How big name retailers stretch real estate muscles to weather hard times

Following less-than-impressive second quarter results, Hudson’s Bay Co. announced it’d be ramping up its real estate strategy in a bid to weather hard times in the retail sector amidst changing trends and growing online competition.

The news follows a recent note to shareholders from Jonathan Litt, in which the activist investor and founder and chief investment officer at Land and Buildings Investment Management LLC, put pressure on the company to lean on its real estate strategy in order to maximize profit.

“Hudson’s Bay is a real estate company, full stop,” wrote Litt in a June letter to HBC’s board. “If there is a smarter and better use of any or all of the locations, stores should be closed and redeveloped and put towards their optimal use.”

Litt has been consistently vocal about the strategy stating that the Saks Fifth Avenue owner’s real estate is valued at $35 a share (about $6.4 billion) making it “more than three times the current share price.”

Litt’s recommendation: turn the HBC-owned Saks Fifth Avenue flagship store in New York City – a property with an estimated equity value of $2.9 billion after net debt of $1.98 billion – into condos, then rent the lower floors to smaller boutiques.

“The Saks Fifth Avenue banner would likely be in high demand from potential buyers, allowing the company to focus on the Canadian market it has long dominated,” he wrote.

While HBC’s recent announcement to shareholders hinted at the possibility of bolstering its real estate strategy, the news this week that the company is selling Lord & Taylor’s flagship store on Fifth Avenue to startup WeWork signals the extent to which the company has fallen in line with Litt’s recommendations.

Hudson’s Bay isn’t the first retailer to delve into the real estate realm. In 2010, Sears tried the same strategy, opening a commercial real estate business under the realty banner with aims to sell or lease its growing number of vacant properties.

Since then. Eddie Lampert, CEO, chairman and largest shareholder of Sears Holdings, has struggled to execute the strategy. The company hopes to generate more than $3 billion in cash from joint venture proceeds and the Seritage Growth Property REIT – a vessel for the sale in leaseback of 235 Sears and Kmart Stores – but Sears is gulping its last dying breaths.

The challenge, it seems, is the retailers pushing into these spaces are still playing in a drastically evolving market fraught with discount retailers and consumers with an eye for digitally-sourced goods.

But that doesn’t mean it’s a poor scheme. McDonald’s – which is contending with its own struggles as consumers lose their taste for fast food – has executed the real estate strategy for years. A scene in the recent biopic The Founder, encapsulates the attitude perfectly: Ray Kroc the man behind McDonald’s local domination (played by Michael Keaton) is losing steam despite having a handful of successful franchises up and running. But his financial consultant and future CFO, Harry Sonneborn, sets him straight: “You’re not in the hamburger business, you’re in the real estate business.”

The Hollywoodized version no doubt derives from Sonneborn’s original sentiment that being a lucrative corporation has less to do with the product than it does with the company’s real estate holdings. As Sonneborn sardonically told a group of investors, according to Eric Schlosser’s Fast Food Nation, “The only reason we sell fifteen-cent hamburgers is because they are the greatest producer of revenue, from which our tenants can pay us our rent.”

McDonald’s leaned heavily on the strategy during the recession, buying up more of the land and buildings where it operates.

Sure, McDonald’s sells hamburgers, but as pointed out, with $30 billion in real estate assets and franchisees forking over 22 percent of their average gross profits in rent each year, the almighty burger chain is actually better classified as a real estate company.

Maybe it’s something HBC might seriously consider as it diversifies to match the changing retail environment. After all, burgers and fashion ebb and flow, but there’s always going to be someone or some business looking for a place to rent.


Andrew Seale

Andrew Seale is a Toronto-based business writer who contributes frequently to Yahoo Canada Finance, The Globe and Mail's Report on Business and The Toronto Star.