Seritage Growth Properties (NYSE: SRG) attracted investment from icon Warren Buffett. It has a $2 billion loan agreement with Buffett's Berkshire Hathaway, too. Some would view these two facts as reason enough to buy the stock. But there's a lot more to understand about investing in this real estate investment trust (REIT) before you decide to become an owner. And the news isn't all good.
The backstory matters
Seritage Growth started its life behind the eight ball. The REIT was spun off from Sears Holdings as a way for the struggling retailer to raise much-needed cash. But this meant that Seritage was heavily exposed to Sears and Kmart stores, two pretty lousy tenants. For confirmation of that, Sears -- once an iconic, powerful company -- declared bankruptcy in 2018, long before the coronavirus pandemic upended the retail sector.
From the get-go, Seritage's goal was to take Sears and Kmart locations and upgrade them for new tenants. A slow and steady transition away from its former parent would have been the ideal, but that clearly didn't happen. And then 2020 and the pandemic made things even more difficult for retail landlords. So, what was a turnaround effort from day one got even harder.
Seritage is doing what it can, and its lenders continue to work with it, but there are still material risks here for investors to consider, including:
1. Seritage hasn't paid a dividend since the first quarter of 2019
Unsurprisingly, that timing is close to when Sears declared bankruptcy. But REITs are specifically designed to pass cash on to shareholders via dividends. That it isn't paying a dividend is a huge statement about the risk here and a very clear indication that management's plans haven't worked out quite as well as hoped. Until it reinstates a dividend, conservative investors might want to steer clear.
2. Around 80% of Seritage's core portfolio is leased and occupied
And that's great. The problem is roughly 20% is what the REIT puts into the "signed not yet opened" category. Basically, that means it is still revitalizing a huge chunk of its portfolio for new tenants before they move in. Construction costs money and usually a lot of it, so cash is a big issue here (which explains the elimination of the dividend).
Until the redevelopment process is further along, there's heightened risk. Note the spike in inflation for everything from labor to building supplies won't help any.
3. The REIT is pruning its portfolio to help raise cash, which is probably a good thing overall
But it's certainly not a sign of strength. When it was split off from Sears, Seritage basically got a hodgepodge of assets that were easy to put into a REIT. Its properties weren't all of the same quality, so selling weaker properties is a good call. However, the company appears to be doing so from a position of weakness; thus, pricing should be a question mark in investors' minds.
There's also the risk that Seritage may end up selling good properties just so it can fund redevelopment at its best properties. That would be a less positive, though perhaps necessary, decision. All in, selling assets looks like an event worth worrying about at least a little.
4. Seritage is at the mercy of Berkshire Hathaway, thanks to the loan it accepted from the giant conglomerate
The REIT isn't in compliance with all of the loan's protective covenants, so it has to get approval from Berkshire when it looks to sell assets. Meanwhile, the loan only goes through 2023, with about $1.6 billion of the $2 billion potential already drawn. Berkshire Hathaway has been willing to work with Seritage so far, but if that company's largesse ends, Seritage could be in for a world of hurt.
Troubled? It depends
Seritage is definitely working on getting itself back on track, and so far, it's been muddling through very troubling times. That doesn't mean it's "in trouble," per se, but it certainly isn't a good option for risk-averse investors.
Indeed, a lot still has to go right for the REIT's efforts to end in success. In fact, it looks like Seritage is managing to stay just a couple of steps ahead of the troubles that could drag it down. If the company stumbles for any reason, the bad news will likely pile up pretty quickly.