From upwardly mobile US firms to national practices with ambitious City plans, we analyse the winners and losers of law firm property.
It’s early February, ten days before Pinsent Masons moves in and the final touches are being made to the firm’s new London offices. Carpets are being fitted, a problem with the lift fixed and the IT guys are looking confused in front of their fancy new AV equipment.
But a shiny new building is not all the firm has signed up for – the move will have a significant effect on profitability. As it stands Pinsents has got a steal – it is paying a below-market rent of £35 per sq ft for a brand new building just around the corner from Liverpool Street station, and will pay considerably less than many rival firms.
After salaries, property is of course one of the biggest costs for any law firm. The past few years have been a good time to bag a deal, but conversely many firms will be kicking themselves for having signed deals at the wrong time, before the economic crisis stuck, leaving them stuck with expensive offices and excess space.
‘The timing was good fortune and good judgement – we hit the right time in the market and the deal we have done will be good for many years.’
Martin Roberts, Pinsents
When Pinsents first started looking for a new building back in 2006, Martin Roberts, head of the London office, was offered the same space when it was still under construction but at a big premium: £55 per sq ft. Two and a half years later the developer was desperate to get the building off its hands, so it slashed rents and lured the firm in with an unusually generous rent-free period of five years (the norm is now nearer 18 months).
‘The rent-free has enabled us to pay for the fit-out, so it’s a deal that’s cost neutral and we haven’t needed to borrow to pay for the move,’ says Roberts. ‘The timing was good fortune and good judgement – we hit the right time in the market and the deal we have done will be good for many years.’ From the client meeting rooms of Pinsents’ 30 Crown Place office, Roberts will be able to see the new home of one firm that didn’t manage to ride the property cycle with such skill.
From September K&L Gates moves to its new offices at One New Change next to St Paul’s Cathedral. The US firm is reputedly paying £61 per sq ft for 120,000 sq ft on a 15-year lease. Each lawyer at K&L Gates will have to pull in a huge £54k before they pay for their desk space, nearly three times as much as at Pinsents where property cost per lawyer is a more modest £18k.
‘We’re comfortable with the deal we got,’ says Tony Griffiths, K&L Gates’ London administrative partner. ‘We wanted flexibility and plenty of expansion space as we want to grow over a period of time,’ he adds.
The difference between Pinsents’ and K&L Gates’ deals was mainly down to timing. K&L Gates inked its deal in pre-recession 2007 and Pinsents negotiated its move at the bottom of the City rental market in late 2009. Since the low point of the London lettings market two years ago, London rents have been steadily creeping up as demand bounces back and office supply remains limited.
‘The year following Lehman Brothers was the best time to relocate, with the bottom of the market being mid-2009,’ says Jeremy Attfield, a partner at property consultants King Sturge, which has advised a number of major law firms over the past few years. ‘Most of the larger UK law firms have a strategy to keep rents in the low to mid £40s per sq ft,’ he adds. Some are well above that mark.
Negative equity
K&L Gates won’t be the only firm kicking itself for signing a deal at the wrong time. Addleshaw Goddard, Reed Smith and Orrick, Herrington & Sutcliffe all signed deals back at the height of the market in 2007 and are all paying over £30k per lawyer annually for property space. These firms are now lumbered with expensive property costs that will hit their pockets hard for years to come.
‘It wasn’t the ideal time to move but there weren’t many ways we could align the chess pieces to get where we wanted to be.’
Mark Jones, Addleshaw Goddard
Mergers have been a major driver for law firm moves over the past few years. Soon after Reed Smith merged with Richards Butler in 2007, the firm decided it needed to move all of its staff under one roof, signing a deal to take 150,000 sq ft for £60 per sq ft in Broadgate Tower in a then buoyant market. The firm now has an annual property bill of £9m and is locked in for at least the next decade, well above many of its City peers.
But Phil Page, Reed Smith’s Europe and Middle East operations director believes the cost of the deal is outweighed by the benefits to the firm of being under one roof. ‘Maybe it wasn’t the best time to do a deal but we think we got a competitive rent for the quality of space that we got,’ says Page, adding that the firm spreads its real estate costs across the firm as a whole. ‘We work as a global business and it’s part of our global real estate overheads. London is just one element of our total property portfolio.’
Reed Smith is one of several cash-rich American firms that have taken space in expensive trophy developments over the past few years. McDermott Will & Emery will pay £55 per sq ft when it moves into the flash new Heron Tower development on Bishopsgate later this year. Weil, Gotshal & Manges will pay £54 per sq ft for a 67,600 sq ft space in the prestigious new Rolls Building on Fetter Lane, when it relocates from Moorgate later this year.
Despite paying above the odds, Weil’s Marco Compagnoni, a partner in the firm’s private equity group, believes the US practice got a good deal. ‘We signed at a good time and the landlord was keen to have us,’ he says. ‘We wanted a modern and sustainable office with good natural light and it was important we weren’t packed in nose to nose.’
Along with paying a relatively high rent, Reed Smith has been hit doubly hard by exposure to sublets. The firm’s rush to move before its property leases on its old premises expired has left it stuck with subletting large chunks of its old building in the relatively undesirable Southwark. ‘We currently sublet just under 28,000 sq ft to an insurance broker, but we still have another 50,000 sq ft we are trying to sublet,’ says Page.
On the market
Many UK firms also took on extra space before the downturn only to find that after redundancies and slower than expected growth they are now burdened with unwanted office space. This extra space is often difficult to shift, as most banks and professional services companies don’t like the cellular style of law firm layouts.
‘A lot of law firms have been looking to sublet but they have been fairly unsuccessful compared to the banks,’ says Jeremy Prosser, a director at property consultants GVA Grimley. ‘It’s more difficult for law firms to sublet as most people can’t use a legal fit-out because they are offices filled with little boxes. So law firms look to other law firms to sublet,’ he says.
Allen & Overy is one good example of this. Since moving into a new HQ in Spitalfields in 2006 and Canary Wharf in 2003 (both signed on 25-year leases in 2002) the firm has never managed to fully fill either space with its own lawyers. Back in 2002 the firm told LB: ‘The important thing is to try and get the balance right between not taking an enormous commercial risk by taking on too much space, becoming reliant on the subletting market, and taking enough space for expansion.’ The economic crisis has certainly knocked things out of kilter.
In its 850,000 sq ft office the firm has only ever occupied two thirds of the building. The remaining 250,000 sq ft is let to Deutsche Bank, along with US firms Proskauer Rose; Paul, Hastings, Janofsky & Walker; and Akin Gump Strauss Hauer & Feld.
Last summer the Magic Circle firm announced it was shutting its Canary Wharf outpost at 40 Bank Street, keeping just a skeleton space for client meetings. The Docklands venture helped the firm to stay close to its banking clients, but has cost the firm £27m in total rent over the past decade. A&O is now also faced with the prospect of subletting the 65,000 sq ft space and is locked into paying rent of £45 per sq ft for the next 15 or so years. If it can’t find a tenant, that’s a potential liability of £2.9m per year for the firm. That’s not a huge overhead for a firm with London revenues in excess of £400m, but is a headache in these increasingly cost-conscious times. And with last month’s announcement that A&O is set to move 180 jobs from London to Belfast, the firm may be looking to sublet yet more space in the years to come.
Simmons & Simmons has also been forced to turn to the subletting market. The firm is currently marketing 42,000 sq ft of space at CityPoint near Moorgate through its agents after Pinsents moved out in February 2011. Again the potential liabilities are high; the firm will lose £136,000 every month it remains without a tenant.
Elsewhere in the City, Addleshaw Goddard was more prudent in its attitude toward sublets. Before making its move to Milton Gate in 2009, the firm made sure it shifted its old lease commitments for its office near Barbican.
Mark Jones, former managing partner who co-ordinated the deal, explains: ‘We were in three different offices that you could walk between in ten minutes, but they may as well have been ten days apart. So the objective was to get everyone under one roof. Our Aldersgate Street office had a lease running until 2020 or so and the practical challenge was that we couldn’t do anything until we could get it off our hands.’
The agents had to put together a deal that got the Aldersgate Street office a new tenant before Addleshaw Goddard moved to Milton Gate paying £47 per sq ft. Defending the relatively high rental price the firm is paying, Jones says: ‘It wasn’t the ideal time to move but there weren’t many ways we could align the chess pieces to get where we wanted to be. We probably ended up in an over-rented building when we first moved in but it was still the right move for the firm.’
Office economics
But just as there are losers with property, there are some clear winners. Rent is largely a question of timing, along with the all important location, and along with Pinsents Stephenson Harwood emerges as one firm that managed to cannily ride the London property market. The firm will pay just £37 per sq ft when it moves into its new offices, the former BP headquarters at 1 Finsbury Circus, in April.
‘We’ve been in our current offices for 25 years and our lease expires in summer 2011,’ chief executive Sharon White says. ‘We first started looking for property before the recession started but rents were quite high at that stage.’ The firm was in talks to take over 107 Cheapside (now the home of US firm Orrick, Herrington & Sutcliffe) back in 2008 for just over £50 per sq ft but pulled out of the deal at the eleventh hour.
‘We got quite a way down the track with one property but there were enough signs that the boom might not continue and we decided that it wasn’t an unmissable opportunity. It was definitely the right call,’ says White. Right call indeed. By scuppering the deal back in 2008 and holding out for a better market the firm has effectively saved over £1.7m a year for the next 15 years, roughly £25m in total.
Another firm that chose the right time to secure a deal is Bristol-headquartered TLT. The firm moved to a relatively small 24,000 sq ft space in 20 Gresham Street in London in May 2010 and is paying a below market rent of £41 per sq ft. The biggest savings, however, have been made by going open plan. The firm ditched the much favoured cellular office layout, squeezing more lawyers into its space and bringing property cost per lawyer to the lowest in our table – just £14k per lawyer in London.
‘We signed the deal in December 2009 and it was the right moment in the property cycle to take advantage of,’ says TLT managing partner David Pester. ‘Open plan is much more efficient and flexible. It suits the culture of the firm and has helped us develop a very flat structure,’ he adds.
Clearly rent forms just one part of the strategic equation when looking to move. For some, being in the right part of the City is a major factor in deciding where to move. Clyde & Co negotiated a rent of £48 per sq ft for its new offices at One St Botolph back in late 2009. On the face of it hardly a bargain, but with office supply in London’s insurance sector limited the firm believes it scored a good package.
‘We are an insurance firm so need to be near the insurance companies. We had to look in EC3, between Aldgate and Bishopsgate. It’s a very small marketplace with nothing new coming on stream,’ says Robert Pilcher, a property partner at Clyde & Co who co-ordinated the deal.
‘The leases are coming to an end on our three current properties in 2012. I was on the management board and we saw the opportunity of the downturn and saw that we could use the weak property market to get the most for our money,’ says Pilcher.
Similarly West End firm Fladgate was prepared to pay a premium to keep its location outside of the City. The firm is reputedly paying in the mid £60s per sq ft for space just a stone’s throw from Covent Garden, a location the firm calls ‘not quite the City and not quite the West End’.
Re-gearing
But Clyde & Co’s fellow insurance firm Barlow Lyde & Gilbert, which is based around the corner from Clyde’s new offices in EC3, felt that as London office supply was so limited there was little point in moving. Instead, last year Barlows negotiated a five-year extension to its London office lease, securing a rent reduction in the process. The firm will not comment on the new rent but it reckons that this re-gear will save it close to £25m over the next eight years, in terms of money saved from fit-out costs, time spent co-ordinating the move, dilapidation costs and rent hikes.
‘The year following Lehman Brothers was the best time to relocate, with the bottom of the market being mid-2009.’
Jeremy Attfield, King Sturge
‘We’re paying less now than we were in the late 1980s,’ says Malcolm Rogerson, a real estate partner at BLG who was heavily involved in the negotiations. Importantly the firm got the landlord to agree to a much-needed refit of the firm’s tired and rather dated office. ‘Why bother taking on new rents and expense in these market conditions? If we moved within EC3 we’d be looking at rents of £45 to £50 per sq ft, why not stay where we are and pay half that?’ he adds.
Other City firms may see the benefits of staying put over the coming years, as City rents are set to rise. Office supply in central London is not expected to increase until 2014 when several big developments, like the ‘cheese grater’, ‘walkie talkie’ and ‘the helter skelter’ come on stream.
‘Many high-profile development schemes have been put on hold or cancelled. We’ve had record lows of development in 2010 and 2011, well below normal levels,’ says Gary Martin, an analyst at property consultant CBRE. ‘There were also a number of large deals by big occupiers, which have brought the amount of office space available down. If you are a large occupier looking for a decent floor-plate, the options are fairly limited,’ he adds.
With no new developments and supply squeezed, market commentators believe that rents may increase by as much as £10 per sq ft over the next two years. With property leases coming to an end at several of the big firms over the next few years, including CMS Cameron McKenna, Bird & Bird and Field Fisher Waterhouse, that could be bad news. These firms may be wishing that they had the foresight to make their move back with Pinsent Masons in 2009. LB
Location, Location, Location
| Firm | Rent per year |
|---|---|
| K&L Gates | £7.32m |
| Addleshaw Goddard | £9.4m |
| Pinsent Masons | £6.9m |
| Reed Smith | £9m |
| McDermott Will & Emery | £1.38m |
How rent-free periods distort the picture
A rent-free period is a sweetener to entice a new tenant into a building, usually offered up front as a cash lump sum, or as a discount on the rent over the term of the lease. In the infamous Halliwells property deal in Manchester the equity partners pocketed their rent-free money, with the equity partners dividing up the £15m cash lump sum between themselves as a nice little windfall, instead of investing it back into the business.
Why don’t landlords just cut the rent?
Landlords like to have a high headline rent to give the impression that tenants are paying more than they actually are, making comparing deals difficult. Take Clyde & Co as an example. On the face of it the firm is paying £48 per sq ft but once their three-year rent-free is factored into the deal Clydes is paying nearer £41 per sq ft on average over the 20-year lease. Having a high headline rent also leaves landlords in a strong bargaining position when rents get reviewed.
What is a normal rent-free period?
Anything from six months to five years depending on market conditions. Back in 2007 the average City rent-free was just 12 months and by 2009 it had crept up to 33 months. Orrick, Herrington & Sutcliffe scored an 18 month rent-free when it moved to 107 Cheapside back in 2009, while Pinsent Masons bagged a five-year rent-free on its move to 30 Crown Place earlier this year.
What do firms do with their rent-frees?
This can vary hugely. Pinsent Masons took their five-year rent-free money as a cash lump sum and used it to pay for the £17m fit-out of their new building. Speechly Bircham decided to spread the cash payments from their two-year rent-free over a five-year period and are using the extra cash to pay for their £10m fit-out loan.
Keep your distance
In general lawyers are a roomy bunch. Their love of two-partner offices means that as a rule of thumb they occupy almost 40% more space than open-plan banks. Choosing to go open plan can have a big effect on how much space a firm occupies and its bottom line.
‘Wall-less offices cost less to build than cellular offices and you can fit more people in,’ says Ken Baker of design consultancy Gensler. ‘A lot of firms have flirted with the idea but not that many have actually done it. Really it depends on the culture of the law firm,’ he adds.
While financially it might make sense to go open plan, the decision to ditch partner offices is guaranteed to ruffle a few feathers. Indeed nearly all the firms LB spoke to for this feature have considered moving to open plan, with some like West End firm Fladgate even trialling it in their old building. But of recent movers, only Addleshaw Goddard, Pinsent Masons and Speechly Bircham have taken the plunge.
Mark Jones, an open-plan enthusiast at Addleshaw Goddard, explains the difficulties of making the move: ‘When we first moved, 20% of staff were active enthusiasts for open-plan and 20% had serious reservations. Now it’s probably 5% to 10% of the partnership who still don’t like it.’ But he believes its been worth it: ‘No-one would suggest it hasn’t been a success. Communications and team working are so much better and there are business opportunities we would not have picked up if we hadn’t been open-plan.’
In contrast, Clyde & Co is sticking to traditional cellular offices for its move. ‘We did a straw poll of staff and got some extreme reactions,’ says Robert Pilcher, a property partner at Clyde & Co, who co-ordinated the move. ‘People told us they felt it would be like working in a call centre. Some of the partners were open to it but a lot of the youngsters were quite negative about it,’ says Pilcher.
But with potentially big property savings to be made, it may make sense for lawyers to be a bit less worried about their office space and keep more of an eye on the bottom line.