In the world of real estate investment trusts (Reit), it is not necessarily the amount investment managers are paid that matters most, but how this is calculated. Remuneration metrics heavily influence manager behaviour, so when their incentives are not aligned with the interests of shareholders, problems can arise.

Many Reit boards appoint third-party contractors to manage the company’s assets and make investment decisions. In the UK, 51% of listed property companies, by number, are externally managed in this way, with PRS Reit (PRSR ) – a specialist in new-build rental homes – among them.

In September, a group of frustrated PRS Reit shareholders challenged its board over its strategy and stubborn discount, which had averaged 35% in the preceding year. The situation provides a fascinating case study of how external manager incentives can impact performance. PRS Reit’s arrangement with its contractor, Sigma, contained two major hallmarks of clumsy contract creation: a fee based on net asset value (NAV) and an overly long term.

PRS Reit’s shareholders argued for a revamped board that would work to sell properties to repay debt where its cost exceeded the net rental yield of the trust’s portfolio, as well as for share buybacks to reduce the discount to less than 10%. These may seem like obvious steps, leading us to wonder why such action had not been taken previously. Yet buybacks also reduce a company’s cash holdings and therefore its asset base. For the manager whose pay is tied to asset value, it is easy to see why buybacks would be resisted even when it would benefit the shareholders who patiently await a healthier capital return.

Also raising shareholder ire was the fact that the PRS board had, earlier in 2024, announced Sigma’s contract would be extended to June 2029.

The obvious concern of such a long, fixed contract is the creation of a ‘poison pill’. I have written before about the virtues of M&A activity as a value underpin for shareholders dealing with stubborn discounts. But should PRS Reit become an acquisition target, any interested party would be obligated to compensate the manager for the remaining years of the contract, a sum amounting to tens of millions of pounds. This payout would have to be deducted from any value paid to shareholders.

The shareholders also pointed out that PRS’s estate of family homes, for which it had previously raised £560m from shareholders to develop, is almost entirely built and the company cannot raise fresh equity to develop more homes due to its persistent discount to NAV.

So, while the manager’s fee was to be slightly reduced, the job would soon become much easier as it moves from overseeing the construction of hundreds of homes into the simpler task of tenanting and operating these homes. In short, the manager was taking a negligible pay cut and ensuring that any changes to their employment would involve protracted contract breakage discussions, while enjoying a significant reduction in responsibilities.

In the end, the board reached an agreement with the requisitioning shareholders. Current non-executive chair Steve Smith will step down at PRS’ next annual general meeting and Geeta Nanda, senior independent director, will take the chair for an interim period while leading the process to appoint a permanent replacement.

Meanwhile, both Robert Naylor and Christopher Mills of Harwood Capital have been appointed to the board as non-executive directors.

Good governance in Germany

We also have another poster child for good governance: one where board and management have worked together to re-engineer the incentivisation and contract costs. The stock is Phoenix Spree Deutschland (PSDL ), a small-cap portfolio of prime Berlin residential properties, where the strategy has evolved to one of de-gearing and asset sales given the gulf between share price and asset values.

The absolute fee paid to its external manager, QSix, has been reduced twice in the past two years, with management given an additional incentive to sell assets – in line with the board’s strategy. It is also worth noting that the manager is keen to impress shareholders as its contract has a continuation vote in July 2025. It is time for all Reit boards to take this type of decisive action and champion governance practices that safeguard the interests of shareholders.

It is possible to get external management right, with good controls including fees based on market capitalisation, a lead manager that eats their own cooking, and one-year – maximum – rolling management contracts. And when a board recognises the need to address a bad external management contract, swift and decisive action to improve governance strengthens governance and helps to ensure long-term value for investors.

The actions of PRS Reit shareholders are an important blueprint for driving essential governance reforms and ensuring that management priorities remain aligned with shareholder interests. The change in PRS Reit board personnel and the upcoming strategy review are welcome consequences. This is a clear victory for investor-led accountability.

Citywire AA-rated Marcus Phayre-Mudge is the fund manager of TR Property Investment Trust (TRY ).

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