Research Trends and Conclusions: Real Estate 2010
Richard Woolley -
The last time Who’s Who Legal examined the real estate markets in June 2009 we signed off our analysis by noting the decline of the real estate department as a major fee earner in full-service law firms.
Developments had been put on hold and transactions had dried up or been scaled down and a lot of firms had made lay-offs or redirected lawyers from their real estate teams to bolster insolvency and corporate groups. Earlier this year lawyers expressed concern that some law firms had drastically reduced the number of newly qualified real estate lawyers they were hiring, expecting a crisis if there is a shortage of experienced professionals to handle the workload when the property markets return to pre-crunch levels. And while the intervening months have not seen markets come close to the highs of 2006 to 2007, a number of the lawyers we consulted at the end of the second quarter noted that their departments were busier than last year and were cautiously optimistic about the future of the sector.
Refinancing and Distressed Investment
While credit has remained constrained and investment in new projects and developments has been low over the past year, real estate lawyers in many jurisdictions have been engaged in restructurings, refinancings and workouts of existing loans to avoid defaults and foreclosures. “The majority of our work over the past year in has been in workouts,” said one source, “and this won’t turn around for a while; there are always more loans coming to term”. In the US alone an estimated $1.4 trillion in real estate loans will come due between 2010 and 2014 according to a Congressional Oversight Panel report published in February. Since 2008, lawyers in many jurisdictions noted that real estate teams are working more closely with members of their firms’ restructuring departments, and some firms, such as Morrison & Foerster, Jenner & Block and WilmerHale, have created groups and task forces to target distressed real estate workouts.
Lenders’ reluctance to extend credit remained a trend well into the first half of 2010, but more recently some lawyers have seen investment capital returning to the marketplace. “We’ve seen a big uptick in lending work in the past two months,” says one source, “all of a sudden it was like someone turned the lights back on; credit is now easier to get and certain borrowers are more active.” In the current climate, investors are focusing on buying up debt and acquiring non-performing loan (NPL) portfolios with the hope of a healthy rate of return when market liquidity returns in earnest, and many lawyers are seeing an increase in this type of transaction.
In June, a study by PricewaterhouseCoopers pointed to similar trends in Europe. The total number of NPLs in Europe rose by 25 per cent last year, and real estate loans are a major contributor to this figure. The UK emerges as the most likely source for NPL deals in this sector in 2010, with commercial real estate lending estimated to be close to £200 billion and prices expected to fall by a further 16 per cent by the end of the year. Italy is also expected to see more activity in this area, with NPLs predicted to increase by 27 per cent in 2010 and a further nine per cent in 2011 with real estate fuelling the majority of the growth. As investors in distressed loans become more active, lawyers throughout the world expect the demand for assistance in NPL transactions to maintain high levels.
Transparency and Growth
Jones Lang LaSalle’s 2010 Global Real Estate Transparency Index reports a notable reduction in transparency over the past two years as property markets have declined and companies have focused on “survival rather than market advancement.” Those markets that have maintained high levels of transparency are recording quicker recovery rates and greater growth than more closed jurisdictions, with the free flow of comprehensive data acting as an incentive to foreign and local investment. This appears to be the case in Australia – which the index found to be the most transparent market globally – where lawyers noted a sustained high volume of international institutional investment activity in the sector and good levels of structuring and transactional work as a consequence. Other notable improvements were charted in Central and Eastern Europe (CEE) and China’s second and third tier cities, such as Dalian, Tianjin and Chengdu, and international developer and investor interest is driving an increase in demand for local counsel.
Dubai was revealed to have undergone one of the biggest declines in transparency over the past two years alongside a dramatic increase in failing real estate developers and defaulting investments, which saw huge drops in property value. Lawyers in the emirate reported high levels of disputes resulting from market shortfalls, and disputes, insolvencies and consolidations are expected to continue into next year. However, proposed new legislation that would make property investors eligible for refunds or replacements to failing developments could restore investor confidence in the region and contribute to an uptick in transactional work.
Competition
Regulatory changes always result in more work for lawyers and some key jurisdictions are on the verge of new measures that will engage real estate lawyers in the coming years. In April 2011, the UK’s commercial property sector will be fully exposed to the 1998 Competition Act for the first time, as the government revokes the traditional exclusion of land agreements from the prohibition on anti-competitive agreements. A one year transitional period began in April 2010, but the new rules will apply retroactively to all pre-existing land agreements and will render any anti-competitive restrictions in agreements void and unenforceable. In addition, the Office of Fair Trading (OFT) will be able to impose fines of up to 10 per cent of a user’s worldwide turnover if a violation is detected. The OFT is scheduled to publish draft guidance on the application of the new rules in October, but lawyers are already experiencing an increase in demand, from both tenants and landlords, for compliance advice, contract assessment and due diligence.
March saw new amendments to toughen up Canada’s Competition Act come into force. While not directly specific to the real estate sector, the new measures, which increase the penalties for abuse of dominance, cartel activity and false advertising, have given rise to more brokers and boards seeking outside counsel to help revise their compliance programmes and bring their staff up to speed. The new rules have already resulted in abuse of dominance proceedings being brought by the Competition Bureau against the Canadian Real Estate Association (CREA). The Bureau alleged that the CREA’s multiple listing system restricts consumer choice in the residential real estate market, preventing agents from offering innovative services and pricing options. With significant fines being introduced for abuse of dominance, clients are also seeking to ensure that the trade associations they work with are in compliance with regulations and that participating employees are aware of the rules.
Sustainability and Greening
One of the most notable trends internationally is the crossover between real estate and environmental law. A global property sustainability survey for the first quarter of 2010 compiled by RICS, the UK body for surveyors, showed an increase in sustainable real estate policy across the world. This emphasis on environmental regulation in the planning of new developments and in the “greening” of existing properties is affecting companies operating at all stages of a property’s life-cycle and increasing demand for outside counsel offering compliance advice, contract negotiation and liability risk assessment.
The UK’s commitment to cut greenhouse gas emissions by 34 per cent in the next 10 years under the Climate Change Act has prompted numerous measures specific to the real estate sector. The Merton Rule was established in 2003 and is now part of the national planning guidance, requiring new developments to generate a minimum of 10 per cent of their energy using on-site renewables. Although the rule is non-statutory, according to Deloitte many UK local planning authorities are prescribing the rule to developments of 10 or more homes and non-residential developments of more than 1,000 square metres. Further to this, changes to part L1A of the UK Building Regulations come into force in October 2010, and will place greater emphasis on the need to improve the energy efficiency of existing buildings as well as new developments. These changes widen the net of potential liability among real estate clients and the demand for greater legal guidance and coverage against liability is expected.
In 2007, the European Council pledged to cut total energy consumption by 20 per cent by 2020, and real estate and construction projects are central to this commitment. Energy use throughout the whole life-cycle of buildings is responsible for 40 per cent of total EU consumption and is the main contributor to greenhouse gas emissions on the continent. Under a new directive published in May, member states must apply minimum requirements as regards the energy performance of new and existing buildings, ensure the certification of their energy performance and require the regular inspection of internal systems in buildings. Compliance with these emerging requirements is driving demand for legal services among developers, property managers and tenants alike.
Green building certification programmes in the US are also gaining importance, according to clean-technology intelligence company Pike Research, which predicts 53 billion square feet of commercial property in the US to be covered by green certifications by 2020. Lawyers and clients in the US are still waiting to see if the Senate will approve new energy legislation before the November elections, but beyond legislative mandates, the commercial incentives for green certification were highlighted by lawyers who note that a certified property is often seen as a more bankable investment in the current highly competitive marketplace. Further to this, independent industry group Architecture 2030 recommended a three year federal tax deduction programme to encourage commercial property owners to complete efficiency renovation projects. As such, lawyers noted that their clients keen to adopt such measures in the hope of maximising profitability and avoiding liability going forward.
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The real estate departments in law firms are still suffering in the wake of the global financial crisis. While the majority of the lawyers we consulted reported an increase in work from the last two quarters of 2009 onwards, big ticket deal-flow is still minimal. The drop off in “pure” real estate work is also a factor, as many property matters require the additional assistance afforded by restructuring and corporate support expertise. However, lawyers were keen to emphasise that the sizeable proportion of their work that is currently focused on assisting clients in reaching transparency or environmental targets, shows that companies are preparing for real estate markets to recover. Jones Lang LaSalle’s analysis of the first two quarters of 2010 found that global commercial property sales had reached US$130 billion; a 50 per cent increase on the same period in 2009. And while London remains the world’s most active city for real estate investment, quarter-on-quarter growth in Canada and Brazil and continuing prosperity in Hong Kong and Taiwan point to a healthy global picture. Against this backdrop, law firms are shaking up their real estate groups and many lawyers think now is a good time to expand as investors loosen the purse strings in the fourth quarter.