At a time when the US property market is showing signs of recovery, investor activist Starboard Value LP has become something of a thorn in the side of US retailing giant Macy’s Inc. Like many retail companies around the world there is renewed competition from the online arena which has had a significant impact upon share prices over the last few years. As a consequence, there is now growing pressure for US retail companies, and retailers around the world, to unlock the value of their real estate portfolios.
Is this a sensible move or simply a short-term means of supporting share prices with uncertain longer term consequences?
Independent property companies
Macy’s is not the only US company to look at spinning of its real estate investments into a separate company. This is a potentially useful means of realising value because it literally separates the underlying business from property assets, which are often easier to value. Indeed there is also the option of selling part or all of the independent property company to investors to bring in cold hard cash.
While Macy’s may not be your typical retail company, currently holding real estate estimated to be valued at $21 billion, it does give you an idea of how companies can maximise their assets. Companies such as McDonald’s have been pursuing such a strategy for some time now as markets become more competitive and more funds are required for expansion.
What are the long-term consequences?
While there is no doubt that a short-term injection of capital, or collateral on which to borrow further funds, would prove very useful for many of the older retail companies who have significant real estate portfolios, what are the long-term consequences? In effect by switching real estate assets to a separate manage company this then places the emphasis on the new management to get the best out of their real estate assets for their shareholders. This would likely lead to an increase in rental values in the longer term which has the potential to squeeze margins for the underlying retailer going forward.
Unfortunately, more and more retail companies around the world are finding that cold hard property assets have little value in the changing retail market. The growing number of online competitors emerging around the world is squeezing margins. Therefore the ability to raise additional funds for further investment in online capabilities would seem sensible in the longer term.
Investment returns are vital
Whatever the long-term consequences of spinning off retail real estate assets under independent management it all comes down to how any funds raised can be invested. If the potential return on investment going forward is greater than any perceived risk of a long-term increase in rental costs then this is a no-brainer. However, if there is potential for long term rental costs to increase at a greater rate than the potential return on investment of the funds raised then the situation becomes a little trickier.
While nobody can see into the future there are significant risks in not unlocking real estate portfolios, which can often be overshadowed by the performance of the underlying business, but there needs to be long-term security going forward. Not an easy situation by any means.