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Incentive compensation - linking employee and owner objectives.

Incentive Compensation - Linking Employee and Owner Objectives

Incentive compensation is not new to real estate. The incentives are very direct in sales and leasing: sell more, lease more, and make more.

In property management the nature of the work is different. Prior to 1987, income incentives in management were sometimes structured around the tax benefits of equity participation. Some owners provided managers with non-recourse loans to buy equity in a project. This provided immediate tax benefits, which no longer exist.

While equity participation can still be an effective long-term incentive based on appreciation of a property, incentives also must focus on the realities of today's economic climate in commercial real estate. Management incentives should concentrate on operations, linking compensation of individuals to their success in achieving the property owner's and corporate goals.

Properly structured, incentive compensation is a powerful tool in the implementation of business strategy. Property managers play a key role because they have day-to-day control over operations and their decisions can have a great effect on profits. Recognizing the impact of good management with incentives makes good business sense.

Benefits of incentive compensation include:

* articulation of corporate objectives and priorities;

* greater employee motivation;

* increased internal communication;

* effective recruitment and retention of high-quality employees;

* improved employee self-awareness; and

* stronger employee advocacy for the company.

Building an incentive program

An incentive compensation program measures performance against predetermined goals. Incentive pay is predetermined and earned based on the level of achievement in meeting these goals. The premise is to place highest priority on activities that lead to the achievement of the property owner's and corporate goals.

Effective incentive compensation programs begin with a clear understanding of the owner's goals for the property, as well the owner's risk profile. Only then can an operational strategy be mapped and responsibilities assigned for tasks that, step by step, will achieve these goals.

Incentives then are based on the operational strategy and can be linked to meeting budgetary goals or the achievement of specific tasks, such as keeping a contractor on schedule, renewing leases, or filing accurate reports in a timely manner.

Key considerations in designing incentive programs are:

* timeliness of rewards,

* objectivity of review criteria toward incentive pay,

* employee control over achieving incentives, and

* ease of administering the incentive program.

Timeliness

Incentive compensation programs are based on behaviorist psychology - a quick reward for good behavior will encourage further good behavior.

Much of the management literature on incentive compensation advises against incentives based on time periods in excess of a year. If the reward is given too long after the desired performance, the relationship between the two is rarely established. When the relationship between behavior and reward is clear, both the employee and company benefit.

A case in point involved a large apartment management company where executive responsibilities included touring apartments as if the executives were seeking units for themselves. The resident manager did not know the executive's relationship to the company. If the resident manager performed the tour using techniques that had been provided in formal training, he or she was rewarded on the spot with $100 and told why.

This informal incentive had impact far beyond the value of a $100 bill. Word of the incident invariably spread and, in a way, the entire company became a little better than it was the day before. Conversely, poor performance was communicated throughout the chain of command.

Incentives can be immediate rewards, as in the case cited above, or designed to reward a pattern of good behavior measured over time, such as accomplishment of capital improvements or leasing goals.

We have attempted quarterly incentive reviews and found the time span too short to provide an adequate view of such long-term performance achievements. Quarterly reviews are also excessively time-consuming. Our incentive compensation reviews for property managers are now done at six-month intervals.

Objectivity of review criteria

Performance criteria at the review must be as objective as possible. Subjective criteria can be established, but must be clearly defined and communicated. It is important that employees recognize that the system is fair. Otherwise they will not be motivated to make it work for themselves and the company.

We have established five major categories to measure the general performance of property managers. (See the accompanying chart.) Performance in each of these areas is scored on a scale of one through twenty. For the review, employees first rate themselves and advocate the appropriateness of their score. A final score is derived by the employee's superior from the review and discussion with the employee of his or her accomplishments.

The cumulative score of each category is the percentage of the potential incentive pay the employee will receive. For example, if an employee's incentive compensation potential for a six-month period is $1,100 and his or her cumulative review score is 80, then the incentive awarded is $800, or 80 percent of $1,000.

This review methodology makes the process as objective as possible. Importantly, the review process, which cannot be postponed, forces communication and requires employees to evaluate themselves and address their own strengths and weaknesses.

Corporate goals are addressed in our plan by tying rewards to renewals of management agreements. For example, one of our property managers receives $3,000 upon the annual renewal of a major, profitable management agreement. In this case, all parties win. The client is happy as evidenced by the renewal, we have the assignment for another year, and the property manager receives a significant bonus.

Ongoing communications are important to adjust activities and keep the management program in the right direction. A formal incentive compensation review is not a substitute for informal and ongoing management communication.

Control

Employees must have control over meeting the criteria on which their performance is judged. Incentive pay can be tied only to tasks for which the employee is accountable and over which he or she has control. If property management and leasing are performed by different companies, it is unfair to link the property manager's incentive pay to leasing performance.

Likewise, even when a manager is responsible for the task, control over performance may be absent. For example, one of the criteria cited above concerns collections. If the owner delays the billing of operating expenses, it is unfair to penalize the property manager when the collections are late. Similarly, the owner or an act of God may require a capital expenditure that is not budgeted. To have the manager suffer because the capital improvements budget ran over is not fair. The review must factor out situations when control is taken away.

Many companies base incentive pay on profit-sharing formulas. However, individual performance may be difficult to link to profits. For employees to believe that they control their destiny, the incentive program must allow stellar performers to receive their reward regardless of the performance of the company. By controlling their performance, employees must see clearly that they control their earnings.

Pitfalls incentive plans

Incentives must be carefully considered and balanced if the desired goals are to be achieved. No one receives any benefit from reports that are turned in on time, but lack necessary information or are inaccurate. Signing a tenant to a long-term lease can mean a big commission for the broker and property manager involved, but may be detrimental to the owner's plans for the property.

A classic case involved a national real estate investment company. Executives had a strong incentive to acquire property, so they did - a great deal of property. Unfortunately, the incentive to acquire property was not balanced with a measure of the quality of the acquisition. Executives collected a great deal of incentive pay, but the effects for the company and many investors were detrimental.

For property managers, the budget can be a strong basis for building an incentive program. For example, incentives may be awarded if expenses are within 95-105 percent of budget (spending less could jeopardize the long-term value of the property), and if income exceeds 95 percent of budget.

Such a system requires strong management of the budgeting process to overcome the potential to build budgets that stack the deck toward receiving incentive pay or to fudge reporting to make results look better than they really are. Holding the December bills until January may make the year look good, but doing so does not reflect normal operations.

Structuring incentives to the job

No one incentive program will work in all situations. Jobs are performed differently under different contractual circumstances for different owners with different goals. We have customized incentive programs to recognize these realities and the fact that people respond to different motivations.

While the concepts are the same, the property manager for second-generation space and the property manager for newly opened space will have incentives for different performance criteria because the management needs of the properties are different.

At a basic level, we have provided incentives for performance that some may consider ordinary to the job, such as turning in accurate and timely reports. This is because we think the basics are worthy of attention in an incentive program. The principle can be compared to the reason behind spring training for professional baseball, where the emphasis is on the basics. People have to be reminded of the importance of the basics because, if they are not carried through, the foundation may fall apart.

To this end, our base salary for a property manager may be 95 to 100 percent of the standard for the market. However, attention to performing administrative basics will bring that salary to 105 percent of the standard. Other incentives for extraordinary work can bring a good property manager a salary much higher than the market rate.

As stated, additional cash incentive awards may be made for leasing, lease renewals, expansions, and the renewal of the management agreement. The amount of incentive reward may differ based on the type of property. For example, a property manager may receive a per-square-foot bonus for renewals or expansions of an industrial property, and another manager may receive more per square foot for renewals or expansions of an office property.

The incentive paid each property manager must be in relationship to the economic benefits to the owner or management company. The incentive program must also reflect the contractual agreement between the owner and management company.

In some cases, the property management company is not paid a commission for leasing activities. The question then is how to pay an incentive to the property manager whose astute work has persuaded a tenant to renew or expand. If the management company is paying the manager's salary, different incentives can be structured for renewals and expansions. If the owner is paying management payroll, he or she should be persuaded to pay managers incentives because of the additional economic benefit received.

People at the same level should be treated alike. The variables for different levels are the amount of reward, stated in percentage of salary or, perhaps, of property income. If equity is involved, how much equity and how long it takes to fully vest the equity interest may also differ at various levels of authority. Vesting provisions in programs, whether equity plans or 401K plans, also encourage people to stay with the company.

As companies grow and create more levels of management, incentive programs may expand as well. Incentive programs may be adjusted to suit responsibilities up through the hierarchy of a company into the executive suite. At higher levels, executives commonly participate in the upside of a property by vesting equity.

In summary

We have found that high-quality individuals respond positively to incentive compensation programs. Once you show employees that they can earn a salary above the market, the reception to the program is very strong. Sophisticated executives realize that they are better off having their incomes tied to measures of their performance.

Incentive compensation programs provide a clear way to single people out and reward them for extraordinary performance. The benefits to the company are that employees will perform better and work harder under a fair system in which they, in effect, control their own destinies. The clear benefit will be improved client relations and ultimately higher profits.

Effective incentive compensation programs take time to establish and require a long-term commitment from management. The program relies on trust, fairness, and communication to succeed. In addition, these attributes must begin at the top of an organization. The results of having a program established can be a change in culture, creating an environment in which the rewards of excellence are aggressively pursued.

William Norwell, CPM[R], is executive vice president of Hawthorn Realty Group, where he directs fee management activities, including property management. Hawthorn manages property for its own portfolio and for institutional and corporate property owners.
COPYRIGHT 1989 National Association of Realtors
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Copyright 1989 Gale, Cengage Learning. All rights reserved.

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Author:Norwell, William D.
Publication:Journal of Property Management
Date:Sep 1, 1989
Words:2122
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