With bidding wars for properties and grass-roots resistance to new construction growing in many communities, real estate companies are asking attorneys not only for standard legal guidance, but also for help in a few areas outside their traditional purview.
“Clients want a one-stop shop that can handle land use, environmental, acquisitions and financing,” says Alan Hammer, a partner in the Roseland, N.J., law office of Wolf Block Schorr and Solis-Cohen LLP. “They can even help if you want to know whether you are buying in a good area of town.”
What's fueling the one-stop shop? In order for law firms to maintain their clients' competitive edge in a seller's market, they must deliver services quickly. In the first half of 2005, a record $112 billion of commercial real estate changed hands, exceeding last year's volume by 50%.
The number of sales transactions rose 40% during that same period, reports Real Capital Analytics. Attorneys must evaluate their clients' transactions quickly before other potential buyers snare a deal.
Development by consensus
The demands on real estate attorneys today mark a striking change for a practice area that centered almost entirely on contracts for sales, acquisitions and leases until a few decades ago. “I was a deal lawyer for 15 years and didn't know the first thing about entitlements,” says Austin attorney Stephen Drenner, a partner at law firm Drenner Stuart Wolff Metcalfe von Kreisler LLP. Now an entitlement specialist, Drenner's public affairs skills are as important as his grasp of contracts or zoning law.
In a recent case, Drenner negotiated with neighborhood associations and environmentalists for nearly a year to reach a mutually acceptable development plan for a Costco-anchored shopping center in Austin called Southwest Marketplace. Both an existing zoning plan and a city ordinance precluded big-box retail on the site where Drenner's client, Dallas-based Cardinal Paragon, wanted to build.
Drenner earned community support by demonstrating that the project his client proposed would impact the environment less than other projects permissible under the zoning.
Based largely on the plan's community endorsement, the Austin City Council allowed Southwest Marketplace to proceed by granting an exception to the city's big-box ban.
“We went to the city council hand-in-hand with the neighborhood groups and environmental groups,” Drenner recalls. “We were able to say, ‘This is a better plan than what's already approved.’”
The scenario is similar to others playing out in communities across the nation, where groups of residents oppose new developments based on concerns ranging from environmental protection to historic preservation, or even job protection.
Developers often need the blessing of neighborhood associations before their projects will pass muster with planning officials, says Michael Tennant, a partner in the Atlanta office of Alston & Bird LLP. “Years ago, elected officials would make land-use decisions. Now it has shifted to a more inclusive process where decisions are based on a consensus of parties.”
Washington, D.C., has formalized the process by establishing Advisory Neighborhood Commissions in each neighborhood to review development proposals. Zoning commissioners are required by law to give “great weight” to neighborhood commission opinions, and developers must prepare legal findings and conclusions responding to specific points raised.
Whayne Quin, who leads the mid-Atlantic land-use and government practice group of law firm Holland & Knight, says neighborhood commissions bring a new level of power to community organizations, making public support imperative for any development proposal. “It seems to me that this trend is reaching a crescendo,” he says, referring to development approval by consensus.
Piloting a development proposal through multiple levels of public scrutiny requires an array of attorneys with experience beyond transactional law. A development may hinge on a grasp of traffic engineering, for example, or interaction with local and state government. “You have to at least have a feel for other areas of law. It's almost a holistic approach to development,” Quin says.
Taxation is one ancillary component of real estate law that is moving to the forefront as the boom in investment sales fuels high prices in virtually all major and secondary markets. Nationwide, CBD office sale prices hit $256 per sq. ft. in the second quarter, a 25% jump in six months, according to Real Capital Analytics, and office prices per square foot have set records in 18 markets this year.
High prices have turned up the heat on real estate attorneys to control taxes and other costs. In New Jersey, for example, the taxes incurred when a $10 million property changes hands are about $120,000. In Philadelphia, transfer tax on a $50 million deal can be as much as $2 million. “In a typical sale it's not uncommon for the attorney to be looking at tax implications as well as the transaction,” says Hammer of Wolf, Block, Schorr and Solis-Cohen. “They're getting it as a package.”
Controlling legal fees
Opposition groups are more numerous and powerful today thanks to e-mail and the Internet, but how does that affect a developer's bottom line? Are attorneys billing more hours as they help developers overcome new levels of red tape?
That varies from deal to deal. “Infill and urban renewal projects are where you really see a dramatic increase in the strategic use of attorneys,” says Chip Clarke, president of the Southwest Region at Transwestern Commercial Services in Houston. “When we develop in a designated industrial environment where the neighbors are used to that kind of development, the change is marginal.”
Legal fees as part of a development's overall cost haven't increased more than 10% in the past three to five years, Clarke estimates. What has changed is the point at which Transwestern deploys its attorneys. For urban infill projects, bringing in legal counsel early can avoid legal battles later and keep overall costs in line with historic levels. “With infill development, because you are facing more organized groups and there are more issues to deal with, you're getting more members on the team early on. That's not just attorneys, but consultants and advisors, too.”
General teams, individual specialists
As real estate companies enter into increasingly complex deals, attorneys are expected to provide more services, says Glen Perkins, executive vice president and managing director of development and acquisitions in the Dallas office of PM Realty Group.
With more than 1,300 employees and 140 million sq. ft. of commercial space, Houston-based PM Realty is one of the nation's largest privately held real estate companies. “A lot of transactions today involve multiple levels of both debt and equity, and that requires an entirely different level of sophistication from the attorney because it's so much more complicated,” Perkins says.
So what does PM Realty look for in its legal representation? For general counsel, the company has standing relationships with one-stop shop law firms. But while the company seeks general expertise in a law firm, it demands specialization from individual attorneys. “When it comes to individual developments, we take a rifle shot,” Perkins says. “We go to the attorney who is most skilled with that type of development.”
Failure to bring in a specialist at critical points in the project can prove costly. Wayne Pathman, founding partner at Pathman Lewis LLP in Miami, says that a client once hired his firm to rezone a tract for development of a 50,000 sq. ft. automotive business, unaware that traffic restrictions would limit the development to less than half that size.
How was the client put in that position? A real estate attorney at another firm had handled the property acquisition, but wasn't aware of the traffic-related zoning limit. Pathman Lewis commissioned a new traffic study, and about eight months later was able to secure necessary approvals for the development. But that process might have been avoided had the client's original attorney consulted a zoning specialist.
Giving clients their due (diligence)
Even those law firms that have fortified their real estate teams with a variety of legal experts may have a hard time keeping up with the heavy demand for due diligence, particularly when clients are in a hurry to submit an acquisition bid.
Holland & Knight has hired extra help to handle the additional workload. “We have to turn around those due-diligence opinions in a very short time because there's so much pressure to move forward with the project,” Quin says. “The intensity is greater and the frequency is greater.”
The race to evaluate acquisitions is creating some interesting trends, says Joshua Stein, a partner in the New York law office of Latham & Watkins LLP. Some sellers have learned they can draw a wider pool of bidders by using their own attorneys to help potential buyers evaluate their offering. The seller's attorneys may provide lease abstracts, financial summaries and other components of a typical due diligence study to potential buyers, saving bidders many hours and thousands of dollars in legal fees. “From a seller's standpoint, if they can make it easier and cheaper for potential buyers to come into the game, they'll have more buyers and that may drive up the bids in these bidding wars,” Stein says.
On the buyer's side, Stein says attorneys working under tight deadlines have learned that some components of due diligence can be covered under contingencies without delaying a contract. With the right exit provisions, a buyer can put a property under contract for purchase subject to the findings of an environmental review, for example, rather than wait for environmental study results before committing to the deal.
Alternatively, investors may simply skip some portions of a review to save time. “When you're dealing with a reputable seller and a good asset that's been well-managed … do you really need to read over the window washer's contract, or the cell phone antenna contract?”
How soon should a developer consult attorneys? It's best to bring in legal counsel before submitting development plans to municipal reviewers, Tennant advises. The attorney can then meet with government planning staff to identify issues that might be corrected before filing a technical site plan.
Back in Austin, Drenner counsels investors “as early as possible,” usually before they place a property under contract. Drawing on an understanding of local jurisdictions and land-use regulations, he helps buyers identify properties that will generate the best yield for their particular development goals. “The better I understand what my client really needs and what the neighborhood's concerns are, the better I do my job,” Drenner says. “As a team, we can usually find a solution.”
Matt Hudgins is an Austin-based writer.
Hot-Button Legal Issues Affecting Real Estate
Eminent Domain Legislation: Expect lawmakers in many states to consider measures limiting the use of eminent domain for economic development. The U.S. Supreme Court ruled June 23 in Kelo v. City of New London that courts — particularly federal courts — will defer to local governments on the issue.
Tax-Increment Financing: The use of incentives to encourage economic development will increase as states limit eminent domain as a redevelopment tool. Expect clashes between those favoring tax-increment financing as a cost-effective means to foster growth and those who view the practice as an inappropriate use of public tax dollars to benefit private developers.
Smart Growth vs. Gated Communities: The proliferation of sprawling gated communities in the current housing boom is the antithesis of the high-density, mixed-use development many cities have embraced under so-called smart growth and new urbanism initiatives. Expect increasing clashes over developer rights versus a city's ability to shape development.
Source: Mike Rubin, vice president of the American College of Real Estate Lawyers.
Buying corporate entities: A tricky legal alternative
Rather than purchase a property directly, some buyers realize tax or financing advantages by acquiring the legal entity that owns a property. It's a trend that illustrates how legally complex some of today's commercial real estate acquisitions have become.
That's what PM Realty Group did in July to obtain Northpoint 3 and 4, a 150,000 sq. ft. medical office complex in Dallas. The company was able to assume an existing loan from the seller by purchasing the partnership that owned the buildings, leaving the original loan undisturbed while taking over as the owner of the owning partnership.
“You have to have sharp attorneys protecting your interests to make sure any potential liabilities have been addressed,” cautions Glen Perkins, PM Realty's executive vice president and managing director of development and acquisitions.
The buyer of an owning entity assumes all of the acquired company's liabilities. That's a major difference from a property purchase, in which the buyer is protected by title insurance and only certain liabilities transfer, says Robert Barron, a shareholder in the Fort Lauderdale, Fla., law office of Berger Singerman PA. “Now you've turned a real estate transaction into a corporate acquisition. The challenge is that many experienced real estate lawyers are not as experienced in buying or selling corporate entities,” he says.
Barron's firm recently helped a client acquire a corporate property owner in a deal valued at more than $100 million. The deal enabled the client to assume an existing loan on the property, avoiding about $350,000 in taxes that would have been triggered, if the buyer had obtained a new loan to purchase the deed. “That's a huge savings,” Barron says. “That pays all the legal fees, and it probably pays your due diligence cost.”
The risks are equally huge, making due diligence all the more critical when acquiring a corporate entity, says David Sacks, a senior associate at Pathman Lewis LLP in Miami.
Any unresolved conflicts with employees, such as a sexual harassment charge, or issues involving previous business ventures or properties owned by the entity being acquired will become the buyer's liabilities at closing, says Sacks. “You could have a parade of horribles that you're unaware of.”
— Matt Hudgins