The rush to buy Sears shares after the struggling retailer said it might spin off 200 to 300 stores as a real estate investment trust wasn't surprising. After all, investors have been waiting a decade for Edward Lampert, the hedge fund pooh-bah who controls Sears Holdings Corp., to tap the cash value of its vast real estate holdings — the company had, at last count, 1,870 Sears and Kmart stores in the U.S.
It will be far more interesting to see if investors rush to buy shares of the new REIT after it's spun off and trading publicly. The REIT's attractiveness as an investment will depend largely on its plans for the Sears stores it owns. If the long-term strategy is to simply collect rents on a load of down-at-the-heels Sears stores, don't expect the shares to soar.
“It would trade at a significant discount” to REITs with stronger investment profiles, predicted analyst Matt McGinley at Evercore ISI Group.
On the other hand, there may be significant upside if the REIT can boot out Sears and convert the floor space to more lucrative uses.
So there's a fundamental tension here: The REIT does better if Sears doesn't survive, while Sears' prospects improve if the REIT lacks key characteristics that real estate investors prize.
According to D.J. Busch, an analyst who follows REITs at Green Street Advisors, retail real estate investors prefer REITs with diversified tenant rosters composed of high-end stores with good credit ratings that pay rents of $20 per square foot or more. They also want the properties to be well-maintained and overseen by an executive team focused only on maximizing returns for the REIT.
And what would a Sears REIT offer? A single-tenant REIT centered on a money-losing retailer with lousy credit, paying department store rents, which can be as low as $3 to $4 per square foot. On top of that, Sears stores need costly makeovers after years of neglect by Mr. Lampert. And the REIT likely would be controlled by Mr. Lampert, whose role as Sears' CEO and largest shareholder gives him a significant stake in the retailer's survival.
Survival is what the spinoff is all about for Sears, which is consuming cash at a rate of about $1.5 billion a year. Mr. McGinley figures Sears would raise about $1.9 billion selling stores to the REIT and pay $150 million or so in annual rent to lease them back. Current Sears shareholders would get rights entitling them to buy REIT shares on a pro rata basis.
But Sears' survival isn't necessarily the best outcome for REIT investors. If the Sears stores in its portfolio shut down, the REIT would be free to boost its income by reconfiguring at least some sites for higher-end tenants. Mr. Busch points to Ala Moana mall in Honolulu, where General Growth Properties Inc. is redeveloping a former Sears store, as a model for the strategy.
Redevelopment likely would be an option only for Sears stores located in so-called “Class A” malls, Mr. Busch said. It's not clear how many such properties Sears owns (as opposed to leases) or how many would be transferred to the REIT. Observers do expect Sears to include its best properties in the REIT, however.
“The only way you can tap into the value of the real estate is if the landlord can recapture the space and repurpose it,” Mr. Busch said. “I don't see how investors get interested unless they see those redevelopment opportunities come to life.”
To bring those opportunities to life, more Sears stores will have to die.
Joe Cahill is a columnist at sister publication Crain's Chicago Business.