Real Estate

Herbert Smith Freehills on real estate

Herbert Smith Freehills’ real estate team looks at the key questions affecting a rapidly changing industry

CRANE

Real Estate |

What are some of the main market trends which are influencing the work flow of your real estate practice in the UK?
Don Rowlands, Head of Real Estate, UK & EMEA

The real estate market in the UK and in other key investment hotspots around the world is proving resilient in the face of economic and political uncertainties. An ever increasing range of organisations from across the globe are looking to participate – from US private equity funds, to Australian superannuation schemes, to Asian pension funds and Hong Kong investors. Global capital is particularly attracted to the UK because of the strong legal and regulatory framework, transaction transparency and the relative ease of doing business – as well as the reputation of UK real estate for holding value, and just a bit of post-Brexit currency arbitrage!

CRANEA buoyant market is good for transaction flow as assets change hands regularly and it also helps to fuel the development market as investors look for wider participation options. Deals become more complex, and more ‘corporatised’, as the interests of a range of participants need to be reflected and protected – something that necessitates specialist legal input.

A buoyant market is also good for occupiers and we are seeing businesses taking advantage of what the market has to offer both in terms of prelets of new premises and the take up of refurbished second-hand stock. However, market analysis suggests that there will be an undersupply of new stock in particular to meet market demand in the not-too-distant future as not enough new development is getting underway. Stock issues may mean fewer options for businesses and more competition for prime locations – so forward planning is key.

Options for occupiers are changing and this is influencing the nature of the transactions we see. The building(s) in which companies do their business are no longer just a bricks and mortar issue for the premises team, but a strategic business decision addressing brand and work force preferences as much as any other underlying factor. So occupiers are thinking more carefully about their premises decisions and want much more operational flexibility: developers/landlords are having to adapt their product. Transactions are becoming more bespoke. The entry into the market of co-working specialists like WeWork/The Office Group/Storey and others is enhancing the options for businesses to be more tailored and flexible in their strategy around premises.

Developments in technology and changes in consumer habits are having a big impact on the logistics subsector which is innovating fast to enhance its product. It is a growth subsector with new developments fuelling interest from both occupiers and investors. Improvements to road and rail infrastructure which help to open up the distribution network further enhance the attractiveness of logistics as an asset class.

Government policy around housing supply is a significant issue in the UK and speeding up the delivery of new product is a focus of the planning regime. One way we are seeing the market adapt is that many more development schemes are mixed use, combining residential with commercial and leisure as the live/work theme grows in importance. From a legal perspective this adds a layer of complexity and increases the number of deal participants.

Finally, we are seeing pretty significant changes and disruption to the markets as a result of Proptech and other technology-related changes (which also impacts on how legal firms deliver their service).

The life of a real estate lawyer in 2018 is as varied and interesting as it is demanding. A market that offers business opportunities across such a wide range of products and subsectors is a rewarding market to work in. Below, some of my HSF real estate colleagues share their thoughts on a few of these trends in more detail.

How has the real estate sector become so ‘corporatised’ over the last ten years, what are the lessons learned and how do they apply to other sectors?
Paul Chases, Partner, Corporate Real Estate

When real estate clients from around the globe acquire or dispose of real estate assets in today’s property market, a significant number of these deals do not actually involve the transfer of title to the relevant property from seller to buyer.

Some of the largest, most complex and highest value property deals that have completed during the last decade have involved:

  • the acquisition and disposal of real estate assets which are held through SPV companies, limited partnerships, limited liability partnerships, unit trusts or fund structures; and
  • corporate joint ventures for the investment in (or development of) real estate assets (which enable parties to more effectively share risk and reward during periods of economic uncertainty or political instability).While real estate acquisitions, disposals or joint ventures will always require property due diligence to be undertaken, such transactions are better characterised as corporate M&A or corporate joint venture deals, hence the ‘corporatisation’ of the real estate sector and the increasing use of the market recognised term, corporate real estate (CRE).

What we have learnt at HSF is that in an increasingly commoditised legal market it is more difficult for lawyers to add value (from a client’s perspective) but, by taking a sector-focused approach (eg to real estate) we are able to do so. Joining up the corporate, real estate, tax, regulatory, finance, planning and construction dots within a single team enables us to advise clients about the markets in which they operate, in a language they understand, and provide sector-specific expertise that cuts to the chase and completes deals seamlessly across different practice areas.

Whichever sector a law firm aspires to be involved in, demonstrating a genuine interest in it and building up sufficient sector-specific experience will almost certainly lead to a much more productive and successful interaction with businesses operating in that sector. In the case of CRE, our clients have chosen to dedicate their time to the sector so it follows that, as their lawyers, we should be doing the same.

When asked to help with a major office relocation or consider the options on your company’s business’ premises, are you ready and able to help?
Nick Turner, Partner, Real Estate

Today’s world seems to be both speeding up and getting less predictable. Much of a general counsel’s working life is spent dealing with the legal aspects of this uncertainty and in providing clear advice and guidance on how a business should proceed.

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These truths apply equally to the premises businesses occupy and trade from. The majority of businesses operate from leased premises where flexibility to alter levels of accommodation or to move on are not within the sole control of the business; the relevant landlord will also have a view.

The one thing that is clear is that many businesses are increasingly looking at their leased premises much as they look at other services they procure; they want value for money and they want flexibility. The problem is that the traditional 15 or 20-year lease does not easily cater for those needs. The good news is that there is more flexibility available out in the market. The trick is to understand what is available and what it involves.

The rise of the serviced office provider is the big news story of the moment. Ten years ago it was a relatively small market with some well-known names dominating. The arrival of WeWork and others has transformed this world. WeWork is now the largest tenant in the City of London in terms of the amount of space leased and many others are moving into this market, driven principally by SMEs looking for much more flexibility over the period they are tied to an office, but also by the additional services they can buy as a part of this model (meeting rooms on demand, catering services without having to run a kitchen etc).

Serviced offices, however, are not the only answer. Increasingly, landlords are willing to offer more flexibility on the leasing deals they offer to tenants. Where once flexibility in a lease meant a break at year ten or 15, it can now come in more forms. For instance, many ‘pre-let’ agreements allow a tenant to secure options to both expand and contract during the development phase of a building. This provides the tenant with a more honed ability to both secure future premises but also tailor the size of them to the requirements of the business.

The development stage is not the end of this process. Many tenants in today’s market seek to agree ‘rights of first offer’ or ‘rights of first refusal’ which allow them a later bite at available premises in a building. The terms of these rights vary, but can involve pre-set levels of rent or matching market offers at the time. All are valuable as they allow a tenant to plan more comprehensively for future expansion of the business.

The story does not end with new leases. There are also opportunities to ‘re-gear’ or amend existing leases to extend the term or introduce break rights. Again, the key for the business is to provide more certainty and/or flexibility to plan for its future. Costly questions of reinstatement liabilities can also be brought into these discussions.

What’s the direction of travel for logistics?
Shona Grey, Partner, Real Estate

Logistics is a ‘hot’ subsector with significant transactional activity on both the occupier and investor sides. Advisers need to be up to speed with the commercial and technological developments in the subsector to ensure the transaction structure and supporting documents match, or at least anticipate, these developments.

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Continued growth and potential consolidation
The expansion and consolidation of the UK logistics subsector sees no sign of slowing down and we predict that 2018 will be another bumper year for both acquisitions and lettings. Last year saw two mega deals dominate the landscape: Chinese Investment Corporation’s acquisition of Blackstone’s Logicor portfolio for £10.5bn and Global Logistic Properties acquisition of Brookfield’s Gazeley platform for £2.1bn. There is potential for further consolidation of the UK market by some of the key global players. At the same time, we expect to see an increasing diversification of the investor entrants into this subsector as it continues to outperform other subsectors and the underlying socio-economic factors behind its expansion (the proliferation of ecommerce and consumer demand for near instantaneous delivery) show no sign of abatement.

Last mile
The increasing need for last mile depots will also be a feature of the market. With suppliers and retailers competing to offer ever shorter delivery times, warehousing in close proximity to highly populated urban areas is in intense demand. Consumer expectations have evolved and next day delivery is viewed as a standard requirement, rather than a luxury, for example with Amazon now being able to offer one-hour deliveries via its Amazon Primenow service. Owners and occupiers will be considering innovative options to maximise floor area in the absence of land availability. Multi-storey warehouses may well be seen, as will mixed-use developments, for example the ‘sheds and beds’ model which sees warehousing and residential combined in close proximity.

Increased automation
To keep up with elevated consumer demand and expectation, occupiers are increasing investment in automation. ‘Co-bots’, robots which work alongside humans, are already used by various of the key online retailers and distributors, with some of the online distributors (particularly on the grocery side) nearing full automation. Increased automation impacts space layout, workforce requirements and with driverless cars becoming an ever closer reality, both owners and occupier of last mile assets will be looking closely at how these developments interact with their existing warehouse stock. The trend towards automation will require both in-house counsel and their advisers to be fully aware of the legal ramifications and compliance factors associated with the use of these technologies.

Occupier approach
The continued growth of the logistics sector is underpinned by occupier, and in turn consumer, demand. As the market consolidates occupiers will seek both flexibility and uniformity across their European, and in some cases global, portfolios. Flexibility will be required to enable distributors to potentially expand and contract across their portfolios to match shifts in consumer demand across regions or countries. Uniformity may be desired across lease terms to ensure that occupier specific requirements are pre-baked into an occupier package and are not renegotiated on each new letting. There will be advantages for landlords in this also as agreed terms and a uniform approach, where practicable, should expedite deal timelines and reduce legal costs. Reflecting the trend towards increased automation, occupier fit outs are becoming increasingly bespoke and high value and, within reason, occupiers will require greater autonomy and control as to how and when such fit outs are carried out. Again, both in-house counsel and external advisers will need to be cognisant of these features.

What are the key ways in which HSF has improved efficiency and saved costs for clients when providing services for transactional work?
Paul Chases, Partner, Corporate Real Estate and Shona Grey, Partner, Real Estate

We are acutely conscious that clients have a choice when it comes to buying legal services, and in 2018 expect their lawyers to innovate and drive efficiencies, while not compromising quality. Our approach in the real estate team is enthusiastic to respond to these challenges, and centres around three key tools.

Legal project management (LPM)
Our specialist LPM unit works alongside the deal team (lawyers and client) to optimise efficiency. A combination of: (i) rigorous scoping and planning; (ii) data-driven monitoring and reporting; and (iii) ongoing process improvement means we are able to:

  • avoid surprises in relation to costs or timing;
  • maximise efficiency in service delivery;
  • make our clients’ lives easier because they are in control of the engagement with the knowledge that their legal budget is being optimised. This is something which we have found to be particularly important for our general counsel clients.

Innovative use of technology to enhance efficiency
We are increasingly turning to the use of established and innovative technologies to improve our document assembly and deal execution, achieve costs savings and ensuring that our lawyers are spending their time on the complex work that both engages them and is what our clients turn to us for. We establish a central ‘Deal Hub’ on our largest and most complex transactions. This provides users, both internal, external and on both sides of the table, with a secure online tool for document sharing, work stream allocation, progress tracking and Q&A.

While the use of AI systems in the UK legal market is still at an early stage, there is a great deal of interest from both in-house and commercial clients as to how such systems can be used to create efficiencies on large-scale transactions, particularly with due diligence. We aim to be at the forefront of these developments and are exploring the potential ways in which AI can be deployed across our deals, together with the ramifications that this may have, for example, from a risk and confidentiality perspective. In-house counsel would be well advised to keep abreast of the different technologies on offer, their potential shortcomings and any internal compliance issues to which their use could give rise. This will lay the groundwork for fully informed discussions with external counsel as and when AI solutions are put forward.

Alternative legal services
The use of project management tools and technologies which provide a more interactive online transaction experience (for example, via the Deal Hub) facilitates the seamless deployment of offsite alternative legal services across matters. HSF has established eight alternative legal services hubs across its international network to support high-volume, document-intensive legal work on a round-the-clock basis. We have real estate specialist teams embedded within that network who are now an integral part of the way we work.

Author(s)

  • Don Rowlands, Head of Real Estate,  UK & EMEA, Herbert Smith Freehills

    Head of Real Estate, UK & EMEA

  • Paul Chases, Partner, Corporate Real Estate, Herbert Smith Freehills

    Partner, Corporate Real Estate

  • Nick Turner, Partner, Real Estate, Herbert Smith Freehills

    Partner, Real Estate

  • Shona Grey, Partner, Real Estate, Herbert Smith Freehills

    Partner, Real Estate