Seritage Growth Properties‘ (NYSE: SRG) The mission to convert the former Sears and Kmart stores for better uses has generated surprising investor interest, despite weak supply and demand dynamics for commercial real estate in recent years. Unfortunately, the REIT has not had the easy task of carrying out its redevelopment plan. Between the rapid collapse of Sears and the COVID-19 pandemic, most of Seritage’s real estate portfolio is now vacant.
The Bulls were hoping that a new direction and a quick plan to sell non-essential properties could turn the tide. However, Seritage’s second quarter earnings report showed the company is still floundering and has no easy way out.
Key indicators are heading in the wrong direction again
In recent years, Seritage has struggled to keep a reasonable proportion of its housing stock occupied. As of June 30, the occupancy rate stood at a dismal 23%. Naturally, this prevents the REIT from producing decent financial results.
In the last quarter, Seritage generated total net operating income of only $ 7.6 million. This barely exceeded the $ 7.3 million total NOI it had generated during the period of the previous year, which was at the height of the pandemic. It was also down from $ 9.4 million in the first quarter – and an average of nearly $ 50 million per quarter in 2016.
The Seritage property in Manchester, New Hampshire is 75% occupied – far better than average for Seritage. Image source: Seritage Growth Properties.
Meanwhile, the REIT reported operating funds of – $ 33.9 million, or $ 0.61 per share. Excluding one-off items such as severance pay, restructuring charges and mortgage registration fees, adjusted FFOs were only slightly better at – $ 29.3 million ($ -0.52 per share) . Adjusted FFOs decreased both sequentially and year over year.
Consumption of cash continues
Seritage’s continued low NOI and FFOs have resulted in consistent cash consumption. The company ended the second quarter with just $ 92.3 million in rent in place. That’s not even enough to cover the $ 116 million annual interest on his $ 1.6 billion term loan.
Adding in general and administrative expenses (typically around $ 10 million per quarter), preferred dividends and operating expenses for vacant properties, Seritage’s costs currently exceed its revenues by more than $ 100 million per year. Any redevelopment expense would be added to this underlying cash expense.
Indeed, in the first half of 2021, Seritage generated approximately $ 124 million in proceeds from the sale of assets and reinvested $ 66 million of that amount in its redevelopment projects. Nonetheless, it ended June with $ 3 million less cash on its balance sheet than it had at the start of the year. In other words, the REIT burned roughly $ 61 million in the first six months of 2021.
Low rental activity
In addition to its woes, Seritage has struggled to maintain its rental pipeline since the pandemic struck a year and a half ago. By early 2020, he had signed leases for future occupancy totaling $ 84.3 million in annual base rent. By the end of the year, that figure had fallen to $ 54.5 million. During the first half of 2021, this “signed-unopened” pipeline continued to narrow, reaching $ 32.3 million at the end of the last quarter.
Image source: Seritage Growth Properties.
Most of these declines were driven by asset sales and the cancellation of store opening plans by tenants. To make matters worse, new rental activity is almost at a standstill. Seritage only signed six leases in the last quarter, totaling a future annual base rent of $ 780,000. In the first quarter, she signed leases for $ 1.5 million in annual base rent. And throughout 2020, he’s signed leases for an annual base rent of $ 7.5 million.
In contrast, between 2017 and 2019, Seritage signed leases for at least $ 40 million in annual rent each year. The recent lack of rental activity is of particular concern as other retail REITs have reported rental activity to have reached a multi-year high in 2021.
This turnaround does not turn
Seritage owns some very attractive real estate (as well as many lower quality properties). However, to take advantage of its opportunities, the REIT would have to dramatically increase its rental business, raise hundreds of millions (if not billions) of dollars in capital, and speed up construction on its redevelopment projects. It won’t be easy.
Meanwhile, Seritage is burning over $ 100 million in silver a year. At best, it will take several years to achieve equilibrium. This consumption of operating cash will absorb a large portion of the proceeds from the sale of its assets, gradually reducing shareholder value.
For investors intrigued by Seritage Growth Properties’ strategy, putting stock on your watch list doesn’t hurt. But until Seritage shows significant signs of progress towards a recovery, investors are likely to sit on the sidelines.
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Adam Levine-Weinberg has no position in the stocks mentioned. The Motley Fool owns shares and recommends Seritage Growth Properties (Class A). The Motley Fool has a disclosure policy.
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