LEGAL ECONOMICS By: Thomas S. Clay ALTMAN & WElL, INC. Management Consultants Ardmore, PA and Orinda, CA
BUY OR LEASE? THE OFFICE SPACE PROBLEM It costs between $4,466 and $6,016 a year to provide office space for the typical lawyer according to The 1979 Survey of Law Firm Economics. This expenditure provides space for the lawyer and support staff and includes expenditures for rent, utilities, janitorial service, real estate taxes and like items. It is a major expense in most law firms. Occupancy costs tend to vary with location. The higher costs are in the first class buildings in large cities. Costs tend to be lower in towns and suburbs. Experts in real estate predict lease rates as high as $40 per square foot in a decade. At present, law firms generally pay from as little as $7.50 to almost $20 per square foot, per year, depending on city and building. Lawyers are generally concerned with the cost of the space they occupy. After all, occupancy may take from four to ten percent of gross receipts. One of the questions often asked by lawyers of their consultants is whether a law firm should continue to lease space or purchase (or build) a building. The answer is never easy to determine and requires significant long range planning and financial analysis. There are a number of factors that must be considered prior to embarking on a construction or purchasing program. Some of the economic and non-economic factors that make office ownership attractive for the law firm are: 1. Flexibility with respect to present and future space needs and office layout if carefully planned. 2. Ability to control many of the factors comprising occupancy costs. 3. A cash return on invested capital to the building owners. 4. Favorable tax treatment of commercial real estate. 5. Appreciation of the real property (an infiation hedge). 3D/Arkansas Lawyer/January 1981
Problems that may arise with ownership if proper planning and management does not occur are: 1. Significant management time is required by owners, diminishing the time available for the practice of law. 2. There is significant financial exposure of the owners if unoccupied space is not leased or not leased at projected rates. 3. Objections by law partners not involved in the real estate ownership to iease rates paid by the firm can occur. Often younger partners perceive that the real estate owners are not equitably setting rates, thus siphoning profits. 4. Younger partners may perceive ownership of the real estate as a "right" acquired with law firm partnership. If policy with respect to admission rights and costs (if in fact there are to be any) are not communicated, serious consequences may arise. Any analysis to determine whether or not the firm should continue to lease space or purchase its own space should include a number of steps. Most law firms should enlist expert services in making these determinations. Growth Law firms should project growth in numbers of lawyers and support personnel based on past experience, expected increases in clients, entry into new areas of law and similar factors. Such long range planning must occur in order to determine the acceptability of present space (and available expansion space) and to determine square footage requirements of space to be purchased or built. Many firms are experiencing the croWding associated with inadequate planning for new personnel. It is generally better to have excess space than to have too little.
Interior Layout Too often lawyers become overly concerned with the aesthetics of a building, in particular the exterior, and do not pay adequate attention to the functional aspects of the interior space. Interior needs should be defined prior to architectural design. The relative length and width affects the utility of interior space. Long narrow buiidings, for example, generally are inefficient as law office space. Inattention to detail in this area often leads to functionally inefficient space. Ownership The partners of a law firm will usually form a separate partnership to hold title to the real estate for tax and liability reasons. If no policies are set for exclusion or addition of new law partners to the real estate partnership, problems will occur. Generally, the partners will build or purchase an existing building and then lease space to the law firm. This arrangement works well until a new law partner is brought in. Often new partners expect to "automatically" obtain an interest in the building. Problems arise if the building owners have no policy with respect to new owners or for determining terms of purchase. In one firm whose founding partners owned the building and would not allow younger law partners to purchase an interest, the younger partners felt that older partners were draining firm funds and threatened to leave. In the crisis which resulted, an appraisal was performed to determine the building value and the younger partners were allowed to buy in. Ironically, most of them declined as the market value of the building was much greater than they had perceived it to be. In fact, the analysis showed that the firm was paying less than market rental rates. Financial Analysis A pro forma financial analysis must