Analysis: The bubble bursts - predictably
It is hard to imagine an industry that, on paper, is less exposed to asset price bubbles, the vagaries of financial markets or the risks of leverage. And yet, as a string of law firm redundancy announcements in recent weeks have made clear, law firms have been far from immune to the speculative bubble that built up since the mid-1990s in the UK property market.With hundreds of redundancies now announced in real estate (see box, right) - including more than 100 jobs being officially put under threat in redundancy consultations last week alone - it has become clear that UK law firms have too many jobs for a real estate sector that is set to substantially shrink over the next two years. So much for cautious, conservative law firms.
With the property market in crisis, law firms’ real estate teams are suffering a wave of job cuts. Claire Ruckin and Alex Novarese ask if lawyers got swept up in the real estate boom
It is hard to imagine an industry that, on paper, is less exposed to asset price bubbles, the vagaries of financial markets or the risks of leverage. And yet, as a string of law firm redundancy announcements in recent weeks have made clear, law firms have been far from immune to the speculative bubble that built up since the mid-1990s in the UK property market.
With hundreds of redundancies now announced in real estate (see box, right) – including more than 100 jobs being officially put under threat in redundancy consultations last week alone – it has become clear that UK law firms have too many jobs for a real estate sector that is set to substantially shrink over the next two years. So much for cautious, conservative law firms.
Law and the property boom
How this point was reached requires some context. In the mid-1990s, as the UK was emerging from a prolonged recession that had sent property prices plunging, the real estate bar was substantially diminished from its late 1980s heyday. At the same time, leading City law firms were beginning to turn their minds in earnest to international expansion. This stance inevitably made transactional practice areas such as M&A and banking more central and, in many cases, pushed real estate, which once would have been regarded as a bedrock of full-service commercial practice, down the pecking order.
This process intensified during the M&A boom of the late 1990s, a time when rumours were rife that property teams were being relegated to mere support departments. Senior real estate lawyers at the time often adopted a defensive tone that stressed their corporate credentials – a stance that was viewed as making their worth apparent but which also served to underline their insecurity. One head of property at a top 10 City law firm was reported to regularly introduce himself at the time as a corporate lawyer.
Had the market forces of the day continued unabated, property lawyers would likely already have suffered that threatened relegation in their firms’ internal hierarchy but the fates, and the dotcom crash, intervened. As business investment, corporate profits and M&A levels plunged between 2002 and 2004, interest rates were aggressively slashed in many Western countries. This, combined with a wrenching reallocation of capital from the over-valued equity markets into property, effectively turbo-charged the rise in property prices that was already well underway.
Figures from the Council of Mortgage Lenders underline the extent of this asset price surge. With the average house price in England stabilising in 1994 at £65,699, prices began rising swiftly again in 1998 when they had reached £79,814. By 2007 they had surged to an average of £221,247, having reached at this point a clearly unsustainable level that had stretched conventional valuation yardsticks to breaking point.
The effect of this was simple. While property typically slumps in an economic downturn, not only did the industry withstand the leaner years of 2002-04, it positively thrived. Law firms, facing corporate practices that were in many cases struggling with the technology, media and telecoms slump, reacted gratefully to the property boom and started investing once more in real estate.
By 2007 the net result of this was plain – there were a number of top 50 UK law firms outside the City that had become increasingly focused – dependent even – on property, in some cases deriving more than 30% of their income for the sector. And then, in August 2007, the credit crunch hit.
The new reality
Step forward to October 2008 and the prolonged credit squeeze has plainly had a dramatic impact on a UK real estate market. In the residential market, mortgage approvals have this year consistently been well under half the levels seen in 2007 as stricken lenders restrict credit. UK mortgage lenders have been pummelled, with Northern Rock and, this week, Bradford & Bingley facing nationalisation, while Halifax Bank of Scotland was last month forced into a shotgun marriage with Lloyds TSB. Housebuilders have reacted this year by slashing employment and construction work. Likewise, real estate investment relying heavily on debt has been severely hit.
The impact on law firms has already been stark. While corporate and banking job cuts have been minimal so far, since the credit squeeze began job losses have been overwhelmingly drawn from real estate, totalling more than 300 so far.
The intensity of the pressure on real estate is underlined by this week’s Big Question poll, which surveyed partners on which practices areas were most likely to see job cuts – 89.5% cited property as the most vulnerable – more than twice as many as any other practice area, (see Big Question).
With redundancies in property departments piling up, unsurprisingly the consensus among property lawyers is that this is a serious reverse and that the market will be depressed through 2009 at the least.
“The general property market is very difficult at the moment,” says Berwin Leighton Paisner (BLP) head of real estate Robert MacGregor (pictured below). “The market should recover by 2010 but until then, firms reliant on the retail and investment market will find it pretty tough.”
Linklaters real estate partner Anne Byrne concurs: “There is a lot of uncertainty in the market and a number of transactions have been put on hold.”
The worst-hit sectors are generally felt in any work focused on the struggling residential market, which has a ‘liquidity’ crisis of its own. While such work has little direct impact on large commercial law firms’ core practices, some have felt the impact through bulk conveyancing arms or mortgage processing businesses. Institutional advisers have also been hit through the impact on housebuilders and property investment companies which have been forced to write down the value of their portfolios. Acquisitions in the real estate sector are sharply down, while lettings in the depressed commercial sectors have also suffered.
In short, aside from expectations (or possibly hope) that there will be plenty of property-related litigation, the depression in the sector shows little signs of abating. Other optimists point to opportunities for planning work, while firms with international networks are hoping that cash-rich foreign investors such as sovereign wealth funds can keep them ticking over. Public sector work, including social housing, is also likely to look relatively attractive. Nevertheless, it is clear that the market is facing fundamental upheaval.
Did firms catch the property bug?
The question the grim market outlook begs given clear indications that the property markets in many Western countries were over-valued, is whether law firms themselves have fallen victim to the UK’s renowned obsession with bricks and mortar.
In relation to the City, where even traditionally property-driven firms such as Nabarro and BLP have been investing heavily in expanding their non-real estate practices, the answer would probably be no.
But for large national and regional law firms, which have in many cases substantially expanded their real estate teams in recent years, there would seem to be a case to answer. And this trend is certainly not limited to firms like Cobbetts and Halliwells that were traditionally property-led.
The focus on real estate has been particularly striking at Wragge & Co, whose property team has expanded to 135 lawyers out of 441 and accounts for nearly a third of its income. Wragges’ decision to consult on 30 job losses, largely from its property team, seems to underline what some would argue was an over-dependence on property.
Wragges’ strategy reflects a shift towards property at several national firms that had once put the main emphasis of their expansion into corporate. When these firms initially struggled to expand beyond their regional strongholds in the mid-1990s, many of them turned to real estate.
Many lawyers answer that they were simply meeting increased demand. As Eversheds head of property Lee Ranson says: “The legal profession responded to simple supply-and-demand rules and bulked up real estate teams.”
But for lawyers losing their jobs in real estate, especially those in the two-to-five years’ post-qualification band, these are worrying times. Demand is collapsing in their sector at a time when they are reaching the defining stage of their legal careers, when they would typically mark themselves out as partner material. It is also the point at which they are the most expensive to maintain.
With the property industry also suffering badly, in-house opportunities will not be in abundance.
For those unlucky enough to be losing their jobs, the likely choice at present appears to be either shifting their practice area or possibly relocating to hot markets such as the Middle East.
James O’Brien, LPA Legal Recruitment director, comments: “This is not a great market at the moment across the board – unless you are in property litigation. When you have large City firms letting people go on the transactional side, it indicates that they do not think it will turn around any time soon.”
Prospects look the best for trainees wanting to specialise in real estate and newly-qualified property lawyers who face the prospect of maturing in a market that is likely to see renewed demand three-to-four years down the line. The same logic applies to high-performing junior partners, if rather less so to mediocre partners further up the lockstep.
In this context the career prospects for property lawyers that stay the course are likely to repeat the experience of the early 1990s, when a generation of real estate lawyers was lost and the survivors were well-placed for when the revival came.
The future of property law
But the question remains: what is the future for real estate as a serious practice area within large commercial law firms, or as a discipline that can attract the most talented lawyers? Currently, property partners are quick to talk up the long-term prospects of their sector.
MacGregor argues: “The firms that can do the more sophisticated corporate or finance-related deals, such as debt portfolio acquisitions, are finding investment flow is to some extent being either replaced or partially replaced by this.”
Linklaters’ Byrne predicts there will be opportunities in a distressed market as people need to dispose of assets quickly and there are some cash buyers around ready to invest.
But for many mid-tier operators, especially the national firms that have grown used to running large real estate teams, it seems hard to see how they can easily adjust to the new world. Wragges, for example, is still expecting property to account for 25% of its turnover – only a drop of 5% compared with the past few years. Eversheds property team accounted for 23% of total turnover last year and the firm is only expecting a small drop this year. And Addleshaw Goddard remains optimistic, expecting to maintain levels of 25% for the coming years.
Eversheds’ Ran son comments: “I do not see real estate going on the back burner. It is a key part of Eversheds’ business in the UK and internationally, and we will continue to prioritise it as a key function for our clients.”
Addleshaws head of real estate Michael Reevey also takes a long-term view, commenting: “The property market is, and always has been, cyclical. Major law firms will look at getting a sensible strategic balance between their practice areas but I would be surprised if many thought that real estate was an area in which they did not want to be.”
However, with a 12-year bubble unwinding and the property finance industry going through radical upheaval, it is at best unclear whether the field of property law can survive in anything like its current size and influence within the legal community.
It is also telling that many real estate partners, particularly those at leading City firms, point to finance and insolvency-related work in the property sector as a potential source of work. It is far from certain that these types of instructions will go to property lawyers, as opposed to advisers in under-utilised corporate, banking and insolvency departments. The advantage of traditional property work is that it stays with property teams and, when it is profitable, real estate lawyers get the credit.
The suspicion is that national law firms, having in some cases ridden the real estate bubble to grow their businesses rather than moving up the value chain, are facing a reality check. At the very least, they can no longer rely on the surging real estate market to boost their organic growth rates.
Perversely, the one ray of light is the very issue that looks so grim right now – the dramatic falls in property assets. With valuations tumbling so quickly in Western economies, the point at which property can find a stable value – by most analysts’ view when valuations have dropped 25%-30% from their 2007 level, can at least come quickly. Realistically, this could happen within 18 months, which would be preferable to a long-drawn out slowdown.
There will always be property-related work, but the days of easy money in real estate look to be not only over for the UK consumer, but also the humble UK lawyer. O’Brien says: “At the higher end of the property market there are still deals being done. Things will not stay still and there will always be investors/clients instructing on big-ticket work. That said, I would not think we will see a re-balance or increased volume of deals for a long time yet.”
Real estate redundancies – the bubble bursts
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