Firm foundations

Law firms in New York are moving to bigger and better premises. Dearbail Jordan asks: who's getting the most out of the situation – the firms or the developers?

Whether by luck or design, itchy-footed law firms appear to be having a field day at the expense of New York's commercial property community.

So far this year, Clifford Chance, O'Melveny & Myers and Pillsbury Winthrop have announced their intentions to pack-up and relocate to larger midtown offices.

Pillsbury is set to move into 180,000sq ft of space in the Bertelsmann Building in Times Square, while Clifford Chance, like its deal with Canary Wharf in London, has again looked to a client, this time Deutsche Bank, to provide a new 380,000sq ft home to the firm. O'Melveny, which recently merged with private equity boutique O'Sullivan, made Boston Properties very happy when it agreed to move into Times Square Tower, the building famously left empty when anchor tenant Arthur Andersen imploded last year.

On one hand, law firm relocations have probably never come at a better time for New York's commercial real estate players. With a market softer than a bowl of blancmange, New York developers and brokers are trying hard to push down worrying midtown vacancy rates.

For Class-A midtown space, real estate services group Cushman & Wakefield pegs the February vacancy rate at 10.9 per cent.

While this is slightly lower than the fourth quarter's 11.1 per cent of free midtown space – compared with the glory days of four years ago, when the amount of vacant square footage fluttered around the 7 per cent mark – things could be better.

Literally thousands of investment bank redundancies have left New York landlords smarting, and while the terrible events of 11 September may have swept displaced tenants from downtown to midtown, it is still not certain that many will stay there.

So law firms, with their counter-cyclical litigation and bankruptcy practices, are just the white knights that property businesses must be looking for.

In all three instances of law firm relocation – Clifford Chance, Pillsbury and O'Melveny – the moves have been precipitated by a merger. Cadwalader Wickersham & Taft is another potential client after it emerged that the firm might consider selling its downtown site following serious growth.

Given market conditions and the thousands upon thousands of square feet of empty office space, one might expect law firms to be snapping up property at substantially reduced rents. However, rents appear to be holding up surprisingly well. According to Cushman, the average rent in February was $53.12(£33.90), an improvement on fourth quarter figures, when midtown rates dipped below the $50 mark to $48.15(£30.75) for the first time in two years.

Reports state that Clifford Chance is paying around $50(£31.93) per sq ft, while Times Square Tower will set firms back from $59(£37.95) to $70(£44.47) per sq ft.

Nevertheless, law firms are highly desirable clients and have not missed the opportunity to generate reductions in overall cost. Landlords are undoubtedly offering more attractive concessions to law firms, which for these cost-conscious creatures means longer rent-free periods and a larger contribution to fit-out costs.

Lewis Miller, senior managing director at broker Insignia/ESG, estimates that it can cost between $150(£95.80) and $200(£127.74) per sq ft for a law firm to fit out its office. “The contribution to fit-out has increased to around $40(£25.55)-$50(£31.93) in this market, if the credit of the tenant is good,” says Miller.

Jonathan Buchman, senior director at Cushman, confirms that “rent-free periods have definitely got longer”.

Just two years ago, a tenant on a 10-year lease might be granted between three and four months of free rent. In this market, says Buchman, this could easily be extended to nine months, or even to a year, if a firm took over 100,000sq ft of space.

However, what has been most noticeable in New York's soggy real estate market is the sudden propensity for landlords to take over the existing leases of prospective legal tenants. Miller says: “Lease takeovers were much more common in the early 1980s, but since then this hasn't been so typical as market rates increased. It's a method that's not been seen for a long time.”

However, Clifford Chance seems to have clinched a corker with its 20-year lease on the Deutsche Bank Building.

Although Ira Hammerman, managing partner of Washington DC and chief operating officer at Clifford Chance, is reluctant to discuss terms since the firm has not yet signed a final lease, the New York market is awash with speculation about the deal.

According to a number of sources, Deutsche Bank has agreed to take on Clifford Chance's remaining lease at the Metropolitan Life Building on Park Avenue.

Bearing in mind that Clifford Chance wants to move next year, and the lease runs until 2009, that is one hell of a concession. O'Melveny, too, is understood to have done very nicely in its deal with Boston Properties.

As luck would have it, Boston Properties is both O'Melveny's existing landlord at the Citigroup Centre, one of two buildings the law firm currently occupies (the other is 30 Rockefeller Center), as well as at its new base. So letting its tenant out of the lease two years early to become the first dweller at Times Square Tower must have seemed like a capital idea.

Experts say this kind of generosity is not such a no-brainer, since landlords can gain back some of the costs on the empty space by including some incremental rent into the tenant's new lease.

For Deutsche Bank, getting rid of 14 floors of its 29 in the midtown area will be a relief as it prepares to unite its New York staff into one headquarters downtown.

However, for Boston Properties, the agreement with O'Melveny is much more important given the company's run of bad luck. Still raw after the collapse of anchor tenant Andersen, Boston Properties courted Pillsbury – but to no avail. Pillsbury ended up with the Bertelsmann Building.

Meanwhile, Clifford Chance, as desirable an anchor tenant as any landlord could desire, decided against Times Square Tower (apparently its second choice behind 240 Madison Avenue) in favour of the Deutsche Bank Building.

In a market where only law firms seem to be moving, no doubt Boston Properties is hoping that O'Melveny will encourage other lawyers to follow.

Ironically, it was originally hoped that Times Square, where Boston Properties has two office blocks, was initially slated to become a kind of Mecca for law firms.

Carl Weisbrod, president of the Alliance for Downtown New York, who was previously the president of the New York City Economic Development Corporation and was involved in overseeing the somewhat elongated Times Square redevelopment project, comments: “When the project was conceived in the early 1980s, one initial thought was to create something like London's Inns of Court.”

Although Dewey Ballantine was set to become the first tenant, significant delays on the project, including protracted lawsuits and the recession of the early 1990s, scuppered the law firm community idea.

However, given market conditions, perhaps this idea could be reignited now that Pillsbury and O'Melveny are moving to the area.

So far, Skadden Arps Slate Meagher & Flom is the only law firm there after becoming one of the first tenants to move into the square in 2000 when it took space in the Conde Nast Building.

O'Melveny is taking just 200,000sq ft in the 1.2m sq ft Times Square Tower, and certainly, Boston Properties admits that law firms are an attractive prospect at the moment and it would not say no to more of the same. Indeed, Boston Properties has contracted Gensler Associates, a specialist in law firm interior design, to fit-out the building, possibly as an impetus to attract potential legal tenants.

It seems, though, that law firms will expect a little bit more than a nice interior to make a developer's day.