After a 25-year run and a record year for transactions, commercial real estate in Canada may finally be at a crossroads. There are several emerging risks that suggest that the long-term outlook for real estate may not be as bright as many believe. Chief among them is the issue of executive succession planning, which threatens to disrupt the industry.
Real estate investment trusts (REITs) and private equity real estate (PERE) managers face a unique challenge in developing succession strategies that identify the next generation of leaders with the skills and experience needed to drive growth. Advocating for succession planning in public companies has typically been the domain of institutional shareholders, but because they are a product intended for retail investors, REITs face little external pressure on the topic of succession and have been mostly unchallenged by boards and shareholders to seriously address the issue.
Without proper planning, Canada’s REITs and PERE managers are running a serious risk. To understand why this challenge is unique to the real estate industry, it’s helpful to consider how REITs in Canada got their start.
The early 90s was devastating for the real estate business. The first REITs emerged largely as a way for real estate sponsors to lure wary investors back into the sector. The founders of the first REITs were fiercely competitive and earned their reputations for being aggressive acquirers as they consolidated properties limited only by their access to capital. They built their companies in their own image and investors cheered the distributions.
Fast forward a few decades, and the same founders are still in charge – but older. According to a CIBC report, in 2016 there were more than 20 REITs included on the S&P/TSX REIT index that were still being led by the original founder, and 70 per cent of the CEOs of companies on the index were expected to retire within the next five years. These findings should be a wake-up call for investors and highlight just how important succession planning is for organizations to ensure that their executives have the right skills and experience to lead in an evolving marketplace.
An Evolving Industry Requires Different Competencies
Change is already coming and it’s clear that the next decade in commercial real estate will be unlike the one previous. The original REIT founders built their businesses on acquisitions, but the next generation of real estate executives will face a host of new and evolving threats, including the continued growth of e-commerce, which has triggered an industry-wide transformation that threatens the very existence of brick-and-mortar retailers (formerly the bread and butter of many of the big REITs). As a result, a strategy focused exclusively on acquisitions and retail leasing may be supported by asset intensification.
In response to these changes, owners have begun mining their portfolios for more residential and mixed-use opportunities which will require different management skills. Instead of being focused solely on deals and acquisitions, which require only a small and focused team, the next generation of real estate executives will need broader management skills, as well as direct experience driving intensification projects and managing mixed-use residential developments.
The Experience Gap
A further risk to consider is the experience gap between the founder and the potential successor. Because real estate has enjoyed a near unbroken 25-year run of success, the second generation of executives – many who are around the age of 45 – have limited experience working through a downturn and will be untested and unprepared when it comes. By avoiding the issue of succession, organizations are missing a valuable opportunity to extend the transfer of knowledge and experience from the founder to the incoming leader.
Organizations need to address the challenges of succession planning with a range of strategies. Here are three considerations when formulating an approach:
- Waiting is risky – Because it’s such a personal matter, founders tend to avoid the issue of succession and often make the mistake of waiting until there is a very narrow window of time until they exit the organization. In most cases, new leaders need to manage through a two-to-three-year development cycle to fully immerse themselves in their roles, so waiting until the current CEO’s exit is in sight puts a smooth transition at risk.
- Tried and true is unreliable: By nature, CEOs and founders tend to hire successors in their own image. Though they are critical to the planning process, founders need to maintain a level of objectivity in terms of what the future needs of the organization will be. The knowledge and experience that got them to this point will not guarantee future success, as the evolving industry requires new abilities, a progressive outlook and a fresh approach to problem-solving.
- Diversity is invaluable: The real estate industry tends to be insular, and therefore those who work within it have likely progressed through their careers with the same world view. As such, investors and boards should encourage diversity at every turn. A global perspective, as well as the perspectives of other industries and genders, is invaluable for incoming executives, and will improve their overall leadership skills and decision-making.
The commercial real estate business may be set for major change. With disruption on the horizon, executives will need new skills to drive continued growth in an evolving market. Leadership assessment methodologies can identify and support the development of top talent.
These tools can be used to evaluate potential internal and external candidates, establish development recommendations and provide the necessary coaching to foster cross-functional knowledge. REITs and organizations with significant real estate portfolios should seize the opportunity to plan for smooth executive successions that ensures that their organizations are well positioned for the future.
Robert Baron is Partner & National Practice Leader of Odgers Berndtson’s Real Estate & Infrastructure executive search practice.