NEW YORK CITY—In today's volatile and constantly changing real estate market, REITs are tasked with designing compensation programs that align management with the strategic goals of the company and still stay within market boundaries. REITs are further challenged to ensure that their key employees are retained and motivated over the long term. These challenges are forcing REITs to relook at their compensation programs to ensure their short-term cash bonus programs, long-term equity vehicles and employment contracts are state of the art and are meeting the needs of their employees and shareholders.

Short Term: Bonus Metrics

In a market of steady growth and profitability, establishing performance targets for short-term incentives is relatively easy. However, in a market where there is a disconnect between stock prices and perceived asset values, as well as shifting strategies to account for a growing number of tenant bankruptcies and the impact resulting from technology, setting performance targets can be more challenging.

In a declining market, management may deem it appropriate to set lower performance targets than those of previous years in order to align performance goals with the realities of the market. Doing so can help employees focus on the organization's long-term strategy as they navigate towards longer-term profit growth. In this circumstance, REITs should also consider including more significant stretch goals for maximum payouts than in prior compensation plans, given that above-target payouts will be harder to justify during those periods, and that a much stronger effort will be required to attain goals.

Shareholders are generally sympathetic to these circumstances and request that the business objectives and the reasons for the reduced metrics be explained clearly in the proxy statement.

Long-term: Going Beyond TSR Metrics

Tying long-term incentives to total shareholder return (“TSR”) measures may present a challenge due to TSR's inherent reliance on macroeconomic factors that (a) management has no control over and (b) therefore make it difficult to design performance-based equity compensation. Disruptive factors such as asset undervaluation or large tenant bankruptcies also present challenges to a TSR-only strategy for designing long-term compensation programs.

For these reasons, non-TSR metrics related to long-term operational measures are increasingly prevalent. In fact, our 2018 Executive Compensation Report: Real Estate Industry Long-Term Incentive Compensation Practices found that 37% of REITS use a non-TSR metric to determine the vesting of performance shares—a percentage that is projected to continue rising.

Select investors and proxy advisory firms have been calling for metric diversification through more long-term (non-TSR) operational measures. Some reasons for non-TSR factors are that they:

Help management retain focus on accomplishing long-term strategic priorities that may enhance long-term value,
Provide a more direct correlation between company results and payout, and
Enable greater flexibility around strategy that may need to shift in order to deal with disruptive factors—a shift that can be incorporated into the compensation program through long-term incentives.

Trends in Special Awards and Severance

Special compensation awards such as the one-time stock award are falling out of favor in the REIT industry. The one-time stock award has come under greater scrutiny in recent years by proxy advisors and institutional shareholders—one reason being that investors generally prefer compensation that is structured in advance over incentive grants that fall outside of the regular compensation program. Although boards and compensation committees may have strong rationale to award special incentive grants, the business justification for these has increased over time with many companies opting in favor of other alternative approaches.

On the other end of compensation programs, yet intricately tied and essential, are severance/separation arrangements and change-in-control provisions; when these provisions are spelled out, they reduce litigation risk for the employer and enhance employees' sense of security. Within the REIT industry, the need to have proper, market-based severance plans in place is receiving greater emphasis due to heightened M&A activity. Some factors to review in the REIT's severance policies are:

Structures for different employee levels (employee agreements, individual vs. company-wide severance policies),
Severance formulas for executives and other employees,
How performance-based equity awards are treated after termination or in connection with change-in-control, and
Tax implications of a change-in-control (including 280G and 4999 excise tax exposure) and 409A compliance.

The long and short of a REIT executive compensation program is that the organization's strategy should impact that compensation model . . . but designing a program that also meets the challenges of today's marketplace may require a shift away from the norm or investor expectations.

Larry Portal is a senior managing director in the real estate solutions practice at FTI Consulting and co-lead of the executive compensation practice. Katie Gaynor is a managing director at FTI Consulting and co-lead of the executive compensation practice.

The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals. FTI Consulting, Inc., including its subsidiaries and affiliates, is a consulting firm and is not a certified public accounting firm or a law firm. The views in this article are not those of ALM's Real Estate Media Group.

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Strategies and Challenges of REIT Executive Compensation Programs

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