SRG - Seritage Growth Properties

[moneyball]

moneyball, what do you think of aviclara's comments on the original VIC writeup?  He/she is pretty good about looking at the short end of things so I'm curious to your thoughts.  I'm not that worried about fraudulent conveyance risk but that risk may pop up in the future if SRG purchases new assets from SHLD. 

 

I sort of look at SRG like a low cost funding vehicle for SHLD, except SRG has a lot of low hanging fruit to capture over the next few years.  I don't think Lampert cares as much about the value of SHLD these days except from the standpoint of keeping them out of bankruptcy.  He's going to have an easier time creating new value for himself in SRG and having SHLD as a cheap call option on the retail business that he seems so fond of being overly involved with.  I haven't looked at the numbers lately but I believe he has more net worth tied up in SRG if you exclude SHLD debt.

 

You almost have to marvel at the financial engineering here and say it might be worth taking another close look at SHLD.  I mean SHLD owners didn't have to put up a lot of capital to buy the assets at $29 (given the difference was made up in debt) and it's already being valued at $49 with Buffett buying stock for his personal account.  I don't think it's a stretch to say SRG could be worth $75 or more in a few years. 

 

If you exclude the way out of the money warrants, SHLD only has a $1.6 billion market cap and can pull this maneuver again if they can keep themselves out of bankruptcy.  I don't know if Lampert has the capital to do it, but another rights offering for more real estate sales could send SHLD back up to $30 within a week of the announcement.  When you look at the current liquidity picture for SHLD it's almost given that they'll need to do that.  What else can they sell at this point now that store closures aren't turning the business cash flow positive?

 

But the bearish side of me knows that Lampert is sitting majority position fulcrum in the 2019 bonds so maybe he just wants to get outside the fraudulent conveyance window given how little capital he has left after the last several rights offerings.  I don't get that vibe off his actions but it's a possibility.

 

Picasso are you asking about my opinion on fraudulent conveyance, specifically? As far as financial engineering goes, I believe the market is just pricing in the fact that the real estate is actually being monetized. I don't view that as financial engineering just more the fact that people think the real estate is worth more under new ownership and is now pricing in future development yield. I for one think it would be insane for a court to believe that SRG's assets are worth a 6 cap on current income under SHLD ownership and I think the appraisals would support that. I mean these projects are highly capital intensive and require years of planning and operational expertise.

[accutronman]

Superb performance today

[moneyball]

Superb performance today

 

I'm just happy I'm finally making some gains on WPG

[accutronman]

A great quarter! And this is why Eddie was so brilliant at creating this stock: "During the first quarter, we signed 214,000 square feet of new leases at average base rents of $32.65 PSF compared to the $6.00 PSF paid by Sears Holdings on a same space basis."

[BTShine]

A great quarter! And this is why Eddie was so brilliant at creating this stock: "During the first quarter, we signed 214,000 square feet of new leases at average base rents of $32.65 PSF compared to the $6.00 PSF paid by Sears Holdings on a same space basis."

 

Yes, it was an excellent quarter.  They are definitely starting with the lowest hanging fruit, which is logical. At some point in the future their psf lease rates will not be this high, but the point where we are signing leases at $10 psf instead of $30 seems pretty far off.

 

 

[mateo999]

I'm just happy I'm finally making some gains on WPG

+1

[Picasso]

I'm just happy I'm finally making some gains on WPG

+1

 

+1

[glorysk87]

I'm a bit late to the party here, but I have a few thoughts/questions/whatever.

 

First, on average rent/sf.  I've seen a few people in this thread say that they're valuing SRG based on an increase in the average base rent/sf to about $8 or $9.  Is this not way too low? Looking at Simon Property Group and GGP respectively, their portfolios run at $49.70 and $61.89 average rent/sf respectively.  Is there that much of a difference in the quality of the assets/locations that justifies the 80% discount to rent that people are assigning?  Or am I just dumb and missing something here?

 

Second - carrying cost of the portfolio.  Does anyone have a handle on this?  If SHLD ends up going into bankruptcy and is able to reject their leases, SRG is suddenly stuck with a few hundred non-cash flow producing properties that they have to carry.  Do we have any idea on the cost just to carry these properties?  While their leverage isn't exceptionally high for a REIT, it does put them in dangerous situation if they lose the cash flow from SHLD.  This is essential in understanding how long they'd be able to survive on their own while retenanting the old SHLD properties.  Not to mention they almost certainly wouldn't be able to pay their dividend under this scenario.

 

Third - what's the cost involved with recapturing and retenanting existing SHLD space?  If they don't spend the requisite money to redevelop the space does it have a negative impact on the rent/sf they're able to attain?

 

These are all very valid questions in my opinion and it doesn't seem that they're being contemplated.  I think the value creation here is enormous if the plan goes off without a hitch. But there are some drastically negative scenarios that I think need to be considered and discounted in the price.  Would appreciate input.

[Guest neiljgsingh]

I'm a bit late to the party here, but I have a few thoughts/questions/whatever.

 

First, on average rent/sf.  I've seen a few people in this thread say that they're valuing SRG based on an increase in the average base rent/sf to about $8 or $9.  Is this not way too low? Looking at Simon Property Group and GGP respectively, their portfolios run at $49.70 and $61.89 average rent/sf respectively.  Is there that much of a difference in the quality of the assets/locations that justifies the 80% discount to rent that people are assigning?  Or am I just dumb and missing something here?

 

Second - carrying cost of the portfolio.  Does anyone have a handle on this?  If SHLD ends up going into bankruptcy and is able to reject their leases, SRG is suddenly stuck with a few hundred non-cash flow producing properties that they have to carry.  Do we have any idea on the cost just to carry these properties?  While their leverage isn't exceptionally high for a REIT, it does put them in dangerous situation if they lose the cash flow from SHLD.  This is essential in understanding how long they'd be able to survive on their own while retenanting the old SHLD properties.  Not to mention they almost certainly wouldn't be able to pay their dividend under this scenario.

 

Third - what's the cost involved with recapturing and retenanting existing SHLD space?  If they don't spend the requisite money to redevelop the space does it have a negative impact on the rent/sf they're able to attain?

 

These are all very valid questions in my opinion and it doesn't seem that they're being contemplated.  I think the value creation here is enormous if the plan goes off without a hitch. But there are some drastically negative scenarios that I think need to be considered and discounted in the price.  Would appreciate input.

 

+1

[moneyball]

I'm a bit late to the party here, but I have a few thoughts/questions/whatever.

 

First, on average rent/sf.  I've seen a few people in this thread say that they're valuing SRG based on an increase in the average base rent/sf to about $8 or $9.  Is this not way too low? Looking at Simon Property Group and GGP respectively, their portfolios run at $49.70 and $61.89 average rent/sf respectively.  Is there that much of a difference in the quality of the assets/locations that justifies the 80% discount to rent that people are assigning?  Or am I just dumb and missing something here?

 

Second - carrying cost of the portfolio.  Does anyone have a handle on this?  If SHLD ends up going into bankruptcy and is able to reject their leases, SRG is suddenly stuck with a few hundred non-cash flow producing properties that they have to carry.  Do we have any idea on the cost just to carry these properties?  While their leverage isn't exceptionally high for a REIT, it does put them in dangerous situation if they lose the cash flow from SHLD.  This is essential in understanding how long they'd be able to survive on their own while retenanting the old SHLD properties.  Not to mention they almost certainly wouldn't be able to pay their dividend under this scenario.

 

Third - what's the cost involved with recapturing and retenanting existing SHLD space?  If they don't spend the requisite money to redevelop the space does it have a negative impact on the rent/sf they're able to attain?

 

These are all very valid questions in my opinion and it doesn't seem that they're being contemplated.  I think the value creation here is enormous if the plan goes off without a hitch. But there are some drastically negative scenarios that I think need to be considered and discounted in the price.  Would appreciate input.

 

I'll be quick because I'm on mobile, but I think that these issues have been addressed here and on the SHLD thread.

 

I'll address one by one:

1.) SRG is not SPG, MAC or GGP. Their assets are more eclectic than the three major A mall reits. Sure they own assets at some of the big three malls, but this comprises only a portion of their assets. See the JPM credit prospectus that I posted a few pages back for details. Looking at a lot of b class malls, standalones, and community shopping centers. Rents here will not be as high esp for anchor tenant spots.

2.) Harder question. If SHLD went bankrupt it would be negative for the REIT as operating costs for the properties don't drop to zero if vacant. (Taxes, maintenance, electricity etc.) But as SRG continues to execute their plan more rents will come from 3rd parties. Look at how much already does. Also in bankruptcy all leases are voided SHLD cannot pick and choose.

3.) I would advise you look at company report and look at development yields. These have been talked about a lot and I think it would be beneficial to look over company presentations and then to look at people's opinions on how yields will play out over time. I think they will fall, cherry picking, a VIC write up from Feb was very optimistic (but maybe too much imo)

 

 

[scorpioncapital]

"In each of the initial and first two renewal terms, annual base rent will be increased by 2.0% per annum for each lease year over the rent for the immediately preceding lease year. For subsequent renewal terms, rent will be set at the commencement of the renewal term at a fair market rent based on a customary third-party appraisal process, taking into account all the terms of the Master Lease and other relevant factors, but in no event will the renewal rent be less than the rent payable in the immediately preceding lease year."

 

Does this mean that in year #3, Seritage and Sears will apply a 3rd party fair market valuation to the leases (assuming Sears is still in business)? Wouldn't that imply a potentially large increase in base rents just for trudging along?

 

 

 

 

 

[glorysk87]

I'll be quick because I'm on mobile, but I think that these issues have been addressed here and on the SHLD thread.

 

I'll address one by one:

1.) SRG is not SPG, MAC or GGP. Their assets are more eclectic than the three major A mall reits. Sure they own assets at some of the big three malls, but this comprises only a portion of their assets. See the JPM credit prospectus that I posted a few pages back for details. Looking at a lot of b class malls, standalones, and community shopping centers. Rents here will not be as high esp for anchor tenant spots.

2.) Harder question. If SHLD went bankrupt it would be negative for the REIT as operating costs for the properties don't drop to zero if vacant. (Taxes, maintenance, electricity etc.) But as SRG continues to execute their plan more rents will come from 3rd parties. Look at how much already does. Also in bankruptcy all leases are voided SHLD cannot pick and choose.

3.) I would advise you look at company report and look at development yields. These have been talked about a lot and I think it would be beneficial to look over company presentations and then to look at people's opinions on how yields will play out over time. I think they will fall, cherry picking, a VIC write up from Feb was very optimistic (but maybe too much imo)

 

1) So what are the appropriate comps here? Anyone have a resource for how to determine accurate market rents? While maybe they can't achieve $50/sf, it still seems to me that $8 or $9 is way too low.  Look at their most recent quarter - SNO leases came in around $24. Any reason that's not sustainable going forward?

 

2) They still have over 70% of their base rent from Sears.  At the current rate, they need Sears to stay solvent for at least a few more years before I'd feel comfortable with the level of diversification of the portfolio. This is my biggest concern currently, as I have no idea what the cost is to carry those properties if Sears goes bankrupt in the next year or so (which is likely).

 

3) I've spent a lot of time going through the presentations. The redevelopments seem pretty expensive to me.  The big concern I have is that it looks like they're quoting yield on cost based on (Incremental Revenue/Cost).  Shouldn't they be using NOI? Otherwise costs aren't taken into account. Unless they're purely triple-net with zero costs associated? Possible. But again, I just don't have the information to make the determination.

[namo]

"In each of the initial and first two renewal terms, annual base rent will be increased by 2.0% per annum for each lease year over the rent for the immediately preceding lease year. For subsequent renewal terms, rent will be set at the commencement of the renewal term at a fair market rent based on a customary third-party appraisal process, taking into account all the terms of the Master Lease and other relevant factors, but in no event will the renewal rent be less than the rent payable in the immediately preceding lease year."

 

Does this mean that in year #3, Seritage and Sears will apply a 3rd party fair market valuation to the leases (assuming Sears is still in business)? Wouldn't that imply a potentially large increase in base rents just for trudging along?

Not at all. You missed the text right above this:

The Master Lease has an initial term of 10 years and contains three options for five-year renewals of the term and a final option for a four-year renewal.

So what you describe would happen in 20 years.

[scorpioncapital]

It did seem too good to be true. In 20 years, it's almost certain the US dollar will be halved!

[peridotcapital]

 

1) So what are the appropriate comps here? Anyone have a resource for how to determine accurate market rents? While maybe they can't achieve $50/sf, it still seems to me that $8 or $9 is way too low.  Look at their most recent quarter - SNO leases came in around $24. Any reason that's not sustainable going forward?

 

 

There are plenty of retail REIT comps that trade publicly. Class B malls like WP Glimcher. Strip centers like Kimco. We are talking average rents in the high teens to mid 20's. That is what you can expect from the average non-Sears tenant.

 

Make some assumptions about the amount of space that SRG can redevelop every year and you can come up with a good approximation of what level of FFO Seritage is going to be looking at 5 or 10 years from now. Then pick a multiple, discount it back to today's dollars and see how it compares with the current price.

 

Another helpful exercise is to assume you wake up tomorrow and Sears has been replaced completely. How would you value SRG if portfolio-wide they were 95% leased at $25/sf tomorrow? Then figure out how many years it will take to get there (hint: a lot) and discount that value back to today.

 

My personal calculations show that while SRG at current prices is not a terrible investment on an annualized basis, it is not a home run either.

[Foreign Tuffett]

Traditional retailers have been performing poorly lately and plan to close stores (GAP, M, plenty of others). I have seen arguments in the media that mall space in particular, and physical retail locations in general, are overbuilt in the US. Anecdotally, my limited experience from observing malls in the Nashville area is that malls can fall into downward spirals very quickly once things start to move in the wrong direction.....sort of an anti-lollapalooza effect. Any thoughts?

I don't follow SRG or SHLD closely, so apologies in advance if this has been covered already.

[glorysk87]

Reading through the 10-k, apparently lease termination fees for the Type 1 properties are capitalized and depreciated over the life of the new lease. Is this typical accounting treatment for a lease termination fee?

 

If so, is the depreciation expense related to the lease termination fees included in the real estate depreciation add-back in calculating FFO?

[glorysk87]

This may be a stupid question.

 

But the value creation in the SRG portfolio appears to be a no-brainer. The real risk is a SHLD bankruptcy before SRG is able to transition most of their portfolio to 3rd party tenants.  So shouldn't it be pretty easy to hedge out the SHLD risk by purchasing long-dated out of the money puts on SHLD? 

[benhacker]

So shouldn't it be pretty easy to hedge out the SHLD risk by purchasing long-dated out of the money puts on SHLD?

 

What do you think you would be willing to pay for this insurance?

 

$13 '18 puts on SHLD are ~$4.50 / share to buy.  So for >30% of the value of SHLD, you can protect a drop for price a bit below the current price.

 

The problem with hedging this is *everyone* wants to be hedging this.  The cost is very high.  borrow on the stock is in the teens, holdco debt yields 15% annually, etc etc etc.

[scorpioncapital]

You might want to look at the single stock future market for this. True, you have to roll over every 6 months but it may be a better deal - https://www.onechicago.com/?p=1018

 

[glorysk87]

 

What do you think you would be willing to pay for this insurance?

 

$13 '18 puts on SHLD are ~$4.50 / share to buy.  So for >30% of the value of SHLD, you can protect a drop for price a bit below the current price.

 

The problem with hedging this is *everyone* wants to be hedging this.  The cost is very high.  borrow on the stock is in the teens, holdco debt yields 15% annually, etc etc etc.

 

I don't agree with you on this. Why would you buy the $13 puts?  The real risk is a SHLD bankruptcy, so you'd want to buy very far out of the money puts.  You could mostly hedge out the risk by buying $5 Jan '18 puts.  That costs about $67k per $1mm of exposure, which isn't too terrible.  You wouldn't have to roll the position either, because by 2018 enough of the SRG portfolio should be redeveloped that the risk of SHLD blowing them up would be greatly diminished.

[peridotcapital]

This may be a stupid question.

 

But the value creation in the SRG portfolio appears to be a no-brainer. The real risk is a SHLD bankruptcy before SRG is able to transition most of their portfolio to 3rd party tenants.  So shouldn't it be pretty easy to hedge out the SHLD risk by purchasing long-dated out of the money puts on SHLD?

 

Or maybe that risk is muted once SRG leases out enough 3rd party space that the profit from those leases covers their interest payments, corporate overhead, and the carry costs of the Sears space. As long as SRG could be at cash flow break-even the day after a Sears liquidation began, I doubt their stock would take that large of a hit given the underlying value of the real estate. Given the rent spreads, that point in time will be here well before they have reached a 50/50 square footage split between Sears and third parties.

[glorysk87]

 

Or maybe that risk is muted once SRG leases out enough 3rd party space that the profit from those leases covers their interest payments, corporate overhead, and the carry costs of the Sears space. As long as SRG could be at cash flow break-even the day after a Sears liquidation began, I doubt their stock would take that large of a hit given the underlying value of the real estate. Given the rent spreads, that point in time will be here well before they have reached a 50/50 square footage split between Sears and third parties.

 

I put together a pretty comprehensive model. My model concludes that SRG needs to have fully half of their portfolio recaptured in order to have any sort of margin of safety.  The timeline for this to happen, at the current redevelopment pace, is the next year and a half. At that point, SRG should have enough of the portfolio turned over that a SHLD bankruptcy wouldn't doom them.  But that still puts you at the end of 2017.  Which is why my thought was to buy the Jan '18 puts for a hedge.  At a cost of $67k per $1mm of SHLD exposure the cost is not significant.

[peridotcapital]

 

 

I put together a pretty comprehensive model. My model concludes that SRG needs to have fully half of their portfolio recaptured in order to have any sort of margin of safety.  The timeline for this to happen, at the current redevelopment pace, is the next year and a half. At that point, SRG should have enough of the portfolio turned over that a SHLD bankruptcy wouldn't doom them.  But that still puts you at the end of 2017.  Which is why my thought was to buy the Jan '18 puts for a hedge.  At a cost of $67k per $1mm of SHLD exposure the cost is not significant.

 

Last quarter they signed new third party leases totaling 214,000 square feet. How on earth can SRG recapture 50% of all the Sears space over the next 18 months?

[glorysk87]

 

Last quarter they signed new third party leases totaling 214,000 square feet. How on earth can SRG recapture 50% of all the Sears space over the next 18 months?

 

On an ABR basis, not a Sq Ft basis. If you're measuring on Sq Footage you're basically missing the entire investment thesis.