* U.S. office vacancy hits 15.9 percent in Q2

* U.S. office rent falls 2.7 percent in Q2

The U.S. office market vacancy rate reached 15.9 percent in the second quarter, its highest in four years and rent fell by the largest amount in more than seven as demand from companies and other office renters remained weak, real estate research firm Reis said Inc.

It's bad, Reis director of research Victor Calanog said. It's decaying and getting worse. Given the depth and magnitude of the recession, you can argue that we are facing a storm of epic proportions and we're only at the beginning.

The weak demand helped push up the average weighted U.S. office vacancy rate 0.70 percentage points during the quarter and 2.7 percentage points compared with a year ago, according to the report released on Tuesday.

Asking rent during the quarter fell 1.4 percent to $28.43 per square foot. Factoring in rent-free months and improvement costs to landlords, effective rent -- the net amount of cash landlords take in -- fell 2.7 percent in the quarter to $23.42 per square foot. The second-quarter drop was more severe than the first quarter's 2.3 percent, dampening hopes the office market is bottoming out, Reis said.

Year over year, rent was down 6.7 percent, the largest one- quarter decline since the first quarter 2002.

This is really only the third quarter that we've experienced negative effective rent growth, Calanog said. Last time, the office sector had four years of negative effective rent growth.

Although the sector has experienced downturns before, the current one may be lethal for lenders and investors who bought property during the boom years of 2005 from 2007. Many of them based the price and the loan on the belief that rents would continue to post strong growth and occupancy increases.

It's like taking on a lot of debt as an individual and now suddenly earning 10 percent 20 percent 30 percent less, he said.

The dwindling cash flow resulting from higher vacancy and lower rent weakens the ability to repay financing and pushes a borrower closer to defaulting on a loan.

The weak second-quarter performance prompted Reis to maintain its February forecast calling for the U.S. office vacancy rate to top out at 18.2 percent in 2010 and for rent to continue to fall through 2011. It also sees the commercial real estate default rate to reach 4.2 percent by the end of the year and peak at 5.2 percent in 2011.

The U.S. vacancy rate was at 12.5 percent in the third quarter of 2007, but has since risen 3.4 percentage points, Reis said.

Of the 79 markets that Reis tracks, vacancy rose in 65 and effective rent fell in 72, indicating the weakness is widespread.

Vacancy in the New York area, which includes all the New York City boroughs except Staten Island, rose 1.2 percentage points to 10.8 percent, the highest since 1996, and effective rent slid 5.2 percent. As far as we can tell for New York, the next two years will be murder, Calanog said.

Boston and Orange County and San Jose California saw rent fall more than 5 percent.

Those results do not bode well for office landlords Brookfield Properties Corp (BPO.TO), Vornado Realty Trust (VNO.N), Boston Properties Inc (BXP.N), SL Green Realty Corp (SLG.N) and Maguire Properties Inc (MPG.N).

About 20 million square feet of office space came on the market than was rented during the quarter, slightly less than the 25.2 million square feet in the prior quarter.

Year-to-date, a net of 45.2 million more square feet of space put onto the market than was rented, on track with Reis' earlier project of about 67.6 million square feet 2009. If the forecast holds true, 2009 will be the worst year for net absorption of office space since Reis began tracking it in 1980. (Reporting by Ilaina Jonas; editing by Andre Grenon)

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