commercial real estate finance industry market update following report digests the comments ......

Commercial Real Estate Finance Industry Market Update

Current State of the US Market and Implications for the Future

Anthony R. Saitta, Managing Director, FPL Associates

Timothy Kessler, Principal, FPL Consulting

Gemma Burgess, Managing Director, Ferguson Partners

COMMERCIAL REAL ESTATE FINANCE INDUSTRY MARKET UPDATE

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Commercial Real Estate Finance Industry Market Update

During the volatile fall of 2016 and winter of

2017, FPL Associates interviewed a select

group of leaders in the commercial mortgage

sector, to gain their perspectives on how

the capital markets have evolved since the

2008 credit crisis and how they will continue

to evolve over the coming three to five year

period. The executives interviewed were

leaders of firms that represented a broad

cross-section of the commercial mortgage

sector, including commercial banks,

life insurance companies, CMBS conduit

lenders, and mortgage REITs and other non-

traditional lenders.

FPL supplemented these interviews with its

own proprietary research on the commercial

real estate finance industry and the data

compiled and market insight developed

through both (i) the significant number of

annual client assignments we conduct in the

industry and (ii) the industry-wide surveys and

reports we regularly publish on both strategic

and operational topics.

The following report digests the comments

and outlooks from the participants in our

interviews and the results of our proprietary

research, covering a wide range of topics

including the ongoing impact of lessons

learned from the 2008 credit crisis, how a

more diverse lender industry continues to

reposition itself, evolving approaches to

risk management, and new dynamics in the

capital markets.

Contents

3 Executive Summary

4 Ongoing Impact of Lessons Learned

5 Investment Outlook

7 A More Diverse Industry

11 Managing Risk

13 Leadership and Organizational Implications

FPL ASSOCIATES | 3

Executive Summary of Findings

○ While market participants remain generally

positive overall in their view on the future

prospects of the commercial real estate

finance industry, they acknowledge the

importance of remaining focused on

lessons learned from the 2008 credit

crisis to avoid future difficulties, including:

■ Don’t assume access to market liquidity

■ Have skin in the game

■ Impose more checks and balances

○ Commercial lenders have sought to

broaden their sources of revenue over

the past several years, primarily through

adding loan servicing and investment sales

capabilities. Many market participants

have found, however, that the successful

integration of these businesses has

required a significant amount of time

and effort due to cultural and operational

differences between them.

○ As a result of the potential economic

impact of some of the legislative priorities

of the new presidential administration

and its focus on accelerating economic

growth, the investment outlook remains

positive. That being said, each of the

main property sectors (office, industrial,

retail and multifamily) has its own unique

set of challenges and headwinds to deal

with. An added uncertainty for many

market participants is the direction of cap

rates given recent moves by the Federal

Reserve to normalize monetary policy and

raise interest rates.

○ The commercial lending industry has

grown more diverse. While banks still

dominate the overall market, insurance

companies as well as mortgage REITs and

other non-traditional lenders have become

increasingly more important sources of

capital over the past several years. After

working through the initial concerns

over risk-retention, the CMBS market is

expected to begin growing again.

○ Regulatory uncertainty emanating from

the federal government has become

a concern for companies, especially

given that many have made significant

investments into systems and processes

to meet the new regulatory requirements

imposed in the aftermath of the 2008

credit crisis.

○ Succession planning and the retention

and development of young talent remain

the key human capital concerns of market

participants, with several acknowledging

that the industry may have fallen behind

in this critical area.

○ The ability to utilize new technologies to

achieve the dual objective of maintaining a

real time collection of market intelligence

for internal business development and as

a way of offering deep market insight to

clients, has become a major priority for

many market participants.


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Ongoing Impact of Lessons Learned

The U.S. commercial real estate finance

industry has for the most part recovered from

its experience in the wake of the 2008 credit

crisis. Although most sectors of the commercial

lending industry have recovered fully and in

fact expanded beyond pre-crisis levels, the

CMBS markets have only revived fitfully from

their near-death experience. Despite this,

our interviewees expressed confidence that

the CMBS market will continue to be an

essential part of the real estate lending

equation. At the same time, they recognize

the ongoing impact of lessons learned for

avoiding future difficulties:

Don’t Assume Access to Market

Liquidity

Liquidity in every market is not an unlimited

asset, there will always be a governor on the

system. Market participants today are much

more sensitive to the highly correlated nature

of the capital markets. Our interviewees

generally felt that since emerging from the

2008 credit crisis, most market participants

have remained significantly more focused on

maintaining their access to numerous sources

of liquidity.

Have Skin in the Game

There is value in having lenders making

investments with an eye toward long term

performance, whether you call it skin in the

game or risk retention, rather than a trading

opportunity. Compensation systems and

internal oversight need to discourage short-

term profit-taking. New risk retention rules

under the Dodd-Frank legislation have

codified this lesson, with respect to the CMBS

markets, while the Basel III increased capital

requirements are having a similar impact on

banks by requiring higher capital reserves in

exchange for investing in riskier assets.

Impose More Checks and Balances

Integrated investment and servicing

businesses can also serve to red flag

problems and risk in mortgage portfolios and

many firms have found that the affiliation

between special servicers and B-piece buyers

has worked, creating more responsibility as

well as “checks and balances” throughout

the system. The expanding role of B-piece

buyers in the new risk retention transaction

structures has already served to add an

additional level of discipline into the CMBS

sector as those investors that are going to

have to live with the first loss positions for the

life of the securitization are becoming much

more involved in the decision making process

around loan quality and pool inclusion.

Even though rating agencies may be best

positioned to spot problems, they cannot

be relied upon to identify all of the potential

issues in a particular securitization.

Broaden Revenue Streams

The most successful companies in the

commercial real estate finance industry have

developed multiple sources of revenue,

primarily through acquiring or building out

either a servicing business or an investment

sales business. While integrating a servicing

business with a lending operation has not

been as difficult, many firms have found that

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it requires a significant amount of effort to

integrate and fully capture the benefits of

entering into the investment sales business

as there tends to be significant cultural and

operational differences between the two.

Although not considered a “sexy” business,

like investment sales, servicing fees provide

very reliable recurring income. When coupled

with a commercial mortgage origination or

mortgage banking business, a significant loan

servicing portfolio can provide a meaningful

level of stability. While transaction income,

whether from originations or sales, may

increase more rapidly than servicing income

when market conditions are favorable, it is not

always available.

As the industry consolidates among bigger

players, more originators tout the benefits

of having servicing and investment sales

platforms. The interface with the customer

both over the life of the loan and in connection

with an acquisition is very helpful to lenders in

creating and maintaining long-term borrower

relationships. Additionally, lenders need

servicing entities to do business with any of

the federal agencies: Fannie Mae, Freddie

Mac or the FHA. Many firms have also found

that the steady income provided by servicing

especially, provides a counter-cyclical income

stream, and if the world falls apart, it is helpful

when you can turn to people managing your

portfolio and get the critical information

you need.

Recognize an Enduring Reality

Not every market participant has learned the

lessons of the credit crisis. Accordingly, when

it comes to investing in a loan portfolio or

CMBS securities — caveat emptor.

Investment Outlook

The interviewees forecast a slightly improved

economic picture, predicting growth to

accelerate modestly over the recent long-term

average annual growth rate of 1.9%, primarily

as a result of the presidential election and the

potential economic impact of several of his

proposals — infrastructure spending and tax

reform, in particular. Other potential policies

were admittedly concerning for some – tariffs

and other trade restrictions, for example.

Looking to the specific core commercial real

estate asset types, our interviewees made the

following general observations:

○ Office. The consensus is that the US

office market will experience a slight

slowdown in 2017 due to a combination

of additional supply coming online and

softer tenant demand. Given the recent

uptick in hiring across the economy,

many firms are finding it more difficult

to identify the right talent. Perhaps the

industry most impacted by this issue is

the technology industry where finding

people with the right skills remains

critical to the sector’s continued growth

and the driver of its office space demand.

More broadly throughout the economy,

competition for talent has led many

firms to consider a range of workplace

innovations, including co-working space.


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○ Industrial. The industrial market

remains positioned to benefit from

the continuation of both cyclical and

structural factors in 2017. Many of

the perceived economic risks to the

sector have lessened and consumer

spending remains strong and growing.

Provided that there are no major

changes to trade policy, which is now

a reasonable question given the new

presidential administration, increasing

supply should be the market’s largest

short-term risk, although this should

not have a significant impact as

current vacancy rates in the sector are

near historic lows.

○ Retail. Consumer spending and

e-commerce are expected to maintain

healthy growth in 2017. Retailers and

landlords will continue to seek ways to

innovate in order to attract customers,

principally designed to create a more

enjoyable shopping experience

centered around entertainment

concepts, dining and technology

enhancements. Not coincidentally, the

strongest rent growth in the sector is

expected in markets with the strongest

job growth. Our interviewees also felt

that there is a growing divergence

within the retail space, where Class A

properties are expected to continue

increasing in value, while Class B/C

assets will increasingly provide owners

with value-add opportunities through

redevelopment and repurposing,

a trend accelerated by the recent

announcement of significant numbers

of intended closures of underproductive

anchors across the country.

○ Multifamily. Our interviewees expect

slower rent growth and rising

vacancies in 2017 as the sector enters

the peak of its development cycle.

As a result, oversupply was cited as

the sector’s most significant near-

term risk, particularly in the luxury

segment of the market, which has

seen a significant amount of activity

over the past few years in downtowns

and gateway markets such as San

Francisco and New York. Concern

was expressed over the fact that

fundamentals on some of these new

projects have slowed meaningfully.

On a brighter note, one interviewee

mentioned a recent development in

which suburban growth is outpacing

urban in an increasing number of

markets resulting in strong suburban

rent and occupancy growth.

Interest Rates and Cap Rates

The interest rate environment is one of the

most significant factors impacting the real

estate capital markets. With the US economy

continuing to expand, albeit at a tepid pace,

the Federal Reserve is likely to raise short-

term rates three times in 2017. Longer-term

interest rates, which have a more direct impact

on real estate financing decisions, however,

are anticipated to remain stable or increase

more modestly, as they already increased

significantly in the immediate aftermath of

the presidential election. Our interviewees

anticipated that the 10-year Treasury yield

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will remain between 2.5% and 3% throughout

2017. The general consensus was that investor

demand for the inherent safety of US debt

should continue to at least partially offset

upward pressure on long-term yields from

the Federal Reserve and the prospect of

higher inflation. Although the Federal Reserve

decision on the near-term direction of interest

rates would appear to be a negative influence

on the capital markets, investors should not

lose a sense of history. The 50-year average

yield on 10-year Treasuries is about 6.3%.

Slightly higher bond yields are not expected

to have a significant impact on capitalization

rates, in part due to strong economic and

commercial real estate fundamentals, in

addition to solid demand from foreign

investors. The spread between capitalization

rates and 10-year Treasuries, which serves as an

estimate of the additional returns commercial

real estate is expected to yield relative to risk-

free government bonds, is wide enough that

the expected incremental adjustments the

Federal Reserve appears set to make over the

near-term will not necessarily result in higher

capitalization rates. Our interviewees almost

uniformly anticipate capitalization rates to

remain fairly steady, particularly in markets

where fundamentals are still improving.

Likewise, underlying real estate asset values

should also remain fairly stable.

A More Diverse Industry

The initial round of deleveraging in the

immediate aftermath of the financial crisis

caused the real estate lending arena to shrink

and significantly altered the industry landscape.

However, over the past five years, the overall

commercial real estate finance industry has

rebounded and has again begun to grow. Despite

this reversal of fortune, not all areas of the

industry have fared equally as well. While banks

have continued to dominate the market and in

fact increased their market share, as illustrated

below, insurers are also back, particularly in core

multifamily markets and increasingly, although

quietly, in the construction to permanent

loan space, where commercial banks are

finding it more difficult to compete given new

capital reserve requirements. Conversely, the

securitization market continues to struggle,

with annual issuance levels far below pre-crisis

levels, as it deals with the effects of new risk

retention rules.

For the industry in aggregate, the amount

of commercial mortgage debt outstanding

is larger than it was five years ago and the

major funding sources have become more

diverse. The biggest challenges remain the

rebuilding of the securitization market as it

deals with the aforementioned effects of risk

retention and whether the federal agencies

(Fannie Mae and Freddie Mac) get replaced or

significantly restructured. Regardless of the

resolution of these challenges, it is clear that

non-traditional lenders are well positioned to

help pick up the slack.

The Market Pie: Banks Still Dominate

Although banks have managed to increase

their overall market share over the past ten


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years and are well capitalized and profitable,

new regulations on capital requirements will

likely limit that growth and may lead them

to reevaluate their role in the construction

lending space, in particular. Insurance

companies have been steady capital

providers for higher quality assets, and while

their market share has increased, they will not

recapture anything near the over 20% market

share held during the early 1980s. Fannie Mae

and Freddie Mac are a wild card. No one can

say with any certainty what will happen to

them even though they have been responsible

for the overwhelming majority of multifamily

market financings since the 2008 credit crisis.

Current consensus among our interviewees is

that they continue to exist for the foreseeable

future and in fact, they each expect to fund

between $55 billion and $60 billion a piece

in 2017. CMBS conduits are still struggling to

recover from the 2008 credit crisis and are

expected to originate between $70 billion

and $75 billion in 2017, roughly the same as

in 2016, which is a far cry from their peak of

activity pre-crisis in 2007 when originations

reached approximately $230 billion. Mortgage

REITs and other non-traditional lenders have

become a more important participant in the

market as they operate largely outside the

current regulatory framework.

The banks are very well positioned to pursue

opportunities with larger assets. Insurance

companies can compete effectively for

trophy asset business too. The middle market

has fewer players than it had in the past and

the opportunity exists for well-capitalized,

less heavily regulated mortgage bankers

and non-traditional lenders to be successful.

These smaller players are more relevant

than ever as they provide smaller borrowers

seeking solutions for refinancing with a range

of possibilities.

Overall, the big, well-capitalized players likely

will remain dominant as over the past decade

they have acquired or built out CMBS, Fannie

Mae and Freddie Mac lending platforms,

commercialized them, and provided access

for their customers to a broader base of

capital sources. That being said, the current

regulatory framework provides opportunities

for mortgage REITs and other non-traditional

lenders to be competitive in certain segments

of the lending market and their importance in

the market is anticipated to continue to grow.

CMBS in the Risk Retention Era

(CMBS 3.0)

Current Market Dynamics. During 2016, CMBS

conduit originations totaled approximately $76

billion, which was down from approximately

$101 billion in 2015, while to date in March

2017 CMBS securitizations have aggregated

approximately $10.1 billion as compared to

originations of approximately $14.6 billion

in 2016, according to data from Commercial

Mortgage Alert. The remaining piece of the

“Wall of Maturities”, originally approximately

$300 billion of CMBS debt that was scheduled

to mature between 2015 and 2018, stands at

approximately $112 billion maturing during

2017 and just over $17.6 billion maturing in

2018, according to data compiled by Trepp.

Since the 2008 credit crisis, the CMBS shops

have made progress on a number of fronts,

including keeping a strong focus on risk

management, making sure that they have

FPL ASSOCIATES | 9

sized their business appropriately – not just to

the market opportunity, but to the capital they

have and overall market liquidity. Interviewees

describe this as following the insurance

company approach – their production went

down when everybody else was going full

steam ahead prior to the 2008 credit crisis

and if you look at their performance there is

just no comparison to what happened to the

CMBS industry in its aftermath.

Despite some successes, there is general

consensus that the industry still needs to

deal with enduring structural issues. The

inherent structure of the CMBS market

makes it a bit dysfunctional. Nobody has fully

solved the master servicer, special servicer,

borrower relationship, and the whole CMBS

securitization process is expensive and

cumbersome. Borrowers still complain about

servicer response time on basic requests,

including the approval of new tenants,

property releases, and loan assumptions,

among other requests.

Risk Retention. On December 24, 2016, the

credit risk retention rule of the Dodd-Frank

legislation went into effect. The rationale for

the rule was to ensure that CMBS sponsors had

“skin in the game” by requiring them to retain

5% of the credit risk in their securitizations.

Under the rules, banks and other issuers

have three options as to which securities

they retain in order to satisfy the retention

requirements: issuers can hold 5% of each

class (the vertical-strip option), the bottom 5%

of a transaction (the horizontal-strip option) or

a combination of the two (the L-strip option).

When using the horizontal- or L-strip options,

issuers can choose to pass off some or all of

the risk-retention responsibility to a qualified

B-piece buyer.

The possibility of passing off the risk retention

responsibility to B-piece buyers via the

horizontal-strip option was initially welcomed

by issuers, however, questions arose as to

whether that alternative would be economical.

The main concern raised was that in order to

meet the 5% threshold, the B-piece would

need to be “thicker” than normal, in fact,

reaching up into the lower end of investment-

grade territory. The concern expressed by

issuers was that they would have to sell the

investment grade pieces at below market

prices in order to increase yields to the level

demanded by B-piece buyers to compensate

them for the illiquidity of their investments,

which would reduce profitability for issuers

and make the horizontal-strip option less

competitive with the other alternatives.

To date, there have been transactions

executed with each alternative. The reception

to the first deal to utilize the horizontal-strip

option showed that issuers’ concerns may

have been overblown. Subsequently, there

have been an additional two transactions

announced that will also utilize the horizontal-

strip option. As more transactions are brought

to market, there will be further price discovery

and further acceptance of the potential

structure options.

Forecast. Our interviewees expressed a

general consensus that while 2017 and

2018 may be bumpy for the CMBS market,

once the kinks have been worked out, full

implementation of risk retention should

increase investor confidence in the asset


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class and thereby increase and broaden the

pool of investors that consider CMBS. In turn,

this increased demand should lower relative

borrowing costs and lead to stronger long-

term growth in the sector. While this might

not be apparent over the next couple of years,

our interviewees nonetheless expressed

confidence in the CMBS sector over the next

3 to 5 years.

While the overall market should recover after

a period of adjustment, the risk retention

requirements and increased costs for

originators should serve to drive many smaller

players out of the market leaving a smaller

group of larger originators that are better able

to deal with the increased costs as well as make

the investments in more sophisticated risk

management systems necessary to address

the holding requirements of risk retention.

Insurance Companies

Insurance company demand for originating

commercial mortgages derives from the

need to continually invest the cash generated

from all of their product lines in fixed income

investments. While no longer significantly

under-allocated in mortgages, they will

likely maintain investment volumes that

will approach their peak production in the

last decade — and in certain segments, like

construction lending, increase their activity.

Insurers have been aggressive, mostly on

prime, institutional quality assets, and regularly

beat Freddie Mac and Fannie Mae on stable,

long-term multifamily re-finances. Several of

our interviewees noted that as more global

capital is being accumulated by fewer, larger,

and highly regulated investment managers

who will need to invest large amounts of

capital effectively and efficiently, the larger

insurance companies, which also operate

globally, will be well positioned due to the

depth, scale, and resources of their firms, to

intermediate between these investors and the

users of capital by providing an array of capital

alternatives up and down the capital stack.

Non-Traditional Lenders

As new regulations take effect in the banking

and securitization sectors that either limit

lenders’ ability to make loans or increase

their cost, new entrants into the market are

positioned to pick up the slack. Non-traditional

lenders, including private equity funds,

mortgage REITs, other non-bank finance

companies, and in a fairly recent development,

private institutional-quality owner/operators,

have been particularly focused on acquisition,

development and construction loans, which

under the new Basel III capital requirements are

more costly for banks to originate as they are

required to reserve significantly more capital

against these assets that are considered to

be “High Volatility Commercial Real Estate”

(HVCRE). As an indicator of the growth these

non-traditional lenders have experienced in

recent years, in the fourth quarter of 2016, in

data accumulated by CBRE Capital Markets,

they accounted for approximately 24% of total

non-agency mortgage originations, which

was significantly more that the CMBS conduit

sector at approximately 13.5% and is beginning

to approach the level of activity of insurance

companies at 34%.

An interesting observation made by several of

our interviewees on the activities of these non-

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traditional lenders, is the fact that the primary

funding source for many of them are bank

credit lines and repo financing. Effectively, this

can be viewed as a way for banks to indirectly

lend to the real estate industry in a way that

has lower capital requirements as compared

to directly lending on real estate.

Mortgage Bankers

Since many smaller and middle-market

borrowers with periodic refinancing needs

frequently do not maintain wide capital market

access, mortgage bankers and brokers find

themselves in high demand to help secure new

loans and recapitalization funds. For borrowers

without direct capital market relationships,

an effective mortgage banker can clear the

market for a client and deliver a customized

financing package that is as good as possible

from an insurer, agency, conduit, or non-

traditional lender. On the capital side, insurers

and some non-traditional lenders, who rely

on correspondent networks, also work with

mortgage bankers who have talent broadly

available geographically and the capital

resources to cover the whole landscape.

Managing Risk

The 2008 credit crisis induced industry-

wide soul searching and widespread calls for

better, more effective government regulation.

But despite the passage of Dodd-Frank

legislation and the adoption of new global

bank capital requirements, interviewees

believe that lenders are still dealing with

how to better manage risk and mitigate

future losses, especially in connection with

loans headed off their balance sheets and

into CMBS offerings. In theory, the economic

impact of the new risk retention rules will allow

the CMBS market to self-police to ensure

that participants make good loans. Similarly,

the increased Basel III capital requirements

for “high volatility commercial real estate”

assets, primarily construction loans, should

push commercial banks to reduce or limit

their exposure to such investments by making

them too expensive to maintain. In practice,

however, it is a question of whether or not

the system breaks down and if underwriting

gets too aggressive. We heard strong

support for the need to incentivize lenders

to first and foremost make good loans, i.e.,

compensate them for underwriting risk rather

than underwriting volume. Unfortunately,

that is easy to say, but harder to implement

under the current cash-based commission

compensation structure where originators are

paid year one while their firms do not know

how a particular loan will perform until further

down the line.

Banks and institutional lenders have also

focused more on the allocation of capital and

risk and return, as it now potentially costs

more to allocate their balance sheet capacity

to various parts of their businesses. As a result,

CMBS and construction lending, for example,

now compete with all other aspects of these

businesses, at least partially on the basis of

their relative risk/return profiles.


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Regulatory Uncertainty

While federal rulemaking has changed

the rules of the game over the past several

years through the adoption of risk retention

and increased capital requirements, the new

presidential administration has introduced

a significant sense of uncertainty over

the potential reconsideration or outright

elimination of several of these regulations.

While no one has specifically proposed

the elimination of risk retention, given the

objectives of the new administration to

eliminate regulations that it deems to be

burdensome and that do not enable American

companies to be competitive with foreign

firms in domestic and foreign markets, it is

possible that some of the newly implemented

rules under the Dodd-Frank legislation may

be modified or outright eliminated.

Reaction among our interviewees was

mixed to this growing uncertainty on federal

rulemaking as significant investments have

been made into systems and processes to

meet the enhanced reporting requirements

as well as in the intellectual capital required

to develop new structures capable of meeting

the risk retention requirements.

Although many participants believe that the

private market could effectively service the

multifamily debt markets, they believe that

the government’s interest in housing broadly,

and housing’s foundational role as part of

the social safety net and as a key economic

driver, will lead Congress to leave the GSE’s

essentially intact for the foreseeable future.

A key factor identified by interviewees is the

high performance level that the GSE’s achieve

today, when appropriately regulated —

operating competency, scale, efficiency, risk

management, and technology and systems.

In addition to new rules, interviewees believe

that the significantly increased oversight has

led to an increased focus on implementing

new technology to improve their firms’ ability

to compile the detailed information required

to be reported to regulators. An unintended

consequence of the new rules and reporting

requirements on small financial institutions

is that it may drive some consolidation to

gain scale and size to afford the necessary

technology enhancements.

Rating agencies

In the new generation of CMBS, the rating

agencies still play a meaningful role. While

our interviewees believe that the process

has improved, it is still far from perfect, as

issuers still pay the agencies, which creates at

least the perception of a conflict. Ultimately,

however, there was a general consensus

among our interviewees that the new rules

around risk retention and the expanding role

of B-piece investors in the decision-making

process of loan inclusion in a securitization

pool, have served to mitigate some of the risk

that the rating agencies will not be able to fully

evaluate the risk of a particular transaction.

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Leadership and Organizational Implications

Risk retention, refashioning CMBS markets,

and government regulations — all the changes

wrought by the 2008 credit crisis meant that

companies needed to become more flexible

and ready to adapt. Having a full set of

products and an integrated team to deliver

them became more important than ever.

All of these changes have had far ranging

implications for how companies need to

organize and the types of leaders they need to

develop. When asked about their most critical

organizational challenges, our interviewees

consistently identified the following mostly

interrelated challenges.

Succession Planning

Succession planning was almost universally

cited as one of the key challenges faced by

our interviewees, almost all of whom were

part of large publicly traded companies.

For these companies, succession planning

has been a priority at the senior-most tier

of executives, but has not historically been

a focus for other levels of management and

certainly not down to the individual producer

level. Several of our interviewees described a

talent gap at their firms between the senior-

most tier and the next group of high potential

employees, which represents a considerable

managerial challenge. As such, succession

planning is receiving a significant amount of

management attention across the industry

and rightfully so as a failed leadership

transition can cause significant management

distraction and business disruption if not

approached thoughtfully.

Developing and Retaining Young Talent

Recruiting, developing, and retaining talented

employees is another key challenge facing

firms in the commercial lending space. The

lending market has been strong the past

several years, which means that demand for

talented personnel has been at a premium,

making it difficult to recruit and retain top

tier talent. Two factors that compound this

issue and make the competition for talent

that much more sharp, were identified by our

interviewees: (i) many senior-level executives

in the industry are nearing retirement, and

(ii) many members of the current crop of

young employees, the so called Millennial

generation, view staying too long at one job

as an indication of a questionable skillset or

lack of ambition.

One way in which many firms have tried

to combat this challenge, is through the

implementation of some form of mentorship/

development program that is designed to

identify and develop high potential young

employees. A common theme shared by our

interviewees was the belief that a firm’s ability

to attract talented individuals and find a way

to retain them and develop them through


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the organization will be an ever more critical

element of success in the industry, and those

firms spending the required time and effort in

this area will be the long-term winners.

Compensation

As the employment market in the industry

has heated up, so too has the focus

on compensation, in particular among

production personnel. While commission-

based compensation programs remain the

predominant model in the industry, several

of our interviewees identified what they

consider to be a developing flaw in the

current system. As a greater role in generating

business is being played by the reputation

and resources of the firm at the expense of

the individual originator, there is a sense that

a commission-based system might not be

the right long-term compensation strategy.

However, almost uniformly, our interviewees

agreed that utilizing a non-commission based

model would render them non-competitive in

today’s industry and would make the already

difficult task of retaining talented employees

virtually impossible.

Being senior executives of primarily public

companies, our interviewees also mentioned

a growing component of their firms’

compensation strategy for high potential

employees – the utilization of equity ownership

or other long-term incentive programs to help

support retention. These long-term incentives

are designed to be “handcuffs” on the

company’s key employees and make it more

difficult for them to be recruited away. Several

identified a potential longer-term educational

issue, however, since most originators have

such a firmly held current cash-based

commission mindset that such programs are

not always valued by employees in the way

that the firms intend.

Technology

The potential benefit of developing new

technology was a particular area of focus for

those of our interviewees that maintained

either a servicing/special servicing business

or an investment sales business. By default,

these businesses collect significant amounts

of information about loan terms, current

market conditions, collateral underwriting,

and borrowers/investors, among other data

points. For the most part, however, such firms

have struggled with converting this wealth

of data into a competitive advantage and

monetizing it. This objective of maintaining

a real time collection of market intelligence

for both internal business development and

loan/portfolio surveillance purposes and as a

way of offering deep market insight to clients

has become a major priority for those firms

that operate in these lines of business.

FPL ASSOCIATES | 15

© 2017 FPL Advisory Group. All rights reserved. No business or professional relationship is created in connection with any provisions of the content of this publication (the “Content”). The Content is provided exclusively with the understanding that FPL Advisory Group is not engaged in rendering professional

advice or services to you, including, without limitation, tax, accounting, or legal advice. Nothing in the Content should be used in or construed as an offer to sell or solicitation of an offer to buy securities or other financial instruments or any advice or recommendation with respect to any securities or financial

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attribution is given to FPL Advisory Group.

The Ferguson Partners recruitment practice consists of five affiliated entities serving FPL’s clients around the world: Ferguson Partners Ltd. headquartered in Chicago with other locations in New York and San Francisco, Ferguson Partners Canada Co. in Toronto, Ferguson Partners Europe Ltd. headquartered

in London with a Japan branch located in Tokyo, Ferguson Partners Hong Kong Ltd. in Hong Kong, and Ferguson Partners Singapore Pte. Ltd. in Singapore. Ferguson Partners Europe Ltd. is registered in England and Wales, No. 4232444, Registered Office: 100 New Bridge Street, London, EC4V 6JA. Ferguson

Partners Singapore Pte. Ltd. is registered in Singapore, Business Registration No. (UEN) 201215619H, Employment Agency License No. 12S6233. FPL Associates L.P., the entity which provides consulting services to FPL’s clients, is headquartered in Chicago.

The views and opinions expressed by each participant are such individual’s own views and are not necessarily the views of FPL Advisory Group or such participant’s employer.

F P L C O N S U LT I N GF P L A S S O C I AT E SF E R G U S O N PA R T N E R S

Strategic Planning

Organziational Design

Corporate Finance

Specialized Research

Benchmarking

Program Design

Contractual & Policy Arrangements

Surveys

Succession Planning

Assessment for Selection or Development

Executive Coaching

Team Effectiveness

Board/Trustee Recruitment

Board Assessment

Chairmen/CEOs/ Presidents Senior Management/ Corporate Officers

MANAGEMENT CONSULTING

COMPENSATION CONSULTING

LEADERSHIP CONSULTING

EXECUTIVE SEARCH

0ur industrypractices

0ur OfficeLocations

Real EstatePrivate Equity/Real

Estate Investment

Managers, Public (REITs)

& Private Owners/

Developers, Property

Services (Brokerage)

Firms, Commercial

Mortgage Investment/

Finance, Residential

Mortgage Investment/

Finance, Homebuilders,

Corporate Real Estate

Hospitality & LeisureLodging (Brands/Owners),

Gaming Resorts &

Casinos, Restaurants,

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Amusement Parks &

Attractions

HealthcareOwners/Investors/

Operators/Financiers

of Seniors Housing,

Hospitals, Health Care

Service Providers

Infrastructure, Engineering & ConstructionInfrastructure Investing:

Transport, Energy,

Social Infrastructure;

Construction &

Engineering

Ferguson Partners

With an emphasis on the right executive fit,

Ferguson Partners offers services in executive

recruitment, as well as leadership consulting.

FPL Associates

Focusing on compensation, FPL Associates assists

with the assessment, design and implementation of

compensation programs.

FPL Consulting

Covering a wide array of business needs, FPL

Consulting partners with clients to develop strategies

and structures to drive competitive performance.

FPL Advisory Group is a global professional services

firm that specializes in providing executive search and

leadership, compensation, and management consulting

solutions to the real estate and a select group of related

industries. Our committed senior professionals bring a

wealth of expertise and category-specific knowledge

to leaders across the real estate, infrastructure,

hospitality and leisure, and healthcare services sectors.

Comprised of three businesses that work together, FPL

Advisory Group offers solutions and services across the

entire business life cycle:

our service offerings

About FPL Advisory Group

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