Why Retailers Are Up on a Down Day

Department store shares up big on a down day.

Dillards has said they are forming a REIT subsidiary. Why do this? Because for some retailers, the value is not in the brand or the merchandise, or the CEO vision — it's in the real estate.

The announcement is a meager three sentences, and it is not clear if this REIT will trade as a separate instrument. This seems unlikely if it's a wholly owned subsidiary, but the idea is that the deeds will be transferred to the subsidiary, which will charge Dillards rent under a "triple net lease" (where the lessee pays rent to the lessor, as well as all taxes, insurance, and maintenance).

That REIT subsidiary could then borrow a significant amount of money, based on the value of the leases.

Why are some retailers up on this? The theory is that this will force a valuation of the real estate separate from the value of the retail operations. In some cases, the REIT could eventually be spun off as a separate company.

This would give the company cash to invest, or — perhaps more likely — buy back shares. How much money would it get? According to Deutsche Bank they own 87% of their retail square footage and it may be worth $2.3-$3.3 billion. Is that a lot? The company has a market capitalization of $2.7 billion. In other words, the market is saying the value of the company IS is largely the real estate.

How much cash could they get? Assuming a loan-to-value ratio of 60 percent (fairly typical) the REIT could get up to $2 billion.

Dillards up 17 percent, but look at the others:

Sears also up 5 percent,

JCPenney up 4 percent,

Macys up 3 percent,

and all own a significant percentage of their real estate.

Sounds great. Why doesn't everyone do it? Because it adds to your risk profile; it makes your earnings a bit more volatile.

Think about it: the retail side has to be able to pay the rent. In many cases, these companies pay very little rent, because when malls are developed developers often charge very little rent for large anchors, instead charging the smaller stores. That could be a major factor in deciding whether or not to create a real estate subsidiary.

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