It may be guilt by association, but investors are betting big that real estate investment trust (REIT) Seritage Growth Properties (NYSE:SRG) is set to fall. It has one of the largest short positions as a percentage of a stock's float of any company on the NYSE and one of the highest days to cover.
For a stock that's already fallen 15% this year and is down nearly 20% over the last 12 months, that's an awful lot of investors thinking it may fall further. But that may have more to do with the poor prospects of Sears Holdings (NASDAQOTH:SHLDQ), with which it is inextricably linked.
An REIT for all the wrong reasons
The REIT was spun off from Sears in 2015 by chairman and CEO Eddie Lampert to buy the stores the retailer was shedding in an attempt to stay solvent. While it has a number of high-profile investors backing it, including Bruce Berkowitz and his Fairholme Capital Management, it also managed to raise some eyebrows when Warren Buffett disclosed he was a significant investor after acquiring an 8% stake in the REIT.
The 2-million-share stake was worth about $73 million at the time, which is a seemingly small sum for the multi-billionaire investor. It was an odd departure nonetheless, which appeared to run counter to his value investing bona fides. Even so, since the investment was disclosed in November 2015, Buffett is still presumably sitting on a 15% profit. More recent investors haven't been so lucky, and they're not likely to see luck turn their way anytime soon.
Having been seeded with several hundred stores from Sears' substantial real estate portfolio, the REIT collects rents from the retailer while it still occupies them, or from other companies if the department store chain has abandoned them. It's usually better if Sears doesn't occupy the space anymore because it can jack up the rents it charges to other retailers.
Get out and stay out!
In an investor presentation last month, Seritage noted that Sears pays deeply discounted rental rates of only $4.45 per square foot. If it can get another retailer to occupy the space instead, it's able to realize rates of anywhere from $13 to $18 per square foot.
Currently, though, Sears occupies 84% of the square footage Seritage leases, yet because its rents are so low, it accounts for only 60% of the annual rent the REIT collects. That's better than when it first started: Third party tenants only accounted for 20% of the rent. On some level, there could be the hope that Sears goes bankrupt so it can convert more real estate to profitable usage.
Yet it's a double-edged sword because the state of the shopping mall is in a serious downward spiral, with real estate information firm CoStar estimating that nearly 1 billion square feet of retail space will need to be "rationalized" over the next few years. If Sears were to go under and liquidate its retail space, that would put a lot of inventory on the market all at once, which would depress pricing. And that already seems to be happening.
A year ago, Seritage reported annual rents that averaged $32.60 per square foot, but that has been halved now to just $16.41 per square foot, while the spread for the rent released from space previously occupied by Sears had narrowed from 5.7 times to 4.0 times. Dumping Sears' properties wholesale onto the market would cause rents to crash.
A downward spiral
But it's possible that could happen. Sears' financial condition continues to worsen, and it reports ever larger losses. Although Lampert has come up with a number of good ideas this year to try to salvage what's left of the retailer, it really is too little, too late.
There is also the possibility that investors were betting Sears would go bankrupt around the first week of July. Lampert had sold his stores to Seritage in July 2015, and some analysts suspected he was keeping Sears afloat simply to make it over that finish line, as he had just enough cash on hand to reach the deadline. Now that the July 8 threshold has come and gone and Sears remains operational, it's possible we'll see the short sellers cover their bets.
Considering the condition of the retailer, though, there's still good reason to believe Seritage Growth Properties' own finances won't markedly improve in the near future.