Capital gains

The bargains to be found in the London property market are enticing US firms. By Steve Johns

Given the current state of the UK economy and the large number of redundancies that have plagued the City of London during the past 18 months, it may seem odd that so many US law firms are seeking new office space.

The fact is that with so many owners and developers of commercial property in London facing the fact that there are few major outstanding requirements for their brand new grade-A currently empty offices, US law firms are a rare shining light of opportunity. It could be argued that US law firms are acting recklessly in the face of poor economic prospects, but these businesses are actually taking advantage of the opportunity to secure prestigious surroundings at discounted prices.

In recent years, law firms have been some of the commercial property market’s most important clients, with relatively deep pockets and requirements for large amounts of office space. Circa 2000, during the height of the economic boom and when merger and acquisition activity was at its zenith, the legal profession evolved at breathtaking speed. US law firms were at the forefront of this expansion, with Europe targeted as a prime opportunity. There are now around 90 US law firms with offices in the UK, according to the US Chamber of Commerce, with the vast majority of these based in London.

At the peak of their expansion, helped by swelling work rates, US firms had little option but to pay top dollar for their office space and were forced to accept UK lease structures that were traditionally less flexible than those in the US, with terms of around 15-20 years.

Altheimer & Gray, Covington & Burling, Davis Polk & Wardwell, McDermott Will & Emery and many other US firms all took space when the market was high, with prime rents reaching between £65 to £70 per sq ft in 2000-01. For those seeking prestigious addresses and a large range of services, the high-profile Tower 42 and CityPoint were an irresistible pull. But times change and prime rents now stand at £45 to £47.50 per sq ft, signalling a significant discount.

These cost savings are an attractive proposition for any firm when billings and profitability might be under pressure, and many developers are offering very attractive sweeteners to lure law firms in terms of rent-free periods, capital contributions and fit-outs. New York’s White & Case, for example, leased 97,000sq ft in June this year with what is believed to have been a four-year rent-free period at the City’s Lion Plaza. The landlord, who was also generous on the fit-out, now has the benefit of a 20-year lease.

Conscious of factors such as overheads per fee-earner, US firms are now taking advantage of this buyers’ market and are either capitalising on forthcoming breaks in their leases or taking on additional space at reduced costs.

Mergers of some law firms, or plain old organic growth, has also led to requirements as firms aim to house staff in a single building – Sidley Austin Brown & Wood and Latham & Watkins, among others, all have significant active requirements.

The relatively poor economy has also led to the contraction of the banking sector, which in turn has affected the legal business. Although there has been a large amount of space put on to the market by the banking sector, this has tended towards larger floorplates.

The trend for many years has been towards large open-plan offices and developers have been falling over themselves to provide vast and ever-increasing floorplates. Such ‘trading floors’, while perfect for the banking sector, are not always ideal for law firms. For reasons of confidentiality, partners usually require their own office with open plan space set aside for support staff. There is even less sharing of offices among US lawyers compared to UK lawyers.

However, with modern office design and spaceplanning, large floorplates can work for lawyers, although generally deep floorplates are less favoured. Cellular space is the space of choice for US law firms with proximity to windows.

Although many US firms are clearly looking for a prestigious address to announce their big plans for London and Europe, most remain conscious to marry optimistic growth predictions with hard economics. A small but not insignificant number have located to Canary Wharf to capitalise on the deals available there.

A common strategy of many banks in the past had been to take leases on more space than they immediately require, to allow growth, and then to sublet it if the need for that extra space never transpired. With the change in the economy, banks are now vying with landlords to offload excess space in a poor market. There are therefore some great opportunities to take footage from these reluctant landlords. There are also openings available from other law firms which have previously fitted out their space and are now disposing of it, including a number of first-generation US law firms which have returned home.

Law firms today have the opportunity to negotiate options for expansion that do not tie them to excessively costly space. This is generally a better route to enabling long-term expansion without short-term outlay.

In general, US firms are in a very strong position in the London property market. They are one of only a small number of tenant types who are active and they are considered a strong covenant with landlords keen to secure a ‘transatlantic name’ for their buildings.

It is certainly a buyers’ market at the moment, but there is a question mark about how long this will last. There are already signs of recovery in some of the key sectors in the US and this is beginning to have an impact on the take-up of office space in important markets such as New York and California. And it is almost always the case that an improvement in market conditions in the US hits London first out of the rest of Europe and many of the large banks in London which have been trying to sub-let space are quietly taking some of it off the market. The tide is turning. Law firms will want to capitalise on the deals that are still available in the market.

Steve Johns is a partner and head of the City agency at Cushman & Wakefield Healey & Baker