My partner, Joe, and I were on a recent call and were asked by a managing partner of a local law firm for our thoughts on whether it was advisable for a firm to own its own building. Joe quickly responded, “If a law firm wishes to own real estate, they should buy the building next door and lease it out, while leasing their own space from another owner.”
While his comment might sound a bit short, Joe’s further explanation made clear why his reasoning is sound and applies to any professional services firm including medical practices and accounting firms. Joe explained that there are two primary problems with owning your own single-tenant building and being the single tenant. First, you lose the flexibility to grow, or to shrink. To grow, your only options become to restack your building to a denser occupancy with smaller and smaller offices or workstations, or to lease additional space in another building, thereby creating a two-office operation. Once you have two separate offices, you end up duplicating things like reception and break areas, thereby creating added expense. To shrink, you either have to sell your building and relocate, or figure out a way to make the building a multi-tenant building and then find tenants for your excess space. The decisions for the firm end up being compromised by the real estate.
The second primary problem with owning your own building is that usually the ownership entity is not the service firm itself but rather a group consisting of some or all of the firm’s partners that leases the building back to the firm. Over time, some of those partners may decide that they do not want to be invested in an office building or may leave the firm. Others may reach retirement age and be more interested in a greater return on the real estate (translated as higher rent) than a lower cost of operations for the firm from which they are retiring. At the same time the firm’s younger professionals not involved in the original ownership group move into more significant production positions in the firm and resent or otherwise do not embrace the arrangement. Experience tells us that this change in perspective among the firm happens faster than most groups anticipate.
While we have worked with firms that own their own buildings, we have found that once firms have been in this situation for 10 years or more, the firm (as opposed to the ownership group) seems to spend more time dealing with the downside rather than the upside of the arrangement.
Service firms with multiple locations find the ownership entity issue to be even more fraught with problems. For instance, if a Birmingham law firm acquires a Montgomery practice and those Montgomery partners own their building, the law firm leadership’s ability to negotiate a fair market transaction for all of the partners is compromised. Instead, they have to carefully avoid conflict with one group of their partners. This usually results in an above-market deal for the law firm.
If the firm instead invests in one of the many opportunities in any real estate market, whether it be the building next door or down the street, all the investment decisions as well as the firm’s office space decisions are market driven. The partners still have the ability to leverage their individual situations by investing together which has the benefit of “putting a little glue on everyone” without tying a typically long term investment so closely to the potentially fluid needs of the firm. A professional leasing and management firm can manage the day to day and be accountable to the ownership.
If your firm finds itself in one of these situations, we can help you with your lease versus own decisions. We can also help you evaluate and structure a sale/leaseback or find a property that meets the investment criteria of the ownership group