Essex Property Trust Retains Strategy After CEO Succession

As you’re reading this, Keith Guericke is sitting on the South China Sea, where the former president and CEO of Palo Alto, Calif.–based Essex Property Trust has been trying out an abbreviated, two-month-long retirement since the end of February. While Guericke admits to a certain amount of personal unease since leaving the CEO post on Jan. 1 (he remains on the board of directors as vice chairman), he is quick to add that, strategically, Essex couldn’t be in a better spot with successor and 24-year Essex veteran Michael Schall at the CEO helm. Let the Philippine sun warm him up to the idea of taking a backseat in leading a $6 billion REIT with 30,072 units across 147 properties in the Western United States. Because from here on out, Schall is more than competent to take care of the shop.

“These kinds of life changes are significant, and I am getting used to it,” Guericke says. “Personally, I’m still getting used to the idea that I’m not the band leader anymore. But corporately, we’ve had an extremely successful transition.”

Credit that seamless transition to a five-year succession plan that saw Schall cross-trained at every C-level position in the company; included the implementation of an anonymous evaluation from the senior executive team; and was staged simultaneously with a behind-the-scenes corporate restructuring initiated in April 2010 that had Schall and Guericke co-occupying the CEO office for the eight months prior to Guericke’s ­retirement.

Keep in mind, all of this was for a candidate seen by the Essex board of directors as the obvious and natural successor to Guericke. Other than some personality differences—Schall leans more toward the conservative and managerial side of the spectrum, compared with Guericke’s more opportunistic, visionary style—all involved say the two executives are of an exact mind when it comes to Essex’s culture, strategy, and business model.

Even Wall Street immediately applauded the move. In a research letter issued by Newport Beach, Calif.–based Green Street Advisors on the day of Guericke’s retirement announcement, analysts wrote that “Mr. Schall and Mr. Guericke share very similar DNA with respect to how they approach capital allocation, operations, and balance sheet management. As such, we expect little to no change in the operational or strategic direction of the company.”

Despite the cut-from-the-same-cloth executive blueprint and the near certainty that Schall was the right man for the job (the board did not seriously consider any alternative candidates and certainly didn’t interview any), Essex took a formulaic, measured, and patient approach to its succession planning. Even with the preplanning and established time line, however, the executive team encountered its fair share of challenges and doubts. Essex’s preparedness serves as an instruction manual to any multifamily apartment firm considering a changing of the guard in the CEO’s office. What’s more, their story shows how readiness at the top can help overcome obstacles and improve operations, despite troubles in the larger economy. And going forward? That means a steady, smooth course ahead for a firm coming out of transition.

RELATIONSHIPS ARE KEY

“I didn’t expect Keith to retire,” says Schall of the half-decade-long process that began when Schall was moved from the CFO to the COO post at Essex in 2005 but was accelerated after Guericke informed him in late 2009 that he planned to step down within a year after filling the CEO role for 22 years. “I was perfectly happy being COO, so when Keith announced that he was going to retire at the end of 2010, I just smiled and thought, ‘Sure you will.’ Keith has always been completely engaged and has such a passion for real estate that I believed his retirement to be unlikely, so I kept asking if he had reconsidered. Finally, the press release announcing his retirement was being drafted, and I said, ‘This is your last chance; you have only one week left to change your mind.’?”

Guericke didn’t balk. In fact, he had already been redirecting CEO-centric requests made to his office over to Schall’s since April 2010, when the senior management team was quietly under way ­restructuring Essex. While Guericke officially remained president and CEO to the public as well as the majority of Essex’s personnel, behind the scenes he was unofficially sharing the CEO role with Schall, who began running the company’s weekly executive meetings and making mission-critical decisions with Guericke only weighing in as counsel.

For Schall, this was the most difficult period of the transition. “Change is never easy, and reassuring and re-establishing my personal relationships with the senior executives was painful at first,” Schall says. “Essentially, everyone loves Keith and his management style, and I needed to walk in and articulate my own view of the world and establish direct-report relationships with a long-term, very capable executive staff. It was uncomfortable for all of us in the beginning, but I also think we have worked through those issues.”

Helping with the working out of those relationships was Steve Umphreys, founder of Menlo Park, Calif.–based Umphreys Group, an executive coaching, board advisement, succession planning, and leadership development HR consultancy. Recommended to Schall by Essex chairman George Marcus, Umphreys assisted the senior management team with leadership and transition counseling highlighted by an anonymous, 360 degree review of Schall as he assumed the CEO chair. “The consultant talked with each of the senior execs to solicit both positive and negative feedback concerning my management style,” Schall says. “The intent was to get an honest assessment of the company and what was on their minds. That process resulted in a lot of useful advice.”

Essex senior vice president of development John Eudy participated in the feedback sessions and says the process was integral to the success of the management changeover, even if it was given a raised eyebrow by senior staffers who had mostly been working together for two decades.

“We’ve all worked together for so long that it seemed like the transition would be natural, so initially I was taken aback by the need for an HR consultant,” Eudy says. “But anytime you have a change in leadership, you want to make sure all eyes are on the transition. I think Mike had more anxiety than the rest of us, but that was an extension of how much thought he was putting into the process. I was never much of a believer in the need for an HR consultant, and now I appreciate and understand the strategic role it plays.”

SPECIAL OPERATIONS

Understanding the strategic role of different business verticals within Essex was essential to Schall’s ascension to the president and CEO helm. When the board of directors began pushing for succession planning in 2005 with Schall as the heir apparent, the then-CFO, who had navigated the firm through its 1994 initial public offering and sat in subsequent charge of the balance sheet for more than a decade, was moved to the position of COO. Not just an effort to get Schall acquainted with on-site property, asset, and portfolio management tactics, the move was also in anticipation of long-term growth opportunities at Essex, particularly the thought that operations would one day eclipse acquisitions and development as a growth vehicle.

“The move from CFO to COO was probably the first significant step in this process, and it was an exciting transition for me,” Schall says. “As the CFO, managing the numbers is fairly straightforward, but in operations, with 800 people, things are completely different: It is an ongoing process of getting critical information from the bottom of the organization to the top of the organization so that good decisions can be made. That might sound simple in concept, but in reality it is not.”

Case in point: Evasive maneuvers to counter the effects of the recession on rent fundamentals followed by a counterattack to push pricing on rents as occupancies stabilized. “When rents were declining very rapidly, we deployed a high occupancy defensive management approach. You’d be surprised at how differently that strategy was interpreted and implemented throughout the company,” Schall says. “We are now pushing rents with less focus on occupancy, and thus need to regear our staff to ask for more rent and accept higher vacancy after conditioning them to be defensive.

“We’re making progress and achieving roughly 5 percent on renewals while still in a transitioning market, and it is going to take a little time before we see robust growth.”

[Leadership Lessons] Michael Schall

PALO ALTO, CALIF - FEB 15, 2011: Portrait of Essex Property Trust CEO Michael Schall. Photographed inside the company's headquarters in Palo Alto, California. PHOTO BY JOHN LEE COPYRIGHT 2011 JOHN LEE PICTURES www.johnleepictures.com

Credit: John Lee

Title: President and CEO
Age: 53
First Job: Auditor with Ernst & Young (then Ernst & Whinney)
Best Decision: Joining Essex in 1986
Favorite Quote: “Managing is like holding a dove in your hand—squeeze too hard and you kill it, not hard enough and it flies away.” —Tommy Lasorda
Greatest Business Challenge: Essex’s IPO in 1994. (“I was CFO at the time.”)
People Most Admired: “My father; [Essex chairman] George Marcus; and [former Essex president and CEO] Keith Guericke”
Leadership Philosophy: “Harness the wisdom of the team, based on complete information and sound processes.”
Best Advice Received: “Keep your life as simple as possible.”
Last Book Read: Barbarians to Bureaucrats: Corporate Life Cycle Strategies, by Lawrence Miller (Clarkson Potter, 1989)
What’s Playing on your iPod: 1970s-era rock

As the company pushed for rent gains in 2010, it also took advantage of acquisition opportunities, purchasing 12 properties for an aggregate cost of $584 million, $281 million of which was allocated to four distressed condo deals that will be converted to rentals with an option to eventually return the properties to the for-sale market. Essex’s limited development pipeline was also active in 2010, and the company currently expects to deliver two new communities in 2011—the 152-unit Muse in North Hollywood, Calif., and the 284-unit Via in Sunnyvale, Calif. Three other projects remain in predevelopment, and the company holds title to three tracts of land for future development.

On the acquisitions side, Schall and the senior management team set 2011 guidance between $300 million and $500 million worth of deals, which will be financed via dispositions of the firm’s slower growth properties, via equity issuances, or by a possible 50/50 joint venture with one of Essex’s institutional partners (which has yet to be finalized). If the JV negotiations are successful, however, the majority of acquisitions would be made out of the joint venture, utilizing leverage of up to 70 percent and likely reducing the expected issuance of common shares of stock.

MAKING HIS MARK

Despite Schall’s commitment to staying the strategic course at Essex and maintaining tight staff relationships, Schall is still a CEO in his own right. A competitive analysis report requested by the board asked Schall to size up Essex against its REIT peers (see “Strategy Sessions” on page 35) and offer suggestions on where he might tactically take the company next.

One distinctive change would have Essex making a significant move into East Coast markets, a territory that the REIT had abandoned under Guericke after an unsuccessful bid for Town and Country Trust’s Mid-Atlantic–­centric portfolio in 2006.

Schall is also interested in adapting the culture at Essex to greater embrace the leveraging of technology generally across the enterprise, and specifically as it relates to operations.

“The senior management team has worked together for many years and shares a common view of Essex’s strategy and direction,” Schall says. “But having said that, I see many opportunities to improve the company, including making attractive investments in a very active acquisitions market; expanding development and redevelopment at the onset of an improving economy; culling the weakest locations in properties from our portfolio; and, of absolutely critical importance, upgrading our technology in operations ­platforms.”

Indeed, on the firm’s 2010 fourth quarter and year-end earnings call, Schall opened his remarks with the comment that improving operational technologies would be a significant component of Essex’s post-Guericke growth. But while the company maintains a $639,000 co-investment in technology on its balance sheet, Schall isn’t quite ready to identify what that investment is or to pinpoint specific systems or IT initiatives that are immediately forthcoming from the REIT.

More immediate will be a cultural change in how IT and systems staff push tech initiatives at the REIT—a cultural change that has Schall craving a deeper understanding of the underlying real estate than implementing technology simply for technology’s sake.

“We get a lot more information with technology, but does it help us manage better? Our management time needs to be focused on issues, not data,” Schall says.

“We get a mountain of data, and clearly we need to sort through it so that critical information is identified: What are the struggling properties, what is the cause of the problem, and what is the appropriate action plan? Time is your enemy: Vacancy is lost forever, and multifamily enterprises are like battleshipsthey don’t turn on a dime. Technology will continue to help us in productively handling ­information.”

THINKING AHEAD

Locating larger deals and forming relationships with new capital partners, oddly enough, will be the purview of Guericke, who remains with the firm as vice chairman of the board and as a consultant (see “A Gradual Retirement” on page 34). Upon his return from the Philippines, Guericke will likely work two or three days a week for the REIT, but will not attend senior management meetings and has even moved his office into a satellite building on the firm’s small Silicon Valley corporate campus.

“We held a company-wide webcast to broadcast to the entire company this transition,” Guericke says. “We want to make sure everyone knows that the philosophy that has been painstakingly developed is going to stay intact. Acquisitions and development were very important to grow this company over time, but today, the driving force is going to be top-notch operations and driving every nickel to the bottom line that we can. That is a change in focus that I think Mike is going to execute, and I think he will execute it well.”

Schall indicated as much on the firm’s 2010 fourth quarter and year-end earnings call, highlighting the criticalness of ongoing property operations improvement during the multifamily sector recovery and the shared, common view of Essex’s strategy and direction that should have Essex watchers expecting the firm to remain on a similar path as under Guericke’s leadership. Currently, the company’s portfolio has an average financial occupancy level of 96.4 percent, besting the industry average of 94.5 percent by almost 2 percentage points.

There is also an opportunity to grow even further: In addition to burning off any leftover concessions and pushing lease renewals, Schall feels on-site operators have the ability to push rents portfolio-wide by 5 percent in 2011. Schall’s first order of business, as a result, will be to emphasize communication up and down the ranks at ­Essex.

During the course of the nearly yearlong transition, Schall recalls the moment he knew the succession was really happening.

“Keith talked about retiring for a long time. Now, I find myself talking about all the things keeping me awake at night,” Schall says. “I think any CEO probably has the same fearthat he or she doesn’t know something critical to the success of the company. While I expect good results, I recognize that the opportunities to improve the company are in the things that are not going well.

“My management style will continue to be based on the wisdom of a well-informed and fully engaged executive team. Give me good information, and we’ll eliminate the blind spots. And from that will come superior decisions, and superior growth.”