Seritage Growth still owes Berkshire Hathaway $1.44 billion

Serage growth properties (NYSE: SRG) began life when it was spun off from Sears Holdings, a now-bankrupt retailer that owns iconic Sears and Kmart brands. It was a rough start that only got worse. And as the company grows stronger, Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) still has a claim of $1.44 billion on the real estate investment trust (REIT).

What a start!

Sears and Kmart were struggling to resuscitate their businesses, fix their merchandise lineup, and attract customers. To free up cash for this effort, Sears Holdings created Seritage Growth Properties, which purchased a collection of stores from the retailer.

It’s not a strange start at all, and there are plenty of REITs that were formed in the same way. Four cornersfor example, was derived from Dard Restaurants not so long ago.

Image source: Getty Images.

That said, there is a notable discrepancy here. Darden is a reasonably strong restaurant operator, so even if Four Corners wants to diversify its business, there’s no particular rush for it to do so. In fact, Darden brands still make up around 60% of its portfolio. Olive Garden alone represents 45% of the portfolio, but it is a strong brand. Four Corners largely buys new assets to increase diversification.

Sears and Kmart, on the other hand, were in deep trouble and were closing stores when Seritage bought the assets. So, from the start, Seritage’s goal was to take over the big empty boxes from Sears and Kmart, refurbish them, and lease them to new tenants at (hopefully) higher rates.

Redevelopment is an expensive and time-consuming undertaking. While the structures were repaired, Seritage collected no rent even though the money for the redevelopment came out. At first it was kind of a race to get away from Sears and Kmart before Sears Holdings imploded. Seritage lost, with the retailer stumbling long before Seritage pulled away completely.

A hand

That said, in 2018 Warren Buffett and Berkshire Hathaway saw the value potential in Seritage’s portfolio and stepped in to help with a loan that could help the REIT bridge the gap between its redevelopment costs and improving its performance. income once he could rent out his updated retail space. It was a welcome help, given that a few months later Sears Holdings declared bankruptcy.

Things were moving forward until the coronavirus hit in 2020 and set the REIT back. Retail was one of the hardest hit real estate sectors at the start of the pandemic.

Things started to look up in 2021, and in early 2022 Seritage was able to repay $160 million on the term loan provided by Berkshire Hathaway. That sounds like a lot, but the term loan had a balance of $1.6 billion. So, he still has $1.44 billion left and little time to pay it back, given that it matures in July 2023.

But the two companies have agreed to an extension until July 2025. However, Seritage must repay the $800 million loan for it to take effect. So Seritage really has until July 2023 to pay another $640 million, which seems pretty reasonable. In fact, that’s a lot more reasonable than $1.44 billion.

For Berkshire Hathaway, which boasts a massive market capitalization of $707 billion, this is actually a very small deal, so it can afford to be patient. That’s a good thing, because without this loan, Seritage, with a market capitalization of $500 million, could have faced a life-or-death situation when Sears Holdings sought court protection.

SSR Chart

SSR data by YCharts

But there’s more good news here, since Seritage is completely out of its former parent. In the third quarter of 2021, it only had 23% of its rent locked in “signed not occupied” (SNO) contracts.

As these come into service and the costs associated with redevelopment of the assets decrease, Seritage’s business should begin to take a turn. It’s not just out of the woods, but as long as Berkshire Hathaway is willing to work with Seritage, there’s still potential for a turnaround here.

Not for the faint of heart

Seritage, from day one, has been a play. The road he has traveled since his beginnings has not been easy, with the bankruptcy of Sears Holdings and the pandemic representing two strong headwinds. Now, the next big issue to watch for investors in special situations seems to be the repayment of the $800 million loan. If the REIT manages to meet the conditions necessary to extend Berkshire Hathaway’s loan, the future looks much brighter.

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Reuben Gregg Brewer has no position in the stocks mentioned. The Motley Fool owns and recommends Berkshire Hathaway (B shares). The Motley Fool recommends Seritage Growth Properties (Class A) and recommends the following options: long calls of $200 in January 2023 on Berkshire Hathaway (B shares), short longs of $200 in January 2023 on Berkshire Hathaway (B shares) and calls short $265 in January 2023 on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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