North American Law Firm Advisory Group Spotlight Report | 2023
2023 is set to be a year of exploration for U.S. and Canadian law firms as they assess return-to-the-office work strategies and contend with an economic outlook that suggests a mild recession may occur by Q3 2023. Despite some indications of stabilization, there is still a great deal of speculation and debate surrounding what the future holds, particularly given the slow return to office. As the office sector grapples with a series of challenges, significant structural shifts may be on the horizon in the years to come.
Leading Law Market Trends
- Focus on Acquisitions and Cost Reduction Strategies on the Rise
- Rents Hold Firm Overall
- Vacancy Is Rising in Most Markets
- Concessions Remain Generous
Focus on Acquisitions and Cost Reduction Strategies on the Rise
In 2021 every firm in the AM Law 100 posted increased revenue, with the average increase being 14.8% and 18 firms posting growth of over 20%. In 2021 legal demand reached a 10-year high of 3.7%, but in 2022 billable hours decreased by 0.1%, In addition to the lower demand in 2022, direct expenses have climbed 10.1% as firms fight for new talent, and indirect expenses are up 10.9%. As a result, firms are being forced to focus on their expenses and find ways to reduce their occupancy costs.
Rents Hold Firm Overall
Full-service, CBD Class A office rents range from $22.89 per square foot in Cleveland to $80.17 per square foot in Manhattan. The average full-service Class A asking rent across the 21 markets is $40.17 per square foot representing a fall of 12.1% since our prior report.
Eight of the 21 markets have Class A asking rents above the survey average, three of which have Class A asking rents of more than $60 per square foot: Austin, Manhattan, and San Francisco. Despite softening fundamentals, just over half of the markets — 12 in total — showed rent gains in 2022. These higher rents were a result of the dramatic increase in tenant improvement allowances and rising operating expenses.
Vacancy Is Rising in Most Markets
All 21 surveyed markets saw an increase in Downtown Class A vacancy in 2022, consistent with national trends. During the pandemic-induced economic downturn, central business districts (CBDs) experienced a more significant rise in vacancy than suburban areas, due to more sublease space being offered.
The average Class A CBD vacancy across surveyed markets rose by 290 basis points, reaching 21.2%, higher than the U.S. national rate of 17.7%.
Among the surveyed markets, the lowest downtown vacancy rates were in Vancouver at 7.4%, Manhattan at 12.4%, and Toronto at 12.8%. On the other hand, 12 CBD markets recorded Class A vacancy rates of over 20%, with Phoenix and Dallas at 31.4%, followed by Nashville at 28.9%.
Concessions Remain Generous
Although asking rents remain relatively flat, rising just 1.8% year-over-year, landlords are offering significantly higher concessions. For instance, the average concessions for a new 10-year lease on Class A space have risen from $84.24 in 2021 to $101.75 per rentable square foot in tenant improvement allowances and from 9.1 months to 10.6 months of rent abatement.
Concessions are most substantial in the northeast, where tenants receive, on average, $118 per square foot in tenant improvements and 13.2 months of rent abatement. This is driven mainly by Manhattan and Washington, D.C., which have the highest concessions across the 21 markets. On the other hand, the Midwest, outside of Chicago, has the lowest concessions, averaging $83 per square foot, with eight months of rent abatement.
Notably, there is a significant gap between concessions in gateway markets, averaging $135 per square foot with 14.4 months of free rent, and the larger and medium-sized cities. Tenant improvement allowances in gateway markets are 45% higher than in the other 17 markets surveyed.
While ten markets have average tenant improvement packages of $100 per square foot or more, this may not be enough to cover tenants’ fit-out costs, which have surged due to a sharp increase in the cost of materials and a shortage of skilled labor. Additionally, supply-chain issues have caused fit-out periods to extend and forced tenants to start to explore their options earlier to allow longer lead times. Additionally, landlords are pressing law firms to sign longer leases to cover these expenses.
2023 Law Firm Survey: Key Takeaways
Long-Term Leases Remain Popular
Although shorter lease terms are becoming more prevalent in the broader office market, law firms are still willing to commit to lease terms of 10 years or longer. In fact, 83% of law firms were willing to commit to longer-term leases.
Short-term Renewals to Continue
To maintain occupancy and income streams, landlords have agreed to short-term renewals while firms evaluate their post-COVID real estate strategies and space requirements. Nonetheless, the trend is diminishing, as only 45% of our surveyed base anticipate this trend to persist over the next 12 to 24 months, compared to 63% in 2021.
Footprints are Shrinking
65% of law firms are expected to reduce their space needs, both when renewing in place or relocating; this is down ten basis points from last year.
Lawyers are Returning to the Office
While Kastle Systems’ survey reports that as of March 2023, the overall office occupancy rate is 48%, the occupancy rate for law firms is significantly higher at 61.9%. Presently, 40% of law firms use between 26% to 50% of their space, while another 50% have occupancy rates of 51% to 75%. The latter group’s share is projected to increase to 80% by the end of 2023.
Remote Working is Here to Stay
It is predicted that only 20% of law firm professional staff will return to working in the office five days per week post-pandemic. The remaining 80% of law firms are expected to adopt some remote work, most commonly two to three days per week.
Single-sized Offices and Demisable Space Dominate Shifts in Space Planning
Law firms are still adjusting their space utilization. However, the trend towards single-size offices is ongoing, with over 80% of law firms either implementing it or expected to do so. Additionally, it is anticipated that nearly 75% of law firms will design space that can be more easily divided, providing greater flexibility if they need to sublease in the future.
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