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The talk of office and its pandemic-powered apocalypse<\/a> might have died down, but the sector\u2019s troubles haven\u2019t. If anything, four years after the pandemic\u2019s onset, office vacancies are growing.<\/p>\n In the second quarter of this year, \u201cthe office sector set a record vacancy rate at 20.1%, breaking the 20% barrier for the first time in history,\u201d a Moody\u2019s analysis<\/a> published today read. \u201cThe slow bleed occurring in the office sector has led to a steady rise in the vacancy rate as permanent shifts in working behavior have outlasted the initial wave of the pandemic four years ago.\u201d<\/p>\n In the prior quarter, as Fortune<\/em> previously reported<\/a>, the office vacancy rate had already reached 19.8%, which was 50 basis points above recessionary peaks recorded in 1986 and 1991, according to Moody\u2019s.<\/p>\n \u201cThe two historic peaks came as a result of underlying macroeconomic conditions,\u201d Nick Luettke, coauthor of the previous analysis and associate economist, told Fortune<\/em> at the time. \u201cThe 1986 vacancy rise came as the result of surging supply with high construction levels, while 1991 came as a result of the previous decade of construction fusing with greater economic uncertainty at the time.\u201d<\/p>\n This time around, as we know, demand plummeted thanks to remote work, but interest rates were an issue, too\u2014the Federal Reserve raised rates multiple times to tame surging inflation that reached a four-decade high in 2022. All commercial real estate is sensitive to interest rates, and after a decade of cheap money, higher rates were especially painful. Still, while interest rates will eventually come down, the issue of demeaning demand, it seems, will remain prevalent.\u00a0<\/p>\n \u201cThe current turbulence in the office sector has a different root cause than previous peaks,\u201d Moody\u2019s said today. \u201cRather than macroeconomic uncertainty, a lasting shift is occurring in the sector as we near equilibrium of working models four years after inflection point of the pandemic.\u201d<\/p>\n Not to mention, Ross Perot Jr., chairman of the Perot Group and Hillwood, once told<\/a> Fortune<\/em>, \u201cit\u2019ll be years before we really understand the damage the pandemic did to the world.\u201d For one, he said, \u201cit broke the habit patterns of millions of people that used to go to work every day in a real office.\u201d<\/p>\n That lack of demand translates to falling rents. In the second quarter of the year, effective rents fell 0.1%, and 0.5% in the last year. Rent growth was positive in 2021 and 2022, but that changed, and rents have been negative or flat for four consecutive quarters, according to the analysis. Meanwhile, net absorption (which essentially refers to the total amount of space that\u2019s been leased, minus the amount of space that\u2019s been vacated for a certain period) was at -13.6 million square feet in the second quarter, the worst it\u2019s been in almost three years.<\/p>\n \u201cThe office sector\u2019s rising vacancy rate highlights the sector\u2019s current struggles, and there\u2019s natural concern over how high the rate will continue to climb,\u201d the analysis read. At this moment, the economy is doing fine on paper, which could be beneficial for offices. Still, \u201cthe future direction and speed of the vacancy rate will hinge on the Federal Reserve\u2019s navigation of the soft landing.\u201d <\/p>\n So far, the Fed seems set to cut interest rates a single time<\/a> this year following hotter-than-expected inflation reports. It\u2019s not clear how much one rate cut would help the office sector, but it faces a much bigger problem of fading necessity\u2014and on that measure, the office world hasn\u2019t fared too well. For its part, Capital Economics predicted office values will fall more than 40% from peak to trough by the end of next year, with no recovery even by 2040 (a more haunting revision from the firm\u2019s prior call). Still, Moody\u2019s head of commercial real estate analysis, Kevin Fagan, once told<\/a> Fortun<\/em>e he expected vacancies to begin to fall after next year.\u00a0<\/p>\n<\/div>\n\n\u2018A lasting shift\u2019 in work habits<\/strong><\/h2>\n
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