Skip to main content
subscribers only

The news sounds so sexy at first.

Following in the footsteps of Loblaw Companies Ltd., Hudson's Bay Co. wants to spin its properties into a new real estate investment trust and raise money through an initial public offering, giving management some cash to do whatever it pleases.

But long-term, things may not be so rosy. REIT valuations are driven by market rents and the prospects of increasing lease payments, and a new REIT holding HBC properties will have to play by the same rules.

For Loblaw, this isn't a problem because the company already accounts for market rents internally, but the same may not be true at HBC. In the company's IPO prospectus, management comes right out and says "we believe our real estate leases have rents that are significantly below current market rents for similar properties," adding that "we believe the market value of our owned and ground leased real estate significantly exceeds current values reflected in our financial statements." If these leases are transferred to a REIT, how long do you think they'll stay below market levels?

To realize the so-called trapped value, the REIT has two main options: jack up rents, or unload some of the leases at market prices, the way HBC sold 189 Zellers leases to Target for $1.8-billion. The problem with the latter option is that HBC is no longer shedding one of its brands. To sell more leases, it would have to get rid of existing locations from the remaining brands – Hudson's Bay, Lord & Taylor and Home Outfitters. Clearly the easiest option then is to raise rents.

If that's the route the REIT opts to take, HBC investors will have some time to run the numbers because like all commercial real estate, existing rates are locked in for a number of years. (The exact length of each lease depends on the property.) The locked-in rates also offer some breathing room for a retailer that can't really afford to see its expenses shoot higher right now, not after posting a loss in its first quarter as a public company.

As for the timing of this REIT announcement, the idea has clearly been mulled over for years. In the prospectus, much space is devoted to detailing all of the company's real estate holdings, and the retailer came right out and said in the document that "we continually assess the potential of our real estate portfolio to realize value, whether through optimizing use (shop-in-shops, space rationalization), financing options or other avenues." Plus, remember which sector HBC chief Richard Baker knows best: real estate.