ITEM 1.
BUSINESS
The Company
Seritage Growth Properties (“Seritage”) (NYSE: SRG), a Maryland real estate investment trust formed on June 3, 2015, is a fully integrated, self-administered and self-managed real estate investment trust (“REIT”) as defined under Section 856(c) of the Internal Revenue Code (the “Code”). Seritage’s assets are held by and its operations are primarily conducted, directly or indirectly, through Seritage Growth Properties, L.P., a Delaware limited partnership (the “Operating Partnership”). Under the partnership agreement of the Operating Partnership, Seritage, as the sole general partner, has exclusive responsibility and discretion in the management and control of the Operating Partnership. Unless otherwise expressly stated or the context otherwise requires, the “Company”, “we,” “us,” and “our” as used herein refer to Seritage, the Operating Partnership and its owned and controlled subsidiaries.
Seritage is principally engaged in the acquisition, ownership, development, redevelopment, management and leasing of diversified retail and mixed-use properties throughout the United States. As of December 31, 2019, the Company’s portfolio consisted of interests in 212 properties totaling approximately 33.4 million square feet of gross leasable area (“GLA”), including 184 wholly owned properties totaling approximately 28.7 million square feet of GLA across 44 states and Puerto Rico (the “Wholly Owned Properties), and interests in 28 joint venture properties totaling approximately 4.7 million square feet of GLA across 14 states (the “JV Properties”).
The Company’s mission is to create and own revitalized shopping, dining, entertainment and mixed-use destinations that provide enriched experiences for consumers and local communities, and create long-term value for our shareholders.
Background
On June 11, 2015, Sears Holdings Corporation (“Sears Holdings” or “Sears”) effected a rights offering (the “Rights Offering”) to Sears Holdings stockholders to purchase common shares of Seritage in order to fund, in part, the $2.7 billion acquisition of (i) 234 of Sears Holdings’ owned properties and one of its ground leased properties, and (ii) its 50% interests in three joint ventures that collectively owned 28 properties, ground leased one property and leased two properties (the “Transaction”). The Rights Offering ended on July 2, 2015, and the Company’s Class A common shares were listed on the New York Stock Exchange (“NYSE”) on July 6, 2015. On July 7, 2015, the Company completed the Transaction with Sears Holdings and commenced operations. The Company did not have any operations prior to the completion of the Rights Offering and Transaction.
On October 15, 2018, Sears Holdings and certain of its affiliates filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code with the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). On February 28, 2019, the Company and certain affiliates of Transform Holdco LLC (“Holdco”), an affiliate of ESL Investments, Inc., executed a master lease with respect to 51 Wholly Owned Properties (the “Holdco Master Lease”), which became effective on March 12, 2019, when the Bankruptcy Court issued an order approving the rejection of the original master lease between the Company and affiliates of Sears Holdings (the “Original Master Lease”).
As of December 31, 2019, the Company leased space at 48 Wholly Owned Properties to Holdco under the Holdco Master Lease and also leased space to Holdco at three JV Properties. As of December 31, 2019, three Wholly Owned Properties were subject to 100% recapture notices pursuant to the terms of the Holdco Master Lease, and 28 Wholly Owned Properties and one JV Property were subject to termination notices pursuant to the terms of the Holdco Master Lease and the lease with Holdco at the JV Property, respectively. Giving effect to this recapture and termination activity, the Company leased space at 17 Wholly Owned Properties to Holdco under the Holdco Master Lease and also leased space to Holdco at two JV Properties.
Edward S. Lampert is the Chairman and Chief Executive Officer of ESL Investments, Inc, which owns Holdco. Mr. Lampert is also the Chairman of Seritage and controls each of the tenant entities that is a party to the Holdco Master Lease.
Business Strategies
The Company’s primary objective is to create value for its shareholders through the re-leasing and redevelopment of the majority of its Wholly Owned Properties and JV Properties. In doing so, the Company expects to meaningfully grow net operating income (“NOI”) and diversify its tenant base while transforming its portfolio from one with a single-tenant retail orientation to one comprised predominately of multi-tenant shopping centers, multifamily properties and larger-scale, mixed-use environments.
- 1 -
In order to achieve its objective, the Company intends to execute the following strategies:
•
Convert single-tenant buildings into multi-tenant properties at meaningfully higher rents. We intend to increase NOI and diversify our portfolio by actively redeveloping space at our properties and re-leasing such space to new, diversified tenants at higher rents than those paid for space currently or formerly occupied by Sears or Kmart prior to redevelopment.
We seek to optimize the mix of tenants at, and maximize the value of, our properties by focusing on growing national retailers and taking into account customer demographics and the competitive environment of each property's market area. We believe that the superior real estate locations, diversity of property types and national footprint that characterize our portfolio, make us well-positioned to meet the store growth needs of retailers across a variety of sectors and concepts. As we lease space to such retailers, we aim to create multi-tenant shopping centers that command superior rents and valuations due to their prime locations, synergies with adjoining retailers and proximity to productive malls and shopping centers.
As of December 31, 2019, we had originated 91 primarily retail redevelopment projects since inception representing an estimated total investment of $1.6-1.7 billion.
•
Maximize value of vast land holdings through retail and mixed-use densification. As of December 31, 2019, our portfolio included approximately 2,800 acres of land, or an average of 13 acres per site, and our most significant geographic concentrations were in higher growth markets in California, Florida, Texas and the Northeast. We believe these land holdings will provide meaningful opportunities for additional retail and mixed-use development.
In particular, we have identified approximately three dozen sites that we believe have the real estate characteristics and demographic profile to support integrated mixed-use development, including retail, residential, office and other uses. Given our fee ownership of these properties and control over parking lots and outparcels, we believe that these sites, as well as others throughout the portfolio, will provide attractive and value-enhancing redevelopment opportunities. In 2019, the Company announced its first three multifamily projects totaling approximately 900 units and 135,000 square feet of integrated retail space. These projects represent the first phases of three larger, mixed-use developments that are entitled for approximately 1,500 multifamily units and over 1,900,000 square feet of commercial space, including office, retail and hotel uses.
•
Leverage existing and future joint venture relationships with leading real estate and financial partners. As of December 31, 2019, we owned 50% interests in 28 JV Properties, including 23 properties in joint ventures with leading regional mall REITs and five properties in joint ventures with other institutional partners, each of which is focused on driving value creation through the same intensive re-leasing and redevelopment activities we pursue at our Wholly Owned Properties.
We expect to participate in future joint ventures to leverage our human and capital resources and pursue additional value-creating projects. We will generally seek partners that provide incremental development expertise and/or capital, or, as a result of circumstances, allow us to create more value together than we believe we could create on our own.
As of December 31, 2019, we had signed joint venture agreements with multifamily partners to entitle and develop over 5,400 apartment units across 14 sites. These agreements are subject to the achievement of certain milestones and other closing conditions and there can be no assurance that such transactions will be consummated.
•
Maintain a flexible capital structure to support value creation activities. We expect to maintain a capital structure that provides us with the financial flexibility and capacity to continue to fund our operations and redevelopment opportunities. We believe that our current capital structure and potential sources of liquidity, including but not limited to, sales of Wholly Owned Properties, sales of interests in JV Properties and potential credit and capital markets transactions (each of which may be subject to compliance with certain conditions and/or the consent of the lender under our $2.0 billion term loan facility), should continue to provide us with access to capital to operate our business and fund our operations and investments in value-creating projects. In addition, our $2.0 billion term loan facility includes an undrawn $400 million incremental funding facility, access to which is subject to certain conditions that we have not yet achieved.
Significant Tenants
As of December 31, 2019, a material amount of the Company’s in-place rental income was generated from Holdco, which leased space at 48 of the Company’s 184 Wholly Owned Properties and three of its 28 JV Properties.
As of December 31, 2019, three Wholly Owned Properties were subject to 100% recapture notices pursuant to the terms of the Holdco Master Lease, and 28 Wholly Owned Properties and one JV Property were subject to termination notices pursuant to the terms of the Holdco Master Lease and the lease with Holdco at the JV Property, respectively. Giving effect to this recapture and termination
- 2 -
activity, the Company leased space at 17 Wholly Owned Properties to Holdco under the Holdco Master Lease and also leased space to Holdco at two JV Properties.
Competition
We compete for investment opportunities and prospective tenants with other REITs, real estate partnerships and other real estate companies, private individuals, investment companies, private equity and hedge fund investors, sovereign funds, pension funds, insurance companies, lenders and other investors, including retailer operators that may close stores and pursue similar real estate strategies. In addition, revenues from our properties are dependent on the ability of our tenants and operators to compete with other retail operators.
Some of our competitors are significantly larger and have greater financial resources and lower costs of capital than we have. Increased competition will make it more challenging to identify and successfully capitalize on investment opportunities that meet our objectives. Our ability to compete is also impacted by national and local economic trends, availability of investment alternatives, availability and cost of capital, construction and renovation costs, existing laws and regulations, new legislation and population trends.
As a landlord, we compete in the real estate market with numerous developers and owners of properties, including the shopping centers in which our properties are located. Some of our competitors have greater economies of scale, relationships with national tenants at multiple properties which are owned or operated by such competitors, access to more resources and greater name recognition than we do. If our competitors offer space at rental rates below the current market rates or below the rentals we currently charge, or on terms and conditions which include locations at multiple properties, we may lose our existing and/or potential tenants and we may be pressured to reduce our rental rates or to offer substantial rent abatements, tenant improvement allowances, early termination rights or below-market renewal options in order to win new tenants and retain tenants when our leases expire.
Environmental Matters
Our properties are subject to environmental laws regulating, among other things, air emissions, wastewater discharges and the handling and disposal of wastes. Certain of the properties were built during the time that asbestos-containing building materials were routinely installed in residential and commercial structures. In addition, a substantial portion of the properties we acquired from Sears Holdings currently include, or previously included, automotive care center facilities and retail fueling facilities, and are or were subject to laws and regulations governing the handling, storage and disposal of hazardous substances contained in some of the products or materials used or sold in the automotive care center facilities (such as motor oil, fluid in hydraulic lifts, antifreeze and solvents and lubricants), the recycling/disposal of batteries and tires, air emissions, wastewater discharges and waste management. In addition to these products or materials, the equipment in use or previously used at such properties, such as service equipment, car lifts, oil/water separators, and storage tanks, has been subject to increasing environmental regulation relating to, among other things, the storage, handling, use, disposal, and transportation of hazardous materials. The Holdco Master Lease obligates Holdco to comply with applicable environmental laws and to indemnify us if their noncompliance results in losses or claims against us, and to remove all automotive care center equipment and facilities upon the expiration or sooner termination of the Holdco Master Lease. Other leases include, or are expected to include similar provisions for other operators of their respective spaces with respect to environmental matters first arising during their occupancy. An operator’s failure to comply could result in fines and penalties or the requirement to undertake corrective actions which may result in significant costs to the operator and thus adversely affect their ability to meet their obligations to us.
Pursuant to U.S. federal, state and local environmental laws and regulations, a current or previous owner or operator of real property may be required to investigate, remove and/or remediate a release of hazardous substances or other regulated materials at, or emanating from, such property. Further, under certain circumstances, such owners or operators of real property may be held liable for property damage, personal injury and/or natural resource damage resulting from or arising in connection with such releases. Certain of these laws have been interpreted to be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility. We also may be liable under certain of these laws for damage that occurred prior to our ownership of a property or at a site where we sent wastes for disposal. The failure to properly remediate a property may also adversely affect our ability to lease, sell or rent the property or to borrow funds using the property as collateral.
Under the Holdco Master Lease, Holdco is required to indemnify us from certain environmental liabilities at the Wholly Owned Properties before or during the period in which each Wholly Owned Property is leased to Holdco, including removal and remediation of all affected facilities and equipment constituting the automotive care center facilities. In addition, an environmental reserve was funded at the closing of the Transaction in the amount of approximately $12.0 million. As of December 31, 2019, the balance of the environmental reserve was approximately $9.5 million.
In connection with the ownership of our current or past properties and any properties that we may acquire in the future, we could be legally responsible for environmental liabilities or costs relating to a release of hazardous substances or other regulated materials at or emanating from such property. We are not aware of any environmental issues that are expected to have a material impact on the operations of our properties.
- 3 -
Insurance
We have comprehensive liability, property and rental loss insurance with respect to our portfolio of properties. We believe that such insurance provides adequate coverage.
REIT Qualification
We elected to be treated as a REIT commencing with the taxable year ended December 31, 2015 and expect to continue to operate so as to qualify as a REIT. So long as we qualify as a REIT, we generally will not be subject to U.S. federal income tax on net taxable income that we distribute annually to our shareholders. In order to qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, including, but not limited to, the real estate qualification of sources of our income, the composition and values of our assets, the amounts we distribute to our shareholders and the diversity of ownership of our stock. In order to comply with REIT requirements, we may need to forego otherwise attractive opportunities and limit our expansion opportunities and the manner in which we conduct our operations. See “Risk Factors-Risks Related to Status as a REIT.”
Financial Information about Industry Segments
We currently operate in a single reportable segment, which includes the acquisition, ownership, development, redevelopment, management and leasing of real estate properties. We review operating and financial results for each property on an individual basis and do not distinguish or group our properties based on geography, size, or type. We, therefore, aggregate all of our properties into one reportable segment due to their similarities with regard to the nature and economics of the properties, tenants and operational process.
Employees
As of February 21, 2020, we had 77 full-time employees. Our employees are not covered by a collective bargaining agreement, and we consider our employee relations to be satisfactory.
Available Information
Our principal offices are located at 500 Fifth Avenue, New York, New York 10110 and our telephone number is (212) 355-7800. Our website address is www.seritage.com. Our reports electronically filed with or furnished to the Securities and Exchange Commission (“SEC”) pursuant to Section 13(a) or 15(d) of the Exchange Act can be accessed through this site, free of charge, as soon as reasonably practicable after we electronically file or furnish such reports. These filings are also available on the SEC’s website at www.sec.gov. Our website also contains copies of our corporate governance guidelines and code of business conduct and ethics as well as the charters of our audit, compensation and nominating and corporate governance committees. The information on our website is not part of this or any other report we file with or furnish to the SEC.
- 4 -
ITEM 1A.
ITEM 1A.
RISK FACTORS
Certain factors may have a material adverse effect on our business, financial condition and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our common shares of beneficial interest could decline, and you could lose part or all of your investment.
Risks Related to Our Business and Operations
We are dependent on the ability of our top tenants, including Holdco, to successfully operate their businesses. Our tenants’ failure to operate their businesses successfully, or the occurrence of an event that has a material adverse effect on the business, financial condition or results of operations of any of our major tenants, could have a material adverse effect on our business, financial condition or results of operations.
A significant portion of our leased properties are leased to our major tenants, including Holdco. For the year ended December 31, 2019, rents paid to us under the Holdco Master Lease represented 30.6% of our revenue for the year. As a result, the success of our investments, at least in the short-term, is materially dependent on the financial condition of our major tenants. At any time, our tenants may experience a downturn in their respective businesses that may significantly weaken their financial condition, particularly during periods of economic uncertainty. This uncertainty may be exacerbated as a result of actual changes in economic conditions, including as a result of market dynamics, trends in consumer income, rising energy prices, tariffs or trade disputes, and natural or manmade disasters, including epidemic or pandemic disease, or the impact of the fear of such changes on consumer behavior. As a result, our tenants may delay lease commencements, decline to extend or renew leases upon expiration, fail to make rental payments when due, close a number of locations or declare bankruptcy. For example, in November 2019, Holdco exercised its rights under the Holdco Master Lease to terminate the Holdco Master Lease, effective March 2020, with respect to 29 stores, 16 of which will be terminated without the payment of a termination fee.
The inability or unwillingness of our any of major tenants, including Holdco, to meet rent obligations and other obligations could materially adversely affect our business, financial condition or results of operations, including a reduction in operating cash flow that can be used to pay the interest, principal and other costs and expenses under our financings, or to pay cash dividends to Seritage shareholders.
In addition, certain of our lease agreements, including the Holdco Master Lease, require our tenants to pay certain insurance, taxes, utilities and maintenance and repair expenses in connection with the leased properties and to indemnify, defend and hold us harmless from and against various claims, litigation and liabilities arising in connection with their respective business, subject to proportionate sharing of expenses and certain other limitations. Our exposure to rental payments from our major tenants, including Holdco, as a material source of our rental income may limit our ability to enforce our rights under our lease agreements with such tenants.
The risk of financial failure of, or default in payment by, a major tenant is magnified in situations where we lease multiple properties to a single tenant under a master lease, and we may be limited in our ability to enforce our rights under such agreements. For example, the Holdco Master Lease is a unitary lease and does not provide for termination with respect to individual properties by reason of the default of the tenant. Failure by Holdco to comply with the terms of the Holdco Master Lease or to comply with the regulations to which the leased properties are subject could require us to find another master lessee for all such leased property and there could be a decrease or cessation of rental payments by Holdco. In such event, we may be unable to locate a suitable master lessee or a lessee for individual properties at similar rental rates and other obligations and in a timely manner or at all, which would have the effect of reducing our rental revenues.
There can be no assurance as to how our major tenants, including Holdco, will perform in the future. Outcomes not currently foreseen by us may occur, any of which could have a material and adverse impact on our business, results of operations and financial condition.
The future bankruptcy or insolvency of any of our tenants, including Holdco, could result in the termination of such tenant’s lease and material losses to us.
The future bankruptcy or insolvency of any of our tenants, including Holdco, could diminish the rental revenue we receive from that property or could force us to “take back” tenant space as a result of a default or a rejection of the lease by a tenant in bankruptcy. Any claims against bankrupt tenants for unpaid future rent are subject to statutory limitations that would likely result in our receipt of rental
revenues that are substantially less than the contractually specified rent we are owed under their leases or no payments at all. In addition, any claim we have for unpaid past rent may not be paid in full. Federal law may prohibit us from evicting a tenant based
- 5 -
solely upon its recent bankruptcy filing (or a tenant in the event of such tenant’s bankruptcy or insolvency). We may also be unable to re-lease a terminated or rejected space or re-lease it on comparable or more favorable terms. If we do re-lease rejected space, we may incur costs for brokerage, marketing and tenant expenses.
Bankruptcy laws afford certain protections to tenants that may also affect the treatment of master leases, such as the Holdco Master Lease. Subject to certain restrictions, a tenant under a master lease generally is required to assume or reject the master lease as a whole, rather than making the decision on a property-by-property basis. This prevents the tenant from assuming only the better performing properties and terminating the master lease with respect to the poorer performing properties.
While we believe that our Holdco Master Lease constitutes a unitary lease that would need to be assumed or rejected as a whole in any bankruptcy proceeding, whether or not a bankruptcy court would require that a master lease be assumed or rejected as a whole depends upon a “facts and circumstances” analysis considering a number of factors, including the parties’ intent, the nature and purpose of the relevant documents, whether there was separate and distinct consideration for each property included in the master lease, the provisions contained in the relevant documents and applicable state law. If a bankruptcy court were to allow the Holdco Master Lease to be rejected in part, certain underperforming leases related to properties we own could be rejected by the tenant in bankruptcy while tenant-favorable leases are allowed to remain in place, thereby adversely affecting payments to us derived from the properties.
In addition, although we believe that the Holdco Master Lease is a “true lease” for purposes of bankruptcy law, it is possible that a bankruptcy court could re-characterize the lease transaction set forth in the Holdco Master Lease as a secured lending transaction. If the Holdco Master Lease is judicially recharacterized as a secured lending transaction, we would not be treated as the owner of the property and could lose certain rights as the owner in a bankruptcy proceeding.
We may not be able to renew leases or re-lease space at our properties, or lease space in newly recaptured properties, and property vacancies could result in significant capital expenditures.
When leases for our properties expire, or when the Holdco Master Lease or a Holdco JV Lease, as applicable, is recaptured or terminated with respect to particular properties, the premises may not be re-leased in a timely manner or at all, or the terms of re-leasing, including the cost of allowances and concessions to tenants, may be less favorable than the then-existing lease terms. The loss of a tenant through lease expiration or other circumstances may require us to spend (in addition to other re-letting expenses) significant amounts of capital to renovate the property before it is suitable for a new tenant and cause us to incur significant costs in the form of ongoing expenses for property maintenance, taxes, insurance and other expenses. Many of the leases we will enter into or acquire may be for properties that are especially suited to the particular business of the tenants operating on those properties. Because these properties have been designed or physically modified for a particular tenant, if the current lease is terminated or not renewed, we may be required to renovate the property at substantial costs, decrease the rent we charge or provide other concessions to re-lease the property. In addition, if we are required or otherwise determine to sell the property, we may have difficulty selling it to a party other than the tenant due to the special purpose for which the property may have been designed or modified. This potential illiquidity may limit our ability to quickly modify our portfolio in response to changes in economic or other conditions, including tenant demand. Also, we may not be able to lease new properties to an appropriate mix of tenants or for rents that are consistent with our expectations. To the extent that our leasing plans are not achieved or we incur significant capital expenditures as a result of property vacancies, our business, results of operations and financial condition could be materially adversely affected. In November 2019, Holdco exercised its rights under the Holdco Master Lease to terminate the Holdco Master Lease with respect to 29 stores effective March 2020.
Following the Sears Holdings bankruptcy, we have been named as a defendant in litigation that could adversely affect our business and financial condition, divert management’s attention from our business, and subject us to significant liabilities, including remedies that may be imposed as a result of a finding of fraudulent conveyance.
On April 18, 2019, at the direction of the Restructuring Sub-Committee of the Restructuring Committee of the Board of Directors of Sears Holdings, plaintiffs Sears Holdings, Sears, Roebuck & Co., Sears Development Co., Kmart Corporation, and Kmart of Washington, LLC commenced a litigation (the “Litigation”) in the Bankruptcy Court naming us and certain of our affiliates, as well as affiliates of ESL Investments, Inc. and Sears Holdings, and certain other third parties, as defendants. The Litigation is dual captioned as In re: Sears Holdings Corporation, et al., Case No. 18-23538 (RDD) and Sears Holdings Corporation et al., v. Lampert et al., Case No. 19-08250 (RDD). The initial complaint has been superseded by the Amended Complaint described below.
On October 15, 2019, the Bankruptcy Court entered an order (the “Confirmation Order”) confirming the Modified Second Amended Joint Chapter 11 Plan of Sears Holdings and its affiliated debtors (the “Chapter 11 Plan”). Pursuant to the terms of the Confirmation Order, upon the effective date of the Chapter 11 Plan, a liquidating trust will be formed, and the Litigation will vest in the liquidating trust. The Confirmation Order further provides that, prior to the effective date of the Chapter 11 Plan and the formation of the liquidating trust, the Litigation shall be controlled by five litigation designees selected by Sears Holdings and the Official Committee
- 6 -
of Unsecured Creditors’ (the “Creditors’ Committee”). For further information, refer to the Chapter 11 Plan, Confirmation Order and liquidating trust agreement, each of which has been publicly filed with the Bankruptcy Court.
On November 25, 2019, the Creditors’ Committee filed a first amended complaint (the “Amended Complaint”) in the Bankruptcy Court naming us and certain of our affiliates, as well as affiliates of ESL Investments, Inc. and Sears Holdings, and certain other third parties, as defendants. The Amended Complaint alleges, among other things, that certain transactions undertaken by Sears Holdings since 2011 (including the July 2015 transactions giving rise to Seritage, the execution of the Master Lease with Sears Holdings (the “Original Master Lease”), and the acquisition of real estate from Sears Holdings) constituted actual and/or constructive fraudulent transfers and/or illegal dividends by Sears Holdings and that the real estate acquired by Seritage from Sears Holdings in July 2015 was worth hundreds of millions of dollars more than the purchase price paid. The Amended Complaint further alleges that certain releases provided to Seritage and certain other defendants in connection with the Sears Holdings derivative litigation in the Delaware Court of Chancery in 2017 should be avoided and/or declared null and void as an actual and/or constructive fraudulent conveyance. The Amended Complaint seeks as relief, among other things, declaratory relief, avoidance of the allegedly actual and/or constructive fraudulent transfers, disgorgement, recovery of the property fraudulently transferred or, in the alternative, compensatory damages in an unspecified amount to be determined at trial, equitable subordination and disallowance of defendants’ claims as creditors, punitive and exemplary damages for any intentional wrongdoing, and reasonable attorneys’ fees, costs, and expenses. On February 21, 2020, the Seritage defendants filed a partial motion to dismiss seeking dismissal of the claims in the Amended Complaint relating to the release received in the Sears Holdings derivative litigation unjust enrichment and equitable subordination.
Fraudulent transfers or conveyances include transfers made or obligations incurred with the actual intent to hinder, delay or defraud current or future creditors, or transfers made or obligations incurred in exchange for less than reasonably equivalent value when the debtor was, or was rendered, insolvent, inadequately capitalized or unable to pay its debts as they become due. To remedy a fraudulent conveyance, a court could void the challenged transfer or obligation, requiring us to return consideration that we received, or impose substantial liabilities upon us for the benefit of unpaid creditors of the debtor that made the fraudulent conveyance, which could adversely affect our financial condition and our results of operations. Among other things, a court could require our shareholders to return to Sears Holdings or its creditors some or all of the securities issued in the distribution made in connection with the formation of Seritage.
Although we believe that the claims against us in the Litigation are without merit and intend to defend against them vigorously, we are not able to predict the ultimate outcome of the Litigation, the magnitude of any potential losses or the effect such litigation may have on us or our operations. It is possible that the Litigation could cause us to incur substantial costs and that they could be resolved adversely to us, result in substantial damages or other forms of relief, result in or be connected to additional claims, affect our relations with counterparties to commercial transactions and divert management’s attention and resources, any of which could harm our business. Protracted litigation, including any adverse outcomes, may have an adverse impact on our business, results of operations or financial condition and could subject us to adverse publicity and require us to incur significant legal fees. Please see Note 9 - Commitments and Contingencies - in this Annual Report on Form 10-K for additional information regarding the Litigation.
Real estate investments are relatively illiquid.
Our properties represent a substantial portion of our total consolidated assets, and these investments are relatively illiquid. Significant expenditures associated with each equity investment, such as mortgage payments, real estate taxes, insurance, and repair and maintenance costs, are generally not reduced when circumstances cause a reduction in income from the investment. If income from a property declines while the related expenses do not decline, our income and cash available to us would be adversely affected. If it becomes necessary or desirable for us to dispose of one or more of our mortgaged properties, we might not be able to obtain a release of the lien on the mortgaged property without payment of the associated debt or other costs and expenses. As a result, our ability to sell one or more of our properties or investments in real estate in response to any changes in economic or other conditions may be limited. If we want to sell a property, we may not be able to dispose of it in the desired time period or at a sale price that would exceed the cost of our investment in that property. In addition, our ability to enter into asset sales or joint ventures is subject to among other uncertainties, our ability to identify prospective purchasers, the willingness of prospective purchasers to enter into transactions on commercially reasonable terms, negotiations with counterparties, satisfactory examination of property and title by the purchasers, the ability to obtain title and other relevant insurance, applicable consent rights of the lender under our term loan facility, the ability of purchasers to obtain adequate financing, and customary closing conditions.
The number of potential buyers for certain properties that we may seek to sell may be limited by the presence of such properties in retail or mall complexes owned or managed by other property owners. In addition, our ability to sell or dispose of certain properties may be hindered by the fact that such properties may be subject to the Holdco Master Lease, as the terms of such master lease or the fact that Holdco is the lessee may make such properties less attractive to a potential buyer than alternative properties that may be for sale. Furthermore, if we decide to sell any of our properties, we may provide financing to purchasers and bear the risk that the purchasers may default, which may delay or prevent our use of the proceeds of the sales for other purposes or the distribution of such proceeds to our shareholders.
- 7 -
Both we and our tenants face a wide range of competition that could affect our ability to operate profitably.
The presence of competitive alternatives, both to our properties and the businesses that lease our properties, affects our ability to lease space and the level of rents we can obtain. Our properties operate in locations that compete with other retail properties and also compete with other forms of retailing, such as catalogs and e-commerce websites. Competition may also come from strip centers, outlet centers, lifestyle centers and malls, and both existing and future development projects. New construction, renovations and expansions at competing sites could also negatively affect our properties. In addition, we compete with other retail property companies for tenants and qualified management. These other retail property companies may have relationships with tenants that we do not have since we have a limited operating history, including with respect to national chains that may be desirable tenants. If we are unable to successfully compete, our business, results of operations and financial condition could be materially adversely affected. See also “Item 1. Business - Competition.”
In addition, the retail business is highly competitive and if our retail tenants fail to differentiate their shopping experiences, create an attractive value proposition or execute their business strategies, they may terminate, default on, or fail to renew their leases with us, and our results of operations and financial condition could be materially adversely affected. Furthermore, we believe that the increase in digital and mobile technology usage has increased the speed of the transition from shopping at physical locations to web-based purchases and that our tenants, including Holdco, may be negatively affected by these changing consumer spending habits. If our tenants are unsuccessful in adapting their businesses, and, as a result terminate, default on, or fail to renew their leases with us, our results of operations and financial condition could be materially adversely affected.
Our pursuit of investments in and redevelopment of properties, and investments in and acquisitions or development of additional properties, may be unsuccessful or fail to meet our expectations.
We intend to grow our business through investments in, and acquisitions or development of, properties, including through the recapture and redevelopment of space at many of our properties. However, our industry is highly competitive, and we face competition from other REITs, investment companies, private equity and hedge fund investors, sovereign funds, lenders, and other investors, some of whom are significantly larger and have greater resources and lower costs of capital. This competition will make it more challenging to identify and successfully capitalize on acquisition and development opportunities that meet our investment objectives. If we are unable to finance acquisitions or other development opportunities on commercially favorable terms, our business, financial condition or results of operations could be materially adversely affected. Additionally, the fact that we must distribute 90% of our net taxable income in order to maintain our qualification as a REIT may limit our ability to rely upon rental payments from leased properties or subsequently acquired properties in order to finance acquisitions. As a result, if debt or equity financing is not available on acceptable terms, further acquisitions or other development opportunities might be limited or curtailed.
Investments in, and acquisitions of, properties we might seek to acquire entail risks associated with real estate investments generally, including (but not limited to) the following risks and as noted elsewhere in this section:
•
we may be unable to acquire a desired property because of competition;
•
even if we are able to acquire a desired property, competition from other potential acquirers may significantly increase the purchase price;
•
even if we enter into agreements for the acquisition of properties, these agreements are subject to customary conditions to closing, including completion of due diligence investigations to our satisfaction;
•
we may incur significant costs and divert management attention in connection with evaluation and negotiation of potential acquisitions, including ones that we are subsequently unable to complete;
•
we may acquire properties that are not initially accretive to our results upon acquisition, and we may not successfully manage and lease those properties to meet our expectations;
•
we may be unable to finance the acquisition on favorable terms in the time period we desire, or at all;
•
even if we are able to finance the acquisition, our cash flow may be insufficient to meet our required principal and interest payments;
•
we may spend more than budgeted to make necessary improvements or renovations to acquired properties;
•
we may be unable to quickly and efficiently integrate new acquisitions, particularly the acquisition of portfolios of properties, into our existing operations;
•
market conditions may result in higher than expected vacancy rates and lower than expected rental rates; and
•
we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities.
- 8 -
In addition, we intend to redevelop a significant portion of the properties purchased from Sears Holdings in prior years in order to make space available for lease to additional retail tenants and potentially other lessees for other uses. The redevelopment of these properties involves the risks associated with real estate development activities generally. Our redevelopment strategies also involve additional risks, including the risk that Holdco may terminate or fail to renew leases with us for the applicable portion of the redeveloped space as a result of our redevelopment activities. If we are unable to successfully redevelop properties or to lease the redeveloped properties to third parties on acceptable terms, our business, results of operations and financial condition could be materially adversely affected.
Current and future redevelopment may not yield expected returns.
We expect to undertake redevelopment, expansion and reinvestment projects involving our properties as part of our long-term strategy. Likewise, each JV expects to undertake redevelopment, expansion and reinvestment projects involving its JV Properties, with respect to which we may be required to make additional capital contributions to the applicable JV under certain circumstances. These projects are subject to a number of risks, including (but not limited to):
•
abandonment of redevelopment activities after expending resources to determine feasibility;
•
loss of rental income, as well as payments of maintenance, repair, real estate taxes and other charges, including from Holdco related to space that is recaptured pursuant to the Holdco Master Lease, which may not be re-leased to third parties;
•
restrictions or obligations imposed pursuant to other agreements;
•
construction and/or lease-up costs (including tenant improvements or allowances) and delays and cost overruns, including construction costs that exceed original estimates;
•
failure to achieve expected occupancy and/or rent levels within the projected time frame or at all;
•
inability to operate successfully in new markets where new properties are located;
•
failure to successfully manage, or find suitable third-party development partners for, the development of residential, office or other mixed-use properties;
•
inability to successfully integrate new or redeveloped properties into existing operations;
•
difficulty obtaining financing on acceptable terms or paying operating expenses and debt service costs associated with redevelopment properties prior to sufficient occupancy and commencement of rental obligations under new leases;
•
changes in zoning, building and land use laws, and conditions, restrictions or limitations of, and delays or failures to obtain, necessary zoning, building, occupancy, land use and other governmental permits;
•
changes in local real estate market conditions, including an oversupply of, or a reduction in demand for, retail space or retail goods, and the availability and creditworthiness of current and prospective tenants;
•
negative perceptions by retailers or shoppers of the safety, convenience and attractiveness of the property;
•
exposure to fluctuations in the general economy due to the significant time lag between commencement and completion of redevelopment projects; and
•
vacancies or ability to rent space on favorable terms, including possible market pressures to offer tenants rent abatements, tenant improvements, early termination rights or below-market renewal options.
If any of these events occur at any time during the process with respect to any project, overall project costs may significantly exceed initial cost estimates, which could result in reduced returns or losses from such investments. In addition, we may not have sufficient liquidity to fund such projects, and delays in the completion of a redevelopment project may provide various tenants the right to withdraw from a property.
Rising expenses could reduce cash flow and funds available for future development.
If any property is not fully occupied or becomes vacant in whole or in part, or if rents are being paid in an amount that is insufficient to cover operating costs and expenses, we could be required to expend funds with respect to that property for operating expenses. Our properties are subject to increases in tax rates and tax assessments, utility costs, insurance costs, repairs, maintenance and administrative expenses, and other operating expenses. We may also incur significant expenditures as a result of deferred maintenance for the properties we have already acquired (subject to reserved funds to cover certain of these costs) and other properties we may acquire in the future. While properties under the Holdco Master Lease are generally subject to a triple-net lease basis (subject to proportionate sharing of operating expenses with respect to space not leased by Holdco), renewals of leases or future leases may not be negotiated on that basis, in which event we may have to pay those costs. If we are unable to lease properties on a triple-net-lease
- 9 -
basis or on a basis requiring the tenants to pay all or some of such expenses, or if tenants fail to pay required tax, utility and other impositions and other operating expenses, we could be required to pay those costs which could adversely affect funds available for future development or cash available for distributions.
We have ongoing capital needs and may not be able to obtain additional financing or other sources of funding on acceptable terms.
As of December 31, 2019, we had aggregate outstanding indebtedness of $1.6 billion. We may incur additional indebtedness in the future to refinance our existing indebtedness, to finance newly acquired properties or capital contributions to joint ventures, or to fund retenanting and redevelopment projects. Our existing debt and any significant additional indebtedness could require a substantial portion of our cash flow to make interest and principal payments. Demands on our cash resources from debt service will reduce funds available to us to pay dividends, make capital expenditures and acquisitions or carry out other aspects of our business strategy. Our indebtedness may also limit our ability to adjust rapidly to changing market conditions, make us more vulnerable to general adverse economic and industry conditions and create competitive disadvantages for us compared to other companies with relatively lower debt levels. Increased future debt service obligations may limit our operational flexibility, including our ability to acquire properties, finance or refinance our properties, contribute properties to joint ventures or sell properties as needed.
Our primary uses of cash include the payment of property operating and other expenses, including general and administrative expenses and debt service, and the reinvestment in and redevelopment of our properties. As a result of a decrease in occupancy levels due to our recapture of space for redevelopment purposes and the execution of termination rights under the Original Master Lease, our property rental income, which is our primary source of operating cash flow, did not fully fund property operating and other expenses incurred during the year ended December 31, 2019. Property operating and other expenses are projected to continue to exceed property rental income until such time as additional tenants commence paying rent, and we plan to incur additional development expenditures as we continue to invest in the redevelopment of our portfolio. While we do not currently have the liquid funds available to fully fund projected property and other expenses and planned development expenditures, we expect to fund these uses of cash with a combination of capital sources including, but not limited to, sales of Wholly Owned Properties, sales of interests in JV Properties and potential credit and capital markets transactions, subject to compliance with certain conditions and/or the consent of our lender under our $2.0 billion term loan facility.
As of December 31, 2019, we were not in compliance with certain financial metrics applicable to us under the agreements governing our term loan facility. As a result, we must receive the consent of the lender to dispose of assets via sale or joint venture and, as of December 31, 2019, the lender had provided such consent for all such transactions submitted for approval. There can be no assurance that the lender will consent to future dispositions of assets. Additionally, the lender has the right to request mortgages against our assets pursuant to the mortgage and collateral requirement and, during the year ended December 31, 2019, the lender has requested mortgages on a majority of our portfolio.
The term loan facility also provides for a $400 million incremental facility. Our ability to access the incremental facility is subject to (i) our achieving rental income from non-Sears Holdings tenants, on an annualized basis (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the fiscal quarter ending prior to the date of incurrence of the incremental facility, of not less than $200 million and (ii) our good faith projection that rental income from non-Sears Holdings tenants (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the succeeding four consecutive fiscal quarters (beginning with the fiscal quarter during which the incremental facility is accessed) will be not less than $200 million. As of December 31, 2019, we have not achieved this level of rental income from non-Sears Holdings tenants.
Moreover, our ability to obtain additional financing and satisfy our financial obligations under indebtedness outstanding from time to time will depend upon our future operating performance, which is subject to then-prevailing general economic, real estate and credit market conditions, including interest rate levels and the availability of credit generally, and financial, business and other factors, many of which are beyond our control. A prolonged worsening of credit market conditions would have a material adverse effect on our ability to obtain financing on favorable terms, if at all.
We may be unable to obtain additional financing or financing on favorable terms or our operating cash flow may be insufficient to satisfy our financial obligations under any indebtedness outstanding from time to time. Among other things, the absence of an investment grade credit rating or any credit rating downgrade could increase our financing costs and could limit our access to financing sources. If financing is not available when needed, or is available only on unfavorable terms, we may be unable to enhance our properties or develop new properties, complete acquisitions or otherwise take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations. A decrease in available liquidity could also impair our ability to pay dividends to our shareholders.
If additional funds are raised through the issuance of equity securities, our shareholders may experience significant dilution. Additionally, sales of substantial amounts of Class A common shares in the public market, or the perception that such sales could
- 10 -
occur, could adversely affect the market price of Class A common shares, may make it more difficult for our shareholders to sell their common shares at a time and price that they deem appropriate, and could impair our future ability to raise capital through an offering of our equity securities.
Changes in federal tax law could materially adversely affect our business, financial condition and profitability by increasing our tax or tax compliance costs.
On December 20, 2017, the U.S. Congress passed Public Law No. 1, known as the “Tax Cuts and Jobs Act of 2017” (the “TCJA”), which was signed into law on December 22, 2017. The enactment of the TCJA has given rise to numerous interpretive issues and ambiguities and future legislation may be enacted to clarify or modify the TCJA. Any such future legislation, as well as any regulations or other interpretive guidance, could take effect retroactively, and could adversely affect our business and financial condition increasing our tax or tax compliance costs. The impact of any such law, regulation or interpretation may have a material and adverse impact on us and our shareholders.
Real estate related taxes may increase, and if these increases are not passed on to tenants, our income will be reduced.
Some local real property tax assessors may seek to reassess some of our properties as a result of our acquisitions and/or redevelopment of properties. Generally, from time to time, our property taxes increase as property values or assessment rates change or for other reasons deemed relevant by the assessors. An increase in the assessed valuation of a property for real estate tax purposes will result in an increase in the related real estate taxes on that property. Although the Holdco Master Lease permits, and some other leases may also permit, us to pass through such tax increases to the tenants for payment, there is no assurance that renewal leases or future leases will be negotiated on the same basis. Increases not passed through to tenants will reduce our income and the cash available for distributions to our shareholders.
Changes in building and/or zoning laws may require us to update a property in the event of recapture or prevent us from fully restoring a property in the event of a substantial casualty loss and/or require us to meet additional or more stringent construction requirements.
Due to changes in, among other things, applicable building and zoning laws, ordinances and codes that may affect certain of our properties that have come into effect after the initial construction of the properties, certain properties may not comply fully with current building and/or zoning laws, including electrical, fire, health and safety codes and regulations, use, lot coverage, parking and setback requirements, but may qualify as permitted non-conforming uses. Such changes in building and zoning laws may require updating various existing physical conditions of buildings in connection with our recapture, renovation, and/or redevelopment of properties. In addition, such changes in building and zoning laws may limit our or our tenants’ ability to restore the premises of a property to its previous condition in the event of a substantial casualty loss with respect to the property or the ability to refurbish, expand or renovate such property to remain compliant, or increase the cost of construction in order to comply with changes in building or zoning codes and regulations. If we are unable to restore a property to its prior use after a substantial casualty loss or are required to comply with more stringent building or zoning codes and regulations, we may be unable to re-lease the space at a comparable effective rent or sell the property at an acceptable price, which may materially and adversely affect us.
Our real estate assets may be subject to impairment charges.
On a periodic basis, we must assess whether there are any indicators that the value of our real estate assets and other investments may be impaired. If an impairment indicator is identified, a property’s value is considered to be impaired only if management’s estimate of current and projected operating cash flows (undiscounted and unlevered), taking into account the anticipated and probability weighted holdings periods, are less than the carrying value of the property. In our estimate of cash flows model, we consider factors such as expected future operating income, trends and prospects, the effects of demand, competition and other factors. If we are evaluating the potential sale of an asset or development alternatives, the undiscounted future cash flows consider the most likely course of action at the balance sheet date based on current plans, intended holding periods and available market information. We are required to make subjective assessments as to whether there are impairments in the value of our real estate assets and other investments. These assessments may have a direct impact on our earnings because recording an impairment charge results in an immediate negative adjustment to earnings. We may take impairment charges in the future related to the impairment of our assets, and any future impairment could have a material adverse effect on our results of operations in the period in which the impairment charge is taken.
Properties in our portfolio may be subject to ground leases; if we are found to be in breach of these ground leases or are unable to renew them, we could be materially and adversely affected.
We currently have one property in our wholly-owned portfolio that is on land subject to a ground lease. Accordingly, we only own a long-term leasehold in the land underlying this property, and we own the improvements thereon only during the term of the ground lease. In the future, our portfolio may include additional properties subject to ground leases or similar interests. If we are found to be
- 11 -
in breach of a ground lease, we could lose the right to use the property and could also be liable to the ground lessor for damages. In addition, unless we can purchase a fee interest in the underlying land or extend the terms of these leases before their expiration, which we may be unable to do, we will lose our right to operate these properties and our interest in the improvements upon expiration of the leases. Our ability to exercise options to extend the term of our ground lease is subject to the condition that we are not in default under the terms of the ground lease at the time that we exercise such options, and we may not be able to exercise our options at such time. In addition, two JV Properties are currently ground leased or leased and, therefore, subject to similar risks. Furthermore, we may not be able to renew our ground lease or future ground leases upon their expiration (after the exercise of all renewal options). If we were to lose the right to use a property due to a breach or non-renewal or final expiration of the ground lease, we would be unable to derive income from such property, which could materially and adversely affect our business, financial conditions or results of operations.
Certain properties within our portfolio are subject to restrictions pursuant to reciprocal easement agreements, operating agreements, or similar agreements, some of which contain a purchase option or right of first refusal or right of first offer in favor of a third party.
Many of the properties in our portfolio are, and properties that we acquire in the future may be, subject to use restrictions and/or operational requirements imposed pursuant to ground leases, restrictive covenants or conditions, reciprocal easement agreements or operating agreements (collectively, “Property Restrictions”) that could adversely affect our ability to redevelop the properties or lease space to third parties. Such Property Restrictions could include, for example, limitations on alterations, changes, expansions, or reconfiguration of properties; limitations on use of properties, including for retail uses only; limitations affecting parking requirements; restrictions on exterior or interior signage or facades; or access to an adjoining mall, among other things. In certain cases, consent of the other party or parties to such agreements may be required when altering, reconfiguring, expanding, redeveloping or re-leasing properties. Failure to secure such consents when necessary may harm our ability to execute leasing, redevelopment or expansion strategies, which could adversely affect our business, financial condition or results of operations. In certain cases, a third party may have a purchase option or right of first refusal or right of first offer that is activated by a sale or transfer of the property, or a change in use or operations, including a closing of the Sears operation or cessation of business operations, on the encumbered property. From time to time, we have been involved in disputes or legal proceedings relating to such Property Restrictions, which may result in the incurrence of legal costs and diversion of management resources to resolve.
Economic conditions may affect the cost of borrowing, which could materially adversely affect our business.
Our business is affected by a number of factors that are largely beyond our control but may nevertheless have a significant negative impact on us. These factors include, but are not limited to:
•
interest rates and credit spreads;
•
the availability of credit, including the price, terms and conditions under which it can be obtained;
•
a decrease in consumer spending or sentiment, including as a result of increases in savings rates and tax increases, and any effect that this may have on retail activity;
•
the actual and perceived state of the real estate and retail markets, market for dividend-paying stocks and public capital markets in general; and
•
unemployment rates, both nationwide and within the primary markets in which we operate.
In addition, economic conditions such as inflation or deflation could materially adversely affect our business, financial condition and results of operations. Deflation may have an impact on our ability to repay our debt. Deflation may delay consumption and thus weaken tenant sales, which may reduce our tenants’ ability to pay rents. Deflationary pressure on retailers may diminish their ability to rent our space and decrease our ability to re-lease the space on favorable terms to us. In an inflationary economic environment, increased inflation may have a pronounced negative impact on the interest expense we pay in connection with our indebtedness and our general and administrative expenses, as these costs could increase at a rate higher than rents we collect. Also, inflation may adversely affect tenant leases with stated rent increases, which could be lower than the increase in inflation at any given time. Inflation could also have an adverse effect on consumer spending, which could impact our tenants’ sales and, in turn, our own results of operations. Restricted lending practices may impact our ability to obtain financing for our properties and may also negatively impact our tenants’ ability to obtain credit. Decreases in consumer demand can have a direct impact on our tenants and the rents we receive.
Compliance with the Americans with Disabilities Act may require us to make expenditures that adversely affect our cash flows.
The Americans with Disabilities Act (the “ADA”) has separate compliance requirements for “public accommodations” and “commercial facilities,” but generally requires that buildings be made accessible to people with disabilities. Compliance with the ADA
- 12 -
requirements could require removal of access barriers, and non-compliance could result in imposition of fines by the United States government or an award of damages to private litigants, or both. While the tenants to whom our properties are leased are generally obligated by law or lease to comply with the ADA provisions applicable to the property being leased to them, if required changes involve other property not being leased to such tenants, if the required changes include greater expenditures than anticipated, or if the changes must be made on a more accelerated basis than anticipated, the ability of these tenants to cover costs could be adversely affected. Moreover, certain other leases may require the landlord to comply with the ADA with respect to the building as a whole and/or the tenant’s space. As a result of any of the foregoing circumstances, we could be required to expend funds to comply with the provisions of the ADA, which could adversely affect our results of operations and financial condition.
Environmental, health, safety and land use laws and regulations may limit or restrict some of our operations.
As the owner or operator of various real properties and facilities, we must comply with various federal, state and local environmental, health, safety and land use laws and regulations. We and our properties are subject to such laws and regulations relating to the use, storage, disposal, emission and release of hazardous and non-hazardous substances and employee health and safety, as well as zoning restrictions. Historically, Sears Holdings, a predecessor to Holdco, did not incur significant expenditures to comply with these laws with respect to the substantial majority of the space at the properties that were subject to the Original Master Lease. However, a substantial portion of our properties that have resulted in certain remediation activities currently include, or previously included, automotive care center facilities and retail fueling facilities, and/or above-ground or underground storage tanks, and are or were subject to laws and regulations governing the handling, storage and disposal of hazardous substances contained in some of the products or materials used or sold in the automotive care center facilities (such as gasoline, motor oil, fluid in hydraulic lifts, antifreeze, solvents and lubricants), the recycling/disposal of batteries and tires, air emissions, wastewater discharges and waste management. In addition to these products, the equipment in use or previously used at such properties, such as service equipment, car lifts, oil/water separators, and storage tanks, has been subject to increasing environmental regulation relating to, among other things, the storage, handling, use, disposal and transportation of hazardous materials. There are also federal, state and local laws, regulations and ordinances that govern the use, removal and/or replacement of underground storage tanks in the event of a release on, or an upgrade or redevelopment of, certain properties. Such laws, as well as common-law standards, may impose liability for any releases of hazardous substances associated with the underground storage tanks and may provide for third parties to seek recovery from owners or operators of such properties for damages associated with such releases. If hazardous substances are released from any underground storage tanks on any of our properties, we may be materially and adversely affected. In a few states, transfers of some types of sites are conditioned upon clean-up of contamination prior to transfer. If any of our properties are subject to such contamination, we may be subject to substantial clean-up costs before we are able to sell or otherwise transfer the property.
The Original Master Lease contained requirements that Sears Holdings indemnify us from certain environmental liabilities; however, following Sears Holdings’ bankruptcy, there can be no assurance that we would be able to collect any amounts due under such indemnification obligations. Under the Holdco Master Lease, Holdco is required to indemnify us from certain environmental liabilities at certain properties, including removal and remediation of all affected facilities and equipment constituting the automotive care center facilities. Although existing and future other leases are expected to require tenants generally to indemnify us for such tenants’ non-compliance with environmental laws as a result of their occupancy, such tenants typically will not be required to indemnify us for environmental non-compliance arising prior to their occupancy. In such cases, we may incur costs and expenses under such leases or as a matter of law. The amount of any environmental liabilities could exceed the amounts for which Holdco or other third parties would be required to indemnify us (or the applicable JV) or their financial ability to do so. In addition, under the terms of the agreements governing our indebtedness, we have deposited funds in a reserve account that will be used to fund costs incurred in correcting certain environmental and other conditions. The amount of such funds may not be sufficient to correct the environmental and other conditions to which they are expected to be applied.
In addition, additional laws which may be passed in the future, or a finding of a violation of or liability under existing laws, could require us and/or one or more of the JVs to make significant expenditures and otherwise limit or restrict some of our or its or their operations, which could have an adverse effect on our business, financial condition and results of operations.
Environmental compliance costs and liabilities associated with real estate properties owned by us may materially and adversely affect us.
Our properties may be subject to known and unknown environmental liabilities under various federal, state and local laws and regulations relating to human health and the environment. Certain of these laws and regulations may impose joint and several liability on certain statutory classes of persons, including owners or operators, for the costs of investigation or remediation of contaminated properties. These laws and regulations apply to past and present business operations on the properties, and the use, storage, handling and recycling or disposal of hazardous substances or wastes. We may face liability regardless of our knowledge of the contamination, the timing of the contamination, the cause of the contamination or the party responsible for the contamination of the property.
- 13 -
We may be held primarily or jointly and severally liable for costs relating to the investigation and clean-up of any of our properties from which there has been a release or threatened release of a regulated material as well as other affected properties, regardless of whether we knew of or caused the release.
As the owner or operator of real property, we may also incur liability based on various building conditions. For example, buildings and other structures on properties that we currently own or operate or those we acquire or operate in the future contain, may contain, or may have contained, asbestos-containing material (or “ACM”). Environmental, health and safety laws require that ACM be properly managed and maintained and may impose fines or penalties on owners, operators or employers for non-compliance with those requirements. These requirements include special precautions, such as removal, abatement or air monitoring, if ACM would be disturbed during maintenance, renovation or demolition of a building, potentially resulting in substantial costs. In addition, we may be subject to liability for personal injury or property damage sustained as a result of exposure to ACM or releases of ACM into the environment. In addition, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants or increase ventilation and/or expose us to liability from our tenants, employees of our tenants, or others if property damage or personal injury occurs.
In addition to these costs, which are typically not limited by law or regulation and could exceed a property’s value, we could be liable for certain other costs, including governmental fines, and injuries to persons, property or natural resources. Further, some environmental laws create a lien on the contaminated site in favor of the government for damages and the costs the government incurs in connection with such contamination. Any such costs or liens could have a material adverse effect on our business or financial condition.
Although we intend to require our tenants to undertake to indemnify us for certain environmental liabilities, including environmental liabilities they cause, the amount of such liabilities could exceed the financial ability of the tenant to indemnify us. The presence of contamination or the failure to remediate contamination may adversely affect our ability to sell or lease the real estate or to borrow using the real estate as collateral.
Each JV is subject to similar risks relating to environmental compliance costs and liabilities associated with its JV Properties, which may reduce the value of our investment in, or distributions to us by, one or more JVs, or require that we make additional capital contributions to one or more JVs.
Possible terrorist activity or other acts of violence could adversely affect our financial condition and results of operations.
Terrorist attacks or other acts of violence may result in declining economic activity, which could harm the demand for goods and services offered by our tenants and the value of our properties and might adversely affect the value of an investment in our securities. Such a resulting decrease in retail demand, could make it difficult for us to renew or re-lease our properties at lease rates equal to or above historical rates. Terrorist activities or violence also could directly affect the value of our properties through damage, destruction or loss, and the availability of insurance for such acts, or of insurance generally, might be lower or cost more, which could increase our operating expenses and adversely affect our financial condition and results of operations. To the extent that our tenants are affected by future attacks, their businesses similarly could be adversely affected, including their ability to continue to meet obligations under their existing leases. These acts might erode business and consumer confidence and spending and might result in increased volatility in national and international financial markets and economies. Any one of these events might decrease demand for real estate, decrease or delay the occupancy of our new or redeveloped properties, and limit our access to capital or increase our cost of raising capital.
Cybersecurity incidents could cause a disruption to our operations, a compromise of confidential information and damage to our business relationships, all of which could negatively impact our business, financial condition and operating results.
Seritage is susceptible to cybersecurity risks that include, among other things, theft, unauthorized monitoring, release, misuse, loss, destruction or corruption of confidential and highly restricted data; denial of service attacks; unauthorized access to relevant systems, compromises to networks or devices; or operational disruption or failures in the physical infrastructure or operating systems of Seritage’s information systems. Seritage’s information systems are essential to the operation of our business and our ability to perform day-to-day operations, including for the secure processing, storage and transmission of confidential and personal information. Seritage must continuously monitor and develop its systems to protect its technology infrastructure and data from misappropriation, corruption and disruption. Cybersecurity risks may also impact properties in which we invest on behalf of clients and tenants of those properties, which could result in a loss of value in our clients’ investment. In addition, due to Seritage’s interconnectivity with third-party service providers and other entities with which Seritage conducts business, Seritage could be adversely impacted if any of them is subject to a successful cyber incident. Although we and our service providers have implemented processes, procedures and controls to help mitigate these risks, there can be no assurance that these measures will be effective or that security breaches or disruptions will not occur. The result of these incidents may include disrupted operations, liability for loss or misappropriation of data, stolen assets or information, increased cybersecurity protection and insurance costs, increased compliance costs, litigation, regulatory enforcement actions and damage to our reputation or business relationships.
- 14 -
We may incur mortgage indebtedness and other borrowings, which may increase our business risks.
We may incur mortgage debt and pledge all or some of our real properties as security for that debt to finance newly acquired properties or capital contributions to joint ventures, or to fund retenanting and redevelopment projects. As of December 31, 2019, we were required to provide mortgages to the lender under our term loan facility on a majority of our portfolio. This restriction, together with the other provisions of the Term Loan Facility, will limit our ability to obtain additional secured financing using such properties as collateral. We may also borrow if we need funds or deem it necessary or advisable to ensure that we maintain our qualification as a REIT for U.S. federal income tax purposes. If there is a shortfall between the cash flow from a property and the cash flow needed to service mortgage debt on a property, then the amount available for distributions to shareholders may be reduced. In addition, incurring mortgage debt increases the risk of loss since defaults on indebtedness secured by a property may result in lenders initiating foreclosure actions. In that case, we could lose the property securing the loan that is in default. For U.S. federal income tax purposes, a foreclosure of any of our properties generally would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds. In such event, the Company may be unable to pay the amount of distributions required in order to maintain its REIT status. If any mortgages contain cross-collateralization or cross-default provisions, a default on a single property could affect multiple properties. If any properties are foreclosed upon due to a default, our ability to pay cash distributions to our shareholders may be adversely affected.
Covenants in our term loan facility may limit our operational flexibility and a covenant breach or default could adversely affect our business and financial condition.
Our term loan facility includes certain financial metrics to govern certain collateral and covenant exceptions set forth in the agreement, including: (i) a total fixed charge coverage ratio of not less than 1.00 to 1.00 for each fiscal quarter beginning with the fiscal quarter ending September 30, 2018 through the fiscal quarter ending June 30, 2021, and not less than 1.20 to 1.00 for each fiscal quarter thereafter; (ii) an unencumbered fixed charge coverage ratio of not less than 1.05 to 1.00 for each fiscal quarter beginning with the fiscal quarter ending September 30, 2018 through the fiscal quarter ending June 30, 2021, and not less than 1.30 to 1.00 for each fiscal quarter thereafter; (iii) a total leverage ratio of not more than 65%; (iv) an unencumbered ratio of not more than 60%; and (v) a minimum net worth of at least $1.2 billion. Any failure to satisfy any of these financial metrics will limit our ability to dispose of assets via sale or joint venture and trigger a requirement for us to provide mortgage collateral to our lender, but will not result in an event of default, mandatory amortization, cash flow sweep or similar provision. As of December 31, 2019, we were in breach of one or more of the financial metrics described above, as a result of which we were required to provide mortgages to the lender under the term loan facility with respect to a majority of our portfolio. Additionally, the lender under our term loan facility has the right to consent to dispositions of properties via asset sales and formation of new joint ventures. This consent right may have the effect of limiting our ability to dispose of properties, whether for strategic reasons or to raise liquidity to fund our operations. The term loan facility also includes certain limitations relating to, among other activities, our ability to: sell assets or merge, consolidate or transfer all or substantially all of our assets; incur additional debt; incur certain liens; enter into, terminate or modify certain material leases and/or the material agreements for our properties; make certain investments (including limitations on joint ventures) and other restricted payments; pay distributions on or repurchase our capital stock; and enter into certain transactions with affiliates.
The term loan facility also provides for a $400 million incremental facility. Our ability to access the incremental facility is subject to (i) our achieving rental income from non-Sears Holdings tenants, on an annualized basis (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the fiscal quarter ending prior to the date of incurrence of the incremental facility, of not less than $200 million and (ii) our good faith projection that rental income from non-Sears Holdings tenants (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the succeeding four consecutive fiscal quarters (beginning with the fiscal quarter during which the incremental facility is accessed) will be not less than $200 million. As of December 31, 2019, we have not achieved this level of rental income from non-Sears Holdings tenants.
We have limited operating history as a REIT and an independent public company, and our inexperience may impede our ability to successfully manage our business or implement effective internal controls.
We have limited operating history owning, leasing or developing properties or operating as a REIT. Similarly, we have limited operating history as an independent public company. We cannot assure you that our past experience will be sufficient to successfully operate our company as a REIT and an independent public company. We are required to implement substantial control systems and procedures in order to maintain our qualification as a REIT, satisfy our periodic and current reporting requirements under applicable SEC regulations and comply with the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the NYSE listing standards. As a result, our management and other personnel need to devote a substantial amount of time to comply with these rules and regulations and establish the corporate infrastructure and controls demanded of a publicly traded REIT. These costs and time commitments could be substantially more than we currently expect. If our finance and accounting organization is unable for any reason to respond adequately to the increased demands, the quality and timeliness of our financial reporting may suffer, and we could experience significant deficiencies or material weaknesses in our disclosure controls and procedures or our internal control over financial reporting.
- 15 -
An inability to establish effective disclosure controls and procedures and internal control over financial reporting or remediate existing deficiencies could cause us to fail to meet our reporting obligations under the Exchange Act, or result in material weaknesses, material misstatements or omissions in our Exchange Act reports, any of which could cause investors to lose confidence in our company, which could have an adverse effect on our revenues and results of operations or the market price of Class A common shares, par value $0.01 per share, Class B non-economic common shares of beneficial interest, par value $0.01 per share (“Class B non-economic common shares”), and Class C non-voting common shares of beneficial interest, par value $0.01 per share (“Class C non-voting common shares”).
Our rights and the rights of our shareholders to take action against our trustees and officers are limited.
As permitted by the Maryland REIT Law, the Company’s Declaration of Trust limits the liability of its trustees and officers to Seritage and its shareholders for money damages, except for liability resulting from:
•
actual receipt of an improper benefit or profit in money, property or services; or
•
a final judgment based upon a finding of active and deliberate dishonesty by the trustee or officer that was material to the cause of action adjudicated.
In addition, our Declaration of Trust authorizes us and our bylaws obligate us to indemnify our present and former trustees and officers for actions taken by them in those capacities and to pay or reimburse their reasonable expenses in advance of final disposition of a proceeding to the maximum extent permitted by Maryland law, and we have entered into indemnification agreements with our trustees and executive officers. As a result, the Company and our shareholders may have more limited rights against our trustees and officers than might otherwise exist absent the provisions in our Declaration of Trust and bylaws or that might exist with other companies. Accordingly, in the event that actions taken by any of our trustees or officers are immune or exculpated from, or indemnified against, liability but which impede our performance, the Company and our shareholders’ ability to recover damages from that trustee or officer will be limited.
Seritage’s Declaration of Trust and bylaws, Maryland law, and the partnership agreement of Operating Partnership contain provisions that may delay, defer or prevent an acquisition of Class A common shares or a change in control.
The Company’s Declaration of Trust and bylaws, Maryland law and the partnership agreement of Operating Partnership contain a number of provisions, the exercise or existence of which could delay, defer or prevent a transaction or a change in control that might involve a premium price for our shareholders or otherwise be in their best interests, including the following:
•
The Company’s Declaration of Trust Contains Restrictions on the Ownership and Transfer of Seritage Shares of Beneficial Interest. In order for us to qualify as a REIT, no more than 50% of the value of all outstanding shares of beneficial interest may be owned, beneficially or constructively, by five or fewer individuals at any time during the last half of each taxable year other than 2015, the first taxable year for which we elected to be taxed as a REIT. Additionally, at least 100 persons must beneficially own our shares of beneficial interest during at least 335 days of a taxable year (other than 2015, the first taxable year for which we elected to be taxed as a REIT). The Company’s Declaration of Trust, with certain exceptions, authorizes the Company’s board of trustees (the “Board of Trustees”) to take such actions as are necessary and desirable to preserve its qualification as a REIT. For this and other purposes, subject to certain exceptions, our Declaration of Trust provides that no person may beneficially or constructively own more than 9.6%, in value or in number of shares, whichever is more restrictive, of all outstanding shares, or all outstanding common shares (including our Class A common shares, our Class B non-economic common shares and our Class C non-voting common shares), of beneficial interest of the Company. We refer to these restrictions collectively as the “ownership limits.” The constructive ownership rules under the Code are complex and may cause shares owned directly or constructively by a group of related individuals or entities to be deemed to be constructively owned by one individual or entity. As a result, the acquisition of less than 9.6% of the outstanding shares of beneficial interest by an individual or entity could cause that individual or entity or another individual or entity to own, beneficially or constructively, the Company’s shares of beneficial interest in violation of the ownership limits. In addition, because we have multiple classes of common shares, the acquisition of Class A common shares may result in a shareholder inadvertently owning, beneficially or constructively, the Company’s shares of beneficial interest in violation of the ownership limits. Our Declaration of Trust also prohibits any person from owning Class A common shares, Series A Cumulative Redeemable Preferred Shares (the “Series A Preferred Shares”), or other shares of beneficial interest that would generally result in (i) our being “closely held” under Section 856(h) of the Code or otherwise cause us to fail to qualify as a REIT, ii) our being beneficially owned by fewer than 100 persons, (iii) any of our income that would otherwise qualify as “rents from real property” for purposes of Section 856(d) of the Code failing to qualify as such, or (iv) our failing to qualify as a “domestically controlled qualified investment entity” within the meaning of Section 897(h) of the Code. Any attempt to own or transfer Class A common shares, Series A Preferred Shares or any of our other shares of beneficial interest in violation of the restrictions on ownership or transfer in our Declaration of Trust may result in the transfer being automatically void. The Company’s Declaration of Trust also provides that if any purposted transfer of Class A common shares, Series A Preferred
- 16 -
Shares, or other such shares of beneficial interest would otherwise result in any person violating the ownership limits or any other restriction on ownership and transfer of shares of beneficial interest described above, then that number of shares (rounded up to the nearest whole share) that would cause the violation will be automatically transferred to, and held by, a trust for the exclusive benefit of a designated charitable beneficiary. Any person who acquires such shares in violation of the ownership limits or any other restriction on ownership and transfer of shares of beneficial interest described above will not be entitled to any dividends on the shares or be entitled to vote the shares or receive any proceeds from the subsequent sale of the shares in excess of the lesser of the price paid by such person for the shares (or, if such person did not give value for such shares, the market price on the day the shares were transferred to the trust) or the amount realized from the sale. We or our designee will have the right to purchase the shares from the trustee at this calculated price as well. The ownership limits and other restrictions on ownership and transfer in our Declaration of Trust may have the effect of preventing, or may be relied upon to prevent, a third party from acquiring control of us if the Board of Trustees does not grant an exemption from the ownership limits, even if our shareholders believe the change in control is in their best interests.
•
The Company’s Board of Trustees Has the Power to Cause Us to Issue Additional Shares of Beneficial Interest and Classify and Reclassify Any Unissued Class A Common Shares without Shareholder Approval. The Company has issued and outstanding, in addition to the Class A common shares, Class B non-economic common shares having, in the aggregate, approximately 5.6% of the voting power of the Company, all of which are held by ESL Partners, L.P. and its affiliates, including Edward S. Lampert (together “ESL”). We have also issued 2,800,000 shares of Series A Preferred Shares that are senior to our common shares with respect to priority of dividend payments and rights upon liquidation, dissolution or winding up. Our Declaration of Trust authorizes us to issue additional authorized but unissued common shares or preferred shares of beneficial interest. In addition, the Board of Trustees may, without shareholder approval, (i) amend the Declaration of Trust to increase or decrease the aggregate number of shares of beneficial interest or the number of shares of beneficial interest of any class or series that we have authority to issue and (ii) classify or reclassify any unissued common shares or preferred shares of beneficial interest and set the preferences, rights and other terms of the classified or reclassified shares. As a result, the Board of Trustees may establish a class or series of common shares or preferred shares of beneficial interest that could delay or prevent a transaction or a change in control that might involve a premium price for Class A common shares or otherwise be in the best interests of our shareholders.
•
The Board of Trustees Is Divided into Three Classes and Trustee Elections Require a Vote of Two-Thirds of the Class A Common Shares and Class B Non-Economic Common Shares Votes Cast. The Board of Trustees is divided into three classes of trustees, with each class to be as nearly equal in number as possible. As a result, approximately one-third of the Board of Trustees will be elected at each annual meeting of shareholders, with, in both contested and uncontested elections, trustees elected by the vote of two-thirds of the votes cast of the Class A common shares and Class B non-economic common shares (voting together as a single class) entitled to be cast in the election of trustees. In the event that an incumbent trustee does not receive a sufficient percentage of votes cast for election, he or she will continue to serve on the Board of Trustees until a successor is duly elected and qualifies. The classification of trustees and requirement that trustee nominees receive a vote of two-thirds of the votes cast of the Class A common shares and Class B non-economic common shares (voting together as a single class) entitled to be cast in the election of trustees may have the effect of making it more difficult for shareholders to change the composition of the Board of Trustees. The requirement that trustee nominees receive a vote of two-thirds of the votes cast of the Class A common shares and Class B non-economic common shares (voting together as a single class) entitled to be cast in the election of trustees may also have the effect of making it more difficult for shareholders to elect trustee nominees that do not receive the votes of shares of beneficial interest held by ESL, which controls approximately 5.6% of the voting power of the Company.
•
The Partnership Agreement of Operating Partnership Provides Holders of Operating Partnership Units Approval Rights over Certain Change in Control Transactions Involving the Company or Operating Partnership. Pursuant to the partnership agreement of Operating Partnership, certain transactions, including mergers, consolidations, conversions or other combinations or extraordinary transactions or transactions that constitute a “change of control” of the Company or Operating Partnership, as defined in the partnership agreement, will require the approval of the partners (other than the Company and entities controlled by it) holding a majority of all the outstanding Operating Partnership units held by all partners (other than the Company and entities controlled by it). These provisions could have the effect of delaying or preventing a change in control. ESL holds all of the Operating Partnership units not held by the Company and entities controlled by it.
•
Certain Provisions of Maryland Law May Limit the Ability of a Third Party to Acquire Control of Us. Certain provisions of the Maryland General Corporation Law (the “MGCL”) applicable to Maryland REITs may have the effect of inhibiting a third party from acquiring us or of impeding a change of control of the Company under circumstances that otherwise could provide Class A common shareholders with the opportunity to realize a premium over the then-prevailing market price of such shares or otherwise be in the best interest of shareholders, including:
o
“business combination” provisions that, subject to certain exceptions and limitations, prohibit certain business combinations between a Maryland REIT and an “interested shareholder” (defined generally as any person who beneficially owns, directly or indirectly, 10% or more of the voting power of the Company’s outstanding voting
- 17 -
shares or an affiliate or associate of the Maryland REIT who, at any time within the two-year period immediately prior to the date in question, was the beneficial owner of 10% or more of the voting power of the then-outstanding shares of the Company) or an affiliate of any interested shareholder and the Maryland REIT for five years after the most recent date on which the shareholder becomes an interested shareholder, and thereafter imposes two supermajority shareholder voting requirements on these combinations;
o
“control share” provisions that provide that, subject to certain exceptions, holders of “control shares” of our company (defined as voting shares that, if aggregated with all other shares owned or controlled by the acquirer, would entitle the acquirer to exercise one of three increasing ranges of voting power in electing trustees) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of issued and outstanding “control shares”) have no voting rights with respect to the control shares except to the extent approved by our shareholders by the affirmative vote of at least two-thirds of all of the votes entitled to be cast on the matter, excluding all interested shares; and
o
Additionally, Title 3, Subtitle 8 of the MGCL permits the Board of Trustees, without shareholder approval and regardless of what is currently provided in our Declaration of Trust or bylaws, to implement certain takeover defenses.
The Board of Trustees has, by resolution, exempted from the provisions of the Maryland Business Combination Act all business combinations (a) between us and (i) Sears Holdings or its affiliates or (ii) ESL or Fairholme Capital Management L.L.C. (“FCM”) and/or certain clients of FCM or their respective affiliates and (b) between us and any other person, provided that in the latter case the business combination is first approved by the Board of Trustees (including a majority of our trustees who are not affiliates or associates of such person). In addition, our bylaws contain a provision opting out of the Maryland control share acquisition act.
We may experience uninsured or underinsured losses, or insurance proceeds may not otherwise be available to us which could result in a significant loss of the capital we have invested in a property, decrease anticipated future revenues or cause us to incur unanticipated expense.
While the Holdco Master Lease and other existing other leases require, and new lease agreements are expected to require, that comprehensive general insurance and hazard insurance be maintained by the tenants with respect to their premises, and we have obtained casualty insurance with respect to our properties, there are certain types of losses, generally of a catastrophic nature, such as earthquakes, hurricanes and floods, that may be uninsurable or not economically insurable. Insurance coverage (net of deductibles) may not be effective or be sufficient to pay the full current market value or current replacement cost of a loss. Inflation, changes in building and zoning codes and ordinances, environmental considerations, and other factors also might make it infeasible to use insurance proceeds to restore or replace the property after such property has been damaged or destroyed. Under such circumstances, the insurance proceeds received might not be adequate to restore the economic position with respect to such property or to comply with the requirements of our mortgages and Property Restrictions. Moreover, the holders of any mortgage indebtedness may require some or all property insurance proceeds to be applied to reduce such indebtedness, rather than being made available for property restoration.
If we experience a loss that is uninsured or that exceeds our policy coverage limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. In addition, if the damaged properties were subject to recourse indebtedness, Property Restrictions or ground leases, we could continue to be liable for the indebtedness or subject to claims for damages even if these properties were irreparably damaged.
In addition, even if damage to our properties is covered by insurance, a disruption of our business or that of our tenants caused by a casualty event may result in the loss of business and/or tenants. The business interruption insurance we or our tenants carry may not fully compensate us for the loss of business or tenants due to an interruption caused by a casualty event. Further, if one of our tenants has insurance but is underinsured, that tenant may be unable to satisfy its payment obligations under its lease with us or its other payment or other obligations.
A disruption in the financial markets may make it more difficult to evaluate the stability, net assets and capitalization of insurance companies and any insurer’s ability to meet its claim payment obligations. A failure of an insurance company to make payments to us upon an event of loss covered by an insurance policy, losses in excess of our policy coverage limits or disruptions to our business or the business of our tenants caused by a casualty event could adversely affect our business, financial condition and results of operations.
Each JV may also experience uninsured or underinsured losses, and also faces other risks related to insurance that are similar to those we face, which could reduce the value of our investment in, or distributions to us by, one or more JVs, or require that we make additional capital contributions to one or more JVs.
- 18 -
Conflicts of interest may exist or could arise in the future between the interests of Seritage shareholders and the interests of holders of Operating Partnership units, and the partnership agreement of Operating Partnership grants holders of Operating Partnership units certain rights, which may harm the interests of Seritage shareholders.
Conflicts of interest may exist or could arise in the future as a result of the relationships between Seritage and its affiliates, on the one hand, and Operating Partnership or any of its partners, on the other. Seritage’s trustees and officers have duties to Seritage under Maryland law in connection with their oversight and management of the company. At the same time, Seritage, as general partner of Operating Partnership, will have duties and obligations to Operating Partnership and its limited partners under Delaware law, as modified by the partnership agreement of Operating Partnership in connection with the management of Operating Partnership.
For example, without the approval of the majority of the Operating Partnership units not held by Seritage and entities controlled by it, Seritage will be prohibited from taking certain extraordinary actions, including change of control transactions of Seritage or Operating Partnership.
ESL owns a substantial percentage of the Operating Partnership units, which may be exchanged for cash or, at the election of Seritage, Class A common shares, and which will result in certain transactions involving Seritage or Operating Partnership requiring the approval of ESL.
As of December 31, 2019, ESL owns approximately 33.9% of the Operating Partnership units, with the remainder of the units held by the Company. In addition, ESL will have the right to acquire additional Operating Partnership units in order to allow it to maintain its relative ownership interest in Operating Partnership if Operating Partnership issues additional units to the Company under certain circumstances, including if we issue additional equity and contribute the funds to Operating Partnership to fund acquisitions or redevelopment of properties, among other uses. In addition, ESL will have the right to require the Operating Partnership to redeem its Operating Partnership units in whole or in part in exchange for cash or, at the election of the Company, Class A common shares, except as described below. Due to the ownership limits set forth in our Declaration of Trust, ESL may dispose of some or all of the Class A common shares it beneficially owns prior to exercising its right to require Operating Partnership to redeem Operating Partnership units, and the partnership agreement of Operating Partnership will permit ESL (and only ESL) to transfer its Operating Partnership units to one or more underwriters to be exchanged for Class A common shares in connection with certain dispositions in order to achieve the same effect as would occur if ESL were to exchange a larger portion of its Operating Partnership units for Class A common shares and then dispose of those shares in an underwritten offering. Sales of a substantial number of Class A common shares in connection with or to raise cash proceeds to facilitate, such a redemption, or the perception that such sales may occur, could adversely affect the market price of the Class A common shares.
In addition, the partnership agreement of Operating Partnership requires the approval of a majority of the Operating Partnership units not held by the Company and entities controlled by it for certain transactions and other actions, including certain modifications to the partnership agreement, withdrawal or succession of the Company as general partner of Operating Partnership, limits on the right of holders of Operating Partnership units to redeem their units, tax elections and certain other matters. Because ESL currently owns a majority of the outstanding Operating Partnership units not held by the Company and entities controlled by it, ESL’s approval will be required in order for the general partner to undertake such actions unless ESL no longer owns a majority of such units. If ESL refuses to approve any such action, our business could be materially adversely affected. Furthermore, ESL owns approximately 2.4% of the outstanding Class A common shares, as well as Class B non-economic common shares having, in the aggregate, 5.6% of the voting power of the Company. In any of these matters, the interests of ESL may differ from or conflict with the interests of our other shareholders.
ESL exerts substantial influence over us and Holdco, and its interests may differ from or conflict with the interests of our other shareholders.
ESL beneficially owns approximately 33.9% of the Operating Partnership units, and approximately 2.4% and 100% of the outstanding Class A common shares and Class B non-economic common shares, respectively, having, in the aggregate, 5.6% of the voting power of Seritage. Sears Holdings was, and Holdco is, an affiliate of ESL. In addition, Mr. Lampert, who previously served as the Chairman of the Board and Chief Executive Officer of Sears Holdings, and is the Chairman and Chief Executive Officer of ESL, serves as the Chairman of the Seritage Board of Trustees. As a result, ESL and its affiliates have substantial influence over us and Holdco. In any matter affecting us, including our relationship with Holdco, the interests of ESL may differ from or conflict with the interests of our other shareholders.
The businesses of each of the GGP JVs, the Simon JV, and the Macerich JV are similar to our business and the occurrence of risks that adversely affect us could also adversely affect our investment in the GGP JVs, the Simon JV and/or the Macerich JV.
The GGP JVs are joint ventures that own and operate certain JV Properties, which consist of nine properties formerly owned or leased by Sears Holdings, the Simon JV is a joint venture that owns and operates certain other JV Properties, which consist of five other
- 19 -
properties formerly owned by Sears Holdings and the Macerich JV is a joint venture that owns and operates the remaining JV Properties, which consist of nine other properties formerly owned by Sears Holdings. A substantial majority of the space at the JV Properties is leased by the applicable JV to Sears Holdings under the applicable JV Master Lease. Except with respect to the rent amounts and the properties covered, the general formats of the JV Master Leases are similar to one another and to the Holdco Master Lease, including with respect to the lessor’s right to recapture space leased to Sears Holdings (other than at one property owned by the Macerich JV) and Sears Holdings’ right to terminate a portion of the lease as to certain properties. As a result, each JV’s business is similar to our business, and each JV is subject to many of the same risks that we face. The occurrence of risks that adversely affect us could also adversely affect one or more JVs and reduce the value of our investment in, or distributions to us from, one or more JVs, or require that we make additional capital contributions to one or more JVs.
In addition, our influence over each JV may be limited by the fact that day-to-day operation of the GGP JVs, the Simon JV and the Macerich JV, and responsibility for leasing and redevelopment activities related to the JV Properties owned by the GGP JVs, the Simon JV and the Macerich JV, as applicable, are generally delegated to GGP, Simon and Macerich, respectively, subject to certain exceptions. The JV Properties owned by the GGP JVs are located at malls owned and operated by Brookfield Properties Retail (formerly GGP Inc.), the JV Properties owned by the Simon JV are located at malls owned and operated by the Simon JV and the JV Properties owned by the Macerich JV are located at malls owned and operated by the Macerich JV. As a result, conflicts of interest may exist or could arise in the future between the interests of GGP, Simon or Macerich and our interests as a holder of 50% interests in the GGP JVs, the Simon JV and the Macerich JV, respectively, including, for example, with respect to decisions as to whether to lease to third parties space at a JV Property or other space at the mall at which such JV Property is located.
We will continue to depend on Holdco to provide certain services at properties where Holdco is the sole or primary tenant and may have difficulty finding replacement services or be required to pay increased costs to replace these services after our agreements with Holdco expire or are terminated.
On February 28, 2019, we and certain affiliates of Holdco executed the Holdco Master Lease. The Holdco Master Lease became effective on March 12, 2019, when the Bankruptcy Court issued an order approving the rejection of the Original Master Lease. The Holdco Master Lease governs the terms of the use and operation of 17 properties leased by us to Holdco as of December 31, 2019 after giving effect to pending recapture or termination activity), including our redevelopment and recapture rights and Holdco’s lease termination rights, and the repair, maintenance and redevelopment-related services Holdco may provide to us. The agreements between us and certain affiliates of Holdco also govern our various interim and ongoing relationships.
If the Holdco Master Lease expires or is terminated, or if Holdco is unable to meet its obligations under the Holdco Master Lease as a result of bankruptcy or otherwise, we may be forced to seek replacement services from alternate providers. These replacement services may be more costly to us or of lower quality, and the transition process to a new service provider may result in interruptions to our business or operations, which could harm our financial condition or results of operations.
Holdco has agreed to indemnify us for certain liabilities. However, these indemnities may be insufficient to insure us against the full amount of such liabilities, and Holdco’s ability to satisfy its indemnification obligations may be impaired in the future.
Pursuant to the Holdco Master Lease, Holdco has agreed to indemnify us for certain liabilities. However, third parties could seek to hold us responsible for any of the liabilities that Holdco has agreed to retain, and Holdco may be unable to fully satisfy its indemnification obligations. Moreover, even if we ultimately succeed in recovering from Holdco any amounts for which we are held liable, we may be temporarily required to bear these losses while seeking recovery from Holdco. Any liabilities in excess of amounts for which we receive timely indemnification from Holdco could have a material adverse effect on our business and financial condition.
Risks Related to Status as a REIT
If we do not qualify to be taxed as a REIT, or fail to remain qualified as a REIT, we will be subject to U.S. federal income tax as a regular corporation and could face a substantial tax liability, which would reduce the amount of cash available for distribution to our shareholders.
We elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our initial taxable year ended December 31, 2015 and have operated, and expect to continue to operate, to qualify as a REIT. In connection with the Transaction, and the December 2017 offering of Series A Preferred Shares, we received opinions of counsel concluding that we have been organized in conformity with the requirements for qualification as a REIT and our current and/or proposed method of operation should enable us to satisfy the requirements for qualification as a REIT as of the respective dates. Investors should be aware, however, that opinions of counsel are not binding on the IRS or any court, and that each opinion was expressed as of the date it was issued and has not been updated. We believe we have continued to operate in conformity with the requirements to qualify as a REIT and that we continue to
- 20 -
satisfy all requirements to maintain our REIT status. However, qualification as a REIT involves the application of highly technical and complex provisions of the Code, for which only a limited number of judicial and administrative interpretations exist.
If we were to fail to qualify as a REIT in any taxable year, and no available relief provision applied, we would be subject to U.S. federal income tax, including, for any taxable year ending on or before December 31, 2017, any applicable alternative minimum tax, on our taxable income at regular corporate rates (which, in the case of U.S. federal income tax, is a maximum of 35% for periods ending on or before December 31, 2017 and 21% thereafter), as well as U.S. state and local income tax, and dividends paid to our shareholders would not be deductible by us in computing our taxable income. Any resulting corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our shareholders, which in turn could have an adverse impact on the value of Class A common shares. Unless we were entitled to relief under certain Code provisions, we also would be disqualified from re-electing to be taxed as a REIT for the four taxable years following the year in which we failed to qualify as a REIT.
Qualifying as a REIT involves highly technical and complex provisions of the Code.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which only limited judicial and administrative authorities exist. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our qualification as a REIT depends on the satisfaction of certain asset, income, organizational, distribution, shareholder ownership and other requirements on a continuing basis. In addition, our ability to satisfy the requirements to qualify as a REIT may depend in part on the actions of third parties over which we have no control or only limited influence, including in cases where we own an equity interest in an entity that is classified as a partnership for U.S. federal income tax purposes.
We could fail to qualify to be taxed as a REIT if income we receive is not treated as qualifying income.
Under applicable provisions of the Code, we will not be treated as a REIT unless we satisfy various requirements, including requirements relating to the sources of our gross income. Rents we receive or accrue from tenants may not be treated as qualifying rent for purposes of these requirements if the applicable lease is not respected as a true lease for U.S. federal income tax purposes and is instead treated as a service contract, joint venture, financing, or some other type of arrangement. We believe that the Holdco Master Lease should be respected as a true lease for U.S. federal income tax purposes. If, contrary to expectations, the Holdco Master Lease is not respected as a true lease for U.S. federal income tax purposes, we may fail to qualify to be taxed as a REIT. Furthermore, our qualification as a REIT depends on the satisfaction of certain asset, income, organizational, distribution, shareholder ownership and other requirements on a continuing basis. Our ability to satisfy the asset tests depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for some of which we will not obtain independent appraisals.
In addition, subject to certain exceptions, rents we receive or accrue from our tenants will not be treated as qualifying rent for purposes of these requirements if we or an actual or constructive owner of 10% or more of our outstanding shares (by value) actually or constructively owns 10% or more of the interests in the assets or net profits of a non-corporate tenant, or, if the tenant is a corporation, 10% or more of the total combined voting power of all classes of stock of such tenant entitled to vote or 10% or more of the total value of all classes of stock of such tenant. For purposes of determining whether rental payments received by a REIT are treated as qualifying rent, the stock, assets or net profits owned by a partner in an entity classified as a partnership for U.S. federal income tax purposes are attributed to such partnership only if the partner owns (directly or indirectly) 25% or more of the capital interest or profits interest in the partnership. As a result of these rules, it is possible that we could be treated as owning 10% or more of a tenant due to entering into a joint venture with a third party that is an actual or constructive owner of such tenant, and in such case rent payments received from such tenant may not be treated as qualifying rent for purposes of these requirements. Our Declaration of Trust provides for restrictions on ownership and transfer of Class A common shares and Series A Preferred Shares, including restrictions on such ownership or transfer that would cause the rents we receive or accrue from a tenant to be treated as non-qualifying rent for purposes of the REIT gross income requirements. Nevertheless, such restrictions may not be effective in ensuring that rents we receive or accrue from our tenants will be treated as qualifying rent for purposes of REIT qualification requirements.
Dividends payable by REITs do not qualify for the reduced tax rates available for certain “qualified dividends,” but would generally qualify for a partial deduction with respect to certain taxpayers.
The maximum U.S. federal income tax rate applicable to income from “qualified dividends” payable by U.S. corporations to U.S. shareholders that are individuals, trusts and estates is currently 20%. Ordinary dividends payable by REITs, however, generally are not eligible for the reduced rates. Although these rules do not adversely affect the taxation of REITs, the more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the shares of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including the Class A common shares. However, for taxable years beginning after December 31, 2017 and ending before January 1, 2026, a U.S. shareholder that is an individual, trust or estate would
- 21 -
generally be entitled to deduct up to 20% of certain ordinary REIT dividends, effectively reducing the rate at which such ordinary REIT dividends are subject to tax. U.S. shareholders should consult their own tax advisors regarding all aspects of such rules and their potential application to dividends from us.
REIT distribution requirements could adversely affect our ability to execute our business plan.
We generally must distribute annually at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction and excluding any net capital gains, in order for us to qualify to be taxed as a REIT (assuming that certain other requirements are also satisfied) so that U.S. federal corporate income tax does not apply to earnings that we distribute. To the extent that we satisfy this distribution requirement and qualify for taxation as a REIT but distribute less than 100% of our REIT taxable income, determined without regard to the dividends paid deduction and including any net capital gains, we will be subject to U.S. federal corporate income tax on our undistributed net taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we distribute to our shareholders in a calendar year is less than a minimum amount specified under U.S. federal tax laws. We declared a dividend on the Company’s Class A and Class C common shares for the first quarter of 2019 and have not declared dividends on the Company’s Class A and Class C common shares since that time, based on our Board of Trustees’ assessment of the Company’s investment opportunities and its expectations of taxable income for the remainder of 2020. We intend to, at a minimum, make distributions to our shareholders to comply with the REIT requirements of the Code, which may be satisfied by dividends on the Company’s Series A Preferred shares.
From time to time, we may generate taxable income greater than our cash flow as a result of differences in timing between the recognition of taxable income and the actual receipt of cash or the effect of nondeductible capital expenditures, the creation of reserves or required debt or amortization payments. If we do not have other funds available in these situations, we could be required to borrow funds on unfavorable terms, sell assets at disadvantageous prices or distribute amounts that would otherwise be invested in future acquisitions to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the REIT distribution requirement and to avoid corporate income tax and the 4% excise tax in a particular year; alternatively, we may distribute taxable stock dividends to our shareholders in the form of additional shares of stock - See “We may from time to time make distributions to our shareholders in the form of taxable stock dividends, which could result in shareholders incurring tax liability without receiving sufficient cash to pay such tax”. These alternatives could increase our costs or reduce our equity. Thus, compliance with the REIT requirements may hinder our ability to grow, which could adversely affect the value of Class A common shares.
Restrictions in our indebtedness, including restrictions on our ability to incur additional indebtedness or make certain distributions, could preclude us from meeting the 90% distribution requirement. Decreases in funds from operations due to unfinanced expenditures for acquisitions of properties or increases in the number of Class A common shares outstanding without commensurate increases in funds from operations each would adversely affect our ability to maintain distributions to our shareholders. Moreover, the failure of tenants to make rental payments under any applicable lease could materially impair our ability to make distributions. Consequently, we may be unable to make distributions at the anticipated distribution rate or any other rate.
We may from time to time make distributions to our shareholders in the form of taxable stock dividends, which could result in shareholders incurring tax liability without receiving sufficient cash to pay such tax.
Although we have no current intention to do so, we may in the future distribute taxable stock dividends to our shareholders in the form of additional shares of our stock. Taxable shareholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of our current and accumulated earnings and profits for U.S. federal income tax purposes. As a result, shareholders may be required to pay income taxes with respect to such dividends in excess of the cash distributions received. If a U.S. shareholder sells our shares that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our shares at the time of the sale. Furthermore, with respect to certain non-U.S. shareholders, we may be required to withhold U.S. federal income tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in its common stock.
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.
Even if we remain qualified for taxation as a REIT, we may be subject to certain U.S. federal, state, local and foreign taxes on our income and assets, including taxes on any undistributed income and state, local or foreign income, property and transfer taxes. For example, in order to meet the REIT qualification requirements, we may hold some of our assets or conduct certain of our activities through one or more taxable REIT subsidiaries (“TRSs”) or other subsidiary corporations that will be subject to federal, state and local corporate-level income taxes as regular C corporations. For taxable years beginning after December 31, 2017, taxpayers, including TRSs, are subject to a limitation on their ability to deduct net business interest (i.e., interest paid or accrued on indebtedness allocable to a trade or business), generally up to 30% of adjusted taxable income, subject to certain exceptions. This provision may limit the ability of our TRS to deduct interest, which could increase its taxable income and corporate income tax. Further, we may incur a
- 22 -
100% excise tax on transactions with a TRS if they are not conducted on an arm’s-length basis. Any of these taxes would decrease cash available for distribution to our shareholders.
Complying with REIT requirements may cause us to liquidate or forgo otherwise attractive opportunities.
To qualify to be taxed as a REIT, we must ensure that, at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and “real estate assets” (as defined in the Code), including certain mortgage loans and securities. The remainder of our investments (other than government securities, qualified real estate assets and securities issued by a TRS) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our total assets (other than government securities, qualified real estate assets and securities issued by a TRS) can consist of the securities of any one issuer, and no more than 20% of the value of our total assets can be represented by securities of one or more TRSs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate or forgo otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our shareholders.
In addition to the asset tests set forth above, to qualify to be taxed as a REIT, we must continually satisfy tests concerning, among other things, the sources of our income, the amounts we distribute to our shareholders and the ownership of our shares of beneficial interest. We may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source-of-income or asset-diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make and, in certain cases, maintain ownership of certain attractive investments.
Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code substantially limit our ability to hedge our assets and liabilities. Any income from a hedging transaction that we enter into to manage the risk of interest rate changes with respect to borrowings made or to be made to acquire or carry real estate assets (or that we enter into to manage risk with respect to a prior hedge entered into in connection with property that has been disposed of or liabilities that have been extinguished) does not constitute “gross income” for purposes of the 75% or 95% gross income tests that apply to REITs, provided that certain identification requirements are met. To the extent that we enter into other types of hedging transactions or fail to properly identify such transaction as a hedge, the income is likely to be treated as non-qualifying income for purposes of both of the gross income tests. As a result of these rules, we may be required to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because our TRS may be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our TRS will generally not provide any tax benefit, except that such losses may only be carried forward and may only be deducted against 80% or future taxable income in the TRS if the losses are incurred generally after December 31, 2017.
Changes in federal tax law affected the taxation of us and may affect the desirability of investing in a REIT relative to a regular non-REIT corporation.
The TCJA reduced the relative competitive advantage of operating as a REIT as compared with operating as a regular non-REIT corporation by reducing the maximum tax rate applicable to regular corporations from 35% to 21% beginning on January 1, 2018. On the other hand, the TCJA also decreased the U.S. federal income tax rate applicable to non-corporate shareholders on ordinary REIT dividends by lowering the maximum applicable individual rate from 39.6% to 37% and permitting non-corporate shareholders of REITs to deduct 20% of ordinary REIT dividends from their taxable income for the taxable years beginning after December 31, 2017 and ending before January 1, 2026 (as discussed above). The TCJA also provided a new limitation on the deduction of net business interest (ad discussed above). A taxpayer engaged in certain businesses relating to real property may elect out of the business interest provision; however, the requirements of this election may be onerous to implement and would require the REIT to utilize potentially disadvantageous depreciation methods on some or all of its assets, including certain “qualified improvement property.” We will determine whether or not to make such an election in our sole discretion and based on all the facts and circumstances. In addition, proposed U.S. Treasury regulations could limit the deduction we may claim for our proportionate share of the compensation expense attributable to the remuneration paid by the Operating Partnership for services performed by certain of our highly ranked and highly compensated employees.
Legislative or other actions affecting REITs or other entities could have a negative effect on us.
The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury. Changes to the tax laws or interpretations thereof, with or without retroactive application, could materially and adversely affect our investors or us. We cannot predict how changes in the tax laws might affect our
- 23 -
investors or us. New legislation, Treasury regulations, administrative interpretations or court decisions could significantly and negatively affect our ability to qualify as a REIT or the U.S. federal income tax consequences to us and our investors of such qualification.
Risks Related to Ownership of our Securities
The market price and trading volume of our securities may be volatile.
The market price of our securities may be volatile, and the trading volume in our securities may fluctuate and cause significant price variations to occur. Some of the factors that could negatively affect the market price of our securities or result in fluctuations in the price or trading volume of our securities include:
•
actual or anticipated variations in our quarterly results of operations or distributions;
•
changes in our funds from operations or earnings estimates;
•
publication of research reports about us or the real estate or retail industries;
•
increases in market interest rates that may cause purchasers of our securities to demand a higher yield;
•
changes in market valuations of similar companies;
•
adverse market reaction to any additional debt we may incur in the future;
•
actions by ESL, or by institutional shareholders;
•
speculation in the press or investment community about our company or industry or the economy in general;
•
adverse performance or potential financial distress or bankruptcy of our major tenants, including Holdco;
•
the occurrence of any of the other risk factors presented in this filing;
•
adverse developments in the Litigation;
•
specific real estate market and real estate economic conditions; and
•
general market and economic conditions.
We have issued Series A Preferred Shares, which, along with future offerings of debt or preferred equity securities, rank senior to our common shares for purposes of distributions or upon liquidation, may adversely affect the market price of our common shares.
We have issued 2,800,000 Series A Cumulative Redeemable Preferred Shares, which are senior to our common shares for purposes of distributions or upon liquidation. The Series A Preferred Shares may limit our ability to make distributions to holders of our common shares.
In the future, we may attempt to increase our capital resources by making additional offerings of debt or preferred equity securities, including medium-term notes, trust preferred securities, senior or subordinated notes and preferred shares. Upon liquidation, holders of our debt securities, Series A Preferred Shares and any additional preferred shares and lenders with respect to other borrowings may receive distributions of our available assets prior to the holders of our common shares. Any additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common shares, or both. Holders of our common shares are not entitled to preemptive rights or other protections against dilution, and will have no voting rights in connection with the issuance of these securities. Our Series A Preferred Shares have, and any additional preferred shares of beneficial interest issued could have, a preference on liquidating distributions or a preference on distribution payments that could limit our ability to make a distribution to the holders of our common shares. Since our decision to issue securities in any future offering will depend in part on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our shareholders bear the risk of our future offerings reducing the market price of our common shares and diluting their holdings in us.
The transactions with Sears Holdings and Holdco could give rise to disputes or other unfavorable effects, which could have a material adverse effect on our business, financial condition or results of operations.
Disputes with third parties could arise out of our historical transactions with Sears Holdings or future transactions with Holdco, and we could experience unfavorable reactions from employees, ratings agencies, regulators or other interested parties. These disputes and reactions of third parties could have a material adverse effect on our business, financial condition or results of operations. In addition, disputes between us and Sears Holdings or Holdco could arise in connection with any of our past or future agreements with those counterparties.
- 24 -
On April 18, 2019, at the direction of the Restructuring Sub-Committee of the Restructuring Committee of the Board of Directors of Sears Holdings, Sears Holdings, Sears, Roebuck & Co., Sears Development Co., Kmart Corporation, and Kmart of Washington, LLC commenced the Litigation in the Bankruptcy Court against the Seritage Defendants. The Litigation is dual captioned as In re: Sears Holdings Corporation, et al., Case No. 18-23538 (RDD) and Sears Holdings Corporation et al., v. Lampert et al., Case No. 19-08250 (RDD). On November 25, 2019, acting pursuant to the Confirmation Order, the Creditors’ Committee filed the Amended Complaint alleging, among other things, that certain transactions undertaken by Sears Holdings since 2011 (including the July 2015 transactions giving rise to Seritage, the execution of the Original Master Lease with Sears Holdings, and the acquisition of real estate from Sears Holdings) constituted actual and/or constructive fraudulent transfers and/or illegal dividends by Sears Holdings and that the real estate acquired by Seritage from Sears Holdings in July 2015 was worth hundreds of millions of dollars more than the purchase price paid. The Amended Complaint further alleges, among other things, that certain releases provided to Seritage and certain other defendants in connection with the Sears Holdings derivative litigation in the Delaware Court of Chancery in 2017 should be avoided and/or declared null and void as an actual and/or constructive fraudulent conveyance. The Amended Complaint seeks as relief, among other things, declaratory relief, avoidance of the allegedly actual and/or constructive fraudulent transfers, disgorgement, recovery of the property fraudulently transferred or, in the alternative, compensatory damages in an unspecified amount to be determined at trial, equitable subordination and disallowance of defendants’ claims as creditors, punitive and exemplary damages for any intentional wrongdoing, and reasonable attorneys’ fees, costs, and expenses. On February 21, 2020, the Seritage defendants filed a partial motion to dismiss seeking dismissal of the claims in the Amended Complaint relating to the release received in the Sears Holdings derivative litigation, unjust enrichment, and equitable subordination.
The number of shares available for future sale could adversely affect the market price of Class A common shares.
We cannot predict whether future issuances of Class A common shares, the availability of Class A common shares for resale in the open market or the conversion of Class C non-voting common shares into Class A common shares will decrease the market price per share of Class A common shares. Sales of a substantial number of Class A common shares in the public market, or the perception that such sales might occur, could adversely affect the market price of the Class A common shares.
Our earnings and cash distributions will affect the market price of Class A common shares.
We believe that the market value of a REIT’s equity securities is based primarily upon market perception of the REIT’s growth potential and its current and potential future cash distributions, whether from operations, sales, acquisitions, development or refinancing, and is secondarily based upon the value of the underlying assets. For these reasons, Class A common shares may trade at prices that are higher or lower than the net asset value per share. To the extent we retain operating cash flow for investment purposes, working capital reserves or other purposes rather than distributing the cash flow to shareholders, these retained funds, while increasing the value of our underlying assets, may negatively impact the market price of Class A common shares. Our failure to meet market expectations with regard to future earnings and cash distributions would likely adversely affect the market price of Class A common shares.
The Series A Preferred Shares have not been rated.
The Series A Preferred Shares have not been rated, and may never be rated, by any nationally recognized statistical rating organization, which may negatively affect their market value and your ability to sell such shares. It is possible, however, that one or more rating agencies might independently determine to assign a rating to the Series A Preferred Shares or that we may elect to obtain a rating of the Series A Preferred Shares in the future. Furthermore, we may elect to issue other securities for which we may seek to obtain a rating. If any ratings are assigned to the Series A Preferred Shares in the future or if we issue other securities with a rating, such ratings, if they are lower than market expectations or are subsequently lowered or withdrawn, could adversely affect the market for or the market value of the Series A Preferred Shares. Ratings only reflect the views of the issuing rating agency or agencies, and such ratings could at any time be revised downward or withdrawn entirely at the discretion of the issuing rating agency. Any such downward revision or withdrawal of a rating could have an adverse effect on the market price of the Series A Preferred Shares. Further, a rating is not a recommendation to purchase, sell or hold any particular security, including the Series A Preferred Shares. In addition, ratings do not reflect market prices or suitability of a security for a particular investor and any future rating of the Series A Preferred Shares may not reflect all risks related to us and our business, or the structure or market value of the Series A Preferred Shares.
An active trading market may not develop for the Series A Preferred Shares or, even if it does develop, may not continue, which may negatively affect the market value of, and the ability of holders of our Series A Preferred Shares to transfer or sell, their shares.
Since the Series A Preferred Shares have no stated maturity date, investors seeking liquidity will be limited to selling their shares in the secondary market. The Series A Preferred Shares are listed on the NYSE under the symbol “SRG PrA,” but there can be no assurance that an active trading market on the NYSE for the Series A Preferred Shares will develop or continue, in which case the market price of the Series A Preferred Shares could be materially and adversely affected and the ability to transfer or sell Series A Preferred Shares would be limited. The market price of the shares will depend on many factors, including:
•
prevailing interest rates;
•
the market for similar securities;
- 25 -
•
investors’ perceptions of us;
•
our issuance of additional preferred equity or indebtedness;
•
general economic and market conditions; and
•
our financial condition, results of operations, business and prospects.
The Series A Preferred Shares are subordinate in right of payment to our existing and future debt, and the interests of the holders of Series A Preferred Shares could be diluted by the issuance of additional preferred shares, including additional Series A Preferred Shares, and by other transactions.
The Series A Preferred Shares rank junior to all of our existing and future debt and to other non-equity claims on us and our assets available to satisfy claims against us, including claims in bankruptcy, liquidation or similar proceedings. Our future debt may include restrictions on our ability to pay dividends to preferred shareholders. As of December 31, 2019, our total indebtedness was $1.6 billion. In addition, we may incur additional indebtedness in the future. Our Declaration of Trust currently authorizes the issuance of up to 10,000,000 shares of preferred shares in one or more classes or series. Our board of trustees has the power to reclassify unissued common shares and preferred shares and to amend our Declaration of Trust, without any action by our shareholders, to increase the aggregate number of shares of beneficial interest of any class or series, including preferred shares, that we are authorized to issue. The issuance of additional preferred shares on parity with or senior to the Series A Preferred Shares with respect to the payment of dividends and the distribution of assets in the event of any liquidation, dissolution or winding up would dilute the interests of the holders of the Series A Preferred Shares, and any issuance of preferred shares senior to the Series A Preferred Shares or of additional indebtedness could adversely affect our ability to pay dividends on, redeem or pay the liquidation preference on the Series A Preferred Shares. Other than the limited conversion right afforded to holders of Series A Preferred Shares that may occur in connection with a Change of Control, none of the provisions relating to the Series A Preferred Shares contain any provisions relating to or limiting our indebtedness or affording the holders of the Series A Preferred Shares protection in the event of a highly leveraged or other transaction, including a merger or the sale, lease or conveyance of all or substantially all our assets or business, that might adversely affect the holders of the Series A Preferred Shares, so long as the rights of holders of the Series A Preferred Shares are not materially and adversely affected.
Dividends on our preferred shares, including the Series A Preferred Shares, are discretionary. We cannot guarantee that we will be able to pay dividends in the future or what the actual dividends will be for any future period.
Future dividends on our preferred shares, including the Series A Preferred Shares, will be authorized by our Board of Trustees and declared by us at the discretion of our board of trustees and will depend on, among other things, our results of operations, cash flow from operations, financial condition and capital requirements, any debt service requirements and any other factors our Board of Trustees deems relevant. Accordingly, we cannot guarantee that we will be able to make cash dividends on our preferred shares or what the actual dividends will be for any future period. However, until we declare payment and pay or set apart the accrued dividends on the Series A Preferred Shares, our ability to pay dividends and make other distributions on our common shares and non-voting shares (including redemptions) will be limited by the terms of the Series A Preferred Shares.
Holders of Series A Preferred Shares will have limited voting rights.
Holders of the Series A Preferred Shares have limited voting rights. Our Class A common shares and our non-economic shares are currently the only shares of beneficial interest of our company with full voting rights. Voting rights for holders of Series A Preferred Shares exist primarily with respect to the right to elect two additional trustees to our Board of Trustees in the event that six quarterly dividends (whether or not consecutive) payable on the Series A Preferred Shares are in arrears, and with respect to voting on amendments to our Declaration of Trust or articles supplementary relating to the Series A Preferred Shares that would materially and adversely affect the rights of holders of the Series A Preferred Shares or create additional classes or series of our shares that are senior to the Series A Preferred Shares with respect to the payment of dividends and the distribution of assets in the event of any liquidation, dissolution or winding up of our affairs. Other than in limited circumstances, holders of Series A Preferred Shares will not have any voting rights.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
There are no unresolved comments from the staff of the SEC as of the date of this Annual Report.
- 26 -
ITEM 2.
ITEM 2.
PROPERTIES
As of December 31, 2019, the Company’s portfolio consisted of interests in 212 properties totaling approximately 33.4 million square feet of GLA, including 184 Wholly Owned Properties totaling approximately 28.7 million square feet of GLA across 44 states and Puerto Rico and interests in 28 JV Properties totaling approximately 4.7 million square feet of GLA across 14 states. The following tables set forth certain information regarding our Wholly Owned Properties and JV Properties based on signed leases as of December 31, 2019, including signed but not yet open leases (“SNO” or “SNO Leases”), and after giving effect to all pending recapture and termination notices:
- 27 -
- 28 -
- 29 -
- 30 -
(1)
Property subject to the Holdco Master Lease.
(2)
Based on signed leases as of December 31, 2019, including SNO Leases.
(3)
Property subject to termination notices pursuant to the terms of the Holdco Master Lease.
(4)
Property subject to recapture notices pursuant to the terms of the Holdco Master Lease.
(5)
Property subject to a ground lease.
- 31 -
- 32 -
The following table sets forth information regarding the geographic diversification of the portfolio based on signed leases as of December 31, 2019, including JV Properties presented at the Company’s proportional share and after giving effect to all pending recapture and termination notices:
(1)
Includes 35 states.
The Holdco Master Lease
On February 28, 2019, the Company and certain affiliates of Holdco executed the Holdco Master Lease which became effective on March 12, 2019 when the Bankruptcy Court issued an order approving the rejection of the original master lease between the Company and certain affiliates of Sears Holdings (the “Original Master Lease”). The Company analyzed this transaction under applicable accounting guidance and determined that the termination of the Original Master Lease and entering into the Holdco Master Lease should be accounted for as a modification in accordance with ASC 842.
The structure of the Holdco Master Lease is consistent with the structure of the Original Master Lease in all material respects, including (i) it is a unitary, non-divisible lease as to all properties, pursuant to which the tenant’s obligations as to each property are cross-defaulted with all obligations of the tenant with respect to all other properties; (ii) it is a triple net lease with respect to all space which is leased thereunder to the tenant, subject to proportional sharing by the tenant for repair and maintenance charges, real property taxes, insurance and other costs and expenses which are common to both the space leased by the tenant and other space occupied by other tenants in the same or other buildings, space which is recaptured pursuant to the Company’s recapture rights described below and all other space which is constructed on the properties; (iii) the tenant is required to make all expenditures reasonably necessary to maintain the premises in good appearance, repair and condition for as long as they are in occupancy; and (iv) the tenant is generally prohibited from subleasing any space demised under the lease.
Term and Renewals
Consistent with the terms of the Original Master Lease, the Holdco Master Lease will expire in July 2025, and contains three options for five-year renewals of the term and a final option for a four-year renewal, as was the case under the Original Master Lease.
The Holdco Master Lease provides for an initial base rent at the same rates which were in place at the time of the modification for accounting purposes. In each of the initial term and the first two renewal terms, consistent with the Original Master Lease, base rent under the Holdco Master Lease will be increased in August of each year by 2.0% per annum for each lease year over the rent for the immediately preceding lease year. For subsequent renewal terms, consistent with the Original Master Lease, rent will be set at the commencement of the renewal term for the Holdco Master Lease at a fair market rent based on a customary third-party appraisal process, taking into account all the terms of the Holdco Master Lease and other relevant factors, but in no event will the renewal rent be less than the rent payable in the immediately preceding lease year. The base rent under the Holdco Master Lease will be subject to an adjustment in the form of a rent credit of up to approximately $12 million in each of the first and second years of the Holdco Master Lease. The rent credit is allocated to specific properties based on the trailing twelve- month EBITDA of the particular property as of December 2018. If any such properties are recaptured by the Company or terminated by Holdco, the base rent credit attributable to such property will no longer be applicable. The rent credit is applicable to base rent only and Holdco is responsible for
- 33 -
repair and maintenance charges, real property taxes, insurance and other costs and expenses associated with its occupancy of the subject properties.
Seritage Recapture Rights
The Holdco Master Lease provides the Company with the right to recapture up to approximately 50% of the space occupied by the tenant at all properties (other than five specified properties) and the right to recapture any automotive care centers which are free-standing or attached as “appendages” to the properties, all outparcels or outlots and certain portions of parking areas and common areas. Upon exercise of any of these partial recapture rights, the Company will generally incur, as applicable, certain costs and expenses for the separation of the recaptured space from the remaining tenant space.
Additionally, in contrast to the Original Master Lease, which permitted the Company to recapture 100% of certain properties upon payment of a specified recapture fee, the Holdco Master Lease provides the Company with the right, beginning in March 2020, to recapture 100% of the space occupied by the tenant at any of the properties included in the Holdco Master Lease (other than five specified properties) without paying a recapture fee. This right to recapture 100% of any property is limited to 10 properties in each year of the Holdco Master Lease term, with carry-over rights if less than 10 properties are recaptured in any given lease year. In the event of a 100% recapture of a property (or termination of a property by Holdco that is subject to a termination fee) and any subsequent redevelopment of such property for retail purposes, Holdco has certain rights of first offer to lease space at specified predefined rates depending on the condition the space is delivered. If the Company does not provide Holdco with a right of first offer on at least one-third of any such properties that are recaptured 100% by the Company (or terminated by Holdco with payment of a termination fee) in a given lease year, then the Company’s 100% recapture rights are subject to payment of a recapture fee until such time as the Company has complied with the foregoing ratio.
Upon the exercise of any of its recapture rights, the Company can reconfigure and rent the recaptured space to new tenants on potentially superior terms as determined by the Company and for its own account.
The Company exercised recapture rights with respect to 70 properties under the Original Master Lease prior to its rejection on March 12, 2019 and with respect to four properties under the Holdco Master Lease during the year ended December 31, 2019, including three properties where the Company had previously exercised certain recapture rights under the Original Master Lease.
The following table provides a summary of the Company’s recapture activity:
(1)
Includes properties for which the Company had converted partial recapture rights to 100% recapture rights.
(2)
Partial recaptures include the recapture of (i) up to approximately 50% of the space occupied by the tenant at all properties, (ii) automotive care centers which are free-standing or attached as “appendages” to the properties, and/or (iii) outparcels or outlots and certain portions of parking areas and common areas.
Holdco Termination Rights
Under the terms of the Holdco Master Lease, Holdco has the right, at any time, to terminate the Holdco Master Lease with respect to any property upon the payment of a termination fee equal to one year of base rent plus annual taxes and other operating expenses. Additionally, beginning in March 2020, Holdco has the right to terminate without payment of a termination fee: (i) up to 16 properties in the second year of the term of the Holdco Master Lease, (ii) up to 12 properties in the third year, (iii) up to 10 properties in the fourth year, and (iv) thereafter, the remaining properties, in each instance with carry over rights if less than the maximum permitted number of properties are terminated in any lease year.
Sears Holdings exercised termination rights with respect to 87 properties under the Original Master Lease prior to its rejection on March 12, 2019 and Holdco exercised termination rights with respect to 29 properties under the Holdco Master Lease during the year ended December 31, 2019.
- 34 -
The following table provides a summary of Sears Holdings’ and Holdco’s termination activity (excluding 31 properties totaling 4.3 million square feet that were rejected on March 12, 2019 as part of Sears Holdings’ bankruptcy filing):
(1)
Two properties were terminated in October 2018.
(2)
One property was terminated in November 2017 and another one was terminated in January 2018.
As of December 31, 2019, the Company had commenced or completed redevelopment projects at 46 of the terminated properties and sold an additional 24 of the terminated properties. The Company intends to continue to announce redevelopment activity as new leases are signed to occupy the space formerly occupied by Sears or Kmart.
Tenant Overview
The following table provides a summary of annual base rent for the portfolio based on signed leases as of December 31, 2019, including JV Properties presented at the Company’s proportional share and after giving effect to all pending recapture and termination notices:
(1)
Includes 17 properties subject to the Holdco Master Lease and two leases between the Company’s unconsolidated joint ventures and Holdco.
(2)
Excludes 32 properties subject to previously exercised recapture or terminations notices.
- 35 -
Top Tenants
The following table lists the top tenants in our portfolio based on signed leases as of December 31, 2019, including JV Properties presented at the Company’s proportional share and giving effect to all pending recapture and termination notices:
Note: The Company has signed 10 leases with Industrious to occupy 330,000 SF under revenue-sharing agreements that are expected to place Industrious among the Company’s top tenants.
(1)
Includes 17 properties subject to the Holdco Master Lease and two leases between the Company’s unconsolidated joint ventures and Holdco.
(2)
Excludes 32 properties subject to previously exercised recapture or terminations notices.
- 36 -
Lease Expirations
The following table sets forth a summary schedule of lease expirations for signed leases, including SNO leases, as of December 31, 2019, including JV Properties presented at the Company’s proportional share and giving effect to all pending recapture and termination notices. The information set forth in the table assumes that no other tenants exercise renewal options or early termination rights:
(1)
Includes 17 properties subject to the Holdco Master Lease and two leases between the Company’s unconsolidated joint ventures and Holdco.
(2) Excludes 32 properties subject to previously exercised recapture or terminations notices.
- 37 -
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
On April 18, 2019, at the direction of the Restructuring Sub-Committee of the Restructuring Committee of the Board of Directors of Sears Holdings, Sears Holdings, Sears, Roebuck & Co., Sears Development Co., Kmart Corporation, and Kmart of Washington, LLC filed a lawsuit (the “Litigation”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) against, among others, Edward S. Lampert, ESL Investments, Inc. and certain of its affiliates and investors, Fairholme Capital Management, L.L.C., certain members of the Sears Holdings board of directors, and the Company, the Operating Partnership, and certain of our affiliates and subsidiaries (the Company, the Operating Partnership, and certain of our affiliates and subsidiaries collectively, the “Seritage Defendants”). The Litigation is dual captioned as In re: Sears Holdings Corporation, et al., Case No. 18-23538 (RDD) and Sears Holdings Corporation et al., v. Lampert et al., Case No. 19-08250 (RDD). The Litigation alleges, among other things, that certain transactions undertaken by Sears Holdings since 2011 constituted actual and/or constructive fraudulent transfers and/or illegal dividends by Sears Holdings. The challenged transactions include the July 2015 transactions giving rise to Seritage, the execution of the Original Master Lease with Sears Holdings, and the acquisition of real estate from Sears Holdings. The Litigation alleges, among other things, that the real estate acquired by Seritage from Sears Holdings in July 2015 was worth at least $649 to $749 million more than the purchase price paid. The Litigation seeks as relief, among other things, declaratory relief, avoidance of the allegedly actual and/or constructive fraudulent transfers and either (i) rescission of the transfers of real estate from Sears Holdings to Seritage in 2015 and return of the proceeds of the transactions between Sears Holdings and Seritage, or, in the alternative, (ii) payment by Seritage to Sears Holdings of damages at least equal to the value of the transferred property.
On October 15, 2019, the Bankruptcy Court entered an order (the “Confirmation Order”) confirming the Modified Second Amended Joint Chapter 11 Plan of Sears Holdings and its affiliated debtors (the “Chapter 11 Plan”). Pursuant to the terms of the Confirmation Order, upon the effective date of the Chapter Plan, a liquidating trust will be formed, and the Litigation will vest in the liquidating trust. The Confirmation Order further provides that, prior to the effective date of the Chapter 11 Plan and the formation of the liquidating trust, the Litigation shall be controlled by five litigation designees selected by Sears Holdings and the Unsecured Creditors’ Committee (the “UCC”). For further information, refer to the Chapter 11 Plan, Confirmation Order and liquidating trust agreement, each of which has been publicly filed with the Bankruptcy Court.
On November 25, 2019, the Creditors’ Committee filed a first amended complaint (the “Amended Complaint”) in the Bankruptcy Court naming us and certain of our affiliates, as well as affiliates of ESL and Sears Holdings, and certain other third parties, as defendants. The Amended Complaint alleges, among other things, that certain transactions undertaken by Sears Holdings since 2011 (including the July 2015 transactions giving rise to Seritage, the execution of the Master Lease with Sears Holdings (the “Original Master Lease”), and the acquisition of real estate from Sears Holdings) constituted actual and/or constructive fraudulent transfers and/or illegal dividends by Sears Holdings and that the real estate acquired by Seritage from Sears Holdings in July 2015 was worth hundreds of millions of dollars more than the purchase price paid. The Amended Complaint further alleges that certain releases provided to Seritage and certain other defendants in connection with the Sears Holdings derivative litigation in the Delaware Court of Chancery in 2017 should be avoided and/or declared null and void as an actual and/or constructive fraudulent conveyance. The Amended Complaint seeks as relief, among other things, declaratory relief, avoidance of the allegedly actual and/or constructive fraudulent transfers, disgorgement, recovery of the property fraudulently transferred or, in the alternative, compensatory damages in an unspecified amount to be determined at trial, equitable subordination and disallowance of defendants’ claims as creditors, punitive and exemplary damages for any intentional wrongdoing, and reasonable attorneys’ fees, costs, and expenses. On February 21, 2020, the Seritage defendants filed a partial motion to dismiss seeking dismissal of the claims in the Amended Complaint relating to the release received in the Sears Holdings derivative litigation, unjust enrichment, and equitable subordination. The Company believes that the claims against the Seritage Defendants in the Litigation are without merit and intends to defend against them vigorously.
In addition to the litigation described above, the Company is subject, from time to time, to various legal proceedings and claims that arise in the ordinary course of business. While the resolution of such matters cannot be predicted with certainty, management believes, based on currently available information, that the final outcome of such matters will not have a material effect on the consolidated financial position, results of operations, cash flows or liquidity of the Company. As of December 31, 2019, and December 31, 2018, the Company did not record any amounts for litigation or other matters.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
- 38 -
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s Class A common stock is listed and traded on the New York Stock Exchange (“NYSE”) under the symbol “SRG”.
The following graph provides a comparison, from July 6, 2015 through December 31, 2019, of the percentage change in the cumulative total shareholder return (assuming reinvestment of dividends) on $100 invested in each of Class A shares of the Company, the Standard & Poor's ("S&P") 500 Index and the SNL US REIT Index, an industry index of publicly-traded REITs (including the Company).
Data for the S&P 500 Index and the SNL US REIT Index were provided by SNL Financial LLC.
Common Shares and Operating Partnership Units
On February 21, 2020, the reported closing sale price per share of our Class A common stock on the NYSE was $37.93.
As of February 21, 2020, there were 36,902,940 Class A common shares issued and outstanding which were held by approximately 139 shareholders of record. The number of shareholders of record does not reflect persons or entities that held their shares in nominee or “street” name.
In addition, as of February 21, 2020, there were 1,242,536 Class B non-economic common shares issued and outstanding and 18,904,645 outstanding Operating Partnership units (“OP Units”) held by limited partners other than the Company. There are no Class C non-voting common shares outstanding.
The Class B non-economic common shares have voting rights, but do not have economic rights and, as such, do not receive dividends and are not included in earnings per share computations.
- 39 -
Class C non-voting common shares have economic rights, but do not have voting rights. Upon any transfer of a Class C non-voting common share to any person other than an affiliate of the holder of such share, such share shall automatically convert into one Class A common share.
The OP Units are generally exchangeable into shares of Class A common stock on a one-for-one basis.
Share-Based Compensation
The following table provides information with respect to the Company’s equity compensation plan at December 31, 2019:
(1)
Represents restricted stock awards and units previously granted and that remain unvested as of December 31, 2019.
(2)
Weighted average exercise price does not apply to restricted stock units (“RSU”).
(3)
Shares remaining available for future issuance under the Seritage Growth Properties 2015 Share Plan, taking into account 216,835 shares of restricted stock previously granted and 441,349 shares subject to grants of RSUs previously granted (including those that remain unvested reported in column (a)).
Dividends and Distributions
The timing, amount and composition of all distributions will be made by the Company at the discretion of its Board of Trustees. Such distributions will depend on the financial position, results of operations, cash flows, capital requirements, debt covenants, applicable law and other factors as the Board of Trustees of Seritage deems relevant.
The Company declared a dividend on the Company’s Class A and Class C common shares for the first quarter of 2019 and has not declared dividends on the Company’s Class A and Class C common shares since that time, based on our Board of Trustees’ assessment of the Company’s investment opportunities and its expectations of taxable income for remainder of 2020. The Company intends to, at a minimum, make distributions to our shareholders to comply with the REIT requirements of the Code, which may be satisfied by dividends on the Company’s preferred shares.
REIT Election
We have elected to be treated as a REIT for U.S. federal income tax and intend to maintain this status in future periods. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including requirements to distribute at least 90% of its ordinary taxable income and to either distribute capital gains to shareholders, or pay corporate income tax on the undistributed capital gains. A REIT will generally not pay U.S. federal income tax if it distributes 100% of its capital gains and ordinary income.
- 40 -
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The following table sets forth selected financial data which should be read in conjunction with the Consolidated Financial Statements and the related Notes and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in this Annual Report:
(1)
Total NOI, FFO and Company FFO are supplemental, non-GAAP financial measurements and do not represent net income as defined by GAAP. For reconciliations of these measures to the respective GAAP measures that we deem most comparable, see “Reconciliation of Non-GAAP Financial Measures to GAAP Financial Measures” below.
(2)
Cash flow data represents the Company's consolidated cash flows as defined by GAAP; operating cash flow does not include cash distributions received from our unconsolidated joint ventures, except to the extent such distributions are in excess of cumulative equity in earnings in unconsolidated joint ventures.
(3)
Other than number of properties, data is based on signed leases as of December 31, 2019, 2018, 2017, 2016 and 2015, respectively, including JV Properties presented at the Company’s proportional share and after giving effect to all pending recapture and termination notices.
- 41 -
ITEM 7.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section contains forward-looking statements that involve risks and uncertainties. Our actual results may vary materially from those discussed in the forward-looking statements as a result of various factors, including, without limitation, those set forth in "Risk Factors" and the other matters set forth in this Annual Report. See "Cautionary Statement Regarding Forward-Looking Statements."
All references to numbered Notes are to specific footnotes to our Consolidated Financial Statements included in this Annual Report. You should read this discussion in conjunction with our Consolidated Financial Statements, the notes thereto and other financial information included elsewhere in this Annual Report. Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). Capitalized terms used, but not defined, in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") have the same meanings as in such Notes.
Overview
We are principally engaged in the acquisition, ownership, development, redevelopment, management, and leasing of diversified retail real estate throughout the United States. As of December 31, 2019, the Company’s portfolio consisted of interests in 212 properties totaling approximately 33.4 million square feet of gross leasable area, including 184 Wholly Owned Properties totaling approximately 28.7 million square feet of GLA across 44 states and Puerto Rico, and interests in 28 JV Properties totaling approximately 4.7 million square feet of GLA across 14 states.
We were formed to unlock the underlying real estate value of a high-quality retail portfolio we acquired from Sears Holdings in July 2015 and our primary objective is to create value for our shareholders through the re-leasing and redevelopment of the majority of our Wholly Owned Properties and JV Properties. In doing so, we expect to meaningfully grow NOI and diversify our tenant base while transforming our portfolio from one with a single-tenant retail orientation to one comprised predominately of multi-tenant shopping centers, multifamily properties and larger-scale, mixed-use environments.
In order to achieve our objective, we intend to execute the following strategies:
•
Convert single-tenant buildings into multi-tenant properties at meaningfully higher rents
•
Maximize value of vast land holdings through retail and mixed-use densification;
•
Leverage existing and future joint venture relationships with leading landlords and financial partners; and
•
Maintain a flexible capital structure to support value creation activities.
On October 15, 2018, Sears Holdings and certain of its affiliates filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code with the Bankruptcy Court. On February 28, 2019, the Company and Holdco, an affiliate of ESL Investments, Inc., executed the Holdco Master Lease with respect to 51 Wholly Owned Properties, which became effective on March 12, 2019, when the Bankruptcy Court issued an order approving the rejection of the Original Master Lease.
As of December 31, 2019, the Company leased space at 48 Wholly Owned Properties to Holdco under the Holdco Master Lease and also leased space to Holdco at three JV Properties. As of December 31, 2019, three Wholly Owned Properties were subject to 100% recapture notices pursuant to the terms of the Holdco Master Lease, and 28 Wholly Owned Properties and one JV Property were subject to termination notices pursuant to the terms of the Holdco Master Lease and the lease with Holdco at the JV Property, respectively. Giving effect to this recapture and termination activity, the Company leased space at 17 Wholly Owned Properties to Holdco under the Holdco Master Lease and also leased space to Holdco at two JV Properties.
Edward S. Lampert is the Chairman and Chief Executive Officer of ESL Investments, Inc, which owns Holdco. Mr. Lampert is also the Chairman of Seritage and controls each of the tenant entities that is a party to the Holdco Master Lease.
Asset Sales and Joint Ventures
During the year ended December 31, 2019, the Company sold 21 properties, plus additional outparcels, totaling 2.5 million square feet and generated gross proceeds of $144.3 million and also completed two joint ventures with adjacent property owners that generated an additional $10.9 million of gross proceeds.
Subsequent to December 31, 2019, the Company sold three assets for $57 million and entered into contracts to sell an additional seven assets. As of February 28, 2020, the Company had assets under contract to sell for anticipated proceeds of $125 million, subject to certain closing conditions.
- 42 -
Effects of Natural Disasters
The Company assessed the impact of the natural disasters (primarily Tropical Storm Karen) that occurred during the year ended December 31, 2019 and determined that this natural disaster did not have a material impact on our operating results or financial position. The Company did not experience interruptions in rental payments nor has it incurred material capital expenditures to repair any property damage.
Results of Operations
We derive substantially all of our revenue from rents received from tenants under existing leases at each of our properties. This revenue generally includes fixed base rents and recoveries of expenses that we have incurred and that we pass through to the individual tenants, in each case as provided in the respective leases.
Our primary cash expenses consist of our property operating expenses, general and administrative expenses, interest expense, and construction and development related costs. Property operating expenses include: real estate taxes, repairs and maintenance, management fees, insurance, ground lease costs and utilities; general and administrative expenses include payroll, office expenses, professional fees, and other administrative expenses; and interest expense is on our term loan facility. In addition, we incur substantial non-cash charges for depreciation of our properties and amortization of intangible assets and liabilities.
Comparison of the Year Ended December 31, 2019 to the Year Ended December 31, 2018
The following table presents selected data on comparative results from the Company’s consolidated statements of operations for the year ended December 31, 2019, as compared to the year ended December 31, 2018 (in thousands):
(1)
Upon adoption of the new lease standard in accordance with Accounting Standard Codification (“ASC”) 842, tenant reimbursements for 2018 have been reclassified to rental income in the consolidated statements of operations to conform to the 2019 financial statement presentation.
Rental Income
The following table presents the results for rental income for the year ended December 31, 2019, as compared to the corresponding period in 2018 (in thousands):
- 43 -
The decrease of $100.5 million in Sears or Kmart rental income during 2019 is primarily due to a reduction in the number of properties leased to Sears or Kmart under the Original Master Lease, as applicable, as a result of recapture and termination activity.
The increase of $36.0 million in diversified tenants rental income during 2019 is primarily due to newly commenced leases at locations formerly occupied by Sears or Kmart.
The increase of $18.4 million in straight-line rental income during 2019 is due to an increase in straight-line rent receivables related to diversified tenants under newly commenced leases during 2019.
Property Operating Expenses and Real Estate Taxes
The Company incurs certain property operating and real estate tax expenses.
The following table presents the comparative results for property operating expenses and real estate taxes for the year ended December 31, 2019, as compared to the corresponding period in 2018 (in thousands):
The increase of $13.4 million in property operating expense in 2019 is primarily due to the Company directly incurring utility and certain common area maintenance expenses at properties for which Sears or Kmart paid such expenses directly during 2018, partially offset by a decrease in property operating expenses as a result of asset sales and an increase in amounts capitalized due to development activity.
The decrease of $3.8 million in real estate taxes in 2019 is primarily due to asset sales and an increase in amounts capitalized due to development activity.
Depreciation and Amortization Expenses
The decrease of $122.0 million in depreciation and amortization expenses in 2019 was due primarily to (i) a reduction of $117.1 million in accelerated amortization attributable to certain lease intangible assets, (ii) approximately $10.0 million of lower net scheduled depreciation and amortization and (iii) $5.2 million increase of accelerated depreciation attributable to certain buildings that were demolished for redevelopment in 2019.
Accelerated amortization results from the recapture of space from, or the termination of space by, Sears Holdings or Holdco. Such recaptures and terminations are deemed lease modifications and require related lease intangibles to be amortized over the shorter of the shortened lease term or the remaining useful life of the asset.
General and Administrative Expenses
General and administrative expenses consist of personnel costs, including share-based compensation, professional fees, office expenses and related expenses.
The increase of $4.4 million in general and administrative expenses in 2019 was driven primarily by (i) changes to the accounting for leasing personnel and legal costs related to leasing activity as a result of the adoption of the new leasing standard in 2019, (ii) legal and advisory fees related to the Sears Holdings’ bankruptcy filing and (iii) increased compensation and related costs resulting from an increase in personnel.
Gain on Sale of Real Estate
During the year ended December 31, 2019, the Company:
−
Sold properties for aggregate consideration of $144.3 million and recorded gains totaling $63.7 million, which are included in gain on the sale of real estate within the consolidated statements of operations;
- 44 -
−
Contributed two properties into joint ventures with adjacent property owners for an aggregate contribution value of $21.7 million and recorded a gain of approximately $3.9 million, which is included in gain on sale of real estate within the consolidated statements of operations;
−
Exchanged land parcels of approximately equal size with an adjacent land owner and recorded a gain of $6.9 million.
Interest Expense
The Company incurs interest expense on its debt net of capitalized costs.
The increase of $4.5 million in interest expense in 2019 was driven by higher average borrowings and interest rates under the term loan facility, partially offset by an increase in amounts capitalized due to increased development activity.
Liquidity and Capital Resources
Our primary uses of cash include the payment of property operating and other expenses, including general and administrative expenses and debt service (collectively, “obligations”), and the reinvestment in and redevelopment of our properties (“development expenditures”). As a result of a decrease in occupancy levels due to our recapture of space for redevelopment purposes and the execution of certain termination rights by Sears Holdings under the Original Master Lease, property rental income, which is our primary source of operating cash flow, did not fully fund obligations incurred during the year ended December 31, 2019 and we had operating cash outflows of $57.7 million. Additionally, our development expenditures during the year ended December 31, 2019 drove investing cash outflows of $299.5 million.
Obligations are projected to continue to exceed property rental income until such time as additional tenants commence paying rent (we had approximately $84.3 million of SNO leases under contract as of December 31, 2019) that will commence paying rent as tenants occupy their leased space), and we plan to incur additional development expenditures as we continue to invest in the redevelopment of our portfolio. While we do not currently have the liquid funds available to satisfy the obligations and development expenditures, we expect to fund our obligations and development expenditures with a combination of capital sources including, but not limited to the following, subject to any approvals that may be required under the Term Loan Agreement:
•
Sales of Wholly Owned Properties. As of December 31, 2019, we had sold 42 Wholly Owned Properties, and additional outparcels at several properties, and generated approximately $258 million of gross proceeds since we began our capital recycling program in July 2017. Subsequent to December 31, 2019, the Company sold three assets for $57 million and entered into contracts to sell an additional seven assets. As of February 28, 2020, the Company had assets under contract to sell for total anticipated proceeds of $125 million, subject to certain closing conditions;
•
Sales of Interests in JV Properties. As of December 31, 2019, we had sold our interests in 13 JV Properties and generated approximately $258 million of gross proceeds since July 2017. Certain of our joint venture agreements also include rights that allow us to sell our interests in select JV Properties to our partners at fair market value;
•
New joint ventures. As of December 31, 2019, we had closed new joint ventures for 10 properties that generated approximately $185 million of gross proceeds since July 2017. In addition to generating liquidity upon closing, new joint ventures also reduce our development expenditures by the amount of our partners’ interests in the ventures;
•
Joint venture debt. We may incur property-level debt in new or existing joint ventures, including construction financing for properties under development and longer-term mortgage debt for stabilized properties; and
•
Other credit and capital markets transactions. We may raise additional capital through the public or private issuance of debt securities, common or preferred equity or other instruments convertible into or exchangeable for common or preferred equity.
In addition, our Term Loan Facility includes a $400 Incremental Funding Facility, access to which is subject to rental income from non-Sears Holdings tenants of at least $200 million, on an annualized basis and after giving effect to SNO leases expected to commence rent payment within 12 months, which we have not yet achieved.
The availability of liquidity from the above sources or initiatives is subject to a range of risks and uncertainties, including those discussed under “Risk Factors-Real estate investments are relatively illiquid” and “Risk Factors-We have ongoing capital needs and may not be able to obtain additional financing or other sources of funding on acceptable terms.”
- 45 -
Term Loan Facility
On July 31, 2018, the Operating Partnership, as borrower, and the Company, as guarantor, entered into a Senior Secured Term Loan Agreement (the “Term Loan Agreement”) providing for a $2.0 billion term loan facility (the “Term Loan Facility”) with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire Hathaway”) as lender and Berkshire Hathaway as administrative agent. The Term Loan Facility provided for an initial funding of $1.6 billion at closing (the “Initial Funding”) and includes a $400 million incremental funding facility (the “Incremental Funding Facility”). The Term Loan Facility matures on July 31, 2023.
The Company used a portion of the proceeds from the Initial Funding to (i) repay existing indebtedness and (ii) pay transaction and related costs. The remaining proceeds from the Initial Funding, as well as borrowings under the Incremental Funding Facility, will be used to fund the Company’s redevelopment pipeline and to pay operating expenses of the Company and its subsidiaries.
Funded amounts under the Term Loan Facility bear interest at an annual rate of 7.0% and unfunded amounts under the Incremental Funding Facility are subject to an annual fee of 1.0% until drawn. The Company prepays the annual fee and amortizes the expense to interest expense on the consolidated statements of operations.
As of December 31, 2019, the aggregate principal amount outstanding under the Term Loan Facility was $1.6 billion.
The Company’s ability to access the Incremental Funding Facility is subject to (i) the Company achieving rental income from non-Sears Holdings tenants, on an annualized basis (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the fiscal quarter ending prior to the date of incurrence of the Incremental Funding Facility, of not less than $200 million and (ii) the Company’s good faith projection that rental income from non-Sears Holdings tenants (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the succeeding four consecutive fiscal quarters (beginning with the fiscal quarter during which the incremental facility is accessed) will be not less than $200 million.
The Term Loan Facility is guaranteed by the Company and, subject to certain exceptions, is required to be guaranteed by all existing and future subsidiaries of the Borrower. The Term Loan Facility is secured on a first lien basis by a pledge of the capital stock of the direct subsidiaries of the Borrower and the guarantors, including its joint venture interests, except as prohibited by the organizational documents of such entities or any joint venture agreements applicable to such entities, and contains a requirement to provide mortgages and other customary collateral upon the breach of certain financial metrics described below, the occurrence and continuation of an event of default and certain other conditions set forth in the Term Loan Agreement.
The Term Loan Facility includes certain financial metrics to govern springing collateral and certain covenant exceptions set forth in the Term Loan Agreement, including: (i) a total fixed charge coverage ratio of not less than 1.00 to 1.00 for each fiscal quarter beginning with the fiscal quarter ending September 30, 2018 through the fiscal quarter ending June 30, 2021, and not less than 1.20 to 1.00 for each fiscal quarter thereafter; (ii) an unencumbered fixed charge coverage ratio of not less than 1.05 to 1.00 for each fiscal quarter beginning with the fiscal quarter ending September 30, 2018 through the fiscal quarter ending June 30, 2021, and not less than 1.30 to 1.00 for each fiscal quarter thereafter; (iii) a total leverage ratio of not more than 65%; (iv) an unencumbered ratio of not more than 60%; and (v) a minimum net worth of at least $1.2 billion. Any failure to satisfy any of these financial metrics limits the Company’s ability to dispose of assets via sale or joint venture and triggers the springing mortgage and collateral requirements but will not result in an event of default. The Term Loan Facility also includes certain limitations relating to, among other activities, the Company’s ability to: sell assets or merge, consolidate or transfer all or substantially all of its assets; incur additional debt; incur certain liens; enter into, terminate or modify certain material leases and/or the material agreements for the Company’s properties; make certain investments (including limitations on joint ventures) and other restricted payments; pay distributions on or repurchase the Company’s capital stock; and enter into certain transactions with affiliates.
The Term Loan Facility contains customary events of default, including (subject to certain materiality thresholds and grace periods) payment default, material inaccuracy of representations or warranties, and bankruptcy or insolvency proceedings. If there is an event of default, the lenders may declare all or any portion of the outstanding indebtedness to be immediately due and payable, exercise any rights they might have under any of the Term Loan Facility documents, and require the Company to pay a default interest rate on overdue amounts equal to 2.0% in excess of the then applicable interest rate.
As of December 31, 2019, the Company was not in compliance with certain of the financial metrics described above. As a result, the Company must receive the consent of Berkshire Hathaway to dispose of assets via sale or joint venture and, as of December 31, 2019, Berkshire Hathaway had provided such consent for all such transactions submitted for approval. There can be no assurance that the lender will consent to future dispositions of assets. Additionally, Berkshire Hathaway has the right to request mortgages against the Company’s assets pursuant to the mortgage and collateral requirement. During the year ended December 31, 2019, Berkshire Hathaway requested mortgages on a majority of the Company’s portfolio which were recorded in accordance with the requirement (the “Lender Request”). There are no changes to the terms and conditions of the Term Loan Facility, or the Company’s ability to operate thereunder, as a result of providing mortgages against any of the Company’s assets pursuant to the mortgage and collateral
- 46 -
requirement. The Company accounted for the Lender Request transaction as a modification of debt as of December 31, 2019. Related to the modification, the Company incurred $5.0 million in mortgage recording costs which are classified as interest expenses on the consolidated statements of operations.
The Company believes it is in compliance with all other terms and conditions of the Term Loan Agreement.
The Company incurred $2.1 million of debt issuance costs related to the Term Loan Facility which are recorded as a direct deduction from the carrying amount of the Term Loan Facility and amortized over the term of the Term Loan Agreement. As of December 31, 2019, the unamortized balance of the Company’s debt issuance costs was $1.5 million.
Preferred Shares
As of December 31, 2019, we had 2,800,000 7.00% Series A Cumulative Redeemable Preferred Shares (the “Series A Preferred Shares”) outstanding. We may not redeem the Series A Preferred Shares before December 14, 2022, except to preserve our status as a REIT or upon the occurrence of a Change of Control, as defined in the trust agreement addendums designating the Series A Preferred Shares. On and after December 14, 2022, we may redeem any or all of the Series A Preferred Shares at $25.00 per share plus any accrued and unpaid dividends. In addition, upon the occurrence of a Change of Control, we may redeem any or all of the Series A Preferred Shares for cash within 120 days after the first date on which such Change of Control occurred at $25.00 per share plus any accrued and unpaid dividends.
Hedging Instruments
The Company’s use of derivative instruments is limited to the management of interest rate exposure and not for speculative purposes. In connection with the issuance of the Company’s original debt facility that funded part of the Transaction in July 2015, the Company purchased for $5.0 million an interest rate cap with a term of four years, a notional amount of $1,261 million and a strike rate of 3.5%. The interest rate cap was measured at fair value and included as a component of prepaid expenses, deferred expenses and other assets on the consolidated balance sheets. The Company had elected not to utilize hedge accounting and therefore the change in fair value was included within change in fair value of interest rate cap on the consolidated statements of operations.
During the year ended December 31, 2018, the Company terminated the interest rate cap concurrent with the repayment of the original debt facility.
For the year ended December 31, 2018 and December 31, 2017, the Company recorded a change in the fair value of the interest rate cap of ($23) thousand, and ($0.7) million, respectively.
Dividends and Distributions
The Company’s Board of Trustees declared the following common stock dividends during 2019 and 2018, with holders of OP Units entitled to an equal distribution per OP unit held on the record date:
The timing, amount, and composition of all dividends and distributions will be made by the Company at the discretion of its Board of Trustees. Such dividends and distributions will depend on the financial position, results of operations, cash flows, capital requirements, debt covenants, applicable law, and other factors as the Board of Trustees of Seritage deems relevant.
The Company declared a dividend on the Company’s Class A and Class C common shares for the first quarter of 2019 and has not declared dividends on the Company’s Class A and Class C common shares since that time, based on our Board of Trustees’ assessment of the Company’s investment opportunities and its expectations of taxable income for the remainder of 2020. The Company intends to, at a minimum, make distributions to shareholders to comply with the REIT requirements of the Code, which may be satisfied by dividends on the Company’s Series A Preferred Shares.
- 47 -
The Company’s Board of Trustees also declared the following dividends on Company’s Series A Preferred Shares during 2019 and 2018:
(1)
This dividend covers the period from, and including, December 14, 2017 to December 31, 2017.
Off-Balance Sheet Arrangements
The Company accounts for its investments in joint ventures that it does not have a controlling interest or is not the primary beneficiary using the equity method of accounting and those investments are reflected on the consolidated balance sheets of the Company as investments in unconsolidated joint ventures. As of December 31, 2019 and December 31, 2018, the Company did not have any off-balance sheet financing arrangements.
Contractual Obligations
Our contractual obligations relate to our Term Loan Facility and non-cancelable operating leases in the form of a ground lease at one of our properties, as well as operating leases for our corporate offices.
Information concerning our obligations and commitments to make future payments under contracts for these loan and lease agreements as of December 31, 2019 is aggregated in the following table (in thousands):
(1)
Includes expected interest payments.
Capital Expenditures
The majority of our capital expenditures, tenant improvement costs and leasing commissions are from our retenanting and redevelopment projects described under the caption “-Retenanting and Redevelopment Projects” below.
During the year ended December 31, 2019, we incurred maintenance capital expenditures of approximately $6.6 million that were not associated with retenanting and redevelopment projects.
During the year ended December 31, 2018, we incurred maintenance capital expenditures of approximately $2.2 million and tenant improvement costs of $0.1 million that were not associated with retenanting and redevelopment projects.
- 48 -
Cash Flows for the Year Ended December 31, 2019 Compared to December 31, 2018
The following table summarizes the Company’s cash flow activities for the years ended December 31, 2019 and 2018 (in thousands):
Cash Flows from Operating Activities
Significant changes in the components of net cash (used in) provided by operating activities include:
−
In 2019, a decrease in operating cash inflows due to net reductions in rental income under the Original Master Lease as a result of recapture and termination activity and an increase in unleased properties, partially offset by an increase in income from new, diversified tenants.
Cash Flows from Investing Activities
Significant components of net cash used in investing activities include:
−
In 2019, development of real estate and property improvements of ($387.7) million and investments in unconsolidated joint ventures of ($54.2) million, partially offset by $140.1 million of net proceeds from the sale of real estate; and
−
In 2018, development of real estate and property improvements of ($313.6) million and investments in unconsolidated joint ventures of ($16.0) million, partially offset by $210.1 million of net proceeds from the sale of real estate.
Cash Flows from Financing Activities
Significant components of net cash (used in) and provided by financing activities include:
−
In 2019, cash distributions to common stockholders and holders of OP Units, ($28.0) million;
−
In 2019, cash distributions to preferred shareholders, ($4.9) million;
−
In 2018, proceeds from the Term Loan Facility, $1,600.0 million;
−
In 2018, repayment of mortgage loans payables, ($1,210.6) million;
−
In 2018, repayment of the Unsecured Term Loan, ($145.0) million;
−
In 2018, cash distributions to common stockholders and holders of OP Units, ($55.8) million; and
−
In 2018, cash distributions to preferred shareholders, ($4.0) million;
Litigation and Other Matters
In accordance with accounting standards regarding loss contingencies, the Company accrues an undiscounted liability for those contingencies where the incurrence of a loss is probable and the amount can be reasonably estimated, and we disclose the amount accrued and the amount of a reasonably possible loss in excess of the amount accrued or disclose the fact that such a range of loss cannot be estimated. We do not record liabilities when the likelihood that the liability has been incurred is probable but the amount cannot be reasonably estimated, or when the liability is believed to be only reasonably possible or remote. In such cases, we disclose the nature of the contingency, and an estimate of the possible loss, range of loss, or disclose the fact that an estimate cannot be made.
During the Sears Holdings bankruptcy proceedings, the Official Committee of Unsecured Creditors of Sears Holdings (the “UCC”) and others, including the Restructuring Subcommittee of the Board of Directors of Sears Holdings, alleged that the 2015 Transactions between us and Sears Holdings constituted a fraudulent conveyance, and indicated an intent to pursue litigation challenging the 2015
- 49 -
Transactions on that and other grounds. The approval of the Holdco Acquisition by the Bankruptcy Court expressly preserved claims relating to the 2015 Transactions between us and Sears Holdings.
On April 18, 2019, at the direction of the Restructuring Sub-Committee of the Restructuring Committee of the Board of Directors of Sears Holdings Corporation, Sears Holdings, Sears, Roebuck & Co., Sears Development Co., Kmart Corporation, and Kmart of Washington, LLC filed a lawsuit (the “Litigation”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) against, among others, Edward S. Lampert, ESL Investments, Inc. and certain of its affiliates and investors, Fairholme Capital Management, L.L.C., certain members of the Sears Holdings board of directors, the Company, the Operating Partnership, and certain of our affiliates and subsidiaries (the Company, the Operating Partnership, and certain of our affiliates and subsidiaries collectively, the “Seritage Defendants”). The Litigation is dual captioned as In re: Sears Holdings Corporation, et al., Case No. 18-23538 (RDD) and Sears Holdings Corporation et al., v. Lampert et al., Case No. 19-08250 (RDD).
The Litigation alleges, among other things, that certain transactions undertaken by Sears Holdings since 2011 constituted actual and/or constructive fraudulent transfers and/or illegal dividends by Sears Holdings. The challenged transactions include the July 2015 transactions giving rise to Seritage, the execution of the Original Master Lease with Sears Holdings, and the acquisition of real estate from Sears Holdings. The Litigation alleges, among other things, that the real estate acquired by Seritage from Sears Holdings in July 2015 was worth at least $649 to $749 million more than the purchase price paid. The Litigation seeks as relief, among other things, declaratory relief, avoidance of the allegedly actual and/or constructive fraudulent transfers and either (i) rescission of the transfers of real estate from Sears Holdings to Seritage in 2015, return of the proceeds of the transactions between Sears Holdings and Seritage, or (ii) in the alternative, payment by Seritage to Sears Holdings of damages at least equal to the value of the transferred property.
On October 15, 2019, the Bankruptcy Court entered an order (the “Confirmation Order”) confirming the Modified Second Amended Joint Chapter 11 Plan of Sears Holdings and its affiliated debtors (the “Chapter 11 Plan”). Pursuant to the terms of the Confirmation Order, upon the effective date of the Chapter Plan, a liquidating trust will be formed, and the Litigation will vest in the liquidating trust. The Confirmation Order further provides that, prior to the effective date of the Chapter 11 Plan and the formation of the liquidating trust, the Litigation shall be controlled by five litigation designees selected by Sears Holdings and the Unsecured Creditors’ Committee (the “UCC”). For further information, refer to the Chapter 11 Plan, Confirmation Order and liquidating trust agreement, each of which has been publicly filed with the Bankruptcy Court.
On February 21, 2020, the Seritage defendants filed a partial motion to dismiss seeking dismissal of the claims in the Amended Complaint relating to the release received in the Sears Holdings derivative litigation, unjust enrichment, and equitable subordination. The Company believes that the claims against the Seritage Defendants in the Litigation are without merit and intends to defend against them vigorously.
The Company is subject, from time to time, to various legal proceedings and claims that arise in the ordinary course of business. While the resolution of such matters cannot be predicted with certainty, management believes, based on currently available information, the final outcome of such ordinary course legal proceedings and claims will not have a material effect on the consolidated financial position, results of operations or liquidity of the Company.
- 50 -
Retenanting and Redevelopment Projects
We are currently retenanting or redeveloping several properties primarily to convert single-tenant buildings occupied, or formerly occupied, by Sears or Kmart into multi-tenant properties occupied by a diversity of retailers and related concepts. The table below provides a brief description of each of the 91 new redevelopment projects originated on our platform as of December 31, 2019. Excluding five projects that have been sold, these projects represent an estimated total investment of $1,580-1,660 million ($1,440-1,520 million at share), of which an estimated $660-740 million ($580-660 million at share) remains to be spent.
- 51 -
- 52 -
We continue to evaluate a number of additional similar projects that are consistent with our primary objective to maximize the value of our properties by redeveloping space currently or formerly occupied by Sears and Kmart and re-leasing it to new, diversified tenants at higher rents. Investment returns are dependent on the success of the leasing and development plans in place for each project, as well as the successful completion of each project. Investment returns are subject to a number of variables, risks, and uncertainties including those disclosed within Item 1A of this Annual Report. We also refer you to our disclosure related to forward-looking statements.
- 53 -
Critical Accounting Policies
In preparing the consolidated financial statements, we have made estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Set forth below is a summary of the accounting policies that we believe are critical to the preparation of our consolidated financial statements. The summary should be read in conjunction with the more complete discussion of our accounting policies included in Note 2 to the audited consolidated financial statements in Part II, Item 8 of this Annual Report.
Real Estate Investments
Real estate assets are recorded at cost, less accumulated depreciation and amortization.
Expenditures for ordinary repairs and maintenance will be expensed as incurred. Significant renovations which improve the property or extend the useful life of the assets are capitalized. As real estate is undergoing redevelopment activities, all amounts directly associated with and attributable to the project, including planning, development and construction costs, interest costs, personnel costs of employees directly involved, and other miscellaneous costs incurred during the period of redevelopment, are capitalized. The capitalization period begins when redevelopment activities are underway and ends when the project is substantially complete.
Depreciation of real estate assets, excluding land, is recognized on a straight-line basis over their estimated useful lives as follows:
Buildings:
25 - 40 years
Site improvements:
5 - 15 years
Tenant improvements:
shorter of the estimated useful life or non-cancelable term of lease
The Company amortizes identified intangibles that have finite lives over the period they are expected to contribute directly or indirectly to the future cash flows of the property or business acquired, generally the remaining non-cancelable term of a related lease.
On a periodic basis, management assesses whether there are indicators that the value of the Company’s real estate assets (including any related intangible assets or liabilities) may be impaired. If an indicator is identified, a real estate asset is considered impaired only if management’s estimate of current and projected operating cash flows (undiscounted and unleveraged), taking into account the anticipated and probability weighted holding period, are less than a real estate asset’s carrying value. Various factors are considered in the estimation process, including expected future operating income, trends and prospects and the effects of demand, competition, and other economic factors. Changes in any estimates and/or assumptions, including the anticipated holding period, could have a material impact on the projected operating cash flows. If management determines that the carrying value of a real estate asset is impaired, a loss will be recorded for the excess of its carrying amount over its estimated fair value. No impairment losses on real estate assets were recognized for the years ended December 31, 2019, 2018 or 2017.
During the year ended December 31, 2019, the Company sold 21 properties and recognized gain on sale of real estate of $42.3 million. The Company also sold 13 outparcel properties and one condo unit and recorded gains totaling $20.6 million and exchanged a portion of one land parcel for two parcels of approximately equal size and recorded a gain of $6.9 million. The Company also contributed a portion of its property located in Austin, TX to a joint venture and its property located in Cockeysville, MD to a joint venture and recorded a gain of approximately $67 thousand and $3.8 million, respectively, which is included in gain on sale of real estate within the consolidated statements of operations.
During the year ended December 31, 2018, the Company sold 21 properties and recognized gain on sale of real estate of $96.2 million. During the year ended December 31, 2017, the Company sold a 50% interest in five properties and recognized gain on sale of real estate of $11.4 million.
Investments in Unconsolidated Joint Ventures
The Company accounts for its investments in unconsolidated joint ventures using the equity method of accounting as the Company exercises significant influence, but does not control these entities. These investments are initially recorded at cost and are subsequently adjusted for cash contributions, cash distributions, and earnings which are recognized in accordance with the terms of the applicable agreement.
To determine the method of accounting for partially owned joint ventures, we evaluate the characteristics of associated entities and determine whether an entity is a variable interest entity ("VIE") and, if so, determine which party is primary beneficiary by analyzing whether we have both the power to direct the entity's significant economic activities and the obligation to absorb potentially
- 54 -
significant losses or receive potentially significant benefits. We will consolidate a VIE if we have determined that we are the primary beneficiary.
On a periodic basis, management assesses whether there are indicators, including the operating performance of the underlying real estate and general market conditions, that the value of the Company’s investments in unconsolidated joint ventures may be impaired. An investment’s value is impaired only if management’s estimate of the fair value of the Company’s investment is less than its carrying value and such difference is deemed to be other-than-temporary. To the extent impairment has occurred, the loss is measured as the excess of the carrying amount of the investment over its estimated fair value. No such impairment losses were recognized for the years ended December 31, 2019, 2018 or 2017.
Revenue Recognition
Rental income is comprised of base rent and reimbursements of property operating expenses. Base rent is recognized on a straight-line basis over the non-cancelable terms of the related leases. For leases that have fixed and measurable base rent escalations, the difference between such rental income earned and the cash rent due under the provisions of the lease is recorded as deferred rent receivable and included as a component of tenant and other receivables on the consolidated balance sheets.
In leasing tenant space, the Company may provide funding to the lessee through a tenant allowance. In accounting for a tenant allowance, the Company will determine whether the allowance represents funding for the construction of leasehold improvements and evaluate the ownership of such improvements. If the Company is considered the owner of the improvements for accounting purposes, the Company will capitalize the amount of the tenant allowance and depreciate it over the shorter of the useful life of the improvements or the related lease term. If the tenant allowance represents a payment for a purpose other than funding leasehold improvements, or in the event the Company is not considered the owner of the improvements for accounting purposes, the allowance is considered to be a lease incentive and is recognized over the lease term as reduction of rental revenue on a straight-line basis.
The Company commences recognizing revenue based on an evaluation of several factors. Revenue recognition under a lease begins when the lessee takes control of the physical use of the leased asset.
Reimbursement of property operating expenses arises from tenant leases which provide for the recovery of all or a portion of the operating expenses and real estate taxes of the respective property. This revenue is accrued in the same periods as the expenses are incurred.
Accounting for Recapture and Termination Activity Pursuant to the Original Master Lease and Holdco Master Lease (see Note 5
Seritage Recapture Rights. The Company generally treats the delivery of a recapture notice as a modification of the lease as of the date of notice. Such a notice and lease modification result in the following accounting adjustments for the recaptured property:
−
The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that are subject to the lease modification are amortized over the remaining shortened life of the lease from the date of notice to the date of vacancy. The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that is attributable to the retained space, if any, is amortized over the remaining life of the lease.
−
The portion of intangible lease assets and liabilities that is deemed to be impacted by the lease modification is amortized over the shorter of the shortened lease term from the date of notice to the date of vacancy or the remaining useful life of the asset or liability. The portion of intangible lease assets and liabilities that is attributable to the retained space, if any, is amortized over the remaining useful life of the asset or liability.
A recapture will generally occur in conjunction with obtaining a new tenant or a real estate development project. As such, termination fees, if any, associated with the recapture notice are generally capitalized as either an initial direct cost of obtaining a new lease or a necessary cost of the real estate project and depreciated over the life of the new lease obtained or the real estate asset being constructed or improved.
Termination Rights. The Original Master Lease provided, and the Holdco Master Lease provides the tenant with certain rights to terminate their lease. Such terminations would generally result in the following accounting adjustments for the terminated property:
−
Accrued rental revenues related to the straight-line method of reporting rental revenue that are subject to the termination are amortized over the remaining shortened life of the lease from the date of notice to the date of vacancy.
−
Intangible lease assets and liabilities that are deemed to be impacted by the termination are amortized over the shorter of the shortened lease term from the date of notice to the date of vacancy or the remaining useful life of the asset or liability.
- 55 -
−
Termination fees required to be paid are recognized as follows:
•
For the portion of the termination fee attributable to the annual base rent of the subject property, termination income is recognized on a straight-line basis over the shortened life of the lease from the date the termination fee becomes legally binding to the date of vacancy.
•
For the portion of the termination fee attributable to estimated real estate taxes and property operating expenses for the subject property, prepaid rental income is recorded in the period such fee is received and recognized as tenant reimbursement revenue in the same periods as the expenses are incurred.
Recent Accounting Pronouncements
Refer to Note 2 of the consolidated financial statements for recently issued accounting pronouncements.
Non-GAAP Supplemental Financial Measures and Definitions
The Company makes reference to NOI, Total NOI, FFO and Company FFO which are financial measures that include adjustments to GAAP.
Net Operating Income ("NOI") and Total NOI
NOI is defined as income from property operations less property operating expenses. Other REITs may use different methodologies for calculating NOI, and accordingly, the Company's depiction of NOI may not be comparable to other REITs. The Company believes NOI provides useful information regarding Seritage, its financial condition, and results of operations because it reflects only those income and expense items that are incurred at the property level.
The Company also uses Total NOI, which includes its proportional share of unconsolidated properties. The Company believes this form of presentation offers insights into the financial performance and condition of the Company as a whole given our ownership of unconsolidated properties that are accounted for under GAAP using the equity method. The Company also considers Total NOI to be a helpful supplemental measure of its operating performance because it excludes from NOI variable items such as termination fee income, as well as non-cash items such as straight-line rent and amortization of lease intangibles.
Due to the adjustments noted, NOI and Total NOI should only be used as an alternative measure of the Company's financial performance.
Funds from Operations ("FFO") and Company FFO
FFO is calculated in accordance with National Association of REITs which defines FFO as net income computed in accordance with GAAP, excluding gains (or losses) from property sales, real estate related depreciation and amortization, and impairment charges on depreciable real estate assets. The Company considers FFO a helpful supplemental measure of the operating performance for equity REITs and a complement to GAAP measures because it is a recognized measure of performance by the real estate industry.
The Company makes certain adjustments to FFO, which it refers to as Company FFO, to account for certain non-cash and non-comparable items, such as termination fee income, unrealized loss on interest rate cap, litigation charges, acquisition-related expenses, amortization of deferred financing costs and certain up-front-hiring costs, that it does not believe are representative of ongoing operating results.
Due to the adjustments noted, FFO and Company FFO should only be used as an alternative measure of the Company's financial performance.
Reconciliation of Non-GAAP Financial Measures to GAAP Financial Measures
None of NOI, Total NOI, FFO and Company FFO are measures that (i) represent cash flow from operations as defined by GAAP; (ii) are indicative of cash available to fund all cash flow needs, including the ability to make distributions; (iii) are alternatives to cash flow as a measure of liquidity; or (iv) should be considered alternatives to net income (which is determined in accordance with GAAP) for purposes of evaluating the Company’s operating performance. Reconciliations of these measures to the respective GAAP measures we deem most comparable are presented below on a comparative basis for all periods.
- 56 -
The following table reconciles NOI and Total NOI to GAAP net loss for the years ended December 31, 2019, 2018 and 2017 (in thousands):
(1)
Includes adjustments for unconsolidated joint ventures.
- 57 -
The following table reconciles FFO and Company FFO to GAAP net loss the years ended December 31, 2019, 2018 and 2017 (in thousands):
- 58 -
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2019, we had $1.6 billion of consolidated debt, all of which is borrowed under our fixed-rate Term Loan Facility and therefore not subject to interest rate fluctuations.
As of December 31, 2019, the estimated fair value of our consolidated debt was $1.6 billion. The estimated fair value of our consolidated debt is calculated based on current market prices and discounted cash flows at the current rate at which similar loans would be made to borrowers with similar credit ratings for the remaining term of such debt.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Consolidated Financial Statements and Consolidated Financial Statement Schedule beginning on page for the required information.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) that are designed to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. Because of inherent limitations, disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of disclosure controls and procedures are met.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Our internal control over financial reporting is a process designed under the supervision of our principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and preparation of our financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
As of December 31, 2019, we conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework utilizing the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in "Internal Control-Integrated Framework (2013)." Based on this assessment, management believes that, as of December 31, 2019, the Company maintained effective internal controls over financial reporting. Deloitte & Touche LLP, the independent registered public accounting firm who audited our consolidated financial statements contained in this Form 10-K, has issued a report on our internal control over financial reporting, which is included herein.
Changes in Internal Controls over Financial Reporting
There were no changes in internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
- 59 -
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information required by Item 10 is hereby incorporated by reference to our definitive proxy statement with respect to our 2020 Annual Meeting of Shareholders, to be filed with the SEC within 120 days following the end of our fiscal year.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by Item 11 is hereby incorporated by reference to our definitive proxy statement with respect to our 2020 Annual Meeting of Shareholders, to be filed with the SEC within 120 days following the end of our fiscal year.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 is hereby incorporated by reference to our definitive proxy statement with respect to our 2020 Annual Meeting of Shareholders, to be filed with the SEC within 120 days following the end of our fiscal year.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 is hereby incorporated by reference to our definitive proxy statement with respect to our 2020 Annual Meeting of Shareholders, to be filed with the SEC within 120 days following the end of our fiscal year.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 is hereby incorporated by reference to our definitive proxy statement with respect to our 2020 Annual Meeting of Shareholders, to be filed with the SEC within 120 days following the end of our fiscal year.
- 60 -
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
(a)
Consolidated Financial Statements and Consolidated Financial Statement Schedule.
The consolidated financial statements and consolidated financial statement schedule listed in the accompanying Index to Consolidated Financial Statements and Consolidated Financial Statement Schedule are filed as part of this Annual Report.
(b)
Exhibits.
Exhibit No.
Description
SEC Document Reference
2.1
Subscription, Distribution and Purchase and Sale Agreement, dated as of June 8, 2015, by and between Seritage Growth Properties and Sears Holdings Corporation
Incorporated by reference to Exhibit 2.1 to our Registration Statement on Form S-11, filed on June 9, 2015.
3.1
Articles of Amendment and Restatement
Incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K, filed on July 10, 2015.
3.2
Articles Supplementary Establishing and Fixing the Rights and Preferences of 7.00% Series A Cumulative Redeemable Preferred Shares of Beneficial Interest, par value $0.01 per share
Incorporated by reference to Exhibit 3.1 to our Registration Statement on Form 8-A, filed on December 14, 2017.
3.3
Amended and Restated Bylaws
Incorporated by reference to Exhibit 3.2 to our Quarterly Report on Form 10-Q, filed on May 3, 2019.
4.1
Registration Rights Agreement by and among Seritage Growth Properties, ESL Investments, Inc., and Seritage Growth Properties, L.P., dated as of July 7, 2015
Incorporated by reference to Exhibit 4.1 to our Current Report on Form 8-K, filed on July 10, 2015.
4.2
Form of specimen certificate evidencing the 7.00% Series A Cumulative Redeemable Preferred Shares of Beneficial Interest, par value $0.01 per share
Incorporated by reference to Exhibit 4.1 to our Registration Statement on Form 8-A, filed on December 14, 2017.
4.3
Description of Capital Stock of Seritage Growth Properties Registered Pursuant to Section 12 of the Securities Exchange Act of 1934
Filed herewith
10.1
Transition Services Agreement by and between Sears Holdings Management Corporation and Seritage Growth Properties, L.P., dated as of July 7, 2015
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed on July 10, 2015.
10.2
Amended and Restated Agreement of Limited Partnership of Seritage Growth Properties, L.P., dated as of December 14, 2017
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed on December 14, 2017.
10.3
Holdco Master Lease by and among Seritage SRC Finance LLC, Seritage KMT Finance LLC, Transform SR Operations LLC and Transform KM Operations LLC, dated as of February 28, 2019
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed on March 15, 2019.
10.4
Side Letter to Holdco Master Lease, by and among Seritage KMT Finance LLC, Seritage SRC Finance LLC, Transform SR Operations LLC and Transform KM Operations LLC, dated as of February 28, 2019
Incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K, filed on March 15, 2019.
10.5
Mortgage Loan Agreement by and among Seritage SRC Finance LLC, Seritage KMT Finance LLC, certain other subsidiaries of Operating Partnership, JPMorgan Chase Bank, National Association and H/2 SO III Funding LLC, dated as of July 7, 2015
Incorporated by reference to Exhibit 10.4 to our Current Report on Form 8-K, filed on July 10, 2015.
- 61 -
Exhibit No.
Description
SEC Document Reference
10.6
Omnibus Amendment to the Mortgage Loan Agreement, dated as of September 28, 2015, by and among Seritage SRC Finance LLC, Seritage KMT Finance LLC, certain other subsidiaries of Operating Partnership, Seritage Growth Properties, Seritage Growth Properties L.P., JPMorgan Chase Bank, National Association and H/2 SO III Funding LLC
Incorporated by reference to Exhibit 10.6 to our Annual Report on Form 10-K, filed on March 1, 2017.
10.7
Second Amendment to Mortgage Loan Agreement, dated as of November 8, 2016, by and among Seritage SRC Finance LLC, Seritage KMT Finance LLC, certain other subsidiaries of Operating Partnership, Seritage Growth Properties, Seritage Growth Properties L.P. and Wells Fargo Bank, National Association
Incorporated by reference to Exhibit 10.7 to our Annual Report on Form 10-K, filed on March 1, 2017.
10.8
Mezzanine Loan Agreement by and among Seritage SRC Mezzanine Finance LLC, Seritage KMT Mezzanine Finance LLC, JPMorgan Chase Bank, National Association and H/2 Special Opportunities III Corp., dated as of July 7, 2015
Incorporated by reference to Exhibit 10.5 to our Current Report on Form 8-K, filed on July 10, 2015.
10.9
Omnibus Amendment to Mezzanine Loan Agreement, dated as of September 28, 2015, by and among Seritage SRC Mezzanine Finance LLC, Seritage KMT Mezzanine Finance LLC, Seritage Growth Properties, Seritage Growth Properties L.P., JPMorgan Chase Bank, National Association and H/2 Special Opportunities III Corp.
Incorporated by reference to Exhibit 10.9 to our Annual Report on Form 10-K, filed on March 1, 2017.
10.10
Second Amendment to Mezzanine Loan Agreement, dated as of November 8, 2016, by and among Seritage SRC Mezzanine Finance LLC, Seritage KMT Mezzanine Finance LLC, Seritage Growth Properties, Seritage Growth Properties, L.P. and Wells Fargo Bank, National Association
Incorporated by reference to Exhibit 10.10 to our Annual Report on Form 10-K, filed on March 1, 2017.
10.11
Third Amendment to Mezzanine Loan Agreement, entered into as of November 8, 2017 and effective as of June 30, 2017, by and among Seritage SRC Mezzanine Finance LLC, Seritage KMT Mezzanine Finance LLC, Seritage Growth Properties, Seritage Growth Properties, L.P. and Wells Fargo Bank, National Association
Incorporated by reference to Exhibit 10.11 to our Annual Report on Form 10-K, filed on February 28, 2018.
10.12
Term Loan Facility by and among Seritage Growth Properties, L.P., Seritage Growth Properties, JPP, LLC and JPP II, LLC, dated as of February 23, 2017
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed on February 24, 2017.
10.13
Senior Unsecured Term Loan Agreement, dated as of December 27, 2017, among Seritage Growth Properties, L.P., Seritage Growth Properties, JPP, LLC, JPP II, LLC and Empyrean Investments, LLC, as lenders, and JPP, LLC, as administrative agent.
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed on December 28, 2017.
10.14
Form of Seritage Growth Properties 2015 Share Plan
Incorporated by reference to Exhibit 10.6 to our Registration Statement on Form S-11, filed on May 11, 2015.
10.15
Seritage Growth Properties Restricted Share Agreement
Incorporated by reference to Exhibit 10.6 to our Current Report on Form 8-K, filed on July 10, 2015.
10.16
Form of Seritage Growth Properties Restricted Share Agreement
Incorporated by reference to Exhibit 10.14 to our Annual Report on Form 10-K, filed on March 1, 2017.
10.17
Form of Seritage Growth Properties Sign-On P-RSU Restricted Share Agreement
Incorporated by reference to Exhibit 10.7 to our Current Report on Form 8-K, filed on July 10, 2015.
- 62 -
Exhibit No.
Description
SEC Document Reference
10.18
Form of Seritage Growth Properties Time-Vesting Restricted Share Unit Agreement
Incorporated by reference to Exhibit 10.8 to our Current Report on Form 8-K, filed on July 10, 2015.
10.19
Form of Seritage Growth Properties Annual P-RSU Restricted Share Agreement
Incorporated by reference to Exhibit 10.9 to our Current Report on Form 8-K, filed on July 10, 2015.
10.20
Employment Agreement with Brian Dickman, dated as of July 6, 2015.
Incorporated by reference to Exhibit 10.10 to our Current Report on Form 8-K, filed on July 10, 2015.
10.21
Employment Agreement with Mary Rottler, dated as of June 2, 2015
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed on June 19, 2015.
10.22
Employment Agreement, dated April 17, 2015, between Benjamin Schall and Seritage Growth Properties
Incorporated by reference to Exhibit 10.8 to our Registration Statement on Form S-11, filed on May 26, 2015.
10.23
Letter Agreement, dated April 30, 2015, among Seritage Growth Properties, Seritage Growth Properties, L.P. and Benjamin Schall
Incorporated by reference to Exhibit 10.9 to our Registration Statement on Form S-11, filed on May 26, 2015.
10.24
Letter Agreement, dated May 15, 2015, between Matthew Fernand and Seritage Growth Properties
Incorporated by reference to Exhibit 10.10 to our Registration Statement on Form S-11, filed on May 26, 2015.
10.25
Letter Agreement, dated May 13, 2015, between James Bry and Seritage Growth Properties
Incorporated by reference to Exhibit 10.11 to our Registration Statement on Form S-11, filed on May 26, 2015.
10.26
Exchange Agreement by and among Seritage Growth Properties, Seritage Growth Properties, L.P., ESL Partners, L.P., and Edward S. Lampert, dated as of June 26, 2015
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed on July 2, 2015.
10.27
Exchange Agreement by and among Seritage Growth Properties and Fairholme Capital Management, L.L.C., dated as of June 30, 2015
Incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K, filed on July 2, 2015.
10.28
Senior Secured Term Loan Agreement, dated July 31, 2018, among Seritage Growth Properties, Seritage Growth Properties, L.P. and Berkshire Hathaway Life Insurance Company of Nebraska
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed on July 31, 2018.
10.29
Employment Agreement, dated May 2, 2018, among Seritage Growth Properties, Seritage Growth Properties, L.P. and Benjamin Schall
Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on May 7, 2018.
10.30
Employment Agreement, dated May 16, 2018, among Seritage Growth Properties, Seritage Growth Properties, L.P. and Kenneth Lombard
Incorporated by reference to Exhibit 10.3 to our Quarterly Report on Form 10-Q, filed on August 3, 2018.
10.31
Form of Seritage Growth Properties Time-Vesting Restricted Share Unit Agreement - 2018 Incentive RSUs
Incorporated by reference to Exhibit 10.4 to our Quarterly Report on Form 10-Q, filed on August 3, 2018.
10.32
Form of Seritage Growth Properties Performance-Vesting Restricted Share Unit Agreement - 2018 Incentive P-RSUs
Incorporated by reference to Exhibit 10.5 to our Quarterly Report on Form 10-Q, filed on August 3, 2018.
10.33
First Amendment to the Master Lease, effective as of October 29, 2019, by and among Seritage SRC Finance LLC and Seritage KMT Finance LLC
Filed herewith.
21.1
List of subsidiaries
Filed herewith.
23.1
Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm
Filed herewith.
- 63 -
Exhibit No.
Description
SEC Document Reference
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Filed herewith.
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Filed herewith.
32.1
Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
Furnished herewith.
32.2
Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
Furnished herewith.
101.INS
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Filed herewith.
101.SCH
Inline XBRL Taxonomy Extension Schema Document
Filed herewith.
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
Filed herewith.
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
Filed herewith.
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
Filed herewith.
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
Filed herewith.
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
Filed herewith.
*
Portions of this exhibit have been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.
- 64 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SERITAGE GROWTH PROPERTIES
Dated: March 2, 2020
/s/ Benjamin W. Schall
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Edward S. Lampert
Chairman of the Board of Trustees
March 2, 2020
Edward S. Lampert
/s/ Benjamin W. Schall
President, Chief Executive Officer and Trustee
(Principal Executive Officer)
March 2, 2020
Benjamin W. Schall
/s/ Brian R. Dickman
Executive Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)
March 2, 2020
Brian R. Dickman
/s/ David S. Fawer
Trustee
March 2, 2020
David S. Fawer
/s/ John T. McClain
Trustee
March 2, 2020
John T. McClain
/s/ Sharon Osberg
Trustee
March 2, 2020
Sharon Osberg
/s/ Thomas M. Steinberg
Trustee
March 2, 2020
Thomas M. Steinberg
/s/ Allison Thrush
Trustee
March 2, 2020
Allison Thrush
- 65 -
SERITAGE GROWTH PROPERTIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
Financial Statements
Page
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2019 and 2018
Consolidated Statements of Operations for the years ended December 31, 2019, 2018 and 2017
Consolidated Statements of Equity for the years ended December 31, 2019, 2018 and 2017
Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018 and 2017
Notes to Consolidated Financial Statements
Financial Statement Schedule
Schedule III-Real estate and accumulated depreciation
All other schedules are omitted since the required information is either not present in any amounts, is not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements and related notes.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholders of
Seritage Growth Properties
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Seritage Growth Properties and subsidiaries (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of operations, equity, and cash flows, for each of the three years in the period ended December 31, 2019, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the US federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Liquidity - Refer to Note 1 to the financial statements
Critical Audit Matter Description
The Company’s primary uses of cash include the payment of property operating and other expenses, including general and administrative expenses and debt service (collectively, “obligations”), and the reinvestment in and redevelopment of its properties (“development expenditures”). As a result of a decrease in occupancy levels due to the Company’s recapture of space for redevelopment purposes and the execution of certain termination rights by Sears Holdings Corporation under a master lease agreement, property rental income, which is the Company’s primary source of operating cash flow, did not fully fund obligations incurred during the year ended December 31, 2019. Obligations are projected to continue to exceed property rental income until such time as additional tenants commence paying rent, and the Company plans to incur additional development expenditures as it continues to invest in the redevelopment of its portfolio.
The Company plans to fund its obligations and development expenditures with a combination of capital sources including, but not limited to, sales of wholly owned properties, sales of interests in joint venture properties (which may include the exercise of certain rights that allow the Company to sell its interests in select joint venture properties to its partners at fair market value) and potential credit and capital markets transactions.
We identified the Company’s liquidity disclosure as a critical audit matter because of the significant judgments in management’s plans to fund its obligations and development expenditures. This required a high degree of auditor judgment and an increased extent of effort when performing audit procedures to evaluate management’s conclusion that it is probable the Company’s plans will be effectively implemented within one year after the date the financial statements are issued and will provide the necessary cash flows to fund the Company’s obligations and development expenditures.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the Company’s liquidity disclosure included the following, among others:
•
We tested the effectiveness of the controls over management’s plans and related disclosures.
•
We tested management’s key assumptions, including projected rental income and property operating costs by comparing such assumptions to underlying lease agreements and historical operating costs.
•
We evaluated management’s estimates relating to redevelopment costs by comparing to underlying development plans and costs spent to date.
•
We evaluated the timing and likelihood of potential sales of wholly owned properties and exercise of put rights within select joint ventures by comparing expected proceeds to comparable market information and historical transactions effectuated by the Company, as well as evaluating the terms and conditions present in joint venture agreements, as applicable.
•
We engaged in discussions with management, including the Chief Executive Officer and Chief Financial Officer regarding management’s intent and ability to generate the planned sources of capital.
•
We evaluated management’s plans in the context of other audit evidence obtained during the audit to determine whether it supported or contradicted the conclusion reached by management.
Real Estate Investments - Holding period - Refer to Note 2 to the financial statements
Critical Audit Matter Description
The Company’s investments in real estate assets are evaluated for impairment periodically or when events or changes in circumstances indicate that the carrying amount of a real estate asset may not be recoverable. The Company uses significant judgment in assessing events or circumstances which might indicate impairment, including but not limited to, changes in management’s intent to hold the asset over a specified period of time. Changes in the Company’s intent to hold a property have a significant impact on the undiscounted cash flows expected to result from the use and eventual disposition of the asset and whether a potential impairment loss shall be measured.
The Company’s use of judgement in the determination the hold period for real estate assets as part of their recoverability assessment is subjective and requires judgment. Because of this, auditing these judgements required a high degree of auditor judgment and extensive auditor effort, especially given the inherent unpredictability involved in the timing of sales of real estate.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the hold period utilized by management in their assessment of real estate assets for recoverability include the following, among others:
•
We tested the effectiveness of the controls over management’s identification of possible circumstances that could indicate the carrying amounts of real estate assets may not be recoverable, including controls over management’s review of significant estimates, specifically, the determination or changes in the Company’s intent to hold a property.
•
We evaluated the reasonableness of management’s assertions regarding its intended period over which to hold its real estate assets by performing the following:
o
Engaged in discussions with management, including the Chief Executive Officer and Chief Financial Officer to evaluate the Company’s plans to develop an asset or dispose of an asset before the end of its estimated useful life.
o
Inspected Board of Directors meeting minutes to identify whether assets have been identified for potential sale.
o
Compared management’s assertions regarding its intent to hold an asset with internal strategic and operating plans.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 2, 2020
We have served as the Company's auditor since 2015.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholders of
Seritage Growth Properties
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Seritage Growth Properties and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2019, of the Company and our report dated March 2, 2020, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 2, 2020
SERITAGE GROWTH PROPERTIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
SERITAGE GROWTH PROPERTIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
SERITAGE GROWTH PROPERTIES
CONSOLIDATED STATEMENT OF EQUITY
(Amounts in thousands)
SERITAGE GROWTH PROPERTIES
CONSOLIDATED STATEMENT OF EQUITY (Continued)
(Amounts in thousands)
SERITAGE GROWTH PROPERTIES
CONSOLIDATED STATEMENT OF EQUITY (Continued)
(Amounts in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
SERITAGE GROWTH PROPERTIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Amounts in thousands)
SERITAGE GROWTH PROPERTIES
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
(Amounts in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
SERITAGE GROWTH PROPERTIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization
Seritage Growth Properties (“Seritage”) (NYSE: SRG), a Maryland real estate investment trust formed on June 3, 2015, is a fully integrated, self-administered and self-managed real estate investment trust (“REIT”) as defined under Section 856(c) of the Internal Revenue Code (the “Code”). Seritage’s assets are held by and its operations are primarily conducted, directly or indirectly, through Seritage Growth Properties, L.P., a Delaware limited partnership (the “Operating Partnership”). Under the partnership agreement of the Operating Partnership, Seritage, as the sole general partner, has exclusive responsibility and discretion in the management and control of the Operating Partnership. Unless otherwise expressly stated or the context otherwise requires, the “Company” and “Seritage” refer to Seritage, the Operating Partnership and its owned and controlled subsidiaries.
Seritage is principally engaged in the acquisition, ownership, development, redevelopment, management and leasing of diversified retail and mixed-use properties throughout the United States. As of December 31, 2019, the Company’s portfolio consisted of interests in 212 properties totaling approximately 33.4 million square feet of GLA, including 184 Wholly Owned Properties totaling approximately 28.7 million square feet of GLA across 44 states and Puerto Rico, and interests in 28 JV Properties totaling approximately 4.7 million square feet of GLA across 14 states.
The Company’s mission is to create and own revitalized shopping, dining, entertainment and mixed-use destinations that provide enriched experiences for consumers and local communities, and create long-term value for our shareholders.
Background
On June 11, 2015, Sears Holdings Corporation (“Sears Holdings” or “Sears”) effected a rights offering (the “Rights Offering”) to Sears Holdings stockholders to purchase common shares of Seritage in order to fund, in part, the $2.7 billion acquisition of (i) 234 of Sears Holdings’ owned properties and one of its ground leased properties, and (ii) its 50% interests in three joint ventures that collectively owned 28 properties, ground leased one property and leased two properties (the “Transaction”). The Rights Offering ended on July 2, 2015, and the Company’s Class A common shares were listed on the New York Stock Exchange (“NYSE”) on July 6, 2015. On July 7, 2015, the Company completed the Transaction with Sears Holdings and commenced operations. The Company did not have any operations prior to the completion of the Rights Offering and Transaction.
On October 15, 2018, Sears Holdings and certain of its affiliates filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code with the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). On February 28, 2019, the Company and certain affiliates of Transform Holdco LLC (“Holdco”), an affiliate of ESL Investments, Inc., executed a master lease with respect to 51 Wholly Owned Properties (the “Holdco Master Lease”), which became effective on March 12, 2019, when the Bankruptcy Court issued an order approving the rejection of the original master lease between the Company and affiliates of Sears Holdings (the “Original Master Lease”).
As of December 31, 2019, the Company leased space at 48 Wholly Owned Properties to Holdco under the Holdco Master Lease and also leased space to Holdco at three JV Properties. As of December 31, 2019, three Wholly Owned Properties were subject to 100% recapture notices pursuant to the terms of the Holdco Master Lease, and 28 Wholly Owned Properties and one JV Property were subject to termination notices pursuant to the terms of the Holdco Master Lease and the lease with Holdco at the JV Property, respectively. In November 2019, Holdco exercised its rights under the Holdco Master Lease to terminate the Holdco Master Lease, effective March 2020, with respect to 29 stores. Giving effect to this recapture and termination activity, the Company leased space at 17 Wholly Owned Properties to Holdco under the Holdco Master Lease and also leased space to Holdco at two JV Properties.
Edward S. Lampert is the Chairman and Chief Executive Officer of ESL Investments, Inc, which owns Holdco. Mr. Lampert is also the Chairman of Seritage and controls each of the tenant entities that is a party to the Holdco Master Lease.
Liquidity
The Company’s primary uses of cash include the payment of property operating and other expenses, including general and administrative expenses and debt service (collectively, “obligations”), and the reinvestment in and redevelopment of its properties (“development expenditures”). As a result of a decrease in occupancy levels due to the Company’s recapture of space for redevelopment purposes and the execution of certain termination rights by Sears Holdings under the Original Master Lease, property rental income, which is the Company’s primary source of operating cash flow, did not fully fund obligations incurred during the year ended December 31, 2019 and the Company had operating cash outflows of $57.7 million. Additionally, the Company’s development expenditures during the year ended December 31, 2019 drove investing cash outflows of $299.5 million.
Obligations are projected to continue to exceed property rental income until such time as additional tenants commence paying rent, and the Company plans to incur additional development expenditures as it continues to invest in the redevelopment of its portfolio. While the Company does not currently have the liquid funds available to satisfy the obligations and development expenditures, the Company expects to fund the obligations and development expenditures with a combination of capital sources including, but not limited to, sales of Wholly Owned Properties, sales of interests in JV Properties (which may include the exercise of certain rights that allow the Company to sell its interests in select JV Properties to its partners at fair market value) and potential credit and capital markets transactions, subject to any approvals that may be required under the Term Loan Agreement, as described in Note 6, Debt. Management has determined that it is probable its plans will be effectively implemented within one year after the date the financial statements are issued and that these actions will provide the necessary cash flows to fund the Company’s obligations and development expenditures.
Note 2 - Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The consolidated financial statements include the accounts of the Company, the Operating Partnership, each of their wholly-owned subsidiaries, and all other entities in which they have a controlling financial interest or entities that meet the definition of a variable interest entity (“VIE”) in which the Company has, as a result of ownership, contractual interests or other financial interests, both the power to direct activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. All intercompany accounts and transactions have been eliminated.
If the Company has an interest in a VIE but it is not determined to be the primary beneficiary, the Company accounts for its interest under the equity method of accounting. Similarly, for those entities which are not VIEs and over which the Company has the ability to exercise significant influence, but does not have a controlling financial interest, the Company accounts for its interests under the equity method of accounting. The Company continually reconsiders its determination of whether an entity is a VIE and whether the Company qualifies as its primary beneficiary. As of December 31, 2019 and December 31, 2018, the Company has several unconsolidated VIEs in the form of joint ventures (see Note 4). The Company does not consolidate these entities because the Company is not the primary beneficiary and the nature of its involvement in the activities of these entities does not give the Company power over decisions that significantly affect these entities’ economic performance.
As of December 31, 2019, the Company holds a 66.1% interest in the Operating Partnership and is the sole general partner which gives the Company exclusive and complete responsibility for the day-to-day management, authority to make decisions, and control of the Operating Partnership. The Company has determined that the Operating Partnership is a VIE as the limited partners in the Operating Partnership, although entitled to vote on certain matters, do not possess kick-out rights or substantive participating rights. Accordingly, the Company consolidates its interest in the Operating Partnership. The assets and liabilities of the Operating Partnership are the same as those of the Company and are presented in the consolidated balance sheet.
To the extent such variable interests are in entities that are not evaluated under the VIE model, the Company evaluates its interests using the voting interest entity model.
Reclassification
Upon adoption on January 1, 2019 of the new lease standard in accordance with ASC 842, tenant reimbursements for 2018 and 2017 have been reclassified to rental income in the consolidated statements of operations to conform to the 2019 financial statement presentation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant assumptions and estimates relate to the useful lives of tangible and intangible assets, real estate impairment assessments, and assessing the recoverability of accounts receivable. These estimates are based on historical experience and other assumptions which management believes are reasonable under the circumstances. Management evaluates its estimates on an ongoing basis and makes revisions to these estimates and related disclosures as experience develops or new information becomes known. Actual results could differ from these estimates.
Segment Reporting
The Company currently operates in a single reportable segment which includes the acquisition, ownership, development, redevelopment, management, and leasing of real estate properties. The Company’s chief operating decision maker, its Chief Executive Officer, assesses and measures the operating and financial results for each property on an individual basis and does not distinguish or group properties based on geography, size, or type. The Company, therefore, aggregates all properties into one reportable segment due to their similarities with regard to the nature and economics of the properties, tenants, and operational process.
Real Estate Investments
Real estate assets are recorded at cost, less accumulated depreciation and amortization.
Expenditures for ordinary repairs and maintenance will be expensed as incurred. Significant renovations which improve the property or extend the useful life of the assets are capitalized. As real estate is undergoing redevelopment activities, all amounts directly associated with and attributable to the project, including planning, development and construction costs, interest costs, personnel costs of employees directly involved, and other miscellaneous costs incurred during the period of redevelopment, are capitalized. The capitalization period begins when redevelopment activities are underway and ends when the project is substantially complete.
Depreciation of real estate assets, excluding land, is recognized on a straight-line basis over their estimated useful lives as follows:
Buildings:
25 - 40 years
Site improvements:
5 - 15 years
Tenant improvements:
shorter of the estimated useful life or non-cancelable term of lease
The Company amortizes identified intangibles that have finite lives over the period they are expected to contribute directly or indirectly to the future cash flows of the property or business acquired, generally the remaining non-cancelable term of a related lease.
On a periodic basis, management assesses whether there are indicators that the value of the Company’s real estate assets (including any related intangible assets or liabilities) may be impaired. If an indicator is identified, a real estate asset is considered impaired only if management’s estimate of current and projected operating cash flows (undiscounted and unleveraged), taking into account the anticipated and probability weighted holding period, are less than a real estate asset’s carrying value. Various factors are considered in the estimation process, including expected future operating income, trends and prospects and the effects of demand, competition, and other economic factors. Changes in any estimates and/or assumptions, including the anticipated holding period, could have a material impact on the projected operating cash flows. If management determines that the carrying value of a real estate asset is impaired, a loss will be recorded for the excess of its carrying amount over its estimated fair value. No impairment losses were recognized for the years ended December 31, 2019, 2018 or 2017.
Real Estate Dispositions
The following table summarizes our gain on sale of real estate, net during the years ended December 31, 2019, 2018, and 2017 (in thousands):
For the year ended December 31, 2019, gain on sales on the consolidated statements of operations also includes a gain of $6.9 million related to an exchange of land parcels of approximately equal size with an adjacent land owner and a loss of $2.3 million related to the West Hartford JV revaluation as discussed in Note 4.
Real Estate Held for Sale
When a real estate asset is identified by management as held for sale, the Company ceases depreciation of the asset and estimates its fair value, net of estimated costs to sell. If the estimated fair value, net of estimated costs to sell, of an asset is less than its net carrying value, an adjustment is recorded to reflect the estimated fair value. Properties classified as real estate held for sale generally represent properties that are under contract for sale and are expected to close within a year.
In evaluating whether a property meets the held for sale criteria, the Company makes a determination as to the point in time that it is probable that a sale will be consummated. Given the nature of all real estate sales contracts, it is not unusual for such contracts to allow potential buyers a period of time to evaluate the property prior to formal acceptance of the contract. In addition, certain other matters critical to the final sale, such as financing arrangements, often remain pending even upon contract acceptance. As a result, properties under contract may not close within the expected time period or at all.
As of December 31, 2019, two properties were classified as held for sale with assets of $5.3 million and no liabilities, and as of December 31, 2018, one property was classified as held for sale with assets of $3.1 million and no liabilities.
Investments in Unconsolidated Joint Ventures
The Company accounts for its investments in unconsolidated joint ventures using the equity method of accounting as the Company exercises significant influence, but does not control these entities. These investments are initially recorded at cost and are subsequently adjusted for cash contributions, cash distributions, and earnings which are recognized in accordance with the terms of the applicable agreement.
On a periodic basis, management assesses whether there are indicators, including the operating performance of the underlying real estate and general market conditions, that the value of the Company’s investments in unconsolidated joint ventures may be impaired. An investment’s value is impaired only if management’s estimate of the fair value of the Company’s investment is less than its carrying value and such difference is deemed to be other-than-temporary. To the extent impairment has occurred, the loss is measured as the excess of the carrying amount of the investment over its estimated fair value. No such impairment losses were recognized for the years ended December 31, 2019, 2018 or 2017.
Cash and Cash Equivalents
The Company considers instruments with an original maturity of three months or less to be cash and cash equivalents. Cash and cash equivalent balances may, at a limited number of banks and financial institutions, exceed insurable amounts. The Company believes it mitigates this risk by investing in or through major financial institutions and primarily in funds that are insured by the United States federal government.
Restricted Cash
Restricted cash represents cash deposited in escrow accounts which generally can only be used for the payment of real estate taxes, debt service, insurance, and future capital expenditures as required by certain loan and lease agreements, as well as legally restricted tenant security deposits.
As of December 31, 2019 and December 31, 2018, the Company did not have any restricted cash. Restricted cash accounts were closed in conjunction with the full repayment of the Mortgage Loans and the Future Funding Facility on July 31, 2018.
Tenant and Other Receivables
Accounts receivable includes unpaid amounts billed to tenants, accrued revenues for future billings to tenants for property expenses, and amounts arising from the straight-lining of rent. The Company periodically reviews its receivables for collectability, taking into consideration changes in factors such as the tenant’s payment history, the financial condition of the tenant, business conditions in the industry in which the tenant operates, and economic conditions in the area where the property is located. For accrued rental income related to the straight-line method of reporting rental income, the Company performs a periodic review of receivable balances to assess the risk of uncollectible amounts and establish appropriate provisions. Any receivables that are deemed to be uncollectible are recognized as a reduction to rental income in the Company’s consolidated statements of operations. Prior period provision for doubtful accounts is presented on the Company's consolidated statements of operations in accordance with the Company's previous presentation and has not been reclassified to rental income.
Tenant and other receivables also include management fees receivable for services performed for the benefit of certain unconsolidated joint ventures. In the event that the collectability of a management fee receivable is in doubt, a provision for uncollectible amounts will be established or a direct write-off of the specific receivable will be made.
Revenue Recognition
Rental income is comprised of base rent and reimbursements of property operating expenses. Base rent is recognized on a straight-line basis over the non-cancelable terms of the related leases. For leases that have fixed and measurable base rent escalations, the difference between such rental income earned and the cash rent due under the provisions of the lease is recorded as deferred rent receivable and included as a component of tenant and other receivables on the consolidated balance sheets.
In leasing tenant space, the Company may provide funding to the lessee through a tenant allowance. In accounting for a tenant allowance, the Company will determine whether the allowance represents funding for the construction of leasehold improvements and evaluate the ownership of such improvements. If the Company is considered the owner of the improvements for accounting purposes, the Company will capitalize the amount of the tenant allowance and depreciate it over the shorter of the useful life of the improvements or the related lease term. If the tenant allowance represents a payment for a purpose other than funding leasehold improvements, or in the event the Company is not considered the owner of the improvements for accounting purposes, the allowance is considered a lease incentive and is recognized over the lease term as a reduction of rental revenue on a straight-line basis.
The Company commences recognizing revenue based on an evaluation of several factors. Revenue recognition under a lease begins when the lessee takes control of the physical use of the leased asset.
Reimbursement of property operating expenses arises from tenant leases which provide for the recovery of all or a portion of the operating expenses and real estate taxes of the respective property. This revenue is accrued in the same periods as the expenses are incurred.
Management and Other Fee Income
Management and other fee income represents property management, construction, leasing and development fees for services performed for the benefit of certain unconsolidated joint ventures. Property management fee income is reported at 100% of the revenue earned from such joint ventures in management and other fee income on the consolidated statements of operations. The Company’s share of management expenses incurred by the unconsolidated joint ventures is reported in equity in income (loss) of unconsolidated joint ventures on the consolidated statements of operations and in other expenses in the combined financial data in Note 4. Leasing and development fees are initially reported at the portion of fees attributable to outside ownership of the related unconsolidated joint ventures. The Company’s share in management fee income is recognized over the useful life of the associated development project, in the case of development fees, or lease term, in the case of leasing fees, as the associated asset is depreciated over the same term and included in equity in income (loss) of unconsolidated joint ventures on the consolidated statements of operations and in other expenses in the combined financial data in Note 4.
Management determined that property and asset management and construction and development management services each represent a series of stand-ready performance obligations satisfied over time with each day of service being a distinct performance obligation. For property and asset management services, the Company is typically compensated for its services through a monthly management fee earned based on a specified percentage of monthly rental income or rental receipts generated from the property under management. For construction and development services, the Company is typically compensated for planning, administering and monitoring the design and construction of projects at our unconsolidated joint venture properties based on a percentage of project costs or a fixed fee. Revenues from such management contracts are recognized over the life of the applicable contract.
Conversely, leasing services are considered to be a single performance obligation, satisfied as of a point in time. The Company’s leasing fee is typically paid upon the occurrence of certain contractual event(s) that may be contingent and the pattern of revenue recognition may differ from the timing of payment. For these services, the obligation is typically the execution of the lease and, as such, revenues are recognized at the point in time when that obligation has been satisfied.
Accounting for Recapture and Termination Activity Pursuant to the Original Master Lease and Holdco Master Lease (see Note 5)
Seritage Recapture Rights. The Company generally treats the delivery of a recapture notice as a modification of the lease as of the date of notice. Such a notice and lease modification result in the following accounting adjustments for the recaptured property:
−
The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that are subject to the lease modification are amortized over the remaining shortened life of the lease from the date of notice to the date of vacancy. The
portion of accrued rental revenues related to the straight-line method of reporting rental revenue that is attributable to the retained space, if any, is amortized over the remaining life of the lease.
−
The portion of intangible lease assets and liabilities that is deemed to be impacted by the lease modification is amortized over the shorter of the shortened lease term from the date of notice to the date of vacancy or the remaining useful life of the asset or liability. The portion of intangible lease assets and liabilities that is attributable to the retained space, if any, is amortized over the remaining useful life of the asset or liability.
A recapture will generally occur in conjunction with obtaining a new tenant or a real estate development project. As such, termination fees, if any, associated with the recapture notice are generally capitalized as either an initial direct cost of obtaining a new lease or a necessary cost of the real estate project and depreciated over the life of the new lease obtained or the real estate asset being constructed or improved.
Termination Rights. The Original Master Lease provided, and the Holdco Master Lease provides the tenant with certain rights to terminate their lease. Such terminations would generally result in the following accounting adjustments for the terminated property:
−
Accrued rental revenues related to the straight-line method of reporting rental revenue that are subject to the termination are amortized over the remaining shortened life of the lease from the date of notice to the date of vacancy.
−
Intangible lease assets and liabilities that are deemed to be impacted by the termination are amortized over the shorter of the shortened lease term from the date of notice to the date of vacancy or the remaining useful life of the asset or liability.
−
Termination fees required to be paid are recognized as follows:
•
For the portion of the termination fee attributable to the annual base rent of the subject property, termination income is recognized on a straight-line basis over the shortened life of the lease from the date the termination fee becomes legally binding to the date of vacancy.
•
For the portion of the termination fee attributable to estimated real estate taxes and property operating expenses for the subject property, prepaid rental income is recorded in the period such fee is received and recognized as tenant reimbursement revenue in the same periods as the expenses are incurred.
Derivatives
The Company’s use of derivative instruments is limited to the management of interest rate exposure and not for speculative purposes. In connection with the issuance of the Company’s Mortgage Loans and Future Funding Facility in July 2015, the Company purchased for $5.0 million an interest rate cap with a term of four years, a notional amount of $1,261 million and a strike rate of 3.5%. The interest rate cap was measured at fair value and included as a component of prepaid expenses, deferred expenses and other assets on the consolidated balance sheets. The Company had elected not to utilize hedge accounting and therefore the change in fair value was included within change in fair value of interest rate cap on the consolidated statements of operations.
During the year ended December 31, 2018, the Company terminated the interest rate cap concurrent with the repayment of the Mortgage Loans and the Future Funding Facility and as such there were no instruments as of December 31, 2019 and December 31, 2018.
For the year ended December 31, 2019, the Company did not record any gain or loss on derivatives. For the year ended December 31, 2018 and December 31, 2017, the Company recorded a change in the fair value of the interest rate cap of ($23) thousand, and ($0.7) million, respectively.
Share-Based Compensation
The Company generally recognizes equity awards to employees as compensation expense and includes such expense within general and administrative expenses in the consolidated statements of operations. Compensation expense for equity awards is based on the grant date fair value of the awards. Compensation expense is recognized ratably over the vesting period for awards with time-based vesting and awards with market-based vesting conditions (e.g. total shareholder return). For awards with performance-based vesting determined by Company operating criteria, the Company recognizes compensation expense at the date the achievement of performance criteria is deemed probable for the amount which would have been recognized ratably from the date of the grant through the date the achievement of performance criteria is deemed probable, and then ratably from the date the achievement of performance criteria is deemed probable through the remainder of the vesting period. The Company utilizes a third-party valuation firm to measure the grant date fair value of restricted stock unit awards with market-based criteria using the Monte Carlo model. Forfeitures are recorded on an actual basis.
Concentration of Credit Risk
Concentrations of credit risk arise when a number of operators, tenants, or obligors related to the Company's investments are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. As of December 31, 2019, 49 of the Company's real estate properties were leased to Holdco and a material amount of the Company’s rental revenues for the year ended December 31, 2019 was derived from the Holdco Master Lease. However, in November 2019, Holdco exercised its termination rights under the Holdco Master Lease with respect to 29 stores effective as of the first quarter of 2020. Until the Company further diversifies the tenancy of its portfolio, an event that has a material adverse effect on the business, financial condition or results of operations of Holdco or another major tenant could have a material adverse effect on the Company’s business, financial condition or results of operations.
Other than the Company's tenant concentration, management believes the Company's portfolio was reasonably diversified by geographical location and did not contain any other significant concentrations of credit risk. As of December 31, 2019, the Company's portfolio of 184 Wholly Owned Properties and 28 JV Properties was diversified by location across 44 states and Puerto Rico.
Earnings per Share
The Company has three classes of common stock. The rights, including the liquidation and dividend rights, of the holders of the Company’s Class A common shares and Class C non-voting common shares are identical, except with respect to voting. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. The net earnings (loss) per share amounts are the same for Class A and Class C common shares because the holders of each class are legally entitled to equal per share distributions whether through dividends or in liquidation. As of August 29, 2018, all outstanding Class C common shares had been exchanged for Class A common shares and there are currently no Class C common shares outstanding.
Class B non-economic common shares are excluded from earnings per share computations as they do not have economic rights.
All outstanding non-vested shares that contain non-forfeitable rights to dividends are considered participating securities and are included in computing earnings per share pursuant to the two-class method which specifies that all outstanding non-vested share-based payment awards that contain non-forfeitable rights to distributions are considered participating securities and should be included in the computation of earnings per share.
Recently Issued Accounting Pronouncements
The following presents Accounting Standards Updates (“ASU”) issued by Financial Accounting Standards Board (“FASB”) which have been adopted by the Company:
ASU
Description
Adoption Date
Effect on the financial statements or other significant matters
ASU 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets
This standard provides guidance for recognizing gains and losses from the transfer of nonfinancial assets. The standard requires a company to derecognize nonfinancial assets once it transfers control of a distinct nonfinancial asset or distinct in substance nonfinancial assets to noncustomers. Additionally, when a company transfers its controlling interest in a nonfinancial asset, but retains a non-controlling ownership interest, the company is required to measure any non-controlling interest it receives or retains at fair value. An entity may elect to apply the amendments in ASU 2017-05 either retrospectively to each period presented in the financial statements (i.e. the retrospective approach) or retrospectively with a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption (i.e. the modified retrospective approach).
January 1, 2018
The Company adopted this update with no impact to beginning retained earnings/accumulated deficit because there were no open contracts at the time of adoption.
ASU
Description
Adoption Date
Effect on the financial statements or other significant matters
ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments
This standard provides classification guidance for eight specific topics including debt extinguishment costs, contingent consideration payments made after a business combination, and distributions received from equity method investees. ASU 2016-15 is effective, on a retrospective basis, for interim and annual periods beginning after December 15, 2017; early adoption is permitted.
January 1, 2018
The Company adopted this standard and applied the cumulative earnings approach to classify distributions received from our equity method investees. The adoption (i) changes our statements of cash flows so that distributions from unconsolidated joint ventures in excess of cumulative equity in earnings are now classified as inflows from investing activities for each period presented and (ii) resulted in a decrease to net cash provided by operating activities and an increase to net cash provided by investing activities of $10.0 million for the year ended December 31, 2017.
ASU 2014-09, Revenue from Contracts with Customers and the related FASB ASU Nos. 2016-12 and 2016-20
This standard provides practical expedients, technical corrections, and improvements for certain aspects of ASU 2014-09. ASU 2014-09 was developed to enable financial statement users to better understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The update’s core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Companies are to use a five-step contract review model to ensure revenue is recognized, measured and disclosed in accordance with this principle. Those steps include the following: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to each performance obligation in the contract, and (v) recognize revenue when or as the entity satisfies a performance obligation. The Company estimates the total transaction price, which generally includes a fixed contract price and may also include variable components. Variable components of the contract price are included in the transaction price to the extent that it is probable that a significant reversal of revenue will not occur. The Company recognizes the estimated transaction price as revenue as it satisfies its performance obligations.
January 1, 2018
The Company adopted this standard using the modified retrospective method. Management concluded that the majority of total revenues consist of rental income from leasing arrangements, which is specifically excluded from the standard. As of January 1, 2018, the Company began accounting for the sale of real estate properties under Subtopic 610-20 which provides for revenue recognition based on transfer of ownership.
ASU
Description
Adoption Date
Effect on the financial statements or other significant matters
ASU 2016-02, Leases (“Topic 842”)
ASU 2018-10, Codification Improvements
ASU 2018-11, Leases, Targeted Improvements
ASU 2018-20, Leases
This standard, as amended by subsequent ASUs on the topic, sets out the principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. Additional guidance and targeted improvements to the February 2016 ASU were made through the issuance of supplementary ASUs in July 2018, December 2018 and March 2019. The accounting applied by the lessor is largely unchanged from that applied under the existing lease standard. However, ASU 2016-02 requires lessees to apply a two-method approach, classifying leases as either finance or operating leases based on the principle of whether the lease is effectively a financed purchase. Lessees are required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months. Leases with a term of 12 months or less should be accounted for consistent with earlier guidance under ASC 840 for operating leases. Lessees should recognize an expense based on the effective interest method for finance leases or on a straight-line basis for operating leases.
January 1, 2019
The Company adopted this standard by electing the package of practical expedients without hindsight which permits the Company to not reassess (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases, and (3) any initial direct costs for any existing leases as of the adoption date.
The Company has a ground lease and several corporate office leases, which are classified as operating leases, for which the Company is required to record a right-of-use asset and a lease liability equal to the present value of the remaining minimum lease payments and will continue to recognize expense on a straight-line basis for these leases. On January 1, 2019, the Company recorded an aggregate of approximately $8.4 million of right-of-use assets and corresponding $8.4 million of lease liabilities upon adoption of this standard. Right-of-use assets and corresponding lease liabilities are included in the prepaid expenses, deferred expenses and other assets and accounts payable, accrued expenses and other liabilities line item respectively on the consolidated balance sheets.
Additionally, the Company is no longer able to capitalize certain internal and external leasing costs. Because of this change, $1.3 million of such costs incurred in previous periods for leases which had not commenced at the beginning of current period were adjusted against opening equity upon adoption.
The Company also combined $11,005 of below-market lease assets pertaining to the ground lease where we are a lessee with the right of use asset recorded for the ground lease as required upon adoption of ASU 2016-02. The below-market lease asset was previously recorded within the lease intangibles on the consolidated balance sheets.
ASU 2018-01, Leases, Land Easement Practical Expedient for Transition to Topic 842
In March 2018, the FASB finalized changes with respect to optional transition relief and approved a practical expedient for lessors that would permit lessors to make an accounting policy election to not separate non-lease components from the associated lease components, by class of underlying asset, if the following two criteria are met: (1) the timing and pattern of transfer of the lease and non-lease components are the same and (2) the lease component would be classified as an operating lease if accounted for separately.
January 1, 2019
The Company has elected the optional transition relief and has determined that it is not required to bifurcate and separately report non-lease components, such as common area maintenance revenue, for operating leases on the consolidated statements of operations for leases where the Company is the lessor. As a result, leases where the Company is the lessor have been accounted for in a similar method to earlier guidance under ASC 840. The Company’s adoption of ASC 842 did not have a material impact on our consolidated financial statements.
The following table represents ASUs to the FASB’s ASC that, as of the year ended December 31, 2019, are not yet effective for the Company and for which the Company has not elected early adoption, where permitted:
ASU
Description
Adoption
Date
Effect on the financial statements or other significant matters
ASU 2016-13,
Financial
Instruments - Credit Losses (Topic 326)
ASU 2018-19,
Codification
improvements to Topic 326, Financial
Instruments - Credit Losses
ASU 2016-13 changes the impairment model for most financial assets and certain other instruments, requiring the use of an "expected credit loss" model and adding more disclosure requirements.
ASU 2018-19 clarifies that impairment of receivables arising from operating leases should accounted for in accordance with Topic 842, Leases.
January 1, 2020
This standard is not expected to have a significant impact to our consolidated financial statements.
Note 3 - Lease Intangible Assets and Liabilities
Lease intangible assets (acquired in-place leases, above-market leases and below-market ground leases) and liabilities (acquired below-market leases), net of accumulated amortization, were $68.2 million and $10.6 million, respectively, as of December 31, 2019, and $123.7 million and $12.3 million, respectively, as of December 31, 2018. The following table summarizes the Company’s lease intangible assets and liabilities (in thousands):
Amortization of acquired below-market leases, net of acquired above-market leases, resulted in additional rental income of $0.5 million, $0.9 million and $1.2 million for the years ended December 31, 2019, 2018 and 2017, respectively. Future amortization of these intangibles is estimated to increase rental income as set forth below (in thousands):
Amortization of acquired below-market ground leases resulted in additional rent expense of $0.2 million for each of the years ended December 31, 2019, 2018 and 2017. Future amortization of the below-market ground lease is estimated to increase property expenses as set forth below (in thousands):
Amortization of acquired in-place leases resulted in additional depreciation and amortization expense of $40.5 million, $173.1 million and $139.5 million for the years ended December 31, 2019, 2018 and 2017, respectively. Future estimated amortization of acquired in-place leases is set forth below (in thousands):
Note 4 - Investments in Unconsolidated Joint Ventures
The Company conducts a portion of its property rental activities through investments in unconsolidated joint ventures. The Company’s partners in these joint ventures are unrelated real estate entities or commercial enterprises. The Company and its joint venture partners make initial and/or ongoing capital contributions to these unconsolidated joint ventures. The obligations to make capital contributions are governed by each unconsolidated joint venture’s respective operating agreement and related governing documents.
As of December 31, 2019, the Company had investments in nine unconsolidated joint ventures as follows:
The Company has contributed certain properties to joint ventures in exchange for equity interests in those joint ventures. The contribution of property to a joint venture is accounted for as a sale of real estate and the Company recognizes the gain (loss) on the sale (the “Gain (Loss)”) based upon the transaction price attributed to the property at the closing of the joint venture transaction (the “Contribution Value”). The Gain (Loss) is included in gain on sale of real estate within the consolidated statements of operations.
In certain circumstances, the Contribution Value is subject to revaluation as defined in the respective joint venture agreements, which may result in an adjustment to the Gain (Loss) recognized. If the Contribution Value is subject to revaluation, the Company initially recognizes the Gain (Loss) at the value that is the expected amount within the range of possible outcomes and will re-evaluate the expected amount on a periodic basis through the final determination date.
Upon revaluation, the primary inputs in determining the Contribution Value will be updated for actual results and may result in a cash settlement or capital account adjustment between the joint venture partners, as well as an adjustment to the Initial Gain (Loss).
Each reporting period, the Company re-analyzes the primary inputs that determine the Contribution Value and the Gain (Loss) for those joint ventures subject to a revaluation. The following table presents summarizes the properties contributed to the Company’s unconsolidated joint ventures:
(1)
The Mark 302 JV is subject to a revaluation upon the earlier of the first anniversary of project stabilization or December 31, 2020. The primary inputs in determining the Contribution Value for the Mark 302 JV are property operating income and total project costs and the Contribution Value will be recalculated to yield a pre-determined rate of return to the investment fund managed by Invesco Real Estate. The Contribution Value cannot be more than $105.0 million or less than $60.0 million, and the Gain (Loss) will not be more than $53.8 million or less than $8.8 million.
(2)
The West Hartford JV is subject to (i) a revaluation upon the earlier of the first anniversary of project stabilization or December 31, 2019, and (ii) an adjustment based on the timing, method and magnitude of the reassessment of the property for real estate tax purposes between 2018 and 2022. The primary inputs in determining the Contribution Value for the West Hartford JV are
property operating income, real estate taxes and total project costs. The Contribution Value cannot be more than $29.6 million or less than $20.4 million, and the Gain (Loss) cannot be more than $5.8 million or more than a $3.4 million loss. As of December 31, 2019, the Company revaluated the Contribution Value and recorded an additional loss of $2.3 million.
(3)
The Cockeysville JV is subject to revaluation if an affiliate of Greenberg Gibbons contributes another adjacent parcel of land (the “Additional Land Parcel”) to the Cockeysville JV if certain milestones are met with respect to entitling the Additional Land Parcel for residential use. If the Additional Land Parcel is contributed to the Cockeysville JV, the Company will record an increased investment in the Cockeysville JV in an amount equal to 50% of the fair value of the Additional Land Parcel at the time of contribution. The Contribution Value of the Cockeysville JV is based upon the Company’s assessment of the probability of the Additional Land Parcel being entitled for residential use. The maximum Gain (Loss) is the fair value of the Additional Land Parcel at the time the Contribution Value is revalued, which cannot be less than $3.8 million.
(4)
The Tech Ridge JV is subject to a revaluation primarily based upon, the number of residential units constructed by the Tech Ridge JV. The Contribution Value cannot be less than $2.75 million.
Other Joint Venture Transactions
The Company has contributed certain property to the following joint ventures in 2017:
GGP JVs
On July 12, 2017, the Company completed two transactions with Brookfield Retail Properties for gross consideration of $247.6 million whereby the Company (i) sold to Brookfield Retail Properties the Company’s 50% JV Interests in eight of the 12 assets in the GGP I JV for $190.1 million and recorded a gain of $43.7 million which is included in gain on sale of interest in unconsolidated joint venture within the consolidated statements of operations; and (ii) contributed five Wholly Owned Properties to the GGP II JV and sold a 50% interest in the new JV Properties to Brookfield Retail Properties for $57.5 million and recorded a gain of $11.5 million which is included in gain on sale of real estate within the consolidated statements of operations.
Simon JV
On November 3, 2017, the Company sold to its partner, Simon Property Group, Inc., its 50% joint venture interests in five of the ten assets in the Simon JV for $68.0 million and recorded a gain of $16.6 million which is included in gain on sale of interest in unconsolidated joint venture within the consolidated statements of operations.
Joint Venture Management and Related Fees
The Company acts as the operating partner and day-to-day manager for the Mark 302 JV, the West Hartford JV, the UTC JV, and Tech Ridge JV. The Company is entitled to receive certain fees for providing management, leasing, and construction supervision services to certain of its joint ventures. The Company also acts as the development manager for one of the properties in the GGP II JV which entitles the Company to receive certain development fees. The Company earned $1.6 million and $1.2 million from these services for the years ended December 31, 2019 and December 31, 2018, respectively.
The following tables present combined financial data for the Company’s unconsolidated joint ventures (in thousands):
Each unconsolidated joint venture is obligated to maintain financial statements in accordance with GAAP. The Company shares in the profits and losses of these unconsolidated joint ventures generally in accordance with the Company’s respective equity interests. In some instances, the Company may recognize profits and losses related to investment in an unconsolidated joint venture that differ from the Company’s equity interest in the unconsolidated joint venture. This may arise from impairments that the Company recognizes related to its investment that differ from the impairments the unconsolidated joint venture recognizes with respect to its assets, differences between the Company’s basis in assets it has transferred to the unconsolidated joint venture and the unconsolidated joint venture’s basis in those assets or other items. There were no joint venture impairment charges for the years ended December 31, 2019, 2018 and 2017.
Note 5 - Leases
On February 28, 2019, the Company and certain affiliates of Holdco executed the Holdco Master Lease which became effective on March 12, 2019 when the Bankruptcy Court issued an order approving the rejection of the Original Master Lease. The Company analyzed this transaction under applicable accounting guidance and determined that the termination of the Original Master Lease and entering into the Holdco Master Lease should be accounted for as a modification in accordance with ASC 842.
Lease Structure
The structure of the Holdco Master Lease is consistent with the structure of the Original Master Lease in all material respects, including (i) it is a unitary, non-divisible lease as to all properties, pursuant to which the tenant’s obligations as to each property are cross-defaulted with all obligations of the tenant with respect to all other properties; (ii) it is a triple net lease with respect to all space which is leased thereunder to the tenant, subject to proportional sharing by the tenant for repair and maintenance charges, real property taxes, insurance and other costs and expenses which are common to both the space leased by the tenant and other space occupied by other tenants in the same or other buildings, space which is recaptured pursuant to the Company’s recapture rights described below and all other space which is constructed on the properties; (iii) the tenant is required to make all expenditures reasonably necessary to maintain the premises in good appearance, repair and condition for as long as they are in occupancy; and (iv) the tenant is generally prohibited from subleasing any space demised under the lease.
Term and Renewals
Consistent with the terms of the Original Master Lease, the Holdco Master Lease will expire in July 2025, and contains three options for five-year renewals of the term and a final option for a four-year renewal, as was the case under the Original Master Lease.
Rental Revenue
The Holdco Master Lease provides for an initial base rent at the same rates which were in place at the time the Original Master Lease was rejected. In each of the initial term and the first two renewal terms, consistent with the Original Master Lease, base rent under the Holdco Master Lease will be increased in August of each year by 2.0% per annum for each lease year over the rent for the immediately preceding lease year. For subsequent renewal terms, consistent with the Original Master Lease, rent will be set at the commencement of the renewal term for the Holdco Master Lease at a fair market rent based on a customary third-party appraisal process, taking into account all the terms of the Holdco Master Lease and other relevant factors, but in no event will the renewal rent be less than the rent payable in the immediately preceding lease year. The base rent under the Holdco Master Lease will be subject to an adjustment in the form of a rent credit of up to approximately $12 million in each of the first and second years of the Holdco Master Lease. The rent credit is allocated to specific properties based on the trailing twelve- month EBITDA of the particular property as of December 2018. If any such properties are recaptured by the Company or terminated by Holdco, the base rent credit attributable to such property will no longer be applicable. The rent credit is applicable to base rent only and Holdco is responsible for repair and maintenance charges, real property taxes, insurance and other costs and expenses associated with its occupancy of the subject properties.
Revenues from the Holdco Master Lease and the Original Master Lease for the years ended December 31, 2019, 2018 and 2017 are as follows (in thousands and excluding straight-line rental income of $0.3 million, ($4.9) million and $0.8 million, respectively.
Seritage Recapture Rights
The Holdco Master Lease provides the Company with the right to recapture up to approximately 50% of the space occupied by the tenant at all properties (other than five specified properties) and the right to recapture any automotive care centers which are free-standing or attached as “appendages” to the properties, all outparcels or outlots and certain portions of parking areas and common areas. Upon exercise of any of these partial recapture rights the Company will generally incur, as applicable, certain costs and expenses for the separation of the recaptured space from the remaining tenant space.
Additionally, in contrast to the Original Master Lease, which permitted the Company to recapture 100% of certain properties upon payment of a specified recapture fee, the Holdco Master Lease provides the Company with the right, beginning in March 2020, to recapture 100% of the space occupied by the tenant at any of the properties included in the Holdco Master Lease (other than five
specified properties) without paying a recapture fee. This right to recapture 100% of any property is limited to 10 properties in each year of the Holdco Master Lease term, with carry-over rights if less than 10 properties are recaptured in any given lease year. In the event of a 100% recapture of a property (or termination of a property by Holdco that is subject to a termination fee) and any subsequent redevelopment of such property for retail purposes, Holdco has certain rights of first offer to lease space at specified predefined rates depending on the condition the space is delivered. If the Company does not provide Holdco with a right of first offer on at least one-third of any such properties that are recaptured 100% by the Company (or terminated by Holdco with payment of a termination fee) in a given lease year, then the Company’s 100% recaptures rights are subject to payment of a recapture fee until such time as the Company has complied with the foregoing ratio.
Upon the exercise of any of its recapture rights, the Company can reconfigure and rent the recaptured space to new, diversified tenants on potentially superior terms as determined by the Company and for its own account.
The Company had previously exercised certain recapture rights with respect to 70 properties under the Original Master Lease prior to its rejection on March 12, 2019, and exercised recapture rights with respect to four properties under the Holdco Master Lease during the year ended December 31, 2019, including three properties where the Company had previously exercised certain recapture rights under the Original Master Lease.
The following table provides a summary of the Company’s recapture activity:
(1)
Includes properties for which the Company had converted partial recapture rights to 100% recapture rights.
(2)
Partial recaptures include the recapture of (i) up to approximately 50% of the space occupied by the tenant at all properties, (ii) automotive care centers which are free-standing or attached as “appendages” to the properties, and/or (iii) outparcels or outlots and certain portions of parking areas and common areas.
Holdco Termination Rights
Under the terms of the Holdco Master Lease, Holdco has the right, at any time, to terminate the Holdco Master Lease with respect to any property upon the payment of a termination fee equal to one year of base rent plus annual taxes and other operating expenses. Additionally, beginning in March 2020, the tenant has the right to terminate without payment of a termination fee: (i) up to 16 properties in the second year of the term of the Holdco Master Lease, (ii) up to 12 properties in the third year, (iii) up to 10 properties in the fourth year, and (iv) thereafter, the remaining properties, in each instance with carry over rights if less than the maximum permitted number of properties are terminated in any lease year.
Sears Holdings exercised termination rights with respect to 87 properties under the Original Master Lease prior to its rejection on March 12, 2019 and Holdco exercised termination rights with respect to 29 properties under the Holdco Master Lease during the year ended December 31, 2019.
The following table provides a summary of Sears Holdings’ and Holdco’s termination activity (excluding 31 properties totaling 4.3 million square feet that were rejected on March 12, 2019 as part of Sears Holdings’ bankruptcy filing):
(1)
Two properties were terminated in October 2018.
(2)
One property was terminated in November 2017 and another one was terminated in January 2018.
As of December 31, 2019, the Company had commenced or completed redevelopment projects at 46 of the terminated properties, and sold an additional 24 of the terminated properties, and will continue to announce redevelopment activity as new leases are signed to occupy the space formerly occupied by Sears or Kmart.
Lessor Disclosures
Future minimum rental receipts, excluding variable payments and tenant reimbursements of expenses, under non-cancelable operating leases executed as of December 31, 2019 and December 31, 2018 is approximately as follows:
The components of lease revenues for the years ended December 31, 2019, December 31, 2018 and December 31, 2017 were as follows:
Lessee Disclosures
The Company has one ground lease and multiple corporate office leases which are classified as operating leases. The Company initially recorded $8.6 million of right-of-use, or ROU, assets and lease liabilities. The Company’s ROU assets were subsequently increased by $11.0 million as a result of the reclassification of acquired below-market lease assets, net, from lease intangible assets, net, during the years ended 2019. As of December 31, 2019, the outstanding amount of ROU assets were $18.5 million.
The Company recorded rent expense related to leased corporate office space of $1.6 million, $0.7 million, and $0.7 million for the years ended December 31, 2019, December 31, 2018 and December 31, 2017, respectively. Such rent expense is classified within general and administrative expenses on the consolidated statements of operations.
In addition, the Company recorded ground rent expense of approximately $45 thousand for each of the years ended December 31, 2019, December 31, 2018 and December 31, 2017, respectively. Such rent expense is classified within general and administrative expenses on the consolidated statements of operations. The ground lease requires the Company to make fixed annual rental payments and expires in 2073 assuming all extension options are exercised.
The following table sets forth information related to the measurement of our lease liabilities as of December 31, 2019:
Note 6 - Debt
Term Loan Facility
On July 31, 2018, the Operating Partnership, as borrower, and the Company, as guarantor, entered into a Senior Secured Term Loan Agreement (the “Term Loan Agreement”) providing for a $2.0 billion term loan facility (the “Term Loan Facility”) with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire Hathaway”) as lender and Berkshire Hathaway as administrative agent. The Term Loan Facility provided for an initial funding of $1.6 billion at closing (the “Initial Funding”) and includes a $400 million incremental funding facility (the “Incremental Funding Facility”) subject to certain conditions described below. The Term Loan Facility matures on July 31, 2023.
The Company used a portion of the proceeds from the Initial Funding to (i) repay existing indebtedness and (ii) pay transaction and related costs. The remaining proceeds from the Initial Funding, as well as borrowings under the Incremental Funding Facility, will be used to fund the Company’s redevelopment pipeline and to pay operating expenses of the Company and its subsidiaries.
Funded amounts under the Term Loan Facility bear interest at an annual rate of 7.0% and unfunded amounts under the Incremental Funding Facility are subject to an annual fee of 1.0% until drawn. The Company prepays the annual fee and amortizes the expense to interest expense on the consolidated statements of operations.
As of December 31, 2019, the aggregate principal amount outstanding under the Term Loan Facility was $1.6 billion.
The Company’s ability to access the Incremental Funding Facility is subject to (i) the Company achieving rental income from non-Sears Holdings tenants, on an annualized basis (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the fiscal quarter ending prior to the date of incurrence of the Incremental Funding Facility, of not less than $200 million and (ii) the Company’s good faith projection that rental income from non-Sears Holdings tenants (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the succeeding four consecutive fiscal quarters (beginning with the fiscal quarter during which the incremental facility is accessed) will be not less than $200 million.
The Term Loan Facility is guaranteed by the Company and, subject to certain exceptions, is required to be guaranteed by all existing and future subsidiaries of the Borrower. The Term Loan Facility is secured on a first lien basis by a pledge of the capital stock of the direct subsidiaries of the Borrower and the guarantors, including its joint venture interests, except as prohibited by the organizational documents of such entities or any joint venture agreements applicable to such entities, and contains a requirement to provide mortgages and other customary collateral upon the breach of certain financial metrics described below, the occurrence and continuation of an event of default and certain other conditions set forth in the Term Loan Agreement.
The Term Loan Facility includes certain financial metrics to govern springing collateral requirements and certain covenant exceptions set forth in the Term Loan Agreement, including: (i) a total fixed charge coverage ratio of not less than 1.00 to 1.00 for each fiscal
quarter beginning with the fiscal quarter ending September 30, 2018 through the fiscal quarter ending June 30, 2021, and not less than 1.20 to 1.00 for each fiscal quarter thereafter; (ii) an unencumbered fixed charge coverage ratio of not less than 1.05 to 1.00 for each fiscal quarter beginning with the fiscal quarter ending September 30, 2018 through the fiscal quarter ending June 30, 2021, and not less than 1.30 to 1.00 for each fiscal quarter thereafter; (iii) a total leverage ratio of not more than 65%; (iv) an unencumbered ratio of not more than 60%; and (v) a minimum net worth of at least $1.2 billion. Any failure to satisfy any of these financial metrics limits the Company’s ability to dispose of assets via sale or joint venture and triggers the springing mortgage and collateral requirements but will not result in an event of default. The Term Loan Facility also includes certain limitations relating to, among other activities, the Company’s ability to: sell assets or merge, consolidate or transfer all or substantially all of its assets; incur additional debt; incur certain liens; enter into, terminate or modify certain material leases and/or the material agreements for the Company’s properties; make certain investments (including limitations on joint ventures) and other restricted payments; pay distributions on or repurchase the Company’s capital stock; and enter into certain transactions with affiliates.
The Term Loan Facility contains customary events of default, including (subject to certain materiality thresholds and grace periods) payment default, material inaccuracy of representations or warranties, and bankruptcy or insolvency proceedings. If there is an event of default, the lenders may declare all or any portion of the outstanding indebtedness to be immediately due and payable, exercise any rights they might have under any of the Term Loan Facility documents, and require the Company to pay a default interest rate on overdue amounts equal to 2.0% in excess of the then applicable interest rate.
As of December 31, 2019, the Company was not in compliance with certain of the financial metrics described above. As a result, the Company must receive the consent of Berkshire Hathaway to dispose of assets via sale or joint venture and, as of December 31, 2019, Berkshire Hathaway had provided such consent for all such transactions submitted for approval. There can be no assurance that the lender will consent to future dispositions of assets. Additionally, Berkshire Hathaway has the right to request mortgages against the Company’s assets pursuant to the mortgage and collateral requirement. During the year ended December 31, 2019, Berkshire Hathaway requested mortgages on a majority of the Company’s portfolio which were recorded in accordance with the requirement (the “Lender Request”). There are no other changes to the terms and conditions of the Term Loan Facility, or the Company’s ability to operate thereunder, as a result of providing mortgages against any of the Company’s assets pursuant to the mortgage and collateral requirement. The Company accounted for the Lender Request transaction as a modification of debt as of December 31, 2019. Related to the modification, the Company incurred $5.0 million mortgage recording costs which are classified as interest expenses on the consolidated statements of operations.
The Company believes it is in compliance with all other terms and conditions of the Term Loan Agreement.
The Company incurred $2.1 million of debt issuance costs related to the Term Loan Facility which are recorded as a direct deduction from the carrying amount of the Term Loan Facility and amortized over the term of the Term Loan Agreement. As of December 31, 2019, the unamortized balance of the Company’s debt issuance costs was $1.5 million.
Mortgage Loans Payable
On July 7, 2015, pursuant to the Transaction, the Company entered into a mortgage loan agreement (the “Mortgage Loan Agreement”) and mezzanine loan agreement (collectively, the “Mortgage Loan Agreements”), providing for term loans in an initial principal amount of approximately $1,161 million (collectively, the “Mortgage Loans”) and a $100 million future funding facility (the “Future Funding Facility”). The Mortgage Loans and Future Funding Facility were secured by all of the Company’s Wholly Owned Properties and a pledge of its equity in the JVs. Pursuant to the terms of the Mortgage Loan Agreements, amounts available under the Future Funding Facility were fully drawn by the Company on June 30, 2017. Such amounts were deposited into a redevelopment reserve and used to fund redevelopment activity at the Company’s properties.
Interest under the Mortgage Loans was due and payable on the payment dates, and all outstanding principal amounts were due when the loan was scheduled to mature on the payment date in July 2019, pursuant to the Loan Agreements. The Company had two one-year extension options subject to the payment of an extension fee and satisfaction of certain other conditions. Borrowings under the Mortgage Loans bore interest at the London Interbank Offered Rates (“LIBOR”) plus, as of July 31, 2018, a weighted-average spread of 485 basis points; payments were made monthly on an interest-only basis. The weighted-average interest rates for the Mortgage Loans and Future Funding Facility for the year ended December 31, 2017 was 6.03%.
The Company incurred $22.3 million of debt issuance costs related to the Mortgage Loans and Future Funding Facility which were recorded as a direct deduction from the carrying amount of the Mortgage Loans and Future Funding Facility and amortized over the term of the Mortgage Loan Agreements. During the year ended December 31, 2018, the Company fully amortized the remaining unamortized debt issuance costs as a result of the full repayment of the Mortgage Loans and Future Funding Facility on July 31, 2018. As of December 31, 2019 and December 31, 2018, the Company had no unamortized debt issuance costs related to the Mortgage Loans and Future Funding Facility.
On July 31, 2018, the aggregate principal amounts outstanding under the Mortgage Loans and the Future Funding Facility were repaid in full and no amounts were outstanding as of December 31, 2019.
Unsecured Delayed Draw Term Loan
On February 23, 2017, the Operating Partnership, as borrower, and the Company, as guarantor, entered into a $200 million senior unsecured delayed draw term loan facility (the “Unsecured Delayed Draw Term Loan”) with JPP, LLC and JPP II, LLC as lenders (collectively, the “Original Lenders”) and JPP, LLC as administrative agent.
The total commitment of the Lenders under the Unsecured Delayed Draw Term Loan was $200 million and the maturity date was December 31, 2017. On February 23, 2017, the Operating Partnership paid to the Original Lenders an upfront commitment fee equal to $1.0 million. On May 24, 2017, the Operating Partnership paid to the Original Lenders an additional, and final, commitment fee of $1.0 million.
The principal amount of loans outstanding under the Unsecured Delayed Draw Term Loan, prior to its repayment, bore a base annual interest rate of 6.50%.
Edward S. Lampert, the Company’s Chairman, is the Chairman and Chief Executive Officer of ESL Investments, Inc., which controls JPP, LLC and JPP II, LLC. The terms of the Unsecured Delayed Draw Term Loan were approved by the Company’s Audit Committee and the Company’s Board of Trustees (with Mr. Lampert recusing himself).
Unsecured Term Loan
On December 27, 2017, the Operating Partnership, as borrower, and the Company, as guarantor, refinanced the Unsecured Delayed Draw Term Loan with a $200 million unsecured term loan facility (the “Unsecured Term Loan”). The principal amount outstanding under the Unsecured Delayed Draw Term Loan at termination was $85 million. No prepayment penalties were triggered and the Unsecured Delayed Draw Term Loan terminated in accordance with its terms.
The lenders under the Unsecured Delayed Draw Term Loan, JPP, LLC and JPP II, LLC, maintained their funding of $85 million in the Unsecured Term Loan, with JPP, LLC appointed as administrative agent under the Unsecured Term Loan. An affiliate of Empyrean Capital Partners, L.P., a Delaware limited partnership (and together with JPP, LLC and JPP II LLC, each an “Initial Lender” and collectively, the “Initial Lenders”), funded $60 million under the Unsecured Term Loan, resulting in a total of $145 million committed and funded under the Unsecured Term Loan at closing. The Borrower paid to each Initial Lender an upfront fee in an aggregate amount equal to 1.00% of the principal amount of the loan made by such Initial Lender.
Under an accordion feature, the Company had the right to increase the total commitments up to $200 million and place an additional $55 million of incremental loans with the Initial Lenders or new lenders. The Initial Lenders under the Unsecured Term Loan were not obligated to make all or any portion of the incremental loans.
The Company used the proceeds of the Unsecured Term Loan, among other things, to refinance the Unsecured Delayed Draw Term Loan, to fund redevelopment projects and for other general corporate purposes. Loans under the Unsecured Term Loan were guaranteed by the Company.
The Unsecured Term Loan matured on the earlier of (i) December 31, 2018 and (ii) the date on which the outstanding indebtedness under the Company’s existing mortgage and mezzanine facilities are repaid in full. The Unsecured Term Loan was prepayable at any time in whole or in part, without any penalty or premium. Amounts drawn under the Unsecured Term Loan and repaid may not have been redrawn.
The principal amount of loans outstanding under the Unsecured Term Loan bore a base annual interest rate of 6.75%.
The Company incurred $1.8 million of debt issuance costs related to the Unsecured Term Loan which was recorded as a direct deduction from the carrying amount of the Unsecured Term Loan and amortized over the term of the loan. During the year ended December 31, 2018, the Company fully amortized the remaining unamortized debt issuance costs as a result of the full repayment of the Unsecured Term Loan on July 31, 2018. As of December 31, 2019 and December 31, 2018, the Company had no unamortized debt issuance costs related to the Unsecured Term Loan.
Edward S. Lampert, the Company’s Chairman, is the Chairman and Chief Executive Officer of ESL Investments, Inc., which controls JPP, LLC and JPP II, LLC. The terms of the Unsecured Term Loan were approved by the Company’s Audit Committee and the Company’s Board of Trustees (with Mr. Lampert recusing himself).
On July 31, 2018, the principal amounts outstanding under the Unsecured Term Loan were repaid in full and no amounts were outstanding as of December 31, 2019.
Note 7 - Income Taxes
The Company has elected to be taxed as a REIT as defined under Section 856(c) of the Code for U.S. federal income tax purposes and expects to continue to operate to qualify as a REIT. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement to currently distribute at least 90% of its adjusted REIT taxable income to its shareholders.
As a REIT, the Company generally will not be subject to U.S. federal income tax on taxable income that is distributed to its shareholders. If the Company fails to qualify as a REIT or does not distribute 100% of its taxable income in any taxable year, it will be subject to U.S. federal income tax at regular corporate rates (including for any taxable year ended on or before December 31, 2017, any applicable alternative minimum tax) and any applicable state and local income taxes.
Even if the Company qualifies for taxation as a REIT, the Company is subject to certain U.S. state, local and Puerto Rico taxes on its income and property, and to U.S. federal income and excise taxes on its undistributed REIT taxable income. The Company’s taxable REIT subsidiaries are subject to corporate income tax.
The Company evaluated whether any uncertain tax positions existed as of December 31, 2019 and 2018 and concluded that there are no uncertain tax positions.
Note 8 - Fair Value Measurements
ASC 820, Fair Value Measurement, defines fair value and establishes a framework for measuring fair value. The objective of fair value is to determine the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the “exit price”). ASC 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels:
Level 1 - quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities
Level 2 - observable prices based on inputs not quoted in active markets, but corroborated by market data
Level 3 - unobservable inputs used when little or no market data is available
The fair value hierarchy gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company also considers counterparty credit risk in its assessment of fair value.
Financial Assets and Liabilities Measured at Fair Value on a Recurring or Non-Recurring Basis
All derivative instruments were carried at fair value and were valued using Level 2 inputs. The Company had no derivative instruments as of December 31, 2019 (an interest rate cap associated with the Mortgage Loans and Future Funding Facility was terminated subsequent to the repayment of the Mortgage Loans and Future Funding Facility on July 31, 2018). The Company utilized an independent third party and interest rate market pricing models to assist management in determining the fair value of this instrument.
The Company had elected not to utilize hedge accounting, and therefore, the change in fair value was included in previous periods within change in fair value of interest rate cap on the consolidated statements of operations. For the year ended December 31, 2019, the Company did not record any gain or loss compared to losses of $23 thousand and $0.7 million for the years ended December 31, 2018 and 2017, respectively.
Financial Assets and Liabilities not Measured at Fair Value
Financial assets and liabilities that are not measured at fair value on the consolidated balance sheets include cash equivalents, term loan facility and mortgage loans payable. The fair value of cash equivalents is classified as Level 1 and the fair value of term loan facility and mortgage loans payable are classified as Level 2. Cash equivalents are carried at cost, which approximates fair value. The fair value of debt obligations is calculated by discounting the future contractual cash flows of these instruments using current risk-adjusted rates available to borrowers with similar credit ratings. As of December 31, 2019 and December 31, 2018, the estimated fair values of the Company’s debt obligations were $1.6 billion and $1.6 billion, respectively, which approximated the carrying value at such dates as the current risk-adjusted rate approximates the stated rates on the Company’s debt obligations.
Note 9 - Commitments and Contingencies
Insurance
The Company maintains general liability insurance and all-risk property and rental value, with sub-limits for certain perils such as floods and earthquakes on each of the Company’s properties. The Company also maintains coverage for terrorism acts as defined by Terrorism Risk Insurance Program Reauthorization Act, which expires in December 2027.
Insurance premiums are charged directly to each of the properties. The Company will be responsible for deductibles and losses in excess of insurance coverage, which could be material. The Company continues to monitor the state of the insurance market and the scope and costs of coverage for acts of terrorism. However, the Company cannot anticipate what coverage will be available on commercially reasonable terms in the future.
Environmental Matters
Under various federal, state and local laws, ordinances and regulations, the Company may be considered an owner or operator of real property or may have arranged for the disposal or treatment of hazardous or toxic substances. As a result, the Company may be liable for certain costs including removal, remediation, government fines and injuries to persons and property. The Company does not believe that any resulting liability from such matters will have a material effect on the consolidated financial position, results of operations or liquidity of the Company.
Under the Holdco Master Lease, Holdco is required to indemnify the Company from certain environmental liabilities at the Wholly Owned Properties before or during the period in which each Wholly Owned Property was leased to Holdco, including removal and remediation of all affected facilities and equipment constituting the automotive care center. In addition, an environmental reserve was funded at the closing of the Transaction in the amount of approximately $12.0 million. As of December 31, 2019, the balance of the environmental reserve was approximately $9.5 million.
Litigation and Other Matters
In accordance with accounting standards regarding loss contingencies, the Company accrues an undiscounted liability for those contingencies where the incurrence of a loss is probable and the amount can be reasonably estimated, and the Company discloses the amount accrued and the amount of a reasonably possible loss in excess of the amount accrued or discloses the fact that such a range of loss cannot be estimated. The Company does not record liabilities when the likelihood that the liability has been incurred is probable but the amount cannot be reasonably estimated, or when the liability is believed to be only reasonably possible or remote.
On April 18, 2019, at the direction of the Restructuring Sub-Committee of the Restructuring Committee of the Board of Directors of Sears Holdings, Sears Holdings, Sears, Roebuck & Co., Sears Development Co., Kmart Corporation, and Kmart of Washington, LLC filed a lawsuit (the “Litigation”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) against, among others, Edward S. Lampert, ESL Investments, Inc. and certain of its affiliates and investors, Fairholme Capital Management, L.L.C., certain members of the Sears Holdings board of directors, and the Company, the Operating Partnership, and certain of our affiliates and subsidiaries (the Company, the Operating Partnership, and certain of our affiliates and subsidiaries collectively, the “Seritage Defendants”). The Litigation is dual captioned as In re: Sears Holdings Corporation, et al., Case No. 18-23538 (RDD) and Sears Holdings Corporation et al., v. Lampert et al., Case No. 19-08250 (RDD). The Litigation alleges, among other things, that certain transactions undertaken by Sears Holdings since 2011 constituted actual and/or constructive fraudulent transfers and/or illegal dividends by Sears Holdings. The challenged transactions include the July 2015 transactions giving rise to Seritage, the execution of the Original Master Lease with Sears Holdings, and the acquisition of real estate from Sears Holdings. The Litigation alleges, among other things, that the real estate acquired by Seritage from Sears Holdings in July 2015 was worth at least $649 to $749 million more than the purchase price paid. The Litigation seeks as relief, among other things, declaratory relief, avoidance of the allegedly actual and/or constructive fraudulent transfers and either (i) rescission of the transfers of real estate from Sears Holdings to Seritage in 2015 and return of the proceeds of the transactions between Sears Holdings and Seritage, or, in the alternative, (ii) payment by Seritage to Sears Holdings of damages at least equal to the value of the transferred property.
On October 15, 2019, the Bankruptcy Court entered an order (the “Confirmation Order”) confirming the Modified Second Amended Joint Chapter 11 Plan of Sears Holdings and its affiliated debtors (the “Chapter 11 Plan”). Pursuant to the terms of the Confirmation Order, upon the effective date of the Chapter Plan, a liquidating trust will be formed, and the Litigation will vest in the liquidating trust. The Confirmation Order further provides that, prior to the effective date of the Chapter 11 Plan and the formation of the liquidating trust, the Litigation shall be controlled by five litigation designees selected by Sears Holdings and the Unsecured Creditors’ Committee (the “UCC”). For further information, refer to the Chapter 11 Plan, Confirmation Order and liquidating trust agreement, each of which has been publicly filed with the Bankruptcy Court.
On February 21, 2020, the Seritage defendants filed a partial motion to dismiss seeking dismissal of the claims in the Amended Complaint relating to the release received in the Sears Holdings derivative litigation, unjust enrichment, and equitable subordination. The Company believes that the claims against the Seritage Defendants in the Litigation are without merit and intends to defend against them vigorously.
In addition to the litigation described above, the Company is subject, from time to time, to various legal proceedings and claims that arise in the ordinary course of business. While the resolution of such matters cannot be predicted with certainty, management believes, based on currently available information, that the final outcome of such matters will not have a material effect on the consolidated financial position, results of operations, cash flows or liquidity of the Company. As of December 31, 2019, and December 31, 2018, the Company did not record any amounts for litigation or other matters.
Note 10 - Related Party Disclosure
Edward S. Lampert
Edward S. Lampert is the Chairman and Chief Executive Officer of ESL, which owns Holdco, and was Chairman of Sears Holdings. Mr. Lampert is also the Chairman of Seritage.
As of December 31, 2019, Mr. Lampert beneficially owned a 33.9% interest in the Operating Partnership and approximately 2.4% and 100% of the outstanding Class A common shares and Class B non-economic common shares, respectively.
Subsidiaries of Holdco, as lessees, and subsidiaries of the Company, as lessors, are parties to the Holdco Master Lease and subsidiaries of Sears Holdings, as lessees, and subsidiaries of the Company, as lessors, were parties to the Original Master Lease (see Note 5).
Unconsolidated Joint Ventures
Certain unconsolidated joint ventures have engaged the Company to provide management, leasing, construction supervision and development services at the properties owned by the unconsolidated joint ventures. Fees for the services performed are reported at 100% of the revenue earned from such joint ventures in management and other fee income on the consolidated statements of operations. The Company’s share of the expenses incurred by the unconsolidated joint ventures is reported in equity in income (loss) of unconsolidated joint ventures on the consolidated statements of operations and in other expenses in the combined financial data in Note 4.
In addition, as of December 31, 2019, the Company had incurred $9.7 million of development expenditures at properties owned by certain unconsolidated joint ventures for which the Company will be repaid by the respective unconsolidated joint ventures. These amounts are included in tenant and other receivables, net on the Company’s consolidated balance sheets. As of December 31, 2018, the Company had incurred $2.1 million of these development expenditures.
Note 11 - Non-Controlling Interests
Partnership Agreement
On July 7, 2015, Seritage and ESL entered into the agreement of limited partnership of the Operating Partnership which was amended and restated on December 14, 2017. Pursuant to this partnership agreement, as the sole general partner of the Operating Partnership, Seritage exercises exclusive and complete responsibility and discretion in its day-to-day management, authority to make decisions, and control of the Operating Partnership, and may not be removed as general partner by the limited partners.
As of December 31, 2019, the Company held a 66.1% interest in the Operating Partnership and ESL held a 33.9% interest. The portions of consolidated entities not owned by the Company are presented as non-controlling interest as of and during the periods presented.
Note 12 - Shareholders’ Equity
Class A Common Shares
On July 7, 2015, the Company issued 22,332,037 Class A common shares at a price of $29.58 per share, for aggregate proceeds of $660.6 million, pursuant to the Rights Offering. The Company incurred costs of approximately $8.2 million related to the Rights Offering. In addition, the Company issued and sold to subsidiaries of each of Brookfield Properties Retail and Simon Property Group, Inc. 1,125,760 Class A common shares at a price of $29.58 per share, or an aggregate purchase price of $33.3 million, in transactions exempt from registration under the Securities Act. The subsidiary of Brookfield Properties Retail liquidated its position during the year ended December 31, 2016 and the subsidiary of Simon Property Group, Inc. liquidated its position during the year ended December 31, 2017.
During the year ended December 31, 2019, 1,214,577 OP Units were exchanged for an equal number of Class A shares.
As of December 31, 2019, 36,897,364 Class A common shares were issued and outstanding.
Class A shares have a par value of $0.01 per share.
Class B Non-Economic Common Shares
On July 7, 2015, the Company issued and sold to ESL 1,589,020 Class B non-economic common shares of beneficial interest in connection with an exchange of cash and subscription rights for Class B non-economic common shares in a transaction exempt from registration under the Securities Act pursuant to Section 4(a)(2) thereof. The aggregate purchase price for the Class B non-economic common shares purchased by ESL was $0.9 million. The Class B non-economic common shares have voting rights, but do not have economic rights and, as such, do not receive dividends and are not included in earnings per share computations.
During the year ended December 31, 2019, 79,829 Class B non-economic common shares were surrendered to the Company.
As of December 31, 2019, 1,242,536 Class B non-economic common shares were issued and outstanding.
Class B non-economic common shares have a par value of $0.01 per share.
Class C Non-Voting Common Shares
On July 7, 2015, the Company issued 6,790,635 Class C non-voting common shares at a price of $29.58 per share, for aggregate proceeds of $200.9 million, pursuant to the Rights Offering. The Class C non-voting common shares have economic rights, but do not have voting rights. Upon any transfer of a Class C non-voting common share to any person other than an affiliate of the holder of such share, such share shall automatically convert into one Class A common share. Class B non-economic common shares have a par value of $0.01 per share.
As of December 31, 2019, there were no Class C non-voting common shares issued or outstanding.
Class C non-voting shares have a par value of $0.01 per share.
Series A Preferred Shares
In December 2017, the Company issued 2,800,000 7.00% Series A Cumulative Redeemable Preferred Shares (the “Series A Preferred Shares”) in a public offering at $25.00 per share. The Company received net proceeds from the offering of approximately $66.4 million, after deducting payment of the underwriting discount and offering expenses, which it used to fund its redevelopment pipeline and for general corporate purposes.
The Company may not redeem the Series A Preferred Shares before December 14, 2022 except to preserve its status as a REIT or upon the occurrence of a Change of Control, as defined in the trust agreement addendum designating the Series A Preferred Shares. On and after December 14, 2022, the Company may redeem any or all of the Series A Preferred Shares at $25.00 per share plus any accrued and unpaid dividends. In addition, upon the occurrence of a Change of Control, the Company may redeem any or all of the Series A Preferred Shares for cash within 120 days after the first date on which such Change of Control occurred at $25.00 per share plus any accrued and unpaid dividends. The Series A Preferred Shares have no stated maturity, are not subject to any sinking fund or mandatory redemption and will remain outstanding indefinitely unless the Company redeems or otherwise repurchases them or they are converted.
Dividends and Distributions
The Company’s Board of Trustees declared the following common stock dividends during 2019 and 2018, with holders of OP Units entitled to an equal distribution per Operating Partnership unit held on the record date:
As previously disclosed, the Company declared a dividend on the Company’s Class A and Class C common shares for the first quarter of 2019 and has not declared dividends on the Company’s Class A and Class C common shares since that time, based on our Board of Trustees’ assessment of the Company’s investment opportunities and its expectations of taxable income for the remainder of 2020. The Company intends to, at a minimum, make distributions to our shareholders to comply with the REIT requirements of the Code, which may be satisfied by dividends on the Company’s Series A Preferred shares.
The Company declared total dividends of $0.25, $1.00 and $1.00 per common share for the years ended December 31, 2019, 2018 and 2017, respectively. The dividends have been reflected as follows for U.S. federal income tax purposes:
(1)
In 2018, the fourth quarter dividend of 2018 declared on October 23, 2018 was allocated to the 2019 tax year.
The Company’s Board of Trustees also declared the following dividends on preferred shares during 2019 and 2018:
(1)
This dividend covers the period from, and including, December 14, 2017 to December 31, 2017.
Note 13 - Earnings per Share
The table below provides a reconciliation of net loss and the number of common shares used in the computations of “basic” earnings per share (“EPS”), which utilizes the weighted-average number of common shares outstanding without regard to dilutive potential common shares, and “diluted” EPS, which includes all such shares. Potentially dilutive securities consist of shares of non-vested restricted stock and the redeemable non-controlling interests in the Operating Partnership.
All outstanding non-vested shares that contain non-forfeitable rights to dividends are considered participating securities and are included in computing EPS pursuant to the two-class method which specifies that all outstanding non-vested share-based payment awards that contain non-forfeitable rights to distributions are considered participating securities and should be included in the computation of EPS.
Earnings per share has not been presented for Class B shareholders, as they do not have economic rights.
No adjustments were made to the numerator for the years ended December 31, 2019, 2018 or 2017 because the Company generated a net loss. During periods of net loss, undistributed losses are not allocated to the participating securities as they are not required to absorb losses.
No adjustments were made to the denominator for the years ended December 31, 2019, 2018 or 2017 because (i) the inclusion of outstanding non-vested restricted shares would have had an anti-dilutive effect and (ii) including the non-controlling interest in the
Operating Partnership would also require that the share of Operating Partnership loss attributable to such interests be added back to net loss, therefore, resulting in no effect on earnings per share.
As of December 31, 2019, 2018 and 2017, there were 349,318, 403,129 and 245,570 shares, respectively, of non-vested restricted shares outstanding.
Note 14 - Share-Based Compensation
On July 7, 2015, the Company adopted the Seritage Growth Properties 2015 Share Plan (the “Plan”). The number of shares of common stock reserved for issuance under the Plan is 3,250,000. The Plan provides for grants of restricted shares, share units, other share-based awards, options, and share appreciation rights, each as defined in the Plan (collectively, the "Awards"). Directors, officers, other employees, and consultants of the Company and its subsidiaries and affiliates are eligible for Awards.
Restricted Shares and Share Units
Pursuant to the Plan, the Company has periodically made grants of restricted shares or share units. The vesting terms of these grants are specific to the individual grant and vary in that a portion of the restricted shares and share units vest in equal annual amounts over the subsequent three years (time-based vesting) and a portion of the restricted shares and share units vest on the third, and in some instances, the fourth anniversary of the grants subject to the achievement of certain performance criteria (performance-based and market-based vesting).
In general, participating employees are required to remain employed for vesting to occur (subject to certain limited exceptions). Restricted shares and share units that do not vest are forfeited. Dividends on restricted shares and share units with time-based vesting are paid to holders of such shares and share units and are not returnable, even if the underlying shares or share units do not ultimately vest. Dividends on restricted shares and share units with performance-based vesting are accrued when declared and paid to holders of such shares on the third, and in some instances, the fourth anniversary of the initial grant subject to the vesting of the underlying shares. See Note 2 for valuation information related to the grants of the awards that are subject to market-based vesting conditions.
The following table summarizes restricted share activity for the grant periods ended December 31, 2019 and 2018:
The Company recognized share-based compensation of $6.8 million, $7.5 million and $7.0 million for the years ended December 31, 2018, 2017 and 2016, respectively. Compensation expenses related to the restricted shares are included in general and administrative expenses on the Company's consolidated statements of operations.
As of December 31, 2019, there were $7.4 million of total unrecognized compensation costs related to the outstanding restricted shares which is expected to be recognized over a weighted-average period of approximately 1.6 years. As of December 31, 2018, there were $9.3 million of total unrecognized compensation costs related to the outstanding restricted shares which is expected to be recognized over a weighted-average period of approximately 1.9 years.
Note 15 - Quarterly Financial Information (unaudited)
The following table sets forth the selected quarterly financial data for the Company (in thousands, except per share amounts):
Certain of the above selected quarterly financial data includes significant depreciation and amortization expense related to the demolition of certain buildings for redevelopment and the accelerated amortization of certain lease intangibles as a result of the recapture of space from, or the termination of space by, Holdco and Sears Holdings. Certain of the above selected quarterly financial data also includes gains on the sale of interests in unconsolidated joint ventures and gains on the sale of real estate. The following table sets forth these selected quarterly financial data for the Company (in thousands, except per share amounts):
(1)
Denotes depreciation and amortization expense related to the demolition of certain buildings for redevelopment and the accelerated amortization of certain lease intangibles.
(2)
Denotes gains on the on the sale of interests in unconsolidated joint ventures and gains on the sale of real estate.
SERITAGE GROWTH PROPERTIES
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2019
(Dollars in thousands)
(1)
The aggregate cost of land, building and improvements (which includes construction in process) for U.S. federal income tax purposes is approximately $2.5 billion.
(2)
The Term Loan Facility is secured on a first lien basis by individual mortgages and a pledge of the capital stock of the direct subsidiaries of the Company, including those that own each of the Company’s properties. See Note 6.
(3)
Depreciation is computed based on the following estimated useful lives:
Building:
25 - 40 years
Site improvements:
5 - 15 years
Tenant improvements:
shorter of the estimated useful life or non-cancelable term of lease
SERITAGE GROWTH PROPERTIES
NOTES TO SCHEDULE III
(Dollars in thousands)
Reconciliation of Real Estate
Reconciliation of Accumulated Depreciation