Exciting times ahead for real estate lawyers

Author: Robert MacGregor, Berwin Leighton Paisner, London

The UK real estate market and, in particular, the London office investment market has continued to boom during the last 12 months, despite higher interest rates and the resulting marginalization of highly geared buyers. Tenant demand has returned, rents are forecast to increase and yields have further compressed.

During 2005 there was a significant departure from the traditional relationship between a strong investment market and occupier demand driving future rental growth. The sheer weight of money seemed to be driving yield compression in the face of weak occupier demand. In the last part of 2006, increased tenant demand and forecasted rental growth have given fresh impetus to the investment market and, combined with continued weight of money, have pushed it to new highs. During the last few months a number of the larger property companies who are likely to convert to Reits in early 2007 (suffering a conversion charge based upon asset values) have largely stood on the sidelines. When they re-enter the market in 2007 as tax-advantaged Reits competitive bidding pressures are likely to increase further.

On the downside, higher prices are putting increased stress on investor returns. Property funds that have raised a significant amount of new investor capital are finding it challenging to find sufficient (or sufficiently attractive) supply in the UK, and so are looking towards Continental Europe (particularly Eastern Europe) for higher returns. Lenders are also finding the market exceptionally competitive, resulting in thinner margins and underweight lending books as more borrowers choose to repay early.

As a result, investors and lenders are looking for increasingly innovative acquisition and debt structures to try and squeeze as much value as possible out of their portfolios. Real estate development transactions are also the subject of greater up-front tax and financial engineering in order to seek higher returns and to facilitate the widest range of options for an exit.

Some major corporates with significant real estate holdings are taking the opportunity offered by such a strong investment market to enhance returns by undertaking sale and leasebacks to purchasers, many of whom look to exit through the capital markets.

In relation to a number of key measures during 2006, London has outperformed New York to become the world's leading financial centre. Financial institutions are growing again in London and this trend looks likely to continue. London's success in the global financial markets can be expected to impact directly on its real estate development and preletting market.

There is now an obvious convergence between New York and London in the way in which real estate deals are structured and financed, and this is only likely to increase. The introduction of Reits is only a small example of this.

What does all this mean for London-based real estate lawyers? In short, it means that there are significantly greater opportunities to travel: to travel with the asset in relation to corporate and finance structures and to travel with clients to help them with transactions in international real estate markets which may offer higher returns.

Real estate's significance as an asset class has grown enormously over recent years and the real estate market has become increasingly global. Many clients, particularly those from the US, are used to real estate lawyers project managing the delivery of their most complex multi-disciplinary transactions that involve real estate assets. For those real estate lawyers who want to take up this challenge there are opportunities to build close working relationships with their clients as they get to understand their businesses better.

However, transaction structures are becoming more complex and core real estate values are still driven off sound real estate development and landlord and tenant documentation. A particular challenge for law firms will be to ensure that their real estate lawyers gain sufficient core real estate and multi-disciplinary skills to be able to lead complex real estate related transactions in the UK and elsewhere. Achieving this essential balance will not be easy.