But CommonWealth, with $7.8 billion in buildings from Hoboken to San Diego, is unlike most other real estate investment trusts in one crucial way: its structure creates a significant conflict of interest. What sets CommonWealth apart is that it employs an outside management company, known as REIT Management and Research, to run the company’s operations and acquire properties. Many REITs were set up this way in the 1980s because they were small, but external managers are an anomaly among today’s much larger REITs.

To make matters more interesting, the outside management company is run by Barry M. Portnoy, CommonWealth’s founder, and his son Adam. Both father and son, moreover, serve on CommonWealth’s five-member board.

REIT Management and Research is paid an advisory fee based on the size of CommonWealth’s assets, rather than on how the investments perform. This is a stark incentive to simply expand the company through acquisitions and, in fact, since March 2010 CommonWealth has issued 88 million new shares to acquire new properties. The number of new shares is almost triple the stock outstanding before the sales. Such issuance dilutes existing shareholders’ stake because it increases the number of investors that share in the company’s income and payouts.

The incentive structure also encourages the management company to pay top dollar for properties. As noted in a recent report from Green Street Advisors, a research firm specializing in REIT analysis, “Selling equity and buying assets, without management rigorously asking ‘At what price?,’ can bleed shareholder value over the long term.”

Sure enough, since 2005, CommonWealth has underperformed the index of commercial office building REITs. In 2012, CommonWealth’s shares fell 7 percent. It cut its dividend last fall.

But because the assets have increased, the management company run by the Portnoys has been raking it in, earning $118 million in advisory fees in the last three years.

THIS might not be a concern if CommonWealth’s outside managers owned a sizable investment in its shares, aligning themselves with the company’s owners. They do not; the management firm’s executives and trustees on the board own 0.33 percent of CommonWealth stock.

So, to recap, the founder of CommonWealth and his son run the company, manage the properties for a hefty fee and dominate the board — all while having little equity stake in the company.

These conflicts in CommonWealth’s structure and oversight make it “uninvestable,” according to Green Street Advisors.

Adam D. Portnoy, CommonWealth’s president, said in an interview that the company’s underperformance had nothing to do with its structure. Rather, he said, it was a result of its transition from a concentration in suburban office buildings to those in central business districts. “We’re trying to reposition the portfolio away from probably the worst performing sector — suburban office buildings,” he said. “It’s a painful process.”

If the conflicts at CommonWealth are so glaring, why don’t shareholders agitate for change? Some have tried, only to encounter an array of barriers that appear to be set up to keep the outside managers’ lucrative contract in place and the company under their control.

The list of entrenchment tactics is lengthy. First is the company’s costly antitakeover measure — also known as a poison pill — that kicks in when an outsider acquires 10 percent of CommonWealth’s shares. Then there are the board’s staggered terms, which make it harder for shareholders to oust a number of trustees at once.

Article source: http://www.nytimes.com/2013/05/05/business/commonwealth-trustees-guarding-the-status-quo.html?partner=rss&emc=rss