US Office Space Vacancies Hit 40-Year High

While the pandemic is partly to blame, the US office market has never recovered from the excesses of the 1980s.

What's going on with the US office market?

The American office market is running into trouble, as workers fail to return to pre-pandemic habits. Office vacancies hit record highs in Q4 2023, according to a report by Moody's Analytics.

The immediate causes? The "new normal" of remote and hybrid work, which companies are embracing as they seek to lower their costs by reducing the physical space they rent. However, the longer-term context is decades of oversupply, resulting from a construction boom in the 1980s.

"Stuck In Limbo"

The report notes that although 2023 ended on a "generally positive macroeconomic note" (especially inflation and labor market strength), commercial real estate is stuck in limbo.

In particular, the office and multifamily sectors were weak, with high interest rates bringing a headwind to new investment and risks to refinancing. As a result, 2023 was the most "downbeat" year for the office sector since the Global Financial Crisis. New construction is at its lowest since 2012.

The national office vacancy rate rose 40 bps to a record-breaking 19.6%, shattering the previous record of 19.3% set twice previously: once in 1986 driven by a five-year period of significant inventory expansion and the other in 1991 during the Savings and Loans Crisis.
Line and bar graph showing office data for Q4 2023

No Systemic Threat?

The rise in vacancies comes as Americans are going back to work, but maintaining some of their pandemic habits. However, this has been a gradual phenomenon, and there has (as yet) been no major impact on the wider economy.

Should the US manage to make the "soft landing" the Federal Reserve has been attempting to engineer, there may be no broader cause for concern. If, however, a recession does materialize, office vacancies could rise further, and fire sales, foreclosures, and bankruptcies could follow. And, while the biggest changes have already occurred, the baseline vacancy rate will now be far higher than it was before 2020.

That is indeed concerning for mid-size to smaller financial institutes which have significant CRE exposures. But so far, Moody’s Analytics CRE does not believe this will become a source of systematic risk for the overall banking system.

Moody's believes that the future holds much greater mixed-space use, as work, entertainment, and retail are combined.

Long-Term Trend

The problems in the office sector are nothing new, stretching back decades. Back in the 1980s, light regulation and cheap land resulted in a large number of new properties being built. The 1990s recession prevented those new offices being filled, and the high vacancy rate has never been addressed; even now, the US vacancy rate is higher than in Europe and Asia.

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