Compensation resembles the ‘bottom of the cycle’

Continued stagnation in the investment and fundraising arenas over the past year has taken its toll on private real estate compensation practices. The post-covid bounce in average remuneration in the industry was robust, but short lived.

Following eight consecutive quarterly declines in global real estate investment volume since the end of 2021, per data from broker CBRE, and an 11-year nadir in annual private real estate fundraising in 2023, as PERE data shows, capital flows have been severely challenged.

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“This really feels like it’s the bottom of the compensation cycle,” says Ghada Sousou, co-founder of executive search firm Sousou Partners, which partnered with PERE to produce this year’s annual private real estate compensation report. “Last year we didn’t get that sense, but this year we do.”

Between 2022 and 2023, the average median growth in total remuneration, excluding carry, across private equity real estate firms and real estate investment managers, was less than 1 percent. This marks the second consecutive year in which average median remuneration growth has fallen. In last year’s compensation study, growth was approximately 5 percent between 2021 and 2022, having fallen from around 9 percent between 2020 and 2021.

“If I would ever use the word brutal, it would be for this year,” says Sousou. “It’s not a surprise, as most of us were aware we’ve been heading in this direction for some time, but it was still brutal.”

Sousou describes the confluence of fundraising challenges, elevated financing costs and issues sourcing deals as a “perfect storm” for managers, with at least one of these three factors impacting every real estate group – from the smaller, independent shops to the large insurance-backed firms.

Naturally, carry largely evaporated and compensation growth became restricted under such conditions. But while the numbers are unfavorable, one key difference between this year’s study and 2021’s – which absorbed the majority of covid-19’s impact on compensation – is sentiment.

“The ground moved underneath us during the pandemic, so it was a frightening time. There were strong reactions in the market in terms of how groups were thinking about compensation,” recalls Sousou. Average median growth that year was -6 percent.

By 2023, however, that fear of the unknown had been largely dispelled – particularly after interest rates stabilized in the second half. In its place came a surge of excitement for what was perceived to be just around the corner: a new real estate cycle and thus significant opportunities for wealth creation.

“There is just a different feel this time around. It’s much more positive because you can see the light at the end of the tunnel,” Sousou adds. Helping to fuel this optimism was also a mutual understanding between employers and employees of what real estate was going through, and so salary and bonus expectations were duly tempered.

Carry on the line

The widespread nature of real estate’s struggles last year may have limited the number of executives moving in order to unlock sizable pay increases. But talent, particularly at the senior end, was on the move for different reasons, such as the ability to earn higher carry and take on new professional opportunities.

Mit Shah, chief executive officer of Atlanta-based hospitality real estate manager Noble Investment Group, says the impact of capital value deterioration on carry has removed much of the incentive for senior talent to stay put – particularly for executives at firms suffering more secular headwinds than others.

“If you’re in a firm that has a large concentration in suburban office, for example, and you foresee that is going to create significant downward pressure on performance, one might conclude that you wouldn’t be walking away from meaningful carried interest to go and start a brand-new carry clock somewhere else,” he explains, adding he has seen this dynamic in his firm’s hiring of new talent.

“As has been the case over previous cycles, there are those that are thinking, the sooner I can start a new carry clock and build value, the more accretive it will be to me long term.”

In addition, senior executives, who Sousou says tend to be more confident in their abilities, have been making sure they are in the right place for the upcoming cycle. In 2023, she observed that, in general, the talent that was available or open to moving was of the highest quality “in a very long time.”

Skills in demand

Firms that are positioning for the new cycle have been laser-focused on upskilling their capabilities, says Sousou. And in a capital-constrained market, this led to the hire of an “unusually high” level of fundraising professionals, in particular.

Despite this, the study shows median average remuneration growth for capital raisers across both real estate private equity firms and investment managers fell into negative territory in 2023, sliding to just under 0 percent. Capital raisers in the second tier of seniority, the director level, were the hardest hit in terms of total compensation minus carry: the median declined 4 percent from $745,000 in 2022 to $715,000 last year. Capital raisers at the managing director level, by contrast, lost 3 percent at the median.

This was “a bit of a humbling” experience for the segment, says Sousou, who notes that a high level of hiring usually bumps up compensation. But in a tough market, and with the majority of fundraising roles tagging pay to performance, many firms will have had their hands tied.

“It’s the most difficult time period in which to raise capital,” admits Shah. “Firms that haven’t been able to raise capital have a constrained ability to deploy capital. And if you can’t deploy capital, there’s limited velocity of financial fulfillment and professional growth.”

Nevertheless, median growth in total compensation for asset management professionals, while also having declined year-on-year, remained robust over 2023. Indeed, at more than 5 percent, the median average growth rate for asset management staff at investment managers was the highest of all categories. At the other end of the scale, acquisitions professionals at investment managers suffered the lowest average growth, with median compensation shrinking by 2 percent.

Sousou points out this divergent compensation trajectory between the two functions reflects both the dearth in dealmaking over the past year, as well as a continued push among firms to improve asset management capabilities in tandem with the value creation side of the cycle.

Improvement in 2024?

“This year is going to be slow, but I don’t think it’s going to be as bad as last year’s comp cycle,” expects Sousou. “The central theme, as we talk to people, is that we’re closer and closer to the bottom. And as you get closer to the bottom, you get more positive.”

Shah is skeptical compensation will recover quickly, however, given managers are under pressure from their investors to realize funds that have already been extended, and on which they will be generating reduced fees.

Unless the transaction market substantially improves and investments can be realized, revenues, profitability and thus compensation will remain restricted for the near term – particularly if interest rates stay higher for longer, he says.

To mitigate further talent flight following another year of slow compensation, Shah says managers can reallocate fund carry and give staff the ability to participate to a much greater extent in the next fundraise.

“But the key question is, how many senior executives are willing to take away from their own wealth creation such that others can participate?” he asks. Shah adds he has done this himself: “I’ve always believed in playing the long game, which I believe the best managers continue to do.”