Studley director offers advice on law firm leasing.
Emphasizing the financial weight of real estate decisions, Walbridge explained that the amount of capital devoted to a law firm's occupancy costs typically rank after payroll as the firm's second-largest expense. "As a result, poor real estate decision-making can contribute significantly to the financial instability of the entire firm," he said.
"In any lease negotiation, there are numerous issues specific to law firms that must be addressed." Walbridge asserted. These include individual partner liability, and the need to maximize lease flexibility to accommodate changes in firm size resulting from mergers or downsizing. "Rather than stranding the firm with too much or too little space, these changes can be accommodated by negotiating in expansion, contraction and even cancellation clauses, as well as liberal rights of sublease and assignment," Walbridge explained. Moving into the lease renegotiation process itself, Walbridge noted that, although some office markets such as Washington D.C., have nearly recovered, most are still feeling the effects of a recessionary economy. Lease rates remain depressed across much of the country, and shrewd tenants will capitalize on this opportunity to renegotiate their leases and obtain more favorable terms and conditions. "In considering this process, a law firm's options are dictated primarily by whether or not the firm has market leverage," Walbridge explained. He defined a lease situation with market leverage as the financially sound firm that has three or less years left on its current lease. "This firm is probably paying an escalated rent that has risen above market rates, and has substantial tenant improvements in place," he related.
Lease renegotiation with market leverage
For this firm, determining a renegotiation strategy begins with an evaluation of several factors, including the present liability of the partners, whether or not the existing space works efficiently for the firm, and whether any large-scale expansion or contraction is anticipated for the near future. Based in part upon the answers to these questions, a law firm with market leverage has three options: stay put and monitor the market, restructure its lease today, or arrange a sublease or lease takeover, and relocate today.
Stay put and monitor the market
According to Walbridge, this scenario assumes the current space is functional for the firm. The advantages of this decision are that the firm has the opportunity to redefine its space requirements and that the firm may have more negotiating leverage with the owner as the date of lease expiration approaches. "The risks of this option include the possibility that the market will tighten in the intervening years, and it may not be possible to obtain as favorable rates one or two years down the road," he noted. Additionally, a firm's space alternatives may also be more limited, especially if the firm requires more than a full floor of Class A office space. "Perhaps most importantly, the firm is stuck paying above-market rent for another three years," he concluded.
Restructure lease today
"This is a very popular alternative, especially in soft markets such as downtown Los Angeles," Walbridge related. The advantages of this include an immediate reduction in occupancy costs, the ability to lock-in today's favorable lease rates for the new lease term, and potentially, the opportunity to re-draft the entire lease. The primary negative to this option is that the firm gives up some of the negotiating leverage it would have closer to lease expiration.
Doing the homework before negotiations
According to Walbridge, a well-prepared firm will do some serious homework before beginning the negotiation process. "First, understand the overall leasing situation at your building, in terms of future expirations and current vacancy, as well as what it will cost the landlord to re-lease the firm's space," Walbridge relayed. This number should include tenant improvements, downtime and lost operating expenses and taxes. "Second, make sure you understand the outside marketplace, in terms of comparable transactions, other tenant demand, and the value of 'law firm compatible' tenant improvements," he cautioned. Finally, make sure you understand the renewal process itself, and how much the owner will lose in the future if the law firm vacates. This number is based on the free rent, marketing time, construction time, and tenant improvements required to accommodate a new tenant.
Lease renegotiation without market leverage
Looking at lease renegotiation from another perspective, Walbridge explained a scenario that applies to the law firm with more than three years remaining on its lease, but is in financial straits that require a reduction in operating costs. Preliminary steps for this firm involve reviewing the lease document for any leverage, and then amassing evidence of the law firm's financial situation in order to get the owner to respond. "If the numbers support it, develop a plausible scenario where key partners could leave, or continue to leave, "Walbridge suggested. He also noted that before a firm opens its books to the owner, it should obtain confidentiality agreements from all applicable parties.
Tools for the actual negotiating process include providing an analysis of the owner's re-leasing costs, as well as its probable financial recovery from the firm if the firm were to disband. "Be tenacious," he warned. "Landlords will resist to the end. You need to make them understand the law business, and the reality of collecting in a default." As a final note, he suggests demonstrating a positive light at the end of the tunnel. "Show exactly how a rent reduction will contribute to the firm's long-term health," he advised.
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|Title Annotation:||Steve Walbridge of Julien J. Studley Inc.|
|Publication:||Real Estate Weekly|
|Date:||Sep 7, 1994|
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