Law Firms Capture Lease Deals On Downtown DC's Periphery (Law360)

By Natalie Rodriguez

Taking advantage of a rare softening of Washington's office market and looming lease expirations, area law firms are cutting new deals in up-and-coming areas around strongholds like K Street and Pennsylvania Avenue to nab new, more flexible spaces and financial perks, some experts say.

Spurred by the chance to downsize to more efficient spaces and snag sweet contract bonuses in a suddenly tenant-friendly market, a bevy of lease deals are happening in hot spots like the East End and the Central Business District. And as law firms hopscotch among buildings, the downtown expanse that's in serious contention is widening just a bit, with firms taking longer looks at the Capitol Hill area and the edges of the East End market, according to some experts.

"The application of business over traditional law firm thinking is dictating these moves. And lawyers are very smart. When they see the economics and see the flexibility ... their views on real estate change dramatically," Sherry Cushman, the new executive managing director of Cushman & Wakefield's law firm advisory practice, told Law360.

Law firms make up a big part of the district's office sector, occupying about 14.5 million square feet or about 10 percent of the district's rentable building area. Most of that is in the East End and Central Business District, which hold about three-quarters of Washington's law firms, according to Property & Portfolio Research Inc., a unit of CoStar Group Inc.

And within those areas, two spots in particular have reigned for their cachet and reputation.

"If you were a law firm in Washington and wanted to make a statement, you were either on K Street or, even better, Pennsylvania Avenue," Cushman said.

But some firms are mulling other, nearby options as developers construct new buildings or update older stock with more built-in flexibility to rearrange interior walls and greater technological capabilities to maximize conference space. They're also adding amenities, such as on-site food establishments and day care centers, according to experts.

Recently, Arent Fox LLP grabbed about 228,255 square feet of space at 1000 Connecticut Ave., according to a NewMark Grubb Knight Frank report. And Arnold & Porter LLP is making a move to Massachusetts Avenue.

"Ten years ago, no way would you have seen a law firm going there," Cushman said.

Part of what spurred Arnold's relocation is the lauded two-tower CityCenterDC complex being developed by Hines Interests LP, Archstone and TFI US Real Estate Fund, experts said. In May, Covington & Burling LLP announced it would become CityCenter's anchor tenant, taking over 420,000 square feet. To lure in Covington, Hines gave it two years of free rent to secure 18 years of cash flow, according to Cushman.

Meanwhile, on the northern edge of downtown, McDermott Will & Emery LLP cut a ribbon on its brand-new 229,112-square-foot space at 500 North Capitol St. earlier this month, after leaving its home further downtown.

"With this move, McDermott becomes one of the first international law firms to be based on Capitol Hill. We believe we are on the cusp of a natural evolution as major law firms and large corporations take a closer look at their local real estate investments," Paul Thompson, co-partner-in-charge of McDermott's Washington office, said in an Oct. 1 statement. "McDermott is bullish on the growth of Capitol Hill as a business district, an important shift we expect to play out over the coming years."

Still, it's not an exodus from the power structure by any means, several experts pointed out.

"I'd say generally the largest firms still do have a preference for being in downtown D.C. All of the 50 largest law firms are within a mile distance of the White House," Erica Champion, a senior real estate economist at PPR, told Law360.

Patrick W. Marr, vice chairman for CBRE Group Inc.'s D.C. market, holds a similar view of the latest trends. "Everybody's kind of going just a little bit east," he said.

"It's more of an accidental phenomenon," he added, noting that the boundary-pushing is an aftereffect of the larger leasing market activity, where landlords are jockeying to secure law firm tenants and the security they bring.

Law firms bring a remarkably reliable rent stream for landlords with, on average, 15- to 20-year leases, according to experts. And using negotiating skills often reserved for clients, law firms have leveraged this and the market's soft spot to push for extra goodies, such as the landlord's assumption of millions in lease liability.

"A few large law firms, in fact, are (as of the writing of this report) in lease negotiations for this reason, with leases likely to be signed in the next couple of quarters," commercial real estate services firm Cassidy Turley said in a second-quarter market report.

All this activity comes as the area has been hit by a perfect storm of election-year uncertainties and looming budget cuts. This has pushed the Washington metro area's office market vacancy to 15.4 percent — the highest it's been since 1994, according to a third-quarter report by Newmark. PPR puts vacancies for the Central Business District, Capitol Hill and the East End at 9.7 percent, with the larger D.C. metro area, including Maryland and northern Virginia areas, at 13.4 percent.

Part of this is due to the closures of several law firm offices, according to some experts. Dewey & LeBoeuf LLP's recent bankruptcy put a heap of vacant Class A space, about 125,000 square feet, on the market, according to a recent Cassidy Turley market report. And that's on top of space from Howrey LLP's bust last year.

But make no mistake, experts say — D.C.'s luster has not faded for law firms. About a third of the lease deals above 15,000 square feet inked this year in the district have come from the legal industry, according to Michael Cohen, director of advisory services at PPR. And about 40 percent of law firm leases are set to roll over in the next two years, which means more activity is expected.

Despite the rising vacancies, average asking rents in D.C. have risen to $51.65 per square foot in the Central Business District, Capitol Hill and East End, and the district average has increased to $45.10 per square foot, according to PPR. And the district's legal solar system remains tightly closed, experts say.

"We have not seen a major law firm completely leave D.C. and go to the suburbs. ... I think it's highly unlikely that we ever will," Cushman said, adding that while satellites with nonlegal staff have sprouted outside the city, a full move likely would require the transplanted attorneys to retake the bar exam.

Experts predict that in the long run, the cycle may come back around. As firms move out of high-demand areas, many owners are making plans to renovate their spaces there, making them more efficient, technologically connected and in tune with desired amenities, according to experts. And that is expected to put some of the older building stock being abandoned back in the race later on.

Some are already using the bump in vacancies to double down on the traditionally prized areas. Cooley LLP, for example, recently renewed its space on Pennsylvania Avenue, bumping its area up to 75,252 square feet by backfilling some space left open by Howrey. The tenant-friendly market allowed it to negotiate some financial consideration of its previous lease, according to a recent CBRE report.

"[You're] going to see some checkerboard movement. ... I think it's going to be interesting," Cushman said.

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