have seen in the global financial crisis, is very different from offensive equity issuances. In the first case, the dilutive effects of issuances are severe, whereas this is not necessarily true in the latter case."

The majority of fund managers see it differently. "The rules, from where we sit in Europe, surrounding the raising of new equity are punitive to the company, forcing them to take a highly discounted rights offering, resulting in a higher cost of capital," says Sam Sahn, portfolio manager at Timbercreek Securities. "With a higher cost of capital it becomes more challenging to grow externally. Perhaps this is why we have seen European real estate companies take on higher level of debt over time. Debt as an asset class is cheaper than equity."

It is an issue that is not going away anytime soon. "To a certain extent, there is a difference in cultures between the US public markets and the European public markets," says Gareth Lewis, director of finance at the European Public Real Estate Association (EPRA). "It is clearly a sensitive issue when you are talking about corporate governance relating to what control investors have. Everyone agrees that the system in Europe is inefficient, and that there could be steps to improve it. The difficulty is that there are some quite powerful shareholder groups within the European market who are very reluctant to give any leeway or concede mechanisms in place."

There is also the matter of discounts. In a 2009 briefing note, equity research provider Jeffries stated that US REITs were raising equity at 7% average discounts to estimated NAVs against a 20-year average of parity with NAV. In the UK, this figure was 39% against a 20-year average discount to NAV of 23% or 16% since REITs were introduced in 2007. US REITs are also "dividend machines". According to Jeffries, UK REITs are now worth half of their 2007 peak value, whereas US REITs have re-equitised and are worth a third more.

"When a deal gets done in the US, it typically adds a 5% discount to the close," says Larry Antonatos, director and product manager of global equities at Brookfield Investment Management. "When you see a big deal being done in Europe its 20-40% discount to the close. I think the reason is because they have these rights offerings. In the US we do it all in one step: you announce you are going to sell the stock, where the price is, and investors can buy it. If everyone knows about it and has the opportunity to participate, then nobody is getting special treatment."

Cohen and Steers also argue that in the US, where pre-emptive rights do not exist, REITs have performed better than those in Europe, because rights offerings have impaired shareholder total returns. In the US, listed REITs have generated an excess return as compared with the direct property index of +513bps per year over the past 20 years. In comparison, UK listed property have underperformed the direct property index by -297bps each year.

Helmut Kurz, fund manager responsible for REITs at German bank Ellwanger & Geiger, responsible, says it is too simplistic to argue that underperformance is a result of voting structures. "It is quite simple why [underperformance] happened. There is too much debt in the UK. Secondly, the US REIT structure has dominated real estate securities since the 1970s, and in the UK it only began in 2007, so it is not equally comparable."

For his part, op't Veld at PGGM believes the arguments are sometimes circumstantial. "The rationale to change current procedures would be that the performance and growth of European property companies are affected negatively by current legislation. However, it is not easy to find proper quantitative support for this view. The lack of growth in the European sector can hardly be attributed solely to pre-emptive voting rights, nor can the performance differential." In fact, he says academic studies in general equities suggest that there is not negative impact on shareholder wealth arising from pre-emptive voting rights.

He does agree, though, that cost of issuance is higher in Europe, the process is lengthy and as a result excessive discounts occur at the time that rights are issued, particularly in the case of defensive issuance.

There is another concern as well. "The US REIT sector has seen more inflows in the last 18 months than they have in the peak of 2006 and 2007, whereas Europe has been a shrinking part of the pot in terms of the global market. Its exposure has come down by well over a third," says Alex Ross, investment manager of the pan-European property share fund at Premier.

The UK REIT market capitalisation has remained relatively stable at 40% of the European universe, according to Jeffries. But it has shrunk to the point of being almost irrelevant on a global scale and is now less than 5% of the market. "The lack of UK REIT activity has fed through into shrinking banking support. Over the past five years, the number of banks that actively research and distribute REIT securities has fallen by a third and average daily trading volumes in the shares have more than halved. REITs are fast becoming the equity markets ‘Shangri-La', the sector that time forgot," says Jeffries.

Robert Houston, principal of St Bride's Strategic Advisers, says he would be in favour of waiving pre-emptive rights, but only if a manager acted in a true and proper manner, with consideration for his existing investors. "If you look at what a number of the large property companies and REITs have done to shareholder value over the last few years, it is not pretty. I could be sympathetic, because I know that unless a share is trading at, or close, or above NAV it's going to be pretty difficult in the UK to raise fresh equity. However, I don't think that the listed REITs and listed property companies think about their investors. They think of them as shareholders, which is entirely different."

Discussions are taking place among industry groups about what sort of flexible structure might replace the existing one. But it will be a long process, warns Harvey. And, as one fund manager is quick to point out: "In Europe, we are all socialists. And no government is going to go up against shareholders on this issue, not in the current climate."