One of the more unique retail REITs, Seritage Growth Properties (NYSE: SRG) was created in 2015 for one specific purpose – to buy a portfolio of retail properties occupied by Sears and Kmart.
I know what you’re thinking. Why on Earth would anybody want to own a Sears or Kmart right now? They wouldn’t, and neither does Seritage.
Seritage’s business model is quite simple. It takes these run-down, outdated, and sometimes vacant real estate assets (many of which are in prime locations – after all, when many Sears were built, they were the place to shop), and re-develops them into modern properties. And not just retail – Seritage aims to build a portfolio of mixed-use properties. Modern retail will certainly be a part of it, but Seritage also integrates residential, office, hotel, and entertainment aspects into its properties.
As one example, Seritage took an old Sears auto center in Pennsylvania and transformed it into two modern restaurant spaces and an entertainment venue (Escape Room).
The best part is that Seritage is still in the early innings of executing on its vision. It has only signed new leases on about 30% of the 31.6 million square feet of space in its portfolio. It hasn’t even announced redevelopment projects at more than half of its properties. Plus, one of Seritage’s strategies is to add density (additional square footage) where it’s practical, so the total size of the portfolio could end up being much more than the original amount.
Early results have been very promising. The average tenant in one of Seritage’s re-developed properties is paying over four times the rent that the former Sears/Kmart tenant was paying. Seritage is achieving double-digit returns on its invested capital and is doing a great job of creating properties that are worth more than the cost of renovations.
Finally, Seritage is the other public REIT backed by Berkshire Hathaway, and the company is committing even more money to Seritage than to its STORE Capital investment. Berkshire is providing as much as $2 billion in funding (including a $1.6 billion term loan that has already been made). Berkshire isn’t in the habit of lending money unless it sees a near-100% possibility of getting paid back. Not only that, but Warren Buffett himself (in his personal stock portfolio) is the REIT’s largest individual shareholder, with an ownership stake of more than 5%.
Simply put, Seritage has been overlooked by REIT investors. Right now, it doesn’t pay a dividend, choosing to put all of its capital into its redevelopment efforts, which has taken it off the radar of income-seeking investors. The current lack of profitability (which isn’t surprising, given that over half of the square footage is still occupied by Sears, Kmart, or no tenants at all) is also likely scaring some investors away.
However, for investors with a long-term mentality, Seritage could turn out to be a diamond in the rough. We believe the company could multiply its rental revenue several times over, and create billions in value for shareholders in the process.