US Office Vacancy Rate Hits Highest in Over 3 Decades: Moody’s

A sign is posted on the window of a retail space for lease on June 14, 2023 in San Francisco, California. Photo by Justin Sullivan/Getty Images

Almost one-fifth of offices in the United States were vacant in the fourth quarter, with new office construction last year falling to its lowest level since 2012.

“The national office vacancy rate rose 40 bps to a record-breaking 19.6 percent” in Q4, 2023, according to a Jan. 8 report by Moody’s Analytics. The 40 bps surge “represented the largest quarterly increase since Q1 2021, setting the latest office vacancy 280 bps higher than its pre-pandemic level.” A high vacancy rate is an important business metric as it indicates that conditions are tough for businesses that are likely looking to cut down on office space costs. It can also suggest an oversupply of offices in the market.

The 19.6 percent vacancy rate, the highest in more than 35 years, exceeded the previous record of 19.3 percent, which was set two times.

The first time was in 1986, with the surge driven by “significant inventory expansion” over a five-year period. The second was in 1991 during the savings and loans crisis when almost a third of America’s savings and loans associations failed between 1986 and 1995.

A high vacancy rate is good for renters and bad for landlords, as the latter may have to start offering lower rents and other incentives to secure renters. The report noted that while asking rents rose by 0.1 percent in the fourth quarter, the effective rent declined by 0.3 percent during this period due to “considerably high vacancies.”

Some experts have raised concerns about the high vacancy rate since small banks tend to be the biggest lenders to commercial real estate.

Moody’s calculated that 24.47 million square feet of office space was added through new construction in 2023, which it claims is below its initial estimate. This is also the lowest level of new office construction since 2012.

“With annual inventory expansion currently sitting at 0.54 percent, new Class A properties which offer flexible or smaller configurations are particularly attractive to tenants who decided to keep the physical office footprint for branding, purposeful gathering, training, and collaboration purposes,” it said.

“Suburban offices also fared better due to their proximity to local communities and, in some cases, shorter commute times.”

Moody’s noted that the “permanence of dynamic hybrid models has effectively muted office demand,” referring to the hybrid work-from-home arrangement. As a result, office demand was the “most downbeat” since the Great Financial Crisis of 2007-08.

“Even though 2023 was largely a year of companies and organizations calling people back into the office, we’re not seeing that it’s typically the standard five days a week back,” Nick Luettke, an associate economist at Moody’s Analytics CRE, said in an interview with Axios. “Hybrid models and flexibility [has] really become the name of the game.”

“If the soft landing is pulled off, [vacancy] numbers are probably not going to rise to much higher than this … But if things do take a turn for the worst in 2024, it’ll probably just keep going for much of the year.”

Real Estate Trouble

In an interview with Construction Drive, Richard Branch, chief economist at the Dodge Construction Network, said that high office vacancy rates are going to put “extreme pressure” on the speculative side of the market.

Speculative office construction involves building an office space before securing a tenant’s lease. It represents 65 percent of office activity by dollar value, Mr. Branch said. Dodge forecasts total office construction starts to decline by 6 percent this year.

“In our five-year forecast window, the office market, in our estimation, never gets back to where it was in 2019,” he said. “We continue to believe here that remote and hybrid is going to continue to be a driving force in the employer-employee relationship.”

A July report from consultancy firm McKinsey stated that office vacancy rates have increased in all cities studied as part of the analysis.

Demand for office space has already fallen partly due to an increase in remote work, and also because of a challenging macroeconomic environment, it said.

“Falling demand will drive down value. In the nine cities we studied, a total of $800 billion (in real terms) in value is at stake by 2030 in the moderate scenario. On average, the total value of office space declines by 26 percent from 2019 to 2030 in the moderate scenario and by 42 percent in the severe one.”

Low office vacancy also raises the issue of debt risk. A Dec. 19 report from commercial real estate software firm CommercialEdge predicts that office loan defaults are “set to rise” since demand is down, expenses are up, and values have dipped as many such loans mature over the coming years.

Almost $150 billion in office loans will mature by the end of 2024, with $300 billion maturing by the end of 2026, the report said.

“It’s important to understand that each loan maturation is highly unique to that property, with many variables contributing to the outcome. Given that physical occupancy rates remain stubbornly low, hovering around 50 percent-55 percent, we are paying close attention as this begins to weigh heavier on the end result,” said Peter Kolaczynski, director at CommercialEdge.