I often ask myself “why is it that the majority of family offices that created their wealth by sharing in the success of the business doesn’t carry that forward when it comes to their family offices and their employees.  To attract the best in the industry and in this case the real estate industry, family offices need  to understand how to do just that.  

The hiring of experts is where the compensation conversation comes into play. The majority of family offices do not want to pay the market for the type of expertise they would like to have in the house (this is especially true for the compensation family members.) Not paying market rate for in-house professionals is not always the case, but this is pretty universal amongst most family offices when hiring a CIO. The problem with this philosophy is searching for a real estate professional to work for the family office.  The potential employee will always ask themselves a question.  Why would they work for a family office to make 50% or even 75% of their income if they worked for a real estate investment firm? It is essential for family offices to understand the importance of pay for performance compensation packages for family offices to attract top real estate professionals. The family office must ask a simple question.  Is it worth paying for that top talent that could make a significant difference in their returns and profitability?  They must remember that real estate does provide the opportunity to maintain and create generational and legacy wealth? 

SO WHY WON’T FAMILY OFFICES ATTRACT THE BEST TALENT?

Let’s use a real estate private equity firm for example.  When you look at the success of real estate private equity firms. their success is primarily due to partnership structures and how the structure rewards partners handsomely. Partnerships are formed because you want to share the wealth and that's how you attract the best talent.  But from a family office perspective when one is working for a very wealthy wealthy person they don't typically think about giving them a piece of the profits and because of that it becomes very difficult for family offices attract the best talent.

Let's say you have a very wealthy person and they wanna set up a private equity firm to invest and they are the only partner and probably get some good people but in the end really good people with the skill set will want a piece of that 20% 

if the family office thinks about doing something it's typically just to salary a and bonus and they usually don't give up a piece of profits or a large piece of the profits to the professionals so because of that they aren't attracting the best talent.

The importance of a pay for performance philosophy for the family office. 

A "Pay for Performance" philosophy is an integral tool to attract and retain top real estate talent.  The philosophy is often alluded to in the general industry. Still, the shoulder-to-shoulder alignment created in real estate is unique.  

The stated goal of most compensation programs is often three-pronged: incent, motivate, and retain. Because of most real estate investments' long-term nature, a family office can effectively tie an employee's compensation directly to a single or portfolio of assets' profitability.

To make a compensation plan work, experienced leadership is essential to developing and implementing an investment philosophy and strategy specifically for real estate.  Whether led by a family member or other governance structure, a comprehensive compensation program that aligns all stakeholder interests is critical, but this is vary rarely the case when working for a family office, and because of this family offices don’t attract the best talent.

Below are key areas to consider and industry best practices or successful compensation plans.  

Property Management vs. Asset Management

Pay for Performance compensation policies in a family office are typically most appropriate for "asset management" instead of "property-level management." Succinctly put, property-level management of real estate includes ongoing maintenance, response to tenant requests, and other daily interactions at the property.  While undoubtedly important, property-level management activities can be outsourced.  Unless a family office has evolved out of an existing real estate business with its own highly functioning property level management company, it would be wise to outsource this function.  

In contrast, asset managers focus on identifying potential investment properties, deal structuring, financing, financial return and reporting, and investor relations.  Whether or not the property level management function has been outsourced, it is also essential for asset managers to have a direct ongoing relationship with property managers.  

The concept of using long term incentives 

Pay for Performance 

The concept of using long-term incentives to motivate professionals is a case of public company practices informing private enterprise.  Most public REITs and real estate investment companies have developed long-term compensation programs that measure performance metrics over time, often over three years.  These compensation plans often reward senior executives for meeting identified benchmarks, such as achieving stock price and dividend returns to shareholders. These plans can be potentially structured to take advantage of taxation at capital gain rates but are more often than not taxed as ordinary income.  

As is frequently the case, these sophisticated compensation plans of public companies, which are fully disclosed in public filings, have influenced private company (including family office) compensation planning.  Following public company precedent, rewarding key executives for value enhancement is the cornerstone of a successful compensation philosophy.  Often referred to as "Pay-for-Performance," this approach incents behavior, motivating the "team" and aligning the family office's interests, providing the capital for those directing the investments.  And while in different forms than their public company counterparts, family offices arguably have the advantage of capital gains tax. Perhaps the most significant benefit of being a private real estate entity is exclusive ties to successful real estate transactions not subject to public markets' whims.

While "Pay-for-Performance" can be the cornerstone of a well-crafted compensation structure, it is not the only element to consider.  Compensating professionals for their time and efforts systematically through base salary and annual achievement bonus is equally essential to ensure the real estate professionals are actively engaged.  Despite best efforts, successful real estate deals and transactions are not guaranteed. If compensation is solely tied to successful outcomes, most professionals will seek to limit risk.

Although not the norm, family offices occasionally allow their senior executives to "co-invest," either with their funds or funds lent by the family office.  The "skin-in-the-game" mentality breeds a sense of ownership and further aligns the interests of all parties.   Family offices also need to make decisions regarding which real estate projects are included in the plan.  Generally, a broad view that consists of all projects are used to avoid the human tendency to focus only on successful projects yielding positive compensation results.

Another compensation consideration is vesting.  As in public company plans, family offices can still require several vesting years, even after creating value. The long-term nature of successful real estate transactions and value creation is a natural fit with fair vesting provisions and retention objectives.  

Using value enhancement based upon the overall real estate investment strategy. 

Value enhancement can be achieved in various ways, depending on the overall real estate investment strategy.    Merely deploying capital without regard to strategic financial assessment could be counterproductive to the family's goals.  Investment type, the capitalization rate, and exit strategies are just several of the factors that should be discussed before committing capital and establishing a compensation plan. 

Categories of real estate can also be rewarded differently.  For example, it would make sense to allocate disproportionate amounts of value enhancement to "Value-Added" and "Opportunistic" investments as opposed to steady income-producing "Core" and "Core Plus" investments, which tend to reflect different strategic plans.  

The use of tax considerations. 

There are both income and estate tax considerations at play when developing an executive compensation plan.  Public companies structured as Umbrella Partnership REITs or "UPREITs" can compensate executives and employees with operating partnership units "OP Units," which, if earned, payout as income subject to favorable capital gain rates. OP Units were slightly affected by the 2017 Tax Reform, which requires carried interest vehicles to be held for three years before qualifying for favorable treatment.  Family offices have more latitude than the public markets to take advantage of capital gains tax rates, especially since real estate investments typically take more than three years to mature.

Strategic advanced estate planning is also possible, mainly when the executive contributes capital.  This is another example of a clear sense of alignment of interests, and often takes the form of a "vertical slice," whereby a proportionate amount of each interest held in a real estate project is transferred, potentially by both the family and the executive, to their respective younger family members (typically through a trust) as a way to meet certain statutory safe harbors.     

Interestingly, even though meaningful tax savings can be achieved, many family leaders are reluctant to structure their compensation to do so.  Some families prefer straightforward, W-2 based payment or eschew what they perceive as tax aggressiveness.  Others do not like the idea of being "partners" with their employees, whether that partnership is real or notional in nature.  

The importance of benchmarking 

Public company disclosure of compensation practices continues to become more detailed and robust. Private company data through subscriptions quantifying executive compensation has become more accessible in addition to surveys conducted and subsequently published by Northern Trust and Family Office Exchange (FOX); private company databases have expanded their reporting by geographies and executive level.  These resources, when used as guidelines, can help to normalize negotiations that might otherwise become acrimonious.  Family offices with boards of advisors and those with family-related boards of directors often cite these resources in gaining approval for paying talented non-family executives amounts that might otherwise be viewed as excessive. 

The importance of culture 

Often, talented real estate executives choose to work for family offices after succeeding in other industry roles.  As an outsider, there can be a tendency to view family offices as appealing alternatives to institutions because of their implied relational and flexible work environments.  When negotiating employment and related compensation, test these assumptions.  While those ideas may be a reality, they can also be first impressions, and compensation arrangements can be negotiated in greater or lesser amounts based on the type of work environment.  Culture can also affect investment direction.  Core and Core Plus real estate investments are certainly more comfortable than when the level of risk rises in Value-Added and Opportunistic categories.   Understanding upfront the level of risk that a family office has experienced and is comfortable with will also influence compensation levels.  

Summary 

Cultivating collaborative and consistent efforts and behavior can go a long way toward the sustainability of a successful real estate platform.  Motivating talented individuals with compensation structures that resonate with real estate savvy professionals is paramount in the competitive employment landscape.  Understanding your strategy and vision as it relates to real estate will allow for creating a compensation structure that is uniquely tailored to the needs of each family office.  

It goes without saying the importance that a family office needs to remember is that when it comes to hiring proven professional that will be investing their money, the people you hire are wanting to create their own wealth, and to do that you are going to need to incentive them in the end with getting a piece of the profits.  Until that mentality changes it's going to be hard to attract the best talent that's possible for the family office.