3 Commercial Real Estate Stocks for the Growing Space Glut

Residential apartment blocks converging in the center

COVID-19 has forced the shuttering of America’s businesses like never before. To fill the void, companies are having to get creative. These 3 commercial real estate stocks could be part of the solution.

Raise your hands if you’ve gone from an office worker bee to a telecommuter! According to the latest Gallup Poll, today 33% of U.S. workers are always working remotely, and 25% are sometimes working from home.

The overlying reason for those statistics is, of course, COVID-19. And while most of us remote workers—as well as our companies—love the flexibility and the cost savings of working from home, there is one industry that is in crisis mode: commercial real estate.

There is now more vacant commercial space dotted across the country than ever before. The crisis started before the coronavirus, as the rise of e-commerce pushed scads of retailers into shuttering stores or even into bankruptcy, including Pier 1, A.C. Moore, Barneys New York, Abercrombie & Fitch, the Gap, GNC, Gymboree, J. Crew, and Macy’s. CoStar Advisory Services says that 10,200 stores closed in 2019.

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Then the pandemic hit, and the biggest names started falling, with bankruptcies from Neiman Marcus, J.C. Penney, Lord & Taylor and Brooks Brothers. In August, CoStar estimated that at least 7,700 more stores with 115 million square feet of commercial real estate were expected to close in 2020.

The spring shutdown then led to the temporary closure of pretty much all brick-and-mortar retail, restaurants, hotels, and office buildings. Many of those businesses won’t survive; those that do manage to remain operating are finding that telecommuting is working for them, so they won’t need as much space in the future.

Result: thousands of buildings and millions of square feet of commercial space will be on the auction block. Estimates are that in New York City alone, hotel closings will result in 25,000 vacant hotel rooms. The American Hotels & Lodging Association projects that almost 25% of hotels in this country may face foreclosure. And CoStar predicts that 172.7 million square feet of Class A office space (usually the highest quality) will come online this year and next.

The question is, what to do with all that space?

How Companies are Filling the Space

Well, you may have heard that we are in a housing crisis. Demand far outstrips supply right now. One solution for the commercial space glut could be to turn some of that space into affordable housing. In fact, last July, that’s exactly what U.S. Housing and Urban Development Secretary Ben Carson suggested. Commercial real estate company Avison Young estimates that as much as 10-20% of office buildings could potentially be repurposed for housing. In fact, we are already seeing that happening.

A recent article in Forbes noted that a small Days Inn Hotel in Branson, Missouri was recently converted from 423 hotel rooms to 341 multifamily affordable units. In Jacksonville, Florida, 103 hotel suites are being converted into housing units by Strata Equity Group. The 676,000 square feet in Manhattan, left after Lord & Taylor went under, is being renovated to accommodate 2,000 Amazon office workers. And in Hollywood, DJM Capital Partners, along with private equity firm Gaw Capital Partners, is turning 100,000 square feet of space at the Hollywood & Highland, a Hollywood entertainment complex, into “creative” office space.

For the renovators, this space glut comes at a much smaller price than building from scratch.

A 2016 report from the National Trust’s Research and Policy Lab compared the cost of new commercial development versus reuse of an existing building. Per square foot, the new development cost about $92, while reuse was estimated to be about $37 per square foot of an existing building. Project management firm Cumming reports that new residential construction in the U.S. averages $225 to $350 a square foot, compared with $150 to $200 for an office-to-residential conversion. For industrial construction, a retail-to-industrial conversion costs $75-$175 per square foot, vs. a new project that can cost $125 to $250 a square foot.

We know who the losers of this trend are—the companies that own all that space. But the winners are going to come from a variety of industries: real estate firms, builders, contractors, and suppliers.

It’s tough to pinpoint the winners among these sectors, but here are some companies to consider that could possibly participate in this windfall of renovation:

3 Commercial Real Estate Stocks to Consider

CBRE Group, Inc. (CBRE) – EPS of $0.73 last quarter, vs. estimate of $0.42

Jones Lang LaSalle Incorporated (JLL) – EPS of $2.99 last quarter, vs. estimate of $1.25

Cushman & Wakefield plc (CWK) – expected to grow 62.3% next year

I also think some of the apartment REITs will be worth watching. I’ll discuss those in my next column!

Nancy Zambell

Secure Your Financial Freedom

Nancy Zambell, Chief Analyst of the Financial Freedom Federation, has spent more than 30 years helping investors navigate the minefields of the financial industry. Nancy's book, Make Money Buying & Selling Stocks is an introduction for new investors and a reminder for experienced investors on how to profit in the stock market.

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