WASHINGTON, D.C. LAW FIRM REAL ESTATE SERIES · 2017-12-18 · The second part examines internal drivers and trends which have led to leaner, more flexible and efficient law firm

PART ONE:THE MORE COMPETITIVE LAW FIRM

CBRE RESEARCH

21 CENTURYLAW FIRM

stTHE

WASHINGTON, D.C. LAW FIRM REAL ESTATE SERIESFal l/Winter 2015

The legal sector has witnessed unprecedented change since the Great Recession. A combination of market pressures and structural shifts in the workplace has driven law firms to increase focus on real estate costs – the second largest expense after payroll compensation.

A new two-part series from CBRE Research examines how law firms in Washington, D.C. have responded to the changing environment and reshaped their real estate decisions.

INTRODUCTION

2 | CBRE RESEARCH

PART I – The More Competitive Law Firm

The first part (covered in this report) discusses the implications of wider market factors in the legal industry, such as the surprisingly large number of firms that have established a new D.C. presence, the local impact of industry mergers and acquisitions as well as large firms that have dissolved. The result is a markedly more competitive legal landscape with associated ramifications for real estate.

PART II – The More Efficient Law Firm

The second part examines internal drivers and trends which have led to leaner, more flexible and efficient law firm operational structures. It provides an overview of the real estate trends among Am Law 100 firms and identifies unexpected pockets of growth. Workplace strategies and relocation trends in the D.C. market are also addressed in detail.

EXECUTIVE SUMMARY: THE MORE COMPETITIVE LAW FIRM

• Washington, D.C. boasts the largest number of Am Law 100 firms in the country – 94, tying with New York City. However, firms entering the D.C. market for the first time are proving to be a material source of future real estate demand. Since 2008, at least 26 law firms have established a new D.C. presence, mitigating in part the space overhang from consolidations and dissolutions.

• New entrants are unencumbered by legacy real estate issues that existing firms may have, resulting in a more streamlined and competitive real estate structure. The fact that these firms have leased approximately 350,000 sq. ft. is an indication of their potential growth trajectory. This trend is likely to continue as new entrants are well-positioned on the real estate expense side to deal with fee compression pressures, and the increasing commoditization of legal work.

• Increased competition has driven unprecedented M&A activity in the legal sector. The impact on larger firms includes headcount rationalization and commensurate real estate consolidation, leading to over 400,000 sq. ft. of space being vacated locally. Given that law firms typically pay premium rents, the real estate aspect of an M&A deal can benefit substantially from early and thoughtful planning. Comprehensive due diligence on the operational, human capital and cash flow elements of real estate is a key driver of a merger’s ultimate success.

• Looking ahead, legal employment in D.C. is forecast to decline further. Vacancy rates for Trophy/Class A buildings tend to rise as employment in the sector falls, particularly in the absence of significant speculative office construction.

• The industry will continue to experience paradigm shifts resulting from technological efficiencies, continued M&A activity and structural changes in the legal workforce towards more contractors and part-time employees. In the absence of new groundbreakings, demand and supply would appear balanced with an estimated 6 million sq. ft. of law firm leasing activity and a similar amount (5.8 million sq. ft.) of potential available new construction coming to market over the next five years. A continuing trend of flight to quality may lead to higher vacancies in aged product as some of the larger firms relocate to start new construction.

42%LAW FIRMS OCCUPY

TROPHY/CLASS A OFFICES IN CORE

SUBMARKETS

26+ LAW FIRMS WITH

NEW D.C. OFFICES SINCE 2008

11 M&A DEALS WITH

LOCAL IMPACT SINCE 2013

94 AM LAW 100 FIRMS

IN D.C.

#1

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PART ONE: THE MORE COMPETITIVE LAW FIRM

WASHINGTON, D.C. | AN IMPORTANT HUB FOR THE LEGAL INDUSTRY

The legal sector has always been a critical part of Washington, D.C.’s economic, political and real estate landscape. The nation’s capital boasts the highest concentration of law firms in the country with the presence of 94 of the Am Law 100 – matched only by New York City – and is the fourth largest U.S. law market by employment.

Following the 2008-2009 financial crisis, law firm employment in the District has fallen by 19% from its pre-recession peak in 2008, accounting for a loss of 6,800 legal sector jobs. The decrease in employment is attributed to several factors, including:

• Muted market demand

• Alternative fee structures leading to fee compression

• Increased M&A activity among law firms

• A series of market departures and dissolutions

• A trend toward more part-time and contract workers

• Increased productivity driven by technology

Employment has since rebounded and is now seeing some growth, albeit not across the board. The legal business around Washington, D.C. is becoming increasingly polarized. The gross revenue of the top 25 firms in the city posted a 4% increase compared to revenues of last year’s top 25, according to the National Law Journal. In terms of service sectors, high-end litigation and regulation activity is growing, while Intellectual Property work is still facing some challenges.

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% of Legal Service Jobs in Professional and Business Services

Total Legal Service Jobs18%

15%

11%

7% 7% 6% 6% 6%5% 5%

Major U.S. Law Markets

4THLARGEST U.S.

LAW MARKET BY EMPLOYMENT

*Source: Bureau of Labor Statistics (BLS), CBRE Research, Q3 2015.

LEGAL SECTOREMPLOYEES

29,400 PROFESSIONALS

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Law firms’ disproportionate impact on D.C.’s office-using sector

BY EMPLOYMENT

6%

BY GDP

12%

TROPHY OCCUPANCY

42%

BY SPACE OCCUPANCY

25%

*Source: Bureau of Economic Analysis, BLS, CBRE Research, Q3 2015.

Law firm employment growth vs. prime office vacancy

*Source: BLS, CBRE Research, Q3 2015.

LAW FIRMS DOMINATE | D.C.’S PREMIUM OFFICE MARKETSDespite accounting for only 6% of D.C.’s total employment and 12% of its GDP in terms of the office-using sectors, law firms occupy 25% of the District’s total office market, making it the largest private-sector occupier. Furthermore, law firms dominate the premium product segment, occupying 42% of the Trophy and Class A buildings in the core CBD and East End markets.

As a result, the performance of the prime real estate segment is closely linked to law firm employment. Vacancy rates for Trophy and Class A buildings in the District tend to rise as employment in the sector falls, particularly in the absence of significant speculative office construction.

*Source: Bureau of Labor Statistics (“BLS”), CBRE Research, Q3 2015.

-10%

-5%

0%

5%

10%

15%

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Employment Growth Trophy/Class A Vacancy Rate

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IMPACT OF MOVE-INS | AND DISSOLUTIONS

Law firms new to the Washington, D.C. market are a material source of recent and future space demand. At least 26 firms have established a new presence in the District since 2008, mitigating in part the 635,000 sq. ft. returned to the market following the dissolution of Dewey & LeBoeuf (150,000 sq. ft.), Thelen (75,000 sq. ft.), Heller Ehrman (83,000 sq. ft.) and Howrey (327,000 sq. ft.).

New entrants are able to better match their real estate footprint to their business needs, negotiate competitive lease terms and take advantage of the latest in workplace design efficiencies and technology innovations. As a result, they are not hampered by legacy real estate strategy issues such as “shadow” and inefficient space that existing firms may have.

The fact that these firms have initially leased approximately 350,000 sq. ft. of Class A and Class B office space is an indication of their commitment to Washington, D.C. and expected future growth. For instance, firms such Shipman & Goodwin and Quarles & Brady have expanded from smaller, short-term space to each lease between 15,000 to 20,000 sq. ft. on a long-term basis. Firms that are starting new operations are focused on real estate flexibility and the ability to grow their space without penalty. This growth trend is likely to continue as new entrants enjoy a financial benefit that allows them to capitalize on fee compression pressures and the increasing commoditization of legal work.

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NEW DIRECT ENTRANTS26 FIRMSNET IMPACT:

345,000 SQ. FT.

LARGE DISSOLUTIONS

4 FIRMSNET IMPACT:

(635,000) SQ. FT.

2009Frankel

Brinks Gilson & Lione

2008

Schulte Roth & Zabel

2010Shipman & Goodwin

Hooper Lundy & Bookman

2011Allen & Overy

Becker & PoliakoffFredericks Peebles & Morgan

SedgwickRatnerPrestia

Dinsmore & ShohlQuinn Emanuel Urquhart & Sullivan

2015Lax & Neville

2014Lowenstein SandlerPorzio, Bromberg & NewmanRosette

2013Cassin & CassinStoel RivesStroock & Stroock & LavanHerrick, FeinsteinMichael Best & Friedrich

2012Gordon Rees Scully MansukhaniQuarles & BradyBass, Berry & Sims Miles & Stockbridge Chapman and Cutler

Sample of law firms opening new offices in Washington, D.C. (2008 to date)

*Source: CBRE Research, Q3 2015.

Over 20,000 SF

10,000-19,999 SF

5,000-9,999 SF

Under 5,000 SF


Increased competition in the legal sector has seen unprecedented M&A activity among law firms. There have been 68 transactions so far in 2015 with some of the biggest international mergers taking place this year.

*Source: Altman Weil, Q3 2015.

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D.C. M&A ACTIVITY11 FIRMSNET IMPACT:

(416,000) SQ. FT.

Consolidation/Contraction

Expansion

Minimal impact

IMPLICATIONS OF MERGERS | & ACQUISITIONS

11 firms in the District have been affected by M&A activity. Among the larger firms, the impact of a merger is primarily one of consolidation. For instance, the Morgan Lewis & Bockius and Bingham McCutchen consolidation and the merger between McKenna Long & Aldridge and Dentons returned a combined 228,000 sq. ft. of vacant space to the market in 2015. In 2014, the Squire Sanders and Patton Boggs as well as the Cooley and Dow Lohnes mergers gave back an estimated 200,000 sq. ft. to the market.

Overview of significant law firm M&A activity with impact on Washington, D.C. (2013 to date)

Number of Mergers & Acquisitions between law firms

*Source: CBRE Research, Q3 2015.

2015

2014

2013

Dentons

Morgan Lewis & Bockius

Silver, Freedman & Taff

Cohen Seglias Pallas Greenhall & Furman

Squire Sanders

Carlton Fields

Locke Lord

McCarter & English

Schiff Hardin

Jones Walker

Cooley

McKenna Long & Aldridge

Bingham McCutchen

Elias, Matz, Tiernan & Herrick

Thaler Liebeler

Patton Boggs

Jorden Burt

Edwards Wildman Palmer

Miller Balis & O’Neil

Bruder, Gentile & Marcoux

Spidi & Fisch

Dow Lohnes


While mergers can result in significant economies of scale and cost savings, particularly for larger firms, the post-merger failures of Dewey & LeBoeuf, Howrey and Thelen highlight the importance of managing the process effectively. Mergers and acquisitions typically shine a spotlight on a host of wider strategic and tactical issues for a firm. However given the high cost implications, real estate needs to be addressed as a priority. The key areas of real estate focus during an M&A process include:

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• Determining the right location is critical, particularly for firms with overlapping footprints. Options include consolidating and rightsizing into existing premises, relocating, or deferring the decision if part of a multimarket portfolio. For firms with shadow space, it can be an opportunity to absorb excess capacity.

• Unexpired lease terms can be a serious liability. Explore cost mitigation measures including consolidating and optimizing separate footprints. For excess real estate, subletting space and negotiating early terminations can be mitigants.

• Undertake space utilization and growth planning to reflect realistic headcount.

OPERATIONAL CONSIDERATIONS

• Law firms are driven primarily by human capital concerns. As a result, real estate decision makers need to be cognizant that any changes in space need to both set and reflect the culture of the merged firm. By materially affecting brand and reputational value, real estate can assist in critical talent recruiting and retention.

HUMAN AND CULTURAL CAPITAL

• Key elements include cash flow analysis, scenario planning combined with benchmarking and occupancy redundancy analysis. Quantifying partnership liability and unamortized costs can assist with capital deployment decisions.

FINANCIAL ISSUES

Early and thoughtful planning of all relevant real estate elements is a key driver of a merger’s ultimate success. Comprehensive real estate due diligence, undertaken during the early stages of a merger or acquisition, can help to ensure that real estate is on a complementary track with the overall M&A process.


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TRENDS TO WATCHThe overall strengthening of the economy is likely to increase demand for legal services. However, this is not expected to translate directly into an expansion in employment, as many firms are expected to hire more part-time and contract lawyers and reduce the number of equity partners and support staff. Moody’s is projecting a decline in legal services employment in D.C. between 2017 and 2020.

Trends likely to shape future real estate decisions in the sector include:

• Paradigm shifts in the industry: Growing competition from service providers other than law firms and new technological solutions like digitalization are likely to redefine occupancy requirements. Mergers and acquisitions are expected to continue, as firms look to bolster their presence and increase efficiencies and competitiveness through acquisitive growth.

• Market activity: There is current visibility of approximately 6 million sq. ft. of law firm real estate expirations and tenants in the market over the next five years, peaking in 2019 – 2020. The activity is equally split in terms of square footage among larger occupiers (50,000+ sq. ft.) and those looking for smaller space.

• Available new supply: Within the next five years, an additional 22 new proposed projects offering 5.8 million sq. ft. of available space could potentially add top quality real estate to the market. Law firms, particularly those currently in older buildings or in locations lacking services, are expected to continue to relocate and downsize, trading up for superior product and amenities.


22 NEW PROJECTS

5.8 MILLION SQ. FT.

CURRENT VISIBILITY

6 MILLION SQ. FT. LAW FIRM

ACTIVITY

REVATHI GREENWOOD

Director of Research & Analysis

+1 202 585 5662

[email protected]

NICK PHILLIPS

Research Coordinator

+1 202 585 5703

[email protected]

WEI XIE

Research Manager

+1 202 585 5642

[email protected]

FOR MORE INFORMATION, PLEASE CONTACT:

© 2015 CBRE, Inc. The information contained in this document has been obtained from sources believed reliable. While CBRE, Inc. does not doubt its accuracy, CBRE, Inc. has not verified it and makes no guarantee, warranty or representation about it. It is your responsibility to independently confirm its accuracy and completeness. Any projections, opinions,

assumptions or estimates used are for example only and do not represent the current or future performance of the property. The value of this transaction to you depends on tax and other factors which should be evaluated by your tax, financial and legal advisors. You and your advisors should conduct a careful, independent investigation of the property to determine to

your satisfaction the suitability of the property for your needs. CBRE and the CBRE logo are service marks of CBRE, Inc. and/or its affiliated or related companies in the United States and other countries. All other marks displayed on this document are the property of their respective owners.

COVERING: • WHICH FIRMS ARE

SHRINKING / GROWING

• WORKPLACE STRATEGIES

• STAY OR GO – RELOCATION TRENDS

COMING UP NEXT

PART II - THE MORE EFFICIENT LAW FIRM

21 CENTURYLAW FIRM

stTHE

WASHINGTON, D.C. LAW FIRM REAL ESTATE SERIES · 2017-12-18 · The second part examines internal drivers and trends which have led to leaner, more flexible and efficient law firm

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