For several years Properties of Seritage Growth‘ (NYSE: SRG) The heavy debt burden posed a significant risk to the shareholders of the Sears real estate spin-off. When the COVID-19 pandemic broke out in 2020 and thwarted Seritage’s recovery plans, that risk suddenly became acute and threatened the future of the REIT.
Last week, Seritage Growth Properties took an important step back toward financial health by paying off $ 160 million in debt early. Still, there is still a lot of work to do to revise her balance sheet so she can focus on executing her turnaround strategy.
Burning cash with no end in sight
Seritage has been continuously burning cash since mid-2018 as the main tenant, Sears Holdings, began closing stores much faster than the REIT managed to remodel them for new tenants.
Before the pandemic, however, Seritage appeared to be well on its way to returning to positive cash flow within a year or two due to a wave of planned tenant openings in redeveloped properties. Unfortunately, the pandemic has bankrupted some Seritage tenants and forced others to close stores or roll back expansion plans. Meanwhile, the REIT sold some rental properties to raise cash.
As a result, Seritage’s actual annual rent fell to $ 92 million by the third quarter of 2021, compared to $ 108 million in late 2019. This caused Adjusted Funds from Operations (FFO) to continue to decline and decline from -15 million US dollars in the fourth quarter of 2019 to -25 million US dollars in the third quarter of 2021.
To make matters worse, Sertag’s pipeline of signed leases for future openings shrank 66% to just $ 29 million of the annual base rent during that period: not nearly enough to bring the REIT back to even FFO.
Cut off debt
High interest expense is one of the biggest barriers to Sertag’s efforts to return to positive FFO and cash flow. The cash interest expense on the term loan facility has been $ 116 million annually for the past several years. That alone makes it essential for Seritage to reduce the debt burden as quickly as possible.
Additionally, Seritage’s $ 1.6 billion term loan will mature in July 2023 Berkshire Hathaway) agreed to extend the term by two years – provided Seritage reduces the balance to $ 800 million by next July. That makes deleveraging even more urgent.
On the plus side, Seritage has identified around 70 properties that it plans to sell. As of September 30, 2021, there were $ 224.4 million in assets for sale. On December 31, the company used a portion of its sales proceeds to make an upfront payment of $ 160 million. This will reduce annual interest expense by $ 11 million.
How much money can Seritage raise?
Seritage appears to have completed a particularly large asset sale last quarter, namely the sale of a former Sears facility in San Bruno, California (just outside of San Francisco) for approximately $ 128 million. The REIT has other valuable lots in its disposal portfolio, including properties in San Jose and Westminster, California.
That said, most of the real estate Seritage wants to unload isn’t worth much. For example, it recently sold a former Kmart in the Tampa suburbs for $ 6 million. This property is far more representative of what Seritage would like to sell than the San Bruno site.
Seritage can certainly raise enough cash from additional asset sales to pay for its proposed near-term renovation expenses of approximately $ 250 million. It should also be able to cover its ongoing cash burn, which is around $ 100 million annually, with no investments. But after those costs are met, it will likely not be enough to seriously contain Seritage’s remaining $ 1.44 billion term loan debt.
Seritage may be hoping to refinance some of its debt by using its best real estate as collateral for mortgages. However, Berkshire Hathaway currently holds mortgages on all of the REIT’s assets. Unless Berkshire agrees to more lenient terms, Seritage would have to raise enough cash to repay the term loan in full to enter the commercial mortgage market.
In short, Seritage is still lacking a clear path to getting its debt to reasonable levels relative to its annual rental income. Meanwhile, the slow pace of leasing over the past two years makes it doubtful that it will break even in the foreseeable future. All in all, investors are finding far more attractive opportunities in the REIT sector.
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