SRG - Seritage Growth Properties

[Mephistopheles]

I've spent a healthy chunk of time analyzing this and have taken a position.

By my best and most conservative estimates, Sears would have to both declare bankruptcy and reject all of the leases in the portfolio within the next 6 to 8 quarters in order to put Seritage in a bad situation. And even then, as long as SRG could access external financing at a reasonable rate of funding, they should be able to survive without too much trouble.  Beyond 8 quarters, the company should be able to generate positive cash flow even if Sears suddenly disappears off the face of the Earth - the one large assumption here is that they're able to continue to recapture and redevelop properties at the same rate that they have been for the last few quarters.  If that suddenly drastically slows then it's a different story.  So that's the downside scenario.

The upside is massive, and I think will happen more quickly than most people expect. A complete turnover of the portfolio (meaning Sears completely gone and new tenants brought in) gets me a price target of ~$224 using an FFO model and $204 using an NAV model.  By my estimates this should take somewhere around 15 years, giving us an annual return of ~11%.  This doesn't take into account any rental inflation, any growth in the portfolio, or really any other sort of excess return that could be generated by the management team.  This is a pure, steady-state portfolio turnover.  So I think there's probably upside even to my estimates.

For anyone who is concerned about the near term Sears bankruptcy risk, it is somewhat cost effective to hedge a position in SRG by buying long-dated SHLD puts.  The Jan '18 expiration covers most of the risk, as by my estimates the risk should be greatly diminished past that point and an investment should no longer need a SHLD hedge after that date.

Thanks for sharing your opinion. How much are you counting for redevelopment spending in your estimate? Like on per sqft basis?

[Mephistopheles]

After going through all the real estate investments Buffett has made, I believe his batting average in real estate is 100%. Below you will find that Buffett is attracted to assets with under market rent (Seritage Growth Properties and NYC real estate), merger arbitrage, liquidations as well as REITS that are simply very undervalued. Enjoy!

Thanks Alex, some great reading material there !

[glorysk87]

Thanks for sharing your opinion. How much are you counting for redevelopment spending in your estimate? Like on per sqft basis?

I'm using $164 psf for redevelopment.

[glorysk87]

I think a fully redeveloped share value in the $200 range that you put out there is entirely reasonable. The 15-year timeframe might be optimistic. Getting there would require both Sears and Kmart to be completely gone by then, and it would imply a redevelopment pace of roughly 2.4 million square feet per year (about 2.5 times their current run-rate). Given the secular trends in bricks and mortar retail (we have too many stores already), I think that is much more of a challenge than dealing with the Sears solvency risks. That said, it's pretty easy to see why Buffett liked this at $36 per share.

Thanks for the input. I actually thought 15 years was relatively conservative.  A 15 year time frame assumes they can redevelop about 550k sq ft per quarter.  It is elevated from current levels but as they generate excess cash from the completed redevelopment properties it should allow them to plow more back in to additional redevelopments at a faster pace.

[moneyball]

Thanks for sharing your opinion. How much are you counting for redevelopment spending in your estimate? Like on per sqft basis?

I'm using $164 psf for redevelopment.

Is there a specific way you get to $164? It seems within reason. We would be looking at rents of $19.68 on new leases assuming yields remain ~12%. Though I think we may see costs that are elevated for a while as SRG continues to look at converting auto centers. Though they have been able to flip some of those at costs lower than  $164

[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.