We’ll Know This Year How Badly Office Was Hurt

The hits keep on coming for the struggling office sector, beset by increasingly disrupted migration patterns and corporate location strategies in the wake of the COVID-19 pandemic. The latest piece of dismal news/? Vacancies will likely show their largest increase this year, with marginal increases expected through 2023 as employers shore up return-to-work strategies, and the national vacancy rate matches the last historic high of 19.7% by 2022, according to Moody’s Analytics REIS.

The national office vacancy rate hit 17.7% in the fourth quarter of 2020, a 40 basis point increase over the third quarter and a 90 basis point increase year-over-year. The report notes that the “magnitude of deterioration in occupancy is relatively benign compared to the Great Recession,” when vacancies rose almost 200 basis points in 2008, but predicts that the true impact of the economic downturn is still yet to be seen.

“Vacancies for the office sector will continue to rise even after the economy begins growing at a consistent rate,” the report says. “But few things about this downturn can be called ‘typical,’ and our current outlook suggests that vacancies will incur its largest increase this year.”

The national vacancy rate is expected to rise to 19.4% at the end of the year, peaking at about 19.7% by 2022. This matches the prior historic high set in 1991, at the peak of the savings and loan crisis.

Ultimately, REIS predicts the sector will continue to be under significant pressure, with the greatest risk on the intermediate and long-term horizon. The reality is that many employers are pushing off physical space needs and decisions until late this year or into 2022, and while the debate is still open as to whether WFH is here to stay permanently, it’s likely going to be the norm for the foreseeable future.  And those tenants who are taking space are doing so with a much smaller footprint. 

Asking and effective rents in the sector have given off mixed signals, but are also likely to show signs of distress throughout this year and into 2022. While asking rents fell by 0.2% and effective rents declined by 0.6% in the fourth quarter, asking rents were actually up 0.4% for the year.

The reasons for that anomaly partially lies in supply, which increased over the course of the year with 33.4 million square feet of new office space coming online. But a more likely explanation lies in standard lags: the best example, of course, being the Great Recession, when asking and effective rents for the sector didn’t crater until 2009, after the US economy had already been in full recession for a year.

REIS predicts asking and effective rents will decline by 4.9% and 7.4% this year, respectively, numbers which aren’t record highs but are nonetheless “devastating.”

“There remains much uncertainty as to how secular shifts in office demand will truly impact performance metrics like rents, occupancies, net operating income, and cap rates,” the report states.