Leave it to Warren Buffett to keep us guessing. The Oracle of Omaha just reported 8% stake in Seritage Growth Properties (SRG), a REIT spinoff of struggling old-line retailer Sears Holdings (SHLD). SRG owns a portfolio of 266 Sears properties, some of which it owns via joint ventures. But it’s essentially a dumping ground for Sears real estate and a vehicle for Sears Chairman Eddie Lampert to extract as much value as he can from a sinking ship. (I wrote about this earlier this year; see article.)
So, why would Warren Buffett want a piece of SRG? When I saw the news, I legitimately thought it was a joke. I actually had to check the SEC site to verify.
Interestingly, Mr. Buffett is not alone here. Contrarian value investor Bruce Berkowitz had amassed a 10% of the company as of the end of last quarter, though he’s been trimming back recently. Berkowitz has been a large shareholder of Sears Holdings for years. In fact, it’s his single biggest holding. So if he sees value in Sears, it’s not shocking that he would also see value in Sears’ spun-off property portfolio. (I wrote about Berkowitz and his highly-concentrated value portfolio earlier this year; see Seven Masters of the Universe.)
Both Warren Buffett and Bruce Berkowitz have had some high-profile mistakes in recent years. Sears has been a disaster for Berkowitz, and Buffett has lost a fortune in IBM (IBM). But both of these gentlemen have absolutely crushed the market over their careers, so when they make a large new position, it’s worth picking into the details.
First, we should clarify a point on size. Yes, Berkshire Hathaway (BRK.A) now owns 8% of SRG, and Berkowitz’s fund owns 10%. But SRG is a tiny REIT with a market cap of about $1 billion. So Berkshire Hathaway’s position, which had a cost basis of just $70 million, is a tiny drop in the bucket. Berkshire Hathaway has a market cap of well over $300 billion. So while the SRG purchase looks big in the headlines, it’s pretty much pocket change for Warren Buffett, the equivalent of buying a Cherry Coke (Buffett’s favorite…) for the rest of us.
Likewise, while Berkowitz owns 10% of SRG, it only accounts for less than 4% of his portfolio.
Still, might there be some value here? Let’s take a look.
Seritage is a new REIT that only began trading in July, so there is not a lot of history to it. And to date, SRG has yet to pay a dividend, though it has promised to do so before year end.
Looking at the financial results, nothing particularly jumps off the page. “Normalized” funds from operations (“FFO”) last quarter came in at $0.52 per share. Annualizing that, SRG trades at a price/FFO multiple of 19. That’s not particularly cheap though not completely out of line for the industry. It also suggests a dividend yield in the 3%-4% range is doable.
Normally, I’m somewhat skeptical of “specialty” REITs that are spun off from a single large property holder. To start, there is major concentration risk. What if Sears finally goes belly up?
And you have to legitimately ask if a spinoff REIT is truly to be run independently for the benefit of its shareholders or if it is little more than a funding vehicle for the former parent company. For example, might Seritage give Sears preferential treatment with below-market rents? Maybe, maybe not. But questions like these should normally cause a spinoff REIT like SRG to trade at a discount to its more diversified and more independent peers.
That was my initial thought. But I was pleasantly surprised to see that 22% of SRG’s rental income comes from tenants other than Sears. And that number should grow over time, presumably allowing for respectable growth in rents as non-Sears tenants pay market rates.
So while a discount to larger peers like Realty Income (O) would still be warranted, that discount should definitely close with time.
When Eddie Lampert first took control of Sears, we all more or less assumed it was his intention to unlock its real estate value while slowly allowing the retail business to wither and die. It might have all gone according to plan had the 2008 meltdown and Great Recession not hit. But with his launch of SRG earlier this year, it looks like Mr. Lampert is still more or less doing what he had always planned to do. (See Is Sears the Next Berkshire Hathaway.)
I wouldn’t be a buyer of SRG at today’s prices. The shares are up about 15% on the news of Warren Buffett’s position, and I think it’s likely that shares drift back down once the news properly sets in. But SRG might be a REIT to watch. In particular, look for progress in the coming quarters in reducing exposure to Sears Holdings and look for dividend guidance in the next quarterly report.
Disclosures: Long O.
Photo credit: DonkeyHotey