Seritage Growth Properties (SRG -1.27%) started its life when it was spun off from Sears Holdings, a now-bankrupt retailer that owns the iconic brand names Sears and Kmart. It was a rough start that has only gotten more difficult. And while the business is getting stronger, Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) still has a $1.44 billion claim on the real estate investment trust (REIT).
What a beginning!
Both Sears and Kmart had been struggling to resurrect their businesses, fix their merchandise mix, and attract customers. In order to free up some cash for that effort, Sears Holdings spun off Seritage Growth Properties, which bought a collection of the retailer's stores.
That's not an odd beginning at all, and there are a large number of REITs that were formed the same basic way. Four Corners, for example, was spun off from Darden Restaurants not too long ago.
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That said, there's a notable divergence here. Darden is a reasonably strong restaurant operator, so while Four Corners wants to diversify its business, there's no particular rush for it to do so. In fact, Darden brands still make up around 60% of its portfolio. Olive Garden alone is 45% of the portfolio, but it's a strong brand. Four Corners is largely buying new assets to increase diversification.
Sears and Kmart, on the other hand, were struggling badly and closing stores when Seritage bought the assets. So from the get-go, Seritage's focus was to take empty Sears and Kmart big boxes back, redevelop them, and lease them out to new tenants at (hopefully) higher rates.
Redevelopment is a costly endeavor, and it takes time. While the structures were being fixed up, Seritage wasn't collecting any rent even though redevelopment cash was going out the door. It was something of a race early on to shift away from Sears and Kmart before Sears Holdings imploded. Seritage lost, with the retailer stumbling well before Seritage had completely moved away from it.
A helping hand
That said, in 2018 Warren Buffett and Berkshire Hathaway saw the value potential in Seritage's portfolio and stepped in to help with a loan that could help the REIT bridge the gap between its redevelopment costs and improved revenues once it could rent out its updated retail space. It was a well-timed assist, given that just a few months later, Sears Holdings declared bankruptcy.
Things were moving along until the coronavirus hit in 2020 and set the REIT back again. Retail was one of the worst-hit property sectors early on in the pandemic.
Things started to look better in 2021, and in early 2022 Seritage was able to repay $160 million on the term loan Berkshire Hathaway provided. That sounds like a lot, but the term loan had a $1.6 billion balance. Thus it still has $1.44 billion to go and not a lot of time to pay it off, given it comes due in July 2023.
But the two companies have agreed to an extension through July 2025. However, Seritage needs to pay down the loan to $800 million for it to take effect. So Seritage really has until July 2023 to pay another $640 million, which seems fairly reasonable. In fact, that's much more reasonable than $1.44 billion.
For Berkshire Hathaway, which sports a massive $707 billion market cap, this is actually a tiny deal, so it can afford to be patient. That's a good thing, because without this loan, Seritage, with a $500 million market cap, could have been facing a life-or-death situation when Sears Holdings sought out court protections.
But there's more good news here, since Seritage is completely out from under its former parent. As of the third quarter of 2021, it had just 23% of its rents tied up in "signed not occupied" (SNO) contracts.
As those come on line and the associated costs for redevelopment of the assets subside, Seritage's business should start to turn a corner. It is not out of the woods just, but as long as Berkshire Hathaway is willing to work with Seritage, there's still turnaround potential here.
Not for the faint of heart
Seritage, from Day One, was a turnaround play. The path it has traversed from its early days has not been an easy one, with the bankruptcy of Sears Holdings and the pandemic representing two gale-force headwinds. Now the next big issue for special-situations investors to watch appears to be getting the loan paid down to $800 million. If the REIT can manage to meet the terms needed to extend the loan from Berkshire Hathaway, the future will look a whole lot brighter.
