Purchase of Saks unearths hidden real estate win in $3.7 billion building
For some owners of big-name retail chains, the buildings in which the businesses reside are as important as the businesses themselves. Sears Holdings CEO Edward Lampert’s complicated real estate machinations have led some to accuse him of profiting from the decline of the two chains he owns. But the most recent news in big retail real estate deals has raised more eyebrows than it has red flags.
Hudson’s Bay Company, owner of Saks Fifth Avenue, took out a $1.25 billion mortgage on the company’s Manhattan flagship store, the total value of the property having been appraised at $3.7 billion. Hudson’s Bay, led by CEO Richard Baker, acquired the entire Saks Fifth Avenue chain last year for just $2.9 billion.
"The value of real estate on Fifth Avenue in New York City has just skyrocketed," said Peter Schaeffer, principal at GlassRatner Advisory and Capital Group, in an interview with RetailWire. "Retail real estate in New York is just crazy, and I think that Baker and [his investment firm] NRDC — I don’t think it was as much that they were smart as much as the property appreciated above and beyond what they ever planned."
According to The New York Times, Mr. Baker intends to use the mortgage to pay down Hudson Bay’s more expensive debt, and CNBC reported that some of the money will be used to update the Saks building.
Such a real estate play is relatively rare, according to Mr. Schaeffer.
"In all honesty, [Mr. Baker’s] MO has always been to essentially buy retailers that had value in their properties, and use the built-in equity to make his acquisitions," said Mr. Schaeffer. "He’s one of the few that’s been successful with that MO."
One reason for the move’s rarity is limited opportunity. When department stores gave way to shopping malls, retailers moved towards having more outlets, leasing at low rents rather than owning the property.
"The only big retailer today that I know of that owns a lot of stores is Home Depot," said Mr. Schaeffer. "They find it much more economical to build their own stores and operate them than to rent them from someone else."
Despite Hudson’s Bay’s gem of a valuation, some believe the real estate prices in Manhattan may have hit a ceiling.
The Times reports, "Some analysts suggest the party may be ending, with real estate prices in New York sailing beyond the peak of the debt-fueled boom in 2007 and profit margins shrinking."
In an interview with CNBC, Mr. Baker referred to the $3.7 billion dollar store as "a little added gift with purchase."
Discussion Questions
Could there be advantages to chains owning their own stores rather than renting in the new economy? Do such complex real estate plays pose unseen risks or advantages to shareholders?
This is a very complex question. The “old” leases were actually 99-year leases. I think Sears has a boatload of those, with 60-year terms.
The value of leasing is that the cost is essentially fixed (although I’m sure there are COLA provisions in the really long ones). The value of owning is that theoretically, it’s an asset that will appreciate. However, in many ways, it’s just a distraction for a company that is meant to be a retailer, not a real estate holdings company. I think that’s the logic behind the statement “It was a gift with purchase.” If he’s a serial real estate mogul, good for him.
When the stock market was flying, then President Bush suggested it would be better to allow U.S. citizens in the market instead of the social security fund. Then the market crashed. No one talks about that option anymore.
Long story short, while it may be an old-fashioned point of view, I believe retailers should be retailers and real estate moguls should be real estate moguls. They are two different industries. The real estate market has proven to be volatile, and we can no longer assume endless appreciation. PLUS, who knows how big the move to online will be? Maybe we won’t need anywhere near that many stores going forward. Too much uncertainty for my taste.
I have seen enough retailers taken out by being trapped by their existing real estate holdings that I’m not a fan of owning property for stores. I mean, OK, can you go wrong in Manhattan? Maybe once upon a time. But demographics shift and properties that once were perfect fits become albatrosses all too quickly. Heck, I think even 20-year leases are too long to guarantee that the demographics of the location will still be appealing by the time the lease ends.
So yes, businesses can diversify and real estate is one place to potentially invest. But if you’re buying, not leasing, then you better be sure you’ve selected the property for the right reason—for a long term real estate investment, and not just because it happens to be a good retail location at this point in time.
Depends on the goals of the company. If a company is looking to expand rapidly, pay huge salaries and bonuses, or pay big short-term dividends, then renting and having huge amounts of debt is the way to go. If a company is more concerned about being able to compete well and having long term viability, then it’s best to be debt free and rent free, owning everything and paying cash. Obviously a retailer cannot expand rapidly without cash but rapid expansion is not the goal of all retailers.
This reminds me of when J.C. Penney moved its headquarters from New York to the prairie known as Plano, TX back in the ’80s. Penney built what at the time was considered a state-of-the-art campus (or unimaginative eyesore depending on who you asked) using only part of the proceeds. The new headquarters was quite controversial and some old-timers still mark the event as the beginning of Penney’s downward spiral. Now an adjacent $2 billion mixed-use development is due to break ground early next year as Penney once again leverages its astronomically-appreciating real estate assets. Retail has become a game of asset leverage and bricks-based retailers are waking up to the value locked up in their physical locations, both as facilitation points for digital commerce and as stand-alone assets. Should retailers be in the real estate business? That train left the station years ago.
When this sort of discussion occurs I am always reminded of a conversation with our company’s assistant controller during a bout of “buyers lament” after a townhouse purchase. His basic observation was that you never know the outcome until the property is sold.
It is great that Hudson’s Bay was able to collateralize their investment in Saks, but whether it was profitable transaction is still unknown. HB could very well find themselves paying off an underwater mortgage if commercial real estate prices drop. A lot of homeowners can identify with that.
When you ask whether others should own their store locations you mention Home Depot as an example. When you really thing about it, Home Depot is in the unique position of supplying the very services necessary to build and maintain a store location. To most retailers, maintaining a department and services that would be used to design and maintain buildings would be pure overhead. Home Depot can use it as a laboratory for testing the products vendors want them to sell.
The Home Depot aside, I don’t think retailers should be real estate owners. If anything, with the constant focus on addressing the “last mile” of the supply chain, the stores will see the most significant changes over the next 10 years. Stores will likely become showrooms, pick up points, and return facilitators. The bigger question is whether retailers should still be signing long term leases.
A company should begin by asking itself, “What business are we really in?”
When Eddie Lampert bought Sears and Kmart he changed the answer…and the future for both companies are now predictably finite, not for Lampert.
The financial and retail worlds are changing, intertwining, adding new member mindsets and that makes the answer harder to determine. Risks, rewards and objectives are increasing. Hey! “What business are we in?”
“New economy”? Please, this is an age old question, with no clear answer (and hence an analysis of annual reports over the years would show all-owned, all-leased or a mixture between companies). Much of the time a company has no choice, since it either has to locate in a mall—by definition a lease—or wants a lucrative location which the owner has no intention of selling (for obvious reasons). The important thing is to pick good locations—be they owned or leased—not just “available” ones.
When a retailer owns its stores, there is rent creep primarily for taxes. While it requires a larger investment to build a store, long term it can be a real advantage. Granted, most real estate does not increase to a New York City level. Caldor was a discounter that owned its stores. In the end, the real estate was worth more than the company.
Every real estate play has risk. Whether the value of the investment goes up or down depends on one’s neighbors. When retailer buys into a new area before all the homes are built, the price is low. If the houses get built and sold, the value of the store increases. If jobs move away and the houses are left empty, the value of the store declines. Long term is very hard to predict.
There’s not a lot of value in ownership unless it yields a specific result or objective on a particular location. Never forget it is location, location, location.
However, when valuing rent, developers and landlords also have to consider the “empty” value. Thus, that gives a retailer an advantage. There isn’t much value in losing your prime tenant.
There’s really not a whole lot of complexity here. It is simply a constant valuation by the retailer of each location.
As Crash Davis said, “Sometimes you win, sometimes you lose, sometimes it rains.”
This particular exchange happened to be a win. Will the next?
Yes, but the temptation to “liquify” real estate at the same time as taking the appreciation into profit has been too great too often—especially in traditional channels or struggling companies. It’s another tool for the CFO to exercise to hit EPS, etc. It’s been well practiced for a long time and the big difference here is the price tag/location.