Lawyers may be reluctant to embrace limited liability partnerships (LLP) for themselves – for fear of telling everyone what they earn – but when it comes to advising property clients, it is a different story.
The LLP legislation, currently grinding its way through Parliament, is seen by some as the panacea to the basic weaknesses facing existing property finance vehicles.
The plan, when the legislation finally comes into force by early next year, is to use it to create a tax-transparent securitised investment vehicle that could become stock market-listed tradable assets.
The limited partnership (LP) – has been available for a while and their use has accelerated over the past two years, as the most lucrative projects are the bigger projects and partnership arrangements allow investors a stake in developments that they would not otherwise be able to afford.
LPs are tax transparent. Partners are assessed individually, which is vital for tax-exempt investors such as pension funds, which would otherwise be unable to recover the corporation and capital gains tax (CGT) that would be incurred in a corporate structure such as an investment trust.
But LPs are not perfect. They are restricted to a maximum of 20 partners and limited partners are prevented (except in some offshore jurisdictions such as Jersey) from taking an active interest in their management. Consequently, trading is difficult: it is banned by the London Stock Exchange.
LLPs could have all of the advantages, but none of the disadvantages of limited partnerships. Unlike LPs, there is no cap on the number of investors, making them more tradable, and all partners can be actively involved in the management of the fund while maintaining limited liability status. A rule change by the London Stock Exchange is all that would be required for them to be listed.
By unanimous consent, the Holy Grail of partnership vehicles is a UK version of tax-transparent and tradable US real estate investment trusts (REITs), which have been the envy of the European property industry for some time. Speculation that the Government may introduce a tax-transparent unit or investment trust in the next budget is largely dismissed as wishful thinking. LLPs seem the only obvious route on the horizon.
However, there is every possibility that property LLP collective investment schemes will never see the light of day, not least because the legislation is aimed at professional and trading partnerships and was not intended to be 'piggy backed' by the property finance industry in this way.
Unsurprisingly, there is a considerable lobbying effort underway to ensure that the legislation does cater for collective schemes, and the Government is not unaware of the need for a
flexible property investment vehicle, but there are several obstacles to overcome.
The practicalities of drafting a 'one size fits all' legislation to cater for the use of LLPs both for professional partnerships and collective investments are difficult to overcome. And although the plans are that LLPs for professional partnerships will be tax transparent, whether that will be the case when they are used for collective investments is uncertain. The Inland Revenue is reputed to be just one of the organisations that are unhappy about this.
While the provision for all partners to be actively involved in the management is cited as an advantage of LLPs, it also brings onerous responsibilities and liabilities. All partners will owe a 'duty of care' in the way that company directors do, and, in the event of insolvency, some distributed monies could be clawed back. All this could impact on the flexibility of such vehicles if the additional burden on investors make trading more difficult. There is also the potential for fraud, given that every investor is effectively an 'agent' of the partnership and can act on its behalf.
The obvious way around this is to distinguish between 'active' and 'passive' partners in a fund (promoters of such funds may be reluctant to use LLP funds if all parties have an equal say), but in the current draft legislation, there is no mechanism for doing so.
LLPs, therefore, are at the 'wait and see' stage. "The draft legislation is very vague," says Philip Goodstone, property partner at Addleshaw Booth & Co. "I would not advise delaying setting up a limited partnership just to wait for the LLP legislation."
So the UK version of REITs may or may not happen, but LPs and LLPs are symptomatic of the re-orientation of property finance towards more innovative and sophisticated vehicles.
For instance, 'sale and leasebacks' have grown in popularity as companies, for whom real estate investment is not a core business, release capital by selling property assets and renting them back. Capital losses on disposal and rent payments are also tax-efficient; capital tied up in property is not.
In some cases this is done via securitisation as a way to escape stamp duty. A special purpose vehicle (SPV) is set up to buy a property, which it funds by issuing debt in the form of bonds. But this loophole may be closed by the Government at the next budget.
The result is that property and corporate finance practices are becoming increasingly entwined – and tax (and partnership lawyers) are essential to virtually every property deal.
"It is simply corporate specialism now – just with a different product," says Robert Kidby, head of property at Lovells. "Developers might as well be baked bean manufacturers. The ability to provide the resources of large corporate, banking and tax capabilities is essential."
As Kidby adds, the property business is going global, in terms of where the investment money comes from and new financing techniques being exported to less developed jurisdictions such as eastern Europe and the Far East.
Where does this leave the market? Property used to be the preserve of the mid-sized West End firm, but City firms are muscling in. Many observers, usually those from the larger firms, predict a polarisation of the market, with the large firms doing sophisticated property finance work and the smaller ones concentrating on traditional property work.
But pressure on fees is greatest at the more traditional end of the market, as basic conveyancing and lease work become increasingly standardised and automated. The British Property Federation has introduced a standard lease and the trend towards shorter leases makes the process easier. As Boodle Hatfield commercial property partner Tim Manning points out: "For straightforward transactions, the competition is not the big firms, it is the entire profession."
Obviously, the mid-sized firms beg to differ. "I cannot see documentation ever being standardised," says property partner at Kennedys, Jeremy Palmer. "There are always different views and these are reflected in the documentation." Palmer points to the retail market where, he says, developers take different approaches to their respective retail centres. "The skill of the lawyer with his red ink is still important," he claims.
Palmer also stresses that some of the major developers, such as British Land and British Airports Authority, still instruct the 'traditional' firms and that property remains a personality-driven business. He does concede that for the big developments, the City firms are in pole position, but that is as much of an opportunity as a threat for the smaller firms.
"For the £100m development, it is true that the bigger firms have an advantage," Palmer says. "But there is a great expanse of work below that figure and still a need for skilled lawyers. There will be a division and the big firms might lose out on the £10m-£20m bracket because of their fees and lack of the personal touch. It is an opportunity for the mid-sized firms. The big stuff is not our market."
Others, such as Boodle Hatfield, seem prepared to fight it out with the big firms on their own turf, buying in any specialist skills required to service increasingly complex transactions. The firm advised on the formation of the LP that financed the redevelopment of Basingstoke town centre last year (their third major transaction of this type) and Manning says this is the "way forward" for property practices.
"Traditional property could be very difficult in the coming years," he says. "It is so mature and there is very little way of adding value. Firms have been investing heavily and competition is intense. The only way to add value is through these innovative structures."
It seems that the key for the smaller practices competing for high-end work is to get your name noticed amid the hue and cry of the major commercial firms. "It helps that we have done these substantial transactions," Manning says. "It gives us a higher profile and makes getting new ones easier. We can hold our own."