The combination of a financial crisis, human resources consultants and the rise of millennials has ushered in a new focus on real estate private equity (PE) values. The discussion today is around work-life balance, integrity, giving back, diversity and feedback.
The much-discussed, over-generalized and often-misunderstood millennial generation is today the front line of deal teams. They are the ones cranking out models and doing the research, and they are key owners in the delivery of reporting packages to investment committees.
So which approach to millennials is the best, and which firms have it right? The answer to both questions is “none.”
The high-turnover firms place too little value on management skills and, in exchange, tolerate the cost of higher than necessary turnover. The apprenticeship model is also flawed, as it erodes the flow of new talent up through the organization, hollowing out what should be dynamic middle management.
The art is to understand the candidates you are hiring, the schools from which you can attract the best candidates, and whether or not candidates should be MBAs. Firms then need to have a clear understanding of what they have to offer candidates in the form of compensation, résumé credibility and culture.
It always starts with compensation
Real estate PE managers need to make better use of deferred compensation plans, which should be a powerful and hugely attractive tool in their effort to attract, motivate, align and retain the very best (young) talent.
Many deferred compensation structures, and particularly those of privately owned, small or mid-tier managers, need a refresh to:
- Be more widely accessible to employees
- Provide greater liquidity
- Incorporate a broader suite of recognition awards to drive better performance behavior.
With good communication, an evolved deferred compensation plan should also help improve retention, allowing a manager to develop a strong and successful culture. Senior employees “buy into” the business and can spend a significant proportion of their careers, or their entire careers, with one employer.
We believe small and mid-tier, privately owned managers in particular need to reinvigorate their deferred compensation plans. Team continuity and the disruption of turnover can be solved through vesting, but long vesting periods need to be paired with an appropriate award level.
A well-balanced plan designed for today’s work environment can be a huge incentive that helps attract, motivate, align and retain the very best young talent.
Attributes of unit award programs
Who is eligible to participate in deferred comp structures?
Leadership, senior staff (e.g. CAO) and front office real estate staff down to VP acquisitions.
What percent of the manager’s interest is granted to employees?
As low as 15% in isolated cases but 25%-40% the most common response.
What is the vesting period?
About one-third of those surveyed said more than five years. But other funds are structured around milestones (first close, final close, end investment period, life of fund) or one-third year one, one-third year three and one-third at realization. Different structures for development orientated deals or development orientated funds (milestones at acquisition, one year in and monetization).
Once vested, does the employee retain the units if they leave the company or is there a mechanism to buy their interest?
Very much depends upon what terms the employee leaves and where they go, but most plans have a mechanism to cover departure with scope to buy out unvested awards (often at a discount).
Does the fund distribute cash awards when earned by the manager or is a portion withheld?
Most distribute 100% or 100% less expenses.
Do you have clawback provisions?
Typically yes. The only exceptions were where structures are very back loaded.
How does your compensation plan meet the needs of tax obligations?
Most entities make tax distributions to address the issue of phantom income, but that is not a universal approach. In some instances, employees have to address this issue themselves. Tax distributions are likely to be subject to clawback if any.
Real estate execs on millennials:
Millennials think they are worth more than market”
Some of the younger acquisition people think they deserve the world”
May perceive themselves to be entitled to more”
Want to understand how they fit and what their career looks like”
Evolving the deferred compensation model to incentivize the private equity real estate executive of the future
Many listed private equity platforms have refined incentive and reward programs to closely align to the performance of their portfolio of funds. Moreover, investor questionnaires are becoming ever more probing into matters around alignment.
This encourages senior staff and other employees to focus on the underlying results of investment funds, as well as the overall performance of the firm and interests of unitholders.
Typically, cash payments to employees relating to carried interest are only made when profitable investments have been realized, and cash is distributed first to investors, then to the firm and finally to employees of the firm. Furthermore, deferred remuneration is often based on a mix of specific fund performance and the wider success of the organization.
The real estate industry is also evolving as emerging trends reshape the way we use the built environment. Private equity real estate funds will need to reconsider their approach to analyzing markets and investments as technology converges with all sectors and enables new tools, analytics and insight.
Technology will be a huge facilitator of better capital allocation decisions but it will also require different skills, not least the ability to build, deploy and manage bespoke tools that provide unparalleled insight into the use of specific assets and the analytics that results. Many of these skills will overlap with the requirements of other sectors and bring private equity real estate firms into direct competition for talent with the wider market.
Base and bonus at that point will likely be obsolete and insufficient to attract candidates with a background in technology who are more likely to be at least partially motivated by softer benefits and career opportunities. The convergence of real estate, finance and technology as well as other sectors will likely force private equity real estate funds to reconsider remuneration structures to compete not only with technology firms but all sectors.
Softer benefits, clearer career paths and the opportunity for everyone to share in the success of the wider organization will become increasingly important. Creating a deferred compensation structure that is open to all with improved liquidity and scope for more intermittent awards will be an essential tool to compete with the opportunities and rewards on offer to employees elsewhere.
Connect with us
Visit ey.com/rhc for more real estate, hospitality, and construction thought leadership.