As Donald Trump once said, ‘real estate is always good’. Nearly $700bn changed hands in the commercial real estate market last year, proving that in times of uncertainty the safe money is on bricks and mortar. Brexit aside, London was seen as the safest bet of all, attracting over $23bn of new investment – $10bn more than New York.
With this money came a range of new buyers, as Chinese insurance companies, Malaysian pension funds, US investment trusts and a growing number of dedicated real estate investment funds all competed for prime assets. For those who remember when London’s commercial property market was dominated by local players, a lot has changed.
‘Property departments were not exactly the most exciting place to be’, says Ashurst global head of real estate Hugh Lumby. ‘We helped a small number of established players to trade buildings in the City and got made fun of by everyone else for being boring. Suddenly the asset class has grown massively and we are doing all the fun stuff.’
They are also doing the complex stuff.
‘The type of deals we are doing would stretch an investment bank’, says Leon Shelley, director of corporate and UK general counsel Westfield. ‘You really can’t get away with just knowing property law anymore.’
To highlight the rise of the humble real estate lawyer, The In-House Lawyer speaks to some of the sector’s leading counsel.
A design for living
In 1968, US office and home furnishing manufacturer Herman Miller released Action Office 2. Marketed as a workplace revolution, its chief novelty was the introduction of partition walls allowing workers a degree of privacy without hindering communication between desks. Fifty years later, most office workers spend their days in this environment. Not for much longer.
‘The old commercial model of putting up a box and filling it with desks and computers won’t generate returns anymore,’ says Mark Packer, general counsel for Europe at property and infrastructure group LendLease, the contractor delivering Google’s new King’s Cross headquarters. ‘Clients want a workspace to feel unique. They also want it to interact with nearby recreational spaces so workers feel like part of a community.’
It is a change felt throughout the sector.
‘Development is no longer about putting a building into an area and getting the best rent you can,’ says Rob Booth of The Crown Estate, one of the largest property managers in the UK.
‘As an industry we are increasingly looking at “placemaking”. It is a much broader view that considers the spaces between the buildings, the environment it creates, the societal impact and whether it will be attractive as a place to work and shop.’
This shift in focus from building to set-piece development can be seen across London, from Land Securities’ Nova development in Victoria – with its manifesto to ‘create work environments that are designed to enhance wellbeing and productivity’ – to The Crown Estate’s St James’s Market, a mixed retail and office scheme that will serve as the company’s new headquarters.
The International Quarter in Stratford, LendLease’s £2.4bn joint venture development with London Continental Railways, reflects another shift in the industry. Though the site will house the new headquarters of the Financial Conduct Authority and Transport for London, it has been built to accommodate potential change in owners and uses. ‘The way people live and work is changing rapidly so creating a flexible space is an important part of delivering value to investors,’ says Packer. ‘Long-term property contracts are becoming less popular and we are always trying to anticipate who the next occupier may be and how they may want a place to look’.
In rethinking how they deliver office and retail space, developers might look to the example of shared workspace provider WeWork.
Founded in 2010, the New York-based company is already valued at over $20bn, making it one of the top ten start-ups globally. That is double the valuation of Land Securities and eight times higher than rival office provider IWG (formerly Regus). Land Securities and IWG own huge portfolios of office space. WeWork owns very little.
WeWork launched in the UK in 2014 and is already London’s largest occupier of office space. This success is based on a simple business model. It rents space off a landlord and leases it on for more money. In fact, the likes of IWG and The Office Group have been doing the same thing for decades. Even so, WeWork’s focus on placemaking has made it a hit with tech companies and start-ups.
Its offices come with a range of services, from receptionists to beverages (inevitably, craft beer). That might not sound much to change an industry of vested interests, but this is not a market that has done much to keep itself relevant.
‘The service offered by landlords has traditionally not been that impressive,’ says Mat Oakley, head of European commercial research at Savills. ‘By treating an office as something other than an abstract space, WeWork has changed what people expect when they rent. Talking of “space as an experience” might sound jargon, but a large number of players in the commercial real estate market are genuinely worried.’
Mainstream landlords are already looking to follow the company’s model. IWG has launched ‘Spaces’, a new brand that offers offices with a similar start-up aesthetic, while in mid-2017 Blackstone bought short-term office provider The Office Group for £500m.
The residential market is seeing an equivalent disruption. The likes of Pure House and Krash are winning over investors by offering shared living space to millennials. But communal living is not for everyone. The shortage of rental properties on the UK market means build-to-let schemes are playing a big role in developers’ plans.
In January 2018, LendLease announced a £1.5bn build-to-let partnership with Canada Pension Plan Investment Board (CPPIB), the largest private equity investor in the world. The partnership will invest in private rental and affordable homes at LendLease’s Elephant Park development in Elephant & Castle.
Public scrutiny will be high. As preferred bidder to the Haringey Development Vehicle (HDV), a £2bn joint partnership with Haringey Council, LendLease has become something of a household name. In January, Haringey Council leader Claire Kober stepped down, accusing her Momentum-backed rivals of trying to sabotage the North London redevelopment scheme. Public demonstrations and media coverage of the spat added fuel to the fire.
In the wake of Carillion’s collapse, the situation has become even more sensitive. ‘Anyone working to deliver projects alongside government will have to think very carefully about how they present themselves,’ warns Packer. ‘Our financial strength is quite different [to Carillion’s] but making sure that is communicated clearly is important.’
Black Friday
Rolling Acres Mall in Akron, Ohio is a go-to reference for real estate investors. One of America’s many abandoned malls, the 1.3m square foot complex has become synonymous with the uncertain future of retail.
But, argues Leon Shelley, director of corporate and UK general counsel at Australian shopping centre operator Westfield, talk of its demise is misguided. ‘Retailers will always need showrooms. Flagship stores in capitals and strategically strong areas are doing very well. We got ahead of the market by focusing on these prime assets.’
Since Shelley joined in 2005, Westfield has sold around half its stores globally. In the UK, it has shed eight outlets to concentrate on its two London stores. It is currently working alongside Hammerson on a new £1.4bn complex in Croydon, South London as part of a long-term plan to regenerate the area.
Westfield recently agreed to a merger with French property investor Unibail-Rodamco. The deal reflects growing consolidation among shopping centre owners. In late 2017 Hammerson, owner of Brent Cross and the Bullring, tabled a £3.4bn big for Trafford Centre owner Intu.
‘Over the last decade there has been a shift in power toward major retail brands who take a very strong negotiating position against shopping centre owners and landlords,’ Shelley comments. ‘The wave of mergers were are seeing in the sector is an attempt to take some of that power back by boosting the negotiating power of shopping centres.’
There has been a shift in power toward major retail brands who take a very strong negotiating position against landlords.
Leon Shelley, Westfield
Bricks-and-mortar retail is facing an even bigger threat: e-commerce. Last year Westfield launched OneMarket, a network to facilitate data sharing among shopping centres, including those operated by its rivals.
‘[Amazon’s] advantage is in the cross-selling of data,’ says Shelley. ‘To ensure we stay meaningful as an industry we need to recognise that and get in the game now. By working together we hope that shopping centres will be able to compete with online retailers on a more even playing field.’
The impact of e-commerce has led to another surprising change in the real estate sector. As Ashurst’s Lumby dryly notes, ‘warehouses have become sexy’.
Solihull-based Nick Smith is first vice president and UK legal counsel at Prologis, a San Francisco-based real estate investment trust (REIT) that is widely considered to be the largest landlord by area in the world. Each year, $1.3tn of goods go through its warehouses. That works out at around 1.7% of the global GDP.
‘Logistics was always the ugly duckling of real estate,’ says Smith. ‘Now we’re in demand with investors and everyone wants to get into the market.’
Keeping up with the demands of online retail providers like Amazon and Alibaba is one of Smith’s main priorities.
‘They want big warehouses that are highly efficient, highly sustainable, and capable of coping with a big through-flow of goods and people. They want facilities that have secure power supplies to support the robots that are increasingly being used in selecting and packing stock. They want urban fulfilment centres and last mile delivery. All of that has an impact on the way we structure ourselves as a business and how we deliver service to the client. It also changes the way you behave as a lawyer. Amazon’s leasing model is very different to the industry norm and you need to be flexible to support their requirements.’
Last year Smith helped set up the Prologis UK Logistics Venture (UKLV), a £1bn co-venture with CBRE Global Investors that will move a chunk of the company’s UK assets into a new fund.
‘I started as a property litigator from Birmingham working at a distribution company whose founder was known as “the shed father”,’ says Smith. ‘Now I’m advising a global REIT on investment funds. That’s how much this sector has changed.’
Dodging the drafting
Merlin Entertainments is best known in the UK as the operator behind Madame Tussauds, Alton Towers and the London Dungeon, but its global portfolio of 150 theme parks, hotels and indoor attractions takes up a lot of real estate.
‘If you think of our business in the simplest terms then each attraction has a property deal sitting under it,’ says group general counsel and company secretary Matt Jowett. ‘In that sense, real estate work is central to everything we do. For big, capital intensive projects we need long-term security of tenure. Negotiating a very good land deal upfront is critical to the success of every investment.’
Strictly speaking, Jowett is not working in the real estate sector. Perhaps that explains his enthusiasm for a property deal. For many GCs in the sector, property forms only a small part of what they do.
‘Prologis owns warehouses, but it is a fund manager and asset manager that owns warehouses,’ notes Smith. ‘I spend my days dealing with banking and finance work, corporate work, tax and structuring as much as anything to do with property.’
Shelley at Westfield did not even do a property seat as a trainee. It has not held him back. ‘There is a lot of real estate law involved when you operate a shopping centre but there is also a lot of very complex financial work involved.’
‘The demands of the sector mean that we are no longer looking for pure property lawyers,’ says Booth at the Crown Estate. ‘The skills needed in-house are similar to those you would expect in any top commercial organisation. Becoming more rounded is going to be a big part of remaining competitive [as a lawyer] in this sector.’
The demand for more rounded counsel has not escaped the attention of law firms. Problematically, argues Iain Morpeth, head of Ropes & Gray’s international real estate investments and transactions group and a partner in the firm’s London arm, UK law firms have traditionally fragmented real estate work across practice areas.
‘The model for delivering on complex deals was to assign the corporate piece to a corporate partner, the finance piece to a finance partner and the property piece to a real estate partner. As a result, real estate practices did not evolve with the market or gain the advantage of embedded experience. The US model is streets ahead and a lot of UK firms are now struggling to adapt.’
Jeremy Clay, global head of real estate at Mayer Brown, has seen similar pressure: ‘Until recently, UK real estate lawyers had a fairly narrow role. They bought and sold property or looked at title. These days, every real estate deal of scale will have a fairly complex structure sitting underneath it, and writing title reports is not going to wash at an elite firm.’
Things may be changing, but LendLease’s Mark Packer says finding the right advisers remains challenging: ‘As a GC you often look at firms and ask “who has got the expertise to do this type of deal?”. Plenty of people can do corporate deals, but real estate corporate deals have all sorts of nuances. You don’t want a general corporate lawyer advising on them but it is rare to find a real estate lawyer with enough experience of corporate structures.’
For partners used to working directly with property developers, the growth of in-house teams in the sector represents another big change.
‘The old view from managing directors was that you don’t need an in-house real estate lawyer,’ says Smith. ‘Gradually, surveyors have realised that it’s much better to work with people who understand the deal they’re working on. We’ve gone from spending £5m a year on legal fees to spending less than £1m by bringing work in-house.’
Lawyers across the sector are seeing the same trend. ‘Ten years ago it was very difficult to justify the overhead of employing lawyers,’ adds Shelley. ‘Businesses are now aware it is a false economy. Having lawyers experienced in the Westfield way is invaluable to getting deals done. It also means we are no longer spending a ridiculous amount with externals.’
As Trump would say, ‘Bad Deal!’
Land of opportunity? A year in review
With yields in London approaching record lows and Brexit uncertainty looming, many expected a slowdown in the commercial market. Instead, the City saw a near-record year of investment.
The UK real estate market’s surprise, says Mat Oakley, head of European commercial research at Savills, is the result of insularity. ‘Everyone was looking at the domestic picture when they should have been looking at what is going on elsewhere. In comparative terms the UK is a low-risk, high-yield market and for Asian investors it is offering far better risk to return than they are seeing at home.’
Around £9bn of the £23bn invested into London came from Asia-Pacific based investors, the bulk from Hong Kong. The two £1bn-plus acquisitions London saw in 2017 – involving 20 Fenchurch Street (the Walkie Talkie) and 122 Leadenhall Street (the Cheesegrater) – were both made by Hong Kong-listed entities. Interest was not confined to trophy assets.
‘Across the entire market we saw high interest from Asia-Pacific investors,’ comments Michelle Howie of Herbert Smith Freehills. ‘Asian investors will typically accept lower yields than US funds and the exchange rate benefit is also giving them a big advantage, allowing them to undercut domestic bidders. However, they typically want to invest in finished product rather than speculative development. There may soon be a shortage of attractive assets.’
Speculative development is facing its own problems, says Iain Morpeth of Ropes & Gray. ‘Core assets offering lower returns are still in demand, but at the more speculative end of the market, funds are struggling to find the opportunities. A return of 20% is becoming a cavalier expectation in the UK and many feel the risk doesn’t justify the reward.’
However, Morpeth adds, the role of funds in the market will continue to grow. ‘Banks are strained for capital and face enormous regulatory burdens, which has led to a shortage of debt to fund new projects. As a result, there has been a growth of debt funds and credit funds taking a strong position in the sector.’ A growing number of funds have been adding real estate capabilities to their portfolios. For example, Bain Capital recently recruited a 20-person team from Harvard University’s investment arm to help form Bain Capital Real Estate, the firm’s first sizable property capability. ‘Large, established funds are trying to get more skin in the game’, says Oakley, ‘but there are also a number of smaller, more aggressive funds bidding for assets and fragmenting the market.’
Office Space – The rise of WeWork
The disruption of traditional industries by tech-backed challengers is a familiar story. Even so, the rise of WeWork has caught many in the commercial real estate sector off-guard. Jonathan Wainstein, real estate counsel for EMEA at WeWork, argues that the market was ripe for a shake-up.
‘Offices are among the most inefficiently used spaces around. Most companies tend to rent far more space than they need because the decision is based either on what other similarly-sized companies are renting or a hunch. No one uses technology to analyse how buildings are being used. WeWork is taking a much more sophisticated approach that helps find the right-sized office for a business. Only by mapping how different companies like to use space can we learn the best way to organise the buildings we occupy.’
Wainstein left Nike’s European headquarters in the Netherlands to join WeWork in November 2017, becoming the fourth member of its EMEA, Israel and Australia real estate team led by associate general counsel Nick DiChiara.
‘Real estate lawyers don’t often get the chance to work at unicorn start-ups. I may not have a tech or data law background but I can still help create better working environments. It is very exciting to be part of business that is creating a new sector.’
Even for a real estate lawyer it can be unfamiliar territory. ‘The traditional lease is just the first stage. We typically do a fairly extensive refitting operation that needs to be approved by the property owner and covered in a legal document. The agreements we have with members [tenants] are also very different from the norm. Documenting that in a way that protects both sides without interrupting the fluidity of the model can be very complicated.’
Last year WeWork doubled the number of desks it lets globally. It plans to do the same in 2018 and will enter a number of new European markets. It is also looking to grow new offerings such as co-living provider WeLive and managed services division Powered by We, which offers refitting services and on-site staff to large corporates. It has already been hired by IBM to manage its Manhattan offices.
It will also look to acquire some of its own buildings outright. Last year WeWork established an investment fund with private equity house Rhone Group and has already spent £600m buying London’s Devonshire Square – a former warehouse of the East India Trading Company – from Blackstone Group.