Analysis to secure the best available premises –2023

The problem

King & Wood Mallesons (KWM) is a top-tier, global law firm with Australian offices in Sydney, Melbourne, Brisbane, Perth and Canberra, totalling over 27,000 sqm of lettable area. In Sydney, KWM’s head office was the first tenant to occupy the Governor Phillip Tower when the building was completed in 1994.

The current 10-year lease term over 10,500 sqm commenced on 1 September 2016 with an option for a further 5-year term from September 2026 with the rent reviewed to the market effective rent.

During 2022, we reported on the emerging supply and demand dynamics which showed that the impact of COVID on the Sydney office market, had resulted in vacancy rates across all quality grades expanding rapidly.

We anticipated that this trend would accelerate because we were convinced that office usage amongst tenants (workers attending the office) would remain low for longer and the amount of uncommitted new supply and the new future vacancy created by the relocating, pre-committed tenants, would be considerable.

In addition, many of our clients were showing a preference to reduce the size of their premises in exchange for better quality space (a flight to quality). We expected this trend to accelerate, increasing the demand for better quality space.

We were concerned that rising long-term vacancy rates would result in many mooted office development projects (predominately premium grade) being deferred and after we analysed our database of lease expiries for large tenants (>6,000 sqm) in Premium Grade or high Grade A space, we identified an emerging paradox – very high overall vacancy rate with very few available options in Premium Grade and high Grade A space for large tenants.

We recommended that KWM adopt a proactive approach and review its options well ahead of the expiry of the existing lease.

Issues and risks

Working closely with KWM, we identified the following key risks:

• Financial risks – the net cost (all costs), over a 10-year lease term could exceed $300 million (nominal value). A commitment of this nature could materially affect the Firm’s performance, positively or negatively over the long term.

• Operational risks and potential business disruption – being the Firm’s head office, the Sydney office accommodates approximately 900 staff, including key partners and some of the most significant revenue earners. Any disruption to the Firm’s operations could have a significant impact.

• Reputational risks – KWM is one of the top 3 law firms in Australia. Apart from the reputational risk associated with a suboptimal outcome, the Firm has significant commitments in relation to achieving sustainability and other ESG targets.

• Internal disruption – KWM wanted to consult widely amongst the partners while being careful to manage expectations and avoid the internal disruption that an unpopular decision could generate.

• B2B relationships – as a large law firm, KWM had relationships with many of the owners of Prime Grade office buildings in Sydney and maintaining these relationships was an important consideration.

In addition to the risk issues, various performance issues (building leaks) had been identified in relation to the existing building which would need to be addressed if the Firm decided to remain at Governor Phillip Tower.

Like many tenants, KWM had to resolve a new workplace strategy to attract more people back into the office more consistently. Allowing for future flexibility in the workplace (expansion and contraction) became a key issue.

Lastly, KWM was concerned about whether the necessary leverage would be available if it started its new lease procurement process, more than 4 years before the expiry of the lease.

Strategy and tactics

Counsel developed a strategy that addressed the risks and issues and would allow us to develop and apply the best possible leverage in order to achieve the optimal outcome.

The strategy involved developing leverage in the following areas:

• Credible alternatives – despite the timing, well before the lease expiry, it was critical to identify credible alternative options to ensure any leverage could be applied.

• Optics – KWM had an option for a further lease term and the Firm was generally satisfied with the existing office space. If other options could be identified, it was important to ensure all market participants understood that under the right circumstances, KWM would relocate.

• Public vs off market – we were confident that we could identify all of the available options through an off-market process which was also KWM’s preferred approach.

• Confidentiality – the careful management of the release of information is always important in developing leverage.

• Dealing with principals – we have long-standing existing relationships with the owners of all the Prime Grade buildings in the Sydney core. This access allows us to engage accurately and efficiently and accelerates the achievement of the optimal outcome.

• Analysis & modelling – accurate and efficient analysis would facilitate an excellent outcome.

Result

During the process, we successfully developed 6 highly credible options on behalf of our client.

Following the initial due diligence, we eliminated 3 options and proceeded to detailed proposals with the remaining 3. A further option was eliminated and following lengthy, detailed negotiations, KWM signed a new lease to remain at Governor Phillip Tower for a further 10 years.

The outcome we negotiated was 15.4% better on a like-for-like basis compared with KWM exercising the option (with an effective market review).

We achieved an outstanding financial outcome and successfully managed all the significant risks.

• Financial risks

• Operational risks and potential business disruption

• Reputational risks

• Internatl disruption

• B2B relationships

• Building performance issues