Brace for Rising Rents

For the last seven years, partners charged with securing new or additional law office space have enjoyed the advantage, with strong leverage at the lease negotiation table. But with the market cycle trending toward higher rents and fewer options in markets across the country, Jones Lang LaSalle's annual Law Firm Perspective reveals that the days of tenants having the upper hand in lease negotiations are on the way out.

While rents are generally up and options are generally down ' there are cities where law firms can still cut a good deal. Here, Elizabeth Cooper and Tom Doughty, co-chairs of Jones Lang LaSalle's law firm practice, explain the key challenges and opportunities for partners shopping for office space.

Q. How would you describe the climate for law firm tenants ' particularly for partners tasked with real estate strategy ' in the U.S. and abroad?

A. Across the board, demand for domestic office space is outpacing supply. This historically brings higher rents, fewer choices and less landlord concessions for things like building out the space or free rent. High corporate profits coupled with historically low development activity are helping to increase the competition for quality office space, so landlord confidence is growing.

Q. When you say rents may be rising ' is that everywhere? How much?

A. Across the U.S., rents over the past year have shot up by an average of 6% in Class A Central Business District spaces, where most law firms are located. Concessions are becoming scarcer too, with rent abatement levels down 18% from 2009. And the numbers are likely to continue in this direction. Last year, 64% of the markets we tracked were “law-firm favorable” ' compared with only 49% this year. By 2015, we expect that number to fall to a striking 7%.

In general, smaller markets will be more challenging for law firms, mostly due to supply constraints and heavy demand. Several markets already favor landlords in leasing negotiations, including San Francisco, Palo Alto, Pittsburgh, Houston, Austin and Denver, for example. Other midsize markets like Dallas, Phoenix, Orange County and Minneapolis will see a final year of balanced negotiations in 2014, and then see scales tip toward landlords in 2015. The good news is that several major markets are still favorable for law firms, including New York, Washington, DC, Chicago and Los Angeles.

For firms with broader geographic real estate needs, JLL's global law firm market report found that London, Hong Kong and Munich are now favoring landlords, while cities like Milan, Paris, Shanghai and Sydney will still be tenant-friendly markets through 2014. Still, international scales are tipping generally toward landlords, too, with worldwide corporate real estate markets projected to tighten by early 2015.

Q. Are there markets where law firm partners handling leasing negotiation still have the upper hand?

A. Yes, for the next 12-24 months, partners should enjoy continued negotiating leverage in, ironically, the markets where law firms already have the most occupancy ' New York, Washington, DC, Chicago and Los Angeles. This grace period of sorts is due to a slower recovery in financial services and government sectors, which is creating additional second-generation space. Still, our research shows that even in large cities ' domestic and global alike ' negotiation leverage will shift from law firms to landlords by 2016. So there is a little more time before the market returns to favor landlords in the places where firms generally lease the most space.

Q. Why now, when economic growth is still tepid? What factors are causing the scales to tip in favor of landlords?

A. The changing ratio of supply and demand is a key driver in this favor shift, but there are more specific factors within that, depending on market and size segment. For example, some areas experiencing economic resurgence are supply-constrained, particularly markets with booming technology and energy sectors. These industries are experiencing double and even triple growth rates compared to the larger economy, so firms in those locations are benefitting from the “boom.”

For example, the energy sector has driven rents up dramatically over the last 12 months in Pittsburgh and Dallas, up 5.6% and 12.6% respectively; while San Francisco is showing a 12.2% rent increase thanks to its booming tech sector. These demand-heavy markets simply have less quality space available, with blocks of available Trophy and Class A spaces shrinking in all sizes this year, most notably in the 25,000-49,999 square-foot and 200,000 square-foot spaces, which have been reduced by 16.9% and 16.2% respectively.

Q. How are law firms different than your other clients ' other users of office space? What does this mean during negotiations?

A. In many ways, law firms are facing many of the same challenges and opportunities as corporate tenants; they want more light reaching interior spaces, more collaborative areas and are using less space per person. But there are certain trends that are just not appropriate for law firms. For example, you can't simply ask that certain types of legal work take place in open-plan offices, nor is hoteling accepted. What this means when a law firm is seeking office space is that firms look for buildings with less interior space and plenty of glass, so that they can offer more offices with windows and permit light to reflect across the floor plate. While attorney offices are decreasing in size as with other industries, they are preferred on the window line, and firms are only considering junior associates be housed in interior offices.

Q. What should partners be asking for, that are “easy asks” for landlords? What's harder for the landlords to give up?

A. Discounts on longer lease terms may still be available because there is always value for a landlord in securing long-term cash flow for the property. There is also potential in asking landlords to modernize a space to fit today's new workplace strategy needs ' it will, after all, only help them increase rents for the next tenants and increase the value of the asset overall. On the other hand, landlords will likely balk at requests for flexibility to build, expand and contract given the impact of these rights on the landlord's pro forma.

Q. What workplace trends are you seeing in law firm relocations?

A. With most office space being underutilized for 60% of a typical workday (that is an average across all industries ' not just law firms), partners are realizing that the size of an office is less a measure of value than its usefulness. Individual attorney offices are shrinking from the traditional average of 150-250 square feet to an average of 135-225 square feet. Beyond attorney offices, firms are further trimming excess space with the help of technology, as traditional law libraries and filing areas have been radically reduced. Digitalization has also resulted in decreased staffing needs from non-revenue-driving support and administrative personnel, so much so that our counts show the ratio of non-revenue-drivers to revenue-drivers has changed from 3:1 to 6:1, and are trending higher. All told, law firms are decreasing the amount of space used by 15.2% upon relocation or renewal.

Q. Should partners consider buying some time in their current office space?

A. Every situation is unique, so firms should check with their real estate advisers. That said, in general the answer will be that with rents on the rise and concessions diminishing, you may be better off moving sooner rather than later to garner those concessions that with efficiency gain will help offset the cost of a relocation. Additionally, from a productivity standpoint, the risk of staying in a space your firm has outgrown may well not be worth the potential cost savings. If relocating will support your productivity, recruitment and retention goals, the benefit of facing higher rent in the right space may significantly outweigh the added expense ' especially given the relative savings possible with rightsizing.

Market choices are another consideration. Law firms with 50,000 square feet of space or more are finding less options in about a third (34.9%) of U.S. markets, so choices can be limited to staying in place, investing in new construction by anchoring a new building or making compromises for space that isn't a perfect fit for the firm's needs. However, the way most markets are going, choices are becoming scarcer, not more plentiful, overall.

Q. Is there any silver lining here for law firm partners?

A. There is ample opportunity for law firms reassessing their real estate needs to make improvements to both their operations and their bottom lines. Looking ahead, the increasingly supply-constrained market will lead to new developments, driving better quality selection that is more aligned with today's work strategies. Indeed, new construction is already underway, some of which will be ready to ease the supply strain by 2015 or 2016. And in the short term, the trend toward smaller spaces will not only help cap cost structures ' it will also help add to space availability as real estate is reconfigured to meet new needs.

Q. What advice do you have for law firm partners shopping for new space?

A. As an attorney, you already know the value of studying all sides of a case. A deep understanding of the local market climate, both in terms of rental rates, concessions and utilization trends, will empower your leasing strategy and give you a leg up in this newly-challenging law office leasing climate. Look at the big picture, and also for the gems of opportunity in the market that will fit your firm's unique business needs. The key for partners looking to update their real estate strategy is to evaluate the cost of office space versus the revenues derived from each office and determine how well the space is or can support your firm's overall business goals.

Elizabeth Cooper and Tom Doughty are International Directors and Law Firm Group Co-leads for Jones Lang LaSalle, resident in the Washington, DC, office. Reach them at [email protected] and [email protected], respectively.'For a copy of the report mentioned in this article, go to http://www.jll.com/united-states/en-us/Research/law-firm-perspective-us-2013-jll.pdf.

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For the last seven years, partners charged with securing new or additional law office space have enjoyed the advantage, with strong leverage at the lease negotiation table. But with the market cycle trending toward higher rents and fewer options in markets across the country, Jones Lang LaSalle's annual Law Firm Perspective reveals that the days of tenants having the upper hand in lease negotiations are on the way out.

While rents are generally up and options are generally down ' there are cities where law firms can still cut a good deal. Here, Elizabeth Cooper and Tom Doughty, co-chairs of Jones Lang LaSalle's law firm practice, explain the key challenges and opportunities for partners shopping for office space.

Q. How would you describe the climate for law firm tenants ' particularly for partners tasked with real estate strategy ' in the U.S. and abroad?

A. Across the board, demand for domestic office space is outpacing supply. This historically brings higher rents, fewer choices and less landlord concessions for things like building out the space or free rent. High corporate profits coupled with historically low development activity are helping to increase the competition for quality office space, so landlord confidence is growing.

Q. When you say rents may be rising ' is that everywhere? How much?

A. Across the U.S., rents over the past year have shot up by an average of 6% in Class A Central Business District spaces, where most law firms are located. Concessions are becoming scarcer too, with rent abatement levels down 18% from 2009. And the numbers are likely to continue in this direction. Last year, 64% of the markets we tracked were “law-firm favorable” ' compared with only 49% this year. By 2015, we expect that number to fall to a striking 7%.

In general, smaller markets will be more challenging for law firms, mostly due to supply constraints and heavy demand. Several markets already favor landlords in leasing negotiations, including San Francisco, Palo Alto, Pittsburgh, Houston, Austin and Denver, for example. Other midsize markets like Dallas, Phoenix, Orange County and Minneapolis will see a final year of balanced negotiations in 2014, and then see scales tip toward landlords in 2015. The good news is that several major markets are still favorable for law firms, including New York, Washington, DC, Chicago and Los Angeles.

For firms with broader geographic real estate needs, JLL's global law firm market report found that London, Hong Kong and Munich are now favoring landlords, while cities like Milan, Paris, Shanghai and Sydney will still be tenant-friendly markets through 2014. Still, international scales are tipping generally toward landlords, too, with worldwide corporate real estate markets projected to tighten by early 2015.

Q. Are there markets where law firm partners handling leasing negotiation still have the upper hand?

A. Yes, for the next 12-24 months, partners should enjoy continued negotiating leverage in, ironically, the markets where law firms already have the most occupancy ' New York, Washington, DC, Chicago and Los Angeles. This grace period of sorts is due to a slower recovery in financial services and government sectors, which is creating additional second-generation space. Still, our research shows that even in large cities ' domestic and global alike ' negotiation leverage will shift from law firms to landlords by 2016. So there is a little more time before the market returns to favor landlords in the places where firms generally lease the most space.

Q. Why now, when economic growth is still tepid? What factors are causing the scales to tip in favor of landlords?

A. The changing ratio of supply and demand is a key driver in this favor shift, but there are more specific factors within that, depending on market and size segment. For example, some areas experiencing economic resurgence are supply-constrained, particularly markets with booming technology and energy sectors. These industries are experiencing double and even triple growth rates compared to the larger economy, so firms in those locations are benefitting from the “boom.”

For example, the energy sector has driven rents up dramatically over the last 12 months in Pittsburgh and Dallas, up 5.6% and 12.6% respectively; while San Francisco is showing a 12.2% rent increase thanks to its booming tech sector. These demand-heavy markets simply have less quality space available, with blocks of available Trophy and Class A spaces shrinking in all sizes this year, most notably in the 25,000-49,999 square-foot and 200,000 square-foot spaces, which have been reduced by 16.9% and 16.2% respectively.

Q. How are law firms different than your other clients ' other users of office space? What does this mean during negotiations?

A. In many ways, law firms are facing many of the same challenges and opportunities as corporate tenants; they want more light reaching interior spaces, more collaborative areas and are using less space per person. But there are certain trends that are just not appropriate for law firms. For example, you can't simply ask that certain types of legal work take place in open-plan offices, nor is hoteling accepted. What this means when a law firm is seeking office space is that firms look for buildings with less interior space and plenty of glass, so that they can offer more offices with windows and permit light to reflect across the floor plate. While attorney offices are decreasing in size as with other industries, they are preferred on the window line, and firms are only considering junior associates be housed in interior offices.

Q. What should partners be asking for, that are “easy asks” for landlords? What's harder for the landlords to give up?

A. Discounts on longer lease terms may still be available because there is always value for a landlord in securing long-term cash flow for the property. There is also potential in asking landlords to modernize a space to fit today's new workplace strategy needs ' it will, after all, only help them increase rents for the next tenants and increase the value of the asset overall. On the other hand, landlords will likely balk at requests for flexibility to build, expand and contract given the impact of these rights on the landlord's pro forma.

Q. What workplace trends are you seeing in law firm relocations?

A. With most office space being underutilized for 60% of a typical workday (that is an average across all industries ' not just law firms), partners are realizing that the size of an office is less a measure of value than its usefulness. Individual attorney offices are shrinking from the traditional average of 150-250 square feet to an average of 135-225 square feet. Beyond attorney offices, firms are further trimming excess space with the help of technology, as traditional law libraries and filing areas have been radically reduced. Digitalization has also resulted in decreased staffing needs from non-revenue-driving support and administrative personnel, so much so that our counts show the ratio of non-revenue-drivers to revenue-drivers has changed from 3:1 to 6:1, and are trending higher. All told, law firms are decreasing the amount of space used by 15.2% upon relocation or renewal.

Q. Should partners consider buying some time in their current office space?

A. Every situation is unique, so firms should check with their real estate advisers. That said, in general the answer will be that with rents on the rise and concessions diminishing, you may be better off moving sooner rather than later to garner those concessions that with efficiency gain will help offset the cost of a relocation. Additionally, from a productivity standpoint, the risk of staying in a space your firm has outgrown may well not be worth the potential cost savings. If relocating will support your productivity, recruitment and retention goals, the benefit of facing higher rent in the right space may significantly outweigh the added expense ' especially given the relative savings possible with rightsizing.

Market choices are another consideration. Law firms with 50,000 square feet of space or more are finding less options in about a third (34.9%) of U.S. markets, so choices can be limited to staying in place, investing in new construction by anchoring a new building or making compromises for space that isn't a perfect fit for the firm's needs. However, the way most markets are going, choices are becoming scarcer, not more plentiful, overall.

Q. Is there any silver lining here for law firm partners?

A. There is ample opportunity for law firms reassessing their real estate needs to make improvements to both their operations and their bottom lines. Looking ahead, the increasingly supply-constrained market will lead to new developments, driving better quality selection that is more aligned with today's work strategies. Indeed, new construction is already underway, some of which will be ready to ease the supply strain by 2015 or 2016. And in the short term, the trend toward smaller spaces will not only help cap cost structures ' it will also help add to space availability as real estate is reconfigured to meet new needs.

Q. What advice do you have for law firm partners shopping for new space?

A. As an attorney, you already know the value of studying all sides of a case. A deep understanding of the local market climate, both in terms of rental rates, concessions and utilization trends, will empower your leasing strategy and give you a leg up in this newly-challenging law office leasing climate. Look at the big picture, and also for the gems of opportunity in the market that will fit your firm's unique business needs. The key for partners looking to update their real estate strategy is to evaluate the cost of office space versus the revenues derived from each office and determine how well the space is or can support your firm's overall business goals.

Elizabeth Cooper and Tom Doughty are International Directors and Law Firm Group Co-leads for Jones Lang LaSalle, resident in the Washington, DC, office. Reach them at [email protected] and [email protected], respectively.'For a copy of the report mentioned in this article, go to http://www.jll.com/united-states/en-us/Research/law-firm-perspective-us-2013-jll.pdf.

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