Could Solos Soon Be Priced Out of Sublet Law Office Space in NYC?

With improving economic conditions and accelerating cost for master leases, small law firms renewing or acquiring sublet law office space in NYC should be making long-term deals while market conditions are still favorable.

Anyone who sublets extra office spaces will tell you that, in terms of turnover, attorneys are the most stable of all professional subtenants.

It’s difficult to move a law practice. So as long as attorney subtenants feel they are being treated fairly, they tend to stay put as long as they can.

The irony is that most lawyers like the idea of having flexibility to move whenever they want. Given the opportunity, most lawyers will choose a short-term sublet agreement, often to their financial detriment.

But the economy is improving and, for months now, commercial real estate has been on a rapid upward trajectory. Small firm attorneys who rely on affordable sublet law office space should be thinking long-term as they enter into new sublet arrangements or renew their existing deals.

By the numbers: NYC commercial leasing is on a winning streak.

According to a recent report from Reuters, the commercial real estate market in New York has fully recovered since the lows of 2007:

• Average rents for office space in Midtown Manhattan are now $77.93 per square foot.
• Rents are still below their 2008 peak of more than $90 a square foot, but up 21% since November 2012.
• Manhattan experienced the seventh consecutive quarter of increasing leasing velocity and remains above the 10-year average.
• Overall leasing availability in Manhattan was just above 10 percent, up more than 2 percentage points from the lows of 2007, just before the U.S. housing bubble burst.
• Leasing has increased to financial services companies, a sign of a continuing U.S. economic recovery.

Law firms are benefiting from the economic recovery.

According to a recent article by Ian Oxman in Aderant’s Think Tank Blog, shrinking demand for legal services appear to be in the rearview mirror. Firms are experiencing an increase in revenue and profits, and are hiring again.

Michael Allen, attorney and principal of legal recruiters Lateral Link concurs. Earlier this year in an article written for Above the Law, Allen reported a 110% increase of lateral hires in New York during the first quarter of 2015 as compared to the same period in 2014.

Corporate work is driving the recovery. There has been a spate of successful IPOs and a general loosening of financial markets. Corporations with easier access capital (and flush from hoarding cash for the past six plus years) have been on a furious hunt for acquisition candidates.

Further down the economic ladder, investors in earlier stage companies, who now have viable exit strategies, are pouring money into startups.

In essence:

More deals are good for law firms ($2.7 trillion this year alone).

More investment capital to spend on corporate growth is good for law firms.

Bigger budgets to protect IP is good for law firms.

Growing corporations means more jobs. More jobs means people will have the financial bandwidth to do the things they have been putting off, like: purchasing a new home, or breaking up with their spouses, completing their estate planning, or emigrating to the US.

All good things for law firms.

Sublet prices have been stagnant for a decade. Price hikes may not be that far off.

According to LookingForSpace founder and office sublet expert Neal Lerner: “Rent prices for individual sublet offices in law firms or shared law office suites is typically a function of the cost of the underlying lease.”

After the start of the Great Recession, commercial lease prices plummeted and stayed low. “The majority of firms that sublet extra office spaces are dealing with older leases, so their underlying cost is still low,” says Lerner.

With a poor economy, law firms have been tied up in long-term leases often with more space than they need.

Given the high supply of extra office space and the low cost basis of older leases, there has been a plethora of cheap sublet law office space available for rent.

For about a decade, small firm lawyers who rely on the sublet market have had a good run. There has been little change in the price for individual sublet offices since 2007.

But with steadily improving market conditions, a change may be on the horizon.

What improving market conditions will mean for solos and small law firms in the market for sublet office space.

Like the way commercial leasing eventually caught up with the residential market, rents for individual office spaces (which lags behind commercial leasing), will eventually start to reflect the higher cost of master leases.

Although the economy has been improving and there may be more work to go around, over the past five years there has been immense downward pressure on attorney fees, especially at the small firm level.

Without an easy way to increase billable rates, when faced with higher leasing costs at renewal, many firms will reduce overhead by surrendering their extra office space. Others may simply be priced out of the market.

Those firms that can’t find affordable options in different neighborhoods may be forced to disband their firm altogether.

At the other end of the spectrum, as the economy improves, financially stable firms will use their extra office space for new hires or will simply absorb the cost without subtenants.

Fundamentally, it’s not in a law firm’s financial interest to have subtenants. There’s much more money to be made billing clients than keeping subtenants happy. For most firms, there’s very little incentive to keep subtenants if they don’t have to.

For firms that will hold on to subtenants, any price increases incurred at lease renewal will be passed through to subtenants.

In the end, costs for sublet office space will rise commensurately with underlying leases, which will be accelerated by any shortening of available supply.

How should a small firm lawyer plan for their future office space needs?

Small firm attorneys renewing sublet agreements (or seeking new ones) should give serious consideration to negotiating a longer-term agreement. By sublet standards, we are talking about a two to four year commitment.

By doing so, firms can lock-in a modest annual rate increase while the sublet market is still reasonably favorable.

Firms that are too unstable to commit to longer-term agreements should think about the limits of their budget and explore all other options if costs start to exceed their financial bandwidth.

Some law firms that sublet space and professional operators of shared office space have done a great job of creating flexible workspace options for attorneys.

While the practice is not yet totally paperless, gone are the days of needing an additional 50 square feet of office space per attorney to store files. There are a lot of options for attorneys to reduce office expenses that were unthinkable even five years ago.

Experienced lawyers are now doubling up in offices, downsizing to a permanent deskspace or coworking membership, or using virtual office rentals to meet clients and receive mail.

Your ego may require a big workspace, but the demands of the practice no longer do. If necessary, most attorneys have the ability to materially downsize their workspace.

What should you do if asked to vacate a sublet law office space unexpectedly?

If asked to leave a sublet law office space unexpectedly, try to negotiate a virtual office arrangement with your current landlord. It will be an inconvenient disruption, but it will buy you some time to explore all your options. Plus, things will remain consistent for your clients until you can secure a long-term solution.

Choosing an office location for a law practice is a big deal. With rising costs, you may need to rethink the way your firm uses office space. That may mean some serious revamping of your firm’s processes and technology.

These are decisions that you do not want to be making while under duress. You don’t want to find yourself in another bad situation six months from now because you acted hastily.

Barring any unforeseen economic catastrophes, it looks like commercial real estate and economic conditions will continue to trend upwards.

Prudent small firm attorneys should make the best long-term deals that they can now to avoid a forced move or being priced out of the market unexpectedly.

Doing so will buy attorneys a little extra time to figure out how to cover the extra expense when they eventually are forced to deal with it.