Banking is different in one respect. As the repository of savings and the chief conduit of credit to the economy, it wields disproportionate political and economic power. By contrast, property is a sector like any other, with firms neither too big nor too important to fail.
This distinction is all-important for taxpayers and parliament. But for investors the difference cuts the opposite way. It means there is nobody but shareholders to foot the bill if a property company gets in trouble. Shareholders therefore need to pay even closer attention to asymmetric pay structures in property than they do in banking.
The top job in the property industry - chief executive of Land Securities (LAND) - was held by Francis Salway between 14th July 2004 and 31st March 2012. Between those dates, £100 invested in the company would have sunk to £94 even if you reinvested dividends. Mr Salway meanwhile collected £9.3m in bonuses and 'long-term' incentives.
I have set out how I calculated this performance-related pay figure in the table below, based on the remuneration section of annual reports. Because both the bonus packages and the terms of disclosure changed at various points, it has necessarily been a slightly approximate exercise. Yet the bald point remains: Mr Salway lost only one year of cash bonus in a crash that cost shareholders a decade of returns. Even then - for the cataclysmic year to 31 Mar 2009 - he earned £879,000 in performance-related pay as shares granted in previous years matured for collection.
| Year ending Mar 31 | Cash bonus (£000s) | Deferred shares vested (£000s) | Long-term share plan vested (£000s) | Total variable pay (£000s) | Total shareholder return (%) |
|---|---|---|---|---|---|
| 2006 | 527 | 228 | 250 | 1,005 | 54.3 |
| 2007 | 536 | 271 | 465 | 1,272 | 13.8 |
| 2008 | 791 | 315 | 601 | 1,707 | -25.9 |
| 2009 | 0 | 382 | 497 | 879 | -65.1 |
| 2010 | 531 | 41 | 309 | 881 | 62.5 |
| 2011 | 617 | 61 | 220 | 898 | 13.0 |
| 2012 | 481 | 647 | 1,579 | 2,707 | 2.5 |
| Total | 3,483 | 1,695 | 4,171 | 9,349 | -6.0* |
Source: company accounts, Datastream *From 14/7/04 to 31/3/12 | |||||
The point is not just that the rewards seem out of step with the returns. It is that management has no incentive to eschew risk. Mr Salway called a new development cycle in early 2010, less than a year after a rescue rights issue. His successor, Rob Noel, has accelerated that strategy - last week he pressed the red button on a speculative development on Ludgate Hill. The bet has paid off so far, yielding very strong mark-to-market gains in a capital-starved market. The question is whether Mr Noel will know when to stop, given the financial incentives to keep going.
Economists call the age-old conflict of interest between managers and shareholders the 'principal-agent problem'. The classic solution is to 'align incentives' by making managers shareholders. This makes sense, but seems hard to implement on an effective scale. You can only force employees to swallow so many shares.
A few smaller companies have big founder-manager shareholdings - notably Mike Slade's Helical Bar (HLCL) and Sten Mortstedt's CLS Holdings (CLI), a long-standing IC tip. Tellingly, both have excellent long-term track records, having resisted the temptation to raise capital in 2009. But a large manager stake is no guarantee of good behaviour. Helical paid 71 per cent of adjusted earnings to a new bonus scheme last year. Pre-tax profits fell from £7.4m to £5m even as the company boasted a 31 per cent gain in property returns.
This is an isolated example of regression. Most property companies have been tweaking their remuneration structures for the better, albeit on a tokenistic scale. British Land’s (BLND) long-term incentive plan used to compare the company’s growth in book value (NAV) against the IPD commercial-property index - a not untypical case of apples and pears (NAV includes the impact of debt, IPD does not). The remuneration committee is now proposing a hybrid arrangement that compares property revaluations against IPD and NAV against 16 FTSE 350 peers.
Such reforms are welcome, but make remuneration reports even more complex and only half-address the underlying problem that property companies consist of debt books as well as property books. UK bonus schemes usually measure managers against the performance of the property books, even though shareholders returns have largely been driven by debt.
It won’t solve the conundrum of short-termism, which requires a wholesale cultural shift, not least among professional investors. But at the very least UK property companies should stop using IPD as a benchmark for executive bonuses. NAV is better - and, at least for income-focused real-estate investment trusts, recurring profits possibly best.
