Landlords become wary of leasing to service tenants: such tenants' paucity of tangible assets increases risk.

One might guess that, with vacancy rates in the downtown area so high, landlords are less particular about their tenants. Not true, however, when it comes to leasing to law firms and other service professions.

One major factor that has landlords concerned is the recent dissolution of the Los Angeles office of law firm Baker & McKenzie. That move, announced in October, opened up a total of 100,000 square feet in Citicorp Plaza's 777 Tower. What was so surprising to landlords around town was the fact that it was Baker & McKenzie, one of the largest law firms in the U.S., who was closing its doors. "Nobody thought a Baker & McKenzie would fall apart," said Kathryn Schloessman, a broker with CB Commercial Real Estate Group specializing in leasing for law firms.

Large professional and corporate tenants are closing down in downtown L.A. and are throwing office space on the market. IBM, for one, announced that it will vacate a sizable chunk of office space in downtown L.A. in 1994.

The problem facing commercial landlords with law firms and other service firms as tenants is that such landlords are typically at much greater risk of losing money when the tenants move out.

When corporations violate terms of a lease contract, the landlord can file suit and go after the corporation's assets. Corporate tenants are, therefore, more likely to meet their rental obligations, real estate industry sources said. Law firms, on the other hand, have few tangible assets because they are service providers. So, as in the case of Baker & McKenzie, the landlord is not recouping any portion of the rent on that space.

"All their (law firms') assets walk out the door at 5 o'clock," said Schloessman. "You don't have that with a corporation."

"The recent dissolution of reputable law firms has placed an emphasis on landlord security," said Parker Jones, leasing manager for ManuLife Real Estate, a major commercial landlord in downtown Los Angeles. The trend among wary L.A. landlords has been to get the partners of the law firm to agree to be held personally liable for the lease obligations of the firm.

"Partners in law firms will always try to resist being personally liable. However, increasingly more landlords are requiring it," said Jones. "It has become very common downtown."

According to several real estate sources, the increasing number of landlords requiring that law partners be held personally liable for the lease obligations of their firms, and the partners' unwillingness to put their cars and homes on the line, has definitely limited the office choices that law firms have. The least likely lessors of downtown L.A. office space to law firms these days, according to several real estate sources, are large institutional owners with deep pockets.

Insurance companies such as Metropolitan Life Insurance Co. have the option of riding out the tough times in downtown and are willing, in some cases, to carry higher vacancy rates in their buildings rather than rent to riskier tenants, such as law firms whose partners refuse to be held personally liable. Landlords take a high risk in leasing to professional firms in general, according to Bob Caudill, managing director of commercial brokerage firm Caudill & Co., simply because landlords incur relatively high costs to move such firms in.

One of the more viable options for law firms seems to be to move into some of the vast amount of sublease space that has opened up on the downtown L.A. market. Much of that sublease space is being offered by downsizing law firms.

Scores of major law firms have downsized and the trend is expected to continue. In addition to Baker & McKenzie, downtown law firms that have sublease space available include such well-known firms as Gibson Dunn & Crutcher, Latham & Watkins, Pillsbury Madison & Sutro, O'Melveny & Myers, Morrison & Foerster, and Skadden Arps Slate Meagher & Flom. Nearly every downtown law firm has space available, according to Schloessman.

Law firms, during the boom years of the 1980s, gobbled up office space in the downtown L.A. area faster and in bigger chunks than most other industries.

"Most of them over-committed to space in the late 1980s, when they were in expansion mode and planned to keep expanding," said Schloessman.

Now the skinny years of the 1990s have hit and most are realizing that trimming down on their space will be healthy in the long run for the firm. According to Hayden Eaves IV, a broker with the downtown office of Cushman & Wakefield of California Inc., "A lot of law firm space was more opulent than functional." Another factor contributing to law firm space being returned to the downtown L.A. market is the wave of mergers that has swept the legal industry.

"I miss the 80s," said veteran downtown broker Caudill. Back then, he explained, when two law firms merged, they took more space than they were previously occupying separately. Now, he said, when two law firms merge, chances are they will move into a much smaller space.