A small firm is looking to make a change at a real estate investment trust, an area typically tough for activism.

• Business: Real estate investment trust that primarily acquires, owns, and operate Class A and office assets in the United States.
• Stock market value: $ 155 million ($ 10.46 per share)

• Ownership: : 6.16%
• Average cost: $ 14.52
• Activist commentary: Engine Capital is an experienced activist investor led by managing partner Arnaud Ajdler, former partner and senior managing director at Crescendo Partners, L.P. 

On May 18, Engine sent a letter to the company’s board calling on it to immediately stop any plans to raise equity and to commence a liquidation or a sale of the company. Engine expressed its concern that the board may be favoring the interests of its external operator and administrative services provider, CIM Group, to the detriment of stockholders.

Engine converted its passive 13G (filed on January 28, 2020) to a 13D this week.

Externally managed REITs are notorious for conflicts of interest and self-dealing and are often the target of activists. This one has a seven-member board that is comprised of CIM Group’s three co-founders and three other individuals with significant ties to CIM Group and its principals. So, it begs the question as to how Engine started out as a passive investor and only after investing discovered that the board may be favoring the interests of the company’s external manager over shareholders.

Any investor in an externally managed REIT should do enough work to know and understand the inherent conflicts of interest. Pursuant to a management agreement, the external manager receives a fee based on the company’s assets and is incentivized to increase assets even if it means diluting shareholders to do so. While, CIM Group does own 19% of the common stock, that does not mean they are aligned with shareholders. Their common stock ownership is worth $ 28.3 million, which seems like a lot, but is nothing compared to the $ 52 million they and their affiliates have taken in fees from the company over just the past two years. So, they are incentivized to keep their management agreement. Selling the company would mean losing a cash cow, and they are unlikely to do that.

More bad news for Engine — externally managed REITs generally structure themselves so they are protected from shareholder activism (i.e., Maryland domicile, plurality voting in uncontested elections). As a result, activists are rarely successful when they target externally managed REITs. Corvex managed to defeat Equity Commonwealth after a long, costly and tenacious battle, but unfortunately, Engine is not Corvex.

Engine is a small activist with limited resources and only a $ 13.25 million investment in this company. While we would love to see them take on the board and win for the sake of good corporate governance, it is extremely improbable that they will devote the expense necessary to fight this battle if the company digs in, which they are most likely to do.

While there are signs of shareholder discontent — at the most recent annual meeting, all seven directors received over 28% of votes against them, with two directors receiving over 40% of votes against — this is hardly enough for an activist like Engine to take on a 19% stockholder with a significant interest in the status quo.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio Manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.