In 2007, following a decade of continual growth, the real estate markets began to slow as financing contracted and prices fell.
The subprime mortgage crisis, highlighted by the governmnet rescue of Fannie Mae and Freddie Mac in the United States - organisations set up to ensure liquidity in the US property market after the great depression - had dire consequences on lending worldwide and exposed cracks in the system that had remained hidden for years. "Their collapse tied things in knots," said David Van Atta of Hanna & Van Atta in California.
The impact of the subprime crisis in the US was felt around the world. As global economic markets suffered, the demand for traditional real estate advice on matters such as financing and purchasing dried up almost completely. But while a gulf opened up between sellers and buyers over the market value of property, lawyers saw an increase in real estate litigation and contract negotiation work.
In the course of our research, the drop in availability of finance, with banks withdrawing commercial and private mortgage offers, was cited as the most important change in the market. The value of commercial mortgaged-backed securities alone fell from more than $200 billion in 2007 to approximately $10 billion. The International Monetary Fund estimated that the collapse of mortgage-backed securities would result in losses of $1 trillion US dollars.
The securities crisis affected the mortgage market and financial institutions were forced to cut back on lending, particularly for high risk or high finance projects as their debts increased. David Baranick of PricewaterhouseCoopers noted in his report ‘Global real estate and the credit crunch: Lessons we should have learned long ago' that before the downturn "residential mortgage lenders competed fiercely with one another to provide homeowners and would-be homeowners with more and more piles of money", but lending rapidly decreased as the cracks began to show.
"Even for substantial corporates, credit facilities have been difficult to obtain or renew," said Dermot Rice from Slaughter and May in London. "Banks' capacity and appetite has been much reduced, and security is now often required where previously a corporate credit alone would have been enough." The lack of finance has had a direct affect on real estate projects and many high-end developments worldwide have been put on hold, including major township projects in India and a $533.3 mixed use project in Jeddah in the United Arab Emirates.
The US has still seen relatively high levels of investment, however a number of major hotels and condominiums are now facing the withdrawal of funds. "Buyers of condominium units in most areas in the US have elected to forfeit their unit reservation deposits on projects under construction because term financing is unavailable and the buyers are unwilling to commit to long term investments in these uncertain times," said John Hastie from Phillips Murrah PC in Norman, Oklahoma. "Those forfeitures place the developers in default under pre-sale requirements in their loan commitments and usually require the conversion of the project to rental units resulting in a drastic change in the economics of the project. The market changes in condominium projects under construction will have a major impact on the lenders financing development of the projects."
The onset of the recession also saw a fall in property prices worldwide, with some countries facing a much sharper decline than others. Developers who bought land when prices were at their peak now face a shortfall between the value of the loan and the current value of the land. For many this inconsistency broke the terms of agreement with the lender and led to the need for specialist advice to arrange loan extensions. Jon Vivian from SJ Berwin in London estimates that "there has been a 40 per cent fall in the value of property and a further 10 per cent fall is expected by the end of 2009."
SMALLER PROJECTS AND SMALLER FIRMS
As banks became more cautious, smaller projects and mixed-use developments began to take the place of the multimillion-dollar deals. Even in the New York real estate market, which has long been one of the most important in the world, the value of new deals began to fall and larger projects were put on hold. "Everything has been scaled down," said Martin Polevoy of DLA Piper LLP in New York "people only used to make a fuss over cases worth more than $500 million, but now $200 million transactions make the headlines". The same trend was also noted by a source in the Czech Republic, who said, "A number of major projects that received funding from foreign banks have been put on hold because the financing deals fell through." The source goes on to note, however, that "smaller projects supported by local capital have continued to prosper." Johannes Conradi from Freshfields Bruckhaus Deringer LLP in Germany said that although the cases he receives tend to be of a lower value, they require as much, if not more time to complete. "The new deals that are coming through are slower and more cautious, and as such require lawyers to concentrate on the finer points of the deal."
With companies watching their outlays and turning to smaller projects, some small and medium-sized firms have benefited from being able to offer lower fees. "As we have lower overheads than some of the larger firms we are able to keep our costs low," said one source. "We do not have the same resources to work on large cross-border projects, but have a good local knowledge that some clients favour." Many more established firms have also reviewed their prices to attract new clients. Large and small firms are all required to offer exceptionally high-quality service for increasingly demanding clients.
To accommodate their clients lawyers are being asked to offer a more responsive service. "Lawyers have been forced to ‘upskill' to deal with the new economic environment," says Graham Lust from Nabarro LLP in London."Restructuring and contract negotiation skills are now a necessary part of everyday deals". Jeremy Clay from Mayer Brown International LLP agrees that the recession has presented new challenges for real estate practitioners. "We are taking on more advisory work and litigation than ever before, it is not possible to rely on deals alone and clients are demanding increased flexibility from their legal team." Robert Ivanhoe from Greenberg Traurig LLP in New York says that his team have "seen an increase in restructuring and recapitalisation work with clients looking to purchase toxic assets at a significant discount". Litigation work is also increasing as clients seek to regain losses and settle disputes resulting from the economic crisis. "Litigation work is being rushed through the Commercial Court in Ireland as cash-strapped defendants are forced to settle or, indeed, throw in the towel,"says John Walsh from Arthur Cox in Dublin.
Alongside restructuring and litigation work lawyers are advising on alternative sources of finance. "There has been a dramatic decrease in the availability of finance worldwide with capital markets suffering and a lack of both debt and equity financing," said Lee Kuntz of Shearman & Sterling LLP in New York. However, some forms of finance have continued to prosper during the recession. Financiers without debts are able to take advantage of the lower prices and reduced competition. Stefan de Hevesy from Vinge in Sweden said, "Investors such as pension funds and insurance companies have unleveraged finance and are still able to provide financial backing." Real estate investment trusts (REITs) have also benefited from the downturn, as they are able to put down instant deposits and avoid high tax rates. When REITs were introduced into the UK in 2007 nine property companies took advantage of the new structure and in 2008 Pakistan became the first emerging market to introduce REITs.
In the economic crisis public-private partnerships (PPPs) are a steady source of work as governments have long-term commitments to regeneration projects and take on the financial burden of the building. "Belgium has seen a lot of PPP work for many years and this type of work is likely to increase," said Yves Moreau from Linklaters LLP in Belgium.
Investors are still looking for opportunities and turning to emerging markets in Eastern Europe, Russia and India. One European source said, "the Middle East had long been seen as a top choice for investment, but even traditionally strong markets such as the United Arab Emirates have been affected by the downturn." However, our sources in various countries emphasise that there is still interest from international investors. Among them, Eduardo Calderon from Costa Rica's BLP Abogados in San José says, "Although Costa Rica has been affected by the credit crunch, foreign buyers who are keen to explore new opportunities are considering investing in the country." In particular, China is also likely to attract greater attention, as the government has relaxed restrictions on real estate investment. Some international clients are also looking for opportunities in countries such as the UK that have been badly affected by the recession. London's real estate prices remain among the most expensive in the world and according to Simon Cookson from Ashurst LLP in London, Britain continues to attract investors. "The UK market is widely recognised as the deepest and most sophisticated real estate market in the world. At times of crisis investors tend to gravitate to the market that they know best and reinvest at home. In addition, the recent comparative strength of the euro against sterling has attracted Eurozone investors to London. This could be a temporary phenomenon."
Other real estate markets have been able to withstand the economic crisis. "Canada is a more conservative market than the US or Europe," says Jim Hilton from Blake Cassels & Graydon LLP, "the size and volume of transactions has fallen, but we have not seen the same dramatic effects, as loan to value rates did not hit the same heights as in the US and our national banks were more cautious." Strict codes of conduct for real estate brokers dictated by provincial legislation have helped to regulate the industry.
LOOKING TO THE FUTURE
"There is a lot of money parked, ready to move as soon as financing again becomes available to investors and developers and values begin to stabilise," says Robert Thompson from Sheppard Mullin Richter & Hampton LLP in California. "Everyone is looking forward to the recovery, but nobody can predict when it will happen." This was a view shared by many of the lawyers we spoke to across the world. For the moment investors are continuing to take a conservative approach to purchasing real estate to avoid excessive risk in an unpredictable market. "Many investors are keen to take advantage of distressed assets. Presently, however, quite a few parties concerned choose a cautious approach as they still need to bridge the gap between their respective price expectations," said Stefan Artner from Dorda Brugger Jordis in Austria. However, it has been suggested that the real estate sector is beginning to show signs of recovery and there is hope that this trend will continue. "I think completed real property transactions will continue to be scarce until at least the third quarter of 2009, although I would expect there to be a small number of purchases by overseas funds in the next couple of months. I think there will also be significant amalgamation and consolidation in the listed property trust sector, with only the strongest surviving," says Michael Back from Freehills in Australia.
The real estate department used to be one of the major fee earners of many law firms, but since 2008 firms having been making job cuts in this area. One anonymous source said, "We have had to retrain some of the staff from our real estate department to work in other areas of the firm such as the insolvency and restructuring practice, as there is not enough work to go round." Another said that his firm had benefited from the redundancies, as he was able to attract highly skilled lawyers from the cutbacks. "Smart clients are able to survive market changes as they adapt to the new environment," says Jeffrey Newman from Sills Cummis & Gross PC in New York "and the same is true for law firms."