Despite June’s Brexit vote, real estate lawyers are confident foreign investment will continue to be a lucrative source of work. Marialuisa Taddia reports.
Three months on from the EU referendum, it is still too early to assess the impact of the Brexit vote on commercial property. The market took a hit in the immediate aftermath, when some of the country’s largest property funds closed and prices at many tower developments in the capital plunged. But the signs are confidence is gradually returning.
The sector is big-money: the invested and owner-occupied commercial market grew 11% to £871bn in 2015, a record level, surpassing the previous peaks of 2006 and 2007 respectively. The amount held by investors increased by 9% to £483bn, the Investment Property Forum (IPF) said in August.
One of the biggest contributors is the influx of foreign capital, particularly in London. Overseas investors now account for 28%, or £135bn, of UK investment property, up from 17% in 2007, with 77% of their holdings in the capital. They already dominate the City office market with 61% of investment property and have been expanding into London’s West End and Midtown office market, the IPF says.
It is no surprise that ‘market forces’, rather than regulation, have been driving work for firms, as Nabarro senior partner Ciaran Carvalho observes. His clients include UK real estate investment trusts (REITs), among them Hammerson, Great Portland Estates and Land Securities.
‘Most activity has been in relation to the continuing flow of foreign investors’ money into the UK market,’ says Richard Vernon, head of real estate at Ashurst, another leading industry player, reflecting the experience of other practitioners.
Foreign investors tend to be from the far east and north America. London-based Vernon explains that they are not just looking for ‘pure investment deals’ but also increasingly at development opportunities. This is because of the lack of supply of good quality assets and high prices, particularly in London where the value of the for-profit bricks-and-mortar sector grew at nearly double the rate of the rest of the country last year.
‘Real estate remains one of the largest traded assets in the investment world,’ Vernon says. ‘There is no reason for that to stop; it remains a very active area.’ Earlier this year, Ashurst advised Chinese state-owned developer Greenland Group on acquiring and securing planning permission for Spire London in London’s Docklands. At 242 metres and 67 storeys, Spire will be Europe’s tallest residential tower. Boosting confidence in the post-Brexit property market, the Shanghai-based developer will start construction of the £800m building in early 2017.
Pinsent Masons, another large player, has also been acting for an increasing number of overseas investors from the US, Asia-Pacific and the Gulf, among them Dubai Holding, Los Angeles-based CBRE Group and China’s Advanced Business Park (ABP). The UK is a ‘safe haven’, particularly for Chinese investors, explains head of commercial property Claire Hughes. The first stop is usually London where they may invest in ‘trophy assets’ such as hotels.
‘They are becoming familiar with our jurisdictional nuances. Unfortunately, English property law is a bit archaic compared to other jurisdictions, but once they get their heads round it then they tend to look at other cathedral cities around the country,’ she says.
At the other end of the spectrum, Hughes notes, are investors who have been buying ‘in huge volumes’ – for example, through distressed debt deals. She points to Pinsents’ mandate to advise US private equity firm Lone Star Funds when it acquired Aviva’s UK real estate portfolio of performing and non-performing loans for £2.25bn.
Firms have also picked up significant roles in the office sector, which saw the greatest increase in value in 2015 – it is now the second-largest commercial property sector by value and the biggest in terms of investment, IPF data shows. Nabarro advised Australian developer Lendlease and London and Continental Railways on the £615m ‘forward funding’ of two buildings in the early stages of construction at The International Quarter – the £2.3bn business district development in Stratford. The buildings, acquired by Deutsche Bank and Legal & General, will be occupied by the Financial Conduct Authority and Transport for London. Both are relocating from Canary Wharf.
Berwin Leighton Paisner is another real estate firm that has seen significant demand from big office occupiers, including banks and law firms. ‘That market is still there. People still need the office space,’ says head of real estate Chris de Pury.
In the digital economy, firms are not just catering for big corporates. Suzanne Gill, commercial property partner at Wedlake Bell, says: ‘If you are a start-up working on a project that might be only temporary, there is no reason why you can’t have a cool and comfy space in the same way you would if you worked for a huge company that spent a fortune on its office fit. That is really having an impact on how much space tenants need and how long they are prepared to commit to a lease for.’
The London firm is advising high-profile ‘creative accelerator’ Second Home, which launched in Shoreditch in 2014, on the acquisition and development of new co-working space in the capital (including in Holland Park); it is also acting for a number of land-owning clients which are using ‘surplus space’ for co-working initiatives, Gill says.
Industrial space is also growing rapidly in value, keeping practitioners busy. ‘Outside London, logistics has really come to the fore,’ Carvalho says. London-headquartered Nabarro also has offices in Manchester and Sheffield.
‘In a sense, logistics is the new retail. If you think of groups like Amazon, Facebook and Google, and anyone involved in the supply chain, they need to store their goods in very large warehouses,’ Carvalho says, pointing to Segro, a UK REIT, which owns, manages and develops warehousing and light industrial property.
‘Their business has done pretty well as a result of the move of traditional retail to “dark stores”.’ In September, the LSE-listed company announced the £340m placing of new shares to exploit rising demand from online retailers. Nabarro and Eversheds were reappointed for a further exclusive three-year contract for UK real estate work to Segro’s legal panel in February.
Firms have also landed big mandates in mixed-use projects, which combine commercial and residential, a trend driven by the shortage of homes in London and the south-east. ‘There is a huge focus, in general terms, on housing, pushed by the government,’ Hughes says. Pinsents is advising Capital & Counties, the London Legacy Development Corporation and China’s ABP, among other developers, on large residential and mixed-used schemes in parts of London that have been designated ‘opportunity areas’ and ‘housing zones’, including Earls Court, the Olympic Legacy Area and Royal Docks .
‘Our practice specialises in the private rented sector and also the build-to-rent side, and there is increasing institutional [investor] interest in it,’ Hughes observes, adding: ‘We are now acting for not only developers, but also funds [that] are investing in this sector.’
Jewel in the crown
Firms pitching for work in the commercial property sector could do far worse than look at the Crown Estate. With a capital value of £12.9bn, the Queen’s property company made a net profit of £304.1m for HM Treasury in the financial year to the end of March, an annual increase of 6.7%.
It has four main portfolios: central London, including Regent Street (pictured) and much of St James’s; regional retail and leisure (the Crown Estate is the UK’s third-largest owner of directly owned shopping parks); agricultural and strategic land (336,000 acres); and offshore wind.
But the London-based organisation only has a ‘tiny’ in-house legal department. ‘It’s an an extremely lean model here,’ says general counsel and company secretary Rob Booth, whose team consists of five lawyers. Booth and, beneath him, ‘a layer of senior legal counsel’, are each responsible for one portfolio. ‘We are very much a pivot point and an architect within a heavily outsourced model where all of the heavy lifting is picked up by our external panel.
‘[Our role] is all about managing, leveraging, engaging and working with our external firms to make sure that they are giving a really good service to our business,’ adds Booth, who took up the GC post in January, succeeding Vivienne King. Booth joined the Crown Estate in 2012 from City firm Herbert Smith Freehills.
The Crown Estate’s panel of external legal advisers includes Hogan Lovells (a team led by Charles Brasted keeps the estate abreast of Brexit issues), Norton Rose Fulbright, Burges Salmon, Gowling WLG, Bond Dickinson, Forsters and Pemberton Greenish. ‘It is not a huge and unwieldy panel,’ Booth says. ‘We tend to build meaningful mandates to ensure that we get good cross-investment between us and our panel firms through the life of those appointments.’
The organisation is reviewing its panel, including for commercial real estate work within its central London portfolio. Asked whether the outcome of the referendum had changed, or was likely to change, the organisation’s approach to outsourcing legal services, Booth says: ‘We have a relatively structured approach to the regularity of our review of who’s on or who’s off. The panel reviews going on at the moment [are] de-linked from the referendum. We anticipate a continued volume of work, certainly over the short- to medium-term.
‘Clearly, we are cognisant of the referendum result. It’s relevant to our strategy but, as things sit at the moment, I haven’t fundamentally altered anything we do because that result came to pass.’
Shortly after the referendum, the Crown Estate said it would review two West End development projects at Morley House and Duke’s Court that had not yet started construction. Booth tells the Gazette: ‘As regards our commercial pipeline, we still approach projects looking at them on their merits in the same way we did before.’
‘Morley House and Duke’s Court would have been reviewed as developments anyway, and they all go to our board for decision through exactly the same process as they did before,’ he says. The timing of the announcement wasn’t ‘necessarily anything triggered by the referendum result of itself. It’s business as usual on that front, really,’ he concludes.
Large-scale mixed-use projects, both in and outside London, have also been a staple of Ashurst, which acts for Berkeley Group, Lend Lease, Grosvenor and Countryside, among other property groups. But Vernon says new requirements to include cheaper homes in new schemes are affecting their viability. The Housing and Planning Act 2016, in force since July, allows the government to set regulations requiring starter homes – sold at a 20% discount to first-time buyers – to be included on residential sites, as a condition for securing planning permission. London mayor Sadiq Khan has set a 50% affordable construction target across London.
Institutional investors are also increasing their holdings in the student accommodation sector, which benefits from overseas students coming to Britain. One example is Canada Pension Plan Investment Board’s £1.1bn acquisition of the British student accommodation portfolio, operating under the Liberty Living brand, from the Brandeaux Student Accommodation Fund. Nabarro advised CPPIB.
Retail remains the largest commercial property sector by value, with firms advising landlords and occupiers of retail units, as well as developers. Russell-Cooke, whose clients include Pret a Manger, Matalan and Sports Direct, recently acted for a freeholder of flagship premises off Leicester Square in taking a surrender of the head lease from KFC and letting part (for £1.5m) to US burger brand Shake Shack, which is opening there later this year.
Earlier this year, Ashurst advised Westfield on its £600m retail extension to Westfield London (owned in a joint venture with Germany’s Commerz Real), to be completed by 2018. ‘Westfield is a very good example of [another] client who has remained active in the current market,’ Vernon says.
So what has been the impact of the Brexit vote? In commercial property, solicitors largely do transactions rather than advisory work, Gill says: ‘What we need is the dealflow, and if the volume of transactions goes down for whatever reason, then that is bad for commercial property lawyers. We have seen a cut in volumes of transactions. What we can’t tell at the moment is whether people have paused over the summer holidays or whether it is a long-term thing.’ The vote affected big transactions, she added.
The financial year to 30 June ‘was definitely a year of two halves’, says Peter Dawson in reference to Russell-Cooke’s commercial property practice, which he heads. ‘Everything was going full steam up to Christmas, and then for various reasons a slowdown occurred from the new year through to summer. Part of that was people’s anxiety regarding Brexit, but it wasn’t the only reason. There are wider global issues. Many of our investors are offshore and the continuing problems with bank lending had an effect.’
Carvalho, who heads Nabarro’s real estate group, says: ‘I wouldn’t say that it has been business as usual because there is certainly more analysis and people are still being cautious, but the real estate market has not ground to a halt. People are still doing [deals].’
There was a slowdown just before the referendum and in the first few weeks after the vote when deals were put on hold, renegotiated or, if they had ‘Brexit clauses’, terminated, Carvalho explains. But things began ‘to settle down’ when Theresa May took office on 13 July. He notes that in the financial year ended 31 August activity in the real estate practice was ‘up a little’ on 2015.
BLP’s UK real estate practice had ‘the quietest June-July for some years’ but then appeared to pick up, says de Pury, adding: ‘I wouldn’t say that things have gone back to normal. The market peaked, certainly for London, about a year ago, so it had quietened down going into Brexit.’
The reactions to the Brexit vote reflect different types of client.
In the aftermath, some of Britain’s largest insurers and asset managers, including Aviva, M&G, Standard Life and Columbia Threadneedle, closed their UK property funds to halt investor redemptions, amid speculation of a possible drop in commercial property prices. Although some funds have since reopened, this reflects a more conservative approach.
Pinsents’ clients include ‘a big array of annuity investors’ such as domestic pension funds and insurance companies, among them Aviva, Legal & General and Royal London.
‘Domestic institutional clients are being far more cautious than many of the overseas clients we act for, who are very excited because [Brexit] is an opportunity for them,’ Hughes says.
For international investors Brexit ‘is a great opportunity because sterling has fallen and there is less competition around’, Carvalho adds. This includes the less risk-averse, shorter-term private equity firms. But not only them.
‘There is much interest in commercial real estate, particularly from the far east, and they tend be either high-net-worth individuals or sovereign wealth funds,’ Carvalho adds. ‘They are long-term investors who are prepared, certainly as regards London, to take a bet on [it]. Obviously there will be some challenges after the referendum. But if you are in this for the longer-term, and it’s wealth preservation and you can’t get returns on bonds and gilts because they are so low, where do you actually put your money to work?’
And what do lawyers say of fears of falling values and rents due to an oversupply of offices in the capital and the relocation of financial institutions to continental Europe? Capitalising on ‘strong occupier demand’, developers started 51 office projects in central London in the six months to the end of March, Deloitte said in a May survey, adding that the amount of office space under construction nearly doubled in 18 months.
But international companies could move 100,000 London jobs to continental Europe if they lost their passporting rights to offer their financial services anywhere in the EU and the wider European Economic Area, according to investment bank Jefferies.
‘There is a perceived lack of grade-A office space in central London coming up in the next year or two, and that isn’t going to change,’ says Vernon. ‘Generally people don’t believe that banks would suddenly up sticks and go to Paris or Frankfurt.’
At any rate, with their network of offices across continental Europe, firms can hedge their bets: ‘London has been too hot for a little while,’ Vernon says. The value of commercial property in the capital was 38% higher than in 2006 while it was 14% lower in the rest of the country.
‘With real estate seen as a global investment asset, investors don’t really mind where it is, provided the price is right and it is in key world cities.
‘Generally, the feedback we are getting from investors is that activity remains pretty stable and although they want to get this sorted out, long-term, from a property perspective, the end result is not going to change people’s view of property and investment into the UK.’
That sense of optimism among practitioners was no doubt bolstered by last month’s news that the £1bn privatisation of the Land Registry was put on hold. ‘The presence of a state guarantee of title is the bedrock of not just commercial property, but property dealings generally in England and Wales. We find it hard to see that there are any benefits in privatisation at all,’ says Dawson, who echoes the consensus among lawyers.
He concludes: ‘It is easy to forget that we have one of, if not the most, sophisticated commercial property systems in the world which is envied by many because of its transparency and fairness – that is not going to go overnight.’
Marialuisa Taddia is a freelance journalist