Macy's Reaps a Windfall From Its Real Estate

Since the beginning of 2015, sales trends have been stubbornly negative at Macy's (M 1.19%). This has caused the No. 1 department store operator to look for new ways to generate cash.

In this segment of Industry Focus: Consumer Goods, analyst Vincent Shen and contributor Adam Levine-Weinberg discuss Macy's real estate strategy. The company has brought in nearly $1 billion in proceeds from real estate sales in the past few years, and it's just getting started.

Vincent Shen: I would like to hone in on Macy's a little bit. It seems, like you mentioned, they had their earnings wipeout hit particularly hard. But I also think they are in a really dynamic situation in that a lot of people talk about, and it was a similar story with Sears for some time before things started really spiraling down the drain, into that real estate, really valuable, company is undervalued just on that basis alone. What are some of the things that Macy's is doing to try to address this weakness? In general, what are you seeing on that side in terms of what they're doing with the real estate? How are they utilizing it? How are they approaching the sales and things on those lines?

Adam Levine-Weinberg: I guess I'll start with the real estate, and then I'll look at some of the other things that they're doing to try to rebuild their core business. On the real estate specifically, about a year or two ago, they were in a bit of a fight with an activist investor that has since sold out and decided to pursue other prospects. Anyway, these activist investors wanted Macy's to spin off their real estate. They estimated the value of their real estate was more than $20 billion, and thought that Macy's should try to put it into a real estate investment trust, somehow split up the company where you would have a real estate company on the one hand and a retail company on the other hand, and that would make the company's valuation go up. Macy's didn't agree, they thought there would be tax problems, and also didn't agree with the logic of how this would create value for shareholders. What they decided to do instead is, they're really focusing on, where do we have real estate where we're not utilizing it effectively and actually getting value out of it? And that's where they're looking to either sell off or in some other way monetize real estate. I'll just give a few examples of things that they're doing.

One thing that they have been trying to do is take stores where they're not necessarily losing money, but they're not making a lot of money, and they sit on very valuable real estate, and just selling those store properties and closing the store. Some places where they've done that recently are in downtown Portland, in downtown Minneapolis, big flagship store buildings that they decided the stores aren't profitable enough anymore -- these aren't vibrant shopping environments -- we're going to close the store. Those two combined brought in more than $100 million.

They're also selling off some mall-based stores to the mall owners. General Growth Properties has bought several Macy's stores. Including all of those together, that's brought in more than $100 million. In San Francisco, Macy's, for many years, has operated a very large flagship store that's close to a million square feet, but then also a separate men's store, which is a quarter of a million square feet. They sold that men's building for $250 million, and over the next two to three years, they're going to take all that inventory, move it into the main store, which is still a very large store, one of the biggest in its system, and they think they will be able to capture most of the sales, maybe even do better, because everyone will be in the same building. But they've also just gotten a windfall of $250 million. That's one aspect of what they're doing.

Shen: Yeah. I'm really glad that you brought up that example in San Francisco. I was there a few weeks ago in Union Square, a huge shopping area, very attractive, tons of traffic in general, because that's the shopping central area of the city, and I couldn't believe the size of these Macy's stores that they had --

Levine-Weinberg: Yeah, they're massive.

Shen: -- separately, right next to each other. You could see the men's store was closed. There was construction around it as they're starting to move things in, as you mentioned. But I couldn't believe they were operating these separately. It makes a lot of sense to bring them under one roof. And it's hard to argue with the $250 million in proceeds that they get from selling that space.

Levine-Weinberg: And if you look, another thing they're doing in San Francisco, in particular, is they're working on a plan to carve out about 10,000 square feet of space on one side of the first floor in that main building and renting it out to luxury retailers that maybe wouldn't sell their products in Macy's, but they'll take space on one of the biggest shopping streets in the city. Some of the retail rents there have been astronomically high, so just carving out this 10,000 square feet of space, that could bring in something like $6 million of annual rent, for years on end. So, that's a really nice way to, one, you get the rent, which is nice -- it boosts the bottom line. But, hopefully, it also gets people in who might not otherwise come to Macy's, and once they're in these little shops in the front of Macy's, they'll walk under the bigger store and maybe they'll see a purchase that they otherwise wouldn't have made.

Shen: And lift their general foot traffic overall.

Levine-Weinberg: Another thing that Macy's has been doing on the real estate front is they're working on a plan with Brookfield Asset Management to redevelop in some way about 50 store sites. In many cases, they keep the store that's already there. But oftentimes, Macy's owns not only the store but a large parking lot area or just vacant space that's not being used. So, it's possible to densify development on these parcels. So, maybe they'll put a restaurant in an outparcel in what's currently a parking lot. In some cases, they could build a mid-rise condo development. There's a lot of options. Real estate where the Macy's store would probably benefit if you brought residents in. That's been a really big trend recently, to have these town center environments where you have mixed use developments, retail, commercial, office space, and residential all in one place --

Shen: A town center model.

Levine-Weinberg: It could not only give Macy's the proceeds up front from selling off this land, or building a building and then selling it, but then you also have a more vibrant shopping environment, which helps the store for many years to come. So, there's a lot of things that Macy's is doing in terms of its real estate. The one last thing I'll mention is, they have a couple of big flagship stores in Chicago and New York. The Chicago flagship is worth hundreds of millions of dollars at least. The New York one has been valued at billions of dollars. These are really valuable properties.

Shen: Really massive space, and in that neighborhood, too, I can imagine they're really valuable.

Levine-Weinberg: Yeah. They're not closing those stores, but they're probably going to lop off a bunch of space at the top and redevelop it in some ways, either office space or maybe even residential or hotel, in some cases. So, that's another thing that could bring in a lot of money over the next two or three years, probably.