10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015

Commission file number 001-37420

 

 

SERITAGE GROWTH PROPERTIES

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   38-3976287

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

489 Fifth Avenue, 18th Floor, New York, New York   10017
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (212) 355-7800

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Class A common shares of beneficial interest, par value

$0.01 per share

  New York Stock Exchange

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes    ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of July 6, 2015 was approximately $1,163,986,000 based upon the closing price of $37.10 of the registrant’s common stock as reported on the New York Stock Exchange. The registrant has elected to use July 6, 2015 as the calculation date, which was the initial trading date of the registrant’s common shares on the New York Stock Exchange, because as of the last business day of the registrant’s most recently completed second fiscal quarter, the registrant was a privately held company.

As of March 4, 2016, the registrant had the following common shares outstanding:

 

Class

   Shares Outstanding  

Class A common shares of beneficial interest, par value $0.01 per share

     25,261,542   

Class B common shares of beneficial interest, par value $0.01 per share

     1,589,020   

Class C common shares of beneficial interest, par value $0.01 per share

     6,329,485   

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Seritage Growth Properties’ Proxy Statement for its 2016 Annual Meeting of Shareholders, to be held May 3, 2016, are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 

 


Table of Contents

SERITAGE GROWTH PROPERTIES

ANNUAL REPORT ON FORM 10-K

PERIOD FROM JULY 7, 2015 (Date Operations Commenced) TO DECEMBER 31, 2015

TABLE OF CONTENTS

 

         Page  

PART I

  

Item 1.

 

Business

     1   

Item 1A.

 

Risk Factors

     5   

Item 1B.

 

Unresolved Staff Comments

     25   

Item 2.

 

Properties

     26   

Item 3.

 

Legal Proceedings

     36   

Item 4.

 

Mine Safety Disclosures

     37   

PART II

  

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     38   

Item 6.

 

Selected Financial Data

     40   

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     41   

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

     51   

Item 8.

 

Financial Statements and Supplementary Data

     51   

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     52   

Item 9A.

 

Controls and Procedures

     52   

Item 9B.

 

Other Information

     52   

PART III

  

Item 10.

 

Directors, Executive Officers, and Corporate Governance

     53   

Item 11.

 

Executive Compensation

     53   

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     53   

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     53   

Item 14.

 

Principal Accounting Fees and Services

     53   

PART IV

  

Item 15.

 

Exhibits and Financial Statement Schedule

     54   
 

Signatures

     57   

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (the “Annual Report”) of Seritage Growth Properties contains statements that constitute forward-looking statements within the meaning of the federal securities laws. Any statements that do not relate to historical or current facts or matters are forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the opposite of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. Statements concerning current conditions may also be forward-looking if they imply a continuation of current conditions. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

Forward-looking statements involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise and we may not be able to realize them. The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:

 

    Declines in retail, real estate and general economic conditions;

 

    Our current dependence on Sears Holdings Corporation for a substantial majority of our revenue;

 

    Sears Holdings Corporation’s termination and other rights under its master lease with us;

 

    Risks relating to our recapture and redevelopment activities and potential acquisition or disposition of properties;

 

    Our limited operating history as an independent public company;

 

    The terms of our indebtedness;

 

    Tax, environmental, health, safety and land use laws and regulations; and

 

    Restrictions with which we are required to comply in order to maintain REIT status.

While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. Except as required by law, we disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors of new information, data or methods, future events or other changes. For a further discussion of these and other factors that could impact our future results, performance or transactions, see “Item 1A. Risk Factors.”

 

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PART I

 

ITEM 1. BUSINESS

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 through, directly or indirectly, 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 real estate throughout the United States. As of December 31, 2015, our portfolio included approximately 42.4 million square feet of gross leasable area (“GLA”), consisting of 235 wholly owned properties totaling over 37.0 million square feet of GLA across 49 states and Puerto Rico, and interests in 31 joint venture properties totaling over 5.4 million square feet of GLA across 17 states.

On June 11, 2015 Sears Holdings Corporation (“Sears Holdings”) 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 234 of Sears Holdings’ owned properties and one of its ground leased properties (the “Wholly Owned Properties”), and its 50% interests in three joint ventures (the “JV Interests”) that collectively own 28 properties, ground lease one property and lease two properties (collectively, the “JV Properties”) (collectively, 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 on July 6, 2015.

On July 7, 2015, the Company completed the Transaction with Sears Holdings and commenced operations. The Company’s only operations prior to the completion of the Rights Offering and Transaction were those incidental to the completion of such activities.

As of December 31, 2015, we leased a substantial majority of the space in our portfolio at all but 11 of the Wholly Owned Properties (such 11 properties, the “Third-Party Properties”) to Sears Holdings under a master lease agreement (the “Master Lease”), with the remainder of such space leased to third-party tenants. The Third-Party Properties, which do not contain a Sears Holdings store or have any space leased to Sears Holdings, are leased solely to third-party tenants. A substantial majority of the space at the JV Properties is also leased to Sears Holdings by, as applicable, GS Portfolio Holdings LLC (the “GGP JV”), a joint venture between a subsidiary of the Operating Partnership and a subsidiary of General Growth Properties, Inc. (together with its other subsidiaries, “GGP”), SPS Portfolio Holdings LLC (the “Simon JV”), a joint venture between a subsidiary of the Operating Partnership and a subsidiary of Simon Property Group, Inc. (together with its other subsidiaries, “Simon”), or MS Portfolio LLC (the “Macerich JV” and, together with the GGP JV and the Simon JV, each, a “JV” and collectively, the “JVs”), a joint venture between a subsidiary of the Operating Partnership and a subsidiary of The Macerich Company (together with its subsidiaries, “Macerich”), in each case under a separate master lease with each JV (the “JV Master Leases”).

The Master Lease and the JV Master Leases provide the Company and the JVs with the right to recapture certain space from Sears Holdings at each property for retenanting or redevelopment purposes.

Business Strategies

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 net operating income (“NOI”) by re-leasing space to third-party retailers at materially higher rents while also substantially diversifying our tenant base. 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. We intend to increase NOI and diversify our portfolio by actively recapturing space at our properties and re-leasing such space to third-party retailers for higher rents than are payable under the Master Lease by Sears Holdings.

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

 

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area. We believe that the superior real estate locations, diversity of property types and national footprint that characterize our portfolio, combined with the unique recapture features of the Master Lease, 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.

 

  Maximize value of vast land holdings through retail and mixed-use densification. Our portfolio includes over 3,000 acres of land, or approximately 13 acres per site for our Wholly Owned Properties, and our most significant geographic concentrations are 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 addition to the right to recapture up to approximately 50% of the space occupied by Sears Holdings at substantially all of our Wholly Owned Properties, the Master Lease provides us with the right to recapture (i) 100% of the stores located at 21 identified properties; (ii) all of any automotive care centers which are free-standing or attached as “appendages” to the stores; and (iii) outparcels or outlots, as well as certain portions of parking areas and common areas.

The 21 identified properties for which we have 100% recapture rights include over 3.9 million square feet of entitled commercial space on over 350 acres of land and our portfolio of automotive care centers encompasses approximately 3.5 million square feet of scarce real estate typically located on the most visible and highly-trafficked site at a property. Given our fee ownership of these properties and control over parking lots and outparcels, we believe that many of these sites, as well as others throughout the portfolio, will provide attractive and value-enhancing development, redevelopment and densification opportunities.

 

  Leverage existing and future joint venture relationships with leading real estate and financial partners. We currently own 50% interests in 31 JV Properties with leading regional mall REITs each of which, we believe, is focused on driving value creation at the JV Properties through recapturing and re-leasing space pursuant to the JV Master Leases.

We participate in 50% of all net value created at the JV Properties and expect to benefit from the leasing and redevelopment platforms of our JV partners, as well as stores that are, generally, located at high-productivity malls within their respective portfolios.

We may 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 expertise or, as a result of circumstances, allow us to create more value together than we believe we could create on our own.

 

  Maintain a flexible capital structure to support value creation activities. The capital structure resulting from the Transaction provides us with sufficient financial flexibility and capacity to fund our current capital needs and redevelopment opportunities. We believe we have access to multiple forms of capital, including internally generated cash from operations, that can provide us with additional funding to invest in value-creating projects.

Significant Tenants

Substantially all of the Company’s real estate properties are leased to Sears Holdings, and the majority of our rental revenues are derived from the Master Lease.

The Master Lease provides Seritage the right to recapture up to approximately 50% of the space occupied by Sears Holdings at each of the Wholly Owned Properties included in the Master Lease (subject to certain exceptions). In addition, Seritage has the right to recapture any automotive care centers which are freestanding or attached as “appendages” to the stores, and all outparcels or outlots, as well as certain portions of parking areas and common areas. We also have the right to recapture 100% of the space occupied by Sears Holdings at each of 21 identified Wholly Owned Properties by making a specified lease termination payment to Sears Holdings. While we will be permitted to exercise our recapture rights all at once or in stages as to any particular property, we will not be permitted to recapture all or substantially all of the space subject to the recapture right at more than 50 Wholly Owned Properties during any lease year.

The Master Lease also provides for certain rights to Sears Holdings to terminate the Master Lease with respect to Wholly Owned Properties that cease to be profitable for operation by Sears Holdings. In order to terminate the Master Lease with respect to a certain property, Sears Holdings must make a payment to us of an amount equal to one year of rent (together with taxes and other expenses) with respect to such property. Such termination right, however, will be limited so that it will not have the effect of reducing the fixed rent under the Master Lease by more than 20% per annum. Further, no such termination rights can be exercised prior to August 1, 2016.

 

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A substantial majority of the space at the JV Properties is leased to Sears Holdings under the JV Master Leases which include recapture rights and termination rights with similar terms as the Master Lease.

Sears Holdings is a publicly traded company and is subject to the informational filing requirements of the Securities Exchange Act of 1934, as amended, and is required to file periodic reports on Form 10-K and Form 10-Q with the Securities and Exchange Commission (“SEC”); refer to www.sec.gov for Sears Holdings Corporation’s publicly available financial information. We make no representation as to the accuracy or completeness of the information regarding Sears Holdings that is available through the SEC’s website or otherwise made available by Sears Holdings or any third party, and none of such information is incorporated by reference herein.

Competition

We compete for investment opportunities and prospective tenants with other REITs, real estate partnerships or other real estate companies, private individuals, investment companies, private equity and hedge fund investors, sovereign funds, pension funds, insurance companies, lenders and other investors. 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 Master Lease obligates Sears Holdings 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 Master Lease. We expect that any future leases will 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

 

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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 Master Lease, Sears Holdings 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 Sears Holdings, including removal and remediation of all affected facilities and equipment constituting the automotive care center facilities (and each JV Master Lease includes a similar requirement of Sears Holdings). In addition, pursuant to the terms our debt financing agreements, an escrow account for environment remediation was funded at the closing of the Transaction in the amount of approximately $12.0 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.

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 plan to elect to be treated as a REIT for U.S. federal income tax purposes commencing with our initial 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 retail properties. We review operating and financial information for each property on an individual basis and therefore, each property represents an individual operating segment. We do not distinguish or group our consolidated operations based on geography, size, or type. We 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 March 4, 2016, we had 21 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 489 Fifth Avenue, New York, New York 10017 and our telephone number is (212) 355-7800. Our website address is www.seritage.com. Our reports electronically filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities 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.

 

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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 will be substantially dependent on Sears Holdings, as a tenant, until we diversify the tenancy of our portfolio, and an event that has a material adverse effect on Sears Holdings’ business, financial condition or results of operations could have a material adverse effect on our business, financial condition or results of operations.

Sears Holdings is the lessee of a substantial majority of our properties and accounts for a substantial majority of our revenues. Under the Master Lease, Sears Holdings is required to pay all insurance, taxes, utilities and maintenance and repair expenses in connection with these leased properties and to indemnify, defend and hold us harmless from and against various claims, litigation and liabilities arising in connection with its business, subject to proportionate sharing of certain of these expenses with occupants of the remainder of the space not leased to Sears Holdings. We also rely on Sears Holdings for certain support services, pursuant to a transition services agreement that we have entered into with a subsidiary of Sears Holdings (the “Transition Services Agreement”). Sears Holdings may not in the future have sufficient assets, income and access to financing to enable it to satisfy its payment obligations under the Master Lease. In addition, Sears Holdings has disclosed that its domestic pension and postretirement benefit plan obligations are currently underfunded. Sears Holdings may have to make significant cash payments to some or all of its pension and postretirement benefit plans, which would reduce the cash available for its businesses, potentially including its rent obligations under the Master Lease. The inability or unwillingness of Sears Holdings to meet its rent obligations and other obligations under the Master Lease could materially adversely affect our business, financial condition or results of operations, including our ability to pay the interest, principal and other costs and expenses under our financings, or to pay dividends to Seritage shareholders as required to maintain our status as a REIT. For these reasons, if Sears Holdings were to experience a material adverse effect on its business, financial condition or results of operations, our business, financial condition or results of operations could also be materially adversely affected.

Our dependence on rental payments from Sears Holdings as our main source of revenues may limit our ability to enforce our rights under the Master Lease. In addition, we may be limited in our ability to enforce our rights under the Master Lease because it 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 Sears Holdings to comply with the terms of the 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 Sears Holdings. 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. In addition, each JV is subject to similar limitations on enforcements of remedies and risks under its respective JV Master Lease, which could reduce the value of our investment in, or distributions to us by, one or more of the JVs.

The bankruptcy or insolvency of any of our tenants, particularly Sears Holdings, could result in the termination of such tenant’s lease and material losses to us.

A tenant bankruptcy or insolvency 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. In particular, a bankruptcy or insolvency of Sears Holdings, which is our primary tenant, could result in a loss of a substantial portion of our rental revenue and materially and adversely affect us. Any claims against bankrupt tenants for unpaid future rent would be 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 will likely not be paid in full. If a tenant becomes bankrupt or insolvent, federal law may prohibit us from evicting such tenant based solely upon such 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.

 

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Sears Holdings leases a substantial majority of our properties. Bankruptcy laws afford certain protections to tenants that may also affect the Master Lease or JV Master Leases. 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. Whether or not a bankruptcy court will 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 in a Sears Holdings bankruptcy were to allow the Master Lease or a JV Master Lease to be rejected in part, certain underperforming leases related to properties we or the applicable JV as landlord under a JV Master Lease, respectively, 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. For this and other reasons, a Sears Holdings bankruptcy could materially and adversely affect us.

In addition, although we believe that the 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 Master Lease as a secured lending transaction. If the Master Lease were 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 the bankruptcy proceeding. In addition, each JV is subject to this risk with respect to its JV Master Lease, which could reduce the value of our investment in, or distribution to us by, one or more of the JVs.

Sears Holdings’ right to terminate the Master Lease with respect to a portion of our properties could negatively impact our business, results of operations and financial condition.

Under the terms of the Master Lease, in each year after the first lease year, Sears Holdings will have the right to terminate the Master Lease with respect to properties representing up to 20% of the aggregate annual rent payment under the Master Lease with respect to all properties, if, with respect to a property leased under the Master Lease, the EBITDAR for the 12-month period ending as of the most recent fiscal quarter end produced by the Sears Holdings store operated there is less than the rent allocated to such property payable during that year. While Sears Holdings must pay a termination fee equal to one year of rent (together with taxes and other expenses) with respect to such property, the value of some of the properties could be materially adversely affected if we are not able to re-lease such properties at the same rates which Sears Holdings was paying in a timely manner or at all, and this may negatively impact our business, results of operations and financial condition. In addition, Sears Holdings will have the right to terminate a portion of the JV Master Lease with the GGP JV with respect to up to four JV Properties in any lease year, the JV Master Lease with the Simon JV with respect to up to three JV Properties in any lease year and the JV Master Lease with the Macerich JV with respect to up to three JV Properties in any lease year, in each case if, with respect to a JV Property owned by the applicable JV, the same EBITDAR condition is satisfied, which could reduce the value of our investment in, or distributions to us by, one or more of the JVs.

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, the premises may not be re-released in a timely manner or at all, or the terms of re-releasing, including the cost of allowances and concessions to tenants, may be less favorable than the current 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.

 

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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.

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 are subject to the Master Lease or a JV Master Lease, as the terms of the Master Lease and the JV Master Leases or the fact that Sears Holdings 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.

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.

In addition, the retail business is highly competitive and if our 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 Sears Holdings, 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.

 

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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.

In addition, we intend to redevelop a significant portion of the properties purchased from Sears Holdings in order to make space available for lease to additional retail tenants and potentially other third-party 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 that Sears Holdings 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, from Sears Holdings related to space that is recaptured pursuant to the Master Lease (or the JV Master Leases) and 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;

 

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    inability to operate successfully in new markets where new properties are located;

 

    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 Master Lease and the JV Master Leases are generally leased on a triple-net basis (subject to proportionate sharing of operating expenses with respect to space not leased by Sears Holdings), 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 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.

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 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 Master Lease and some third-party tenant leases may 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, among other things, in 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

 

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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 considers 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 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 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, three 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 Holdings operation or cessation of business operations, on the encumbered property.

 

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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 market, 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 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 third-party 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 has not incurred significant expenditures to comply with these laws with respect to the substantial majority of the space at the properties. 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

 

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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.

Under the Master Lease, Sears Holdings is required to indemnify us from certain environmental liabilities at the properties purchased from Sears Holdings before or during the period in which each property is leased to Sears Holdings, including removal and remediation of all affected facilities and equipment constituting the automotive care center facilities (and each JV Master Lease includes a similar requirement of Sears Holdings). Although existing and future third-party 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 Sears Holdings or other third parties are 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.

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.

 

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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.

We may have future capital needs and may not be able to obtain additional financing on acceptable terms.

As of December 31, 2015, we had aggregate outstanding indebtedness of approximately $1.2 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.

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.

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 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.

 

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We expect to 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 obtain funds to acquire additional real properties. The Company may also borrow if it needs funds or deems it necessary or advisable to assure that it maintains its qualification as a REIT for 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 tax purposes, a foreclosure of any of our properties 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, which could result in us losing our REIT status.

Covenants in our debt agreements may limit our operational flexibility, and a covenant breach or default could materially adversely affect our business and financial condition.

The agreements governing our indebtedness contain customary covenants for a real estate financing, including restrictions on the ability of the borrowers under the agreements governing our existing indebtedness to grant liens on their assets (including the Wholly Owned Properties and JV Interests, which comprise substantially all of our assets as of the closing of the Transaction), incur additional indebtedness, or transfer or sell assets. Such restrictions also include cash flow sweep provisions based on certain measures of our financial and operating performance, including in the case that “Debt Yield” (the ratio of net operating income for the borrowers to their debt) is less than 11.0% or if we fail to achieve certain thresholds for tenant diversification. If a cash flow sweep period is triggered under the loan agreements, we expect that we will be constrained in our ability to use cash generated by the Wholly Owned Properties to pay dividends and distributions to holders of Seritage common shares and Operating Partnership units. The covenants in our loan agreements also require Seritage to maintain a minimum consolidated liquidity and minimum consolidated net worth. Covenants that limit our operational flexibility as well as defaults under our debt instruments could have a material adverse effect on our business and financial condition.

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 independent from Sears Holdings 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. The Company is required to implement substantial control systems and procedures in order to maintain its qualification as a REIT, satisfy its 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.

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”).

For as long as we are an “emerging growth company” under the recently enacted JOBS Act or we remain a non-accelerated filer, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404(b). We could be an emerging growth company until December 31,

 

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2020. An independent assessment of the effectiveness of our internal controls could detect problems that our management’s assessment might not detect. Undetected material weaknesses in our internal controls could lead to financial statement restatements and require us to incur the expense of remediation.

For as long as we are an emerging growth company and while remaining a non-accelerated filer, we will not be required to comply with certain reporting requirements that apply to other public companies.

As an “emerging growth company” under the JOBS Act, we may take advantage of provisions that, among other things, reduce certain reporting requirements, including relating to accounting standards and compensation disclosure. For as long as we are an emerging growth company and while remaining a non-accelerated filer, which may be up to five full fiscal years, unlike most other public companies, we will not be required to:

 

    provide an auditor’s attestation report on the effectiveness of our system of internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act;

 

    comply with any new requirements adopted by the Public Company Accounting Oversight Board, requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer;

 

    provide certain disclosure regarding executive compensation required of larger public companies; or

 

    hold shareholder advisory votes on executive compensation.

Our status as an “emerging growth company” under the JOBS Act may make it more difficult to raise capital as and when we need it.

Because of the exemptions from various reporting requirements provided to us as an “emerging growth company,” we may be less attractive to investors and it may be difficult for us to raise additional capital as and when we need it. Investors may be unable to compare our business with other companies in our industry if they believe that our financial accounting is not as transparent as other companies in our industry. If we are unable to raise additional capital as and when we need it, our financial condition and results of operations may be materially and adversely affected.

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, the Company’s Declaration of Trust authorizes it and Seritage’s bylaws obligate it to indemnify its 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.

 

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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 Companys 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 common shares may be owned, beneficially or constructively, by five or fewer individuals at any time during the last half of each taxable year other than the first year for which we elect to be taxed as a REIT. Additionally, at least 100 persons must beneficially own Class A common shares during at least 335 days of a taxable year (other than the first taxable year for which we elect to be taxed as a REIT). The Company’s Declaration of Trust, with certain exceptions, authorizes 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 of our shares 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 that would result in our being “closely held” under Section 856(h) of the Code or otherwise cause us to fail to qualify as a REIT. Any attempt to own or transfer Class A common shares or any of our other shares of beneficial interest in violation of these restrictions or other 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 Class A common shares in excess of the ownership limits will be transferred to a trust for the exclusive benefit of a designated charitable beneficiary, and that any person who acquires Class A common shares in violation of the ownership limits 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 6.0% of the voting power of the Company, all of which are held by ESL Partners, L.P. and Edward S. Lampert (“ESL”), and Class C non-voting common shares entitled to, in the aggregate, 21.4% of the dividends or other distributions issued to holders of shares of beneficial interest of the Company, all of which are held by clients (“Fairholme Clients”) of Fairholme Capital Management L.L.C. (“FCM”). 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 75% of the Class A Common Shares and Class B Non-Economic Common Shares Entitled to Vote. 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 75% of the votes 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,

 

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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 75% of the votes 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 75% of the votes 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 and/or Fairholme Clients, which control approximately 9.7% and approximately 9.0%, respectively, 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:

 

    “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 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;

 

    “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

 

    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 FCM and/or Fairholme Clients and their respective affiliates and (b) between us and any other person, provided that such 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.

 

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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 Master Lease and other existing third-party 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.

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, 2015, ESL owns approximately 43.4% 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

 

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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 change of control transactions involving Seritage or Operating Partnership, sales of all or substantially all of the assets of Operating Partnership, waivers to the excess share provision in the Declaration of Trust of the Company, 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. As long as ESL owns a majority of the outstanding Operating Partnership units not held by the Company and entities controlled by it (and, for certain actions, as long as ESL holds at least 40% of the economic interests of Seritage and Operating Partnership on a combined basis), ESL’s approval will be required in order for the general partner to undertake such actions. If ESL refuses to approve a transaction, our business could be materially adversely affected. Furthermore, ESL owns approximately 3.9% of the outstanding Class A common shares, as well as Class B non-economic common shares having, in the aggregate, 9.7% 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 Sears Holdings, and its interests may differ from or conflict with the interests of our other shareholders.

As of December 31, 2015, ESL beneficially owns approximately 43.4% of the Operating Partnership units, and approximately 3.9% of the outstanding Class A common shares and Class B non-economic common shares having, in the aggregate, 9.7% of the voting power of Seritage. ESL also beneficially owns approximately 49.6% of the outstanding common stock of Sears Holdings. In addition, Mr. Lampert, the Chairman of the Board and Chief Executive Officer of Sears Holdings and 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 Sears Holdings. In any matter affecting us, including our relationship with Sears Holdings, the interests of ESL may differ from or conflict with the interests of our other shareholders.

The businesses of each of the GGP JV, 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 JV, the Simon JV and/or the Macerich JV.

The GGP JV is a joint venture that owns and operates certain JV Properties, which consist of twelve 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 ten other 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 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 JV, the Simon JV and the Macerich JV, and responsibility for leasing and redevelopment activities related to the JV Properties owned by the GGP JV, 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 JV are located at malls owned and operated

 

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by GGP, 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 JV, 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 depend on Sears Holdings to provide us with certain services for our business which may not be sufficient to meet our business needs, and we may have difficulty finding replacement services or be required to pay increased costs to replace these services after our agreements with Sears Holdings expire.

Certain administrative services required for the operation of our business are provided by Sears Holdings. We entered into various agreements that effected the purchase and sale of the acquired properties and the lease or sublease of a substantial majority of the acquired properties to Sears Holdings, including, among others, the Subscription, Distribution and Purchase and Sale Agreement, the Master Lease and the Transition Services Agreement. The Subscription, Distribution and Purchase and Sale Agreement provide for, among other things, our responsibility for liabilities relating to our business and the responsibility of Sears Holdings for liabilities unrelated to our business. The agreements between us and Sears Holdings also govern our various interim and ongoing relationships. The Subscription, Distribution and Purchase and Sale Agreement also contains indemnification obligations and ongoing commitments of us and Sears Holdings. The Master Lease governs the terms of the use and operation of the properties leased by us to Sears Holdings, including our redevelopment and recapture rights and Sears Holdings’ lease termination rights, and the repair, maintenance and redevelopment-related services Sears Holdings may provide to us. Under the Transition Services Agreement, Sears Holdings Management Corporation continues to provide select corporate support services to us.

After these agreements expire, or if Sears Holdings is unable to meet its obligations under these agreements, 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.

Sears Holdings 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 Sears Holdings’ ability to satisfy its indemnification obligations may be impaired in the future.

Pursuant to the Subscription, Distribution and Purchase and Sale Agreement and the Master Lease, Sears Holdings has agreed to indemnify us for certain liabilities. However, third parties could seek to hold us responsible for any of the liabilities that Sears Holdings has agreed to retain, and Sears Holdings may be unable to fully satisfy its indemnification obligations. Moreover, even if we ultimately succeed in recovering from Sears Holdings any amounts for which we are held liable, we may be temporarily required to bear these losses while seeking recovery from Sears Holdings. Any liabilities in excess of amounts for which we receive timely indemnification from Sears Holdings 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 plan to elect to be taxed as a REIT for U.S. federal income tax purposes commencing with our initial taxable year ended December 31, 2015 and expect to continue to operate to qualify as a REIT. References throughout this document to the “first taxable year” for which we have elected to be taxed as a REIT refer to the taxable year ended December 31, 2015. In connection with the Transaction, the Company received an opinion of Wachtell, Lipton, Rosen & Katz (“Wachtell Lipton”) with respect to its qualification as a REIT. Investors should be aware, however, that opinions of counsel are not binding on the IRS or any court. The opinion of Wachtell Lipton represented only the view of Wachtell Lipton based on its review and analysis of existing law and on certain representations as to factual matters and covenants made by us, including representations relating to the values of our assets and the sources of our income. The opinion is expressed as of the date it was issued. Wachtell Lipton has no obligation to advise us or the holders of Class A common shares of any subsequent change in the matters stated, represented or assumed or of any subsequent change in applicable law. Furthermore, both the validity of the opinion of Wachtell Lipton and our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, shareholder ownership and other requirements on a continuing basis, the results of

 

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which will not be monitored by Wachtell Lipton. 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.

If we were to fail to qualify as a REIT in any taxable year, we would be subject to U.S. federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and dividends paid to our shareholders would not be deductible by the Company 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, the Company 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. The Company’s 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 from Sears Holdings 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 Sears Holdings will not be treated as qualifying rent for purposes of these requirements if the Master 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. If the 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 Sears Holdings (or other 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 the Class A common shares actually or constructively owns 10% or more of the total combined voting power of all classes of Sears Holdings stock (or the stock of such other tenant) entitled to vote or 10% or more of the total value of all classes of Sears Holdings stock (or the stock of such other tenant). The Company’s Declaration of Trust provides for restrictions on ownership and transfer of Class A common shares, including restrictions on such ownership or transfer that would cause the rents we receive or accrue from Sears Holdings (or other tenants) 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 Sears Holdings (or other 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 some dividends.

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%. 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.

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

 

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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 intend to, at a minimum, make distributions to our shareholders to comply with the REIT requirements of the Code.

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. 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 Sears Holdings to make rental payments under the Master Lease would materially impair our ability to make distributions. Consequently, we may be unable to make distributions at the anticipated distribution rate or any other rate.

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, Seritage 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. In addition, we may incur a 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 25% of the value of our total assets can be represented by securities of one or more TRSs. If the Company fails 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 certain attractive investments.

 

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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 risk of interest rate changes with respect to borrowings made or to be made to acquire or carry real estate assets 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 could theoretically be carried back or forward against past or future taxable income in the TRS.

Legislative or other actions affecting REITs 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 (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 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 our investors and the Company of such qualification.

Risks Related to Ownership of our Common Shares

The market price and trading volume of our common shares may be volatile.

The market price of our common shares may be volatile, and the trading volume in our common shares may fluctuate and cause significant price variations to occur. Some of the factors that could negatively affect the market price of our common shares or result in fluctuations in the price or trading volume of our common shares 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 common shares 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 FCM and/or Fairholme Clients, or by institutional shareholders;

 

    speculation in the press or investment community about our company or industry or the economy in general;

 

    adverse performance by Sears Holdings, our primary tenant;

 

    the occurrence of any of the other risk factors presented in this filing;

 

    specific real estate market and real estate economic conditions; and

 

    general market and economic conditions.

 

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Future offerings of debt, which would be senior to our common shares upon liquidation, and/or preferred equity securities, which may be senior to our common shares for purposes of distributions or upon liquidation, may adversely affect the market price 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 and preferred shares and lenders with respect to other borrowings may receive distributions of our available assets prior to the holders of our common shares. 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 preferred shares of beneficial interest, if 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 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 transactions with Sears Holdings, 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 (and our subsidiaries) could arise in connection with any of the Subscription, Distribution and Purchase and Sale Agreement, the Master Lease, the Transition Services Agreement or other agreements.

A court could deem aspects of the transactions with Sears Holdings to be a fraudulent conveyance and void the transaction or impose substantial liabilities upon us.

A court could deem aspects of the transactions with Sears Holdings (such as the acquisition of properties from Sears Holdings) to be a fraudulent conveyance upon a subsequent legal challenge by unpaid creditors or a bankruptcy trustee of the debtor that made the conveyance. Fraudulent 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, the court could require our shareholders to return to Sears Holdings some or all of the Class A common shares issued in the distribution. Whether a transaction is a fraudulent conveyance may vary depending upon, among other things, the jurisdiction whose law is being applied.

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 and Class C non-voting 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 and Class C non-voting common shares.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

There are no unresolved comments from the staff of the SEC as of the date of this Annual Report.

 

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ITEM 2. PROPERTIES

As of December 31, 2015, our portfolio included 235 Wholly Owned Properties totaling over 37.0 million square feet of GLA across 49 states and Puerto Rico, and 50% interests in 31 JV Properties totaling over 5.4 million square feet of GLA across 17 states. The following tables set forth certain information regarding our Wholly Owned Properties and JV Properties based on signed leases as of December 31, 2015, including signed but not yet open leases (“SNO leases”):

 

Wholly Owned Properties

 
                   GLA (3)            
    

City

  

State

   Recapture
Rights (1)(2)
  Total      Sears
Holdings
     Third
Parties
     Vacant     

Sears or

Kmart

  

Significant Third-party Tenants (3)

   %
Leased
 
1   

Anchorage

   AK    100%     257,900         204,100         42,900         10,900       Sears   

Lands’ End, Nordstrom Rack

     95.8
2   

Cullman

   AL    50%     98,500         98,500         0         0       Kmart   

n/a

     100.0
3   

North Little Rock

   AR    50%     185,700         185,700         0         0       Sears   

n/a

     100.0
4   

Russellville

   AR    50%     88,000         88,000         0         0       Kmart   

n/a

     100.0
5   

Flagstaff

   AZ    50%     66,200         66,200         0         0       Sears   

n/a

     100.0
6   

Mesa

   AZ    50%     121,900         121,900         0         0       Sears   

n/a

     100.0
7   

Peoria

   AZ    n/a     104,400         0         104,400         0       n/a   

At Home

     100.0
8   

Phoenix

   AZ    50%     144,200         144,200         0         0       Sears   

n/a

     100.0
9   

Phoenix

   AZ    n/a     151,200         0         151,200         0       n/a   

At Home

     100.0
10   

Prescott

   AZ    50%     102,300         102,300         0         0       Sears   

n/a

     100.0
11   

Sierra Vista

   AZ    50%     94,700         94,700         0         0       Sears   

n/a

     100.0
12   

Sierra Vista

   AZ    50%     86,100         86,100         0         0       Kmart   

n/a

     100.0
13   

Tucson

   AZ    50%     250,100         250,100         0         0       Sears   

n/a

     100.0
14   

Yuma

   AZ    50%     90,400         90,400         0         0       Sears   

n/a

     100.0
15   

Antioch

   CA    50%     95,200         95,200         0         0       Kmart   

n/a

     100.0
16   

Big Bear Lake

   CA    50%     80,000         69,300         7,900         2,800       Kmart    Radio Shack, Subway, Wells Fargo Bank      96.5
17   

Carson

   CA    50%     181,200         163,400         17,800         0       Sears    Applebee’s, Chick-Fil-A, Chipotle Mexican Grill, Jersey Mike’s, Smash Burger      100.0
18   

Chula Vista

   CA    50%     250,100         250,100         0         0       Sears   

n/a

     100.0
19   

Citrus Heights

   CA    50%     289,500         280,700         8,800         0       Sears   

Lands’ End

     100.0
20   

Delano

   CA    50%     86,100         86,100         0         0       Kmart   

n/a

     100.0
21   

El Cajon

   CA    50%     286,500         275,700         10,800         0       Sears    Lands’ End, Wireless Choice      100.0
22   

El Centro

   CA    50%     139,700         139,700         0         0       Sears   

n/a

     100.0
23   

Fairfield

   CA    50%     164,100         159,300         4,800         0       Sears   

Lands’ End

     100.0
24   

Florin

   CA    50%     272,700         272,700         0         0       Sears   

n/a

     100.0
25   

Fresno

   CA    50%     217,600         217,600         0         0       Sears   

n/a

     100.0
26   

McKinleyville

   CA    50%     94,800         94,800         0         0       Kmart   

n/a

     100.0
27   

Merced

   CA    50%     92,600         92,600         0         0       Sears   

n/a

     100.0
28   

Montclair

   CA    50%     174,700         174,700         0         0       Sears   

n/a

     100.0
29   

Moreno Valley

   CA    50%     169,400         169,400         0         0       Sears   

n/a

     100.0
30   

Newark

   CA    50%     145,800         145,800         0         0       Sears   

n/a

     100.0
31   

North Hollywood

   CA    50%     151,000         151,000         0         0       Sears   

n/a

     100.0

 

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Wholly Owned Properties

 
                   GLA (3)            
    

City

  

State

   Recapture
Rights (1)(2)
  Total      Sears
Holdings
     Third
Parties
     Vacant     

Sears or

Kmart

  

Significant Third-party Tenants (3)

   %
Leased
 

32

   Northridge    CA    50%     291,800         256,900         34,900         0       Sears    Ashley Furniture      100.0

33

   Palm Desert    CA    50%     151,500         151,500         0         0       Sears    n/a      100.0

34

   Ramona    CA    50%     107,500         87,000         14,700         5,800       Kmart    Dollar Tree, Little Caesar’s      94.6

35

   Riverside    CA    50%     214,200         202,000         12,200         0       Sears    Bank of America      100.0

36

   Riverside    CA    50%     132,600         94,500         38,100         0       Kmart    Jack in the Box      100.0

37

   Roseville    CA    50%     139,000         131,400         7,600         0       Sears    Lands’ End      100.0

38

   Salinas    CA    50%     133,000         133,000         0         0       Sears    n/a      100.0

39

   San Bernardino    CA    100%     264,700         264,700         0         0       Sears    n/a      100.0

40

   San Bruno    CA    50%     276,600         267,900         8,700         0       Sears    Lands’ End      100.0

41

   San Diego    CA    50%     194,800         164,800         30,000         0       Sears    Lands’ End, Williams-Sonoma      100.0

42

   San Jose    CA    50%     262,500         262,500         0         0       Sears    n/a      100.0

43

   Santa Cruz    CA    50%     119,600         105,800         13,800         0       Sears    Lands’ End      100.0

44

   Santa Maria    CA    50%     108,600         108,600         0         0       Sears    n/a      100.0

45

   Santa Monica    CA    100%     117,800         112,000         5,800         0       Sears    Lands’ End      100.0

46

   Santa Paula    CA    50%     71,300         71,300         0         0       Kmart    n/a      100.0

47

   Temecula    CA    50%     115,600         115,600         0         0       Sears    n/a      100.0

48

   Thousand Oaks    CA    50%     164,000         50,300         113,700         0       Sears    DSW, Nordstrom Rack, The Sports Authority      100.0

49

   Ventura    CA    50%     178,600         171,900         6,700         0       Sears    Lands’ End      100.0

50

   Visalia    CA    50%     75,600         75,600         0         0       Sears    n/a      100.0

51

   West Covina    CA    50%     142,000         142,000         0         0       Sears    n/a      100.0

52

   Westminster    CA    100%     197,900         197,900         0         0       Sears    n/a      100.0

53

   Lakewood    CO    50%     153,000         153,000         0         0       Sears    n/a      100.0

54

   Thornton    CO    50%     190,200         190,200         0         0       Kmart    n/a      100.0

55

   Waterford    CT    50%     149,300         141,800         7,500         0       Sears    Lands’ End      100.0

56

   West Hartford    CT    100%     202,100         186,900         15,200         0       Sears    Lands’ End, Olive Garden      100.0

57

   Rehoboth Beach    DE    50%     122,200         117,200         5,000         0       Kmart    Chick-Fil-A      100.0

58

   Altamonte Springs    FL    50%     214,300         205,600         8,700         0       Sears    Seasons 52      100.0

59

   Boca Raton    FL    50%     178,500         167,600         10,900         0       Sears    Lands’ End, Washington Mutual      100.0

60

   Bradenton    FL    50%     99,900         99,900         0         0       Sears    n/a      100.0

61

   Bradenton    FL    50%     82,900         82,900         0         0       Kmart    n/a      100.0

62

   Clearwater    FL    50%     211,700         129,700         82,000         0       Sears    Lands’ End, Nordstrom Rack, Whole Foods      100.0

63

   Doral    FL    50%     212,900         212,900         0         0       Sears    n/a      100.0

64

   Ft. Myers    FL    50%     146,800         146,800         0         0       Sears    n/a      100.0

65

   Gainesville    FL    50%     140,500         140,500         0         0       Sears    n/a      100.0

66

   Hialeah    FL    50%     197,400         184,400         13,000         0       Sears    Forever 21, Goodwill      100.0

67

   Hialeah    FL    50%     106,400         88,400         18,000         0       Kmart    Aldi      100.0

68

   Kissimmee    FL    50%     148,900         112,500         36,400         0       Kmart    Big Lots      100.0

 

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Wholly Owned Properties

 
                   GLA (3)            
    

City

  

State

   Recapture
Rights (1)(2)
  Total      Sears
Holdings
     Third
Parties
     Vacant     

Sears or

Kmart

  

Significant Third-party Tenants (3)

   %
Leased
 

69

   Lakeland    FL    50%     156,200         156,200         0         0       Sears    n/a      100.0

70

   Melbourne    FL    50%     102,600         102,600         0         0       Sears    n/a      100.0

71

   Miami    FL    100%     173,300         173,300         0         0       Sears    n/a      100.0

72

   Miami    FL    100%     170,100         170,100         0         0       Sears    n/a      100.0

73

   Naples    FL    50%     161,900         151,800         10,100         0       Sears    n/a      100.0

74

   North Miami    FL    100%     122,200         106,300         15,900         0       Kmart    Aldi      100.0

75

   Ocala    FL    50%     146,200         146,200         0         0       Sears    n/a      100.0

76

   Orange Park    FL    n/a     87,400         0         87,400         0       n/a    Old Time Pottery, Freddy’s Frozen Custard      100.0

77

   Orlando    FL    100%     202,000         197,500         4,500         0       Sears    Lands’ End      100.0

78

   Panama City    FL    50%     139,300         139,300         0         0       Sears    n/a      100.0

79

   Pensacola    FL    50%     212,300         212,300         0         0       Sears    n/a      100.0

80

   Plantation    FL    50%     201,600         201,600         0         0       Sears    n/a      100.0

81

   Sarasota    FL    50%     212,500         204,500         8,000         0       Sears    Lands’ End      100.0

82

   St. Petersburg    FL    50%     120,600         120,600         0         0       Kmart    n/a      100.0

83

   St. Petersburg    FL    100%     193,900         187,000         6,900         0       Sears    n/a      100.0

84

   Atlanta    GA    50%     226,300         218,700         7,600         0       Sears    Lands’ End      100.0

85

   Savannah    GA    100%     167,300         155,700         11,600         0       Sears    Golden Corral      100.0

86

   Honolulu (4)    HI    100%     77,400         34,100         43,300         0       Kmart    Long’s Drugs (CVS), PetSmart      100.0

87

   Algona    IA    50%     99,300         99,300         0         0       Kmart    n/a      100.0

88

   Cedar Rapids    IA    50%     146,000         141,100         4,900         0       Sears    Lands’ End      100.0

89

   Charles City    IA    50%     96,600         96,600         0         0       Kmart    n/a      100.0

90

   Webster City    IA    50%     40,800         40,800         0         0       Kmart    n/a      100.0

91

   Boise    ID    50%     123,600         123,600         0         0       Sears    n/a      100.0

92

   Chicago    IL    50%     356,700         356,700         0         0       Sears    n/a      100.0

93

   Chicago    IL    50%     293,700         293,700         0         0       Sears    n/a      100.0

94

   Chicago    IL    50%     168,500         118,800         49,700         0       Kmart    China Town Buffet, Chuck E Cheese      100.0

95

   Homewood    IL    n/a     196,100         0         196,100         0       n/a    Wal-Mart      100.0

96

   Joliet    IL    50%     204,600         204,600         0         0       Sears    n/a      100.0

97

   Lombard    IL    n/a     139,300         0         139,300         0       n/a    The Dump      100.0

100

   Orland Park    IL    50%     199,600         192,400         7,200         0       Sears    Lands’ End      100.0

101

   Springfield    IL    50%     126,900         84,200         42,700         0       Kmart    Casual Male, Popeye’s, Staples      100.0

102

   Steger    IL    50%     87,400         87,400         0         0       Kmart    n/a      100.0

103

   Elkhart    IN    50%     86,500         86,500         0         0       Kmart    n/a      100.0

104

   Ft. Wayne    IN    50%     220,000         213,500         6,500         0       Sears    Lands’ End      100.0

105

   Merrillville    IN    50%     173,100         108,300         38,900         25,900       Kmart    Dollar Tree, Payless ShoeSource, Sherwin-Williams      85.0

106

   Leavenworth    KS    50%     83,600         76,900         6,700         0       Kmart    Sears Hometown      100.0

 

- 28 -


Table of Contents

Wholly Owned Properties

 
                   GLA (3)            
    

City

  

State

   Recapture
Rights (1)(2)
  Total      Sears
Holdings
     Third
Parties
     Vacant     

Sears or

Kmart

  

Significant Third-party Tenants (3)

   %
Leased
 

107

   Overland Park    KS    50%     223,200         215,000         8,200         0       Sears    Lands’ End      100.0

108

   Hopkinsville    KY    50%     93,000         70,300         4,900         17,800       Kmart    Cato Fashions      80.9

109

   Owensboro    KY    50%     68,300         68,300         0         0       Kmart    n/a      100.0

110

   Paducah    KY    50%     108,200         108,200         0         0       Sears    n/a      100.0

111

   Houma    LA    50%     101,400         96,700         4,700         0       Kmart    Meineke Car Care      100.0

112

   Lafayette    LA    50%     194,900         194,900         0         0       Sears    n/a      100.0

113

   New Iberia    LA    50%     91,700         91,700         0         0       Kmart    n/a      100.0

114

   Braintree (4)    MA    100%     113,500         65,900         47,600         0       Kmart    Nordstrom Rack      100.0

115

   Saugus    MA    50%     210,500         204,900         5,600         0       Sears    Lands’ End      100.0

116

   Bowie    MD    50%     131,500         131,500         0         0       Sears    n/a      100.0

117

   Cockeysville    MD    50%     165,900         149,700         16,200         0       Sears    Lands’ End      100.0

118

   Edgewater    MD    50%     117,200         117,200         0         0       Kmart    n/a      100.0

119

   Hagerstown    MD    50%     122,700         122,700         0         0       Sears    n/a      100.0

120

   Madawaska    ME    50%     49,700         49,700         0         0       Kmart    n/a      100.0

121

   Alpena    MI    50%     118,200         118,200         0         0       Kmart    n/a      100.0

122

   Jackson    MI    50%     152,700         144,200         8,500         0       Sears    Panera Bread, Pizza Hut      100.0

123

   Lincoln Park    MI    50%     301,700         297,900         3,800         0       Sears    Bank of America      100.0

124

   Manistee    MI    50%     94,600         87,800         6,800         0       Kmart    Hometown Dealer      100.0

125

   Roseville    MI    50%     385,400         367,400         18,000         0       Sears    Lands’ End, Red Robin      100.0

126

   Sault Ste. Marie    MI    50%     92,700         92,700         0         0       Kmart    n/a      100.0

127

   St. Clair Shores    MI    100%     122,200         118,000         4,200         0       Kmart    n/a      100.0

128

   Troy    MI    50%     402,600         380,900         21,700         0       Sears    Krispy Kreme, Lands’ End, Logan’s Roadhouse      100.0

129

   Ypsilanti    MI    n/a     99,400         0         99,400         0       n/a    At Home      100.0

130

   Burnsville    MN    50%     167,400         161,700         5,700         0       Sears    Lands’ End      100.0

137

   Springfield    MO    n/a     112,900         0         112,900         0       n/a    At Home      100.0

138

   Columbus    MS    50%     166,700         117,100         2,800         46,800       Kmart    Enterprise Leasing Company      71.9

139

   Havre    MT    50%     94,700         94,700         0         0       Kmart    n/a      100.0

140

   Asheville    NC    50%     240,700         232,400         8,300         0       Sears    Lands’ End      100.0

141

   Concord    NC    50%     171,300         137,500         33,800         0       Kmart    Sears Outlet      100.0

142

   Greensboro    NC    n/a     173,300         0         171,600         1,700       n/a    Floor & Décor, Gabriel Brothers, Sears Outlet      99.0

143

   Minot    ND    50%     110,400         108,100         2,300         0       Kmart    US Bank      100.0

144

   Kearney    NE    50%     86,500         86,500         0         0       Kmart    n/a      100.0

145

   Manchester    NH    50%     144,100         135,100         9,000         0       Sears    Lands’ End      100.0

146

   Nashua    NH    50%     167,100         159,500         7,600         0       Sears    Lands’ End      100.0

147

   Portsmouth    NH    50%     127,000         120,100         6,900         0       Sears    Lands’ End      100.0

 

- 29 -


Table of Contents

Wholly Owned Properties

 
                   GLA (3)            
    

City

  

State

   Recapture
Rights (1)(2)
  Total      Sears
Holdings
     Third
Parties
     Vacant     

Sears or

Kmart

  

Significant Third-party Tenants (3)

   %
Leased
 

148

   Salem    NH    50%     206,500         119,000         87,500         0       Sears    Dick’s Sporting Goods, Lands’ End      100.0

149

   Middletown    NJ    100%     191,200         176,100         15,100         0       Sears    Investors Bank, Lands’ End, Wendy’s      100.0

150

   Watchung    NJ    100%     262,900         253,900         9,000         0       Sears    Lands’ End      100.0

151

   Wayne    NJ    50%     327,400         317,700         9,700         0       Sears    Lands’ End      100.0

152

   Deming    NM    50%     96,600         96,600         0         0       Kmart    n/a      100.0

153

   Farmington    NM    50%     90,700         90,700         0         0       Kmart    n/a      100.0

154

   Hobbs    NM    50%     88,900         88,900         0         0       Kmart    n/a      100.0

155

   Henderson    NV    50%     143,900         122,800         21,100         0       Kmart    Sears Outlet      100.0

156

   Las Vegas    NV    50%     150,200         150,200         0         0       Sears    n/a      100.0

157

   Reno    NV    50%     198,800         198,800         0         0       Sears    n/a      100.0

158

   Albany    NY    50%     305,700         264,300         41,400         0       Sears    Lands’ End, Whole Foods      100.0

159

   Clay    NY    50%     146,500         138,000         8,500         0       Sears    Lands’ End      100.0

160

   East Northport    NY    50%     195,400         187,000         8,400         0       Sears    Lands’ End      100.0

161

   Hicksville    NY    100%     362,600         332,100         30,500         0       Sears    Chase Bank, Chipotle Mexican Grill, Citigroup, Lands’ End, Red Lobster, TD Bank      100.0

162

   Johnson City    NY    50%     155,100         155,100         0         0       Sears    n/a      100.0

163

   Olean    NY    50%     118,000         118,000         0         0       Kmart    n/a      100.0

164

   Rochester    NY    50%     128,500         128,500         0         0       Sears    n/a      100.0

165

   Sidney    NY    50%     94,400         94,400         0         0       Kmart    n/a      100.0

166

   Victor    NY    50%     123,000         115,300         7,700         0       Sears    Lands’ End      100.0

167

   Yorktown Heights    NY    50%     160,000         153,700         6,300         0       Sears    Lands’ End      100.0

168

   Canton    OH    50%     219,400         210,400         9,000         0       Sears    Lands’ End      100.0

169

   Chapel Hill    OH    50%     196,300         187,200         9,100         0       Sears    Lands’ End      100.0

170

   Dayton    OH    50%     192,500         183,500         9,000         0       Sears    Lands’ End      100.0

171

   Kenton    OH    50%     96,100         96,100         0         0       Kmart    n/a      100.0

172

   Marietta    OH    50%     87,500         87,500         0         0       Kmart    n/a      100.0

173

   Mentor    OH    50%     219,100         208,700         10,400         0       Sears    Lands’ End      100.0

174

   Middleburg Heights    OH    50%     359,000         351,600         7,400         0       Sears    Lands’ End      100.0

175

   North Canton    OH    50%     87,100         84,200         2,900         0       Kmart    Burger King      100.0

176

   Tallmadge    OH    50%     84,200         84,200         0         0       Kmart    n/a      100.0

177

   Toledo    OH    50%     218,700         209,900         8,800         0       Sears    Lands’ End      100.0

178

   Muskogee    OK    50%     87,500         87,500         0         0       Kmart    n/a      100.0

179

   Oklahoma City    OK    50%     173,700         173,700         0         0       Sears    n/a      100.0

180

   Tulsa    OK    n/a     87,200         0         87,200         0       n/a    Long John Silver’s, Hobby Lobby      100.0

181

   Happy Valley    OR    50%     144,300         137,900         6,400         0       Sears    Lands’ End      100.0

182

   The Dalles    OR    50%     87,100         87,100         0         0       Kmart    n/a      100.0

 

- 30 -


Table of Contents

Wholly Owned Properties

 
                   GLA (3)            
    

City

  

State

   Recapture
Rights (1)(2)
  Total      Sears
Holdings
     Third
Parties
     Vacant     

Sears or

Kmart

  

Significant Third-party Tenants (3)

   %
Leased
 

183

   Carlisle    PA    50%     117,800         117,800         0         0       Kmart    n/a      100.0

184

   Columbia    PA    50%     86,700         86,700         0         0       Kmart    n/a      100.0

185

   King Of Prussia (5)    PA    n/a     210,800         0         205,800         5,000       n/a    Dick’s Sporting Goods, Primark, Outback Steakhouse, Yard House      97.6

186

   Lebanon    PA    50%     117,200         117,200         0         0       Kmart    n/a      100.0

187

   Mount Pleasant    PA    50%     83,500         83,500         0         0       Kmart    n/a      100.0

188

   Walnutport    PA    50%     121,200         121,200         0         0       Kmart    n/a      100.0

189

   York    PA    50%     82,000         82,000         0         0       Kmart    n/a      100.0

190

   Bayamon    PR    50%     115,200         114,600         600         0       Kmart    n/a      100.0

191

   Caguas    PR    50%     138,700         138,700         0         0       Sears    n/a      100.0

192

   Carolina    PR    50%     198,000         198,000         0         0       Sears    n/a      100.0

193

   Guaynabo    PR    50%     217,300         115,700         89,500         12,100       Kmart    Baskin Robbins, Firstbank, Gamestop, McDonald’s, Ocean Garden Buffet, Payless ShoeSource, Rent-a-Center, Sally Beauty Supply, T-Mobile      94.4

194

   Mayaguez    PR    50%     118,200         118,200         0         0       Kmart    n/a      100.0

195

   Ponce    PR    50%     126,900         126,900         0         0       Kmart    n/a      100.0

196

   Warwick    RI    50%     246,000         216,900         29,100         0       Sears    Chuck E Cheese, Lands’ End, On The Border, Wendy’s      100.0

197

   Anderson    SC    50%     118,700         118,700         0         0       Kmart    n/a      100.0

198

   Charleston    SC    50%     138,800         132,000         6,800         0       Sears    Carrabba’s Italian Grill      100.0

199

   Rock Hill    SC    50%     89,300         89,300         0         0       Kmart    n/a      100.0

200

   Sioux Falls    SD    50%     72,500         72,500         0         0       Kmart    n/a      100.0

201

   Cordova    TN    50%     160,900         156,100         4,800         0       Sears    Lands’ End      100.0

202

   Memphis (4)    TN    100%     202,400         158,500         43,900         0       Sears    Lands’ End, Nordstrom Rack      100.0

203

   Austin    TX    50%     172,000         172,000         0         0       Sears    n/a      100.0

204

   Dallas    TX    50%     205,300         205,300         0         0       Sears    n/a      100.0

205

   El Paso    TX    50%     112,100         103,700         8,400         0       Kmart    n/a      100.0

206

   Friendswood    TX    50%     166,000         166,000         0         0       Sears    n/a      100.0

207

   Harlingen    TX    50%     91,700         91,700         0         0       Kmart    n/a      100.0

208

   Houston    TX    50%     218,600         209,500         9,100         0       Sears    Lands’ End, Torchy’s Tacos      100.0

209

   Houston    TX    n/a     134,000         0         134,000         0       n/a    At Home      100.0

210

   Ingram    TX    50%     168,400         168,400         0         0       Sears    n/a      100.0

211

   Irving    TX    50%     170,900         79,500         91,400         0       Sears    Pollo Tropical, Taco Cabana, Winco      100.0

212

   San Antonio (6)    TX    50%     221,900         210,500         11,400         0       Sears    Long Horn Steakhouse, Orvis      100.0

213

   Shepherd    TX    50%     201,700         201,700         0         0       Sears    n/a      100.0

214

   Valley View    TX    100%     235,000         229,200         5,800         0       Sears    Jared Galleria of Jewelry      100.0

215

   Westwood    TX    50%     215,000         215,000         0         0       Sears    n/a      100.0

216

   Layton    UT    50%     166,800         90,000         11,000         65,800       Kmart    Arby’s      60.6

 

- 31 -


Table of Contents

Wholly Owned Properties

 
                   GLA (3)            
    

City

  

State

   Recapture
Rights (1)(2)
  Total      Sears
Holdings
     Third
Parties
     Vacant     

Sears or

Kmart

  

Significant Third-party Tenants (3)

   %
Leased
 

217

   West Jordan    UT    50%     205,400         201,100         4,300         0       Sears    Lands’ End      100.0

218

   Alexandria    VA    50%     262,100         252,500         9,600         0       Sears    Lands’ End      100.0

219

   Chesapeake    VA    50%     169,400         169,400         0         0       Sears    n/a      100.0

220

   Fairfax    VA    50%     225,800         214,100         11,700         0       Sears    Lands’ End      100.0

221

   Hampton    VA    50%     245,000         245,000         0         0       Sears    n/a      100.0

222

   Virginia Beach    VA    50%     200,400         86,900         113,500         0       Sears    BB&T, DSW, The Fresh Market, Nordstrom Rack, REI      100.0

223

   Warrenton    VA    50%     121,000         113,900         7,100         0       Sears    Lands’ End      100.0

224

   Redmond    WA    50%     274,900         255,900         19,000         0       Sears    Lands’ End, Red Robin, Sprint      100.0

225

   Vancouver    WA    50%     129,700         124,900         4,800         0       Sears    Lands’ End      100.0

226

   Yakima    WA    50%     117,300         97,300         0         20,000       Kmart    Vacant      82.9

227

   Greendale    WI    50%     238,400         238,400         0         0       Sears    n/a      100.0

228

   Madison    WI    50%     138,300         130,200         8,100         0       Sears    Lands’ End      100.0

229

   Platteville    WI    50%     94,800         94,800         0         0       Kmart    n/a      100.0

230

   Charleston    WV    50%     105,600         105,600         0         0       Kmart    n/a      100.0

231

   Elkins    WV    50%     99,600         94,900         0         4,700       Kmart    Vacant      95.3

232

   Scott Depot    WV    50%     89,800         89,800         0         0       Kmart    n/a      100.0

233

   Casper    WY    50%     91,400         91,300         100         0       Kmart    n/a      100.0

234

   Gillette    WY    50%     94,600         94,600         0         0       Kmart    n/a      100.0

235

   Riverton    WY    50%     94,800         94,800         0         0       Kmart    n/a      100.0
          

 

 

    

 

 

    

 

 

    

 

 

          

 

 

 
   Total - Wholly Owned Properties     37,018,600         33,416,200         3,383,100         219,300               99.4
          

 

 

    

 

 

    

 

 

    

 

 

          

 

 

 

 

(1) Properties with 50% recapture rights are subject to the Company’s right to recapture approximately 50% of the space within a store (subject to certain exceptions) In addition, the Company has the right to recapture any automotive care centers which are free-standing or attached as “appendages” to the stores and all outparcels or outlots, as well as certain portions of parking areas and common areas. These properties were referred to as “Type II” properties in the Company’s Form S-11 dated June 8, 2015.
(2) In addition to the 50% recapture rights described above, properties with 100% recapture rights are subject to the Company’s right to recapture the entire space within a store for a specified fee. These properties were referred to as “Type I” properties in the Company’s Form S-11 dated June 8, 2015.
(3) Based on signed leases as of December 31, 2015, including SNO leases.
(4) The Company exercised its recapture rights for this property during the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015.
(5) Property is subject to a ground lease.
(6) The Company submitted a recapture notice for this property subsequent to December 31, 2015.

 

JV Properties

 
                 GLA (2)          
    

City

  State   Recapture
Rights (1)
  Total     Sears
Holdings
    Third
Parties
    Vacant     Sears or
Kmart
 

Third-party Tenants (2)

  %
Leased
 

1

   Chandler   AZ   50%     141,600        141,600        0        0      Sears   n/a     100.0

2

   Glendale   AZ   50%     125,000        125,000        0        0      Sears   n/a     100.0

3

   Bakersfield (3)   CA   50%     204,200        204,200        0        0      Sears   n/a     100.0

 

- 32 -


Table of Contents

JV Properties

 
                 GLA (2)          
    

City

  State   Recapture
Rights (1)
  Total     Sears
Holdings
    Third
Parties
    Vacant     Sears or
Kmart
 

Third-party Tenants (2)

  %
Leased
 

4

   Brea   CA   50%     168,200        163,800        4,400        0      Sears  

Lands’ End

    100.0

5

   Cerritos   CA   50%     277,600        277,600        0        0      Sears   n/a     100.0

6

   Modesto   CA   50%     148,600        148,600        0        0      Sears   n/a     100.0

7

   Santa Rosa   CA   50%     165,400        161,600        3,800        0      Sears   Lands’ End     100.0

8

   Danbury   CT   50%     178,400        108,400        70,000        0      Sears   Primark     100.0

9

   Pembroke Pines (3)(4)   FL   50%     144,200        144,200        0        0      Sears   n/a     100.0

10

   Oak Brook   IL   50%     314,000        219,600        94,400        0      Sears   Lands’ End, Pinstripes, Williams-Sonoma     100.0

11

   Burlington   MA   50%     271,200        184,800        86,400        0      Sears   Lands’ End, Primark     100.0

12

   Natick (4)   MA   50%     190,600        176,200        14,400        0      Sears   Lands’ End     100.0

13

   Columbia   MD   50%     149,000        142,000        7,000        0      Sears   Lands’ End     100.0

14

   Ann Arbor   MI   50%     170,600        156,400        14,200        0      Sears   Lands’ End     100.0

15

   Minnetonka   MN   50%     205,000        199,200        5,800        0      Sears   Lands’ End     100.0

16

   Deptford   NJ   50%     191,800        183,800        8,000        0      Sears   Lands’ End     100.0

17

   Freehold   NJ   50%     139,400        72,200        67,200        0      Sears   Primark     100.0

18

   Paramus   NJ   50%     192,400        177,200        15,200        0      Sears   Lands’ End     100.0

19

   Toms River   NJ   50%     109,200        109,200        0        0      Sears   n/a     100.0

20

   Albuquerque (5)   NM   50%     166,600        157,600        9,000        0      Sears   n/a     100.0

21

   Nanuet   NY   50%     221,400        213,800        7,600        0      Sears   Lands’ End     100.0

22

   Staten Island (5)   NY   50%     188,800        82,800        106,000        0      Sears   Lands’ End, Primark     100.0

23

   Norman (4)   OK   50%     66,800        66,800        0        0      Sears   n/a     100.0

24

   Tulsa   OK   50%     150,200        150,200        0        0      Sears   n/a     100.0

25

   Portland   OR   50%     220,000        205,800        14,200        0      Sears   Lands’ End     100.0

26

   Pittsburgh   PA   50%     176,600        159,600        17,000        0      Sears   Lands’ End     100.0

27

   Austin   TX   50%     164,600        164,600        0        0      Sears   n/a     100.0

28

   Frisco   TX   50%     163,000        163,000        0        0      Sears   n/a     100.0

29

   Lubbock   TX   50%     150,600        150,600        0        0      Sears   n/a     100.0

30

   Midland   TX   50%     116,600        116,600        0        0      Sears   n/a     100.0

31

   Lynnwood   WA   50%     177,600        170,600        7,000        0      Sears   Lands’ End     100.0
        

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 
   Total - JV Properties       5,449,200        4,897,600        551,600        0            100.0
        

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

 

(1)   Properties with 50% recapture rights are subject to the Company’s right to recapture approximately 50% of the space within a store (subject to certain exceptions). In addition, the Company has the right to recapture any automotive care centers which are free-standing or attached as “appendages” to the stores and all outparcels or outlots, as well as certain portions of parking areas and common areas.

(2)   Based on signed leases as of December 31, 2015, including SNO leases.

(3)   The JV submitted a recapture notice for this property subsequent to December 31, 2015.

(4)   Property is subject to a lease or ground lease agreement.

(5)   The JV submitted a recapture notice for this property during the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015.

 

        

      

      

      

      

 

                    

266

  

Grand Total - All Properties

    42,467,800        38,313,800        3,934,700        219,300            99.5

 

        

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

266

  

Grand Total - All Properties (at share)

    39,743,200        35,865,000        3,658,900        219,300            99.4

 

        

 

 

   

 

 

   

 

 

   

 

 

       

 

 

 

 

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The following table sets forth information regarding the geographic diversification of our portfolio, with JV Properties presented at our proportional share, based on signed leases as of December 31, 2015, including SNO leases:

 

(dollars in thousands except PSF amounts)  

State

   Number of
Properties
     Annual
Base Rent
     % of Total
Annual Base
Rent
    Annual Base
Rent PSF
 

California

     43       $ 39,926         19.7   $ 5.85   

Florida

     27         23,086         11.4     5.48   

New York

     12         12,684         6.2     6.36   

Texas

     17         12,480         6.1     4.78   

Illinois

     12         9,166         4.5     4.06   

Pennsylvania

     8         8,413         4.1     9.32   

New Jersey

     7         7,171         3.5     6.53   

Michigan

     10         6,571         3.2     3.54   

Virginia

     6         6,553         3.2     5.35   

Puerto Rico

     6         6,318         3.1     7.00   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total Top 10

     148       $ 132,368         65.0   $ 5.54   

Other (1)

     118         70,570         35.0     4.51   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

     266       $ 202,938         100.0   $ 5.13   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Includes 40 states.

The Master Lease and JV Master Leases

The Master Lease

The Master Lease is a unitary, non-divisible lease as to all properties, with Sears Holdings’ obligations as to each property cross-defaulted with all obligations of Sears Holdings with respect to all other properties. The Master Lease generally is a triple net lease with respect to all space which is leased thereunder to Sears Holdings, subject to proportional sharing by Sears Holdings for repair and maintenance charges, real property taxes, insurance and other costs and expenses which are common to both the space leased by Sears Holdings and other space occupied by unrelated third-party tenants in the same or other buildings pursuant to third-party leases, space which is recaptured pursuant to the Company recapture rights described below and all other space which is constructed on the properties. Under the Master Lease, Sears Holdings 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.

The Master Lease has an initial term of 10 years and contains three options for five-year renewals of the term and a final option for a four-year renewal. In each of the initial and first two renewal terms, base rent will be increased by 2.0% per annum for each lease year over the rent for the immediately preceding lease year. For subsequent renewal terms, rent will be set at the commencement of the renewal term at a fair market rent based on a customary third-party appraisal process, taking into account all the terms of the 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 Master Lease provides the Company with the right to recapture up to approximately 50% of the space occupied by Sears Holdings at the 224 Wholly Owned Properties included in the Master Lease (subject to certain exceptions). In addition, Seritage has 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 the parking areas and common areas. Upon exercise of this recapture right, we will generally incur certain costs and expenses for the separation of the recaptured space from the remaining Sears Holdings space and can reconfigure and rent the recaptured space to third-party tenants on potentially superior terms determined by us and for our own account. We also have the right to recapture 100% of the space occupied by Sears Holdings at each of 21 identified Wholly Owned Properties by making a specified lease termination payment to Sears Holdings, after which we expect to be able to reposition and re-lease those stores on potentially superior terms determined by us and for our own account. While we will be permitted to exercise our recapture rights all at once or in stages as to any particular property, we will not be permitted to recapture all or substantially all of the space subject to the recapture right at more than 50 Wholly Owned Properties during any lease year.

 

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The Master Lease also provides for certain rights of Sears Holdings to terminate the Master Lease with respect to Wholly Owned Properties that cease to be profitable for operation by Sears Holdings (those stores that possess Earnings Before Interest, Taxes, Depreciation, Amortization and Rent (or “EBITDAR”) for the 12 month period ending as of the last day of the most recently completed fiscal quarter of Sears Holdings that is less than the base rent for that store) after the first lease year. In order to terminate the Master Lease with respect to a certain property, Sears Holdings must make a payment to us of an amount equal to one year of rent (together with taxes and other expenses) with respect to such property. Sears Holdings’ termination right is limited to terminating the Master Lease with respect to properties representing up to 20% of the aggregate annual rent payment under the Master Lease with respect to all properties in any lease year. Further, no such termination rights can be exercised prior to August 1, 2016.

The JV Master Leases

The JV Master Leases are unitary, non-severable leases for all JV Properties in the applicable JV Master Lease and are generally triple net leases with respect to the space occupied by Sears Holdings, subject to Sears Holdings’ proportionate sharing of taxes and other operating expenses with respect to properties that have third-party tenants of the GGP JV, the Simon JV and the Macerich JV, as applicable. The JV Master Leases each have an initial term of 10 years, and in each case Sears Holdings has three separate, consecutive five-year renewal options to extend the initial term. For each JV Master Lease in each of the initial and renewal terms, after the third lease year of the initial term, the annual base rent for the remainder of the term and all renewal terms will be increased by 2% per annum for each lease year over the rent for the immediately preceding lease year.

Each JV Master Lease provides the GGP JV, the Simon JV and the Macerich JV, as applicable, with the right to recapture (without additional payment) up to approximately 50% of the space occupied by Sears Holdings under such JV Master Lease (subject to certain exceptions). In addition, Seritage has the right to recapture any automotive care centers which are free-standing or attached as “appendages” to the JV Properties, all outparcels or outlots, and certain portions of parking areas and common areas at the JV Properties, in each case under such JV Master Lease (other than with respect to one property owned by the Macerich JV). The Simon JV has the additional right to recapture 100% of the space occupied by Sears Holdings at some of the JV Properties under its JV Master Lease for termination fees as provided in such JV Master Lease.

Each JV Master Lease also provides Sears Holdings with the right to terminate the lease with respect to underperforming stores upon payment of a termination fee calculated as provided in the JV Master Lease. In the case of the JV Properties owned by the GGP JV, the Simon JV and the Macerich JV, Sears Holdings’ termination right is limited to no more than four JV Properties, three JV Properties and three JV Properties, respectively, in any lease year.

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 Master Lease.

Tenant Summary

The following table sets forth information regarding our tenants and our leases, with JV Properties presented at our proportional share, based on signed leases as of December 31, 2015, including SNO leases:

 

(in thousands except number of leases and PSF amounts)  

Tenant

   Number of
Leases
     Leased
GLA
     % of Total
Leased GLA
    Annual
Base Rent
     % of Total
Annual Base
Rent
    Annual Base
Rent PSF
 

Sears Holdings (1)

     255         35,865         90.7   $ 154,255         76.0   $ 4.30   

In-place third-party leases

     240         3,035         7.7     35,747         17.6     11.78   

SNO third-party leases

     30         624         1.6     12,936         6.4     20.73   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Sub-total third-party leases

     270         3,659         9.3     48,683         24.0     13.31   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total

     525         39,524         100.0   $ 202,938         100.0   $ 5.13   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) Leases reflects number of properties subject to the Master Lease and JV Master Leases.

 

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The following table lists the top five tenants at our properties, including JV Properties presented at our proportional share, based on signed leases as of December 31, 2015, including SNO leases:

 

(dollars in thousands)                     

Tenant

   Number of
Leases
     Annual
Base Rent
     % of Total
Annual Base Rent
 

Sears Holdings (1)

     255       $ 154,255         76.0

Lands’ End (2)

     74         7,134         3.5

Primark

     5         5,544         2.7

Nordstrom Rack

     6         4,388         2.2

At Home

     5         2,732         1.3

 

(1) Leases reflects number of properties subject to the Master Lease and JV Master Leases.
(2) Lease agreements between Sears Holdings and Lands’ End were retained as a sublease under the Master Lease. However, Sears Holdings pays us additional rent under the Master Lease (in lieu of base rent attributable to the Lands’ End space leased to Sears Holdings under the Master Lease) an amount equal to rent payments (including expenses) required to be made by Lands’ End under the Lands’ End leases.

Lease Expirations

The following table sets forth a summary schedule of lease expirations for signed leases, including SNO leases, with JV Properties presented at our proportional share, as of December 31, 2015. The information set forth in the table assumes that tenants exercise no renewal options or early termination rights:

 

(in thousands except number of leases)                      

Year

   Number of
Leases (1)
     Leased
GLA
     % of Total
Leased GLA
    Annual
Base Rent
     % of Total
Annual Base Rent
 

Month-to-Month

     18         59         0.1   $ 943         0.5

2016

     23         110         0.3     1,594         0.8

2017

     24         178         0.5     2,542         1.3

2018

     39         234         0.6     4,237         2.1

2019

     41         595         1.5     4,520         2.2

2020

     40         416         1.1     3,841         1.9

2021

     8         189         0.5     1,550         0.8

2022

     4         18         0.0     810         0.4

2023

     7         348         0.9     6,220         3.1

2024

     5         74         0.2     1,395         0.7

2025

     267         36,137         91.4     157,552         77.5

Thereafter

     49         1,166         2.9     17,734         8.7
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

     525         39,524         100.0   $ 202,938         100.0
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) In 2025, leases includes 255 properties subject to the Master Lease and JV Master Leases.

 

ITEM 3. LEGAL PROCEEDINGS

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.

 

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Litigation Relating to the Transaction

In May and June of 2015, four purported Sears Holdings shareholders filed lawsuits in the Delaware Court of Chancery challenging the Transaction, which lawsuits have since been consolidated into a single action captioned In re Sears Holdings Corporation Stockholder and Derivative Litigation, Consol. C.A. No. 11081-VCL (the “Action”). On October 15, 2015, plaintiffs filed a verified consolidated stockholder derivative complaint (the “Complaint”) in the Action against defendants the individual members of Sears Holdings’ Board of Directors, ESL, Sears Holdings’ CEO, FCM, and Seritage. The plaintiffs have brought the Action derivatively on behalf of Sears Holdings, which is named as a nominal defendant, and allege that the Sears Holdings directors, as well as ESL (in its capacity as the alleged controlling stockholder of Sears Holdings), breached their fiduciary duties to Sears Holdings shareholders by selling the Wholly Owned Properties to Seritage at a price that was unfairly low and was the result of a process that allegedly was flawed. The Complaint also alleges that Seritage and FCM aided and abetted these alleged fiduciary breaches. Among other forms of relief, the plaintiffs are currently seeking damages in unspecified amounts. Due to uncertainties surrounding the status and outcome of this matter, management cannot reasonably estimate the possible loss or range of loss, if any, that may arise from this matter. The Company believes that the plaintiffs’ claims and allegations against the Company are legally without merit and intends to contest these lawsuits vigorously.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

 

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 Company’s Class A common stock began trading on July 6, 2015. The following table presents the high and low sales prices for our Class A common stock on the NYSE and the dividends declared per share for the periods indicated:

 

     Stock Price      Dividends
Declared
 

Quarter Ended

   High      Low     

December 31, 2015

   $ 42.50       $ 33.84       $ 0.50   

September 30, 2015

     44.00         36.97         —     

The following graph provides a comparison, from July 6, 2015 through December 31, 2015, 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 LC.

 

LOGO

 

Index

   7/6/15      7/31/15      8/31/15      9/30/15      10/31/15      11/30/15      12/31/15  

Seritage Growth Properties

     100.00         130.36         134.18         125.93         142.43         123.39         137.64   

S&P 500

     100.00         101.79         95.65         93.28         101.15         101.45         99.85   

SNL US REIT Equity

     100.00         102.72         96.73         98.88         105.33         104.92         106.28   

On March 4, 2016, the reported closing sale price per share of our Class A common stock on the NYSE was $42.63.

At March 4, 2016, there were 25,261,542 Class A common shares issued and outstanding which were held by approximately 154 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, at March 4, 2016, there were 1,589,020 Class B non-economic common shares issued and outstanding, 6,329,485 Class C non-voting common shares issued and outstanding and 24,176,327 outstanding Operating Partnership units held by limited partners other than the Company.

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.

 

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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. During the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, 17,450 net shares of Class C non-voting common shares were converted to Class A common shares.

The Operating Partnership units are generally exchangeable into shares of Class A common stock on a one-for-one basis.

We currently intend to pay quarterly distributions in cash. However, 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.

We plan to elect to be treated as a REIT for U.S. Federal income tax purposes in connection with the filing of our first U.S. federal tax return 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 our 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 federal taxes if it distributes 100% of its capital gains and ordinary income.

 

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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:

 

     July 7, 2015
(Date Operations
Commenced) to
December 31, 2015
 

Operating Data

  

Total revenue

   $ 113,571   

Total expenses

     122,944   

Equity in income of unconsolidated joint ventures

     4,772   

Net loss

     (38,803

Net loss attributable to common shareholders

     (22,338

Net loss per share attributable to Class A and Class C common shareholders – Basic and diluted (1)(2)

   $ (0.71

Dividends declared per share

     0.50   

Total NOI (3)

   $ 89,493   

EBITDA (4)

     67,496   

Adjusted EBITDA (4)

     90,732   

Funds from Operations (“FFO”) (5)

     36,061   

Normalized FFO (5)

     61,954   

Cash Flow Data (6)

  

Operating activities

   $ 17,671   

Investing activities

     (2,730,399

Financing activities

     2,775,595   

Balance Sheet Data

  

Investment in real estate, net

   $ 1,639,275   

Total assets

     2,833,359   

Mortgage loans payable, net

     1,142,422   

Total liabilities

     1,263,282   

Non-controlling interests

     683,382   

Total equity

     1,570,077   

Other Data (7)

  

Number of properties

     266   

Gross leasable area (sq. ft.)

     42,468   

Percentage leased

     99.4

Annual base rent

   $ 202,938   

Rent PSF

   $ 5.13   
  

 

(1) Earnings per share is not presented for Class B shareholders as they do not have economic rights.
(2) Non-vested restricted shares are excluded from the computation of diluted loss per share because their inclusion would have an anti-dilutive effect.
(3) Total NOI is presented at our proportional share and does not represent operating income as defined by GAAP. See page 49.
(4) EBITDA and Adjusted EBITDA are supplemental financial measurements and do not represent net income as defined by GAAP. See page 49.
(5) FFO and Normalized FFO are supplemental financial measurements and do not represent net income as defined by GAAP. See page 50.
(6) Cash flow data only represents the Company’s consolidated cash flows as defined by GAAP and as such, operating cash flow does not include the cash received from our unconsolidated joint ventures, except to the extent of operating distributions from our unconsolidated joint ventures.
(7) JV Properties are presented at our proportional share; based on signed leases as of December 31, 2015, including SNO leases.

 

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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 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, 2015, our portfolio included over 42.4 million square feet of GLA, consisting of 235 Wholly Owned Properties totaling over 37.0 million square feet of GLA across 49 states and Puerto Rico, and interests in 31 JV Properties totaling over 5.4 million square feet of GLA across 17 states.

As of December 31, 2015, we leased a substantial majority of the space in our portfolio at all but 11 of the Wholly Owned Properties (such 11 properties, the “Third-Party Properties”) to Sears Holdings under a Master Lease agreement, with the remainder of such space leased to third-party tenants. The Third-Party Properties, which do not contain a Sears Holdings store or have any space leased to Sears Holdings, are leased solely to third-party tenants. A substantial majority of the space at the JV Properties is also leased to Sears Holdings by, as applicable, the GGP JV, the Simon JV or the Macerich JV in each case under a separate JV Master Lease.

We generate revenues primarily by leasing our properties to tenants, including both Sears Holdings and third-party tenants, who operate retail stores (and potentially other uses) in the leased premises, a business model common to many publicly traded REITs. In addition to revenues generated under the Master Lease through rent payments from Sears Holdings, we generate revenue through leases to third-party tenants under existing and future leases for space at our properties.

The Master Lease provides us with the right to recapture up to approximately 50% of the space occupied by Sears Holdings at the 224 Wholly Owned Properties included in the Master Lease (subject to certain exceptions and limitations). In addition, Seritage has the right to recapture any automotive care centers which are free-standing or attached as “appendages” to the properties, and all outparcels or outlots and certain portions of parking areas and common areas. Upon exercise of this recapture right, we will generally incur certain costs and expenses for the separation of the recaptured space from the remaining Sears Holdings space and can reconfigure and rent the recaptured space to third-party tenants on potentially superior terms determined by us and for our own account. We also have the right to recapture 100% of the space occupied by Sears Holdings at each of 21 identified Wholly Owned Properties by making a specified lease termination payment to Sears Holdings, after which we expect to be able to reposition and re-lease those stores on potentially superior terms determined by us and for our own account.

With respect to the JV Properties, each JV Master Lease provides for similar recapture rights as the Master Lease governing the Company’s Wholly Owned Properties.

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 orientation to one comprised predominately of first-class, multi-tenant shopping centers. 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.

 

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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 expenses, insurance, ground lease costs and utilities; general and administrative expenses include payroll, office expenses, professional fees, and other administrative expenses; and interest expense is primarily on our mortgage loan payable. In addition, we incur substantial non-cash charges for depreciation and amortization on our properties and related intangible assets and liabilities resulting from the Transaction.

We did not have any revenues or expenses until we completed the Transaction on July 7, 2015.

Rental Income

Our earnings are primarily the result of the rental revenue generated through rent payments from Sears Holdings under the Master Lease. During the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, and excluding the effect of straight-line rent, the rental income attributable directly to Sears was $64.8 million, or approximately 83.5% of total rental income earned in the period.

In addition to revenues generated under the Master Lease through rent payments from Sears Holdings, we generate revenue through direct leases to third-party tenants for space at our properties. During the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, and excluding the effect of straight-line rent, the rental income attributable to third-party tenants was $12.9 million, or 16.5% of total rental income earned in the period.

On an annual basis, and taking into account all signed leases, including those which have not yet commenced rental payments, rental income attributable to third-party tenants would have represented approximately 24.0% of total annual base rental income as of December 31, 2015.

For the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, the Company recognized total rental income of $86.6 million, including straight-line rent of approximately $8.3 million, percentage rent of approximately $0.1 million and other adjustments of approximately $0.5 million.

Tenant Reimbursements and Property Operating Expenses

Pursuant to the provisions of the Master Lease and many third-party leases, the Company is entitled to be reimbursed for certain property related expenses. For the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, the Company recorded tenant reimbursement income of $26.9 million, compared to property operating expenses and real estate tax expense aggregating $28.7 million.

General and Administrative Expenses

General and administrative expenses consist of personnel costs, including stock-based compensation, professional fees, office expenses, acquisition costs and overhead expenses. For the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, the Company incurred general and administrative expenses of approximately $10.0 million of which approximately $1.9 million consisted of up-front personnel costs related to the hiring of certain executives.

Acquisition-Related Expenses

The Company incurred $18.4 million of non-recurring costs related to the Transaction, including due diligence, legal, consulting and other similar expenses. These costs are included in acquisition-related expenses on the consolidated statement of operations.

Interest expense

For the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, the Company incurred $30.5 million of interest expense related to the Mortgage Loans, including amortization of debt issuance costs in the amount of $2.7 million.

 

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Unrealized Loss on Interest Rate Cap

In connection with the issuance of the Mortgage Loans, the Company purchased for $5.0 million an interest rate cap with a term of four years, a notional amount of $1.26 billion and a strike rate of 3.5%. As of December 31, 2015, the interest rate cap had a fair value of approximately $2.1 million.

Liquidity and Capital Resources

Property rental income is our primary source of cash and is dependent on a number of factors including occupancy levels and rental rates, as well as our tenants’ ability to pay rent. Our primary uses of cash include payment of operating expenses, debt service, reinvestment in and redevelopment of properties and distributions to shareholders. We believe that we currently have sufficient liquidity to satisfy all of our commitments in the form of $62.9 million of unrestricted cash, $92.5 million of restricted cash and $100.0 million of borrowing capacity under our Future Funding Facility as of December 31, 2015, as well as anticipated cash provided by operations.

We may raise capital through public or private issuances of debt securities, common or preferred equity or other instruments convertible into or exchangeable for common or preferred equity, as well as other capital raising activities such as asset sales or joint ventures.

Mortgage Notes Payable

During the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, pursuant to the Transaction, the Company entered into Loan Agreements providing for Mortgage Loans in an initial principal amount of approximately $1.16 billion and a $100 million Future Funding Facility, which we expect to be available to us to finance the redevelopment of properties in our portfolio from time to time, subject to satisfaction of certain conditions. No amounts have been drawn as of December 31, 2015 under the Future Funding Facility.

The Mortgage Loans mature in July 2019. The Company has two one-year extension options subject to the payment of an extension fee and satisfaction of certain other conditions. Borrowings under the Mortgage Loans bear interest at the London Interbank Offered Rates (“LIBOR”) plus, as of December 31, 2015, a weighted-average spread of 465 basis points; payments are made monthly on an interest-only basis. The weighted-average interest rate for the Mortgage Loans for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 was 4.96%.

All obligations under the Loan Agreements are non-recourse to the borrowers and the pledgors of the JV Interests and the guarantors thereunder, except that (i) the borrowers and the guarantors will be liable, on a joint and several basis, for losses incurred by the lenders in respect of certain matters customary for commercial real estate loans, including misappropriation of funds and certain environmental liabilities and (ii) the indebtedness under the Loan Agreements will be fully recourse to the borrowers and guarantors upon the occurrence of certain events customary for commercial real estate loans, including without limitation prohibited transfers, prohibited voluntary liens and bankruptcy. Additionally the guarantors delivered a limited completion guaranty with respect to future redevelopments undertaken by the borrowers at the properties.

The Mortgage Loans are secured by all of our Wholly Owned Properties and a pledge of our equity in the JVs. The Loan Agreements contain terms that limit our ability to incur additional indebtedness on these properties and may require lender approval of certain major tenant leases or significant redevelopment projects. The Loan Agreement prohibits repayment of any amounts outstanding for the first 12 months (other than repayments in connection with property releases and certain other exceptions) and contains a yield maintenance provision for the early extinguishment of the debt within the first 30 months. The Company believes it is currently in compliance with all material terms and conditions of the Loan Agreements.

Hedging Instruments

In connection with the issuance of the Company’s mortgage loans, we purchased for $5.0 million an interest rate cap with a term of four years, a notional amount of $1.26 billion and a strike rate of 3.5%. Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. The interest rate cap is measured at fair value and included as a component of prepaid expenses, deferred expenses and other assets on the consolidated balance sheet. The Company did not elect hedge accounting and therefore the change in fair value is included within unrealized loss on interest rate cap on the consolidated statement of operations. For the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, the Company recorded a loss of $2.9 million related to the change in fair value of the interest rate cap.

 

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Dividends and Distributions

On December 17, 2015, the Company’s Board of Trustees declared a cash dividend of $0.50 per share for the period from July 7, 2015 (Date Operations Commenced) through to December 31, 2015. The dividend was paid on January 14, 2016 to Class A and Class C shareholders of record on December 31, 2015. The holders of Operating Partnership units were entitled to an equal distribution per Operating Partnership unit held as of December 31, 2015.

On March 8, 2016, the Company’s Board of Trustees declared a cash dividend of $0.25 per share for the quarter ending March 31, 2016. The dividend will be paid on April 14, 2016 to Class A and Class C shareholders of record on March 31, 2016. The holders of Operating Partnership units are entitled to an equal distribution per Operating Partnership unit held as of March 31, 2016.

We currently intend to pay quarterly dividends and distributions in cash. However, 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

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, 2015 we did not have any off-balance sheet financing arrangements.

Contractual Obligations

Our contractual obligations relate to our mortgage loans payable and non-cancelable operating leases in the form of a ground lease at one of our properties, as well as the operating lease for our corporate office.

Information concerning our obligations and commitments to make future payments under contracts for these loan and lease agreements is aggregated in the following table (in thousands):

 

            Payments due by Period  

Contractual Obligation

   Total      Within
1 year
     1 - 3 years      3 -5 years      After
5 years
 

Long-term debt (1)

   $ 1,362,550       $ 57,586       $ 115,171       $ 1,189,793       $ —     

Operating leases

     3,105         412         854         826         1,013   

 

(1) Includes expected interest payments.

Capital Expenditures

Capital expenditures for Wholly Owned Properties under the Master Lease are generally the responsibility of the tenant. Given that the substantial majority of our GLA is subject to the Master Lease as of December 31, 2015, we do not currently anticipate incurring material expenses related to maintenance capital expenditures, tenant improvements or leasing commissions, outside of those associated with retenanting and redevelopment projects as described below.

During the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, we incurred maintenance capital expenditures of less than $0.1 million and did not pay for any tenant improvements or leasing commissions that were not associated with retenanting and redevelopment projects.

Summary of Cash Flows

Net cash provided by operating activities for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 was $13.7 million and included (i) $26.9 million of cash from operating income (net of acquisition-related expenses of $18.4 million) and (ii) a $13.2 million net decrease in cash due to timing of cash receipts and payments related to changes in operating assets and liabilities.

Net cash used in investing activities for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 was $2.7 billion which was primarily a result of the Transaction.

Net cash provided by financing activities for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 was $2.8 billion and included (i) $1.6 billion of gross cash proceeds from the issuance of common stock and non-controlling interests; (ii) $1.2 billion of gross cash proceeds from the issuance of the Mortgage Loans; and (iii) $29.6 million of offering and financing costs.

 

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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.

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 or liquidity of the Company.

In May and June of 2015, four purported Sears Holdings shareholders filed lawsuits in the Delaware Court of Chancery challenging the Transaction, which lawsuits have since been consolidated into a single action captioned In re Sears Holdings Corporation Stockholder and Derivative Litigation, Consol. C.A. No. 11081-VCL (the “Action”). On October 15, 2015, plaintiffs filed a verified consolidated stockholder derivative complaint (the “Complaint”) in the Action against defendants the individual members of Sears Holdings’ Board of Directors, ESL Investments, Inc. (together with its affiliates, “ESL”), Sears Holdings’ CEO, Fairholme Capital Management L.L.C. (“FCM”), and Seritage. The plaintiffs have brought the Action derivatively on behalf of Sears Holdings, which is named as a nominal defendant, and allege that the Sears Holdings directors, as well as ESL (in its capacity as the alleged controlling stockholder of Sears Holdings), breached their fiduciary duties to Sears Holdings shareholders by selling the Wholly Owned Properties to Seritage at a price that was unfairly low and was the result of a process that allegedly was flawed. The Complaint also alleges that Seritage and FCM aided and abetted these alleged fiduciary breaches. Among other forms of relief, the plaintiffs are currently seeking damages in unspecified amounts. The Company believes that the plaintiffs’ claims and allegations against the Company are legally without merit and intends to contest these lawsuits vigorously. Due to, among other things, the fact that the litigation is at a very early stage, management cannot reasonably estimate the possible loss or range of loss, if any, that may arise from this matter.

Retenanting and Redevelopment Projects

We are currently retenanting or redeveloping several properties primarily to convert single-tenant buildings occupied by Sears Holdings into multi-tenant properties occupied by a diversity of retailers and related concepts. The table below summarizes new projects initiated by the Company during the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015:

 

(dollars in thousands)                          

Property

 

Description

  Total Project
Square Feet
    Total Est.
Development Cost (1)
    Total Est.
Project Cost (1)
    Est.
Construction
Start
  Est.
Substantial
Completion

King of Prussia, PA

  Repurpose of former auto center space for Outback Steakhouse, Yard House and small shop retail     29,100      $ 3,900      $ 3,900      Q1 2016   Q4 2016

Braintree, MA

  100% recapture; redevelopment of existing building to be anchored by Nordstrom Rack and Saks Off 5th     90,000        11,700        12,100      Q1 2016   Q4 2016

Honolulu, HI

  100% recapture; redevelopment of existing building for Longs Drugs (CVS), PetSmart and Ross Dress For Less     79,000        8,500        19,700      Q2 2016   Q2 2017

Memphis, TN

  100% recapture; demolish and construct new buildings to be anchored by Nordstrom Rack     135,200        24,100        25,200      Q2 2016   Q3 2017

San Antonio, TX

  Recapture and repurpose auto center space for Orvis and Jared’s Jeweler     19,500        3,300        3,300      Q3 2016   Q2 2017
   

 

 

   

 

 

   

 

 

     

Total

      352,800      $ 51,500      $ 64,200       
   

 

 

   

 

 

   

 

 

     

 

(1) Total estimated development costs exclude, and total estimated project costs include, termination fees to recapture 100% of property.

 

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We plan to fund these projects with available cash balances, cash flow from operations, draws against the Future Funding Facility and other potential capital raising activities.

The Company also acquired 15 retenanting or redevelopment projects that were in various stages of development at the closing of the Transaction. The projected total cost of these projects was approximately $63.6 million of which a portion was incurred by Sears Holdings prior to the Transaction and for which reserve accounts were established at the closing of the Transaction to fund the remaining costs to be incurred by the Company. Of the 15 projects acquired by the Company, seven have been substantially completed and delivered to tenants as of December 31, 2015. The remaining eight projects, representing a total Company investment of approximately $29.7 million, are under development and have approximately $21.7 million remaining to be deployed as of December 31, 2015.

We continue to evaluate a number of additional retenanting and redevelopment projects that are consistent with our primary objective to maximize the value of our properties by recapturing space from Sears Holdings and re-leasing it to third-party 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 our Annual Report. We also refer you to our disclosure related to forward-looking statements.

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 combined financial statements in Part II, Item 8 of this Annual Report.

Accounting for Real Estate Acquisitions

Upon the acquisition of real estate, the Company assesses the fair value of acquired assets and liabilities assumed, including land, buildings, improvements and identified intangibles such as above-market and below-market leases, in-place leases and other items, as applicable, and allocates the purchase price based on these assessments. In making estimates of fair values, the Company may use a number of sources, including data provided by third parties, as well as information obtained by the Company as a result of its due diligence, including expected future cash flows of the property and various characteristics of the markets where the property is located.

The fair values of tangible assets are determined on an “if vacant” basis. The “if vacant” fair value allocated to land is generally estimated via a market or sales comparison approach with the subject site being compared to similar properties that have sold or are currently listed for sale. The comparable properties are adjusted for dissimilar characteristics such as market conditions, location, access/frontage, size, shape/topography, or intended use, including the impact of any encumbrances on such use. The “if vacant” value allocated to buildings and site improvements is generally estimated using an income approach and a cost approach that utilizes published guidelines for current replacement cost or actual construction costs for similar, recently developed properties. Assumptions used in the income approach include capitalization and discount rates, lease-up time, market rents, make ready costs, land value, and site improvement value.

The estimated fair value of in-place tenant leases includes lease origination costs (the costs the Company would have incurred to lease the property to the current occupancy level) and the lost revenues during the period necessary to lease-up from vacant to the current occupancy level. Such estimates include the fair value of leasing commissions, legal costs and tenant coordination costs that would be incurred to lease the property to this occupancy level. Additionally, the Company evaluates the time period over which such occupancy level would be achieved and include an estimate of the net operating costs (primarily real estate taxes, insurance and utilities) incurred during the lease-up period, which generally ranges up to one year. The fair value of acquired in-place tenant leases is included in lease intangible assets on the consolidated balance sheet and amortized over the remaining lease term for each tenant.

Identifiable intangible assets and liabilities are calculated for above-market and below-market tenant and ground leases where the Company is either the lessor or the lessee. The difference between the contractual rental rates and the Company’s estimate of market rental rates is measured over a period equal to the remaining non-cancelable term of the leases, including significantly below-market renewal options for which exercise of the renewal option appears to be reasonably assured. Above-market tenant leases and below-market ground leases are included in lease intangible assets on the consolidated balance sheet and below-market tenant leases are included in accounts payable, accrued expenses and other liabilities on the consolidated balance sheet.

 

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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 which generally range from five to 40 years. Tenant improvements are amortized on a straight-line basis over the shorter of the estimated useful life or non-cancelable term of lease.

We amortize 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.

Investments in Unconsolidated Joint Ventures

The Company accounts for its investments in unconsolidated joint ventures using the equity method of accounting. 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 significant losses or receive potentially significant benefits. We will consolidate a VIE if we have determined that we are the primary beneficiary.

Revenue Recognition

Rental income is recognized on a straight-line basis over the non-cancelable terms of the related leases. For leases that have fixed and measurable 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 sheet.

In leasing tenant space, we may provide funding to the lessee through a tenant allowance. In accounting for a tenant allowance, we will determine whether the allowance represents funding for the construction of leasehold improvements and evaluate the ownership of such improvements. If we are considered the owner of the improvements for accounting purposes, we 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 we are 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 straight-line basis.

Accounting for Recapture and Termination Activity Pursuant to the Master Lease

We generally treat recapture and termination activity pursuant to the Master Lease as modifications of the Master Lease as of the date of notice. Such notices and lease modifications result in the following accounting adjustments for the recaptured or terminated property:

 

    The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that is associated with recapture is deemed to be a lease modification and amortized over the remaining shortened life of the lease from the date of notice to the date of termination. 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 Master Lease.

 

    The portion of intangible lease assets and liabilities that are deemed to be impacted by the lease modification is amortized over the shorter of the shortened lease term 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 is amortized over the remaining useful life of the asset or liability.

 

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Additionally, termination fees paid by us to Sears Holding, if any, in connection with a 100% recapture notice are generally capitalized as a necessary cost of the real estate project and depreciated over the life of the real estate asset being constructed or improved. Termination fees required to be paid by Sears Holdings to us in connection with a lease termination by Sears Holdings are recognized as income over the shortened life of the lease from the date of notice to the date of termination.

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, Normalized FFO, EBITDA and Adjusted EBITDA.

Net Operating Income (“NOI”) and Total NOI

We define NOI 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. We believe NOI provides useful information regarding the Company, 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 uses Total NOI, which includes its share of unconsolidated properties and excludes certain GAAP adjustments, to present the Company’s proportional share of NOI excluding non-cash items. We believe Total NOI is a helpful supplemental measure of our operating performance. However, due to the adjustments noted, Total NOI should only be used as an alternative measure of the Company’s financial performance.

Earnings Before Interest Expense, Income Tax, Depreciation, and Amortization (“EBITDA”) and Adjusted EBITDA

We define EBITDA as NOI less administrative expenses and other operational items. EBITDA is a commonly used measure of performance in many industries, but may not be comparable to measures calculated by other companies. We believe EBITDA provides useful information to investors regarding our results of operations because it removes the impact of our capital structure (primarily interest expense) and our asset base (primarily depreciation and amortization). Management also believes the use of EBITDA facilitates comparisons between us and other equity REITs, retail property owners who are not REITs and other capital-intensive companies.

The Company also considers Adjusted EBITDA to be a helpful supplemental measure of its operating performance because it excludes from EBITDA certain other non-cash and non-comparable items that we do not believe are representative of ongoing operating results. However, due to the adjustments noted, Adjusted EBITDA should only be used as an alternative measure of the Company’s financial performance

Funds From Operations (“FFO”) and Normalized FFO

We define FFO using the definition set forth by the National Association of Real Estate Investment Trusts (“NAREIT”), which may not be comparable to measures calculated by other companies who do not use the NAREIT definition of FFO. FFO is calculated 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 asset.

We consider 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. FFO facilitates an understanding of the operating performance of our properties between periods because it does not give effect to real estate depreciation and amortization which are calculated to allocate the cost of a property over its useful life. Since values for well-maintained real estate assets have historically increased or decreased based upon prevailing market conditions, the Company believes that FFO provides investors with a clearer view of the Company’s operating performance.

The Company makes certain adjustments to FFO, which it refers to as Normalized FFO, to account for certain non-cash and non-comparable items, such as loss on interest rate cap, acquisition-related expenses, and up-front-hiring and personnel costs, that it does not believe are representative of ongoing operating results. Due to the adjustments noted, Normalized FFO should only be used as an alternative measure of the Company’s financial performance.

 

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Reconciliation of Non-GAAP Financial Measures to GAAP Financial Measures

None of Total NOI, FFO, Normalized FFO, EBITDA and Adjusted EBITDA 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.

The following table reconciles Total NOI to GAAP operating income or loss for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 (in thousands):

 

     July 7, 2015
(Date Operations
Commenced) to
December 31, 2015
 

TOTAL NET OPERATING INCOME

  

GAAP operating loss

   $ (9,373

Depreciation and amortization

     65,907   

General and administrative

     9,956   

Acquisition-related expenses

     18,397   

NOI of unconsolidated joint ventures

     14,456   
  

 

 

 

Total NOI before certain non-cash adjustments

     99,343   
  

 

 

 

Straight-line rent adjustment (1)

     (9,353

Above/below market rental income/expense (1)

     (497
  

 

 

 

Total NOI

   $ 89,493   
  

 

 

 

 

(1) Includes adjustments for unconsolidated joint ventures.

The following table reconciles EBITDA and Adjusted EBITDA to GAAP net loss for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 (in thousands):

 

     July 7, 2015
(Date Operations
Commenced) to
December 31, 2015
 

EBITDA

  

Net loss

   $ (38,803

Depreciation and amortization

     65,907   

Depreciation and amortization (unconsolidated joint ventures)

     8,987   

Interest expense

     30,461   

Provision for income and other taxes

     944   
  

 

 

 

EBITDA

   $ 67,496   
  

 

 

 

ADJUSTED EBITDA

  

EBITDA

   $ 67,496   

Unrealized loss on interest rate cap

     2,933   

Acquisition-related expenses

     18,397   

Up-front hiring and personnel costs

     1,906   
  

 

 

 

Adjusted EBITDA

   $ 90,732   
  

 

 

 

 

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The following table reconciles FFO and Normalized FFO to GAAP loss for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 (in thousands):

 

     July 7, 2015
(Date Operations
Commenced) to
December 31, 2015
 

FUNDS FROM OPERATIONS

  

Net loss

   $ (38,803

Real estate depreciation and amortization (consolidated properties)

     65,877   

Real estate depreciation and amortization (unconsolidated joint ventures)

     8,987   
  

 

 

 

FFO attributable to Seritage Growth Properties

   $ 36,061   
  

 

 

 

    

  
  

 

 

 

FFO per diluted common share and unit

   $ 0.65   
  

 

 

 

NORMALIZED FUNDS FROM OPERATIONS

  

Funds from Operations

   $ 36,061   

Unrealized loss on interest rate cap

     2,933   

Amortization of deferred financing costs

     2,657   

Acquisition-related expenses

     18,397   

Up-front hiring and personnel costs

     1,906   
  

 

 

 

Normalized FFO attributable to Seritage Growth Properties

   $ 61,954   
  

 

 

 

    

  
  

 

 

 

Normalized FFO per diluted common share and unit

   $ 1.12   
  

 

 

 

WEIGHTED AVERAGE COMMON SHARES AND UNITS

  

Weighted average common shares outstanding

     31,386   

Weighted average OP units outstanding

     24,176   
  

 

 

 

Weighted average common shares and units outstanding

     55,562   
  

 

 

 

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to market risk associated with changes in interest rates both in terms of existing variable-rate debt and the price of new fixed-rate debt upon maturity of existing debt and to fund investments. As of December 31, 2015, we had $1,161 million of consolidated debt, all of which of was our variable-rate Mortgage Loans Payable. An immediate 100 basis point change in the underlying interest rate would result in an $11.6 million increase to interest expense and corresponding decrease to operating cash flow.

The Company has managed and will continue to manage interest rate risk through the use of interest rate caps and/or swaps and by taking advantage of favorable market conditions for fixed-rate debt and/or equity or equity-linked capital, depending on our analysis of the interest rate environment and the costs and risks of such strategies.

As of December 31, 2015, the estimated fair value of our consolidated debt was $1.2 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. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reference is made to the Consolidated Financial Statements and Consolidated Financial Statement Schedule beginning on page F-1 for the required information.

 

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

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 Securities Exchange Act of 1934 (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.

No Management Report or Attestation Report Regarding Internal Control

This Annual Report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of the Company’s registered public accounting firm due to a transition period established by rules of the SEC for newly public companies.

Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

None.

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

Incorporated herein by reference to our definitive proxy statement with respect to our 2016 Annual Meeting of Shareholders.

 

ITEM 11. EXECUTIVE COMPENSATION

Incorporated herein by reference to our definitive proxy statement with respect to our 2016 Annual Meeting of Shareholders.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Incorporated herein by reference to our definitive proxy statement with respect to our 2016 Annual Meeting of Shareholders.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Incorporated herein by reference to our definitive proxy statement with respect to our 2016 Annual Meeting of Shareholders.

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Incorporated herein by reference to our definitive proxy statement with respect to our 2016 Annual Meeting of Shareholders.

 

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PART IV

 

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    Amended and Restated Bylaws    Incorporated by reference to Exhibit 3.2 to our Current Report on Form 8-K, filed on July 10, 2015
    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
  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    Agreement of Limited Partnership of Seritage Growth Properties, L.P., dated as of July 7, 2015    Incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K, filed on July 10, 2015
  10.3    Master Lease by and among Seritage SRC Finance LLC, Seritage KMT Finance LLC, Kmart Operations, LLC, and Sears Operations, LLC, dated as of July 7, 2015    Incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K, filed on July 10, 2015
  10.4    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
  10.5    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

 

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  10.6

  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

  10.7

  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

  10.8

  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

  10.9

  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

  10.10

  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

  10.11

  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

  10.12

  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

  10.13

  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

  10.14

  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

  10.15

  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

  10.16

  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

 

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  10.17

  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

  21.1

  List of subsidiaries    Filed herewith.

  23.1

  Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm    Filed herewith.

  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    Filed 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    Filed herewith.

101.INS

  XBRL Instance Document    Filed herewith.

101.SCH

  XBRL Taxonomy Extension Schema Document    Filed herewith.

101.CAL

  XBRL Taxonomy Extension Calculation Linkbase Document    Filed herewith.

101.DEF

  XBRL Taxonomy Extension Definition Linkbase Document    Filed herewith.

101.LAB

  XBRL Taxonomy Extension Label Linkbase Document    Filed herewith.

101.PRE

  XBRL Taxonomy Extension Presentation Linkbase Document    Filed herewith.

 

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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 11, 2016      

/s/ Benjamin 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 11, 2016

Edward S. Lampert     

/s/ Benjamin W. Schall

  

President, Chief Executive Officer and Trustee

(Principal Executive Officer)

 

March 11, 2016

Benjamin W. Schall     

/s/ Brian R. Dickman

  

Executive Vice President, Chief Financial Officer

(Principal Financial and Accounting Officer)

 

March 11, 2016

Brian R. Dickman     

/s/ David S. Fawer

   Trustee  

March 11, 2016

David S. Fawer     

/s/ Kenneth T. Lombard

   Trustee  

March 11, 2016

Kenneth T. Lombard     

/s/ John. T. McClain

   Trustee  

March 11, 2016

John T. McClain     

/s/ Thomas M. Steinberg

   Trustee  

March 11, 2016

Thomas M. Steinberg     

 

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SERITAGE GROWTH PROPERTIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULE

 

Financial Statements

 

  
     Page  

Report of Independent Registered Public Accounting Firm

     F-2   

Consolidated Balance Sheet as of December 31, 2015

     F-3   

Consolidated Statement of Operations for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015

     F-4   

Consolidated Statement of Equity for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015

     F-5   

Consolidated Statement of Cash Flows for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015

     F-6   

Notes to Consolidated Financial Statements

     F-7   

Financial Statement Schedule

  

Schedule III—Real estate and accumulated depreciation

     F-26   

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.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Trustees and Shareholders of

Seritage Growth Properties

New York, New York

We have audited the accompanying consolidated balance sheet of Seritage Growth Properties and subsidiaries (the “Company”) as of December 31, 2015, and the related consolidated statements of operations, equity, and cash flows for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015. Our audit also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Seritage Growth Properties and subsidiaries as of December 31, 2015, and the results of their operations and their cash flows for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ Deloitte & Touche LLP

New York, New York

March 11, 2016

 

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SERITAGE GROWTH PROPERTIES

CONSOLIDATED BALANCE SHEET

(Amounts in thousands, except share and per share amounts)

 

     December 31, 2015  

ASSETS

  

Investment in real estate

  

Land

   $ 840,563   

Buildings and improvements

     814,652   

Accumulated depreciation

     (29,076
  

 

 

 
     1,626,139   

Construction in progress

     13,136   
  

 

 

 

Net investment in real estate

     1,639,275   

Investment in unconsolidated joint ventures

     427,052   

Cash and cash equivalents

     62,867   

Restricted cash

     92,475   

Tenant and other receivables, net

     9,772   

Lease intangible assets, net

     578,795   

Prepaid expenses, deferred expenses and other assets, net

     23,123   
  

 

 

 

Total assets

   $ 2,833,359   
  

 

 

 

LIABILITIES AND EQUITY

  

Liabilities

  

Mortgage loans payable, net

   $ 1,142,422   

Accounts payable, accrued expenses and other liabilities

     120,860   
  

 

 

 

Total liabilities

     1,263,282   
  

 

 

 

Commitments and contingencies (Note 10)

  

Shareholders’ Equity

  

Class A shares $0.01 par value; 100,000,000 shares authorized; 24,817,842 shares issued and outstanding

     248   

Class B shares $0.01 par value; 5,000,000 shares authorized; 1,589,020 shares issued and outstanding

     16   

Class C shares $0.01 par value; 50,000,000 shares authorized; 6,773,185 shares issued and outstanding

     68   

Additional paid-in capital

     924,508   

Accumulated deficit

     (38,145
  

 

 

 

Total shareholders’ equity

     886,695   

Non-controlling interests

     683,382   
  

 

 

 

Total equity

     1,570,077   
  

 

 

 

Total liabilities and equity

   $ 2,833,359   
  

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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SERITAGE GROWTH PROPERTIES

CONSOLIDATED STATEMENT OF OPERATIONS

(Amounts in thousands, except per share amounts)

 

     July 7, 2015  
     (Date Operations  
     Commenced) to  
     December 31, 2015  

REVENUE

  

Rental income

   $ 86,645   

Tenant reimbursements

     26,926   
  

 

 

 

Total revenue

     113,571   
  

 

 

 

EXPENSES

  

Property operating

     6,329   

Real estate taxes

     22,355   

Depreciation and amortization

     65,907   

General and administrative

     9,956   

Acquisition-related expenses

     18,397   
  

 

 

 

Total expenses

     122,944   
  

 

 

 

Operating loss

     (9,373

Equity in income of unconsolidated joint ventures

     4,772   

Interest and other income

     136   

Interest expense

     (30,461

Unrealized loss on interest rate cap

     (2,933
  

 

 

 

Loss before income taxes

     (37,859

Provision for income taxes

     (944
  

 

 

 

Net loss

     (38,803

Net loss attributable to non-controlling interests

     16,465   
  

 

 

 

Net loss attributable to common shareholders

   $ (22,338
  

 

 

 

Net loss per share attributable to Class A and Class C common shareholders – Basic and diluted

   $ (0.71
  

 

 

 

Weighted average Class A and Class C common shares outstanding – Basic and diluted

     31,386   
  

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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SERITAGE GROWTH PROPERTIES

CONSOLIDATED STATEMENT OF EQUITY

(Amounts in thousands)

 

    Class A     Class B     Class C     Additional     Accumulated     Non-Controlling     Total  
    Shares     Amount     Shares     Amount     Shares     Amount     Paid-In Capital     Deficit     Interests     Equity  

Balance at July 7, 2015 (Date Operations Commenced)

    24,584      $ 246        1,589      $ 16        6,790      $ 68      $ 923,636      $ —        $ 711,991      $ 1,635,957   

Net loss

    —          —          —          —          —          —          —          (22,338     (16,465     (38,803

Offering related costs

    —          —          —          —          —          —          (70     —          (56     (126

Dividends and distributions declared ($0.50 per share and unit)

    —          —          —          —          —          —          —          (15,807     (12,088     (27,895

Issuance of restricted stock, net (216,835 common shares)

    217        2        —          —          —          —          (2     —          —          —     

Stock-based compensation

    —          —          —          —          —          —          944        —          —          944   

Share class exchanges, net (17,450 common shares)

    17        0        —          —          (17     (0     —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2015

    24,818      $ 248        1,589      $ 16        6,773      $ 68      $ 924,508      $ (38,145   $ 683,382      $ 1,570,077   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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SERITAGE GROWTH PROPERTIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(Amounts in thousands)

 

     July 7, 2015
(Date Operations
Commenced) to
December 31, 2015
 

CASH FLOW FROM OPERATING ACTIVITIES

  

Net loss

   $ (38,803

Adjustments to reconcile net loss to net cash provided by operating activities:

  

Equity in income of unconsolidated joint ventures

     (4,772

Distributions from unconsolidated joint ventures

     6,733   

Unrealized loss on interest rate cap

     2,933   

Stock-based compensation

     944   

Depreciation and amortization

     65,907   

Amortization of deferred financing costs

     2,657   

Amortization of above and below market leases, net

     (388

Straight-line rent adjustment

     (8,299

Change in operating assets and liabilities

  

Tenants and other receivables

     (1,473

Prepaid expenses, deferred expenses and other assets

     (25,596

Restricted cash

     (3,761

Accounts payable, accrued expenses and other liabilities

     21,589   
  

 

 

 

Net cash provided by operating activities

     17,671   
  

 

 

 

CASH FLOW FROM INVESTING ACTIVITIES

  

Acquisition of real estate and unconsolidated joint ventures

     (2,653,019

Development of real estate

     (11,273

Increase in restricted cash

     (66,107
  

 

 

 

Net cash used in investing activities

     (2,730,399
  

 

 

 

CASH FLOW FROM FINANCING ACTIVITIES

  

Proceeds from issuance of mortgage loans payable, net

     1,161,196   

Payment of financing costs

     (21,431

Proceeds from issuance of common stock and non-controlling interest

     1,644,042   

Offering related costs

     (8,212
  

 

 

 

Net cash provided by financing activities

     2,775,595   
  

 

 

 

Net increase in cash and cash equivalents

     62,867   

Cash and cash equivalents, beginning of period

     —     
  

 

 

 

Cash and cash equivalents, end of period

   $ 62,867   
  

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

  

Cash payments for interest

   $ 25,325   

Capitalized interest

     226   

Income taxes paid

     944   

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES

  

Development of real estate financed with accounts payable

   $ 2,856   

Dividends and distribution declared and unpaid

     27,894   

The accompanying notes are an integral part of these consolidated financial statements.

 

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SERITAGE GROWTH PROPERTIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Organization

Seritage Growth Properties was organized in Maryland on June 3, 2015 and initially capitalized with 100 shares of Class A common shares. The Company conducts its operations through Seritage Growth Properties, L.P. (the “Operating Partnership”), a Delaware limited partnership that was formed on April 22, 2015. Unless the context otherwise requires, “Seritage” and the “Company” refer to Seritage Growth Properties, the Operating Partnership and its subsidiaries.

On June 11, 2015 Sears Holdings Corporation (“Sears Holdings”) 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 234 of Sears Holdings’ owned properties and one of its ground leased properties (the “Wholly Owned Properties”), and its 50% interests in three joint ventures (such joint ventures, the “JVs,” and such 50% joint venture interests the “JV Interests”) that collectively own 28 properties, ground lease one property and lease two properties (collectively, the “JV Properties”) (collectively, 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 (see Note 3) and commenced operations. The Company did not have any operations prior to the completion of the Rights Offering and Transaction.

Seritage is a fully-integrated, self-administered, self-managed real estate investment trust (“REIT”) primarily engaged in the real property business through the Company’s investment in the Operating Partnership. Subsidiaries of the Operating Partnership lease a substantial majority of the space at all but 11 of the Wholly Owned Properties back to Sears Holdings under a master lease agreement (“Master Lease”), with the remainder of such space leased to third-party tenants. A substantial majority of the space at the JV Properties is also leased (or subleased) by the JVs to Sears Holdings under master lease agreements (collectively, the “JV Master Leases”). The Master Lease and the JV Master Leases provide the Company and the JVs with the right to recapture certain space from Sears Holdings at each property for retenanting or redevelopment purposes.

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 variable interest entity and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the variable interest entity. 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.

To the extent such variable interests are in entities that cannot be evaluated under the Variable Interest Model, the Company evaluates its interests using the Voting Interest Entity Model. The Company has a variable interest in the Operating Partnership. The Operating Partnership is not currently within the scope of the Variable Interest Model and is instead evaluated under the Voting Interest Entity Model. The Company holds a 56.6% 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. 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, the Company consolidates its interest in the Operating Partnership.

 

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The portions of consolidated entities not owned by the Company and the Operating Partnership are presented as non-controlling interests as of and during the period presented.

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 fair values of acquired assets and liabilities assumed for purposes of applying the acquisition method of accounting, the useful lives of tangible and intangible assets, real estate impairment assessments, and assessing the recoverability of accounts receivables. 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 retail properties. The Company reviews operating and financial information for each property on an individual basis and therefore, each property represents an individual operating segment. The Company does not distinguish or group consolidated operations based on geography, size, or type. The Company 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.

Accounting for Real Estate Acquisitions

Upon the acquisition of real estate, the Company assesses the fair value of acquired assets and liabilities assumed, including land, buildings, improvements and identified intangibles such as above-market and below-market leases, in-place leases and other items, as applicable, and allocates the purchase price based on these assessments. In making estimates of fair values, the Company may use a number of sources, including data provided by third parties, as well as information obtained by the Company as a result of its due diligence, including expected future cash flows of the property and various characteristics of the markets where the property is located.

The fair values of tangible assets are determined on an “if vacant” basis. The “if vacant” fair value allocated to land is generally estimated via a market or sales comparison approach with the subject site being compared to similar properties that have sold or are currently listed for sale. The comparable properties are adjusted for dissimilar characteristics such as market conditions, location, access/frontage, size, shape/topography, or intended use, including the impact of any encumbrances on such use. The “if vacant” value allocated to buildings and site improvements is generally estimated using an income approach and a cost approach that utilizes published guidelines for current replacement cost or actual construction costs for similar, recently developed properties. Assumptions used in the income approach include capitalization and discount rates, lease-up time, market rents, make ready costs, land value, and site improvement value.

The estimated fair value of in-place tenant leases includes lease origination costs (the costs the Company would have incurred to lease the property to the current occupancy level) and the lost revenues during the period necessary to lease-up from vacant to the current occupancy level. Such estimates include the fair value of leasing commissions, legal costs and tenant coordination costs that would be incurred to lease the property to this occupancy level. Additionally, the Company evaluates the time period over which such occupancy level would be achieved and include an estimate of the net operating costs (primarily real estate taxes, insurance and utilities) incurred during the lease-up period, which generally ranges up to one year. The fair value of acquired in-place tenant leases is included in lease intangible assets on the consolidated balance sheet and amortized over the remaining lease term for each tenant.

Identifiable intangible assets and liabilities are calculated for above-market and below-market tenant and ground leases where the Company is either the lessor or the lessee. The difference between the contractual rental rates and the Company’s estimate of market rental rates is measured over a period equal to the remaining non-cancelable term of the leases including significantly below-market renewal options for which exercise of the renewal option appears to be reasonably assured. Above-market tenant leases and below-market ground leases are included in lease intangible assets on the consolidated balance sheet; below-market tenant leases and above-market ground leases are included in accounts payable, accrued expenses and other liabilities on the consolidated balance sheet. The values assigned to above-market and below-market tenant leases are amortized as reductions and increases. respectively, to base rental revenue over the remaining term of the respective leases. The values assigned to below-market and above-market ground leases are amortized as increases and reductions, respectively, to property operating expenses over the remaining term of the respective leases.

The Company expenses transaction costs associated with business combinations in the period incurred. These costs are included in acquisition-related expenses within the consolidated statement of operations.

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.

 

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Depreciation of real estate assets, excluding land, is recognized on a straight-line basis over their estimated useful lives as follows:

 

Building:

  

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. 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 such impairment losses were recognized for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015.

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 period from July 7, 2015 (Date Operations Commenced) through December 31, 2015.

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, 2015, the Company had approximately $92.5 million of restricted cash, including $51.3 million related to future capital investments such as unfunded construction commitments, deferred maintenance and environmental reserves, and $41.2 million related to basic property carrying costs such as real estate taxes, insurance and ground rent.

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. In the event that the collectability of a receivable with respect to any tenant is in doubt, a provision for uncollectible amounts will be established or a direct write-off of the specific rent receivable will be made. For accrued rental revenues related to the straight-line method of reporting rental revenue, the Company performs a periodic review of receivable balances to assess the risk of uncollectible amounts and establish appropriate provisions.

 

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Revenue Recognition

Rental income is recognized on a straight-line basis over the non-cancelable terms of the related leases. For leases that have fixed and measurable 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 sheet.

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 straight-line basis.

The Company commences recognizing revenue based on an evaluation of a number of factors. In most cases, revenue recognition under a lease begins when the lessee takes possession of or controls the physical use of the leased asset. Generally, this occurs on the lease commencement date.

Tenant reimbursement income 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 Master Lease

Seritage 100% Recapture Rights. The Company generally treats the delivery of a 100% recapture notice as a modification of the Master Lease as of the date of notice. Such a notice and lease modification result in the following accounting adjustments for the recaptured property:

 

  Accrued rental revenues related to the straight-line method of reporting rental revenue that is deemed uncollectable as result of the lease modification is amortized over the remaining shortened life of the lease from the date of notice to the date of termination.

 

  Intangible lease assets and liabilities that are deemed to be impacted by the lease modification are amortized over the shorter of the shortened lease term or the remaining useful life of the asset or liability.

A 100% 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 100% recapture notice are generally capitalized as either an initial direct cost of obtaining a new leases 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.

Seritage 50% Recapture Rights. The Company generally treats the delivery of a 50% recapture notice as a modification of the Master 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 is subject to the lease modification is amortized over the remaining shortened life of the lease from the date of notice to the date of termination. The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that is attributable to the retained space is amortized over the remaining life of the Master Lease.

 

  The portion of intangible lease assets and liabilities that are deemed to be impacted by the lease modification is amortized over the shorter of the shortened lease term 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 is amortized over the remaining useful life of the asset or liability.

 

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Sears Holdings Termination Rights. The Master Lease provides Sears Holdings with certain rights to terminate the Master Lease with respect to properties that cease to be profitable for operation by Sears Holdings. Such a termination 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 is subject to the termination is amortized over the remaining shortened life of the lease from the date of notice to the date of termination.

 

  Intangible lease assets and liabilities that are deemed to be impacted by the termination are amortized over the shorter of the shortened lease term or the remaining useful life of the asset or liability.

Additionally, termination fees required to be paid by Sears Holdings to the Company are recognized as income over the remaining shortened life of the lease from the date of notice to the date of termination.

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, the Company purchased for $5.0 million an interest rate cap with a term of four years, a notional amount of $1.26 billion and a strike rate of 3.5%. The interest rate cap is measured at fair value and included as a component of prepaid expenses, deferred expenses and other assets on the consolidated balance sheet. The Company has elected not to utilize hedge accounting and therefore the change in fair value is included within change in fair value of interest rate cap on the consolidated statement of operations. For the period July 7, 2015 (Date Operations Commenced) through December 31, 2015, the Company recorded a loss of $2.9 million related to the change in fair value of the interest rate cap.

Stock-Based Compensation

The Company generally recognizes equity awards to employees as compensation expense and includes such expense within general and administrative expenses on the consolidated statement of operations. Compensation expense for equity awards is generally based on the fair value of the common shares at the date of the grant and is recognized (i) ratably over the vesting period for awards with time-based vesting and (ii) for awards with performance-based vesting, at the date the achievement of performance criteria is deemed probable, an amount equal to that 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.

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, 2015, substantially all of the Company’s real estate properties were leased to Sears Holdings and the majority of Company’s rental revenues were derived from the Master Lease (see Note 6). Sears Holdings is a publicly traded company that is subject to the informational filing requirements of the Securities Exchange Act of 1934, as amended, and is required to file periodic reports on Form 10-K and Form 10-Q with the SEC. Refer to www.sec.gov for Sears Holdings Corporation publicly-available financial information.

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, 2015, the Company’s portfolio of 235 Wholly Owned Properties was diversified by location across 49 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 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. 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

On February 25, 2016, the Financial Accounting Standards Boards (“FASB”) issued Accounting Standards Codification (“ASC”) 842 (“ASC 842”), “Leases” which replaces the existing guidance in ASC 840, Leases. ASC 842 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. ASC 842 requires a dual approach

 

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for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use (ROU) asset and a corresponding lease liability. For finance leases, the lessee would recognize interest expense and amortization of the ROU asset and for operating leases, the lessee would recognize a straight-line total lease expense. The Company is currently assessing the impact that adoption of this guidance will have on its consolidated financial statements and footnote disclosures.

In September 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-16, which amends Topic 805, Business Combinations, and requires the recognition of purchase price allocation adjustments that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, and eliminates the requirement to retrospectively account for these adjustments. ASU 2015-16 is effective, on a prospective basis, for interim and annual periods beginning after December 15, 2015; early adoption is permitted. The Company has chosen to early adopt ASU 2015-16 during the current period on a prospective basis and it did not have an impact on the consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs,” which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected. ASU 2015-03 is effective for annual periods beginning after December 31, 2015. Early adoption is permitted. The Company elected to early adopt ASU 2015-03 during the current period for the costs related to the mortgage loans issued in connection with the Transaction. As the Company has not previously reported debt issuance costs and mortgage loans payable within the consolidated financial statements, retrospective application is not required. As such, debt issuance costs, net of accumulated amortization, are netted against mortgage loans payable on the consolidated balance sheet.

In February 2015, the FASB issued ASU 2015-02, “Amendments to the Consolidation Analysis,” which makes certain changes to both the variable interest model and the voting model, including changes to (1) the identification of variable interests (fees paid to a decision maker or service provider), (2) the variable interest entity characteristics for a limited partnership or similar entity and (3) the primary beneficiary determination. ASU 2015-02 is effective for annual periods beginning after December 15, 2015. Although the Company has not yet finalized its evaluation of this new accounting standard, aside from certain expanded disclosure requirements, it is not expected that the adoption of this standard will have a material impact on the consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. ASU 2014-09 states that “an entity recognizes 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.” While ASU 2014-09 specifically references contracts with customers, it may apply to certain other transactions such as the sale of real estate or equipment. In July 2015, the FASB voted to defer the effective date of ASU 2014-09 by one year. Accordingly, ASU 2014-09 is effective for annual periods beginning after December 15, 2017, with early adoption permitted for annual periods beginning after December 15, 2016. The standard can be applied either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment recognized as of the date of initial application. The Company is evaluating the impact of adopting this new accounting standard on its consolidated financial statements.

Note 3 – Acquisitions

On July 7, 2015, the Company purchased the Wholly Owned Properties and JV Interests at their fair value for $2.7 billion, with the substantial majority of such properties being leased back to Sears Holdings.

 

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The following table summarizes the purchase price and fair values of the net assets acquired in the Transaction (in thousands):

 

Proceeds from issuance of common stock and non-controlling interest

      $ 1,644,042   

Less: Offering related costs

        (8,212

Proceeds from issuance of mortgage loans payable

        1,161,196   

Less: Deferred financing costs

        (21,431
     

 

 

 

Total sources of funds net of offering and financing costs

        2,775,595   
     

 

 

 

Real estate assets acquired

     

Land

     840,563      

Buildings and improvements

     810,499      

Lease intangibles

     

In-place leases

     595,443      

Below-market ground lease

     11,766      

Above-market leases

     9,058      

Below-market leases

     (20,045   

Investments in unconsolidated joint ventures

     429,012      
  

 

 

    

Total fair value of real estate assets acquired

        2,676,296   

Plus: Restricted cash

     

Environmental expenses reserve

     12,034      

Deferred maintenance reserve

     10,575      
  

 

 

    

Total restricted cash

        22,609   

Less: Assumed liabilities

     

Real estate taxes payable

     (23,277   

Environmental expenses

     (12,034   

Deferred maintenance

     (10,575   

Total assumed liabilities

        (45,886
     

 

 

 

Net cash paid for acquisition of real estate and unconsolidated joint ventures

        2,653,019   
  

 

 

 

Additional (sources) / uses of cash

     

Prepaid rent

     (26,855   

Initial funding of unfunded construction commitments reserve (restricted cash)

     42,470      

Initial funding of property carry costs reserve (restricted cash)

     32,482      

Initial funding of interest expense reserve (restricted cash)

     4,924      

Acquisition-related expenses

     18,340      

Prepaid interest expense

     1,249      

Total additional (sources) uses of cash, net

        72,610   
     

 

 

 

Remaining excess cash from transaction

      $ 49,966   
     

 

 

 

The allocation of the consideration for this acquisition remains subject to adjustment as the Company finalizes its purchase price allocation. The Company is utilizing an independent third party to assist management with its determination of the final allocation of value.

 

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Note 4 – 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 $578.8 million and $19.0 million as of December 31, 2015, respectively. The following table summarizes the Company’s lease intangible assets and liabilities (in thousands):

 

     Gross      Accumulated     

Wtd. Avg.

Remaining

Amortization

 

Lease Intangible Assets

   Asset      Amortization      Balance      Period  

In-place leases, net

   $ 595,443       $ (36,800    $ 558,643         8.4 years   

Below-market ground leases, net

     11,766         (102      11,664         57.5 years  

Above-market leases, net

     9,058         (570      8,488         8.8 years   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 616,267       $ (37,472    $ 578,795         9.4 years   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Gross      Accumulated      Wtd. Avg.
Remaining
Amortization
 

Lease Intangible Liabilities

   Liability      Amortization      Balance      Period  

Below-market leases, net

   $ 20,045       $ (1,059    $ 18,986         11.4 years   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 20,045       $ (1,059    $ 18,986         11.4 years   
  

 

 

    

 

 

    

 

 

    

 

 

 

Amortization of acquired below-market leases, net of acquired above-market leases resulted in additional rental income of $0.5 million for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015. Estimated annual amortization of acquired below-market leases, net of acquired above-market leases for each of the five succeeding years commencing January 1, 2016 is as follows (in thousands):

 

2016

   $ (978

2017

     (978

2018

     (978

2019

     (951

2020

     (822

Amortization of acquired below-market ground leases resulted in additional rent expense of $0.1 million for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015. Estimated annual amortization of acquired below-market ground leases for each of the five succeeding years commencing January 1, 2016 is as follows (in thousands):

 

2016

   $ 203   

2017

     203   

2018

     203   

2019

     203   

2020

     203   

Amortization of acquired in-place leases resulted in additional depreciation and amortization expense of $36.8 million for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015. Estimated annual amortization of acquired in-place leases for each of the five succeeding years commencing January 1, 2016 is as follows (in thousands):

 

2016

   $ 73,601   

2017

     73,601   

2018

     73,033   

2019

     70,228   

2020

     67,372   

Note 5 – Investments in Unconsolidated Joint Ventures

The Company conducts a portion of its property rental activities through investments in unconsolidated joint ventures for which the Company holds less than a controlling interest. The Company’s partners in these unconsolidated joint ventures are unrelated real estate entities or commercial enterprises. The Company and its unconsolidated 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.

The Company currently has investments in three unconsolidated entities: GS Portfolio Holdings LLC (the “GGP JV”), a joint venture between Seritage and a subsidiary of General Growth Properties, Inc. (together with its subsidiaries, “GGP”), SPS Portfolio Holdings LLC (the “Simon JV”), a joint venture between Seritage and a subsidiary of Simon Property Group, Inc. (together with its subsidiaries, “Simon”), and MS Portfolio LLC (the “Macerich JV”), a joint venture between Seritage and a

 

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subsidiary of The Macerich Company (together with its subsidiaries, “Macerich”). A substantial majority of the space at the JV Properties is leased to Sears Holdings under the JV Master Leases which include recapture rights and termination rights with similar terms as those described under the Master Lease. The GGP JV submitted recapture notices related to two properties during the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 and submitted recapture notices related to two additional properties subsequent to December 31, 2015.

The Company’s investments in unconsolidated joint ventures at December 31, 2015, consisted of (in thousands):