Who’s Who Legal brings together Roger Winston at Ballard Spahr and Joel Rothstein at Sidley Austin to discuss the current state of real estate construction, the growing importance of public-private partnerships in attracting investments and upcoming challenges real estate lawyers will be facing over the coming years.
Roger Winston: The US continues to be perceived as a safe and stable venue for investment, and real estate investment in the US is no exception. In addition, low interest rates have led institutional investors to look to real estate for both income-producing properties and longer-term investments. Traditional sources of capital, such as life companies and pension funds, now compete with foreign capital, EB-5 regional centres and crowdfunding.
Joel Rothstein: The fundamental challenge in the US facing real estate market players is accurately assessing where we are in the current market cycle. The market has thrived in recent years, bolstered by cheap capital in the form of low interest rates and abundant liquidity of fund investors. At the same time, the US market as a safe and transparent market, free from the volatility plaguing other global markets, has been a magnet for cross-border investors seeking institutional grade investments and opportunities to deploy capital in alternative investment assets. These factors have all propped up the market.
Nevertheless, a slowdown in any market is inevitable. Recently, we have seen some clients take a second look at potential opportunities and spend more time on underwriting transactions. As a result we do perceive a slowdown, or at least a more cautious approach being taken in certain geographic regions and in some asset types. The compression of cap rates and intense competition for attractive assets in first-tier cities has had an impact on investor fervour for deals. At the same time, the factors that have been propping up the market largely remain for now, indicating a precipitous fall is not imminent. This all suggests we may be entering a period of more modest and stable growth and a more conservative approach in making real estate investment decisions. The US market remains attractive but supercharged returns will unlikely be the norm. We are entering a slow-motion slowdown in the market.
Joel Rothstein: Demographic trends favour infill urban development. Millennials want to be located in urban areas close to transportation, work, restaurants and cultural amenities. At the same time, empty nesters and baby boomers approaching retirement are opting out of the suburban lifestyle and downsizing in favour of higher-density housing in urban locations.
The post-World War II model of urban development in the US focused on suburban single family subdivisions and large shopping malls linked to a car-oriented transportation system is no longer the universal model. City centres or areas close to city centres are seeing a resurgence of redevelopment and improvements to accommodate the millennials and the older baby boomers. This has created niche opportunities for residential developers as well as developers of retail properties who are capitalising on the renewed interest in city centre locations for development.
Roger Winston: The DC area continues to experience a significant increase in development. Due to limitations on developable space (as well as significant building height limitations imposed by the Height of Buildings Act of 1910), much of the new development in the region consists of dense mixed-use projects that create a number of legal challenges. Given high acquisition, construction and entitlement costs, affordable housing is difficult to achieve, except in the case of mandatory inclusionary zoning requirements for most new projects.
The demand for office space in the DC area remains a bit weak. Historically, government jobs have bolstered the DC office market but that is no longer the case and the region is attempting to create more private-sector jobs. Law firms have also been significant users of office space, but many law firms have contracted their office space requirements. It is not unusual to see a law firm renew or move to a new office with 20 per cent less space required, even if the number of attorneys and staff remain the same.
In terms of residential development, that demand had remained very strong, especially for rental apartments. The for-sale condominium market in the DC area has started to come back as well, although not with the gusto of the last real estate boom. Condo development also carries the risk of litigation, which may result in a reduced supply.
Roger Winston: We continue to see more and more P3 transactions. Some of these are for much-needed public infrastructure projects, and others support the upfront costs and infrastructure for large private developments. For example, $660 million in public funding, through tax increment financing, is being sought to support the Port Covington project in Baltimore, one of the largest urban renewal projects in the USA.
Joel Rothstein: In the current fractious political environment in the US, large-scale governmental programmes or initiatives can often meet stiff opposition from the proponents of smaller government. Public-private partnerships, however, generally remain a somewhat popular alternative to the programmes where the government goes it alone. These partnerships are not generally tainted with the label of “big government”.
I remain optimistic that public-private partnership will continue to play an important role in regenerating cities and promoting investment. These initiatives when designed as a win-win for all participants involved can be quite popular and effective. Nevertheless, there are limits to the impacts of public private partnership. These initiatives are devised and implemented on a very local level and are not uniformly introduced or used across the country. Thus a successful programme will inevitably only have limited impact geographically. Public-private partnerships in the US in the area of urban development tend to be one-off success stories (or sometimes failures) rather than programmes of national application and national import.
Joel Rothstein: In order to survive in the competitive real estate legal services industry it is necessary to be innovative and flexible. Over the last decade or so there has been a bifurcation of the law firms servicing the real estate industry in the US. One category of firm focuses on a regional real estate practice. This practice is oriented more towards routine real estate transactions including basic purchase and sale transactions, leasing, land use and development entitlements, and standard financing transactions. The other category of law firm focuses on a complex international real estate practice. This practice is typically a hybrid practice that incorporates elements of private equity, corporate and securities law along with traditional real estate law. This practice focuses more on complex cross-border or multi-jurisdictional transactions, portfolio financing and structured finance products, as well as real estate private equity, and real estate merger and M&A transactions.
The two categories of real estate law firm practices also tend to have very different fee schedules. The international firms are unable to compete with regional firms on price. Therefore, in order to justify the higher fee rates, the international firms must offer some unique or exemplary service. This service may include expertise in specialised complex and sometimes market pioneering transactions and/or providing the deep resources required to handle large-scale transactions that require coordinating expertise across jurisdictions and across practice areas.
In order to successfully inhabit the international law firm real estate practice space it is crucial to be at the forefront of new deal structures and offer the ability to execute transactions which few other firms are able to successfully execute in a timely and efficient matter. Our main challenge in the year to come, and in the years that follow, is to have the ability and insight to innovate and be ahead of the curve, to identify key deal trends, understand and become expert in new deal structures and remain relevant to our clients as a provider of value added rather than routine legal services.
Roger Winston: Providing cutting-edge legal services in a value-oriented and cost-effective manner will continue to be a challenge for law firms. This may be especially challenging for very large law firms. Starting salaries for first-year associates with no experience are as high as US$180,000, and partner hourly rates at these firms sometimes exceed US$1,000. For complex litigation or M&A practices, such costs may be sustainable, but for most real estate transactions, they are not. Clients are increasingly seeking more value-oriented services and pricing and are looking more to middle-market or real estate boutique law firms. Even for these middle-market and real estate boutique firms, providing cost-effective services will become more of a priority. As an example, we now have a director of pricing and legal project management who oversees a firm-wide team of professionals focused on understanding the business needs of clients, and creating practical and innovative pricing and legal project management strategies designed to meet those needs. The objective is to provide clients with exceptional service centred on client value, cost-effectiveness, predictability and efficiency. The goal is to endeavour to understand how each client’s business operates and to identify its specific goals, business objectives and areas of potential exposure. We then use a proprietary set of analytical tools and strategies aimed at more effectively budgeting, pricing, staffing and managing client matters in a way that aligns with their businesses. When matters are concluded, the team reviews client feedback and uses data analytics to devise strategies to improve matter performance and further strengthen client relationships.