Seritage Growth Properties is still significantly exposed to Sears Holdings Corp., the troubled department store reported this week to be on the verge of filing for bankruptcy protection, but investors can take comfort in the progress that the real estate investment trust has made on the financing and leasing fronts in recent quarters, an analyst said.
Seritage shares took a hit along with those of Sears, after the latter was reported to have hired an adviser, M-III Partners LLC, to help prepare a bankruptcy filing ahead of an important debt maturity next week. Edward Lampert, Sears' CEO and, through his hedge fund, ESL Investments Inc., the retailer's most significant shareholder and lender, had sounded a warning about significant liquidity constraints in late September, after years of cost-cutting, refinancing, asset sales and store closures.
Lampert serves as Seritage's board chairman, but RBC Capital Markets analyst Wes Golladay said the REIT's management has no special knowledge about the timing or likelihood of a possible Sears bankruptcy filing or liquidation.
"They're watching [the Sears situation] just like we are," he said.
Seritage, which was spun off from Sears in 2015, had the largest exposure to Sears Holdings at midyear among all equity REITs, with 167 leases aggregating about 21.3 million square feet, or 71.9% of the REIT's total leasable area, according to S&P Global Market Intelligence data.
Management at Seritage has spent the last three-plus years working to take control of, redevelop and re-lease Sears space at higher rents. In an interview, Golladay described Seritage as largely prepared for any significant turn in the yearslong "Sears on the brink" chronicle. The REIT has leased more than 4 million square feet of space to third-party tenants, and though many have yet to occupy the space — Seritage has a massive $800 million-plus redevelopment pipeline — the company has visibility on net operating income gains down the line, and it has the capital to fund its plan.
Golladay estimated that Seritage only needs to re-lease 30% to 35% of the Sears space to recover the potential lost rent from the ailing department store and the carrying costs of the vacant space.
According to Seritage's most recent financial supplement, the REIT receives $96.6 million in annual base rent from Sears, equating to $4.54 per square foot. In comparison, the remaining 8.3 million square feet owned by Seritage leased to parties other than Sears generated $127.3 million in annual base rent, or $15.31 per square foot.
"When you're getting a 300% spread, you don't have to re-lease all the space to get the economics back," the analyst said. "[Seritage's leaders] just have to execute their plan. This is an external shock that they don't have control over, but they're just doing what they can do: Leasing square footage and preparing the balance sheet. And that's what they've done."
Golladay also applauded Seritage's efforts to establish partnerships with retailers and other real estate players, some of whom, in a bankruptcy scenario, could come in and take over some of the Sears leases.
"It's good real estate at the end of the day," he said of the Sears locations.
Seritage shares were down 11.1% for the week of Oct. 12.
