City firms scramble to offload office space as market drops

City law firms moving to new premises are facing the uncomfortable reality of paying above-market rents on new office buildings while struggling to sublet existing premises.

The worst hit will be firms such as Reed Smith, which signed up for 155,000sq ft in Broadgate Tower in January this year, when prices were considerably higher than they are now. The firm is due to move into the building at the beginning of next year, but has yet to find a tenant for one of its ­existing buildings, Beaufort House in EC2.

With the property market worsening considerably in the past few weeks, Richard Norton, a director at property agent Jones Lang LaSalle, warned that, for the forseeable future at least, the climate for signing new leases in the City is ­likely to be tough.

“It’s pretty grim,” he said. “The hardest thing is that, even if the opportunity to move is there, funding the cost of the move and the fit is impossible.”

Reed Smith currently leases 86,000sq ft in ­Beaufort House and is tied into a lease until 2014. ­Market sources claimed that the firm was paying between £40 and £45 per sq ft for the space – although the firm said the rate is “significantly below” that figure – meaning it pays an annual rent in the region of £3m.

The firm has been able to sublet its other existing building, Minerva House on London’s South Bank, a 39,000sq ft space with a lease running until 2016; but once it moves into Broadgate Tower its rental costs will increase significantly. The firm has signed up for around 155,000 sq ft of space at between £56 and £62 per sq ft – the equivalent of an annual rent of around £9m. As the firm signed a pre-let agreement ;with ;the ­property’s developer British Land it will have been able to negotiate a rent-free period of at least a year on its 15.5-year lease.

Reed Smith partner Tim Foster, who is overseeing the move, argued that the £56-£62 per sq ft figure was “significantly incorrect”, adding: “Taking all lease terms into account, we think we have a good deal.”

Other firms preparing to move in the coming months are Addleshaw Goddard and Mayer Brown, with the former consolidating its dual-office operation into one site in London’s Milton Gate, while the latter is preparing to move into 201 Bishopsgate.

Both signed their property deals when the market was much stronger – Mayer Brown at the end of last year, Addleshaws at the beginning of this year – but Mayer Brown will avoid having to pay for two ­buildings at once after negotiating a deal that will see British Land take back the firm’s existing premises on Pilgrim Street.

Addleshaws managing partner Mark Jones said the firm had found tenants
to sublet its offices on ­Aldersgate Street and Noble Street, which have leases running until 2020 and 2014 respectively. Although the tenant for Noble Street has yet to sign, Jones said it would not be a major concern if the deal fell through as the firm negotiated a break clause in its lease each year from 2010 onwards.

“The only budget we ever did was on the basis that we wouldn’t sub-let it,” added Jones. “The current rent on Aldersgate Street is £3m while Noble Street is £1.4m. Last year’s profit was £64m. I’m not saying I want to keep paying that, but if I do have to, so be it.”

Addleshaws has also ­rented out a floor in its new building on a five-year lease and, having revised its growth plans, will put another floor on the market on a three-year lease.

The firm is not alone in trying to offload space, which is unsurprising given that property is the second-biggest expense a firm faces after staffing costs, with rents typically accounting for between 5 and 10 per cent of total expenditure.

Firms looking to trim those costs by renting out space include Allen & Overy, Freshfields ;Bruckhaus Deringer, Kirkland & Ellis and Shearman & Sterling.
Falling rents are failing to entice anyone to sign up for the new stock coming on to the market, with vacancy rates, which currently stand at 6 per cent (4 per cent a year ago), expected to rise to around 10 per cent by the end of next year.

With rents expected to be 10 per cent lower at the end of the year than at the start, firms looking to move could find a bargain. Yet they are still reluctant to move.

Orrick Herrington & ­Sutcliffe, one of several firms looking for new offices, has long been ­associated with a move to London’s Cheapside. But as chairman and CEO Ralph Baxter told The Lawyer last week: “We haven’t signed anything with anybody.”