By Robbie Whelan
Rising real-estate values are driving more retail companies to
consider splitting off their real-estate assets to generate
cash.
Late last month, Hudson's Bay Co., the Canadian parent company
of Saks Fifth Avenue and Lord & Taylor department stores,
announced a $1.7 billion joint venture with U.S. mall operator
Simon Property Group Inc. involving 42 department stores. Hudson's
Bay will retain 80% of the joint venture but will lease its store
space back from the company. It plans eventually to split off the
venture into a real-estate investment trust.
The same month, Sears Holdings Corp. said it would split off as
many as 300 of its best locations into a separate company by June
to raise money.
Activist investors, meanwhile, have pushed for real-estate
split-offs at a half-dozen other companies over the last six
months, including fast-food chain McDonald's Corp., department
store Dillard's Inc. and casino operator MGM Resorts
International.
At least a few companies are taking the suggestion seriously.
Late last year, Darden Restaurants Inc. said it had hired bankers
from J.P. Morgan Chase & Co. and Moelis & Co. to explore
options for monetizing its real-estate portfolio, which includes
some 1,200 restaurants such as Olive Garden and Capital Grille. In
December, casino operator Pinnacle Entertainment Inc. said it would
seek REIT status as part of a split-off of its real-estate
assets.
The trend is being driven in part by the record-high valuations
for real-estate assets. The Green Street Commercial Property Price
Index, a measure of commercial real-estate values across all
property types, was up 14% at the end of February, the most recent
data available, from its 2007 market peak. The MSCI U.S. REIT
Index, a benchmark for real-estate stocks, reached 1192.61 this
week, just 3.7% below its early 2007 record.
Low interest rates and high bond prices are also driving
investors into real estate, where the yields are better, said
Stanley Shashoua, a senior vice president with Simon Property who
helped orchestrate the deal for the Lord & Taylor and Saks
properties.
Another factor: favorable tax treatment. Since they were
established as a corporate structure in the 1960s, REITs have been
able to pay little or no tax on their earnings as long as they
distribute the bulk of their profits to investors through
dividends. Tax savings led to a wave of REIT conversions over the
last two years by companies with large real-estate portfolios,
including data-storage firms, operators of telecommunications
infrastructure and even gym owners.
"If you combine higher multiples with tax savings, there's a lot
of creative thinking that goes on," said Jim Sullivan, a managing
director at Green Street Advisors, the research firm that produces
the price index.
For some companies, a real-estate split-off is a way to shine
light on their value so investors will pay a premium for the
company's shares.
"We own assets that were invisible to our shareholders and what
we've done is expose them to shareholders so they can understand
what value is related to the real estate," said Richard Baker,
Hudson's Bay's chief executive. "This is a very different type of
situation from years ago when retailers sought to create
real-estate ventures in order to develop new projects."
Hudson's Bay's shares are up 17% on the Toronto Stock Exchange
since announcing its joint venture with Simon on Feb. 25.
The danger for operating companies is that split-off companies
won't get the lofty valuations they expect because investors might
worry their profits are too dependent on the fortunes of a single
tenant.
If Sears or Dillard's or K-Mart gets in trouble, "Even a whisper
of trouble is going to affect the cost of equity capital" for a
split-off that owns those retailers' locations, said Gilbert Menna,
a partner at Goodwin Procter LP in Boston and chairman of its
real-estate capital-markets group.
Some market watchers point to the experience of Penn National
Gaming Inc., a casino operator that split off its real-estate
assets into a REIT called Gaming & Leisure Properties Inc. in
late 2013. Since the transaction was completed, Penn National's
share price has fallen more than 73%, which was expected because of
the value of the assets being separated from the company. Gaming
& Leisure Properties has seen its share price fall 16% since
the split.
Real-estate split-offs are "a kind of instant way of creating
shareholder value," said Alex Bumazhny, a casino analyst who covers
Penn National for Fitch Ratings. Mr. Bumazhny pointed out that
Gaming & Leisure's shares are trading at 16.5 times earnings,
more than twice Penn National's old multiple. "But the jury is
still out as far as long-term performance."
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