8 Trends That Will Shape, Challenge REIT Compensation Practices

There is ample evidence that the collapse of the financial markets and the economic downturn both domestically and worldwide over the past two years have had a severe impact on real estate capital, liquidity and asset values. For executive compensation, the downward pressure is widespread on performance and pay, policy and precedent, and in both public and private enterprises.

Every structural change in the real estate industry resulting from this recession will have an impact on executive pay, and these changes will be compounded by new and prospective regulatory actions aimed at restricting and regulating CEO and executive compensation.

No one knows the exact timing of an economic turnaround much less its "shape", but clearly the forces affecting executive compensation and its governance are many more than ever before. Each of these forces must be approached carefully in order to craft appropriate strategies that will guide the design, management and alignment of incentive programs capable of attracting and retaining talent and motivating leadership, while correlating with risk, performance and future sustainable growth.

It is not too soon, and in fact it is the appropriate time, to consider the many forces that will influence executive compensation over the next few years, and the strategies, policy and practices needed to effectively re-structure incentive, performance measurement, and compensation governance. Here is a look at eight of the key issues going forward.

Reality and Rollback
  • The economic downturn has been the cause of major shifts in compensation practices.
  • Asset value loss and operating cost pressure will make management and boards hesitant and conservative in unfreezing and/or reinstating reduced base salaries, raising target incentive opportunities, and recovering long-term incentive values and award levels.
  • Management will need to re-assess general policy on how to sustain morale and pay/retain key employees, compounded by attention to new regulations and need for creative new pay practices.
Regulatory Actions
  • As witnessed in Federal bailout conditions, executive compensation is one of the recession's scapegoats, and pay restriction actions tested in the financial services sector will be ripe for precedent in "broader" reform. 
  • Shareholder "Say-on-Pay," greater disclosure, splitting CEO/chairman role, annual board re-election, and other restrictions/regulations are now being considered by the SEC and Congress. 
  • Any approvals will impact REIT (as well as all public company) compensation and governance practices, increasing complexity, analysis, disclosure, cost, and creativity to an industry that has earned high marks in governance.
Shareholder Involvement
  • "Say-on-Pay" may well pass (although non-binding), and with it, bring a new and different era of plan design, approval timing, award rationale, and shareholder communication needs.
  • "Say-on-Pay" would push compensation committees to establish greater outreach, dialogue, idea exchange and communication programs with institutional and individual shareholders, diluting time from other matters, increasing resource needs and integrating feedback/input.
  • To avoid undermining governance, shareholder vote will likely have influence on greater strategic alignment, more long-term performance triggers, and restrictions in size, cash and payout terms.
Reinforcing Performance
  • With new regulatory oversight, current vs. future executive compensation design will increase its emphasis on performance, requiring adapting plans to new realities of opportunities and growth.
  • To bridge the economic downturn, compensation plans may emphasize greater discretion by boards, "interim" incentive plans oriented to operating survival, and deferred incentives.
  • Emerging plan design issues include: re-calibrating awards to new performance expectations; multi-year performance sustainability; indexing; greater emphasis on strategic goals; leadership development; and restricted holding periods/triggers/ownership, including post separation.
Proxy: From Disclosure to Marketing
  • The disclosure requirements for compensation information in the SEC Proxy Statement (and CD&A) have been increasing annually and "Say-on-Pay" will make it even more challenging.
  • With a shareholder non-binding vote, the Proxy as a legal document may well need to transform into a better marketing/shareholder communication tool. SEC disclosure doesn't fully reflect LTIP value loss, a needed perspective to fairly chronicle pay vs. performance.
  • Less obscure, more specific, more detailed, footnotes presented in other formats, greater clarity and more rationale are a few of the potential changes in the style and communications capacity.
New Views of Risk and Return
  • Capital in-flow over the last decade of market growth made REITs an accessible asset class, sold for diversification and income, and with broadly similar patterns of performance among various REIT sectors.
  • In recovery, will investors be aggressive to make up lost value and be less risk averse, or the opposite? Scrutiny will increase REIT sub-sector and company specific analysis and strategy.
  • Greater distinctions among sectors/companies in the face of increased disclosure/scrutiny may alter REIT compensation review, requiring more explicit definition of peer groups and absolute/relative performance metrics, and reduce the validity of cross-sector, asset-based peer groups.
New Governance Challenges
  • Proposed regulatory changes could incorrectly shift board accountability of compensation from independent analysis and review, toward day-to-day decision making. The paradox of greater governing complexity and the need for simplicity in concept/communication expands.
  • The future may require compensation committees to have more outside resources, advising on a continuous more than intermittent basis, expanded membership, more frequent meetings, and increased compensation.
Demand for Top Talent Endures
  • Executive compensation will always in part be driven by the supply and demand for recruiting and retaining top talent and this element in the equation of compensation will not change.
  • The management needs of the real estate industry are well documented, and with potentially many key industry leaders retiring in the next few years, the need to focus on succession planning grows.
  • Regardless of regulatory change and recovering market opportunities/realities, executive compensation trends, plans, design and governance will play a significant role in future success.
Author Credit: James B. Wright is managing partner of CEL Compensation Advisors, LLC. This article has been summarized and adapted for NAREIT's use. To receive the full version of this article, including 12 trends, contact the author at jim@celassociates.com.