The COVID-19 pandemic has been hard on retail real estate investment trusts (REITs), and Seritage Growth Properties (NYSE: SRG) was hit even harder than most. At the March 2020 lows, Seritage was about 90% below its pre-pandemic high and looked like it was pricing in a worst-case scenario.
Seritage was created to transform a portfolio of struggling but high-potential retail real estate assets. And while the long-term potential is certainly still there, the obstacles to success have become much greater. Here's the latest on Seritage's business and what it could mean to long-term investors.
Seritage's ambitious vision
Seritage was created for the specific purpose of buying a portfolio of retail properties occupied by Sears (OTC: SHLDQ). The point wasn't to own a bunch of Sears stores but rather to redevelop them as the Sears locations gradually closed down. The idea was that the properties are largely in excellent locations, and if redeveloped into modern mixed-use real estate assets, there could be tremendous value to unlock. The plan has been to sell some of the assets to raise capital and invest heavily in the properties that have the most potential.
As of June 2020, Seritage owns 199 properties (including 28 joint ventures) with a total of 31.6 million square feet. And this is after the company raised a total of $860 million from asset sales since its 2015 inception. Of the current portfolio, roughly 10.65 million square feet have been re-leased, so Seritage is still in the relatively early stages of its transformation plan.
Why Seritage has been so hard-hit
For one thing, most of Seritage's retail tenants were forced to close as the coronavirus outbreak worsened in the United States, and rent collection took a major hit in the first half of 2020.
To make matters worse, Seritage doesn't have nearly as much liquidity as other retail REITs. It has a $400 million credit facility, but it isn't allowed to access it until it meets certain leasing goals (which it hasn't met yet). Seritage largely relies on the income from its occupied properties, as well as from asset sales, to fund its operations. If Seritage isn't collecting much rent from its tenants and has trouble selling certain assets, it could end up in serious financial trouble.
Recent results have been encouraging
Fortunately, Seritage's recent results show that while the company is still far from out of the woods yet, the situation looks better than investors may have thought.
As of August 4, about 93% of Seritage's tenants had reopened for business, and most were fully reopened (meaning not just for curbside/delivery). The company had successfully collected 66% of its second-quarter rent and had agreed to defer an additional 21% -- and having followed retail REITs closely, I can tell you that having 87% of rent accounted for during the worst quarter of the pandemic is no small feat. Furthermore, July rent collection had improved to 74%, showing that there's a clearly positive trend.
Also encouraging was the news that the company had closed on $166.3 million in asset sales during the first half (including $98.6 million in the second quarter) and had an additional $91.5 million under contract. The company produced negative funds from operations of about $45 million for the first six months of the year, so these asset sales provide some much-needed breathing room. In all, the company ended the second quarter with $92.6 million in cash on its balance sheet.
What's more, Seritage announced that it had restarted some high-value redevelopment projects which will require $42.7 million of investment to bring $12.7 million of annual rental income online over the next year or so.
Since releasing these figures, Seritage's stock is higher by about 45%, so it's fair to say investors liked what they read.
Seritage in 10 years
When fellow investors ask me how I see Seritage performing over the next 10 years, I tell them "it's either going to be really good or really bad." Either Seritage's short-term funding issues will turn out just fine and the portfolio redevelopment can proceed as planned or the company will run into serious financial troubles, and probably sooner than later. In the former scenario, Seritage could be a multibagger for those brave enough to buy it and hold. In the latter scenario, however, shareholders could potentially see big losses.
In a nutshell, I see Seritage as somewhat of a gamble over the next decade. The risk-reward characteristics of the stock look rather compelling, and in full disclosure I've added to my Seritage position during the pandemic, but I wouldn't put any money in that I wasn't prepared to lose if things didn't go well.