To Buy or Not to Buy...
To Buy or Not to Buy...
By Leland J. Reicher, Esq., CPA, at the request of the Law Practice Management Section Executive Committee. Reicher is a named partner with the law firm of Reish Luftman McDaniel & Reicher. He focuses on real estate and business law for closely held businesses, professional service firms, and their owners. He can be reached through the firm’s Web site at www.reish.com. The opinions expressed are his own.
If there are low interest rates or low prices for commercial real estate, or a booming economy, many law firms consider purchasing a building in which to house their offices. Prior to making a decision, take a look at a few factors.
First up on the analysis is how much can you get for your money. After the partners agree upon a purchase amount, then the search begins for a suitable building.
Partners see that the type of building they can get for their money is usually not nearly as nice as their current offices. If a firm is headquartered in an “A” building, chances are that they won’t be able to purchase an “A” or even a “B” building. The “C” space they can afford is not what they are accustomed to. Furthermore, if the firm has “A” clients, they may not want to downgrade their image when they move to a “C” space.
Sometimes, a firm will find “C” space that needs significant renovation. So now the partners will have to fork over additional money to improve the space so it is presentable to clients.
If the partners find a suitable building, probably a low rise, then the next question is parking. Oftentimes, parking in low rises is minimal and very bad. You probably don’t want your clients driving around in the surrounding neighborhood looking for a spot on the street to park their cars.
Even if you do find a building that meets your image requirements, will the building be adequate for your firm in 5, 10, or 20 years from now? If your strategic plan outlines an expansion goal, does the building have enough space to meet your future space needs?
The space issue leads to an efficiency question. If your firm needs to be on two or more different floors because each floor doesn’t have enough space for the entire firm, then you’ll probably sacrifice some efficiency when employees go from one floor to another. You’ll probably need to have photocopy, kitchen, and other services available on each floor.
Another consideration is the risk of investing in real estate. The haunting question: Is the real estate market peaking and ready to slide, or will it continue to climb for years? If the market is turning downward, partners will find themselves upside down very fast -- owing more on the mortgage than the building is worth. This situation can place enormous financial strain on a partnership and has been a big problem for a number of law firms in California.
A future consideration when purchasing a building is what happens if equity partners leave? If this is the case, then a buy/sell agreement among the partners provides for the valuation of the building and the buyout of the departing partner. Partners may be motivated to leave if they want to cash out of their real estate investment. Remaining partners may not be able to afford the buyout.
The final and most critical issue that sinks most real estate deals is the conflict of interest. Unless one person or a group of people own 100 percent of the law firm and 100 percent of the building, then it’s very hard for this arrangement to work. The conflict arises when one group of partners is leasing to another group comprised of different partners. Neither group believes they are getting the best deal. The real estate partners want to charge the law firm the market rate for the space since they don’t want to lose money. And the law firm partners want a better deal than the other tenants.
If there are other tenants in the building, the real estate partners are landlords and need to hire a company to manage the property. This presents another set of issues where the partners now have to focus time and energy on making “landlord” decisions.
A number of firms that have purchased their own building and held it for many years have made hefty profits but not without headaches along the way and sacrificing the image of their firm. Before deciding to purchase a building, take a hard look at the advantages and the disadvantages of commercial real estate ownership.
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