When is $24M not enough? A quick case study on risk, decision-making, and compensation in commercial real estate.
'Tis the season...
Vornado, a large NYC office owner, just disclosed $6M+ in special bonuses for its top executives despite a 50%+ drop in its stock price over the last few years.
Thinking vs. processing...
This situation exemplifies the most common phrase from our FastTrack courses: Thinking vs. process.
VNO's top four executives are "thinkers" who get $24M a year to make critical decisions. They get paid 20x more than the junior VNO executives ("processors") who perform repeatable tasks like modeling, inspections, summaries, etc.
[Sidenote: There's nothing wrong with processing, but we focus on thinking skills in our FastTrack courses because they are more durable and valuable than memorizable knowledge and processing skills.]
A non-commoditized business...
VNO's four top executives represent only about 0.1% of the company's staff but receive the lion's share of monetary benefits due to their expertise. In sum, these four are much harder to replace than a good financial modeler.
Real estate risk vs. compensation...
-- Core properties are relatively safe, income-oriented investments in good locations with solid tenants. Managers get fixed fees for being disciplined, keeping an eye on risks, and selecting good investments.
-- Opportunistic investments have a lot more upside but are riskier and require specialized skills. Perfect example: Real estate development requires expertise that earns developers a share of profits in addition to fixed fees.
REITs are inherently skewed toward core investments. By definition, they have to distribute 90%+ of their income and are discouraged from participating in quick flips, development, etc.
To be clear, top REIT managers get paid well, but their compensation is in salary and bonuses from options tied to share performance.
A few challenges...
1. REIT stock prices are down, so option values are down. No one likes falling pay, especially senior REIT executives.
2. Many REITs have sizable development operations. These projects can generate significant profits but aren't favored by shareholders and analysts, who prefer safety, security, and dependability.
3. Developers know how much value they create when projects go well and expect to get a share of profits, regardless of corporate structures, shareholder demands, etc.
---- Competing perspectives ----
Shareholders: 'This new bonus pool is bullsh*t. I invested for income, not development risk. Maybe you should get paid when I get paid, but my investment in your firm is down by 50%.'
Vornado: 'We can monetize our development skills by bringing in outside capital, and we need to use fees on that capital to motivate and retain our talent.'
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