SRG - Seritage Growth Properties

[scorpioncapital]

Is there a reason they are paying a dividend at all if they use 90% of rental income for redevelopment? Or perhaps that would be the next move if there is some short-term distress?

 

[AJB96]

1. Management confirmed to me that they expect future redevelopment costs to average $100 PSF. It's been higher so far because the King of Prussia Mall is one of the best malls in the country and they demolished the property and rebuilt it. The $100 PSF number doesn't include Santa Monica or the Aventura Mall which will cost more but will also have higher rents.

 

2. This might give a good framework to think about what future signed lease rates may be for the mall properties that SRG ownes. SRG's mall properties are A- on average and are in malls that average sales of $500 PSF. Most the properties are in malls that average sales in the $400-$600 PSF range. This was all confirmed by management. Not counting the JV real estate, SRG has 21.6m in mall sq ft out of a total of 39m sq ft.

 

 

                                  GGP        US Avrg*      Simon Property      Macerich        Taubman Centers      Seritage

Sales PSF                  $588        $400              $620                      $635              $800                        $500

Base Rent PSF            $73          $38                $49                        $54.32          $60.38                        ?

Rent as % of sales      12.4%    10%              8%                        8.6%              7.5%                          ?

 

 

Source:

 

Page 29:

http://api40.10kwizard.com/cgi/convert/pdf/GGP-20160219-10K-20151231.pdf?ipage=10756987&xml=1&quest=1&rid=23&section=1&sequence=-1&pdf=1&dn=1

 

US average mall rents: http://therealdeal.com/issues_articles/the-malls-are-all-right/

 

Simon Property annual report page 51: http://investors.simon.com/phoenix.zhtml?c=113968&p=irol-reportsAnnual

 

Macerich Annual Report page 11:http://investing.macerich.com/phoenix.zhtml?c=80539&p=irol-reportsAnnual&section=Annual%20Reports%20%26%20Proxy

 

Taubman Annual Report: http://investors.taubman.com/investors/financial-information/sec-filings/default.aspx

 

*Data from 2010

[Deepdive]

Yea, it attracts a certain dividend-focused shareholder base, which will allow SRG to use equity as a currency.

[Packer16]

This does sound interesting but isn't a portion of the segment they are playing in (B locations) on the edge of obsolescence?  In speaking with Bruce Flatt, his strategy has been to stay away from B malls (malls you go to just buy stuff versus the A malls which are destinations) as these are the ones that will not survive Amazon and the other online players.  The destination malls are the ones that will continue to do well.  In looking at the mall list, the King of Prussia mall from what I remember from the 1990s is an A mall, however, in the Rochester area mall Greece Ridge is a B mall.  Has anyone gone through the mall list and determined how these malls split out between A & B malls?  TIA.

 

Packer

[peridotcapital]

1. Management confirmed to me that they expect future redevelopment costs to average $100 PSF. It's been higher so far because the King of Prussia Mall is one of the best malls in the country and they demolished the property and rebuilt it. The $100 PSF number doesn't include Santa Monica or the Aventura Mall which will cost more but will also have higher rents.

 

2. This might give a good framework to think about what future signed lease rates may be. SRG's properties are A- on average and are in malls that average sales of $500 PSF. Most the properties are in malls that average sales in the $400-$600 PSF range. This was all confirmed by management.

 

 

                                  GGP        US Avrg*      Simon Property      Macerich        Taubman Centers      Seritage

Sales PSF                  $588        $400              $620                      $635              $800                        $500

Base Rent PSF            $73          $38                $49                        $54.32          $60.38                        ?

Rent as % of sales      12.4%    10%              8%                        8.6%              7.5%                          ?

 

 

 

Let's not forget that 35% of the locations are Kmarts. Developing those is not going to result in tenant sales of $500/sf. The idea that base rent across the entire SRG portfolio will average roughly $40/sf (8% of $500) upon redevelopment seems overly optimistic to put it mildly.

[AJB96]

1. Management confirmed to me that they expect future redevelopment costs to average $100 PSF. It's been higher so far because the King of Prussia Mall is one of the best malls in the country and they demolished the property and rebuilt it. The $100 PSF number doesn't include Santa Monica or the Aventura Mall which will cost more but will also have higher rents.

 

2. This might give a good framework to think about what future signed lease rates may be. SRG's properties are A- on average and are in malls that average sales of $500 PSF. Most the properties are in malls that average sales in the $400-$600 PSF range. This was all confirmed by management.

 

 

                                  GGP        US Avrg*      Simon Property      Macerich        Taubman Centers      Seritage

Sales PSF                  $588        $400              $620                      $635              $800                        $500

Base Rent PSF            $73          $38                $49                        $54.32          $60.38                        ?

Rent as % of sales      12.4%    10%              8%                        8.6%              7.5%                          ?

 

 

 

Let's not forget that 35% of the locations are Kmarts. Developing those is not going to result in tenant sales of $500/sf. The idea that base rent across the entire SRG portfolio will average roughly $40/sf (8% of $500) upon redevelopment seems overly optimistic to put it mildly.

 

You're right Peridotcapital. In my post I was referring to just the mall real estate which is 21.6m sq ft out of 39m in total non JV sq ft. I updated my post to make this more clear.

 

The K-Marts are mostly if not all free standing locations that will end up with lower rent then the mall real estate. Sure many of the K-Marts are probably duds. Even if you assume these properties are never re-leased and rent remains at $4.29 PSF, the remaining real estate leaves a lot of upside. However, many of the free standing locations are very high quality as well. Take a look at the free standing Sears location on Colorado Avenue in Santa Monica just a couple blocks from the water. This is an incredibly valuable property.

 

There is 21.6m in mall real estate (not counting the JV real estate) that is very high quality. This 21.6m sq ft of mall real estate is in malls that are generating average sales of over $500 PSF. Seritage's mall property is class A quality. Seritage owns sq ft in 27 of the top 144 malls in the United States according to the 2016 Goldman Sachs Top Mall List (see page 19 of the Sears presentation attached and the Goldman top mall survey attached). Some of these top malls are the Aventura Mall in Aventura FL, King of Prussia Mall in Pennsylvania, Oakbrook Shopping Center in Oakbrook IL, Natick Mall in Natick MA, Memorial City Mall in Houston TX, Freehold Raceway Mall in Freehold NJ, Town Center at Boca Raton, Yorktown Center in Lombard IL to name a few. Seritage has the right to recapture 50% of the sq ft in all of these properties.

 

I think a rational way to think about what range PSF rents will be after redevelopment is to look at what peers are getting in similar malls which I did in a previous post.

 

The overall portfolio is generating rent of just $5 PSF which is far under market rates. Class B mall properties go for $20 PSF. And we know Seritage's properties are class A on average based on the mall sales PSF. Of course they need to spend a lot on redevelopment to be able to charge these higher rents. Seritage's current stock price implies very little to no value to the under priced leases. So even even if all future real estate goes for $20 PSF, the stock will be a home run. As Buffett says, "I want to be roughly right not precisely wrong."

 

So far they have signed close to one million sq ft at $32.65 PSF. When I became interested a couple months ago when the stock was at $37, that implied a cap rate in the upper 6% range based on current NOI + signed but not yet opened leases. Over time these under priced leases will be recaptured from Sears Holdings as Seritage exercises their recapture rights and Sears cancels leases on unprofitable stores. Those recaptured properties will be redeveloped and re-leased to third parties at higher rates. This is certain to provide a boost to earnings as they re-lease this real estate at higher rates. I'm not paying much of a premium for this opportunity. With reasonable assumptions of recapture, redevelopment costs and re-leasing the real estate at market rates it's not hard to get to the $150+ stock price cited in the Value Investor Club report in 5-7 years.

 

Alex

q1_2016-earnings-release-presentation.pdf

GS_Top_100_malls.pdf

[peridotcapital]

 

You're right Peridotcapital. In my post I was referring to just the mall real estate which is 21.6m sq ft out of 39m in total non JV sq ft. I updated my post to make this more clear.

 

The K-Marts are mostly if not all free standing locations that will end up with lower rent then the mall real estate. Sure many of the K-Marts are probably duds. Even if you assume these properties are never re-leased and rent remains at $4.29 PSF, the remaining real estate leaves a lot of upside. However, many of the free standing locations are very high quality as well. Take a look at the free standing Sears location on Colorado Avenue in Santa Monica just a couple blocks from the water. This is an incredibly valuable property.

 

There is 21.6m in mall real estate (not counting the JV real estate) that is very high quality. This 21.6m sq ft of mall real estate is in malls that are generating average sales of over $500 PSF. Seritage's mall property is class A quality. Seritage owns sq ft in 27 of the top 144 malls in the United States according to the 2016 Goldman Sachs Top Mall List (see page 19 of the Sears presentation attached and the Goldman top mall survey attached). Some of these top malls are the Aventura Mall in Aventura FL, King of Prussia Mall in Pennsylvania, Oakbrook Shopping Center in Oakbrook IL, Natick Mall in Natick MA, Memorial City Mall in Houston TX, Freehold Raceway Mall in Freehold NJ, Town Center at Boca Raton, Yorktown Center in Lombard IL to name a few. Seritage has the right to recapture 50% of the sq ft in all of these properties.

 

I think a rational way to think about what range PSF rents will be after redevelopment is to look at what peers are getting in similar malls which I did in a previous post.

 

The overall portfolio is generating rent of just $5 PSF which is far under market rates. Class B mall properties go for $20 PSF. And we know Seritage's properties are class A on average based on the mall sales PSF. Of course they need to spend a lot on redevelopment to be able to charge these higher rents. Seritage's current stock price implies very little to no value to the under priced leases. So even even if all future real estate goes for $20 PSF, the stock will be a home run. As Buffett says, I want to be roughly right not precisely wrong.

 

So far they have signed close to one million sq ft at $32.65 PSF. When I became interested a couple months ago when the stock was at $37, that implied a cap rate in the upper 6% range based on current NOI + signed but not yet opened leases. Over time these under priced leases will be recaptured from Sears Holdings as Seritage exercises their recapture rights and Sears cancels leases on unprofitable stores. Those recaptured properties will be redeveloped and re-leased to third parties at higher rates. This is certain to provide a boost to earnings as they re-lease this real estate at higher rates. I'm not paying much or any premium for this opportunity. With reasonable assumptions of recapture, redevelopment costs and re-leasing the real estate at market rates it's not hard to get to the $150+ stock price cited in the Value Investor Club report in 5-7 years.

 

Alex

 

Alex,

 

How do you come to the conclusion that the "non-JV" locations average over $500/sf? Given that the GS Top 100 list is entirely $500/sf and up, and more than half of the SRG stores on that list are in the JVs (which are of very high quality), it is hard for me to imagine that the non JV malls could average $500. There are plenty of $300-$400/sf properties included in the lot. Aren't there over 100 non-JV mall locations? You are saying that more than half of those are above $500/sf?

 

Thanks!

 

 

[scorpioncapital]

You know, how bad can owning Seritage be? It's a bit of an inflation play too. I mean you could buy a highly leveraged bank (and Buffett has bought banks too), anything stuffed with financial assets - or you could try for some real estate. Even at 165sq development cost and a $8/sq foot average rent (to be ultra conservative), it's a return of 5%. Use leverage at 2:1 and you are hoping to get something like 10%. If inflation picks up a bit, rents go up but you've redeveloped now when those capital costs have not yet taken off. It's a bit of an invest in today's dollars when those dollars will be worth much less tomorrow. The balancing act with the Sears bankruptcy is a shorter-term hurdle and it'd be interesting to see what kind of a tantrum the market throws. Like they say, you have another good idea at this size and relative safety?

[AJB96]

The data points came from the CEO Ben Schall. If you'd like to verify the numbers you're welcome to reach out to him.

 

I was told by the CEO that the mall properties in Seritage's portfolio are in malls that average sales PSF of $500. The majority of these malls have sales PSF in the $400-$600 range. Seritage owns 21.6m in mall sq ft. The 21.6m sq ft that I referenced in the above post is taken directly from the annual report and it does include their proportional interest in the JVs. I used the correct square feet but referenced it incorrectly. This number comes from page 12 of the Q1 supplement (attached below).

 

It's not hard to independently verify what the CEO is telling me. I count 24 mall properties on the top 100 list that Seritage owns square feet in. The list of top 100 malls is attached and the properties Seritage owns sq ft in are highlighted. The simple average sales per square foot of those 24 malls is $703. The CEO said over the portfolio of 133 malls, the majority of them are malls with $400-$600 in sales PSF. So as I mentioned in the above post, it seems very reasonable that across the mall portfolio of 21.6m sq ft that sales per sq ft average $500.

 

I think the quality of real estate that Seritage owns is higher quality than the market appreciates.

 

Now that I'm on this topic. Through redevelopment, the amount of square feet can and will increase. There is a significant amount of excess acres and oversized parking lots in the portfolio. This is already happening with a planned McDonalds that will go in the parking lot of one of their properties.

 

Alex

 

 

Q1_supplement.pdf

GS_Top_100_malls_highlighted.pdf

[peridotcapital]

The data points came from the CEO Ben Schall. If you'd like to verify the numbers you're welcome to reach out to him.

 

I was told by the CEO that the mall properties in Seritage's portfolio are in malls that average sales PSF of $500. The majority of these malls have sales PSF in the $400-$600 range. Seritage owns 21.6m in mall sq ft. The 21.6m sq ft that I referenced in the above post is taken directly from the annual report and it does include their proportional interest in the JVs. I used the correct square feet but referenced it incorrectly. This number comes from page 12 of the Q1 supplement (attached below).

 

It's not hard to independently verify what the CEO is telling me. I count 24 mall properties on the top 100 list that Seritage owns square feet in. The list of top 100 malls is attached and the properties Seritage owns sq ft in are highlighted. The simple average sales per square foot of those 24 malls is $703. The CEO said over the portfolio of 133 malls, the majority of them are malls with $400-$600 in sales PSF. So as I mentioned in the above post, it seems very reasonable that across the mall portfolio of 21.6m sq ft that sales per sq ft average $500.

 

I think the quality of real estate that Seritage owns is higher quality than the market appreciates.

 

Now that I'm on this topic. Through redevelopment, the amount of square feet can and will increase. There is a significant amount of excess acres and oversized parking lots in the portfolio. This is already happening with a planned McDonalds that will go in the parking lot of one of their properties.

 

Alex

 

 

 

Okay, including the JVs I think the $500 average makes a lot more sense. It just did not seem plausible that it could be that high without those 31 stores, given how high quality the JV properties are.

 

I'm interested in getting long this stock and admittedly missed an opportunity already when it was in the 30's. I agree that the portfolio is better than many believe. I am just trying to get comfortable with the current multiple (~21x FFO including all signed leases). I am hesitant because that is at/slightly above the current multiples for MAC/GGP/SPG and I feel like I want to get some sort of discount to those best in class mall owners. Of course, SRG will likely be growing NOI faster than that trio. So then it really comes down to whether I think they can grow NOI at a fast enough rate to compensate for the fact that multiple expansion from here would seem unwarranted (and if rates rise and/or mall traffic starts to fall faster, the mall companies would likely see multiples contract across the board).

 

Anyway, I'll stop rambling... thanks for the insight!

[handycap5]

Has anyone confirmed there is no risk of fraudulent conveyance if Sears goes bankrupt?

 

Thanks.

[accutronman]

Read the VIC article referenced in the second post of the first page of this thread regarding fraudulent conveyance

[Steven B]

Thanks for the analysis guys.

 

I think it's not a question if Seritage will be worth substantially more, it's just a matter of when. However the when is pretty important. I'm not sure what the gross absorption numbers are or how fast they can redevelop these things but I'd venture to say this will be a pretty long project. It seems like the run rate is 1-2M sqft annually. Couldn't get much more from management than "we're committed to realizing the value of our portfolio", so I'm not exactly sure what the timeline is. 

 

This seems much different than Buffet's NYC RE venture in the 90s. 10% unlevered yields (don't think he's referring to Cap Rate), mismanaged building with quick ways to add value, 20% of rent will be boosted almost 10x within ten years without putting in a penny, not having a bankruptcy risk as your main tenant and oh did I mention the building is in NYC (adjacent to NYU)? That sounds like a no-brainer. This, while I won't say is a no-brainer, should yield a very decent 8-12% return for a long time, with possible upside depending on timelines and such. It makes a ton of sense for someone like Buffett.

 

How are they financing all these redevelopments? Don't think it has been discussed but curious to get everyone's take.

 

Alex, thanks for sending me into a one hour rabbit hole with those links a few pages back. Very enjoyable!

[glorysk87]

Steven B - I'd caution you on calling it a no-brainer.  SRG is currently reimbursed by Sears for all property operating expenses and real estate taxes.  If Sears goes bankrupt, those costs get directly passed to SRG. They're not insignificant. By my estimates, having to cover those costs would immediately cause SRG to be generating negative cash flow.

[moneyball]

This does sound interesting but isn't a portion of the segment they are playing in (B locations) on the edge of obsolescence?  In speaking with Bruce Flatt, his strategy has been to stay away from B malls (malls you go to just buy stuff versus the A malls which are destinations) as these are the ones that will not survive Amazon and the other online players.  The destination malls are the ones that will continue to do well.  In looking at the mall list, the King of Prussia mall from what I remember from the 1990s is an A mall, however, in the Rochester area mall Greece Ridge is a B mall.  Has anyone gone through the mall list and determined how these malls split out between A & B malls?  TIA.

 

Packer

 

Just a quick counter point as Brookfield did buy Rouse (Firmly B-Class Malls) by buying the portion of the company they didn't own.

[moneyball]

Is there a reason they are paying a dividend at all if they use 90% of rental income for redevelopment? Or perhaps that would be the next move if there is some short-term distress?

 

Just REIT regulations. Just because they reinvest the cash does not mean they do not have to pay out dividends. 90% of all net income (read not cash flow which is better approximated by FFO/AFFO) has to be paid out in the form of dividends.

[scorpioncapital]

Is there a reason they are paying a dividend at all if they use 90% of rental income for redevelopment? Or perhaps that would be the next move if there is some short-term distress?

 

Just REIT regulations. Just because they reinvest the cash does not mean they do not have to pay out dividends. 90% of all net income (read not cash flow which is better approximated by FFO/AFFO) has to be paid out in the form of dividends.

 

I looked at Seritage financial supplement for the last 4 quarters (sine July 2015) and they have not had any net income at all. It's been a cumulative net loss of $30 million. Yet they are paying $1 per share dividend. Does this mean this is a voluntary dividend from cash-flow or cash on hand that is not legally required to be paid?

[thinkpad]

As far as I understand the legal details for REITs, SRG don't have to pay a dividend.

As a shareholder I would prefer they keep this cash to redevelop their properties...

 

[glorysk87]

Re: the dividend discussion - REITs generally have to strike a fine line. Often they have no net income, so legally they're not required to pay a dividend. However, if they pay out nothing, REIT investors shun the company and they lose out both in terms of liquidity and share price, which significantly increases their cost of equity.  Much of the time it is beneficial to pay a dividend just in order to keep the investor base satisfied.

 

I wish they could retain all cash as well, as I think it would be best for the company. However if they were to do this I believe a lot of shareholders would disappear, negatively impacting their share price and cost of equity.

[Mephistopheles]

Re: the dividend discussion - REITs generally have to strike a fine line. Often they have no net income, so legally they're not required to pay a dividend. However, if they pay out nothing, REIT investors shun the company and they lose out both in terms of liquidity and share price, which significantly increases their cost of equity.  Much of the time it is beneficial to pay a dividend just in order to keep the investor base satisfied.

 

I wish they could retain all cash as well, as I think it would be best for the company. However if they were to do this I believe a lot of shareholders would disappear, negatively impacting their share price and cost of equity.

 

In this case, it's majority owned by shareholders who I'm sure would rather have them retain the money as well - and would love the stock to go down. So I don't get why they need to have the dividend.

[benhacker]

REITs payout rules are based on taxable income (IRS) and not GAAP net income. 

 

I'm not sure without some expertise here, that you could tease out what their payout is required to be...

[alpha asset strategies]

http://seekingalpha.com/article/3985666-sears-almost-checkmate-must-pawn-stores-stay-game

 

Brad Thomas - a top-rated financial blogger / analyst who specializes in REITs - is actually advising to short SRG.  The primary issue of course is the highly uncertain future of its main tenant, SHLD.  Also, SRG has had a very nice run since Buffett's investment was made public.

 

I'm not sure what to make of this recommendation, but Brad Thomas does have an excellent track record:

 

https://www.tipranks.com/bloggers/brad-thomas

[glorysk87]

I've followed Brad Thomas for quite a long time. I have been very unimpressed. He doesn't seem to have any deep or critical thinking ability. He's very good at analyzing REITs based on their financial metrics, but when it comes to anything even remotely complex, he's totally lost.

 

There have been numerous examples where he's recommended REITs but completely and utterly missed important red flags. If you read his articles he almost NEVER does any of his own modeling or analysis. He simply copies and pastes stuff from either sell-side reports or other third party research. He tends to take things at face value, and simply parrots them back to his readers. (note, all of his exhibits in the SRG article are from B&S Research)

 

His decent track record comes from the fact that he almost exclusively writes about very conservative safe REIT investments, and started making his picks at the end of 2010.  Very hard to lose money over that time frame in REITs especially when focusing on safety/preservation of capital rather than absolute return.

 

He doesn't have a very strong background. IMO he's exceedingly average and has no real specialized knowledge in the space. So take that for what it's worth.

[alpha asset strategies]

I've followed Brad Thomas for quite a long time. I have been very unimpressed. He doesn't seem to have any deep or critical thinking ability. He's very good at analyzing REITs based on their financial metrics, but when it comes to anything even remotely complex, he's totally lost.

 

There have been numerous examples where he's recommended REITs but completely and utterly missed important red flags. If you read his articles he almost NEVER does any of his own modeling or analysis. He simply copies and pastes stuff from either sell-side reports or other third party research. He tends to take things at face value, and simply parrots them back to his readers. (note, all of his exhibits in the SRG article are from B&S Research)

 

His decent track record comes from the fact that he almost exclusively writes about very conservative safe REIT investments, and started making his picks at the end of 2010.  Very hard to lose money over that time frame in REITs especially when focusing on safety/preservation of capital rather than absolute return.

 

He doesn't have a very strong background. IMO he's exceedingly average and has no real specialized knowledge in the space. So take that for what it's worth.

 

glorysk87-

 

I have not researched SRG much at all and have no position.  As such, I have a few questions:

 

1.  Do you think SRG will face a funding gap - as Brad Thomas indicates?

 

2.  If there is a funding gap, do you think they will handle it via additional borrowing or by issuing equity?

 

Thanks!

[glorysk87]

I mean. Brad's whole "analysis" is based on the assumption that SHLD will put the maximum allowable properties to SRG every year.

 

He's saying that he thinks SHLD will vacate 7mm sq ft and put the properties back to SRG *next month*. If you operate under that assumption then of course they'll face a funding gap.  But that's an extreme assumption and I'm not sure it's based in reality.

 

I dunno. The whole article is rife with this whacked out doomsday assumptions. It's not a rational way to look at the company.