UP Front: Compensation for Corporate Real Estate Professionals Jumps
In a recent survey of corporate real estate executives at corporations globally, 87% reported that their base salary increased from 2017 to 2018, by…
In a recent survey of corporate real estate executives at corporations globally, 87% reported that their base salary increased from 2017 to 2018, by an average of 5.3%. In addition, 80% projected further increases of roughly 4% on average in 2019, according to a survey conducted by CoreNet Global and FPL Associates.
Total annual remuneration, including long-term incentives, for a global head of corporate real estate was $385,000 in 2018, compared to $339,000 in 2017.
“Salary increases continue to be the predominant practice for CRE and other real estate sectors. The prevalence of bonus increases, however, continues to be split between firms indicating increasing awards (~50%) and no change from the prior year. We have found this is largely due to firms indicating that performance based incentives are falling at or near target,” said FPL Associates.
The function of corporate real estate is an increasingly strategic function of the corporation–directly tied to many others, including workplace strategy and design, corporate finance, site location and often overall corporate branding.
Corporate real estate professionals have strategic responsibility for their corporations’ total real estate footprint of owned and leased space; they generally manage portfolios with millions of square feet of property spanning multiple continents. Corporate real estate touches all classes of property, land and buildings such as office facilities, data centers, manufacturing facilities, logistic centers, corporate headquarters, distribution facilities, retail stores and hotels.
The average corporate real estate department that participated in the survey manages 505 locations and more than 35 million square feet. The companies represented had an average of 41,000 employees and an average of $40 billion in annual revenue.
“We know that corporate real estate for the last several years has become an increasingly strategic function within the corporate hierarchy, which is why compensation levels have been consistently increasing year to year,” said Tim Venable, Senior Vice President at CoreNet Global. “This year in particular, CoreNet Global completed FutureForward 2025, which is a projection of how the profession will continue to evolve and how CoreNet Global will respond. We believe that corporate real estate will become a broader function that encompasses the overall employee experience.”—Natalie Dolce
INVESTORS’ VIEW: Private Equity Investors’ Interest in CRE Begins to Slow
Private real estate investors are showing signs of approaching investments with greater caution, according to Preqin. Real estate investors issued 215 fund searches in Q1 2019, the majority, or 61%, of which was for a single-fund commitment. By contrast, only 8% searched for a single-fund commitment a year ago. A third of investors are looking to make 2-9 new commitments this year and 6% will target 10 or more funds, according to Preqin. Another worrisome data point: 63% of investors are looking to commit less than $100 million to real estate in the year ahead, compared to 46% in Q1 2018.
Preqin’s survey also showed that investors’ appetite for risk is waning with 61% of fund searches in Q1 2019 fore core real estate funds, up from 53% in Q1 2018. By contrast, 45% of investors will each target value-added and opportunistic funds, down from 55% and 48% at the start of 2018 respectively.
Preqin also reported that deal-making stalled in the first quarter, with 1,997 deals globally worth a combined $79 billion closing during that time frame. In almost every quarter of 2018, by contrast, at least $100 billion in deals closed for a total of more than 9,000. —Erika Morphy
BEHIND THE DEAL: Realty Mogul Hits 300 Projects Funded
Crowdfunding platform Realty Mogul has surpassed 300 projects funded. While this is a significant milestone for the crowdfunding market, it is also an impressive achievement for a private equity firm in general. “There are very few private equity firms in real estate that have financed 300 assets,” says Jilliene Helman, CEO at Realty Mogul. “While our transaction sizes are smaller than most private equity firms, the fact that we now have operating data on over 300 properties gives us a true competitive advantage with data. This is very much in line with our growth expectations.”
Realty Mogul has focused on value-add multifamily deals, and will continue to target these assets in its investment strategy. Of the 300 assets funded, 60% were value-add multifamily deals. “While there is risk in every real estate investment, we have found value-add multifamily transactions to be quite attractive as they mix current cash flow from existing tenants with the opportunity for appreciation from value-add renovations and increasing rental rates over time,” says Helman. “I am also a big believer in diversification and the majority of the investments we make in multifamily are 100-plus units so if one tenant moves out, the property as s whole can still perform.”
Looking ahead, Realty Mogul plans to execute a similar strategy to grow the platform. “Our goal is to continue to grow assets under management by investing in high quality commercial real estate where we like the risk-reward calculation,” says Helman. “To date we have distributed over $100 million back to our investors and we strive to help investors build wealth through commercial real estate.”—Kelsi Maree Borland
SECTOR VIEW: Near-Term Outlook for Lodging Remains Positive (But Fragile)
Although the hotel industry has been operating at peak levels for several years, accelerated supply growth, which has been readily absorbed in most markets due to the expanding economy, has contributed to weaker than normal average room rate growth. Furthermore, despite shortages of, and escalating costs of labor, on average nationally hotel owners and managers have sufficiently controlled other operating costs to achieve the highest levels of gross operating profit margins in more than fifty years. With this said, due in part to rising minimum wage rates, profit margins of numerous assets situated in major US markets have contracted.
Current threats to the U.S. lodging industry include (but are not limited to): continued international trade tensions and effects from tariff rate implementation, domestic and international political uncertainty, natural disasters, terrorism, maturation of Airbnb as it delves deeper into the mainstream hotel market, and OTA pricing transparency placing negative pressure on room rate growth. The sector continues to be challenged with continued historically low unemployment and rapidly rising wages, as well as property tax and insurance expenses increasing at levels well above underlying inflation. Although the nation is experiencing a slowdown of inbound international demand, domestic air passenger growth remains steady. Notwithstanding a cautious backdrop due to a variety of heightened macro/growth concerns, hotel financing continues to be widely available with debt providers competing by narrowing spreads even with interest rates falling once again. Furthermore, an array of investable foreign and domestic equity is broadly available as record amounts of capital chases yield.
While the fundamentals of the US lodging industry are simultaneously favorable to buy, sell, refinance, and develop a variety of lodging product types, and the near-term outlook for lodging remains positive, given the myriad of global and domestic issues that can rapidly develop into full blown crises, short term future industry performance is fragile.—Daniel H. Lesser
LOCAL SPOTLIGHT: WASHINGTON, DC: Is the Love Affair Between Foreign Investors and DC Ending?
Net foreign investment in the Washington, DC office market fell into the negative in Q1 2019 after posting a sharp decline the prior year, according to a JLL research note. Prior to this overseas capital flooded the market at record levels from 2015-2017. Report author John Andril, Senior Research Analyst, Office Capital Markets notes that there are several reasons for this drop:
Lack of Trophy offerings: Foreign investors in Washington, DC heavily favor the downtown Trophy office segment, and over the past few years, there has rarely been more than one Trophy asset for sale at a time, Andril writes. “It has been seven months since the last Trophy sale, and there is currently just one Trophy building being marketed.” Compare that to the preceding five years, when a Trophy office building traded hands every four months on average.
Pricing/rent disconnect & cap rate compression: The competition for DC’s limited Trophy offerings has led to a series of record-priced sales over the past few years despite a complete lack of underlying rent growth. In fact, Trophy rents declined by 2.4% between 2017 and Q1 2019, Andril writes. “Absent any growth in rental income, Trophy cap rates compressed to an average of 4.0%-4.25%, pushing many investors to seek higher yield in other real estate markets or other asset classes altogether,” he says. Property owners decided to pull nine buildings from the market last year after failing to achieve their pricing expectations in the face of a thinning buyer pool—including two that were targeting more than $1,000 per square foot.
Rising hedging costs: Fluctuations in the US dollar have driven up the hedging costs associated with owning dollar-denominated assets including US real estate, according to the research note. “Currently exceeding 2% of total investment for European buyers, these costs erode potential returns and dramatically narrow the field of office investment opportunities that make financial sense,” it says.
Tightened CFIUS restrictions: As a result of the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), a broadened range of foreign investments are subject to review by the Committee on Foreign Investment in the US (CFIUS). This process has the potential to impede or prevent foreign purchases of buildings that are leased to the federal government or are even proximate to such buildings, Andril writes. “Needless to say, a sizeable portion of the Washington, DC office inventory falls into these categories.”
The conclusion of the report offers a glimmer of hope to DC landlords.
“Although these factors have dampened demand and volume in Q1, expect foreign capital to return to Washington, DC over the remainder of the year,” according to Andril. He notes that there are currently four stabilized, core-profile Trophy/Class A offerings on the market alongside an additional six coming to the market—and these opportunities are certain to attract overseas investors.—Erika Morphy
COMPENSATION TRENDS: REIT Executive Compensation Strategies and Challenges
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
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. The views in this article are not necessarily those of ALM’s Real Estate Media Group.
Exec Watch
Michael J. Franco has been promoted to president of Vornado Realty Trust. Franco, 50, who has been with Vornado since 2011, was one of a number of what Vornado chairman and CEO Steven Roth termed as “important and even generational” changes in its senior management. Franco most recently served as EVP-chief investment officer at Vornado where he has been the lead for acquisitions, dispositions and financings and has been involved in all the REIT’s important decisions and strategy.