A New Spin on REIT Spin-Off Deals

By Stuart Eisenberg, Partner & RE Practice Leader, BDO USA L.L.P: What is pushing investors to put the pressure on retailers to cash in on the value of their real estate?

Stuart Eisenberg

Soaring property values have investors putting the pressure on retailers, including Macy’s, to cash in on the value of their real estate by entering into lease-back deals or hybrid joint ventures, say analysts at the Wall Street Journal. In fact, the July announcement of Starboard Value’s investment plan to spin Macy’s real estate into a REIT spurred a 4 percent increase in the company’s shares.

Proponents of the move say using it to extract value from real estate can generate a boost in shares, as is the case of Hudson’s Bay Co., which entered into a joint venture with mall operator Simon Properties and experienced a 24 percent boost to its shares since the deal was announced in February. Critics say leasing the property back from the buyer saddles the retailer with higher long-term costs that could hamper their ability to adapt to market changes and may not be worth the short-term gain.

When taking this approach, two main avenues are commonly discussed: a business can sell part or all of its real estate to a third party, taking the proceeds and leasing the property back under a long-term  rental agreement; alternatively, some retailers have chosen to spin off (through transfer or sale) the real estate to a newly formed REIT. Taking the latter approach hands control of the property over to the REIT, with the retailer then leasing back the property.

As major retail chains, Macy’s included, continue to make adjustments to their retail spaces to accommodate for the market forces generated by the rise of e-commerce and shifting consumer preferences, deals like these are gaining more traction as a way to take advantage of a booming real estate market and extract value from a business’ non-cash flowing assets.

Specifically, in what areas could retailers benefit by taking this approach?

Liquidity

In the short-term, spinning off real estate can be an effective value add and can generate an immediate influx in cash for the retailer. The funds can then be used to pay down debt and lower interest, invest in improvements or expand. If a retailer is performing well, it can be more practical to rent rather than own, as funds aren’t tied up in a long-term asset, but rather are available to invest in the operating business. For some retailers, this can be an important consideration and one that justifies entering into a lease agreement with the buyer and committing to increased costs in the long-term.

Asset Management

Spinning off real estate effectively shifts responsibility for property management onto the buyer, which can benefit retailers by reducing costs associated with property maintenance and capital projects, as well as reducing payroll expenses and/or a third-party management costs.

Investor Benefit

It’s important to note that a major driving force behind the uptick in lease-back deals has been a push from the investment community to take advantage of the current real estate market. Investor satisfaction is an essential consideration for retailers, especially as they weather disruption in the consumer business space. Some retailers could be subject to lower valuations if investors underestimate the value of the real estate held by the retailer, so spinning all or part of the real estate off can increase valuation and share prices, adding value from an investment perspective.

Historically, retailers direct their focus more on operating stores and generating revenue than on extracting value. With real estate values holding strong at a high level, Macy’s CEO explained in a recent CNBC segment the importance of the company approaching new real estate deal structures with an open mind, while also taking care to consider implications, such as shifting tax burdens. If Macy’s valuation grows as investors have modeled, some predict that a new model for retailers could emerge as a way to stimulate growth, generate liquidity and boost valuation.