U.S. Office Rents Won’t Return to Pre-Pandemic Levels Until 2026, Says Moody’s Analytics

by Jeff Shaw

NEW YORK CITY — It will take at least five years for office-using companies in the United States to demand enough office space to push rents to pre-pandemic levels, with more short-term pain for office owners on the horizon, according to projections by Moody’s Analytics.

The New York City-based research firm, which is a subsidiary of ratings agency Moody’s Corp. (NYSE: MCO), issued the forecast last week, punctuating its findings with an assertion that U.S. office vacancy would rise to 19.4 percent in 2021.

That figure would represent a 30-year high, surpassing the national vacancy rate of 17.6 percent that occurred in 2010 toward the end of the Great Recession. It would also be the highest national vacancy rate recorded since the 19.7 percent posted during the Savings & Loan Crisis of the early 1990s.

In addition, the report from Moody’s Analytics predicted that the national office vacancy rate of nearly 20 percent would hold equally steady in 2022, while rents would fall much more sharply in 2021 than the 0.7 percent decline they posted in 2020.

Effective office rents are projected to decrease by 7.5 percent in 2021 before recovering in 2022 as companies continue to implement entire or partial work-from-home programs in response to COVID-19. The shift to remote working structures is also likely to deter many office users from moving forward with and office lease renewal or expansion plans they may have had.

“Though we expect the office sector will suffer more severely in 2021 than it did in 2020, the vaccine rollout brings hope for more in-person business later this year and into 2022,” says Barbara Denham, senior commercial real estate economist at Moody’s Analytics.

In terms of specific markets, the report found that office rent declines were likely to be sharpest in Tier 1 markets like San Francisco and New York City. Moody’s Analytics is forecasting negative rent growth of 15 percent and 8.9 percent, respectively, for those markets in 2021. Both of those office markets are likely to bottom out in terms of asking rents in late 2022, the report concluded.

Among the most high-profile companies in either of these markets to recently announce a long-term plan to de-densify its office buildings is Salesforce (NYSE: CRM). The San Francisco-based cloud software provider, one of the fastest-growing companies of the last five years whose workforce now exceeds 50,000, told the Wall Street Journal that it will continue with remote-work programs after the pandemic subsides. Employees who do come into their offices will find their settings vastly altered in terms of density.

According to the Journal, Salesforce expects that in the post-pandemic world, roughly two-thirds of its employees will come into the office one to three days per week. While it’s worth noting that 40 percent of the company’s workforce adhered to this structure before the pandemic, Salesforce executive Brent Hyder said that he “doesn’t believe we’ll keep every [office] space in every city we’re in, including San Francisco.”

The pessimistic sentiment stems in part from a poor finish to 2020. Moody’s Analytics’ fourth-quarter report found that the U.S. office market ended the year with a vacancy rate of 17.7 percent, fueled by some 10 million square feet of negative net absorption in the fourth quarter.

That vacancy rate represents an increase of 40 basis points from the third quarter and an increase of 90 basis points year over year. The fourth-quarter report also stated that effective rents dropped by 0.6 percent during that period.

“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,” conclude the authors of the fourth-quarter report.

Different Sources, Similar Conclusions

As of December 2020, office leasing activity was down by 61 percent year-to-date, according to the VTS Office Demand Index (VODI), which tracks tenant demand for office buildings across the nation via in-person and virtual touring activity.

The index charted national leasing trends over the course of 2020, finding that the most severe drop-off occurred at the onset of the pandemic in the spring, followed by a modest recovery in the summer and more activity in the third quarter, only to close the year on another decline. The VODI synopsis of 2020 did note, however, that the fourth quarter is typically the slowest time for office leasing based on seasonal patterns.

The U.S. office market is still facing tremendous uncertainty in terms of when, what and how a full recovery will take place, notes Simon Rubinsohn, chief economist for the Royal Institute of Chartered Surveyors (RICS), a London-based business valuation and economic research group. Nonetheless, early indicators suggest that an office market rebound will be defined by less density within buildings.

“In our surveys, we’ve asked businesses how much less office space they think they will require based on pandemic-related changes, and the general consensus is somewhere in the neighborhood of 15 percent,” he says. “The comments and feedback we’ve received indicate that high-spec buildings that are better equipped to address health and wellness concerns, as well as environmental sustainability, will be at the forefront of investors’ minds.”

Rubinsohn concurs that office rents across the nation are likely to remain under downward pressure for the next 12 to 18 months, in primary and secondary markets alike. He is, however, encouraged by existing research that supports team usage of physical office space as a means of fostering productive collaboration.

— Taylor Williams

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