CREJ - Office Properties Quarterly - March 2016
Even with record revenue of $81 billion and annual growth of 4.5 percent, AmLaw 100 firms still face considerable economic challenges. Fee compression and a weaker demand for services are forcing law firms to seek efficiencies. To offset these challenges, a main area of focus is on what is typically the second-biggest expense item on a firm’s financials – real estate. Denver area law firms are pushing to become more efficient and considering alternative workplace solutions to reduce occupancy costs and create environments that help attract and retain top talent. This objective is complicated by a real estate market where there is declining vacancy and competition for the most desirable office space. Denver’s strong economy has caused vacancies to fall and rents in trophy buildings to rise 2½ times faster than the overall market average. Maintaining high profitability in the face of this environment demands a sharp focus and effective strategies to counter record high rental rates. Following are some of the biggest challenges a firm will face and some opportunities to address them. Challenges The market is tight. Demand from multiple industries continues to absorb available office space. In the past year, Liberty Global, WeWork, Prologis, DaVita and Transamerica all signed leases in the central business district, representing absorption of more than 700,000 square feet. Even with the downturn in oil and gas, we have seen tenant growth and demand for new construction and existing Class A space. Owners are raising rates. Denver has experienced a flurry of capital markets activity. A new wave of institutional investors paid record prices for properties. Many of these investors followed their purchase with capital improvements, including lobby renovation, common conference rooms, athletic facilities and cyber-lounges. The cost of these activities required owners to raise rents and sometimes reduce concessions. These groups are bullish on Denver, but seeking immediate returns in the form of higher rent. It’s more expensive to build out space. Construction and labor expenditures continue to rise, driving up the cost of space build-outs. Space that previously could be constructed for $50 per sf is now closer to $75 per sf with similar inflation occurring everywhere along the spectrum. Also firms are incorporating more collaborative space and technology, which contributes to higher construction costs. Opportunities New construction in the pipeline. A measure of relief greets tenants in the form of new construction. Within the next 10 quarters, seven CBD projects will add nearly 1.9 million sf of space to the market. Since space under construction is growing faster than preleasing, this bodes well both for law firms and other occupiers. As supply increases, there will be vacancy created throughout the market. Unless tenants absorb space faster than the projected deliveries, there will be an increase in vacancy and corresponding downward pressure on rental rates. Explore subleasing. Sublease dispositions create opportunity for users. Right now, energy-sector companies are responsible for 52 percent of CBD sublease space. Many of these subleases contain high-end build-out, long remaining lease terms and are held by a master lessor that is still creditworthy. Law firms typically use similar space and can take advantage of exceptional plug-and-play options. Consider alternative space solutions. The legal industry is resistant to dramatic change. However, more firms are considering alternative workplace solutions. This includes progressive areas, incorporation of open space, uniform office sizes and greater use of technology throughout. These options are especially attractive as firms adjust to work trends and the preferences of the millennial generation. Many of these solutions provide opportunities to reduce the overall footprint and save money on rent. But, more often, they are an investment in the workplace that contributes toward better work efficiency and productivity. Look outside the CBD. With leasing costs rising across core urban areas, some law firms are considering relocating outside of the CBD. When taking parking into consideration, there is an opportunity to reduce occupancy costs by 30 to 50 percent in some suburban markets. There also are a number of projects in the suburbs that are incorporating elements of “new urbanism” where individuals can live, work and play. This will attract some CBD office tenants and law firms trying to differentiate their work environment.