Property solicitors will need to adapt to a rapidly changing market

Property has been anything but ‘as safe as houses’ for solicitors who deal with residential conveyancing since the onset of the credit crunch. Their colleagues in the commercial property sector have encountered equally thin pickings.

But, slowly and unevenly, both sectors of the property market are recovering, and buyers and developers are losing some of the caution that marked the recession’s depths.

As if recession were not enough to deal with, residential conveyancers face the threat of competition from new rivals once alternative business structures are permitted from October 2011.

Commercial property does not face any such threat, but firms there can still see themselves fighting for their share of a much smaller market for some years.

Industry forecasts are, at best, cautious (see box) but among lawyers there is a feeling that the worst may be over.

ResidentialIt has been awful in residential, no two ways about it. But at least there are now chinks of light. Former Law Society president Paul Marsh, now Chancery Lane’s property industry spokesman and a consultant at Surrey firm Downs, observes that the residential market has experienced ‘a huge falling away’ since 2007/08. ‘It has an impact on us not just in lower volumes but in the growth of demands for referral fees to estate agents,’ he says.

‘Firms that do not pay referral fees are losing out in the market. It tends to be the large estate agents that do it, and if you want to deal with them you have to put in a lot of infrastructure to deal with the high volume and the sort of constant contact these firms want.’

Even discounting referral fees, Marsh says the market is ‘highly competitive between solicitors’; with even quite small firms that are prepared to spend on marketing taking the lion’s share of what is available from rivals, which would once have expected to get some work as a matter of course from their local conveyancing market.

The modest recovery so far experienced will not really take hold until liquidity returns and lenders make loans more easily available again. The sharp contraction in lending led to many more customers making false claims to secure loans, of course, something Marsh believes solicitors have little power to control.

‘[That] led to an increase in mortgage fraud because people are being squeezed and find it difficult to get loans,’ he says. ‘Solicitors are like the security guards at an airport at the gate being blamed if people jump the queue.’

The Council of Mortgage Lenders is less sanguine. It recently called for closer scrutiny of law firms to crack down on mortgage fraud committed by solicitors, and a comprehensive review of the way solicitors are regulated.

Richard Atkins, conveyancing partner at Luton firm Taylor Walton, is cautiously upbeat about market conditions, suggesting that ‘things are better than they were 12-18 months ago and there is a patchy recovery’. He adds: ‘Estate agents say good homes in good locations are selling, but overall conditions are fragile, though things are on the way up rather than down.’

In the meantime, less work has meant fewer lawyers in this field. He notes: ‘Firms now feel busier, but that is because they have fewer people doing the work. I cannot think of a firm that has not scaled back significantly.’

One factor that some argue exacerbated the recession’s impact was the advent of home information packs (HIPs).

Peter Rodd, a partner at Margate firm Boys and Maughan, and chairman of the Law Society Property Section, hopes the Conservatives, should they win the general election, will quickly suspend the operation of HIPs ahead of a change to the law.

‘Traditionally, in spring, people would ask an estate agent to value their home out of curiosity, get a higher valuation than they expected and then put it on the market even when they had not originally planned to,’ Rodd explains.

‘The problem with HIPs is that you cannot do that because there is a cost to the seller.’

Marsh goes further, calling HIPs ‘the biggest [conveyancing] disaster of the last 50 years, set up by people who misunderstand how the market operates’, and says they have discouraged vendors and stifled an already short supply of homes.

He asks: ‘In the last three years HIPs have cost the public £1bn but have they really given the public £1bn of value?’

And what of the companies that build new homes, and so ultimately keep the housing market active? They have suffered grievously too.

The lending squeeze has made it hard for housebuilders to borrow money to buy land, even if they could build at a profit in the current climate.

Neil Bucknell, partner and head of the property section at Guildford firm Laytons, says that he now finds ‘there are very busy [companies], but they are the exception rather than the rule’.

He adds: ‘Many major developers rely on housebuilding that is in some way subsidised by the public sector, such as schemes that help first-time buyers. That is what is keeping the lower end of the market going.

‘I think things are beginning to move on the development side, but development is unattractive to banks – unlike three years ago.’

All is not lost. Low interest rates have clobbered savers and made it hard to convince banks to lend but ‘if you have got a job and an income, it’s not a bad time to buy as money is cheap’, Bucknell says.

First-time buyers find things particularly difficult unless they qualify for some sort of public subsidy, and he does not expect to see the kind of properties once aimed at them making a comeback in the foreseeable future.

‘Large developments of flats on a brownfield site in a city centre would be the least likely thing of all to sell at the moment, but there were a lot of them a few years ago,’ he says.

As we now know, meanwhile, ABSs are slated to arrive in October 2011, intruding on the traditional domain of battered conveyancing firms.

Anthony Ruane, a senior partner at Optima Legal, which acts largely for property lenders, argues that these new providers will drive out small firms that cannot compete, other than in specialised niches.

‘I could imagine a big lender coming in and employing a law firm to do the legal bit of the process,’ he says. ‘It will be a challenge, or opportunity, for legal firms.’

Rodd, however, reckons that ABSs will not necessarily sound the death knell for the high street conveyancer. ‘Solicitors can compete by providing a quality service locally,’ he says.

‘I cannot imagine that Tesco [or whoever] would offer it at every store. I’m not saying Tesco does not offer a quality service but it could not be everywhere.

‘There is always a certain percentage of the market that values signing papers in front of a solicitor, which is easier if you can go to a local office.’

Atkins believes solicitors who are determined enough can survive ABSs, and doubts that the market will attract many entrants.

‘Law firms have had a certain role in housing transactions and we cannot take that role for granted. I can see solicitors acting for other businesses who enter the market through the Legal Services Act,’ he says. ‘However, prices are so competitive that if anyone thinks there is a pot of gold at the end of this particular rainbow they should think very carefully, as many people may get their fingers burned taking on conveyancing.

‘They will come to realise they have to work extremely hard for a reasonable return on residential conveyancing.’

Conveyancing has of course changed in recent years with the rise of specialist ‘conveyancing factories’ that have invested heavily in information technology.

Marsh sees the conveyancing factories ‘consolidating a bit, but the market is saturated so I cannot see how it will grow’. He suggests law firms that want to stay in conveyancing should improve their marketing and reduce costs through efficiency, staff cuts and better use of IT.

Electronic conveyancing ‘has made transactions easier but does not reduce their complexity, and you need the scale to invest in electronic systems’, Ruane notes.

He points out that the Land Registry, despite cutting staff numbers as part of its transformation programme to reflect the slump in transaction volumes, is still making technical innovations such as moving to digital signatures.

‘Conveyancing is becoming commoditised and if you want do that you need to focus on the technology, and those that do not are on a hiding to nothing,’ he says.

According to Ruane, some 8,000 firms do conveyancing, but 760 of these do 60% of the work, ‘so you can see the market consolidating that way’.

He sees an eventual polarisation between firms large enough to invest in IT doing commoditised conveyancing on one hand, and those that do more specialised and complex cases on the other. ‘It will be difficult for a firm to have a foot in both camps,’ he suggests.

CommercialThe sight of cranes constitutes a bellwether of health in commercial property, and around London at least they can be seen on the skyline once again as a hesitant recovery begins to take hold.

Law Society council member for commercial property Nick Fluck, a partner at Stamford firm Stapleton & Son, says his work comes mainly from the storage and distribution depots industry and from smaller residential sites for up to around 1,200 homes.

‘Developers are less nervous than they were and are starting to feel this might be a good time to acquire some land,’ he says.

‘There is perhaps a feeling that developers having been more or less shut down are now prepared to build but want to limit risk.

‘For example, they might build the affordable housing element of a site, because that is effectively pre-sold to a housing association, and then want to sell off the remaining parts.’

He finds that the low volume of conventional transactions has led to the rise of some less usual ones. ‘We are seeing a lot of tenants looking for smaller premises,’ he says. ‘There are also tenants looking to reduce their outgoings and there are cases where landlords have accepted rent reductions in return for term extensions, but that tends to be for small-scale landlords, larger ones don’t do it and probably never would.’

Developers who would once simply have bought a site and ‘landbanked’ it until they were ready to build are now more wary of having their cash tied up in this way.

This has led to the rise of promotion agreements, where a developer tells a landowner that it is interested in a site and will apply for planning permission if given a right to then buy the land once that is secured.

‘These deals tend to be rather complex because landowners will be looking for a return that the developer cannot guarantee, and will want to avoid being tied to one developer for too long,’ Fluck explains.

Simon Kenley, a partner at Berwin Leighton Paisner, says performance has varied sharply across different facets of the commercial property market.

‘For example, as activity levels in the development market fell, there was greater activity in inward investment and managing distressed real estate assets,’ he says.

Kenley sees an increasing number of deals flowing from distressed sales of property, though not as many as the market had anticipated, as cases of commercial tenants failing to meet rent commitments have been fewer than expected.

‘The banks have balanced the risk of taking rent that someone can pay, rather than acting against them on technical breaches of lending covenants,’ he notes.

Some major developers are starting to build London office schemes, but the rest of the UK has not yet seen the same growth, he says, with the exception of projects supported by the public sector, where the Homes and Communities Agency has been encouraging private sector funding in some stalled large-scale residential developments.

Of course, banks’ lack of willingness to lend hampers commercial projects just as it does residential sales.

‘With the lack of debt available, the market is looking to investors to get the developments moving through forward funding, forward sales and joint ventures,’ Kenley says.

‘London has always been an attractive investment opportunity and the weakness of the pound is encouraging much higher interest from foreign investors.

‘There is a lot of equity from sovereign wealth and private equity funds, which is looking for good investments.

‘With little available prime stock, prices are being driven up and anyone who was brave enough to buy in 2009 will have made significant returns from commercial property.’

Commercial property lawyers are perhaps the beneficiaries of dealing with a more predictable market than that of residential conveyancers.

As Marsh notes: ‘Commercial property is a sophisticated market and I think it is doing better than residential because the people in it are running businesses and understand that you cannot just stand still.

‘Unlike private residential buyers, people there know what they are doing; no one ever buys commercial property just because it is near their mother’s home.’

It argues that threats of inflation, tax rises, public spending cuts and higher unemployment will reverse the trend of rising house prices seen in 2009 – though not by more than 3%.

The company says its ‘relatively conservative view of the rate of price growth from 2012 reflects our expectation that current low levels of mortgage availability will improve only slowly over time’.

Knight Frank concludes: ‘It would be wrong to expect a rapid recovery in the housing market. Similarly, it would be wrong to expect carnage. Real demand is strong, supply in the wider market and the new-build sector is very low and we are unlikely to see a rapid shift away from a low interest rate environment.’

In commercial property, Knight Frank says the lack of supply of prime properties has meant prices have gradually improved for better quality secondary properties. With the exception of shopping centres, all parts of the commercial market saw yields improve in their best properties.

Knight’s commercial forecast, issued in February, boldly states: ‘Let us remind ourselves here that we are now out of recession. Property provided a positive return last year, the economy is growing (just) and if you work in the central London market you’re probably wondering why no one’s opened the champagne yet.’

Another view comes from the British Property Federation, which represents companies active in this market.

Spokesman Kurt Mueller says: ‘The banks will this year likely begin to address the enormous property debt on their books, seeking out partners and joint ventures to improve distressed assets and portfolios.

‘This will present opportunities in the market, but it will be a long hard slog before the £225bn of outstanding commercial property loans are dealt with sufficiently.’

Mueller says the dearth of mortgage finance will hold back the residential market, despite signs of revival.

‘With first-time buyers being mostly priced out and unable to access mortgage funding, other types of housing will have to step in to meet the unwavering demand for more houses,’ he says.

‘The most obvious alternative to traditional housebuilding for sale is the private rented sector and a new build-to-let model.’

Mark Smulian is a freelance journalist