Works in progress

Commercial property spans an ever wider range of legal work – from leasing office and retail space, to developing and investing in new homes, big-box distribution centres and places for students to live. But practitioners in this area, perhaps more so than any other branch of legal practice, are at the mercy of commercial and economic trends.

The exciting thing that has happened for overseas investors has been the fall in sterling

Suzanne Gill, Wedlake Bell

One of the most significant drivers recently has been the value of the pound. Over three-quarters of capital invested in the London market in 2018 came from outside the UK, according to estimates by real estate giant JLL. ‘The exciting thing that has happened for overseas investors has been the fall in sterling,’ says Suzanne Gill, commercial property partner at Wedlake Bell and a Gazette columnist. This, ‘coupled with the UK’s reputation as having laws that we actually enforce, means that property assets in the UK are relatively cheap at the moment, but they still remain trustworthy’, Gill observes. 

Adding to the attractiveness of British assets for foreign landlords is a type of lease, known as full repairing and insurance (or FRI) which renders tenants responsible for all maintenance and repair costs. ‘Foreign investor clients tell me that this is not the case on the continent, where they… have to pay a lot more towards the maintenance of the building than they do when they buy assets in England and Wales,’ Gill says. 

Development rights

Permitted development rights, first introduced in 2015, have reduced office supply in London and other UK cities. Demand and prices have risen as a result, Gill adds. These rights allow the conversion of office accommodation to residential use without the need for planning permission from the local authority. For example, in Richmond, Islington and other London boroughs ‘that has had a huge impact on the supply of offices because a developer can buy a former office block, convert it into flats and sell them for a large sum of money’, Gill says. Thus developers can realise returns quickly, as opposed to receiving monthly rents over the duration of the lease.  

Bumper year

Last year was a bumper one for City office investment. This reached a record high of £3.6bn of stock traded in the second quarter, CBRE data shows, led by the £1bn sale of 5 Broadgate to Hong Kong’s CK Asset Holdings. Some 82% of the capital invested came from overseas, with Asian investors accounting for half. Despite the unknowns of Brexit, the global real estate adviser said in January that it only expected a ‘slight fall’ in office investment and occupier transactions in the UK this year. 

‘Extraordinarily busy,’ is how Ashurst partner Richard Vernon describes the buying, selling and developing of Grade A office space, particularly in central London. ‘The appetite for supplying this type of asset remains high and that is why developers and development financiers are prepared to build more of these assets’, says Vernon, who heads the real estate department for the EMEA (Europe, Middle East and Africa) and the US business regions. 

Since the global financial crisis, investors from Malaysia have been followed by counterparts from China and Hong Kong, and more recently South Korea, Japan and Singapore. Ciaran Carvalho, who heads the UK real estate team at CMS, says that these investors are familiar with the UK legal system, either because they come from common law-based jurisdictions or were educated here. ‘The rule of law is very important. They know they won’t get their property confiscated by the government, they have absolute title to it, and they really like that,’ he says. 

Then there is the boom in e-commerce, which is generating ever bigger business for commercial property departments as UK institutional money looks at alternative assets to invest in. ‘Whereas retail made up the vast majority of the [real estate] investment cake, that has shifted over a period of time,’ says Leona Ahmed, co-head of real estate at Addleshaw Goddard. ‘Where we have seen money being deployed is in logistics, not surprising given the amount of online retailing there is now,’ she says, referencing food retailers, such as Ocado and Sainsbury’s, and their ‘customer fulfilment centres’.

CMS and FTI Consulting recently published research covering more than 350 real estate investors, developers and advisers responsible for assets worth more than £400bn. This shows that although retail still accounts for up to half of most UK institutional investors’ portfolios, it is only appealing to 7% of respondents, down from 35% in 2016; by contrast, logistics appealed to 74%. Investors are looking for out-of-town ‘big box’ warehouses and ‘last mile’ urban logistics centres. This is not just a UK phenomenon, however. Vernon says demand ‘is just ballooning, and showing no sign of stopping in this country and throughout Europe’. And indeed elsewhere – the firm’s Australian team has been equally busy. 

Whereas retail made up the vast majority of the [real estate] investment cake, that has shifted over a period of time. Where we have seen money being deployed is in logistics

Leona Ahmed, Addleshaw Goddard 

‘Retail is dead, no one is buying retail or they are repurposing it,’ observes Claire Hughes, head of real estate at Pinsent Masons, another firm that has seen an uptick in instructions linked to logistics. For instance, the firm is acting for Legal & General Annuity Fund in the ‘forward-funding’ of Amazon’s 2.2m sq ft distribution warehouse at London Distribution Park in Essex. The warehouse will be one of the UK’s largest, Hughes says. 

Better yields

Pension funds and other institutional investors use forward funding structures for assets that have not yet been built to receive better yields for their investment. ‘Forward fund structuring is what we are doing for our big annuity clients such as Legal & General, Aviva and Royal London,’ Hughes says. ‘It is to fund these great big distribution warehouses because of the changes in online shopping.’ 

The same structures apply to other types of investment project such as student housing and the private rented sector (PRS, also known as build-to-rent) – two other boom areas. ‘Where the work has increased for us big time is on [these] alternatives,’ Hughes says. ‘Big funds see value in producing a product which happens to be large residential buildings that house generations X, Y and Z,’ she says. 

Pinsents has a full-service practice dedicated to student accommodation that comprises specialists in property, construction, planning, funds, finance and tax. Clients include institutional investors and developers – among them Aviva, Apache Capital Partners, Aberdeen Standard Investments and Bricks Capital. 

Build-to-rent is ‘on a fast track to replicate the institutionalisation seen in the student housing sector’ JLL predicts, ‘with a lot of capital chasing PRS.’ Pinsents is advising on several such projects, including UK residential landlord Grainger on the forward funding and forward purchase of build-to-rent assets in Salford, Milton Keynes and Leeds; and a number of London boroughs on the best ‘structures’ for build-to-rent developments in their areas.  

‘We are moving to a more continental European model, where that younger age group is more likely to remain in rented accommodation for much longer. That is driving a huge demand for [PRS] in many of the schemes we are involved in,’ Vernon says. He points to the London mayor’s target to build 65,000 new homes each year (nationwide, the government’s ambition is to build 300,000 homes a year by the mid-2020s). ‘That has driven a lot of our business and continues to do so,’ regardless of Brexit, political change or a recession. None of these factors, Vernon contends, ‘is going to have an impact on the fact that the UK has identified that we need to build a lot of homes’. 

Ashurst is advising large developers including Lendlease, Berkeley Group and Grosvenor on flagship projects such as the £2.3bn redevelopment and regeneration of Euston station, part of the construction of the HS2; the £8bn plan to regenerate Thamesmead in south-east London; and the garden towns programme launched by the government in August. All projects will result in the construction of thousands of new homes. 

Investors are also focusing on the elderly: ‘Increasingly, we are moving to the retirement living sector where the older generations cannot afford to hold on to their great big family houses, and want to be in a community,’ Hughes says. 

These opportunities have not escaped far-eastern investors, which are diversifying beyond buying prime office buildings in central London. ‘Many of them are successful developers in their own country, and they have got more comfortable with taking a bit more risk, which is associated with development,’ Carvalho says. One example is EcoWorld, a Malaysian developer, which entered into a £400m joint venture with Invesco Real Estate to build more than 1,000 new homes in east and west London.

Demand for buy-to-rent

Foreign companies are investing in distribution and logistics – CMS, for example, recently advised Singapore-based Global Logistics Properties, backed by Chinese private equity, on the UK aspects of its $2.8bn acquisition of European logistics firm Gazeley. They are also tapping ‘the incredibly popular demand for buy-to-rent in the UK’, including in regional cities such as Manchester. ‘There is so much development going on there,’ Carvalho says. The firm’s fast-expanding Manchester team is working on a number of high- profile development and construction projects – for instance, advising Hong Kong-based developer Far East Consortium International on the Northern Gateway project, which will deliver more than 10,000 homes in the next decade and generate more than £1bn of investment. 

Lawyers are also assisting investors in the use of ‘corporate wrappers’, whereby the property assets are held by special purpose vehicles, typically offshore structures in low-tax or no-tax jurisdictions. One main advantage is that investors will trade in the shares in the wrapper rather than the underlying property assets, as this will not attract stamp duty land tax in the UK. 

‘An increasing number of the very high-value related transactions are done by way of corporate share acquisitions because you only pay a small stamp duty on [them] relative to the large amount of money that is paid on commercial property transactions. And that comes into the advice that we give,’ says Hughes. There are also ‘wider tax transparency issues’ concerning the jurisdiction in which to structure these ‘PropCos’. 

‘We don’t think of ourselves as property lawyers now, some of what we do is in property law, but our overall offer is real estate,’ Hughes says. This means understanding funds law and funds formation, market forces and other drivers, particularly at pan-European level, where business growth for the firm has come over the past few years. Pinsents recently opened an office in Dublin, where many fund managers have set up in anticipation of Brexit. 

Vernon’s own department has worked on around 50 ‘major’ real estate asset acquisitions in London over the past two years. ‘[With one exception] they were all corporate wrapper-type deals. These are often structured through Luxembourg, the Channel Islands or the Isle of Man where there are favourable treatments from the tax perspective,’ he says. 

Taxes

An unwelcome new development in the sector from this month is the requirement for non-UK residents to pay UK capital gains tax on all UK residential and commercial real estate. This will also affect the sale of shares held within the SVPs or ‘wrappers’ held offshore. 

Yet practitioners are not overly concerned. When the Treasury first announced the plan in November 2017, it sparked fears that foreign buyers would be deterred from investing in British property. ‘That was a big shock,’ concedes David Jones, a partner and head of the real estate capital markets team at Ashurst. But ‘people have now [accepted] that this is coming and it is factored into the transactions,’ he says. ‘What drives all of these investments are the global capital markets, the foreign exchanges and interest rates around the world.’

Other transparency initiatives, such as the government’s plan to establish a publicly accessible beneficial ownership register of overseas entities that own UK property, could represent a hit to the sector. But not necessarily. In July last year, the Department for Business, Energy & Industrial Strategy published a draft Registration of Overseas Entities Bill, whose principal aim is to fight money laundering through the purchase of UK property. ‘It is very much something that the industry is anticipating will come about,’ Ahmed says. ‘If people have to disclose their identity, we don’t know whether that will preclude them from wanting to buy assets [in the UK] or indeed whether that will just be accepted and won’t be an issue.’ 

Brexit

What about Brexit? Firms report a slowdown (particularly in investment) since the start of the year, but Carvalho observes that the first quarter of the calendar year is ‘traditionally the quietest’ because it is when ‘many asset allocators work out their strategy’.  

Hughes says: ‘Where there is the benefit of the exchange rate, the American, the Canadian and the far-eastern clients are still buying and going ahead, but the continental European funds, particularly the German funds, are definitely holding fire.’ She adds that certain asset classes are more protected than others. For example, offices and retail transactions have slowed in many UK regions, while alternative asset investments such as student housing are continuing ‘at the same rate’ because they are seen as value for money. 

Vernon’s view is that clients’ current ‘pause or hold’ approach to some deals is the same as the market saw in the run-up to the referendum. They are waiting to ‘see what the answer is’, he says. 

He adds: ‘A hard Brexit will have an impact one way or another but at least it will give certainty. To be honest, a delay will just mean that the uncertainty continues, and we will just have more pause until there is certainty.’ 

Investment volumes in the UK property market in 2019 are expected to reach £55bn, with returns of 4.3% – marginally down on last year’s £60bn and 5.6%, JLL predicted in January. In March, the Office for Budget Responsibility revised down its forecast for GDP growth in 2019 from 1.6% to 1.2%, due to a slowing world economy and declining business investment in the UK linked to Brexit uncertainty. 

Gill says that, whether caused by Brexit, the US or China, ‘in an economic downturn people are always more ready to litigate about property, just as they are more ready to litigate about anything else’. 

Linked to the UK exiting the EU is the ongoing case between the European Medicines Agency (EMA), which will move to Amsterdam post-Brexit, and Canary Wharf Group, to be heard in the Court of Appeal. The dispute focuses on whether or not Brexit could amount to ‘frustration’ of the EMA’s 25-year lease, worth £500m, at Canary Wharf. 

‘A lot of our clients are watching the case with interest, and we are talking to them about the possible impact of this decision,’ says Ashurst partner Alison Hardy, who argues that the EMA’s appeal against the High Court’s decision ‘is an attempt to try and get in front of the European Court of Justice, to see if they can run this argument’. 

Hardy points to the rise in commercial property insolvencies, particularly in the retail sector. ‘We act for landlords who are dealing with company voluntary arrangements,’ says Hardy. ‘That is obviously quite a challenge, particularly because of how CVAs are impacting landlords.’ That is because high-street retailer tenants have used the process to reduce rent and restructure their leases. There was a 53% increase in retail CVAs in 2018, according to Deloitte. 

Hardy predicts there will be more administrations and CVA proposals as a result of Brexit, although the ‘death of the high street’ will probably play a bigger role. For her part, Hughes notes ‘the distress experienced by many of the retailers that have large portfolios of properties’, but adds, ‘we are seeing more solution finding and resolving before [litigation] happens.’ Indeed, Pinsents acted for House of Fraser (Stores) Limited (with a portfolio of 59 stores across the UK) in its high-profile CVA and subsequent administration process last summer.  

Marialuisa Taddia is a freelance journalist