SRG - Seritage Growth Properties

[KJP]

A company developing property probably shouldn't have any free cash flow. I don't think the idea of free cash flow supporting development cost is necessarily the metric to consider. Look at a cable company. In fact, a case can be made that no cash flow is just fine during this phase of the process. But when the building is complete and the rents are coming in, you are in the harvesting phase and then FCF is most certainly warranted. What is important, of course, is to match development cost with resources on hand, or raising capital, or developing slowly enough to support the venture. I also don't think the dividend is warranted but it suggests they are not developing at top speed yet. I wouldn't be upset or surprised if the dividend was cut to zero during this process.

Yeah I think your comparison to cable companies is spot on. So probably best way of looking at SRG in the short-medium term would be to conservatively estimate out NOI, and then back into a NAV using comp cap rates?

How are you accounting for the money and time it will take to get to your stabilized NOI?

My model uses a bunch of different inputs/assumptions to play with so feel free to check it out. I'll be the first to admit it's still plenty rough around the edges, but I'm still new to valuing REITs so I'd love any suggestions/criticisms about the model, assumptions used, formulas, etc.

Thanks for posting this.  I may be misunderstanding your spreadsheets, but I don't think the changes in cash & cash equivalents on your projected cash flow statements match up with your projected balance sheets.

Also, I understand you to be projected SRG to recapture and re-rent at higher rates 2 million sq ft per year.  I also understand you to project $100 million per year in CapEx.  Can you explain the math behind the $100 million per year in CapEx in light of 2 million sq ft annual recapture and the maintenance CapEx needs of the other square footage? 

[SlowAppreciation]

A company developing property probably shouldn't have any free cash flow. I don't think the idea of free cash flow supporting development cost is necessarily the metric to consider. Look at a cable company. In fact, a case can be made that no cash flow is just fine during this phase of the process. But when the building is complete and the rents are coming in, you are in the harvesting phase and then FCF is most certainly warranted. What is important, of course, is to match development cost with resources on hand, or raising capital, or developing slowly enough to support the venture. I also don't think the dividend is warranted but it suggests they are not developing at top speed yet. I wouldn't be upset or surprised if the dividend was cut to zero during this process.

Yeah I think your comparison to cable companies is spot on. So probably best way of looking at SRG in the short-medium term would be to conservatively estimate out NOI, and then back into a NAV using comp cap rates?

How are you accounting for the money and time it will take to get to your stabilized NOI?

My model uses a bunch of different inputs/assumptions to play with so feel free to check it out. I'll be the first to admit it's still plenty rough around the edges, but I'm still new to valuing REITs so I'd love any suggestions/criticisms about the model, assumptions used, formulas, etc.

Thanks for posting this.  I may be misunderstanding your spreadsheets, but I don't think the changes in cash & cash equivalents on your projected cash flow statements match up with your projected balance sheets.

Also, I understand you to be projected SRG to recapture and re-rent at higher rates 2 million sq ft per year.  I also understand you to project $100 million per year in CapEx.  Can you explain the math behind the $100 million per year in CapEx in light of 2 million sq ft annual recapture and the maintenance CapEx needs of the other square footage?

No you're 100% right. I haven't setup all the formulas between the balance sheet and cash flows yet.

The understated CapEx is just me messing around with different inputs. But yes, the CapEx number should be a product of the estimated 2million sqft/yr and $100 sq/ft redevelopment costs. So yep, should be $200m/yr.

Other than that, any glaring errors/omissions? I feel like I'm not properly account for the JV income (just add to NOI?).

[SlowAppreciation]

Made some more updates to my model:

[scorpioncapital]

I also think SRG is a play on the wildcard of much higher inflation than expected down the road. For example, one scenario is a long period of low rates like now, perhaps continuing forward for a while longer. This is a good environment for the redevelopment because you are getting nice new renovated properties at prices that - eventually, when the inflation comes will cost much more to build to maintain the high rental prices of properties of that "new" calibre. Conversely, if inflation does not happen, or not as quickly, then you can control the development cost nice and slow, and do it with lower wages. But I think this wildcard factor is one reason I do want some exposure to real estate. Between precious metals, art, TIPS, and businesses, real estate has shown to be a strong hedge of inflation. The low to high rent differential at SRG is icing on the cake for the low inflation scenario while possibly putting upward pressure on the share price if the history of the world repeats itself - namely higher inflation. Inflation is certainly not good, it is in fact, an economic failure, but people want pleasure today and pain tomorrow and some problems are so big that politicians may dictate to central banks to create it despite the fact that it will end badly.

[KJP]

Made some more updates to my model:

As you work toward connecting your projected cash flow statement to your projected balance sheet, you'll have to make some assumptions about where the capital is going to come from.  Once you decide that, you can then project actual interest expense (with an interest rate assumption), rather than using a percentage of revenue for interest expenses.  That will also help you understand how dependent the company is (or is not) on external funding sources and determine whether access to capital is a risk to your thesis.

SRG is a REIT.  Will the tax rules require it to start paying a dividend at some point?  If so, will that require additional external capital?

It also may be useful to try this exercise with another real estate company that has a long pathway for reinvesting capital into existing projects/assets, such as Howard Hughes, to see whether the returns and risks in SRG are attractive to you relative to other, similar investments.

[Mephistopheles]

Made some more updates to my model:

SRG is a REIT.  Will the tax rules require it to start paying a dividend at some point?  If so, will that require additional external capital?

Unfortunately, they already pay a dividend, even though they don't have to and even though they need all of the capital they can get. I think it's because the management owns restricted shares which they can't monetize for some time, except for when it pays dividends.

[KJP]

Made some more updates to my model:

As you work toward connecting your projected cash flow statement to your projected balance sheet, you'll have to make some assumptions about where the capital is going to come from.  Once you decide that, you can then project actual interest expense (with an interest rate assumption), rather than using a percentage of revenue for interest expenses.  That will also help you understand how dependent the company is (or is not) on external funding sources and determine whether access to capital is a risk to your thesis.

SRG is a REIT.  Will the tax rules require it to start paying a dividend at some point?  If so, will that require additional external capital?

It also may be useful to try this exercise with another real estate company that has a long pathway for reinvesting capital into existing projects/assets, such as Howard Hughes, to see whether the returns and risks in SRG are attractive to you relative to other, similar investments.

Also, what amount of maintenance CapEx is necessary, beyond the $200 million of recapture CapEx you include in  your model?

[HalfMeasure]

Made some more updates to my model:

Thanks for sharing. Just taking a look at the NOI valuation - not a REIT expert, but won't adding the cumulative discounted NOI from FY2017-FY2024 overstate the value of the assets as that NOI needs to be plowed back into redevelopment in order to reach terminal NOI? Wouldn't this be analogous to overstating a FCF valuation by not including growth CapEx during an abnormal growth period?

[SlowAppreciation]

Made some more updates to my model:

As you work toward connecting your projected cash flow statement to your projected balance sheet, you'll have to make some assumptions about where the capital is going to come from.  Once you decide that, you can then project actual interest expense (with an interest rate assumption), rather than using a percentage of revenue for interest expenses.  That will also help you understand how dependent the company is (or is not) on external funding sources and determine whether access to capital is a risk to your thesis.

SRG is a REIT.  Will the tax rules require it to start paying a dividend at some point?  If so, will that require additional external capital?

It also may be useful to try this exercise with another real estate company that has a long pathway for reinvesting capital into existing projects/assets, such as Howard Hughes, to see whether the returns and risks in SRG are attractive to you relative to other, similar investments.

Yeah I haven't seen too many SRG write ups that factor in additional capital needs (aside from the short ones). I do think they'll need to raise some money and don't really see how they won't be able to unless they can keep the $20+ leases coming. But if memory serves correctly, SNO are around $19/sqft now, which is actually down from a few quarters ago when it was $23/sqft. Could've just been one or two projects skewing it higher though.

[SlowAppreciation]

Made some more updates to my model:

Thanks for sharing. Just taking a look at the NOI valuation - not a REIT expert, but won't adding the cumulative discounted NOI from FY2017-FY2024 overstate the value of the assets as that NOI needs to be plowed back into redevelopment in order to reach terminal NOI? Wouldn't this be analogous to overstating a FCF valuation by not including growth CapEx during an abnormal growth period?

I'm also fairly new to REITs so take my model and everything I say with a grain of salt.... there are far more knowledgable people here who can probably better answer, but from what I've learned, there are 4 main ways of valuing REITs: NOI, FFO, AFFO and NAV.

Think of NOI as the same as EBITDA on the property level, but not on a company level. My understanding is that the whole point of NOI is to value the operating profit of individual properties, rather than that of the entire company. Took me a while to wrap my head around since I'm not a real estate expert, but that's my understanding of it at least.

FFO/AFFO are more or less variants of a DCF model, with certain charges included/excluded. If you're concerned about the treatment of growth CapEx, AFFO is probably going to be the best one. 

And NAV is sorta/kinda a variant of book value (though one based on current market values rather than historical cost) and can be calculated by taking NOI and dividing it by the comp cap rates. This will give you a rough idea of how much a buyer would be willing to pay for the property(ies).

(again, might want to wait for someone else here to chime in before taking anything I say as gospel)