During the past year, significant discussions emerged from the popular press predicting the demise of traditional retailing and the ascendancy of Internet shopping. Some analysts predict that Internet sales could approach $50 billion in three or four years, which would account for approximately 2.5% of all retail sales.

Needless to say, the impact of E-commerce on the levels and approaches to executive and employee compensation is not imminent.

Much more influential on compensation practices of the retail sector are the strong profits reported by many retail tenants and the slowdown in consolidations by retailers. Both of these factors have made the retail real estate sector an attractive opportunity for investors, regardless of whether they are private or institutional.

While 1999 has seen the slowdown of consolidations by retailers, 1998 saw a substantial amount of merger activity in retail real estate. It has been estimated that, in the third quarter alone, more than $10 billion of transactions were completed. Two of the more significant transactions of 1998 were:

* Simon Property Group's nearly $6 billion acquisition of Corporate Property Investors. This merger serves to reinforce the company's strong presence nationwide.

* The acquisition of Excel Realty Trust by New Plan Realty Trust. This transaction created one of the largest strip center companies in the country. The new company now owns and operates nearly 300 properties.

Other major transactions included acquisitions involving The Rouse Co., Developers Diversified Realty, Westfield America, Kimco, Glimcher Realty and Bradley Real Estate. All of the above completed deals totaled in excess of $300 million.

Lessened availability of capital in 1999 has slowed the pace of acquisition transactions, but the development pipeline continues to move forward as the retail industry focuses on growth from core operations, with the construction of retail centers continuing briskly across the country. Older regional malls, unanchored strip centers and discount power centers are reinventing and/or repositioning themselves for the coming of the millennium.

While some may find business activity within the retail sector unsettling, for most, the continued strong activity and demand is viewed in a positive light. 1999 should be a year that sees further strengthening of employee compensation levels.

Retail real estate performance should lead to larger and more frequent salary increases, larger bonus or commission awards, expanded participation in long-term or deferred compensation arrangements, and the expansion of employee benefits.

Base salaries fluctuate FPL Associates' recent study of the retail real estate industry's compensation trends shows a dramatic increase in the level of interest attached to this subject. Participation in the 1999 study reached a record high, with the addition of several mega-corporations and regionally focused enterprises.

This year's survey includes compensation data on more than 1,500 incumbents. Table 1 summarizes the salary information for 20 positions organized into five categories: staff, leasing, construction, development and operations.

For most positions, we observed base salary increases in the 5% to 7% range. While the average increase was not dramatically different from 1998, the number of incumbents receiving raises was generally up. In many organizations, virtually everyone received an increase, which has not been the situation in periods of tighter budgets.

Certain areas of the organization received slightly stronger increases than others. Property operations and financial positions received increases that frequently ranged from 7% to 12%.

The importance of cash flow from operations is being rewarded. Given a continued healthy real estate and economic environment, we would expect this pattern to continue for the next few years.

Same position, different pay ... why? An examination of the high and low salary ranges demonstrates the wide dispersion of compensation for positions that have the same basic level of responsibility. Based on our experience, the difference in salary level normally can be attributed to a few key variables. Two significant factors are the scope of the position and pay philosophy.

Scope of the position. A strong correlation usually exists between salary levels and the business variable that drives the complexity or challenge of the position. The practical application of this simple concept is, however, quite difficult to demonstrate.

Salary levels at the executive level would correlate, for example, with market capitalization, sales revenue, asset value, etc. For operations management positions, the relationship could exist with the number of properties managed, square footage, operating income, etc.

FPL Associates is currently conducting a major research initiative to further investigate this issue. Our analysis will attempt to identify the key variables that have the strongest impact on individual positions within the retail, multifamily and office asset classes.

Pay philosophy. Compensation philosophy and strategy directly impacts the establishment of salary levels. A company's pay philosophy frequently addresses the following issues: comparative peer group; positioning of salary in the market; and the role of salary in total compensation.

Additional factors that affect salary levels are: Are low salaries offset by high incentives? Who is the competition? Do you lead or are you in the middle of the market?

Annual incentives In this section, we examine if the increase in salary dispersion continues into total annual compensation through the use of annual incentives or commission awards.

In 1998, the most direct influence on retail real estate professionals' total compensation was performance. This included performance at the corporate, regional and property (mall/shopping center) levels. A growing portion of a professional's compensation is dependent not only on how well they performed individually but also on how well their business performed.

In Table 2, we present total annual compensation figures. Total annual compensation is defined to include the sum of an incumbent's base salary plus their annual incentive, bonus or commission payment. Bonus payments made in 1999 or at the end of 1998 were, in most cases, for performance during the 1998 year.

In evaluating the total annual compensation in 1998, one finds that virtually every position across companies was up over 1997. Increased business performance resulted in increases in total annual compensation from 1997 to 1998.

Table 3 summarizes these compensation increases by functional area. 1998 compensation reflected the emphasis of developing new projects and improving the bottom line, with development and financial management areas receiving total increases in the 20% to 30% range.

Performance measures Annual incentive plans are designed to establish a proper relationship between what an individual is expected to accomplish and the performance of their property, region or corporation.

As retail real estate companies grow more sophisticated and complex, compensation programs will likely become more formalized and structured. For example, a company might identify an incentive opportunity range for each general level of position that will participate, as well as a corresponding level of expected performance.

The larger and more geographically dispersed a company gets, the more difficult it is to establish assessment or performance evaluations that are consistent and objective. In order for a more structured incentive arrangement to succeed, there must be agreement on the compensable performance measures and standards.

For example, performance standards might be established for consistency with the following definitions of performance.

Threshold performance - signifies minimally acceptable achievement, but falls short of targets. This represents the performance level that has to be achieved before any bonus will be earned.

Target performance - signifies a stretch achievement that normally means meeting the business objectives. In many situations, this would represent budget-level performance.

Maximum performance - signifies a significant achievement, and would be considered above-average performance by industry standards.

Table 4 shows typical performance-level opportunities as a percent of base salary. Identifying and agreeing on the key performance measures and standards is critically important if a company's pay-for-performance program is to have credibility and effectiveness.

Future considerations With another year that promises continued growth and business activity in the retail sector, retail real estate performance will most likely lead to larger and more frequent compensation awards at all levels.

Understanding the scope of the position and formulating a clear and concise pay philosophy will be key issues as companies attempt to remain competitive. This will necessitate monitoring both individual and business performance, leading to the development of annual incentive plans that establish clear pay-for-performance programs.

Companies taking such steps will be better equipped to attract and retain high-caliber employees.