Law firms have historically been one of the largest consumers of office space in the City of Philadelphia. In fact, almost every trophy building constructed in the late 1980s and early 1990s included one or more large law firms as an anchor tenant. If you wanted to fill up your building in Center City, there was a good chance you needed some law firm tenants. Even today, law firms constitute a significant portion of the down town market. The top 20 law firms alone account for more than 15% of the Class A market. The problem is this industry is consuming less and less space.
In the past 24 months alone, Ballard Spahr, Reed Smith and Drinker Biddle have given back over 150,000sf collectively (including shrinkage after their move in the case of Reed Smith). And more is on the way. The fact is that law firms are consuming less space per attorney and many firms have fewer attorneys and staff than they did when they signed their leases 10 years ago. Whereas law firms in the 1990s aspired to a high leverage structure with 2-3 associates per partner, today many are at 1:1 or even less. The layoffs and smaller hiring classes that resulted after the Recession of 2008 appear to be permanent paradigm shifts as opposed to temporary conditions. Likewise, law firms have dramatically cut down on their staff to attorney ratios. In the 1990s, it was not uncommon for this ratio to range between 1-2 attorneys per secretary, today many firms are at 3 and 4 to 1. The reduction in attorneys and staff, combined with shrinkage in the size of individual offices and work stations means firms need less space. A recent law firm survey released by Wells Fargo identifies reduction in office space as a major objective of many Philadelphia firms in the coming years.
Unfortunately, leases are relatively long term commitments. Companies and law firms are forced to make long term projections about their future space needs. If they guess wrong, it can be years before they can correct their mistakes. While changes in space utilization have historically happened gradually, that was not the case in 2008. The Great Recession and the resultant paradigm shift in law firm businesses has left many firms with more space than they need today and are likely to need in the future.
Up until the 2008, it was fairly easy to plan out law firm space. Typically in Philadelphia, all attorneys had windowed offices. Associates got two windows (typically 5 feet per window for a width of 10 feet) and partners got three windows (15 feet). The depths of the offices were between 12 and 15 feet and were ultimately dictated by the core depth of the building (the distance from the window line and the interior core of the building where the elevators, restrooms and mechanical rooms are). Law firms took enough space to ensure all of their attorneys got their windowed offices and then they figured out what to do with the interior space. The problem is that many of their traditional uses for interior space have shrunk or disappeared. Firms now need less space for secretaries and administrators, paper file storage, libraries etc. Today, buildings with large, square floor plates that have lots of interior space are not ideally suited for law firms; thinner, rectangular floor plates with a higher ratio of perimeter glass to interior space are favored. Because of the changing space utilization, today we are seeing many large law firms either move or shrink and restack when their leases expire.
What does this mean for the Philadelphia office market? The larger law firms will continue to shed space as their leases come up for renewal. Some buildings will become inefficient for law firms and they will move to more efficient ones. Because law firms as an industry continue to be a major occupier of space in the City, this downsizing will have an impact on the market.
The good news for landlords is that this shrinkage will be gradual as the larger leases are staggered over periods of years. Nevertheless, landlords can no longer count on the region’s large law firms to grow in the future and lease up more and more of their inventory. With an 18% decrease in law school applications over the past two years, it appears that law as an industry will not continue to grow at the historic levels we saw in the 1980s through 2007. Law firms will need to get more creative in how they utilize space. Some firms are considering putting associates in interior offices; something unheard of in the past outside of high rent markets like New York City. This will enable them to take less space and more effectively utilize the interior spaces on the floor (credit derek). For smaller law firms, the shedding of space by the larger firms will create opportunities. They may be able to take over high end office space shed by the larger firms thereby reducing their initial build out or retrofit costs. In many cases, this space contains features and finishes that smaller firms would never be able to afford. For tenants generally (i.e., not just law firms), the pending space givebacks may create softness in the market and opportunities for aggressive lease deals.
When there are fundamental paradigm shifts in how a large industry consumes office space, it is important to understand how this will impact the market. Make no mistake, the legal industry has changed and law firms are changing the way they utilize space. If the last 24 months are any indication, things are going to get interesting.
For more information contact Glenn Blumenfeld