According to Moody’s Analytics REIS, office vacancies rose 30 basis points to 17.4% in the third quarter.
Close to 9 million square feet of office space coming online in Q3 helped drive that increase. In 2019, the quarterly average of new office space delivered was 11.8 million square feet.
As vacancies increased, asking rents rose 0.2%, according to Moody’s Analytics. However, effective rents fell by 0.2%.
With long lease terms, office performance usually trails the overall economy. According to Moody’s Investor Services group and CompStak, the average office lease term is 9.1 years in length. With leases larger than 100,000 square feet, that figure rises to over 12 years.
“As such, distress will likely be reflected in staggered ways, depending on the performance metric. We might not see definitive evidence of a decline in demand for office space until much later, if at all, despite widespread speculations about how remote working is likely to have a lasting impact,” writes Victor Calanog, Ph.D., head of Commercial Real Estate Economics at Moody’s Analytics.
Still, the office sector faces pressure. By the end of the year, REIS expects office vacancies to hit 18.0%. Additionally, they will continue to rise for the next two years before peaking at 19.6% in 2023. Since the vacancy rate was 16.8% at the end of 2019, Moody’s says a 270-basis point increase in vacancies over the next four years in the forecast period is “actually relatively mild, compared to the 510-basis point increase that the sector recorded during the Great Financial Crisis.” In Q3 2007, the vacancy rate was 12.5%. Vacancies did not hit their peak of 17.6% until Q1 2011.
REIS projects that asking and effective rents will decline by a record amount of 7.2% and 11.7%, respectively, over the remainder of 2020 through 2021.
As landlords deal with rising vacancies, they could also have to compete with sublease space.
Cushman & Wakefield found that 15 million square feet of total office sublease space was added to the market in the first half of the year. The market experienced a 21.8% increase in total office sublease space, accounting for 1.4% of total office inventory. As the overall space increased, so did the vacancy rate. The US sublease vacancy is 10.5% of total vacancy, which is an increase over the 9.2% posted in Q4 2019.