CBRE LAW FIRM SERIES WASHINGTON, D.C.002).pdfCATALYST FOR RISING CONCESSIONS | The D.C. office...

CBRE LAW FIRM SERIESWASHINGTON, D.C.

2017-2018

REAL ESTATE TRENDS

Executive Summary

ARE WE THERE YET? | 44% of Am Law 100 firms in the District have reset their space requirement since 2013 when the current cycle of law firm densification began in full scale. Leases established pre-recession, as well as leases signed between 2008 and 2012, will likely necessitate additional rightsizing and may return up to 1.9 million sq. ft. to the market in the coming years.

CATALYST FOR RISING CONCESSIONS | The D.C. office market remains highly concessionary, especially for sought after law firm tenants. More than 60% of law firm leases (by sq. ft.) since 2013 have received a TI allowance in excess of $100 per sq. ft. With an abundance of new supply on the horizon, the competition amongst landlords is expected to intensify.

EXPANDING CITY BOUNDARIES | As law firms seek the highest quality space, they have shown willingness to trade traditional locations for new neighborhoods, the perhaps most drastic example being Fish & Richardson’s relocation from K street to the Wharf in Southwest. While we do not see this as a widespread phenomenon in the near term, it helps attest the viability of high-end development in D.C.’s emerging markets.

NEW SUPPLY ABOUNDS | 9.2 million sq. ft. of newly constructed or renovated space is slated to deliver to D.C.’s core markets in the next five years. The influx of new supply and soft market conditions may incentivize more law firm relocations to first-generation space, further escalating vacancy rates of commodity-class buildings. Net effective rents will likely remain compressed due to aggressive concessions.

MODERNIZING THE WORKPLACE | With millennials now the largest cohort in the U.S. labor force, law firms need to build flexibility into their space to enable a more socially connected and collaborative experience in the workplace. Firms are increasingly leveraging technology and seeking amenities that promote collaboration, health and wellness.

LAW FIRM SERIES: WASHINGTON, D.C.

2 | © 2017 CBRE, Inc. CBRE Research

Table of Contents

PAGE 4 | D.C. Law Firm Leasing Overview

PAGE 5 | Net Effective Rents

PAGE 6 | Am Law 100 Leasing—Where Are We in the Cycle?

PAGE 7 | Am Law 100 Leasing—Move versus Stay

PAGE 8 | Some Growth Drivers

PAGE 9 | M&A Activity

PAGE 10 | Workplace Strategy

PAGE 11 | Looking Forward—Supply

PAGE 12 | Looking Forward—Demand


CBRE Research © 2017 CBRE, Inc. | 3

The legal sector has always been a critical driver of D.C.’s

economic, political and real estate landscape

OVERVIEW

Law Firm Leasing

Figure 2: Law Firms’ Contribution to D.C.’s Economic and Real Estate Landscape

Figure 1: D.C. Law Firm Presence

* Including firms with a footprint of 10,000 sq. ft. or greater | ** Source: CBRE Research, Q3 2017

There are 237 law firms with a footprint of 10,000 sq. ft. or greater in the District, occupying a total of 16.2 million sq. ft., which accounts for 18% of the city’s total occupied office space and as much as 46% of the Trophy and Class A occupancy. The sector contributes on average 1.5 million sq. ft. of leasing activity annually.

The law firm industry has witnessed unprecedented paradigm shifts in recent years. A combination of market pressures and structural changes in the workplace has driven law firms to increase focus on real estate costs—the second largest capital expense after payroll compensation. Since the densification trend began in the sector in 2013, law firms in D.C. have returned more than 2 million sq. ft. of vacant space to the market, which has had a material impact on the market’s overall supply and demand metrics.

Employment

5%

Gross Regional Product

11%

Space Occupancy

18%

Trophy & Class A Occupancy

46%

Figure 3: Legal Sector Leasing Velocity by Year (MSF)

* Including leases 10,000 sq. ft. or greater | ** Source: CBRE Research, Q3 2017

Average1.48 MSF

680,000 SF

YTD 2017201620152014201320122011201020092008

923,000 SF

1.58 MSF

2.41 MSF

1.22 MSF

2.03 MSF2.10 MSF

1.73 MSF

918,000 SF

1.22 MSF

0.0

0.5

1.0

1.5

2.0

2.5

3.0

94 Firms | 11.6 MSF

Am Law 100

Avg. Firm Size124,000 SF

64 Firms | 2.4 MSF

Am Law 101-200


79 Firms | 2.2 MSF

Other*


Aggregate: 237 Firms | 16.2 MSF | 70,000 SF Avg. Firm Size



* Including firms with a footprint of 10,000 sq. ft. or greater | ** Source: CBRE Research, Q3 2017

Reflective of the overall lack of demand growth, net effective rents* (NER) in the legal sector have remained largely flat in recent years, with an average annual growth rate of merely 0.2% since 2008. The average NER currently sits at $69.09 per sq. ft. per annum on a full service basis.

NER & PRELEASES

Net Effective Rents

NER$69.09

Base Rent$70.05

TIA$95.92

* Based on direct leases 10,000 sq. ft. or greater signed YTD 2017* All rent values are per sq. ft. per annum on a full service basis |** Source: CBRE Research, Q3

NER & CONCESSIONS

The fluctuation in average annual NERs is mostly driven by the amount of preleasing activity in a given year, whereby more preleases would yield a higher average NER, as new construction projects tend to command premium rents.

The five years with the lowest NER (2009-2011, 2013-2014), which averaged $63.84, also recorded the least amount of preleasing activity (8.9% of total leasing volume). The other five years (2008, 2012, 2015-YTD 2017) averaged $69.69 in NER and 45.0% in the share of preleases.

Average base rents have risen at an annual rate of 0.9% since 2008. However, highly concessionary market conditions—especially for much sought after law firm tenants—drove NER growth rates down.

Average tenant improvement allowances (TIA) received by law firm tenants have grown 32% since 2008, from $65.44 per sq. ft. in 2008 to $95.92 YTD 2017. TIAs above $100 have become a common occurrence, seen in more than 60% of the total space leased by law firms.

0%

50%

100%

2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD 2017

TIA $100 or higher TIA below $100

Figure 5: Share of TIAs $100 or Higher by Year (by SF)

* Based on direct leases 10,000 sq. ft. or greater | ** Source: CBRE Research, Q3 2017

Figure 6: Law Firm Net Effective Rents (NER)

* Net effective rents (NER) are calculated using base rents escalated by escalations and bumps, and discounted by tenant improvement allowances and abatements. NNN leases are grossed up to full service based on a scale determined by the asset class. NERs are not discounted as net present values. | ** Source: CBRE Research, Q3 2017

0%

10%

20%

30%

40%

50%

60%

70%

$35

$40

$45

$50

$55

$60

$65

$70

$75

2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD 2017

Average NER Average Base Rent % of Prelease in Total Space Leased(L) (L) (R)

* Based on direct leases 10,000 sq. ft. or greater

Figure 4: Fundamental Stats



ARE WE THERE YET?

Where Are We in the Cycle?Am Law 100 Leasing

While 75 of the 94 (80%) Am Law 100 firms in the District have signed their most recent lease since 2008, some of the earlier leases did not involve a full reprogramming of the workspace. Only 41 firms (44%) have reset their space requirement since 2013 when the current cycle of law firm densification began in full scale. Leases established pre-recession, as well as leases signed between 2008 and 2012, will likely necessitate additional rightsizing in the coming years. These firms occupy 7.4 million sq. ft. in their current footprint, which at a hypothetical contraction rate of 25%, could return up to 1.9 million sq. ft. to the market.

A MORE COMPETITIVE LANDSCAPE

In a recent survey of top U.S. law firms conducted by Altman Weil, law firm partners and chairs saw more price competition and increased focus on efficiency as the two most prevalent trends. The decline in service demand and intensifying price competition point to a continued need to control operating expenses and increase operational efficiency, which will likely translate into further contractionary activity by the sector in the near future.

Figure 7: Am Law 100 Leases Pre- and Post-Recession

A TRUMP BUMP?

Changes in federal policy could spur demand drivers for the legal sector in D.C., partially mitigating some of the above-mentioned headwinds. These could include trade agreement renegotiations, tax code changes, new regulatory regimes, all of which require more legal work within various industries. One-party control in Washington has historically yielded an increase in the number of bills passed into law, with a positive impact on legal work demand. However, it remains to be seen whether the White House and Congress will unite around a policy agenda.

Trend Share of Supporting Survey Results (%)

More price competition 95.4

Improved practice efficiency 94.3

Fewer support staff 88.8

Technology replacing human resources 84.4

More commoditized legal work 84.2

Figure 8: Top Legal Market Trends - 2017

* Source: Altman Weil, Law Firms in Transition 2017

* Source: CBRE Research, Q3 2017

By Numberof Firms

20%

44%

36%

Current lease signed since 2013Current lease signed between 2008 and 2013

Current lease signed pre-recession



CATALYST FOR DEVELOPMENT ACTIVITY

Am Law 100 Leasing

Move versus Stay

As Am Law 100 firms addressed their real estate needs in response to evolving market conditions post-recession, a slight majority (55%) elected to relocate, while the remaining firms chose to renew in place. Of the relocating firms, 68% opted for space in newly constructed or renovated buildings.

As law firms seek the newest and highest quality space available in the marketplace, they have been a catalyst for new development activity in the District. Since 2010, 14 out of 23 (61%) new buildings delivered in D.C.’s core submarkets have been anchored by a law firm. While there is typically a significant rent premium involved, landlord concessions are more aggressive, which offsets relocation and buildout costs.

QUALITATIVE CONSIDERATIONS OF

RELOCATION VERSUS RENEWAL IN PLACE

Relocation, especially to newly built or redeveloped projects, provides firms with access to state-of-the-art buildings and the best opportunity to reconfigure and upgrade space standards. It also establishes a workspace optimized for branding and recruiting needs. Record concessions offset the capital required on a cost basis for a new, efficient buildout.

REDEFINING CITY BOUNDARIES

In pursuit of the highest quality space available, law firms have demonstrated willingness to trade traditional locations for new and unconventional neighborhoods, as seen in the cases of Venable, Arnold & Porter and most recently Fish & Richardson. This helps expand and redefine the boundaries of the central business district in a city with limited developable land.

* Based on Am Law 100 leases signed 2008 - YTD 2017 | ** Source: CBRE Research, Q3 2017

Firm New Address New SF Previous Address Previous SF Contraction Rate Sign Date

Goodwin Procter 1900 N Street, NW 80,000 901 New York Avenue, NW 110,000 27% Q3 2017

Akin Gump Strauss Hauer & Feld

2001 K Street, NW (North Building) 189,000 1333 New Hampshire Avenue, NW 212,000 11% Q1 2017

Paul Hastings 2050 M Street, NW 97,000 875 15th Street, NW 125,000 22% Q4 2016

Fish & Richardson 1000 Maine Avenue, SW 59,000 1425 K Street, NW 64,000 8% Q4 2016

Figure 11: Recent Law Firm Preleases

Number of Firms

Average Lease Size (SF)

Aggregate Market Effect (SF)

Renewal 34 133,000 (351,000)

Relocation to First Generation Space

28 113,000 (239,000)

Relocation to Second Generation Space

13 50,500 (15,000)

Figure 9: Renewal versus Relocation Activity

Base Rent ($/SF)

Term (Years)

TIA ($/SF)Abatement (Months)

Trophy50-65 NNN77-92 FS

15 130+ 16

Redevelopment45-54 NNN72-81 FS

10-15 100-120 12

Relet Class A 59-72 FS 5-10 70-105 6-10

Figure 10: Current Pricing Guidance by Asset Class





Some Growth Drivers

While the overall impact of Am Law 100 leasing has been one of contraction, a number of firms have needed to add back space after a prior downsize to accommodate growing business needs and headcount. Since 2016, 11 Am Law 100 firms have expanded either in place or to a new location, with an aggregate growth of 143,500 sq. ft.

Firm Address Original SF SF Added Activity Type Sign Date

Murphy & McGonigle 1001 G Street, NW (West) 14,000 15,000 Relocation Q1 2017

O’Donoghue & O’Donoghue 5301 Wisconsin Avenue, NW 10,000 7,000 Relocation Q1 2017

Cohen & Gresser* 2001 Pennsylvania Avenue, NW 0 8,000 New Entry Q4 2016

Bradley Arant Boult Cummings 1615 L Street, NW 28,000 7,000 Expansion Q4 2016

Wilkinson Walsh & Eskovitz 2001 M Street, NW 16,000 16,000 Relocation Q4 2016

Munger Tolles & Olson* 1155 F Street, NW 0 11,000 New Entry Q4 2016

Figure 14: Recent Expansions from outside of Am Law 100

* Sublease | ** Source: CBRE Research, Q3 2017

Figure 13: Law Firm Net Absorption Since 2010 (SF, 000’s)

(537)

129

(600)

(400)

(200)

0

200

* Triggered by the signing of a lease | * Does not include net absorption from M&A, dissolutions, termination options, etc. | ** Source: CBRE Research, Q3 2017

Am Law 100 Non Am Law 100

AM LAW 100

OUTSIDE AM LAW 100

Small- to medium-sized firms outside the Am Law 100 rankings—some of which are recent arrivals to D.C.—have been a source of growth in the office market, having generated 129,000 sq. ft. of positive absorption since 2010. In comparison, Am Law 100 firms have shed 537,000 sq. ft. during the same period.

Firm Address Original SF SF Added Activity Type Sign Date

Kirkland & Ellis 1301 Pennsylvania Avenue, NW 188,000 15,000 Future Expansion in Place Q3 2017

Cleary Gottlieb 2112 Pennsylvania Avenue, NW 115,000 11,500 Future Expansion in Place Q3 2017

Venable 600 Massachusetts Avenue, NW 245,000 20,200 Expansion in Place Q1 2017

Covington & Burling 1001 G Street, NW (West) 420,000 12,200 Additional Location Q1 2017

Boies Schiller & Flexner 1401 New York Avenue, NW 37,000 18,600 Expansion in Place Q4 2016

White & Case 700 12th Street, NW 148,000 10,100 Expansion in Place Q4 2016

Figure 12: Recent Am Law 100 Expansions




M&A ActivityIncreased competition in the legal sector has led to an uptick in M&A activity. There have been 17 mergers since 2013 that have affected the D.C. office space, returning a combined 588,000 sq. ft. to the market.

The recently announced merger between Norton Rose Fulbright and Chadbourne & Parke will create a combined force of more than 130 attorneys, likely leading to a relocation to accommodate new space requirements of the integrated firm.

SPACE PLANNING POST M&A

The real estate aspect of a merger can benefit substantially from early and thoughtful planning. Comprehensive due diligence on the operational, human capital and cash flow elements of real estate is a key driver of a merger’s ultimate success.

Figure 15: Select Law firm M&A activity with impact on the D.C. market

Norton Rose Fulbright

Arnold & PorterBlank Rome

Baker DonelsonKirkland & EllisSeyfarth Shaw

DentonsLocke Lord

Morgan Lewis & BockiusSquire Sanders

Cooley

Kaye ScholerDickstein Shapiro Ober KalerBancroft

McKenna Long & AldridgeEdwards Wildman Palmer

Bingham McCutchenPatton BoggsDow Lohnes

2016

2015

2014

2017

* Source: Altman Weil MergerLine, 2017

Fanelli Haag

Chadbourne & Parke



Workplace Strategy

With millennials now the largest cohort in the U.S. labor force, law firms need to build flexibility into their space to ensure that it is nimble enough to accommodate the need for a more socially connected and collaborative experience in the workplace.

As law firms relocate to higher efficiency space or restack while renewing in place, workspaces are redesigned not only to reduce operating expenses, but to also foster a flexible and collaborative work environment, improve talent acquisition, and enhance branding. Firms are increasingly seeking topnotch amenities that promote health and wellness. Desired amenities include rooftop terrace, modern fitness centers, bike storage as well as fast and reliable full-building Wi-Fi.

Figure 16: Workplace Trends - Key Drivers of Change

Two sized offices for attorneys - 1 for partners and 1 for associates/Internal stair to promote connectivity between floors

Standardization

Collaboration

Technology

Talent

More open-address work areas and multi-purpose social areas. Lunchrooms on windows are the “family room” of the firm: attorney lounges, gatherings, etc.

Teaming or huddle rooms with glass walls and no doors to provide visual access, engagement and collaboration

Enhanced IT support to increase mobility and facilitate connectivity with back-office functions located in less expensive markets

Enhanced technology means less paper, fewer file and case rooms, and record centers with no permanent files

Amenities that focus on employee health and wellness such as fitness centers and bike storage

Social space such as rooftop terraces and lounge areas



Looking Forward – SupplyLaw firms in Washington, D.C. will see increased relocation options in the coming years, with new supply being added to the market and second-generation space becoming available due to existing tenants moving to new construction.

In terms of existing inventory, D.C.’s current vacancy rate of 12.5% is at its highest since 1992. There are 884 available blocks greater than 10,000 sq. ft. However, as law firms increase in size, their potential options dwindle. There are currently 26 blocks of Trophy or Class A office space available greater than 50,000 sq. ft. in the core submarkets of CBD and East End, and only 10 blocks with 100,000 sq. ft. or more.

9.2 million sq. ft. of newly constructed or renovated space is slated to deliver in the CBD and East End by 2021, 6.5 million sq. ft. of which remains available as of Q2 2017. The uptick in development activity may lead to an overstocked market for the top segment, continuing the downward pressure on rents and forcing landlords to offer even more aggressive concessions. Additionally, increased efficiencies offered by new construction will enable higher space utilization, likely leading to a reduction in footprint by relocating tenants and a subsequent rise in market vacancy rates.

Figure 17: Upcoming Deliveries in the CBD and East End PreleasedAvailable in Buildings under Construction or Renovation

Available in Planned Buildings

2019 2020 20210

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2017 2018

SF (000’s)




Looking Forward – Demand67 firms with a current footprint of 25,000 sq. ft. or greater have a lease set to expire by 2025, totaling 6.4 million sq. ft. Mid-sized law firms (25,000+ sq. ft.) typically begin the process of evaluating real estate needs at least two years prior to their lease expiration, with larger firms (75,000+ sq. ft.) starting as much as four to five years in advance to avail themselves to initiate new construction. With 2.1 million sq. ft. of law firm leases expiring in 2020 and 2021, leasing activity within the sector is expected to increase in the next two years.

0.0

0.5

1.0

1.5

2.0

2.5

2018 2019 2020 2021 2022 2023 2024 2025

Figure 18: Upcoming law firm lease expirations (MSF)

* Including leases 25,000 sq. ft. or greater | ** Source: CBRE Research, Q3 2017

113,000 SF216,000 SF

1.28 MSF

830,000 SF

640,000 SF

834,000 SF

2.01 MSF

487,000 SF

Law firms currently in the market are looking to reduce their occupancy by an average of 29%, which will lead to an overall contraction of 546,000 sq. ft. in the next two to three years. The average age of the buildings they currently occupy is 24 years, with some built as early as in the 1960’s. The aging inventory, coupled with the robust development pipeline and highly concessionary market conditions, may incentivize more firms to relocate to new construction, further escalating the amount of vacancy in older buildings.





For more information, contact:

The Law Firm Practice Group:

Workplace StrategyChris Murray, AIA, LEED APDirector+1 202 253 [email protected]

Project Management Neil PendletonSenior Managing Director +1 312 297 [email protected]

Washington, D.C. ResearchWei XieResearch Manager+1 202 585 [email protected]

Washington, D.C. ResearchTim Whitebread Senior Research Analyst+1 202 585 5562 [email protected]

Washington, D.C. John GermanoExecutive Managing Director+1 202 585 [email protected]

Build on Advantage

Information contained herein, including projections, has been obtained from sources believed to be reliable. While we do not doubt its accuracy, we have not verified it and make no guarantee, warranty or representation about it. It is your responsibility to confirm independently its accuracy and completeness. This information is presented exclusively for use by CBRE clients and professionals and all rights to the material are reserved and cannot be reproduced without prior written permission of CBRE.

CBRE’s Global Law Firm Practice Group is dedicated to advising law firms on real estate and business strategies around the world. Having worked with 87% of the American Law 100, the group offers a full-service platform and seamless delivery of services to its law firm clients, including access to the most comprehensive, proprietary market research in the commercial real estate industry.

With more than 50 law firm industry experts covering major, secondary and emerging law markets worldwide, the group understands the unique issues in the legal industry and accommodates individual firm goals and business strategies with every real estate transaction.

Law Firm Practice Group Jamie Georgas Global Chair+1 312 935 [email protected]

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