A new report on the Washington, D.C., legal market from real estate giant CBRE finds law firms migrating west, following new construction in the city's central business district. They are also not leasing as much space as they once did, and they're facing more competition for "trophy" buildings with technology companies and co-working spaces.

The report, which examines the legal industry's real estate footprint in D.C., measured factors including law firm employment in the region, leasing costs and total occupancy.

A Lawyer's Town

D.C. is a lawyer's town. Among Am Law 100 firms, 95 have a presence in the district. Law firms contribute $12 billion annually to the local economy, make up 27% of the overall tenant base for office rental and are anchoring nine of the 20 new buildings going up between 2018 and 2020 in the central business district and east end submarkets, according to CBRE.

The legal industry in D.C. makes up 14% of the GDP of the city. Nationally, the legal industry makes up about 1% of total GDP, according to CBRE, illustrating its outsize influence in the capital.

The firms also spend big. Wei Xie, senior research manager and Mid-Atlantic research lead at CBRE, said that law firms occupy 60% of the available "trophy" real estate properties in the city—buildings with a lot of amenities and a price tag to match. Meanwhile, asking rents for Class A office space rose again in the second quarter of 2019, reaching $62.45 per square foot.

Lou Christopher, vice chair at CBRE, said that law firms are willing to spend more on high-end real estate for a couple of reasons, including the potential to help recruiting and the "rightsizing" of older offices that were built for a different time. Those older buildings have space dedicated to large law libraries and secretarial pools that the modern law firm has little use for.

As a consequence, Christopher said, firms are paying more for face rent but downsizing their footprints, so money is still saved.

Of the top five largest law firm real estate transactions that CBRE tracked from the third quarter of 2018 through the second quarter this year, three firms were renewing leases but contracting their footprints, one was renewing but expanding, and one—Williams & Connolly—was relocating to a new, larger space.

The CBRE study found that aggregate revenue among D.C. firms increased by 8% in 2018, topping 5.5% growth in 2017.

Christopher said the increase could be due to increased litigation work (much as another study by Thompson Reuters found) as well some large mergers and acquisitions deals, although the study found that M&A work as a whole in D.C. was down, much like in the overall market.

Leasing and Space

That increased revenue did not translate into more space, though. D.C. law firms accounted for 724,000 square feet of leased space in the first three quarters of 2019, and are projected to occupy about 1 million square feet for the year. This is significantly below the 10-year average of 1.6 million square feet.

The CBRE study did predict an uptick for next year, though, as firms are expected to be looking for 1.7 million square feet of space. The study further suggested that this could also provide headwinds for the market as firms continue to contract with more efficient use of space.

That contraction has at least slowed compared to recent years. In 2015 and 2016, contraction for square footage in D.C. was over 23% each year. In 2018 it was 4%, and thus far in 2019 it is 7%.

According to CBRE, 85% of Big Law firms in D.C. reside in either the central business district or the east end submarkets. The company defines the central district as running from 15th Street NW to 22nd Street NW east to west and U.S. Highway 50 to P Street NW south to north. The east end runs from the east at 2nd Street NW to 14th Street NW and is bordered by Madison Drive NW to the south and P Street NW to the north.

The western end of the central business district has seen an influx of firm movement recently, as it has been a hotbed of new construction activity. Since 2017, 15 law firms have moved to the area, the CBRE report said.

Those firms have leased roughly 1.3 million square feet of space and 14 of the 15 entered new construction or redeveloped buildings and were on average shedding 20% of the square footage of their previous buildings, furthering Christopher's earlier assertion that D.C. firms are looking for newer, smaller spaces.

Market Factors

Aside from price per square foot, there were several market factors the report said could influence the next few years of law firm real estate activity in the D.C. area.

Construction costs in the area have risen 10% over the past two years, which has affected both office rental as well as relocation costs, the study said. Law firms could be disproportionately impacted because of their tendency to occupy newer and more high-end buildings.

The fiscal year 2020 budget for D.C. took effect Oct. 1 and includes an increase for both commercial property taxes as well as deed and recordation transfer taxes, increasing the cost burden on landlords who will then pass those costs along to tenants, the CBRE study said.

The report also touches on the influx of technology companies and co-working facilities in the area. Xie said that while the market is soft right now, competition for the larger, newer and nicer buildings in the area could intensify as these newer entrants into the D.C. marketplace continue to grow.

The arrival of Amazon in D.C.-adjacent Crystal City was the largest and most talked about entry, but Xie and Christopher said there are other, smaller tech and co-working players taking up space as well.

Christopher and Xie said law firms and nonprofits were once the clear demand drivers in the area, but the local economy is diversifying as companies see the potential in the highly educated workforce that inhabits the D.C. metro area.

"Since 2018, co-working added 1.4 million square feet of occupied space," Xie said. "Tech added another 600,000 square feet. That is about 2 million additional square feet, and there will be more."

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