Seritage Growth Properties (SRG +0.18%) is an unprofitable real estate investment trust, or REIT, whose business model involves gradually redeveloping a portfolio of former Sears properties into modern mixed-use developments. In this Motley Fool Live video clip, recorded on Aug. 23, Fool.com contributors Matt Frankel, CFP, and Jason Hall discuss why Seritage's risk-reward dynamics could make sense for investors who can handle a binary outcome.
Matt Frankel: This is Seritage Growth Properties, ticker symbol is SRG.
Jason Hall: Yeah, I think the bottom line, this is the stock's down 40% and Seritage, basically this is Sears' real estate book. It was spun off as a separate business with the idea of doing three things; leasing as much of the property as they could, developing the most high-value assets, redeveloping them into something besides a Sears, and divesting the non-core assets. Of their 20 best properties, probably half of them are worth more than Seritage is as a business now. But you'll have to have the money to develop them, and that's the problem. To be blunt, Appian's (APPN +1.75%) the one that has fallen the most. I think there's an argument that maybe Seritage should be the one that's fallen the most. Because at the end of the day, of all of these six companies, this is the one that's probably closest to being a binary outcome play. When the company reported earnings last quarter, the percentage of its properties that are occupied with a paying tenant is lower than it was a year ago.
Frankel: They've sold a lot of occupied properties.
Hall: Well, right. A couple of things are happening. They're having to sell those occupied properties because those are the only ones that are seen as valuable.
Frankel: Yeah, who wants an old Sears?
Hall: Right, exactly. An old Sears that doesn't have a tenant. I mean, that's the challenge. You add all of these things together and you have this business that has this massive amount of potential, but it's absolutely burning through cash. The metrics that you look at for a traditional REIT are deteriorating. The question is whether or not they can get to the finish line. By the finish line, I really mean the starting line for the redevelopment, with having enough capital to be able to redevelop those properties. We both rated this four, which I thought was interesting. I think it's because we both see, I don't want to speak for you, but I'm going to anyway, I think we both see the risk-reward profile as having eroded because their balance sheet has eroded. But the potential is still absolutely enormous if they can get a little bit of generosity from some of their friends to provide the capital they need just to make it and start developing those properties.
Frankel: You mentioned generosity of some of their friends. It's worth mentioning who their lender is.
Hall: Yeah, Uncle Warren?
Frankel: Yeah. The only debt the company has is a $1.6 billion term loan that is from Berkshire Hathaway (BRK.A 0.24%)(BRK.B 0.38%). They have a $400 million line of credit that they surely need access to, but can't get access to until they can meet some targets, $200 million in non-serious leases they're are not even close.
Hall: Nowhere near.
Frankel: I'll run through some of the book case right now because Jason was just rained on the parade a minute ago.
Hall: I did that on purpose. I wanted you to have a moment to be optimistic.
Frankel: Like you said it, the REIT fundamentals are terrible. It's not only losing money, they need to sell off their portfolio to survive.
Hall: It's like wrecking your truck to get the insurance money to make your truck payment, that's what the cable guy said.
Frankel: It's a REIT with negative income that doesn't pay a dividend. What's a REIT that doesn't pay a dividend? I quoted an Iron Man line in lower last show that, "This is a weapons manufacturer that's not making weapons." It's a REIT that is not renting their properties. What I would say is they do have a brand new leadership team which I absolutely love. Fun fact, it's the first REIT in history where the top three spots are occupied by women. New CEO Andrea Olshan was previously CEO for family company Olshan Properties. Pretty much to the exact same thing so a lot of experience and redevelopment. She is getting much more aggressive than previous leadership when it comes to their redevelopment strategy. Announced recently that they want to sell about one-third of the assets like now, to raise a ton of capital to invest in their highest value properties. I don't know why management wasn't doing this from the beginning. Their largest, most valuable assets aren't open yet, they haven't finished redeveloping them yet. The first one opens later this year. I believe that's one in San Diego out your way.
Hall: I think so.
Frankel: Then the one in the Miami area, which is a potentially very high-value property, is scheduled for next year, 2022. These are potentially high-value assets and they are valuable enough. If those two properties are successful, that could be the $200 million leasing target that could get them there by itself.
Hall: Just two primaries.
Frankel: It's going to take a lot of money to get them there. I've said this before on show with Jason, if we knew that Seritage is going to be able to execute on its most valuable properties and develop them, this would be a $100 stock. We don't know that. I think out of the six here, this is the one that's by far the most binary outcome.
Hall: Yeah, no doubt about that.
Frankel: In five-years, I believe this is going to be worth either zero or over $100.
