SRG got news that its largest client was canceling more leases.
Such news would normally be trouble for a REIT.
But, so far, this is turning out to be the best-case outcome for SRG.
A few years ago, Sears Holdings (NASDAQ:SHLD) spun off Seritage Growth Properties (NYSE:SRG). It was a move to raise much-needed cash for Seritage's financially weak former parent. But as Sears continues to struggle, Seritage's position is actually looking better and better. Here's why Sears' plan to cancel more Seritage leases is such good news for this relatively young real estate investment trust, or REIT.
Beholden
When Sears Holdings spun off Seritage, the new REIT basically had one customer - Sears. To be fair, there were already smaller lessees in the mix. But Sears and Kmart were the 800-lb gorillas. And they were both in big trouble, with a long history of aging stores that didn't resonate with customers and, not surprisingly, falling sales.
From the get-go, the future for Seritage was not about Sears and Kmart so much as it was about diversification away from Sears and Kmart. That's still a work in progress, but Seritage is making headway. In fact, by the middle of the year, rent from companies other than Sears Holdings made up nearly 30% of revenues.
There's a big risk here, though, because Sears Holdings still represents around 90% of Seritage's leased square footage. If Sears were to fall into bankruptcy, which is a completely reasonable expectation, Seritage could find itself with a large number of vacated leases. If that were to happen all at once, the REIT would have a problem on its hands.
Slow decline
Which is why it's so nice to see Sears Holdings still in a relatively slow-motion fall from grace. For example, the retailer just announced it was going to close even more stores this year, adding another 64 Kmarts to the list. That will impact 17 Seritage properties. That's a reasonable number for Seritage, which owns or is a partner in 260 or so properties in total.
Better yet, the lease terminations require Sears Holdings to pay a year's worth of rent to Seritage. That means the REIT will have some time to market and fix up the properties before the top and bottom lines feel the hit. A slow and orderly decline at Sears Holdings is really in the best interest of Seritage.
The future is bright
There's more to like about this process, too. Sears Holdings pays an average of $4.30 per square foot for rent to Seritage. The company's non-Sears Holdings tenants pay an average of nearly $12 per square foot. And new tenants are being pitched at as much as $22 per square foot. So getting rid of a Sears or Kmart is great for Seritage's long-term future.
But that's true only if Sears Holdings doesn't blow up all at once. Which is why Seritage is appropriate only for more aggressive investors. Should the decline at Sears Holdings speed up materially, Seritage could have a near-term problem on its hands. Trying to fix and market 17 additional properties in a year or so is one thing, trying to do the same thing with 90% of your portfolio is another. That's not something a risk-averse investor should be betting on, particularly since the REIT's yield is so low.
To be fair, it's unlikely that Seritage would get back all of its properties, but when it comes to bankruptcy, you never know what can happen. That said, more aggressive investors looking for a special situation stock should like the Seritage story.
There's a lot of potential for growth without any need to buy a single property. Which is also why aggressive investors should like the store closure news that just came out of Sears Holdings. Indeed, so far, the slow decline of Sears and Kmart, two retail icons, is working out very well for Seritage Growth Properties. If you own the REIT, you should hope this trend keeps going.