Seritage Growth Properties — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. Seritage began operations on July 7, 2015, so the comparison period is only July 7–December 31, 2015 and is not a full-year comparison.
Business context and portfolio
Seritage is a retail real estate REIT focused on acquiring, leasing, redeveloping and repositioning properties. At year-end it reported 235 wholly owned properties and 50% interests in 31 joint-venture properties, with approximately 42.2 million square feet of gross leasable area (GLA). The portfolio was 99.2% leased based on signed leases, including leases not yet open.
Sears Holdings remained the dominant tenant. On a proportional portfolio basis, Sears represented 85.9% of leased GLA and 63.9% of annual rent under signed leases; third-party tenants represented 36.1% of annual rent, including signed but not yet commenced leases. The company’s strategy is to recapture Sears space, redevelop it and lease it to third parties, often at higher rents.
Financial and operating results
| Metric | 2016 | Prior comparison period |
|---|---|---|
| Total revenue | $248.7 million | $113.6 million |
| Net loss | $91.0 million | $38.8 million |
| Net loss attributable to common shareholders | $51.6 million | $22.3 million |
| Net loss per Class A and Class C share | $1.64 | $0.71 |
| Operating cash flow | $92.4 million | $17.7 million |
| Investing cash flow | $(52.8) million | $(2,730.4) million |
| Financing cash flow | $(50.5) million | $2,775.6 million |
Revenue comprised $186.4 million of rental income and $62.3 million of tenant reimbursements. Rental income increased by $99.8 million, reflecting the longer reporting period, completed redevelopments and contractual rent increases, partly offset by recaptures. Sears-related rental income, excluding straight-line rent, was $133.2 million, or 79.5% of rental income; third-party rental income was $34.3 million, or 20.5%.
GAAP operating loss was $30.4 million. Total NOI, a non-GAAP measure including the company’s share of joint ventures and excluding specified items, was $190.5 million; FFO was $106.5 million ($1.92 per diluted share and unit), and Company FFO was $127.3 million ($2.29 per diluted share and unit). These non-GAAP measures are not substitutes for net income or cash flow. No conventional operating margin is presented in the filing.
Year-end total assets were $2.71 billion, total liabilities $1.29 billion and total equity $1.42 billion. Mortgage loans payable were $1.167 billion net of financing costs; principal outstanding was approximately $1.181 billion, including $20 million drawn on the future funding facility. Unrestricted cash was $52.0 million and restricted cash was $87.6 million. The restricted balance was reserved for specified property costs and is not equivalent to freely available cash.
Changes, outlook and notable items
- Third-party tenants’ share of signed annual base rent rose to 36.1% from 24.0% at year-end 2015, while signed annual rent increased to $231.7 million from $202.9 million. Rent per square foot rose to $5.91 from $5.13. These are year-end leasing measures, not full-year recognized revenue.
- During 2016, Sears terminated leases at 17 stores totaling approximately 1.7 million square feet; it paid about $10 million in termination fees after vacating in January 2017. In January 2017, Sears gave notice to terminate 19 more stores totaling approximately 1.9 million square feet. Combined base rent for the 36 stores was about $11.9 million at year-end 2016; the additional stores were expected to be vacated in April 2017.
- The company reported 33 new wholly owned redevelopment projects, with estimated total project costs of $399.1 million and $353.9 million remaining to spend at year-end. Management estimated projected incremental annual income of $48.7 million and a 12%–13% incremental yield for those projects, based on stabilized-rent assumptions; it cautioned that targets may not be achieved. Funding was expected from cash, operating cash flow, the future funding facility and other capital sources.
- Mortgage debt bears variable LIBOR-based interest, with a 5.24% weighted-average rate in 2016, and matures in July 2019, subject to extension options. A 100-basis-point rate increase was estimated to raise annual interest expense by $11.8 million. In November 2016, amendments resolved a cash-sweep disagreement; Seritage posted $30 million and committed to monthly $3.3 million redevelopment-reserve deposits. No cash sweep was imposed following the amendments.
- After year-end, Seritage entered into a $200 million delayed-draw unsecured term loan, undrawn at closing, at a 6.50% base rate and with maturity no later than December 31, 2017. It is a related-party transaction with lenders controlled by ESL; Mr. Lampert recused himself from approval.
- A settlement of litigation challenging the 2015 Sears property transaction provides for $40 million in total payments, of which Seritage agreed to pay $19 million. The company recorded the $19 million charge in 2016; court approval was scheduled for May 9, 2017. Defendants denied the allegations.
- Management intends to continue quarterly cash distributions; the board retains discretion over timing and amount. The 2016 declared dividend was $1.00 per Class A and Class C share. The filing provides no quantified company-wide earnings or NOI guidance.
Key risks include dependence on Sears’ ability to pay rent, Sears’ lease termination rights and potential bankruptcy, execution and funding risks for redevelopment, variable-rate debt and covenant restrictions, retail-market and e-commerce pressures, environmental liabilities, and continued REIT qualification. Management reported effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions.
Important facts for investors to verify
- Review Sears Holdings’ current financial condition, rent coverage, store closure plans and ability to meet Master Lease obligations.
- Track actual lease commencements, occupancy, rent levels and realized returns against the redevelopment pipeline’s estimates; distinguish signed leases from rent-producing space.
- Confirm the status and cash impact of the 19 announced lease terminations, associated fees, and the company’s ability to re-lease the vacated properties.
- Assess unrestricted liquidity separately from restricted reserves, future-funding availability and the post-year-end term loan; monitor debt maturities, interest-rate exposure and cash-sweep covenants.
- Confirm court approval and final payment terms of the transaction litigation settlement, and assess any additional environmental or other contingencies.
- Monitor REIT qualification and the board’s capacity and willingness to sustain distributions while funding redevelopment and servicing debt.