How the Legal Industry Landscape is Shaping Occupancy Trends

Savills Studley Insights
September 22, 2016
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Heidi Learner

Heidi Learner

Chief Economist

As we enter the eighth year of the economic recovery, most segments of the labor market have experienced a sustained increase in headcount (Chart 1). However, employment in the legal industry has failed to rebound in line with the rest of the economy. Unlike the finance sector —whose lackluster growth can be blamed on extensive regulation — no such basis exists to explain the sluggishness in the legal sector. While it’s unclear why demand is slowing, it’s apparent that downward pressure on fees has caused firms to reevaluate expenses.

Even with new regulation such as Dodd-Frank, which likely has reshaped the financial sector on a permanent basis, employment at financial services firms has managed to rise over the last two years (Chart 2); in contrast, headcount growth at law firms has remained stagnant and has yet to return to its pre-recession level. Prospects for accelerating growth seem unlikely; the number of law school graduates has declined for two consecutive years to under 40,000 for the Class of 2015 - down from a peak of almost 47,000 just two years prior.

Chart 1: Cumulative Change in Headcount, July 2007 – July 2016

Chart 1: Cumulative Change in Headcount, July 2007 – July 2016

Chart 2: Finance & Law Firm Employment (Seasonally-Adjusted in Thousands)

Chart 2: Finance & Law Firm Employment (Seasonally-Adjusted in Thousands)

Even law firm compensation isn’t what it used to be. While starting salaries for new attorneys have reached new highs at some firms (in June, Cravath Swaine & Moore raised starting salaries to $180,000 from its longtime standard of $160,000), median starting salaries have barely budged over the last few years nationally, and were 20%-30% higher in 2008 and 2009 than today (Chart 3). Just over half of 2015 law school graduates were working in the private sector, and nearly 10% of graduates were unemployed and seeking work.

Chart 3: Law Firm Median Starting Salaries

Chart 3: Law Firm Median Starting Salaries

Not all firms are shrinking headcount, however. Chart 4 shows the total count of lawyers across the top 20 firms by gross revenue and highlights that only a handful of firms (Skadden Arps, Mayer Brown and Weil Gotshal) reduced headcount between 2012 and 2016.

Chart 4: Total Lawyer Count by Firm (American Lawyer’s 2016 Survey, Top 20 firms)

Chart 4: Total Lawyer Count by Firm (American Lawyer’s 2016 Survey, Top 20 firms)

However, these firms appear to be the exception, rather than the rule. The “Am Law 200,” a list of highest-grossing law firms, is produced on an annual basis by The American Lawyer. In analyzing the data, it became readily apparent that the top 100 firms (i.e., the Am Law 100) outperformed their smaller counterparts (the Am Law Second 100) by a significant margin. Chart 5 shows that aggregate attorney count at firms in the Am Law Second 100 (i.e., those ranked 101st through 200th) contracted by 1.1% between 2014 and 2015, and fell a further 3.5% between 2015 and 2016.

Chart 5: Total Lawyer Count at Am Law Second 100 Firms

Chart 5: Total Lawyer Count at Am Law Second 100 Firms

Even with the reduction in headcount across the Am Law Second 100 firms — which should have left higher revenue producers in place — cumulative growth in revenue per attorney is still slightly higher for those firms at the top half of the Am Law 200 than the bottom half (8.6% vs. 6.4%) as shown in Table 1. Moreover, growth in profitability on a per attorney basis between 2012 and 2016 is significantly greater for the top 100 firms (12.4%) than for the Second 100 (4.9%), evidenced by the fact that the top 100 firms pay their partners more on average (Chart 6). It appears that it is the smaller firms that have faced the most pressure on fees, with the larger firms maintaining control of the least price sensitive clients; it is also possible that headcount at smaller firms is still elevated relative to their larger brethren.

Table 1: Am Law 200 Firm Metrics by Tier

Table 1: Am Law 200 Firm Metrics by Tier

Chart 6: Average Compensation per Partner by Am Law 200 Ranking, 2016

Chart 6: Average Compensation per Partner by Am Law 200 Ranking, 2016

While there is no shortage of concerns over the future of the operating environment for law firms, one of the most persistent — and cost effective — trends over the last few years has been the downsizing of office space, which has resulted in lower real estate costs.

In larger metro areas, rental expense averaged 8.1% of law firms’ gross receipts per equity partner — a non-trivial amount that provides an opportunity to realize cost savings through more effective utilization of space. To accomplish this, many firms are in the process of actively looking for subtenants (Appendix 1), while others have already sublet space or have downsized at lease expiry. In Table 2 we highlight the top firms by attorney count in several major markets. Not surprisingly, many of the firms have reduced their space over time, with some of the largest reductions in space occurring when firms moved to more efficient construction in new buildings.

The relationship between occupied space per attorney is not entirely independent of the total number of attorneys for a given office (Chart 7). As firms employ more attorneys in each office — with the largest offices most likely to be located in the largest (and most expensive) cities — the level of associated staff begins to drop, which likely reflects the basic law of supply and demand: when a resource is more costly, one typically uses less of it (Chart 8). For example, the ratio of attorneys to paralegals in Washington, D.C. is more than twice as great as it is nationally — not unexpected given that paralegal salaries in Washington command a 40% premium to the average salary nationally. Moreover, the metric of space per attorney may overstate the true space allocation on a per employee basis for many headquarters locations. Headquarters offices will typically employ dozens of other professional staff — accounting or human resources personnel, for example — which may make the ratio of square feet per attorney somewhat less relevant.

Chart 7: Occupied SF per Attorney vs. Attorney Count by Largest Firms by City, 2016

Chart 7: Occupied SF per Attorney vs. Attorney Count by Largest Firms by City, 2016

Chart 8: Ratio of Attorneys to Paralegals vs Paralegal Average Salary, 2016

Chart 8: Ratio of Attorneys to Paralegals vs Paralegal Average Salary, 2016

Table 2: Law Firm Attorney Count and Occupied Space by City (Headquarters Locations in Bold)

Table 2: Law Firm Attorney Count and Occupied Space by City (Headquarters Locations in Bold)

For firms on the smaller end of the spectrum, relatively little space appears to be needed. A survey undertaken by the Phoenix office of Savills Studley in conjunction with the Association for Legal Administrators (ALA) in March 2016, found that among smaller firms (those with fewer than 20 attorneys), none occupied more than 13,000 sf (Chart 9). However, because larger firms are likely to be in offices with more gathering spaces (whether libraries, conference rooms or communal areas), it’s not surprising to see that the square footage per attorney is higher for these larger firms than for their smaller counterparts.

Even though at this point in 2007, there were nearly 50,000 more people working in the legal industry than there are today, we note that not every firm is downsizing. Nonetheless, we expect that many of the larger firms will continue to shed space — in a manner similar to the moves by the firms noted below.

Chart 9: Occupied SF of Office Space vs. Attorney Count by Phoenix Law Firms, 2016

Chart 9: Occupied SF of Office Space vs. Attorney Count by Phoenix Law Firms, 2016

However, absolute reductions in space aren’t the only measures that law firms are undertaking to boost profitability. On the expense side, firms have been reining in support staff and the number of paralegals employed (Chart 10), while on the revenue side, firms have continued to face pressure to move toward alternative fee arrangements (Chart 11).

Chart 10: Ratio of Support Staff to All Attorneys

Chart 10: Ratio of Support Staff to All Attorneys

Chart 11: Percentage of Firms Reporting an Increase in Alternative Fee Arrangements, by Firm Size

Chart 11: Percentage of Firms Reporting an Increase in Alternative Fee Arrangements,by Firm Size

Merger and acquisition activity among law firms continues in earnest (Appendix II) as firms look to strengthen their ability to serve their clients by adding new practice areas and growing existing ones, all while reducing duplicative expenses. Already, 2016 is shaping up to possibly best 2015’s tally in terms of the number of merger deals — and more mergers were announced in 2015 than in 2014. Additionally, research budgets are down (Chart 12) and increasing number of firms — both large and small — are pursuing alternative staffing strategies (Table 3).

Chart 12: Prior Year Median Spending on Research Subscriptions

Chart 12: Prior Year Median Spending on Research Subscriptions

As law firms continue to explore ways to further reduce expenses, many are considering the use of universal or standard-size offices, paring back the perk of the super-sized corner office in favor of 150 to 165 sf per associate and partner alike (Table 4). Moreover, in addition to reducing upfront costs by allocating fewer square feet to each attorney, universal office sizes offer the benefit of lower transition costs and less disruption to the work environment; offices no longer need to be physically reconfigured to make room for a newly-promoted partner, for example.

Table 3: Percentage of Firms Employing Alternative Staffing Strategies, by Firm Size

Table 3: Percentage of Firms EmployingAlternative Staffing Strategies, by Firm Size

Table 4: Law Firms that have Moved to Standard Office Sizes

Table 4: Law Firms that have Movedto Standard Office Sizes

Similarly, firms continue to shift their operations — from accounting, HR, information technology and legal support staff — to lower-cost locales (Table 5). Following a search for a place to locate its second global business services center, Hogan Lovells recently selected Louisville, Kentucky for its 31,000 sf operations center, promising to hire 100 people in the Louisville office within the first year at an average of $65,000 (and gradually building a 250-person workforce by year eight) in exchange for an incentive package worth up to $4 million. An added benefit to shifting operations to a “neutral” city is the perception that all offices have access to a firm’s operations staff.

In a sector where individual offices are still the rule rather than the exception, we expect that law firms will occupy increasingly less space in the years ahead and look to extract many of the space efficiencies that other service sector firms have already embraced.

Table 5: Law Firms with Lower-Cost Back Office Operations

Table 5: Law Firms with Lower-CostBack Office Operations

Heidi Learner

Heidi Learner

Ms. Learner analyzes the macroeconomic and legislative environment affecting commercial real estate markets on a national and regional basis and develops real-time measures of supply and demand for commercial space.