A number of law firms around Washington are getting into the real estate business: not just advising real estate clients, but becoming limited partners in development deals on buildings where they plan to rent offices.
While there are still many Washington firms content with simply renting with no ownership interest, some of the biggest firms have successfully negotiated for equity in their buildings, including Shaw Pittman Potts & Trowbridge, Surrey & Morse, Lane & Edson and Steptoe & Johnson. Others, including Hogan & Hartson, are working on deals that may include an equity position.
Real estate analysts in Washington say law firms here have been interested in gaining equity positions for years but that it wasn't until the recent office glut that they have been able to win ownership participation from developers.
"There's only one reason this is happening, and that is so landlords can get tenants in their buildings," said Justin Hinders, a local commercial real estate broker. "From the developer's point of view, if he can get a prestigious, economically viable, creditworthy law firm as his first tenant, he has a better chance of leasing up."
For a developer having trouble leasing a building, offering a tenant a bit of equity is less painful than lowering rental rates, said one attorney with Shaw Pittmann.
"The $1 of equity costs the developer less than a $1 less in rent," said the lawyer. "The developer has the problem of not being able to get his permanent financing until he reaches a specific income level, so he doesn't want to reduce the rental rates. The equity is the only thing that doesn't cost him anything."
For the law firm, taking an ownership interest provides a tax shelter for income, something most Washington law firms are eagerly looking for, and income if the building is sold. Steptoe & Johnson negotiated a deal that over time turns over the entire building to the law firm. But analysts say that most firms get only small shares in the equity, between 5 and 20 percent, because the developers usually do not have that much left to give up. The law firms generally are brought in as limited partners to protect them from liability in case the building gets into trouble, and the firms usually are asked to make a capital contribution.
Lawyers in firms looking at these options, however, say that equity ownership can often be troublesome, even if the firm is protected from calls for additional cash contributions. And the biggest hazard, say the lawyers, is internal political problems.
"You get real problems when some of the partners are landlords and the newer partners are tenants, not to mention what happens if some of the partners get a stream of income from the investment while others are getting nothing," said one attorney with a firm taking an equity position. "I know for a fact that a number of firms have been torn up over that issue. Many decide to stick to what they know best, and that's law."
Arnold & Porter bought a piece of property at 19th and N streets NW several years ago, with the intention of erecting its own building. Later, however, the firm sold the property and instead signed what one attorney there called "an advantageous" lease with Oliver T. Carr for space in the city's West End.
That lawyer said the firm chose to sell the land because it would not accommodate a building large enough for the rapidly growing firm, but others in the legal community here in Washington said the real estate development created serious problems for the partners at Arnold & Porter.
Hinders said he knew of a law firm in Washington that, because it represented developers, was repeatedly offered equity positions in different buildings.
"They never took any of the offers because just talking about it created big problems," said Hinders. "They finally decided they were lawyers, not developers, and should stick with that."
"At a law firm everybody has to be friends or life becomes very difficult," said one lawyer at Shaw Pittman, who said the equity position his firm has negotiated has sparked internal battles. "Working out an arrangement that does not create a divisive atmosphere is a problem."
Stephen Goldstein, a local real estate analyst with Julien J. Studley Inc., said that law firms taking equity positions are usually those looking for space in the choice locations, such as along Connecticut Avenue, where the developers can hold out for higher rents but are usually willing to offer a bit of equity to get the right tenant.
He said that for firms moving into areas considered less prime -- such as the West End several years ago or east of 15th Street today -- developers are willing to offer lower rental rates, a deal most firms find better than an equity position and higher rental rates.
Members of the firm Lane & Edson, which owns equity in its building at 2300 M St. NW, were unwilling to discuss the details of their deal, but one lawyer said that by choosing to own part of the building in the West End the firm was making a statement of "confidence" in the rental market in that area.
"I think the major change in thinking that led law firms into such deals came in the late '70s, when a lot of the local firms began to grow and national firms opened up Washington offices," said Goldstein, of Julien Studley. "It is an indication that these firms feel they are here for the long-term, and that the office space market in Washington is a good long-term investment."
One firm, Surrey & Morse of New York, was bullish enough to initiate development of a building. The law firm found a site at 1250 I St. NW and offered to put up all the capital. The Charles E. Smith Co. developed the building for half of the equity, leaving Surrey & Morse with 50 percent ownership interest. One member of the firm reported that the firm -- which is occupying several of the floors in the partially leased building -- is able to write off the losses from unleased space against its yearly earnings.