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Bull vs. Bear: Seritage Growth Properties

Since being spun off from Sears Holdings six years ago, Seritage Growth Properties (NYSE: SRG) has attracted interest from several high-profile investors, led by Warren Buffett. Yet despite the REIT's attractive real estate and substantial redevelopment opportunities, Seritage stock has fallen in value since going public in 2015.

Is Seritage finally ready to cash in on its potential? Or did the COVID-19 pandemic crush its prospects? Below, two veteran Foolish contributors debate the merits of Seritage Growth Properties stock.

Adam Levine-Weinberg, CFA: Too much risk, too little upside

Seritage Growth Properties had a lot of potential -- before the COVID-19 pandemic. However, it no longer has enough upside to justify the risk of owning it.

Entering 2020, Seritage's portfolio was 43% leased. It had $107.7 million of in-place annual rent and leases signed for future occupancy totaling $84.3 million of annual rent. However, Seritage made a big bet on "experiential" tenants: e.g., gyms, movie theaters, family entertainment centers, and co-working spaces. Many of these tenants ran into trouble during the pandemic.

As a result, by March 31, 2021, the portfolio was less than 29% leased. In-place rent had fallen to $93.4 million, and Seritage had just $36.3 million of annual rent signed for future occupancy.

Image source: Adam Levine-Weinberg.

Even in late 2019, Seritage was burning cash, but it had a clear path to reaching breakeven by late 2020 or early 2021. Now, it is burning cash even faster -- about $100 million a year before it spends a dime on redevelopment -- and is years away from breakeven.

Asset sales: a double-edged sword

Seritage's business plan entails ambitious redevelopments of its real estate. However, it had just $144.5 million of cash on hand as of March 31: enough to cover about a year of operational cash burn and normal liquidity needs.

To give itself more runway and cover redevelopment spending, Seritage has relied on asset sales. It has raised about $1.2 billion from selling real estate since being spun off from Sears in 2015. Seritage owned interests in 179 properties as of March 31 -- down from 266 in mid-2015 -- and had several more under contract for sale.

New CEO Andrea Olshan hopes to sell another 40 or 50 assets, raising more cash and whittling the portfolio down to 120 to 130 properties. However, most of Seritage's real estate is vacant. Unless it sells its highest-potential locations, vacant assets probably won't fetch high prices. And if Seritage sells some of its few fully occupied properties, in-place rent will fall further, worsening its cash burn.

Real estate development comes with risks

Finally, while Seritage owns a few dozen high-potential assets, redeveloping them profitably won't be easy.

Seritage commenced work on its first three premier projects in 2017, expecting to complete them by the end of 2019. Not one has opened yet. As of Dec. 31, 2019, Esplanade at Aventura was 50% leased, The Collection at UTC in San Diego was two-thirds leased, and Mark 302 in Santa Monica didn't have a single tenant. Since then, many prospective tenants have pulled out, while new lease signings have been few and far between.

Esplanade at Aventura is behind schedule and only half leased. Image source: Seritage Growth Properties.

Looking ahead, major risks include soaring construction costs, zoning restrictions, uncertainty about demand, and long lead times. For example, Seritage doesn't expect to begin construction on its premier asset in Alexandria, Virginia until at least 2023, with the first buildings ready for occupancy in 2025 at best.

Seritage doesn't have that kind of time. Its cash burn over the next several years will offset much of the potential gains from successful redevelopments. That leaves too little upside to justify the risk of investing in a company with persistent cash burn.

Matt Frankel, CFP: Tremendous untapped potential that the market is overlooking

I certainly share some of Adam's concerns. The rate of cash burn is problematic, and the huge decline in signed leases over the past year or so isn't exactly encouraging. And it's absolutely true that redeveloping Seritage's most promising assets is going to be a heavy lift, and one that is likely to take years to complete.

To be clear, Seritage is not a low-risk stock by any definition of the term. I think this is a clear case of a binary outcome – Seritage will either ultimately go to zero or will be a ten-bagger for patient investors who buy in at the current cheap valuation. And I think there are far better odds of the latter happening than the market is giving credit for.

First off, consider just how cheap Seritage is right now. Its market cap of $780 million implies that you're getting its 26 million square foot portfolio for roughly $30 per square foot. The average retail property in the United States rents for more than $18 per square foot per year, and high-quality spaces like Seritage aims to develop can rent for several times that amount. The median base rent at Seritage's premier Aventura property that Adam referenced is $100.

Even including Seritage's $1.6 billion term loan, you're still only paying about $90/SF. Sure, much of Seritage's properties are vacant Sears buildings, but that's a low valuation to pay for retail real estate, much of which is in top-notch locations. More significantly, you're paying for the 2,300 acres of land Seritage owns, much of which is vacant parking lots with endless redevelopment possibilities.

As I mentioned, the cash burn is certainly concerning, but that's why I'm a big fan of new CEO Andrea Olshan's plan to quickly sell Seritage's non-core assets. We don't know exactly what assets she plans to sell, but based on the company's recent activity (32 properties and 16 outparcels sold for $417 million in 2020) and the overall strength of the real estate market in 2021, this could easily generate $500 million or more in sorely needed cash to accelerate Seritage's redevelopment efforts. If put to good use, Seritage could be cash-flow positive by the end of next year and could become a truly self-sustaining and value-creating redevelopment machine.

A fascinating stock to watch

Clearly, there are plenty of reasons to be optimistic about Seritage's long-term outlook -- but plenty of reasons to be pessimistic, too. Only time will tell whether Seritage's strengths outweigh its weaknesses or vice versa.

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Adam Levine-Weinberg has no position in any of the stocks mentioned. Matthew Frankel, CFP owns shares of Seritage Growth Properties (Class A). The Motley Fool owns shares of and recommends Seritage Growth Properties (Class A). The Motley Fool has a disclosure policy.


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