SRG - Seritage Growth Properties

[HalfMeasure]

New 8K - Sears terminating leases on 19 stores or 1.9m sqft. Anyone know if this is incremental to the terminations announced in September, or an updated number? Any idea how to get lookthrough into which locations were terminated?

[Picasso]

Seems likely that SRG will do some kind of rights offering to buy more assets off SHLD.  I'll be curious if Buffett participates in that kind of situation.

 

It will be hard for anyone else to buy SHLD properties ahead of the potential for massive supply hitting the market.  SRG has some interest in keeping SHLD as a viable tenant for a couple more years so I imagine they would be the highest bidder for anything getting peeled off SHLD.

 

That loan to SRG was surprisingly expensive too.  These cash commitments from ESL are really adding up...

[SlowAppreciation]

The aggregate annual base rent at these stores is approximately $5.9 million, or 2.7% of the Company’s total annual base rent

[CorpRaider]

Seems likely that SRG will do some kind of rights offering to buy more assets off SHLD.  I'll be curious if Buffett participates in that kind of situation.

 

It will be hard for anyone else to buy SHLD properties ahead of the potential for massive supply hitting the market.  SRG has some interest in keeping SHLD as a viable tenant for a couple more years so I imagine they would be the highest bidder for anything getting peeled off SHLD.

 

That loan to SRG was surprisingly expensive too.  These cash commitments from ESL are really adding up...

 

Yeah the loan was puzzling to me too.  They couldn't arrange more attractive (or equivalent) financing from an unrelated party?  I don't get what he's playing at.  You would think he wouldn't be that eager to lend even more $$$, especially if it wasn't required.  Agree, sort of always figured some dilution was coming down the pike (perhaps a couple of tranches) and waiting for that and/or SHLD filing to really look at getting long. 

[beaufort]

"You would think he wouldn't be that eager to lend even more $$$, especially if it wasn't required."

 

My guess is that the money is required.  We just don't know it yet.

 

 

[Picasso]

I actually think there's a way for SRG to issue equity and buy SHLD properties in a way that is good for both SRG and SHLD.  If it's done in a way similar to the current master lease, then I'd say maybe not that great.  But if they're getting the ability to take 100% instead of 50% with various termination fees on better development yields, then you could say that SRG is an entity that can pay a bit more for these assets.  1) it would drive returns at SRG (and Lampert would benefit through his portion of a rights offering), 2) it would give SRG more time to work on the existing redevelopment (they clearly need more time to avoid triggering debt yield covenants), 3) anything credit positive at SHLD (such as large asset sales) is a positive for SRG (at least for the next couple or few years).  So say Lampert puts up a block of assets for sale, SRG could easily be the highest bidder, it's very possible that SRG would react favorably to this, any rights offering would be oversubbed and Lampert wouldn't need to foot the bill for another $1 billion on his own.

 

It might better explain the harsh unsecured loan to SRG.  Without ESL backstopping with asset sales or redevelopment capital it's hard to get anyone else to participate or jump in the water first.  Part of me thinks this unsecured loan would make me nervous as an equity holder of SRG, the other part of me thinks its just the first step to a more positive transaction.

 

Plus Lampert's incentives are now moving closer into the debt of SHLD and equity of SRG.  SHLD equity has become a call option (just based on $ value at ESL) and it's clear that he's got much more capital in other assets that are more reliant on the passing of time and slowing the bleed.  Will be interesting to see what happens.

[HalfMeasure]

I actually think there's a way for SRG to issue equity and buy SHLD properties in a way that is good for both SRG and SHLD.  If it's done in a way similar to the current master lease, then I'd say maybe not that great.  But if they're getting the ability to take 100% instead of 50% with various termination fees on better development yields, then you could say that SRG is an entity that can pay a bit more for these assets.  1) it would drive returns at SRG (and Lampert would benefit through his portion of a rights offering), 2) it would give SRG more time to work on the existing redevelopment (they clearly need more time to avoid triggering debt yield covenants), 3) anything credit positive at SHLD (such as large asset sales) is a positive for SRG (at least for the next couple or few years).  So say Lampert puts up a block of assets for sale, SRG could easily be the highest bidder, it's very possible that SRG would react favorably to this, any rights offering would be oversubbed and Lampert wouldn't need to foot the bill for another $1 billion on his own.

 

I guess the question would be how much SRG can pay before it gets dilutive, and how much debt they can put on the assets they would be buying and at what cost. The problem would be that they would need capital not just to buy the assets but also to redevelop the assets immediately if they recapture 100% immediately.

[scorpioncapital]

I think in any investment if you don't invest , you are returning capital, eventually it catches up and you're in run-off. Guess what we have here is at least the possibility of an opportunity to invest in development,  somewhere where large amounts of capital can be put to work. I see it as no sin to raise money to invest, depending on the price of the offering and the prospects of the investment. It may be that in the final analysis all will hinge on the success of redeveloping large amounts of space in former malls and retail spots and the new properties being successful, whether they end up being retail or something else. Apparently it was worth a bet of about 1/10th of 1% of Buffet's wealth...Is it worth your bet?

[BTShine]

CBRE gave an update on U.S. Retail Real Estate last month:

 

http://www.cbre.us/research/2016-U-S-Reports/Pages/Q3-2016-US-Retail-MarketView-Snapshot.aspx

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Q3 2016 U.S. Retail MarketView Snapshot

 

December 8, 2016

 

Despite the highest GDP growth recorded in two years, consumer sentiment showed a slight decline in Q3. This drop, though small, is partly attributed to uncertainty during the run-up to November’s presidential election.

 

Total retail and food service sales increased by 2.5% year-over-year in Q3 2016. Core sales, which exclude gasoline stations and motor vehicle & parts dealers, grew at a higher 3.5%. However, both indices showed a slight deceleration from the growth seen in Q2.

 

Demand for retail space throughout the nation remained steady in Q3, with 16.9 million sq. ft. of positive net absorption. Year-to-date, absorption totals 55.7 million sq. ft. —8% higher than the same period in 2015.

 

Retail completions remain subdued since the recession nearly eight years ago. However, the rolling 12-month total had been on a continuous upward trend between Q1 2011 and Q1 2016.

 

The overall U.S. retail market has seen availability either drop or stay the same for 23 consecutive quarters. The last time overall availability increased was in Q1 2011 when it was near the peak of 10.1%.

 

The U.S. has now experienced 11 consecutive quarters of positive year-over-year rent growth. Net asking retail rent averaged $16.44 per sq. ft. nationally in Q3—up 4.1% from Q3 2015 and 7.3% from the cycle low of $15.32 per sq. ft. in Q4 2013.

 

Acquisitions of U.S. retail properties remained very active in Q3, but at slightly lower levels compared with last year and earlier in 2016.

 

The healthy labor market and increased traction in wage and income growth are boosting consumer confidence, which bodes well for continued improvement in U.S. retail market fundamentals.

[CorpRaider]

It seems like Macys and BAM are going to be dumping a lot of SF on the market too.  I really can't see why a department store would exist anymore unless it is in a convenient urban location (you know like they were originally).

[Gregmal]

It seems like Macys and BAM are going to be dumping a lot of SF on the market too.  I really can't see why a department store would exist anymore unless it is in a convenient urban location (you know like they were originally).

 

Yup. I've long loved and followed the SHLD story. SRG was basically the crux of the story being put into a safety asset. I've wanted to own this forever but the things you mentioned and the overall secular decline for the entire retail sector makes this hard to really leap at. It long been my personal take that the day SHLD files for bankruptcy will be within a 6 month window of when the optimal time to initiate a SRG position occurs. But the developments with M & Co could mean even more of the same type of asset coming to market all around the same time, which gives me further pause.

[dutchman]

Peridotcalital you were regretting having missed this in the 30s.  Are you buying here?  I guess shld bankruptcy could introduce some unknown unknowns.

 

[KJP]

Why do people like this more than/why does it generate so much more interest than Howard Hughes? 

 

Put another way, why are people more interested in the opportunity to invest a lot of capital into Sears' collection of real estate, as opposed to Howard Hughes' assets, e.g., Ward Village, the South Street Seaport, the Woodlands and Columbia, MD?

[KCLarkin]

Why do people like this more than/why does it generate so much more interest than Howard Hughes?

 

I'm not a fan of real estate plays. But isn't the thesis for SRG pretty simple? Sears is paying below market rents. Eventually, these assets will be re-let at market rates. A bit similar to buffett's real estate near NYU?

 

HHC might be more attractive, but the thesis is more complicated.

 

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Here, too, the analysis was simple. As had been the case with the farm, the unleveraged current yield from the property was about 10%. But the property had been undermanaged by the RTC, and its income would increase when several vacant stores were leased. Even more important, the largest tenant -- who occupied around 20% of the project’s space -- was paying rent of about $5 per foot, whereas other tenants averaged $70. The expiration of this bargain lease in nine years was certain to provide a major boost to earnings. The property’s location was also superb: NYU wasn’t going anywhere.

[Mephistopheles]

I don't see SHLD going bankrupt any time soon. Lampert will continue with asset sales/provide financing which will keep it afloat for the medium term, by when hopefully SRG has enough in commitments to be break even without the SHLD rent.

 

The big risk imo is the simultaneous closings of stores across the country: SHLD, Macy's, Kohl's, WMT, everything. It's likely that the class B and C properties of SRG will suffer quite a bit as a result. The real value is in the class A properties which are still very strong.

[KJP]

 

I'm not a fan of real estate plays. But isn't the thesis for SRG pretty simple? Sears is paying below market rents. Eventually, these assets will be re-let at market rates. A bit similar to buffett's real estate near NYU?

 

HHC might be more attractive, but the thesis is more complicated.

 

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That may be a concise statement of the SRG thesis, but it glosses over significant complexity.

 

Both SRG and HHC are development plays that will stretch over decades.  So, at a very high level, what's actually easier to assess:  (i) the effects of a potential SHLD bankruptcy and estimating demand and "market rents" for Sears-type assets sprinkled all over the country over the next 10-20 years, or (ii) whether, over the next 20 years, there will be continued demand for housing and office/retail space in Honolulu, a high-end Houston suburb (which is entirely controlled by HHC), a very high-end Las Vegas suburb, and a small city midway between Baltimore and DC, along with continued demand for access to the South Street Seaport?

 

I think (ii) is actually easier to understand and assess than (i).  I'm not saying HHC will definitely turn out to be a better investment than SRG.  I'm just surprised that people interested in long-term development plays aren't more interested in the company that appears to have much better assets.

 

EDIT:  Also, regarding your Buffett example, aren't HHC's assets more like being "next to NYU" than the Sears/SRG assets? 

 

And you may be right that all real estate plays are somewhat dubious, because the underlying return to investors depends in part of how fast the assets are developed, which is impossible to predict accurately when you're talking about developments/land sales over decades.  But given that fact, isn't it even more important to favor the assets that are most likely to continue to appreciate over time ( e.g., oceanfront land in Honolulu, South Street Seaport) versus real estate assets in flux (malls)?

[KCLarkin]

Both SRG and HHC are development plays that will stretch over decades.

 

I think the issue is that the HHC portfolio is more eccentric. Mixed-use. Suburbs. Downtowns. Hawaii. Vegas. The Seritage portfolio is more uniform and therefore simpler to understand.

 

So, back to your original question. Why does SRG generate more interest than HHC? Because it is easier to understand. With HHC, you need to analyze property by property. With SRG, I think you could get pretty far just making some portfolio-level assumptions.

 

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The other obvious reason why SRG attracts interest is that Buffett bought it in his PA.

[KJP]

 

I think the issue is that the HHC portfolio is more eccentric. Mixed-use. Suburbs. Downtowns. Hawaii. Vegas. The Seritage portfolio is more uniform and therefore simpler to understand.

 

So, back to your original question. Why does SRG generate more interest than HHC? Because it is easier to understand. With HHC, you need to analyze property by property. With SRG, I think you could get pretty far just making some portfolio-level assumptions.

 

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The other obvious reason why SRG attracts interest is that Buffett bought it in his PA.

 

Fair enough.  It may indeed take five spreadsheets rather than one for some investors to feel comfortable with HHC, and the Buffett point is undoubtedly true.  But I do believe the "portfolio-level assumptions" being made for SRG are sweeping a fair amount of complexity under the rug, and that HHC's assets are better. 

[scorpioncapital]

It feels like loans to SHLD are subsidizing SRG via the rental income. If that stops, then the loans that were given to SHLD can shift to SRG and indeed we see that happening with the 200m loan @ 6.5% to SRG directly.

 

The only issue with the argument of below market rents moving to market rents is that this opportunity would be available to anyone who decides to start a REIT, close their retail operations and redevelop their properties (e.g. Macy's/Brookfield). The $4/square foot benefit would seem to only occur if Seritage was sold those properties at a valuation that reflected that low price, otherwise with the redevelopment cost (which presumably others will have to pay as well) then everyone is aiming for higher rents...Also the $4/square foot or $150m per year seems such a small amount compared to the 2-3x higher market rent that the real cost is the redevelopment. Let's hope interest rates stay low enough so that construction costs don't skyrocket.

 

However commercial real estate is a decent inflation hedge and provides current income.

If disinflation is the status quo, concentration costs should be reasonable and if inflation takes hold the asset value should increase but not sure if it will increase faster than the construction costs.

[peridotcapital]

Peridotcalital you were regretting having missed this in the 30s.  Are you buying here?  I guess shld bankruptcy could introduce some unknown unknowns.

 

Funny you should ask... I began initiating positions yesterday when it dipped below $40. Lots of moving parts to the story that require close observation (obviously), so I am not diving in too aggressively, but with a "3" handle it starts to get interesting (~15x FFO based on signed leases).

[peridotcapital]

Why do people like this more than/why does it generate so much more interest than Howard Hughes? 

 

Put another way, why are people more interested in the opportunity to invest a lot of capital into Sears' collection of real estate, as opposed to Howard Hughes' assets, e.g., Ward Village, the South Street Seaport, the Woodlands and Columbia, MD?

 

I think the higher level of interest on this site is just due to SRG being related to the Sears/Eddie Lampert story, which many here find so remarkable/fascinating/shocking/disturbing/etc.

 

I have owned HHC since 2013 and I would certainly not say that SRG has better assets... I'm not sure anyone would claim that. SRG is easier to analyze because we know exactly what the properties are and they are quite similar. So we take a $15 or $20 average rent, or whatever you want to use, and it's pretty simple to discount back cash flows over 10 or 20 years.

 

HHC is different because we really don't know what they are going to build in the future. What will HHC's operating asset NOI be in 10 years? Who the heck knows. Sure, some people are assuming they build 1 condo tower a year for a decade in Ward Village (or whatever they plug into their DCF model), but the degree of confidence in that sort of guesswork is probably quite low given the outside factors that will influence build-out plans.

 

But I guess your main question is, if HHC has better assets, a great balance sheet, and what appears to be a solid management team, why even bother with SRG if you are interested in long-term real estate development stories? To me, it's the valuation. I might be willing to pay up a little for HHC's assets, but at the right price, SRG might look attractive too even if the assets are worse. It's all about what you are getting and what price you paying, right?

 

SRG: $2.2B equity/$3.3B E/V

 

HHC: $4.3B equity/$5.9B E/V

 

Including signed leases, Seritage's annualized FFO  is pushing $150M.

 

Howard Hughes is projecting 2019 NOI of $220M ex-SSSP. Let's call it $300M all-in. You would get roughly the same FFO ($150M) in 2019 using current interest and G&A run-rates.

 

So there's a clear valuation gap between the two. I would argue that is due to the asset quality differential. So at current stock prices, SRG might outperform even with less desirable assets.

[KJP]

 

SRG is easier to analyze because we know exactly what the properties are and they are quite similar. So we take a $15 or $20 average rent, or whatever you want to use, and it's pretty simple to discount back cash flows over 10 or 20 years.

 

HHC is different because we really don't know what they are going to build in the future. What will HHC's operating asset NOI be in 10 years? Who the heck knows. Sure, some people are assuming they build 1 condo tower a year for a decade in Ward Village (or whatever they plug into their DCF model), but the degree of confidence in that sort of guesswork is probably quite low given the outside factors that will influence build-out plans.

 

But I guess your main question is, if HHC has better assets, a great balance sheet, and what appears to be a solid management team, why even bother with SRG if you are interested in long-term real estate development stories? To me, it's the valuation. I might be willing to pay up a little for HHC's assets, but at the right price, SRG might look attractive too even if the assets are worse. It's all about what you are getting and what price you paying, right?

 

SRG: $2.2B equity/$3.3B E/V

 

HHC: $4.3B equity/$5.9B E/V

 

Including signed leases, Seritage's annualized FFO  is pushing $150M.

 

Howard Hughes is projecting 2019 NOI of $220M ex-SSSP. Let's call it $300M all-in. You would get roughly the same FFO ($150M) in 2019 using current interest and G&A run-rates.

 

So there's a clear valuation gap between the two. I would argue that is due to the asset quality differential. So at current stock prices, SRG might outperform even with less desirable assets.

 

That's fair.  I'm just less sanguine about the SRG/Sears assets.

 

Your HHC numbers don't include cash margin on land/condo sales, right?  I realize those are very difficult to predict the timing of. 

[peridotcapital]

 

That's fair.  I'm just less sanguine about the SRG/Sears assets.

 

Your HHC numbers don't include cash margin on land/condo sales, right?  I realize those are very difficult to predict the timing of.

 

Correct, I excluded the net proceeds from one-time property sales. That money will obviously help fund development in the sense that debt financing requirements will be lower, which should hold interest expenses in check. But the more detailed way of valuing it would be to separate the operating properties (FFO multiple) and the undeveloped land (DCF) and sum the two.

 

It might seem like apples to oranges to ignore it in my post, but SRG also has a lot of embedded real estate value that is not included in the FFO figure I used (below market leases on Sears locations they continue to use).

 

[KJP]

 

That's fair.  I'm just less sanguine about the SRG/Sears assets.

 

Your HHC numbers don't include cash margin on land/condo sales, right?  I realize those are very difficult to predict the timing of.

 

Correct, I excluded the net proceeds from one-time property sales. That money will obviously help fund development in the sense that debt financing requirements will be lower, which should hold interest expenses in check. But the more detailed way of valuing it would be to separate the operating properties (FFO multiple) and the undeveloped land (DCF) and sum the two.

 

It might seem like apples to oranges to ignore it in my post, but SRG also has a lot of embedded real estate value that is not included in the FFO figure I used (below market leases on Sears locations they continue to use).

 

You've clearly been paying attention to HHC, so perhaps there are many others like you that have analyzed it/are following it and it just doesn't generate the same number of posts on this board that SRG/SHLD do because of all the hubbub surrounding Sears. 

 

For newcomers to the area who are interested in long-term real estate development stories, though, I would encourage them to look at both.  I would also throw in Dream Unlimited for the Canadian crowd, but that's even more of a grabbag than HHC. 

[koshigoe]

anybody thinking there might be short squeeze coming up with low valuation and 28% of shares short? It is one of most shorted stocks on NYSE, and with small float could move up quickly like last spring. lots of value hands in this however low it goes...

 

http://www.wsj.com/mdc/public/page/2_3062-nyseshort-highlites.html