Guest post by Nick Suarez, Parker Webb and Scott Bluhm, Newmark Grubb Zimmer
Law firms, which have historically been among the least efficient office-space users, have begun taking a closer look at their real estate strategies during the past couple years to reduce occupancy costs and respond to disruptions in the legal industry.
There are three factors leading law firms to reevaluate their space needs: law firm revenues have disproportionately favored multi-national firms, occupancy costs are the largest law firm expense after lawyer compensation and rental rates have been on the rise since the third quarter of 2012.
Since the Great Recession of 2008-2012, law firm revenues have been slow to recover. In 2015, large multinational firms are expected to see near pre-recession revenue increases; however, small, community firms are expecting low to no increases in revenue.
According to the 2015 Client Advisory white paper co-authored by Citi Private Bank and Hildebrandt Consulting, The American Law 50 saw 2.4 percent demand growth in 2014, the Am Law 51-100 saw 1.1 percent demand growth and the Am Law 101-200 firms saw 0.5 percent, while firms outside the American Law 200 saw a decrease in demand.
This shows that demand growth has disproportionately favored large, multinational law firms since the recession. It is interesting to compare increases in demand growth with increases in office rental rates nationally as the average office rental rate increased 4.3 percent between the first quarter of 2014 and first quarter of 2015. This shows the potential for an ever-widening gap between law firm demand growth and rental rate increases.
According to the 2015 Client Advisory, occupancy expenses are the largest expense after lawyer compensation. Firms typically dedicate 8 percent of their budget toward their occupancy costs, and that number is even higher for large firms. In response, many firms have reduced office sizes for all partners and associates across the firm. According to HNTB, firms nationally are migrating from upwards of 900 total square feet per attorney to as efficient as 550 total square feet per attorney with an average between 650 to 750 total square feet per attorney. This figure would include not just the attorney’s private offices, but is also a ratio of the total square footage per firm divided by the number of attorneys within that firm. Additionally, individual attorney offices are shrinking and standardizing nationally to about 200 square feet for partners and 120 square feet for associates.
Firms are also eliminating space by decreasing the ratio of support staff per attorney. According to Wes Crosby with HNTB Architecture, who has nearly 20 years of experience in designing law firm office space, we are seeing attorney-to-legal-assistant ratios on average of 5:1 with ratios as high as 9:1 nationally. Many firms are also relocating administrative offices to other markets where rental space and labor is cheaper. This has been a common trend in the Kansas City market as our low occupancy costs and low costs of labor have attracted many firms for their back-office locations.
Technology has also been a big driver in eliminating unnecessary space. Document and file storage areas are being reduced as many firms transition to digital files. Additionally, digital archives have replaced law libraries, freeing up the space they had previously occupied. However, technology is a significant expense for firms and we expect this expense to rise throughout 2015.
Kansas City firms are fortunate to be located in a market with very competitive rental rates compared to other regional and national metropolitan areas, though the Kansas City market is tightening. In Kansas City, we have seen our sixth consecutive quarter of increasing asking rental rates, with average asking rental rates reaching $17.72 per square foot per year in the first quarter of 2015 across the Kansas City metropolitan area.
Average Class A, B, and C rental rates are at $20.14, $16.86 and $14.12 per square foot respectively. This compares to average asking rental rates of $26.91 in Chicago, $18.33 in Saint Louis, and $23.50 per square foot in Denver. In Kansas City, vacancy rates have decreased from 15.28 percent to 14.43 percent over the past year, and the first quarter of 2015 saw positive absorption of 153,308 square feet, further illustrating the tightening office market across the metro.
An important transaction to note is Littler Mendelson PC’s decision to move its global service center from San Francisco to Kansas City. Littler Mendelson PC will bring 275 jobs occupying 45,000 square feet at 2301 McGee Street in Kansas City. This follows Sedgwick LLP’s announcement in February of 2014 to bring 100 employees to the same building at 2301 McGee, and is consistent with the trend of large law firms relocating back-office staff to markets with lower occupancy costs and labor costs.
While law firms have historically been among the least efficient office space users, they are also positioned to benefit the most from the current office space reduction trends. As firms continue to closely monitor their financial bottom line, becoming more efficient with their office space practices will help to reduce unnecessary overhead. Law firms will be able to invest the savings from occupancy cost reductions in new technology and talent. According to the 2015 Client Advisory, many firms are reporting a short supply of mid-level associates. Law firms who take advantage of creative solutions to their occupancy expenses will be able to better compete for the diminishing pool of talent and position themselves for success.
Nick Suarez, Parker Webb and Scott Bluhm are commercial real estate brokers with Newmark Grubb Zimmer in Kansas City. They have significant experience and knowledge with law firm tenant representation.