Distress On the Horizon For Troubled Office Sector

Distress is finally coming for the office sector, according to a new analysis of first-quarter data by Moodys’ Analytics REIS.

Vacancies soared in the first quarter of the year, with the national rate rising by 40 basis points to end the period at 18.2% and 15.8 million square feet of occupied stock being removed from the market. Asking rents fell by 0.3% while effective rents dropped by 0.8%.

While the COVID recession “may well go down as the shortest recession in history,” because of the forced widespread adoption of WFH practices across a variety of employment sectors, the debate over whether office space will remain relevant rages on.  More than 40% of office-users were working remotely at least part time last year, according to US Bureau of Labor Statistics and Atlanta Fed data.

But this much is clear:  “It appears that distress is finally manifesting in ways somewhat commensurate with the upheaval in the general economy from last year,” according to Victor Calanog, head of Commercial Real Estate Economics at Moody’s Analytics.

While the income side has seen its share of distress, fewer owners are selling at a significant discount, Calanog writes. But REIS isn’t ruling out the possibility of distress on the pricing side altogether: there is, Calanog notes, intermediate to long term risk associated with the shift to remote work policies, and “a lot of uncertainty remains” as the economy slowly claws back to a new normal. But there’s little systematic evidence of fire sales at distressed prices for office properties, he says.

REIS predicts this year will continue to be rough for the office sector, but GDP growth of 5% this year and next will blunt the worst projections for the asset class. That growth, coupled with a spike in jobs both before and after the most recent round of government stimulus and the Biden Administration’s commitment to boosting infrastructure, will buoy office. Vacancies will likely increase for another few years and asking and effective rent growth will remain negative in 2021, but the firm predicts they could turn marginally positive by 2022.

The most recent Moody’s analysis echoes another take from economists Barbara Byrne Denham and Thomas LaSalvia that says a “seismic shift in the demand for square footage is unlikely.” The pair say a lag in CRE market stress will be followed by a “slow and steady return to pre-pandemic rents and vacancy rates.”