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Law firms continued to merge in 2005, according to legal consultants Hildebrandt International. In fact, U.S. firms completed 49 mergers last year alone. Even more significantly, the average size of such mergers has steadily grown. In 2004, Hildebrandt reports, the average size of the smaller firm increased more than twofold. From the mega-mergers of DLA, Piper Rudnick and Gray Cary Ware & Freidenrich, with 3,000 attorneys, to Pillsbury Winthrop and Shaw Pittman, with 900, 2005′s rapid pace of mergers shows no signs of abating this year. Earlier this month, for example, Bingham McCutchen announced its merger with Swidler Berlin, bringing together nearly 1,000 attorneys nationwide. And numerous other recent examples abound. From a business standpoint, the advantages of such mergers to both the acquiring and acquired firms can’t be discounted. However, many real estate lease decisions are often overshadowed in this process and must be seriously considered to best ensure both near-term and longer-term return on investment. REMEMBER THE REAL ESTATE It’s no secret that one of a firm’s single largest expenses is its real estate, especially in prime downtown locations. In Washington, D.C., for example, such desirable space is at a premium, making it difficult for the largest firms to find suitable space on their own, let alone in a merger. The District currently has a modest overall vacancy rate of approximately 6.5 percent, making it the tightest major market in the country. In addition, 26 percent of vacant office space (approximately two million square feet) is located in submarkets not traditionally favored by high-profile law firms, including Southwest, NOMA (north of Massachusetts Avenue), and Capitol Hill. Thus, taking such considerations into account, a more relevant D.C. vacancy rate is actually closer to 5.8 percent. Lease rates for high-quality law firm space currently exceed $55 per square foot. This rate can fluctuate based on variables such as location of the building, amount of square footage leased by a firm, location of the firm within the building, timing of occupancy, and so on. This prohibitive expense, coupled with the limited availability of space in blocks of over 100,000 square feet either already on the market or under construction, can be daunting. As such, most firms with these requirements are actively in the market at least 24 months before their lease expiration date. Another complicating factor is that the District is a small building market overall, with a typical property averaging just 200,000 to 250,000 square feet. Unlike in most other major metropolitan law firm markets, D.C. property owners are simply not accustomed to accommodating larger firms requiring more than 200,000 square feet on a regular basis. From a mergers and acquisitions standpoint, therefore, the creation of ever-larger firms is forcing an increasing number of the biggest firms to identify and acquire space in multiple buildings to accommodate both their immediate and long-term needs. A noteworthy example is the merger of Wilmer, Cutler & Pickering and Hale and Dorr, whose new combined WilmerHale headquarters encompasses not just two but three contiguous buildings on Pennsylvania Avenue Northwest. It is possible that future mergers by two large firms may simply require split operations by default for an extended period until a large enough property can be secured for the entire firm. KEEP IN MIND If nothing else is clear in mergers, it’s clear that even the best tactical decisions made following the transaction are no substitute for smart, strategic growth planning in advance. Planning should incorporate three considerations… • Expansion Many large firms sign leases in new or existing vacant buildings as early as two to three years before they are scheduled to occupy them. Thus, they need to anticipate how they will accommodate any potential sudden and significant increase in space if they merge before relocating. They may need to negotiate significant expansion options at various points throughout the lease term, such as during the third, seventh, and eleventh lease years. For example, Dewey Ballantine will initially occupy approximately 50 percent of its new building at 975 F St. N.W., but has expansion options that will allow it to take control of the entire 180,000-square-foot building over the 15-year lease term. • Hold Space Another solution is to negotiate a pre-occupancy option to expand. In this scenario, the landlord holds a significant portion of space off the market until a specific date before the building is complete and open to tenants, granting the lead law firm rights to lease all or part of the “held back” space. Of course, the landlord will resist such a concession, as it dramatically hampers his ability to fully lease the building prior to delivery, but it allows the lead law firm tremendous flexibility in meeting unanticipated growth through mergers or other situations. Virtually every anchor law firm — a firm large enough to jump-start a development — is able to obtain some early expansion rights. • Termination This factor is an especially important consideration for firms anticipating that they might be likely acquisition targets. Both small and midsize firms fitting this profile should therefore be sure to negotiate termination options in their leases. In some cases, such options are tailored on a contingency basis, to be exercised only in the event of a merger or acquisition. Firms would, therefore, benefit by making these options as flexible as possible in terms of when they can terminate, whether they need a one-time option versus a rolling option, or what sort of penalties they might pay. Although usually outweighed or discounted in the context of a merger’s anticipated cost savings, many risks may remain, including the most significant: subleasing space that is left behind. No matter how tight a local office market overall, the sublease market almost always leases at a slower rate and at a significant rent discount compared to direct space. In fact, a large block of available space can take months and even years to sublease. What are the key reasons behind this market barrier? Among others, they include a limited remaining lease term or existing renovations, along with a limited ability to expand and renew. READING TEA LEAVES For the balance of 2006 and beyond, law firm mergers will continue to be a fact of life. While we can’t hope to predict who may be next, the commercial real estate market appears to be making every possible effort to respond to this accelerating trend. Given their awareness of the lack of large building options, most developers are now more routinely looking to assemble larger sites. In the District, for example, many properties that were originally underdeveloped are considering adding, or have added, additional floors to accommodate ever-larger tenants. For example, 2020 K St. N.W. added three floors and will serve as the new Bingham McCutchen address, housing 175 lawyers by the end of the year. Despite many market and lease issues that must be considered, there are numerous ways to prepare for a merger. In short, law firms need to disregard the conventional leases to which both the D.C. market and other major markets nationwide have grown accustomed. Creativity and strategic planning are paramount when it comes to negotiating a new long-term lease. With the proper balance of the two, you’ll come that much closer to accomplishing your firm’s evolving real estate goals as you grow.
Richard Lane is a principal with West, Lane & Schlager Realty Advisors Oncor International. He specializes in representing law firms in the downtown Washington, D.C., market.

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