Can this REIT get out of debt before it’s too late?
For several years, Seritage Growth Properties‘ (NYSE: SRG) The heavy indebtedness posed a significant risk to shareholders of the Sears spin-off company. When the COVID-19 pandemic struck in 2020, disrupting Seritage redevelopment plans, that risk suddenly became acute, threatening the future of the FPI.
Last week, Seritage Growth Properties took an important step on the path to returning to financial health by prepaying $ 160 million in debt. Nonetheless, he still has a lot of work to do to turn around his balance sheet so that he can focus on executing his turnaround strategy.
Burn endless money in sight
Seritage has been spending money consistently since mid-2018, when lead tenant Sears Holdings began closing stores much faster than the REIT could redevelop for new tenants.
That said, before the pandemic, Seritage appeared to be on track to return to positive cash flow within a year or two due to a wave of planned tenant openings in redeveloped properties. Sadly, the pandemic has pushed some of Seritage’s tenants into bankruptcy and forced others to close stores or reverse their expansion plans. During this time, the REIT sold rent-generating properties to raise funds.
As a result, by the third quarter of 2021, Seritage’s annual in-place rent had fallen to $ 92 million, from $ 108 million at the end of 2019. This sent Adjusted Operating Funds (FFO) down even further. in negative territory, down from – $ 15 million in Q4 2019 to – $ 25 million in Q3 2021.
Worse yet, Seritage’s signed lease pipeline for future openings shrank 66% during that time to just $ 29 million in annual base rent: not enough to bring the REIT back to FFO balance.
Reduce your debt
High interest charges are one of the main obstacles to Seritage’s efforts to return to FFOs and positive cash flow. Interest expense in cash on its term loan facility has totaled $ 116 million annually for the past several years. For this alone, it is essential for Seritage to reduce its debt as quickly as possible.
In addition, Seritage’s $ 1.6 billion term loan matures in July 2023. At the end of November, the lender (a subsidiary of Berkshire Hathaway) has agreed to extend the deadline by two years, on condition that Seritage reduce the balance to $ 800 million by next July. This makes debt reduction even more urgent.
On the positive side, Seritage has identified around 70 properties that it intends to sell. As of September 30, 2021, it had $ 224.4 million in assets under contract to sell. On December 31, it used part of the proceeds from its asset sale to make a $ 160 million prepayment. This will reduce annual interest expense by $ 11 million.
How much money can Seritage raise?
Seritage appears to have completed a particularly large asset sale last quarter, selling a former Sears location in San Bruno, Calif. (Just outside of San Francisco) for around $ 128 million. The REIT still has other valuable sites in its divestiture portfolio, including properties in San Jose and Westminster, California.
That said, most of the real estate Seritage wants to offload isn’t worth much. For example, he recently sold an old Kmart in the suburbs of Tampa for $ 6 million. This property is much more representative of what Seritage is looking to sell than the San Bruno site.
Seritage can certainly raise enough cash through the sale of additional assets to pay for its planned near-term redevelopment expenses of around $ 250 million. It should also be able to cover its ongoing cash consumption, which remains around $ 100 million per year, excluding capital spending. But after covering those costs, there probably won’t be enough left to seriously reduce Seritage’s remaining term debt by $ 1.44 billion.
Seritage can hope to refinance some of its debt using its best properties as mortgage collateral. However, Berkshire Hathaway currently holds mortgages on all of the REIT’s assets. Unless Berkshire agrees to more lenient terms, Seritage would need to raise enough liquidity to fully repay the term loan in order to tap the commercial mortgage market.
In short, Seritage still does not have a clear path to reduce its debt to a reasonable level compared to its annual rental income. Meanwhile, the slowness of leasing over the past two years casts doubt on its ability to break even any time soon. All in all, investors may find much better opportunities elsewhere in the REIT industry.
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