J.C. Penney (NYSE:JCP) recently announced that it was exploring a sale of its Plano office complex, with a view to leasing back some of the space. It appears that the sale could raise around $380 million for J.C. Penney, as its headquarters is in a quite desirable location that many companies are moving to. The leaseback will increase SG&A costs modestly for J.C. Penney, but overall the deal should also result in interest savings that exceed the increased SG&A costs. Overall, the transaction could reduce J.C. Penney's debt by nearly $400 million as well as improve its overall cash flow by $13 million per year. While not transformative, this is an incrementally positive move that is also a logical one given J.C. Penney's diminished need for office space.
Valuing The Plano Headquarters
J.C. Penney's Plano headquarters is located in the Legacy Frisco submarket of Dallas, which is a hot area that many companies are moving to. This submarket has an average gross rental rate of $32.80 per square foot for Class A office space, while operating costs are estimated at 45% of the gross rental rate. This results in net operating income equal to $18.04 per square foot. The cap rate for Class A office space in Dallas is estimated at 6.5% to 7.0%, so Class A office space in Legacy Frisco would sell for approximately $267 per square foot.
Class B office space in Dallas rents for approximately 72% of Class A office space, so the gross rental rate for Class B office space in Legacy Frisco is estimated at $23.62 per square foot. With operating costs of 45% of that rate, net operating income would equal $12.99 per square foot for Class B office space in Legacy Frisco. The cap rate for Class B office space in Dallas is estimated at 8.0% to 9.0%, so Class B office space in Legacy Frisco would sell for approximately $153 per square foot.
J.C. Penney's office complex is described as Class A office space, but it is also 24 years old, which makes it a somewhat older building with less desirable layouts than more modern buildings. If J.C. Penney's office complex can fetch in between Class A and Class B rates (a bit closer to the Class B average due to age), it would sell for approximately $200 per square foot. As a check, one Plano office building built in 1985 was valued at $139 per square foot back in 2012. However, property values seem to have increased significantly since then, as another 1985 office building in nearby Irving sold for $225 million in 2012 and then $330 million in 2015, albeit after $12 million in upgrades.
At $200 per square foot, J.C Penney could receive approximately $360 million for its office complex, perhaps increasing to around $370 million to $380 million when including the value of the additional 40 acres available for development. J.C. Penney had a 240 acre undeveloped land parcel valued at $90 million in 2014.
Effect On Costs And Cash Flow
J.C. Penney is reportedly planning on leasing 600,000 square feet for its headquarters. This would cost J.C. Penney around $9 million to $10 million per year in additional costs, based on market rents and subtracting the operating and maintenance costs that it would save. J.C. Penney can shrink the space it uses considerably due to its layoffs at headquarters over the past few years, plus the trends for offices to use less space per employee.
J.C. Penney's headquarters was pledged as collateral for its 2013 secured term loan, so it appears that the net proceeds from this asset sale will need to go towards paying down that loan. This should help reduce J.C. Penney's interest costs fairly significantly though, as the secured term loan has an interest rate of LIBOR + 5.0% with a 1% LIBOR floor. J.C. Penney could save approximately $23 million per year in interest costs as a result. J.C. Penney's cash flow would improve by around $13 million per year due to this transaction.
J.C. Penney is continuing to make incremental progress in deleveraging, and the potential sale and partial leaseback of its headquarters is another positive step in this endeavor. I estimate that J.C. Penney can reduce its debt by nearly $400 million and also improve its cash flow by around $13 million per year from this deal. The outlook for J.C. Penney's credit rating remains positive from a combination of improving operational performance and asset sales.
Disclosure: I am/we are long JCP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.