Why would Warren Buffett own 7% of a REIT heavily dependent on a rapidly deteriorating retailer?
At first glance, that's a head-scratcher. Buffet, chairman of Berkshire Hathaway Inc. (BRK.B - Get Report) , has personal investments in Seritage Growth Properties (SRG - Get Report) , a real estate investment trust holding Sears Holdings Corp. (SHLD) properties.
Buffett, it turns out, is Seritage's largest individual shareholder: his 7.16% stake in the company as of March 10 dwarfed even Sears CEO Edward Lampert's 1.9% stake as of March 31. The company's largest institutional shareholder is Bruce Berkowitz's Fairholme Capital Management LLC, also a significant Sears shareholder. Lampert's ESL Investments Inc. holds a 1.87% stake in Seritage as well.
Buffett revealed a stake in Seritage in late 2015, a few months after the company spun off from Sears. A "substantial majority" of its revenue comes from Sears, whose properties Seritage bought in a sale-and-leaseback transaction.
Buffett's Seritage strategy is all about the evolving retail landscape.
Seritage, which has 42.4 million square feet of gross leasable area, can attempt to find new tenants for its properties. "Our primary objective is to create value for our shareholders through the re-leasing and redevelopment of the majority of our Wholly Owned Properties and JV Properties," Seritage said in its most recent 10-K. "In doing so, we expect to meaningfully grow NOI and diversify our tenant base while transforming our portfolio from one with a single-tenant orientation to one comprised predominately of first-class, multi-tenant shopping centers."
There are 50 redevelopment projects in the works on former Sears properties as of June 30. In Braintree, Mass., for instance, Seritage is almost done converting a Sears store into outposts for Nordstrom Inc.'s (JWN - Get Report) Nordstrom Rack Hudson's Bay Co.'s Saks Off Fifth discount retailers. In Hialeah, Florida, discount grocer Aldi will soon be joined by Bed Bath & Beyond Inc. (BBBY - Get Report) "and additional junior anchors" in a former Sears site. St. Petersburg, Florida's old Sears will be demolished, with new construction for Dick's Sporting Goods Inc. (DKS - Get Report) , Five Below Inc. (FIVE - Get Report) and Brinker International Inc.'s (EAT - Get Report) Chili's restaurant chain. A downsized Sears in Canton, Ohio, will add a Dave & Buster's Entertainment Inc. (PLAY - Get Report) and other restaurants. Other new tenants include Burlington Stores Inc. (BURL - Get Report) , TJX Cos. Inc.'s (TJX - Get Report) TJ Maxx, Ulta Beauty Inc. (ULTA - Get Report) , Michaels Cos. Inc. (MIK - Get Report) , Cinemark Holdings Inc. (CNK - Get Report) and Shake Shack Inc. (SHAK - Get Report) .
These new tenants are paying way more than Sears is, with RBC Capital Markets LLC analyst Wes Golladay expecting these higher rents to increase Seritage's rental revenue by 17% in 2018. "Elevated leasing activity at Seritage" is an encouraging sign, he wrote, but "performance at Sears remains an overhang and a likely near-term driver for the shares."
While Seritage is diversifying away from Sears, it depends on rents from Sears locations as it develops these new properties and attracts new tenants. Shares are up 10.8% year to date, beating the S&P 500's increase of 9.3% during the same period, well above Sears' fall of 8.9% so far in 2017.
The formation of Seritage was one of several real estate transactions Sears entered into that year, including a 50-50 joint venture with General Growth Properties Inc. (GGP) , through which GGP paid $165 million for a 50% stake in a JV comprising the twelve Sears properties located in GGP malls. Sears formed a similar relationship with Macerich Co. (MAC - Get Report) , which paid $150 million for a 50% interest in a JV to which Sears contributed the nine properties it operates in Macerich malls.
The Seritage stake held by Buffett, who famously urged that investors buy American stocks during the financial crisis, is worth about $95 million, a drop in the bucket for someone with a net worth of nearly $80 billion. If Sears holds on long enough to maintain Seritage's redevelopment pace, the demise of the once-great American retailer won't hurt Buffett's portfolio too badly.
By the way, Buffett turns 87 today, Wednesday, Aug.30. The Seritage investment may turn out to be a gift that keeps on giving. So, Happy Birthday, Warren.
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Editors' pick: Originally published August 30.