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January 27, 2010 6:46 PM

In Ailing CRE Market, Law Firms Seek New Leases

Posted by Brian Baxter

With the commercial real estate market getting clobbered lately, law firms are looking for deals when it comes to signing new leases.

Following a flurry of law firm office rental news in November and December, sibling publication GlobeSt.com reported earlier this month that a thaw in credit markets was responsible for an increase in year-end lease signings.

Panelists on a real estate conference organized by Bisnow, meanwhile, expressed optimism that rental rates are rising as sublet space is taken off the market. And in another potentially good sign for the ailing CRE market, Reuters cited a recent survey, coauthored by Bingham McCutchen, which noted that distressed investors were likely to target real estate assets this year as corporate restructuring opportunities diminished.

Law firms seeking space in this environment need to keep a few important factors in mind.

"If you've got the capital to advance tenant improvements [it's a great market], because many buildings are turning into zombie buildings," says Baker & McKenzie real estate partner Michael Smith. "That means the buildings are running well but the landlords don't have the capital to improve them."

Landlords have traditionally advanced tenants funds to improve space being leased with the understanding that the money will be repaid via the rental stream, Smith says. But a landlord that is either in default or has maxed out on their lines of credit cannot make such advances. So while there may be plenty of cheap, available space out there, it's difficult for many strapped landlords to fill their buildings.

"Those buildings might be pretty, but they don't work well. So unless you want to pay for things yourself, you're in a much stronger negotiating position," Smith says. "But do I want to put $10 million into somebody else's building? Not necessarily, because there could be complications."

So why don't firms own their own buildings?

For two simple reasons, Smith says.

"Owning your own building is a great idea for tax and income purposes, but how do you deal with partners coming in and out of the firm?" Smith says. "It makes a lot of sense in the beginning, but five years down the road you've got a whole group of property owners arguing about whether or not to stay in a space. That'll just create internal conflict."

A second issue for a firm owning their own real estate: making a simple determination about how it should best allocate capital. "If your business is only generating real estate revenue, you ought to go into the real estate business," Smith adds.

For its part, Smith's firm just signed a lease to relocate its Chicago headquarters from 255,700 square feet of space at One Prudential Plaza to 237,000 square feet of space in the Blue Cross & Blue Shield Building. The firm will occupy seven floors at the 55-story office tower in the city's East Loop. The move is scheduled to take place in December 2012. (Smith declined to comment on Baker's Chicago lease.)

Indianapolis firm Barnes & Thornburg and San Francisco's Sedgwick, Detert, Moran & Arnold have also signed leases for new office space in Chicago this month. The Illinois Real Estate Journal reports that the leases for both firms are at the UBS Tower in the city's West Loop. The leases are slated to begin in 2012, with Sedgwick signing a medium-term lease for 19,346 square feet of space and B&T inking a long-term lease for 83,000 square feet.

Mark Rust, managing partner of B&T's Chicago office, told Crain's Chicago Business that having office space in the signature property was an asset in recruiting lawyers from rival firms.

Firms aren't just looking for new space in the Windy City. The New York Post reported this week that Proskauer Rose was in negotiations to take 400,000 square feet of space at 11 Times Square in New York. While the Post reported that talks are still tentative, it would be a major move for the firm, which has leased space at The Morgan Stanley Building in midtown Manhattan for the past 20 years. (Proskauer real estate cochairs David Weinberger and Ronald Sernau did not immediately respond to requests for comment.)

Also on the lookout for new leases in New York are Winston & Strawn and Dorsey & Whitney. According to reports this month by The New York Observer--owned by real estate scion Jared Kushner--Winston has hired real estate brokerage Studley to search for 250,000 square feet of space in Manhattan.

The firm currently leases 200,000 square feet of space at the iconic MetLife Building, which the Observer notes is more than double the 90,000 square feet of space Winston took when it first signed a lease there in 1995. (Winston real estate chair Corey Tessler in New York wasn't immediately available for comment.)

Dorsey on the other hand is looking to downsize in Manhattan, reports the Observer, noting the firm let go of 55 staffers last June. The Observer reports Dorsey is looking for 70,000 square feet of space, which would be a significant reduction from the 101,000 square feet it's currently leasing at 250 Park Avenue. According to the Observer, Dorsey leases about 19,000 feet of that space to another firm.

Not to be left out is Washington, D.C., where the office market is poised to pass New York as the nation's most expensive, reports The Wall Street Journal.

Troutman Sanders, which completed its merger with D.C. firm Ross, Dixon & Bell last year, added 36,000 square feet of space to its 16-year lease to accommodate its new employees. Also taking new space in the nation's capital was Sutherland Asbill & Brennan, which signed a 15-year lease for 156,676 square feet of space earlier this month.

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