Compensation Trends within the Retail Real Estate Industry
By Cimi B. Silverberg
Director, FPL Associates Consulting
Recent economic turmoil is affecting the retail real estate sector in a variety of ways. On one hand, the stock market declines during the fourth quarter of 2000 (which have continued into 2001) have shaken consumer confidence, and one would expect a decrease in consumer spending. Chicago-based Montgomery Ward, who filed for Chapter 11 bankruptcy protection in December of 2000, and closed 250 stores in 30 states during the first quarter of 2001 was one such fatality.
On the other hand, investment in real estate has increased, as investors shift capital from risky technology companies to the more stable real estate sector. While the S&P 500 decreased by 12% and the NASDAQ fell more than 25% in the first quarter of 2001, the Morgan Stanley REIT index was down a mere 0.5%. Retail REITs were one of the top three performing REIT sectors with a total return of 7.5% for the first quarter of 2001. According to SNL Real Estate Securities Weekly, outlet centers boasted a total return of 10.2%, enclosed malls earned a total return of 7.3% and shopping centers had a total return of 7.1%.
A February 5, 2001 report on a survey conducted by Merrill Lynch & Company, states that demand for retail real estate decreased slightly from 2000. The "community/power center anchors" sector is the only sector planning to open more new stores this year than last year. The mall specialty stores, community center tenants, and power center anchors expect to open new stores in 2001, although fewer than they opened in 2000, while the mall anchors anticipate a net closing of stores (most likely due to the 44 stores J.C. Penney expects to close in 2001). However, Merrill Lynch analysts have positive expectations for neighborhood shopping centers with large grocery store anchors due to the "more stable and predictable income stream during an economic slowdown."
Over the past year there has also been some consolidation and privatization in the retail real estate industry, and analysts expect such consolidation to continue. To name a few: Rodamco North America purchased Urban Shopping Centers, Inc.; Heritage Property Investment Trust acquired Bradley Real Estate, Inc.; U.S. Retail Partners, LLC bought out First Washington Realty Trust, and Pan Pacific Retail Properties acquired Western Properties Trust.
As the industry continues to change, the type of personnel and talent required to lead these organizations is evolving. Management teams at many large real estate companies are shifting from "entrepreneurial founders" to more institutional and professionally managed teams. Succession planning issues are beginning to arise within larger companies, as these founders pass on the torch to the next generation.
So, how will these changes impact executive and employee compensation? While the full effects of the industry commotion will take time to fully emerge, one thing is clear: organizations continue to focus their efforts on recruiting, retaining and rewarding appropriate talent. Retail real estate companies must design and implement pay strategies that effectively motivate management to achieve corporate, business unit, and individual goals.
FPL Associates Consulting is in the process of conducting its annual study of the compensation practices within the retail real estate industry. In the discussion that follows, FPL provides preliminary results from that study.
Table 1 summarizes base salary data for eighteen positions organized into the following categories: staff, leasing, construction, development and operations.
For most positions we observed base salary increases in the 4% to 10% range, which is similar to the percentage increases from last year. The functional areas that received slightly stronger increases than others were leasing and property management. Senior-level positions received smaller increases in base salary, with a greater portion of compensation provided in the form of annual and long-term incentives.
2000-2001 Market Competitive Base Salaries
Wide ranges from the lower quartile to the upper quartile of base salary for a given position can be attributed to several factors: the scope of the position, the size of the organization, the experience level of the incumbent, the incumbents’ past performance, and potentially, geographic location, among others. Compensation philosophy and strategy also directly impact salary levels. A company’s pay philosophy frequently addresses the following issues: comparative peer group, positioning of salary within the competitive market, and the role of salary in total compensation. For example, a company’s philosophy may be to provide base salaries at the upper quartile of the marketplace, while another company’s philosophy may be to provide lower than median market salaries offset by higher incentive opportunities.
Geographic Salary Differentials
While the compensation information presented in this article represents a national average, questions often arise regarding the variances in pay for cities across the United States. Individuals should be aware of two key issues when exploring the idea of geographic salary differentials.
- Pay practice differences are not necessarily the same as cost of living differences. The classic example is Boston, which has a high cost of living, but has relatively modest salary levels, due to the great number of young professionals who desire to live and work within the city.
- Geographic differentials tend to have less of an influence on higher salary levels. For example, an administrative assistant in Des Moines, Iowa will be paid far less than the same position would receive in New York City. However, Chief Executive Officers are less affected by geographic differentials. Rather, industry, company size and performance are more significant factors when considering pay for higher-level executives.
Annual Incentives and Total Annual Compensation
As companies strive to link pay to performance, the portion of a professional’s compensation that is provided through the annual incentive or bonus is increasing over time. As a percentage of salary, the earnings opportunity is higher for more senior positions, and decreases as one moves down the organizational hierarchy. However, several positions don’t necessarily follow this pattern. For example, the annual bonus and/or commission may be the largest component of compensation for leasing positions, with a relatively modest base salary.
There is also a difference in cash compensation between public and private companies. For key executives and members of the management team, private companies tend to pay lower cash compensation with higher long-term incentive opportunities as compared to public companies.
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 2001 or at the end of 2000 were, in most cases, for performance during the year 2000.
2000 Total Annual Compensation Levels
Long-Term Incentive Compensation
A growing proportion of compensation is provided to executives in the form of long-term incentive compensation. Over eighty percent of reporting companies provide some form of long-term incentive compensation to one or more of their employees.
Long-term incentive compensation seems to be more prevalent in public companies. However, within private companies, certain senior executives often have an equity ownership in a particular asset or portfolio of assets. Because executives often purchase these equity positions, executives may not consider such arrangements as "compensation" although they do provide incentives to management.
In most companies, long-term incentive compensation is reserved for awards to the senior-most executives. Yet, several companies have provided long-term incentive compensation to mid-level and lower-level management positions. In the real estate industry, in general, several companies provided long-term incentive compensation to lower-level positions in order to compete with high-tech companies who provide options to almost all of their employees. It remains to be seen whether companies continue this practice, as a result of the "dot-com" shake up.
Within public companies, the most commonly utilized long-term incentive vehicles are stock options (both incentive stock options and non-qualified stock options) and restricted stock. Whereas in prior years, most public companies utilized option-only programs, FPL has seen a growing trend toward the use of restricted stock in conjunction with options. Within the private sector, phantom equity arrangements and participation in real estate assets and portfolios are more prevalent. Some private companies provide equity (options or stock) in the company itself, similar to public long-term incentive models.
Several public companies have created "private-like" long-term incentive vehicles. For example, several public real estate companies have created asset value participation programs, primarily for development professionals, in order to prevent their development professionals from defecting to the private sector. Other companies have created "synthetic" vehicles, that are phantom instruments tied to one or a number of performance-based objectives such as stock price, real estate asset value, portfolio value, corporate enterprise value, FFO growth, relative shareholder return vs. an index, etc. These synthetic vehicles allow more flexibility (i.e., they can be tied to multiple performance measures, both market and operations based), and they conserve shares reserved under the company’s long-term incentive plans.
Table 3 illustrates the typical mix of base salary, annual incentives (bonus), and long-term incentives for the top three executives within a typical organization. As one moves down the organizational hierarchy, base salary is a larger proportion of total compensation. At middle management and junior levels, long-term incentive compensation makes up little or no portion of total remuneration.
Typical Compensation Mix for Executive Officers
Shopping Center Owners/Managers: Perceptions of Year 2000 Performance
Shopping center owners and managers were varied in rating their financial performance during the year 2000. 61% of respondents reported results better than 1999, with 22% reporting their best year ever. In 1999, 25% reported that they had the best year ever. 17% reported that 2000 performance was worse than 1999, with 6% reporting that performance was "significantly worse" than 1999. In 1999, 5% of companies reported that their financial performance was significantly worse than the prior year, and in 1998, no companies reported performance that was worse than the prior year. Table 4 summarizes the perceptions of year 2000 financial performance versus the prior year, for the survey participants.
Shopping Center Owners/Managers: Perceptions of Year 2000 Performance
Because the decline in the economy will have effects on both the retail and the real estate industries, retail real estate companies should brace themselves for a rocky ride. It will be interesting to see if companies truly use a "pay for performance" philosophy. We already know that compensation increases when performance increases, but if performance decreases, will compensation decrease? That is, are wages truly "sticky"?
Executive management must fully understand the scope and responsibilities of each position within their organization and effectively communicate this information to each employee. Furthermore, a concise and understandable compensation philosophy will help organizations develop compensation programs that effectively motivate management to achieve company goals. Companies that have an organized compensation philosophy and effectively designed compensation programs will be better positioned to attract and retain high-quality talent.
Cimi Silverberg is a Director with FPL Associates, L.P., a subsidiary of FPL Advisory Group, in Chicago, IL. FPL Advisory Group offers a unique combination of human resources, management consulting, executive compensation, and financial advisory services to the real estate and financial services industries.