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While many law firms view occupancy costs as a significant operating expense — usually second only to payroll costs — one firm has managed to play the real estate game by buying and selling its building two times in the last 20 years, even turning a profit in the process. Back in the late 1970s, Steptoe & Johnson was the dominant tenant at 1250 Connecticut Ave., N.W., but was growing rapidly and running out of space. By the time it started to look for a new building, “no existing space was to be had that provided the right location as well as the design layout, flexibility, and growth potential we needed,” says partner Howard Stahl. So, after assessing several other sites that offered an equity investment, the law firm ventured into what many consider dangerous waters: It purchased a ground lease of land at 1330 Connecticut Ave., N.W., and built a building on the spot. While focusing on its plans for the new building, Steptoe did not lose sight of its existing obligations at 1250 Connecticut Ave. At the time, the firm’s lease had seven years to run. The firm, however, had a right of first refusal if the owner decided to sell the building. When the owner located a third-party buyer and asked the firm to waive the right, Steptoe instead exercised it and assigned the purchase contract to JMB. In exchange, JMB agreed to allow Steptoe to terminate its existing lease as soon as it was ready to move into the new building. Although the firm used seller-prepared plans for the shell of the building, construction and design involved numerous partners and associates. Separate committees handled construction and layout, décor, and relocation. The firm eventually began to move into its new building in December 1984. The interior style was traditional, with wide corridors; walls in soft blues, browns, and greens; and generous amounts of crown molding throughout. The move was completed in early 1985. At that time, the building had more room than Steptoe needed, so the firm leased three half-floors to tenants on a schedule of lease expirations that allowed the firm to take back space as it grew. The firm has gradually taken over almost all of the leased space and now occupies all but the third floor, a small area on the second floor, and the retail space on the first floor. With changes in the tax laws in 1986, new rules about passive losses meant that it made less economic sense for law firms to own their buildings. Added to that, the real estate market was extremely hot, so the firm decided it was time to try to sell the building. Steptoe located a buyer willing to pay an aggressive price for the property in exchange for a 20-year lease with two five-year options to renew. The sale closed in August 1988. By 1989, real estate values in the area had fallen precipitously, and many office buildings had high vacancy rates. Steptoe started to rethink its options. In 1998, the firm began to evaluate whether to remain in the building at the end of its initial 20-year lease or to relocate. In 2000, before the firm had made a final decision, the owner of the building, a pension fund located in Florida, which had by then also acquired the fee interest in the land, put both up for sale. A number of potential buyers were interested, but only if Steptoe promised immediately either to renew its lease or to vacate the building at the initial term ending of the lease. Since the lease did not require Steptoe to make any decision until the end of 2006, Steptoe decided to wait. No buyer came forward. After months of negotiations headed by Stahl, Steptoe agreed to buy the building and fee interest in the land for a price that was about 90 percent of what it received for the building and ground lease in 1988. Besides the obvious profits, why did Steptoe decide to get back into the real estate market? There were several reasons. While recognizing that it is generally not a good idea for law firms to venture outside the practice of law, Steptoe saw a chance to control some big costs. Although Steptoe’s lease renewal rights were on favorable terms, the firm anticipated that its rent might jump during the remaining term of the lease and any renewal periods, since rental rates were rising all over the area. Moreover, since the firm had grown considerably by 2000, it would occupy most of the building itself, so there was little risk of empty space. Because of the extremely competitive purchase price the firm had negotiated with the seller, Steptoe could fix its rent high enough to cover the debt on the building, but well below current market rates. The firm borrowed 100 percent of the purchase price of the building, mainly on a nonrecourse basis, keeping the personal liability of partners at a minimum while substantially reducing firm overhead. Finally, because tax laws had changed by 2000, the issues in a law partnership owning its own building — substantial problems when the firm first bought the building — had disappeared. By 2003, the Washington metropolitan real estate market had heated up considerably. According to published reports, one building at 2300 N St., N.W., sold for more than $408 per square foot, while 1399 New York Ave., N.W., sold for $505 per square foot. A number of partners had not been in favor of getting back into the real estate market, and those concerns grew after the tragic events of Sept. 11, 2001. In addition to concerns about a law firm venturing into the business of real estate ownership, Sept. 11 created additional anxiety about what would happen to Washington property prices if another attack occurred here. As a result, the firm decided to test the waters and see if it could locate a buyer that would pay a price high enough to justify selling, but would also agree to keep the rent at below-market rates. The brokerage company of Cassidy & Pinkard, in affiliation with Susan Carras, was engaged to try to sell the property. A number of offers were received, but the best one was from Boston Properties. That offer not only satisfied Steptoe’s price and rent criteria, but also provided some incidental benefits: Boston Properties, rather than selling after a few years, is known typically to hold on to properties on a long-term basis, providing ownership continuity, and is also generally known to provide first-rate management of its office buildings. Negotiations continued from the summer of 2003 until January 2004, when a definitive sale agreement was at last signed for a price of $86,606,000. In addition, the lease with Steptoe assumed by Boston Properties as part of the transaction keeps the rent at well below market rates throughout the term. One of the components of the sale was that the buyer had to assume Steptoe’s existing deed of trust on the building since this was subject to strict prepayment restrictions. The loan assumption process was finally completed at the end of March and the building sale closed — for the second time — on April 1, 2004. The transaction also includes allowances to be used for tenant improvements as well as certain capital improvements in the building. The firm intends to use its tenant improvement allowance to fund a general rehab of its space as well as creating new offices and redesigning the layout. Boston Properties plans, among other things, to replace the air-conditioning units in the building. All this work is currently being planned and is expected to be completed over the next two years. The net result is that the firm has sold its building for a significant profit on two separate occasions and has ensured that its rent for a modernized building and renovated space are fixed for 14 years at a price considerably below market rates. Moreover, the firm has shifted the risk of real estate ownership to a professional and diversified real estate company. When asked if the firm ever expected to be a repeat owner of the same building, Chairman Roger Warin responds, “No, but some partners in the firm keep in close touch with what is going on in the local real estate market, and just as we try to anticipate how external factors will help or harm our clients, we do the same thing with the firm’s assets.” Caroline Gaudet is a partner in the transactions group of the D.C. office of Steptoe & Johnson LLP, where she handles commercial real estate and general commercial transactions. Robert E. Jordan III is a partner in the litigation group of Steptoe & Johnson and was heavily involved in the original construction of the building.

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