The real estate sector has a long way to go before it regains the healthy levels of three years ago. James Swift reports
Real estate departments, the sick men of commercial law firms during the depths of the global financial crash, are at last showing signs of convalescence.
Figures collated for the top 20 real estate practices among UK firms for the 2010-11 financial year show a stark improvement on the year before. But, given that 2009-10 was Armageddon as far as the sector was concerned, the bar for improvement was set pretty low and the figures this year still fall some way short of 2007-08’s peak.
To give you some idea just how far short they fall, Clifford Chance’s real estate turnover in 2009-10 is almost 30 per cent shy of what it was in 2007-08, as is CMS Cameron McKenna’s. SJ Berwin is down almost 50 per cent over the same period.
That said, real estate lawyers constantly talk about stricter fee conditions and reduced deal volume as ’the new normal’, so perhaps comparisons with that point in time are unhelpful. 2010-11’s figures are cause for lawyers to celebrate, though perhaps only with some moderately priced prosecco rather than champagne.
To elaborate, in 2009-10 16 out of the top 20 real estate practices experienced a drop in turnover. Freshfields Bruckhaus Deringer was the worst hit dropping almost 15 per cent, though that might have felt like a reprieve for the firm, which experienced a 27 per cent drop the year before. CMS Cameron McKenna performed the best, growing by a little over 7 per cent.
In contrast, in 2010-11 only three real estate departments suffered a drop: Clifford Chance, CMS Cameron McKenna and Trowers & Hamlins.
Eversheds’ real estate department grew by the largest percentage, going from £63.9m in 2009-10 to £81.5m in 2010-11, the equivalent of 27.5 per cent. But this figure is inflated by the firm’s recent decision to include projects in its categorisation of real estate, and true growth at Eversheds has been around 11 per cent, or £71m – still a big improvement on the previous year when the team’s revenue fell by 8 per cent.
The latter, which comes in for high praise for showing genuine growth and carving out a position in the market where it can focus its practice on high-end work, announced on 19 September, that it was launching two real estate-focused offices in Germany (Berlin and Frankfurt) with a team of Linklaters partners.
Norton Rose, meanwhile, has entered the rankings for the first time on the back of its merger with Australian firm Deacons, adding an extra dimension to the table.
“The year before was very flat,” says Eversheds real estate head Julie Stobart, “whereas this year [2010-11] we saw the investor market coming back. One thing that’s helped us is the breadth of our client business. We don’t need much of an increase to see a rise across the board. If 70 per cent of our practice was developer work, we wouldn’t have seen any increase, and the public sector is still not doing anything because there’s no cash and no decisions being made.”
It is not just lawyers extolling the return of investors. According to data from Real Capital Analytics, in the first six months of 2011 alone, around $12.3bn (£7.82bn) was invested in offices, shops and homes in London, more than any other city in the world.
Of course, the return of activity in London’s prime real estate market is not new – it was being talked about at least a year ago – but its impact on law firms’ top lines is only just becoming visible.
Freshfields client Almacantar, which was co-established by former Land Securities director Mike Hussey, was a good example of an investor targeting prime assets.
In April 2011 the firm advised Almacantar on its £100m purchase of the Centre Point tower, and then in June on the fund’s £80m purchase of the Marble Arch Tower.
ccording to Chris Morris, head of real estate at Freshfields, the deals were a sign that buyers thought they were looking at the bottom of the market.
Likewise, Nabarro has grabbed some newsworthy mandates, acting for long-time client Great Portland Estates, which raised £160m on the international bond market in April 2011 to aid its pursuit of top-tier properties in central London. The firm has advised the developer on its purchase of Royal Mail’s 2.3acre Rathbone sorting office for £120m (see page 11). Ashurst advised The Royal Mail Group on the sale.
Nabarro also advised Great Portland Estate on its joint venture purchase with The BP Pension Fund of 200 and 214 Gray’s Inn Road in London, a grade A office block leased to four tenants, most notably ITN, for £132.75m from an affiliate of US fund Beacon Capital. Linklaters advised Beacon Capital.
A big driver behind the growth in the central London market has been the influx of foreign investors, mainly from Asia and the Middle East but also from some European countries, such as Germany, and the US.
And although the investors see London property as sound, joint ventures and other structures are becoming increasingly popular, as foreign investors want to team up with a UK player who knows the market and can share the risk.
“We’ve found that there’s been a lot of joint venture work, in both the UK and EU,” says SJ Berwin real estate partner David Ryland. “Quite often these joint ventures are structured like funds and it’s a lengthy process. In a way, deals are getting more difficult because there are different types of equity and debt coming in and that can make the capital stack more complicated.”
“It’s been another challenging year but I think the market has improved overall and we’re seeing more confidence from investors,” says Clifford Chance real estate partner Mark Payne, who adds that although the firm has seen its turnover fall this is down to lower deal volumes and the team is happy with its market share. “Good quality properties in London have done very well and we’ve also seen quite a few new entrants from abroad, which we’re well placed to land because of our international network.
e’re also seeing a trend for corporatisation. We’re seeing a lot of deals being done through joint ventures, which plays to our strengths because we understand real estate and how to structure these vehicles.”
But not even joint ventures are enough to convince anyone to invest in anything that is not top quality; once you drop down and look at secondary and tertiary properties, activity in the sector falls off a cliff.
“This is the biggest division in the regions I’ve ever seen and the driver is international investors that are only looking at certain locations,” says Lindsay Morgan, head of real estate for Europe and the Middle East at Norton Rose.
“It’s all about the South East and all about London,” confirms Pinsent Masons real estate head Arthur Lovitt, whose firm does not include its construction practice in its real estate turnover figures. “There’s a huge amount of demand in the lending scenario for quality products and I think it’s unlikely that banks or insurance companies will move into the secondary or tertiary property market, so that’s where the equity players come in.”
As a consequence of the limited prime products, investors have been looking at alternative investments. Student accommodation is one area that has picked up.
In one high-profile example, Eversheds acted for Legal & General Property on its £116m purchase of Battersea-based student accommodation Griffon Studios from a joint venture (forged between Berkeley First and Imperial College London), advised by Ashurst. The student flats were a perfect fit for Legal & General Property’s portfolio. The fund has been snapping up long-term investments with solid covenants, paying £50m to finance the hotel and conference element of the Football Association’s national football centre in Burton-on-Trent and acquiring two Tesco stores portfolios, both of which Eversheds advised on.
Eversheds’ work with Legal & General Property also nods towards another development: the increased reliance on insurance companies as investors. It is a trend that is likely to become more important if bank lending becomes scarcer.
“We see a steady flow of new lending from a reasonably solid group of banks and building societies at the moment,” says Toby Barker, head of DLA Piper’s London real estate finance team. “But there’s a long way to go yet and recent references to banks’ exposure to government bonds, quantitative easing and confidence in inter-bank lending are reminders that the market is still fragile.”
Work relating to supermarkets and hotels has been strong this year, according to CMS Cameron McKenna real estate partner Mark Heighton, who adds that his firm’s property practice is budgeting for a small amount of growth (around 5 per cent) in the 2011-12 financial year, on the back of opportunistic buyers.
There has also been talk of investors setting up funds for residential property portfolios for some time, as rents rise steadily in London. But concrete deals are few and far between and many feel that although it is a sector that shows promise, the returns are not yet there.
“There are a number of investors out there who are looking at the detail of how to structure private residential funds, but we haven’t seen any of these come to the market fully yet,” says Ann Byrne, Linklaters’ head of real estate. “The levels of return are still quite low and there’s only a certain type of investor that may find this type of fund attractive: one that’s looking for a safe haven for their money over a long period.”
Banks have yet to start releasing distressed assets in any meaningful way, so there has been little pick up in activity there. However, most partners are confident that in the next couple of years refinancing will provide a steady, though not spectacular, slew of work.
“I get the impression that the banks are shepherding themselves in the direction of doing more disposals,” states one real estate partner at an international law firm.
In short, the figures for real estate teams this year took a definite turn for the better on the back of some exciting deals in the capital and abroad, but they do not herald a sustained rebound and, though thankful for respite after a couple of disastrous years, lawyers are restrained in their analysis of the market.
“Whether what we’re seeing is a genuine return to profit is another matter – it’s difficult to judge,” says Pinsent Masons senior consultant David Taylor. “There’s been no let up in fee pressure and deal volume is low compared with 2007. There’s fierce competition at all levels and firms are taking on work they wouldn’t have done before. You have public sector trusts saying they don’t want to pay more than £160 per hour, but expecting top-quality advice.”
Fortunately, most firms have already cut their cloth to fit a reduced market. In fact, the promising turnover figures posted by the top firms owe as much to internal restructuring as they do a pick up in work.
Meanwhile, the economic woes of Greece and the downgrading of US debt have created a lot of uncertainty in the past month or two. One real estate partner says: “In the past three to four weeks, banks have gone backwards, regardless of what they say.”
It is far too early to say whether the sector will slip back into a critical condition on the back of recent troubles, but it is clear that the road to recovery will be long and slow.
As one partner sums up the situation: “It’s still a difficult market – a bloody impossible market in some ways – but we’re tackling it in the best way we can.”