Some retail analysts are questioning the announced plan by Dillard’s Inc. to move ownership of its real estate into a subsidiary, and some observers – including the head of the largest mall-operating company in the U.S. – wonder whether the real estate investment trust will even happen.
"It is something that makes really very little sense to anyone except somebody who believes that there is some value in the department store … in a mall," said Kenneth Leonard, principal of Leonard Associates of Chicago, which specializes in retailing and shopping center real estate.
The Little Rock department store chain has released no details about its planned REIT. It announced the creation of the REIT in a three-sentence filing with the U.S. Securities & Exchange Commission on Jan. 19, and investors reacted favorably.
The filing said Dillard’s would transfer some of its properties into the REIT,
which would then lease them back to Dillard’s. The company also said the move would "enhance its ability to access debt or preferred stock and thereby enhance its liquidity."
Dillard’s followed that up with a mention in its March 23 annual report that said Dillard’s operating subsidiaries had transferred "certain real estate interests to the REIT." The report also said Dillard’s paid Ste-phens Inc. of Little Rock $250,000 for "analysis with regard to the Company’s real estate trust transaction." Dillard’s board member Warren Stephens is the CEO of Stephens Inc.
Dillard’s spokeswoman Julie Bull declined last week to release any more details on the REIT. The REIT wasn’t mentioned at all by Dillard’s CEO William Dillard II or President Alex Dillard at the annual shareholders’ meeting on May 21.
In theory, forming a REIT would generate a lot of cash for Dillard’s, said Howard Davidowitz, chairman of Davidowitz & Associates Inc., a retail consulting and investment banking firm in New York.
"When this is talked about, it sounds great, because you’re unlocking the value from the real estate," he said.
As of April 30, Dillard’s operated 294 stores and 14 clearance centers in 29 states. For the fiscal year than ended Jan. 29, Dillard’s valued its property and equipment at $2.6 billion. On Jan. 29, Dillard’s owned 240 stores and leased 41 of them. With the remaining stores, it either owned the building on leased land or partially owned and partially leased.
"Let’s assume they have equity in each of these properties," said Barnet Phillips IV, a retired partner and former head of the REIT Practice Group of Skadden Arps Slate Meagher & Flom LLP of New York. "They can now finance based upon the value of all equity in that subsidiary very easily from a corporate standpoint because that subsidiary can go out and borrow money and pledge its assets."
Or Dillard’s might want to establish separate credit for the REIT, he said.
Money generated through the REIT then could be used for Dillard’s shareholders or for something else related to the company, Davidowitz said.
Dillard’s has been using its extra cash to buy back Dillard’s stock and not to build stores. Last week, Dillard’s board of directors approved another share repurchase program that allows the company to repurchase up to $250 million in Class A common stock.
In its 2010 fiscal year, Dillard’s bought back $414 million in stock.
After a few years, Phillips said, Dillard’s could spin off the REIT into its own company. Another possibility is that current Dillard’s shareholders could get shares in the REIT.
"It just depends on what Dillard’s wants to do," he said.
Still, Davidowitz said, he believes the recent run-up in the price of Dillard’s stock is tied to the speculation surrounding the future of the REIT. Dillard’s stock (NYSE:DDS) closed at $37.54 on Jan. 19, and the REIT was announced after the close. The next day, Jan. 20, it closed up almost 12 percent at $41.96. After Dillard’s reported an especially profitable first quarter, the stock reached a record high of $56.76 on May 13 and had settled back at about $53 last week.
Potential Problems
But there are issues that have some analysts concerned about the REIT plan.
If Dillard’s creates a publicly traded subsidiary, the company would have to "deal with it at arm’s length," Phillips said. "And therefore, you have a little bit less control over the subsidiary’s desires to lease the real estate to Wal-Mart or maybe somebody else," such as a competitor, Phillips said.
Creating the REIT could cause other problems for Dillard’s, Davidowitz said, because Dillard’s would have to start paying fair market rent to the REIT for the stores that it owned. And that becomes a negative for creating the REIT, he said.
"Because when the rents were factored in, … it doesn’t work," Davidowitz said.
He said some retailers, such as McDonald’s and Target, had considered doing a REIT, but had scrapped the idea. "Because the numbers didn’t work," he said.
Leonard questioned the value Dillard’s placed on its real estate and doesn’t believe it is the market value. In recent years, the closing of any anchor department store in a mall has generally created a dark space because a replacement tenant can’t be found. Even Dillard’s said it has no plans to open stores during its current fiscal year.
"It has been proven time and time again that there just isn’t any value there, or if the value is there, the value is so little that it’s meaningless," Leonard said.
Leonard calculated that Dillard’s is spending about $1.2 million annually for insurance, security, real estate taxes and other expenses on each store it has closed in a mall.
"Now would you buy a stock or a piece of real estate that could possibly be an empty store that costs you $1.2 million every year just to preserve it?" Leonard said. Since the end of January 2009, Dillard’s has closed 21 stores.
David Simon, the CEO of Simon Property Group Inc. of Indianapolis, said in an earnings call on Feb. 4 that he didn’t see the Dillard’s REIT moving forward.
"I have no inside knowledge of this, obviously, but I don’t think there’s any market at all about a self-managed, one-tenant REIT that’s going to go access the public markets," he said during the call.
Davidowitz said that four months after the announcement of the REIT, he would have expected to have heard more details about it.
"My own instinct is they’re finding out that this is much more complex, which is what everybody found out," he said.
He said he thinks Dillard’s won’t move forward with the REIT.
Phillips disagrees. Dillard’s probably isn’t "having any second thoughts," Philips said. "I don’t think you can interpret silence as being anything really."
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