General Practice, Solo & Small Firm DivisionMagazine
American Bar Association
General Practice, Solo, and Small Firm Division The Compleat Lawyer
Spring 1997 copyright American Bar Association. All rights reserved.
The Business of Law
By Edward Poll
Edward Poll is a law practice management consultant. He is the author of Attorney & Law Firm Guide to The Business of Law: Planning & Operating for Survival & Growth (ABA General Practice Section, 1994). If you have comments about this column, call 800/837-5880, fax 310/578-1769, or send e-mail to EdPoll@LawBiz.com. This article is based in part on an interview with Vincent A. Pellerito, an office-property consultant with the national real estate services firm of Grubb & Ellis.
One of the most significant costs for law firms is their leasing or occupancy expense. In fact, rent is usually the second largest expense item for the average law practice; only payroll for staff is larger.
A firm may spend as much as 20 percent of its total overhead for occupancy or rent. While lawyers should review all expense areas for possible savings, if you only think of rent as a fixed obligation with no room for savings, think again: You can save money on rent!
Restructure Your Lease
Market conditions change. While real estate values fluctuate dramatically and have actually come down in many areas of the country in recent times, many lawyers are locked into leases that were made during earlier real estate boom times. Law firms that signed leases in the late 1980s and early 1990s are probably paying dramatically higher rates than would be the case if they were new tenants today.
One strategy is to try to restructure your existing lease by asking for a lower rent or extending the lease term. How? Everyone - including your landlord - knows that it's cheaper to keep an existing customer than it is to get a new one. Landlords generally do not want to see an interruption in rent; they would rather see a reduction than a cessation. Before you ask for lower rent, check rates in the area. If your current rent is higher than that being paid by other firms, go to the landlord and explain that you cannot remain competitive with other firms if your rent - the second largest portion of your overhead - is higher than someone else's down the street. Your rent needs to be lowered to be comparable to those rents being paid by others in your profession. You can also remind the landlord that if you stay, he or she will not have to pay the new tenant improvement costs that will undoubtedly be incurred if you leave and a new tenant moves in.
An alternative strategy is to ask for an extension of the lease term at the current rate. Since all rents do eventually go up, you can effectively lower your average annual lease cost by extending the lease term at the existing rental rate.
Realize that landlords have cost pressures too. They may have a large loan with high mortgage payments, and are willing to take a reduction in rent rather than interrupt their cash flow. Alternatively, they may want to refinance the building, in which case the degree of building occupancy is the primary concern. Landlords may be very willing to renegotiate your lease; you just have to ask.
Use Lease Audits for Leverage
Many costs are paid for by tenants, including after-hours HVAC (heating, ventilating, and air conditioning), as well as operating-expense "pass-throughs." In most office leases, the tenant pays a fixed base rate sum plus an additional amount, usually called an "escalation" or "pass-through." The extra charge is based on a pro-rata share of the building expenses each year of the lease. Pass-throughs have been a gold mine for landlords, especially in a declining real estate market. When property values and corresponding lease rates decrease, operating expenses in many buildings tend to increase to offset this loss. Your goal is to reduce these pass-through charges.
Most tenants pay without question the operating-expenses statement and pass-throughs that the landlord submits. The tenant never expects the bill to have any discrepancies or errors. On the flip side, landlords seldom review each tenant's lease - how one tenant's lease differs from other leases, or which exclusions from operating expenses one tenant may have negotiated that other tenants did not. Landlords generally do not take the time to note differences; they simply assess operating expenses based on a tenant's proportionate share of a building's occupancy.
But according to commercial real estate experts, landlords are frequently inaccurate or overly aggressive in the pass-throughs, knowing that most tenants merely accept and pay the figures billed with the normal monthly rent. Overcharges can result from arithmetic errors, inaccurate assumptions, expenses not permitted under your lease or as a matter of law, overstatement of your fair share, failure to credit offsetting revenues or recoveries, understatement of credits, or inefficient building operations. Experts estimate that these excessive charges can equal $1 to $3 per square foot per year, or more.
A lease audit is an effective way to review, verify, and examine questionable pass-through charges. Your strategy is to analyze these charges carefully and either try to reduce them or use them as lease bargaining leverage. Auditing the operating expenses of a building may provide enough information to give you a distinct advantage in negotiating new terms and conditions for the balance of the lease term, including lower rent. In fact, depending on the results of such an audit, the landlord may owe you a refund for overcharges previously collected.
You'll need to bring in experts who can conduct the audit, and who can provide additional information such as market knowledge, recent comparable transactions, and trends in the marketplace. Smaller tenants of the same landlord can join together to split the costs of a lease audit. Tenants who do not audit a landlord's expenses are missing a good opportunity to reduce costs.
Competition as Leverage
If you're nearing the end of an existing lease, your negotiating leverage over the landlord is the possibility of your moving out and leaving him or her with an empty space. Landlords will do almost anything reasonable to prevent losing a tenant and losing the resulting cash flow.
One way to strengthen your position is to invite competition among other landlords in the area by letting them know that you are thinking of relocating. Your current landlord will soon learn that you're in the market for a new location and will likely want to discuss your tenancy. Even more than not wanting to lose tenants, landlords especially don't want to litigate against lawyers.