After a four-year “buyers’ market” for space, securing quality space is becoming more difficult and more costly. The vast majority of business owners I speak with are hiring and expanding. Over the past 18 months, downtown vacancy decreased from 21.1 percent to 15.3 percent, a 27 percent reduction in the vacancy rate. Meanwhile, rents have increased across all classes of buildings. Year-to-date, average asking rents in the Financial District are up 8.24 percent, to $29.67 per square foot, per year. Annualized, this represents a 17 percent increase in rental rates.
In addition, there are approximately 300,000 square feet of leases pending that could reduce vacancy to just over 14 percent in the Central Business District. For the first time in a long time, tenants may find themselves competing with other prospective tenants for Class A spaces, as landlords are now receiving multiple offers. View spaces are in extremely short supply. In light of the tightening market, savvy law firms should accelerate leasing decisions and formulate a strategy and project plan with a real estate adviser 12-18 months before their lease expiration.
Real estate decisions fundamentally impact the most significant components of business:
- Employee recruitment and retention
- Firm image and culture
Even those firms that do not want to move must plan in advance because the key to securing the best deal from your existing landlord is to create the credible threat of your relocation. If a tenant does not have agreement on the terms of a new deal in writing with at least six months to go on their lease, the landlord will have the upper hand in negotiations — costing the tenant dearly.
By historical standards, rents are still low, and the leasing market is generally tenant-favorable. However, tenants should be forewarned that the window of opportunity is closing quickly. Looking back at past cycles, you will note that rent spikes tend to be more acute than most anticipate. Rents could increase by 20 percent annually in 2006 and 2007, while leasing concessions like “free rent” may disappear and tenant improvement contributions from landlords diminish considerably. The sooner you can make a new deal, the better the deal will be.
Here are some tips for making the most profitable leasing decisions:
UNDERSTAND YOUR LOCAL REAL ESTATE MARKET
Real estate is a local market business. Regardless of national or regional economic conditions and forecasts, local real estate submarkets have a unique supply-and-demand picture that will in large part determine the general economic terms of the lease transaction.
Understand the supply-and-demand characteristics for the size, quality and location of office space that you desire. For example, while there may in fact be six million square feet available in the Central Business District, if your requirements call for a five-year lease of 10,000-12,000 square feet in a Class A building north of Market Street, then today you may find less than a dozen buildings with attractive options.
Many firms make the mistake of relying on general market reports they receive periodically from commercial brokerage firms. These reports can provide a general sense of market conditions and trends, but may not apply to a firm’s unique needs.
TIME IS OF THE ESSENCE
The single most costly mistake made by lawyers and law firms is underestimating the time required to relocate, or waiting too long to finalize and document an agreement with an existing landlord to remain in their current office space. Savvy law firms develop a strategic real estate plan 12-18 months prior to their lease expiration or any option notice dates.
Many law firms mistakenly decide to stay in place without comparing their current premises with alternatives available out in the market. It is critical to understand that a decision to stay or move should not actually be made until there’s a complete understanding of the opportunities available in the market. To maximize real estate’s contribution to your firm’s success, you must view staying in your current space as just another option that should be driven to compete with all viable alternatives.
LEVEL THE PLAYING FIELD
Whether you are predisposed to staying in your current office space or eager to relocate to a new space, you should work with a professional real estate adviser to level the playing field between you and the landlords or agents you will face in negotiations.
If you choose to negotiate without an adviser on your side, then you will be at a severe disadvantage when facing landlords and their agents in negotiations. As attorneys, you and your partners are focused on growing or maintaining your law practice to maximize profit. Landlords are no different, except their core business is real estate. Landlords and their agents are in business to maximize the value of their buildings. They achieve this by securing the highest rent possible, minimizing their capital contributions toward tenant leasehold improvements, and writing lease language that is as restrictive, inflexible and landlord-favorable as possible.
When you stop to think about it, the deck is really stacked against you as a tenant. Landlords and their agents are real estate professionals who are negotiating real estate deals all day, every day. They have access to real-time insider information that a tenant simply does not have.
Without a professional adviser on your side, you cannot have access to any of these specialized resources or insider information. Your last real estate negotiation was probably five years ago or more, but your landlord and his agent negotiated five deals last month.
None of the above is intended to question your negotiating skills or business acumen. The bottom line is that your real estate occupancy costs will likely be your firm’s second largest expense after salaries. You would be prudent to avail yourself of professional advisory services.
WHO WORKS FOR WHOM?
Before commencing any discussion with a landlord or their agents, it is imperative that you understand who, if anyone, is looking out for your firm’s best interests. A tenant adviser is a person who helps prospective tenants or buyers locate suitable commercial property. A tenant adviser can provide you with sound analysis of real estate market conditions, inform you about space availability and negotiate business and economic lease terms with a landlord or their agents.
Before you commit to renting a property, make sure that you have a tenant adviser representing your interests. Landlords also hire brokers, but they serve as the landlord’s advocate and are obligated to look after the landlord’s best interests. Regardless of how friendly or helpful they may seem, never forget that they are working for the owner to maximize the value of the building.
Although a building owner also pays a tenant broker’s fee, tenant advisers don’t work as exclusive leasing agents for one property or one landlord.
A tenant adviser will be able to give you objective advice, since commission is not directly tied to a particular property. In addition, working with a tenant adviser lets a landlord know you’re seriously looking at multiple leasing opportunities. This will make a landlord more competitive and willing to negotiate favorable lease terms.
COMPARE TENANT ADVISERS
Even a tenant who remains in contact with a broker he has used in the past should talk with several tenant advisers before deciding to go with the same agent time after time. Just as in your profession, there is a wide spectrum of competency, professionalism and effectiveness among real estate brokers. More often than not, tenants who take the time to compare and contrast several advisers find that the broker they’ve used in the past may not be the best adviser now that their business has grown and matured.
THE BOTTOM LINE
In today’s market, law firms that attempt to deal directly with their landlord fail to take full advantage of an unprecedented opportunity to reduce costs and increase profitability. (It’s like going to court without an attorney.) Engaging a competent real estate professional is the only way to ensure that a lease renewal or renegotiation reflects current market conditions. Research and experience indicates that professionally represented law firms negotiate leases that are 15-20 percent lower in total, effective cost (including commissions) than firms who are not represented.
Your firm’s office lease can be a competitive advantage or disadvantage. In light of market conditions, all firms should assess their unique situation to consider how they may be able to take advantage of this still tenant-favorable leasing market in order to: improve cash flow and profitability; increase operational flexibility to expand or contract; and enhance recruitment, productivity and retention of key attorneys.
John Giordani is a tenant adviser with the CAC Group in San Francisco. He can be reached at (415) 291-4918 or [email protected].
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