For more than a year, Macy's (NYSE:M) has been actively pursuing a deal to sell off excess space in its State Street flagship store in Chicago. The upper floors of the State Street building have been underutilized for a long time, and the strength of the real estate market makes this a good time to cash out.
This week, Macy's reached a tentative agreement to sell about 700,000 square feet of space in the Chicago flagship building, according to the Chicago Tribune. The prospective buyer is one of Macy's existing real estate partners, Brookfield Asset Management (NYSE:BAM). This deal will help Macy's accelerate its efforts to pay down debt.
Making better use of its assets
Today, the Macy's flagship location in Chicago is one of the company's two largest stores, along with the Herald Square flagship in Manhattan. The State Street building has more than 2 million square feet of space -- about 10 times more than the average Macy's full-line store -- spread across a basement and 14 above-ground floors.
This is far more space than the company needs, even for a flagship store. Indeed, the current Macy's store only occupies the basement and first eight floors of the building. The upper floors are used for special events, storage, and offices -- and some of the space isn't used at all.
Macy's idea is to downsize the Chicago flagship modestly by moving the departments currently found on the eighth floor to underutilized space elsewhere in the store. It will then sell floors 8-14 to Brookfield Asset Management for redevelopment. Brookfield plans to convert the space to loft-style offices.
Assessing the deal
Neither Macy's nor Brookfield Asset Management has revealed the sale price for the proposed deal in Chicago. However, Macy's finalized a similar deal in Seattle last month, which provides some basis for estimating the potential proceeds of this transaction.
In Seattle, Macy's sold two floors, along with some basement space, in its downtown store to Starwood Capital for $50 million. The sale price works out to about $277/square foot.
Last year, office rents in downtown Chicago were about 15% lower than in Seattle, but rising quickly. A variety of other factors could impact the sale price, such as the cost of repurposing the upper floors into offices and the larger amount of space available in the Chicago deal. But a reasonable guess of the likely sale price would be in the range of $200-$300/square foot, or $140 million-$210 million in total.
More deals on the way
Macy's has already received more than $1 billion in proceeds since 2015 from a variety of asset sales. Thanks to its massive asset base, Macy's still has plenty of additional real estate deals in the pipeline.
During the next year or so, the company's partnership with Brookfield Asset Management should start to produce tangible results. Since early 2017, Brookfield has been working on "pre-development plans" for about 50 Macy's properties. In many cases, this may involve building retail, residential, office, or hotel space on underutilized land owned by Macy's (such as parking lots). Macy's management has indicated that some of the properties being studied hold huge potential for value creation.
Longer term, Macy's biggest real estate opportunity is the revitalization of its 2.2 million square foot Manhattan flagship store. However, due to the complexity of the site and its massive value, Macy's is moving at a very deliberate pace in deciding how to proceed.
What the Chicago deal means for Macy's
Even if Brookfield pays $140 million-$210 million for the upper floors of Macy's State Street store, the sale price will be relatively small compared to Macy's $12 billion enterprise value. However, it would still be a significant achievement in the context of Macy's debt-reduction efforts.
Aside from maintaining its dividend, Macy's top capital-allocation priority this year is debt reduction. Year to date, Macy's has already paid down $550 million of debt. Furthermore, Macy's generates the bulk of its cash flow during the holiday quarter, which should enable it to repurchase as much as $500 million of debt in the next few quarters.
Asset-sale proceeds will add to the company's dry powder for debt reduction, helping Macy's to hit its leverage targets faster than if it were relying on its free-cash-flow production alone. This, in turn, will put Macy's in a position to start buying back its extremely cheap stock again, driving long-term earnings-per-share growth.
Some investors think that Macy's should have moved faster to generate cash from its real estate. But even at its current pace, Macy's is steadily wringing out lots of value for investors from its real estate holdings.