Office Fundamentals Started to Slip in Q2 Despite Long-Term Leases

The office sector has been weathering the COVID-19 pandemic better than retail, partly because of protection from long-term leases, but office fundamentals started to slip in the second quarter, according to a new report by REIS, a subsidiary of Moody’s Analytics.

The national office vacancy rate jumped by 10 basis points, ending the quarter at 17.1%. REIS forecasted that the national office vacancy rate will rise to 19.3% by year-end and peak at around 20% in 2021. That exceeds the previous historic high vacancy rate of 19.7% at the peak of the Savings and Loan crisis in 1991, the report said.

Only 3.3 million square feet of office space came to market, compared to a quarterly average of 11.8 million square feet in 2019, because construction slowed markedly, the report said. 

Asking rents fell by 0.1% and effective rents fell by 0.4%, after both had risen by 0.4% in the first quarter before the pandemic hit. REIS projected record declines in rents—down 6.2% for asking rents and 10.5% for effective rents—with a continued slide in 2021. 

Those figures are in line with REIS’s projections last quarter, and “there is little evidence that the recovery will progress much faster than expected,” said the report’s author, Victor Calanog, the head of commercial real estate economics, research and economics for REIS.

Ongoing projections of economic distress will continue to place pressure on the office sector, REIS forecasted. Moody’s Analytics expects GDP to decline by about 6.5% this year—a distress level about 1.7 times greater than during the 2008 to 2009 financial crisis. What’s more, it is transpiring in 12 months instead of 18 months, mostly concentrated in the second quarter, the report said.

Spiking infection rates in southern and western states have created ongoing uncertainty about the pace of economic recovery. Despite some reopening of the economy, employees are in no rush to return to the office without a “credible, reliable vaccine protocol made widely available,” the report said. 

But if the widely predicted trend of companies shrinking their office footprints in favor of remote work comes to pass, it will shake out over the next three to 10 years, because of the long-term nature of office leases, the report said. The average lease term is close to 10 years, according to CompStak, a Moody’s Analytics data partner.

“The longer this situation persists, however, the greater the incentive for companies both big and small to reevaluate their current office footprint and future needs for office space,” the report added.