The accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 – Organization
Seritage Growth Properties (“Seritage”) (NYSE: SRG), a Maryland real estate investment trust formed on June 3, 2015, is a fully integrated, self-administered and self-managed real estate investment trust (“REIT”) as defined under Section 856(c) of the Internal Revenue Code (the “Code”). Seritage’s assets are held by and its operations are primarily conducted, directly or indirectly, through Seritage Growth Properties, L.P., a Delaware limited partnership (the “Operating Partnership”). Under the partnership agreement of the Operating Partnership, Seritage, as the sole general partner, has exclusive responsibility and discretion in the management and control of the Operating Partnership. Unless otherwise expressly stated or the context otherwise requires, the “Company” and “Seritage” refer to Seritage, the Operating Partnership and its owned and controlled subsidiaries.
Seritage is principally engaged in the acquisition, ownership, development, redevelopment, management and leasing of diversified retail and mixed-use properties throughout the United States. As of June 30, 2020, the Company’s portfolio consisted of interests in 199 properties totaling approximately 31.6 million square feet of gross leasable area (“GLA”), including 171 wholly owned properties totaling approximately 27.1 million square feet of GLA across 44 states and Puerto Rico (the “Wholly Owned Properties), and interests in 28 joint venture properties totaling approximately 4.5 million square feet of GLA across 14 states (the “JV Properties”).
On June 11, 2015, Sears Holdings Corporation (“Sears Holdings” or “Sears”) effected a rights offering to Sears Holdings stockholders to purchase common shares of Seritage in order to fund, in part, the $2.7 billion acquisition of (i) 234 of Sears Holdings’ owned properties and one of its ground leased properties, and (ii) its 50% interests in three joint ventures that collectively owned 28 properties, ground leased one property and leased two properties (the “Transaction”). Concurrent with the Transaction, the Company leased back to Sears Holdings space at 224 of the acquired properties under a master lease agreement (the “Original Master Lease”) and space at all 31 properties owned by the acquired joint ventures under multiple master lease agreements. On February 28, 2019, the Company and certain affiliates of Transform Holdco LLC (“Holdco”), an affiliate of ESL Investments, Inc., executed a master lease with respect to 51 Wholly Owned Properties (the “Holdco Master Lease”), which became effective on March 12, 2019.
As of June 30, 2020, the Company leased space at five Wholly Owned Properties to Holdco under the Holdco Master Lease, after giving effect to the pending termination of the Holdco Master Lease at 12 properties.
Since inception, and excluding nine projects that have been sold, the Company has completed or substantially completed 58 redevelopment projects and, prior to the coronavirus (“COVID-19”) pandemic, had an additional 42 projects in various stages of redevelopment. As of June 30, 2020, including its proportional share of unconsolidated joint venture properties, the Company had 6.5 million square feet of GLA leased to diversified tenants under in-place leases, 3.4 million square feet of GLA leased to diversified tenants under signed not yet opened (“SNO”) leases, and 18.8 million square feet of GLA available for lease and/or redevelopment.
COVID-19 Pandemic
The spread of a novel strain of COVID-19 pandemic continues to have a significant impact on the retail, retail real estate and real estate development industries in the United States, including the Company’s properties. As of August 4, 2020, approximately 93% of the Company’s in-place tenants (representing 92% of leased GLA and 86% of annual base rent (“ABR”) were open and/or operating in some capacity and the Company continues to work with tenants to collect rent, including evaluating select rent deferral requests.
As of August 4, 2020, the Company had collected 66% of rental income for the three months ended June 30, 2020, and agreed to defer an additional 21%, from tenants other than Holdco. As of August 4, 2020, the Company had also collected 74% of July 2020 rental income, and agreed to defer an additional 7%, from tenants other than Holdco. While the Company intends to enforce its contractual rights under its leases, there can be no assurance that additional rental modification agreements will be reached or that tenants will meet their future obligations.
The Company continues to advance its response to the COVID-19 pandemic with an emphasis on managing its cash resources and preserving the value of its assets and its platform, including by (i) negotiating rent deferral agreements with tenants, (ii) negotiating extended payment terms with vendors and contractors, (iii) amending its Term Loan Facility (as defined below) to provide for the potential deferral of interest expense, (iv) monetizing certain assets and (v) selectively allocating capital to restarting components of previously announced redevelopment projects.
As a result of the rapid development, fluidity and uncertainty surrounding this situation, the Company expects that these conditions will change, potentially significantly, in future periods and results for the three and six months ended June 30, 2020 may not be indicative of the impact of the COVID-19 pandemic on the Company’s business for the third quarter of 2020 or for future periods. As
- 9 -
such, the Company cannot reasonably estimate the impact of COVID-19 on its financial condition, results of operations or cash flows over the foreseeable future.
Liquidity
In response to the COVID-19 pandemic, the Company has taken a number of actions to manage its cash resources, including keeping the majority of its construction projects on hold, reducing operating and corporate expenses, and amending certain terms of its Term Loan Facility, as described in Note 6, Debt.
The Company’s primary uses of cash include the payment of property operating and other expenses, including general and administrative expenses and debt service (collectively, “obligations”), and, on a selective basis given the current environment, the reinvestment in and redevelopment of its properties (“development expenditures”). As a result of a decrease in occupancy levels due to the Company’s recapture of space for redevelopment purposes and the execution of certain termination rights by Sears Holdings under the Original Master Lease and Holdco under the Holdco Master Lease, property rental income, which is the Company’s primary source of operating cash flow, did not fully fund obligations incurred during the six months ended June 30, 2020 and the Company had net operating cash outflows of $18.3 million. Additionally, the Company’s development expenditures during the six months ended June 30, 2020 drove net investing cash outflows of $36.7 million.
Obligations are projected to continue to exceed property rental income and the COVID-19 pandemic has created uncertainty with respect to rent collections and the timing of the Company’s construction projects, the majority of which remain on hold. While the Company does not currently have the liquid funds available to satisfy its obligations and development expenditures, the Company expects to fund such obligations and any development expenditures with a combination of capital sources including, but not limited to, cash on hand, sales of Wholly Owned Properties, sales of interests in JV Properties, and potential credit and capital markets transactions, subject to any approvals that may be required under the Company’s Term Loan Facility, as described in Note 6, Debt. Management has determined that it is probable its plans will be effectively implemented within one year after the date the financial statements are issued and that these actions will provide the necessary cash flows to fund the Company’s obligations and development expenditures.
Note 2 – Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
These condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K, as amended, (the “Annual Report”), for the year ended December 31, 2019. Certain footnote disclosures which would substantially duplicate those contained in our Annual Report have been condensed or omitted from this quarterly report. In the opinion of management, all adjustments necessary for a fair presentation (which include only normal recurring adjustments) have been included in this quarterly report. Operating results of three and six months ended June 30, 2020 may not be indicative of the results that may be expected for any other interim period or for the year ending December 31, 2020. Capitalized terms used, but not defined in this quarterly report, have the same meanings as set forth in our Annual Report.
The accompanying condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The condensed consolidated financial statements include the accounts of the Company, the Operating Partnership, each of their wholly-owned subsidiaries, and all other entities in which they have a controlling financial interest or entities that meet the definition of a variable interest entity (“VIE”) in which the Company has, as a result of ownership, contractual interests or other financial interests, both the power to direct activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. All intercompany accounts and transactions have been eliminated.
If the Company has an interest in a VIE but it is not determined to be the primary beneficiary, the Company accounts for its interest under the equity method of accounting. Similarly, for those entities which are not VIEs and over which the Company has the ability to exercise significant influence, but does not have a controlling financial interest, the Company accounts for its interests under the equity method of accounting. The Company continually reconsiders its determination of whether an entity is a VIE and whether the Company qualifies as its primary beneficiary. As of June 30, 2020 and December 31, 2019, the Company has several unconsolidated VIEs in the form of joint ventures (see Note 4). The Company does not consolidate these entities because the Company is not the primary beneficiary and the nature of its involvement in the activities of these entities does not give the Company power over decisions that significantly affect these entities’ economic performance.
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As of June 30, 2020, the Company holds a 69.1% interest in the Operating Partnership and is the sole general partner which gives the Company exclusive and complete responsibility for the day-to-day management, authority to make decisions, and control of the Operating Partnership. The Company has determined that the Operating Partnership is a VIE as the limited partners in the Operating Partnership, although entitled to vote on certain matters, do not possess kick-out rights or substantive participating rights. Accordingly, the Company consolidates its interest in the Operating Partnership. The assets and liabilities of the Operating Partnership are the same as those of the Company and are presented in the condensed consolidated balance sheet.
To the extent such variable interests are in entities that are not evaluated under the VIE model, the Company evaluates its interests using the voting interest entity model.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant assumptions and estimates relate to the useful lives of tangible and intangible assets, real estate impairment assessments, and assessing the recoverability of accounts receivable. These estimates are based on historical experience and other assumptions which management believes are reasonable under the circumstances. Management evaluates its estimates on an ongoing basis and makes revisions to these estimates and related disclosures as experience develops or new information becomes known. Actual results could differ from these estimates.
Real Estate Investments
Real estate assets are recorded at cost, less accumulated depreciation and amortization.
Expenditures for ordinary repairs and maintenance will be expensed as incurred. Significant renovations which improve the property or extend the useful life of the assets are capitalized. As real estate is undergoing redevelopment activities, all amounts directly associated with and attributable to the project, including planning, development and construction costs, interest costs, personnel costs of employees directly involved, and other miscellaneous costs incurred during the period of redevelopment, are capitalized. The capitalization period begins when redevelopment activities are underway and ends when the project is substantially complete.
Depreciation of real estate assets, excluding land, is recognized on a straight-line basis over their estimated useful lives as follows:
|
Buildings:
|
25 – 40 years
|
|
Site improvements:
|
5 – 15 years
|
|
Tenant improvements:
|
shorter of the estimated useful life or non-cancelable term of lease
|
The Company amortizes identified intangibles that have finite lives over the period they are expected to contribute directly or indirectly to the future cash flows of the property or business acquired, generally the remaining non-cancelable term of a related lease.
On a periodic basis, management assesses whether there are indicators that the value of the Company’s real estate assets (including any related intangible assets or liabilities) may be impaired. These indicators include macroeconomic conditions, such as the expected impact of the current COVID-19 pandemic. If an indicator is identified, a real estate asset is considered impaired if management’s estimate of current and projected operating cash flows (undiscounted and unleveraged), taking into account the anticipated and probability weighted holding period, are less than a real estate asset’s carrying value. Various factors are considered in the estimation process, including expected future operating income, trends and prospects and the effects of demand, competition, and other economic factors. Changes in any estimates and/or assumptions, including the anticipated holding period, could have a material impact on the projected operating cash flows. If management determines that the carrying value of a real estate asset is impaired, a loss will be recorded for the excess of its carrying amount over its estimated fair value. If the COVID-19 pandemic causes economic and market conditions to deteriorate further, subsequent tests for impairment may result in future impairment charges. The Company recognized $1.8 million in impairment losses for the three and six months ended June 30, 2020. Such impairment losses are classified within gain on sale of real estate within the condensed consolidated statements of operations. No impairment losses were recognized for the three and six months ended June 30, 2019.
Real Estate Dispositions
When the Company disposes of all or a portion of a real estate asset, it recognizes a gain or loss on sale of real estate as the difference between the carrying value and consideration received. Consideration consists of cash proceeds received and in certain circumstances, non-cash consideration which is typically in the form of equity in unconsolidated joint ventures in the Company’s condensed
- 11 -
consolidated statements of operations. For more information on the Company’s unconsolidated joint venture transactions refer to Note 4.
The following table summarizes our gain on sale of real estate, net during the three and six months ended June 30, 2020 and June 30, 2019 (in thousands):
|
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
Contributions to unconsolidated joint ventures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross proceeds
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
18.7
|
|
|
Gain on sale of real estate, net
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3.8
|
|
|
Dispositions to third parties
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross proceeds
|
|
$
|
98.6
|
|
|
$
|
11.4
|
|
|
$
|
158.9
|
|
|
$
|
40.9
|
|
|
Gain on sale of real estate, net (1) (2)
|
|
|
52.1
|
|
|
|
11.6
|
|
|
|
72.9
|
|
|
|
29.3
|
|
|
Total gains on contributions and dispositions, net
|
|
$
|
52.1
|
|
|
$
|
11.6
|
|
|
$
|
72.9
|
|
|
$
|
33.1
|
|
(1)Includes impairment losses of $1.8 million for the three and six months ended June 30, 2020, which are classified within gain on sale of real estate, net within the condensed consolidated statements of operations.
(2)Includes gain of $6.9 million related to the exchange of a portion of one land parcel for two parcels of approximately equal size for the three and six months ended June 30, 2019.
Real Estate Held for Sale
When a real estate asset is identified by management as held for sale, the Company ceases depreciation of the asset and estimates its fair value, net of estimated costs to sell. If the estimated fair value, net of estimated costs to sell, of an asset is less than its net carrying value, an adjustment is recorded to reflect the estimated fair value. Properties classified as real estate held for sale generally represent properties that are under contract for sale and are expected to close within a year.
In evaluating whether a property meets the held for sale criteria, the Company makes a determination as to the point in time that it is probable that a sale will be consummated. Given the nature of all real estate sales contracts, it is not unusual for such contracts to allow potential buyers a period of time to evaluate the property prior to formal acceptance of the contract. In addition, certain other matters critical to the final sale, such as financing arrangements, often remain pending even upon contract acceptance. As a result, properties under contract may not close within the expected time period or at all.
As of June 30, 2020, one property was classified as held for sale with assets of $3.2 million and no liabilities, and as of December 31, 2019, two properties were classified as held for sale with assets of $5.3 million and no liabilities.
Investments in Unconsolidated Joint Ventures
The Company accounts for its investments in unconsolidated joint ventures using the equity method of accounting as the Company exercises significant influence, but does not control these entities. These investments are initially recorded at cost and are subsequently adjusted for cash contributions, cash distributions, and earnings which are recognized in accordance with the terms of the applicable agreement.
On a periodic basis, management assesses whether there are indicators, including the operating performance of the underlying real estate and general market conditions (which include macroeconomic conditions such as the expected impact of the current COVID-19 pandemic), that the value of the Company’s investments in unconsolidated joint ventures may be impaired. An investment’s value is impaired 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. If the COVID-19 pandemic causes economic and market conditions to deteriorate further, subsequent tests for impairment may result in future impairment charges. No such impairment losses were recognized for each of the three and six months ended June 30, 2020 or June 30, 2019.
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.
- 12 -
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, including the expected impact of the COVID-19 pandemic, and economic conditions in the area where the property is located. For accrued rental income related to the straight-line method of reporting rental income, the Company performs a periodic review of receivable balances to assess the risk of uncollectible amounts and establish appropriate provisions. Any receivables that are deemed to be uncollectible are recognized as a reduction to rental income in the Company’s condensed consolidated statements of operations.
The Company recorded an allowance for doubtful accounts of $3.3 million during the three months ended June 30, 2020. In addition, the Company also recorded a reversal of previously recorded straight-line rent of $4.7 million for the three months ended June 30, 2020. In certain circumstances, when the Company believes that it is not reasonably certain that it will collect future amounts due, the Company will cease accruing rental income and the portion of rental income related to the straight-line method and instead the Company will recognize rental income on a cash basis. If future circumstances change such that the Company believes that it is reasonably certain that the Company will collect all rental income remaining on such leases, the Company will resume accruing rental income.
Due to the COVID-19 pandemic, the Company has entered into amendments to existing leases with certain tenants (the “Rent Deferral Agreements”), that provide for the deferral of all or some portion of rental payments due during the period which such tenant was affected by the COVID-19 pandemic (“Deferred Rent”). The Rent Deferral Agreements typically provide for repayment of the Deferred Rent within 6-12 months following the end of the rent deferral period and, in many instances, waive certain other conditions in favor of the Company while Deferred Rent is outstanding. Deferred Rent generally becomes immediately due and payable under the Rent Deferral Agreements if the tenant does not make the minimum contractual payments or otherwise defaults on the lease.
Tenant and other receivables also include management fees receivable for services performed for the benefit of certain unconsolidated joint ventures. In the event that the collectability of a management fee receivable is in doubt, a provision for uncollectible amounts will be established or a direct write-off of the specific receivable will be made.
Revenue Recognition
Rental income is comprised of base rent and reimbursements of property operating expenses. Base rent is recognized on a straight-line basis over the non-cancelable terms of the related leases. For leases that have fixed and measurable base rent escalations, the difference between such rental income earned and the cash rent due under the provisions of the lease is recorded as deferred rent receivable and included as a component of tenant and other receivables on the condensed consolidated balance sheets.
In leasing tenant space, the Company may provide funding to the lessee through a tenant allowance. In accounting for a tenant allowance, the Company will determine whether the allowance represents funding for the construction of leasehold improvements and evaluate the ownership of such improvements. If the Company is considered the owner of the improvements for accounting purposes, the Company will capitalize the amount of the tenant allowance and depreciate it over the shorter of the useful life of the improvements or the related lease term. If the tenant allowance represents a payment for a purpose other than funding leasehold improvements, or in the event the Company is not considered the owner of the improvements for accounting purposes, the allowance is considered a lease incentive and is recognized over the lease term as a reduction of rental revenue on a straight-line basis.
The Company commences recognizing revenue based on an evaluation of several factors. Revenue recognition under a lease begins when the lessee takes control of the physical use of the leased asset.
As discussed further below in Recently Issued Accounting Pronouncements, the Company has elected to avail itself of the relief provided in the Lease Modification Question and Answer Document (the “Lease Modification Q&A”) issued by the Financial Accounting Standards Board (the “FASB”) in April 2020 and elected to not account for the Deferral Agreements on a lease by lease basis as modifications because the overall amount and term of the modified leases are significantly unchanged. As a result, the Company has not adjusted accrued rental revenues or the portion of accrued rental revenues related to the straight-line method for the portion which has been deferred. When the Deferred Rents are repaid, the Company will relieve the accrual in tenant and other receivables.
Reimbursement of property operating expenses arises from tenant leases which provide for the recovery of all or a portion of the operating expenses and real estate taxes of the respective property. This revenue is accrued in the same periods as the expenses are incurred.
- 13 -
Management and Other Fee Income
Management and other fee income represents property management, construction, leasing and development fees for services performed for the benefit of certain unconsolidated joint ventures.
Property management fee income is reported at 100% of the revenue earned from such joint ventures in management and other fee income on the condensed consolidated statements of operations. The Company’s share of management expenses incurred by the unconsolidated joint ventures is reported in equity in income (loss) of unconsolidated joint ventures on the condensed consolidated statements of operations and in other expenses in the combined financial data in Note 4.
Leasing and development fees are initially reported at the portion of revenue earned attributable to outside ownership of the related unconsolidated joint ventures. The Company’s share in leasing and development fee income is recognized over the useful life of the associated development project, in the case of development fees, or lease term, in the case of leasing fees, as the associated asset is depreciated over the same term and included in equity in income (loss) of unconsolidated joint ventures on the condensed consolidated statements of operations and in other expenses in the combined financial data in Note 4.
Management determined that property and asset management and construction and development management services each represent a series of stand-ready performance obligations satisfied over time with each day of service being a distinct performance obligation. For property and asset management services, the Company is typically compensated for its services through a monthly management fee earned based on a specified percentage of monthly rental income or rental receipts generated from the property under management. For construction and development services, the Company is typically compensated for planning, administering and monitoring the design and construction of projects at our unconsolidated joint venture properties based on a percentage of project costs or a fixed fee. Revenues from such management contracts are recognized over the life of the applicable contract.
Conversely, leasing services are considered to be performance obligations, satisfied as of a point in time. The Company’s leasing fee is typically paid upon the occurrence of certain contractual event(s) that may be contingent and the pattern of revenue recognition may differ from the timing of payment. For these services, the obligations are typically satisfied at lease execution and tenant opening date, and revenue is recognized in accordance with the related agreement at the point in time when the obligation has been satisfied.
Accounting for Recapture and Termination Activity Pursuant to the Original Master Lease and Holdco Master Lease (see Note 5)
Seritage Recapture Rights. The Company generally treats the delivery of a recapture notice as a modification of the lease as of the date of notice. Such a notice and lease modification result in the following accounting adjustments for the recaptured property:
|
−
|
The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that are subject to the lease modification are amortized over the remaining shortened life of the lease from the date of notice to the date of vacancy. The portion of accrued rental revenues related to the straight-line method of reporting rental revenue that is attributable to the retained space, if any, is amortized over the remaining life of the lease.
|
|
−
|
The portion of intangible lease assets and liabilities that is deemed to be impacted by the lease modification is amortized over the shorter of the shortened lease term from the date of notice to the date of vacancy or the remaining useful life of the asset or liability. The portion of intangible lease assets and liabilities that is attributable to the retained space, if any, is amortized over the remaining useful life of the asset or liability.
|
A recapture will generally occur in conjunction with obtaining a new tenant or a real estate development project. As such, termination fees, if any, associated with the recapture notice are generally capitalized as either an initial direct cost of obtaining a new lease or a necessary cost of the real estate project and depreciated over the life of the new lease obtained or the real estate asset being constructed or improved.
Termination Rights. The Original Master Lease provided, and the Holdco Master Lease provides the tenant with certain rights to terminate their lease. Such terminations would generally result in the following accounting adjustments for the terminated property:
|
−
|
Accrued rental revenues related to the straight-line method of reporting rental revenue that are subject to the termination are amortized over the remaining shortened life of the lease from the date of notice to the date of vacancy.
|
|
−
|
Intangible lease assets and liabilities that are deemed to be impacted by the termination are amortized over the shorter of the shortened lease term from the date of notice to the date of vacancy or the remaining useful life of the asset or liability.
|
- 14 -
|
−
|
Termination fees required to be paid are recognized as follows:
|
|
|
•
|
For the portion of the termination fee attributable to the annual base rent of the subject property, termination income is recognized on a straight-line basis over the shortened life of the lease from the date the termination fee becomes legally binding to the date of vacancy.
|
|
|
•
|
For the portion of the termination fee attributable to estimated real estate taxes and property operating expenses for the subject property, prepaid rental income is recorded in the period such fee is received and recognized as tenant reimbursement revenue in the same periods as the expenses are incurred.
|
Share-Based Compensation
The Company generally recognizes equity awards to employees as compensation expense and includes such expense within general and administrative expenses in the condensed consolidated statements of operations. Compensation expense for equity awards is based on the grant date fair value of the awards. Compensation expense is recognized ratably over the vesting period for awards with time-based vesting and awards with market-based vesting conditions (e.g. total shareholder return). For awards with performance-based vesting determined by Company operating criteria, the Company recognizes compensation expense at the date the achievement of performance criteria is deemed probable for the amount which would have been recognized ratably from the date of the grant through the date the achievement of performance criteria is deemed probable, and then ratably from the date the achievement of performance criteria is deemed probable through the remainder of the vesting period. The Company utilizes a third-party valuation firm to measure the grant date fair value of restricted stock unit awards with market-based criteria using the Monte Carlo model. Forfeitures are recorded on an actual basis.
Concentration of Credit Risk
Concentrations of credit risk arise when a number of operators, tenants, or obligors related to the Company's investments are engaged in similar business activities, or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations, including those to the Company, to be similarly affected by changes in economic conditions. As of June 30, 2020, the Company leased space at five Wholly Owned Properties to Holdco under the Holdco Master Lease, after giving effect to the 12 terminations pursuant to the Amendment (as defined below), and a material amount of the Company’s rental revenues for the six months ended June 30, 2020 was derived from the Holdco Master Lease. As a result, the Company’s exposure to Holdco has been reduced to a level such that Holdco no longer represents a significant concentration of credit risk with the exception of the termination payment due pursuant to the Amendment (as defined below). Management believes the Company's portfolio is reasonably diversified by tenant and geographical location and does not contain any other significant concentrations of credit risk. As of June 30, 2020, the Company's portfolio of 171 Wholly Owned Properties and 28 JV Properties was diversified by location across 44 states and Puerto Rico.
Earnings per Share
The Company has three classes of common stock. The rights, including the liquidation and dividend rights, of the holders of the Company’s Class A common shares and Class C non-voting common shares are identical, except with respect to voting. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. The net earnings (loss) per share amounts are the same for Class A and Class C common shares because the holders of each class are legally entitled to equal per share distributions whether through dividends or in liquidation. As of August 29, 2018, all outstanding Class C common shares had been exchanged for Class A common shares and there are currently no Class C common shares outstanding.
Class B non-economic common shares are excluded from earnings per share computations as they do not have economic rights. As of June 30, 2020, all outstanding Class B common shares have been surrendered and there are currently no Class B common shares outstanding. As of June 30, 2019, 1,247,060 Class B non-economic common shares were issued and outstanding.
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.
- 15 -
Recently Issued Accounting Pronouncements
The following presents Accounting Standards Updates (“ASU”) issued by the FASB which have been adopted by the Company:
|
|
|
|
|
|
ASU
|
Description
|
Adoption Date
|
Effect on the financial statements or other significant matters
|
|
ASU 2016-02, Leases (“Topic 842”)
ASU 2018-10, Codification Improvements
ASU 2018-11, Leases, Targeted Improvements
ASU 2018-20, Leases
|
This standard, as amended by subsequent ASUs on the topic, sets out the principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. Additional guidance and targeted improvements to the February 2016 ASU were made through the issuance of supplementary ASUs in July 2018, December 2018 and March 2019. The accounting applied by the lessor is largely unchanged from that applied under the existing lease standard. However, ASU 2016-02 requires lessees to apply a two-method approach, classifying leases as either finance or operating leases based on the principle of whether the lease is effectively a financed purchase. Lessees are required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months. Leases with a term of 12 months or less should be accounted for consistent with earlier guidance under ASC 840 for operating leases. Lessees should recognize an expense based on the effective interest method for finance leases or on a straight-line basis for operating leases.
|
January 1, 2019
|
The Company adopted this standard by electing the package of practical expedients without hindsight which permits the Company to not reassess (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases, and (3) any initial direct costs for any existing leases as of the adoption date.
The Company has a ground lease and several corporate office leases, which are classified as operating leases, for which the Company is required to record a right-of-use asset and a lease liability equal to the present value of the remaining minimum lease payments and will continue to recognize expense on a straight-line basis for these leases. On January 1, 2019, the Company recorded an aggregate of approximately $8.4 million of right-of-use assets and corresponding $8.4 million of lease liabilities upon adoption of this standard. Right-of-use assets and corresponding lease liabilities are included in the prepaid expenses, deferred expenses and other assets and accounts payable, accrued expenses and other liabilities line item respectively on the condensed consolidated balance sheets.
Additionally, the Company is no longer able to capitalize certain internal and external leasing costs. Because of this change, $1.3 million of such costs incurred in previous periods for leases which had not commenced at the beginning of current period were adjusted against opening equity upon adoption.
The Company also combined $11,005 of below-market lease assets pertaining to the ground lease where we are a lessee with the right of use asset recorded for the ground lease as required upon adoption of ASU 2016-02. The below-market lease asset was previously recorded within the lease intangibles on the condensed consolidated balance sheets.
|
- 16 -
|
|
|
|
|
|
ASU
|
Description
|
Adoption Date
|
Effect on the financial statements or other significant matters
|
|
ASU 2018-01, Leases, Land Easement Practical Expedient for Transition to Topic 842
|
In March 2018, the FASB finalized changes with respect to optional transition relief and approved a practical expedient for lessors that would permit lessors to make an accounting policy election to not separate non-lease components from the associated lease components, by class of underlying asset, if the following two criteria are met: (1) the timing and pattern of transfer of
the lease and non-lease components are the same and (2) the lease component would be classified as an operating lease if accounted for separately.
|
January 1, 2019
|
The Company has elected the optional transition relief and has determined that it is not required to bifurcate and separately report non-lease components, such as common area maintenance revenue, for operating leases on the condensed consolidated statements of operations for leases where the Company is the lessor. As a result, leases where the Company is the lessor have been accounted for in a similar method to earlier guidance under ASC 840. The Company’s adoption of ASC 842 did not have a material impact on our condensed consolidated financial statements.
|
|
ASU 2016-13,
Financial
Instruments – Credit Losses (Topic 326)
ASU 2018-19,
Codification
improvements to Topic 326, Financial
Instruments – Credit Losses
|
ASU 2016-13 changes the impairment model for most financial assets and certain other instruments, requiring the use of an "expected credit loss" model and adding more disclosure requirements.
ASU 2018-19 clarifies that impairment of receivables arising from operating leases should accounted for in accordance with Topic 842, Leases.
|
January 1, 2020
|
The Company’s adoption of ASU 2016-13 did not have a material impact on our condensed consolidated financial statements.
|
|
The Lease Modification Q&A
|
In April 2020, the FASB staff issued the Lease Modification Q&A focused on the application of lease accounting guidance to lease concessions provided as a result of the COVID-19 pandemic. Under existing lease guidance, the Company would have to determine, on a lease by lease basis, if a lease concession was the result of a new arrangement reached with the tenant or if a lease concession was under the enforceable rights and obligations within the existing lease agreement. The Lease Modification Q&A allows the Company, if certain criteria have been met, to bypass the lease by lease analysis, and instead elect to either apply the lease modification accounting framework or not, with such election applied consistently to leases with similar characteristics and similar circumstances.
|
April 10, 2020
|
The Company has elected to avail itself of the relief provided in the Lease Modification Q&A for all leases which were modified during the second quarter of 2020. The Company entered into Rent Deferral Agreements on 50 leases as of June 30, 2020 and an additional 6 leases subsequent to the end of the quarter. The Company has determined that the deferral agreements are all substantially similar arrangements and has elected to bypass the lease by lease analysis. This election did not result in a material change to the Company’s financial statements. The impact of this election is dependent upon the circumstances and characteristics of future modifications and as such the impact of the Lease Modification Q&A may change. Refer to revenue recognition in Note 2 for further information regarding the deferral agreements and their impact to the Company’s results of operations.
|
Note 3 – Lease Intangible Assets and Liabilities
Lease intangible assets (acquired in-place leases, above-market leases and below-market ground leases) and liabilities (acquired below-market leases), net of accumulated amortization, were $32.0 million and $7.7 million, respectively, as of June 30, 2020 and $68.2 million and $10.6 million, respectively, as of December 31, 2019. The following table summarizes the Company’s lease intangible assets and liabilities (in thousands):
|
June 30, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
Accumulated
|
|
|
|
|
|
|
Lease Intangible Assets
|
|
Asset
|
|
|
Amortization
|
|
|
Balance
|
|
|
In-place leases, net
|
|
$
|
196,587
|
|
|
$
|
(167,050
|
)
|
|
$
|
29,537
|
|
|
Above-market leases, net
|
|
|
5,563
|
|
|
|
(3,150
|
)
|
|
$
|
2,413
|
|
|
Total
|
|
$
|
202,150
|
|
|
$
|
(170,200
|
)
|
|
$
|
31,950
|
|
- 17 -
|
|
|
Gross
|
|
|
Accumulated
|
|
|
|
|
|
|
Lease Intangible Liabilities
|
|
Liability
|
|
|
Amortization
|
|
|
Balance
|
|
|
Below-market leases, net
|
|
$
|
11,938
|
|
|
$
|
(4,241
|
)
|
|
$
|
7,697
|
|
|
Total
|
|
$
|
11,938
|
|
|
$
|
(4,241
|
)
|
|
$
|
7,697
|
|
|
December 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
Accumulated
|
|
|
|
|
|
|
Lease Intangible Assets
|
|
Asset
|
|
|
Amortization
|
|
|
Balance
|
|
|
In-place leases, net
|
|
$
|
245,745
|
|
|
$
|
(180,639
|
)
|
|
$
|
65,106
|
|
|
Above-market leases, net
|
|
|
6,625
|
|
|
|
(3,578
|
)
|
|
|
3,047
|
|
|
Total
|
|
$
|
252,370
|
|
|
$
|
(184,217
|
)
|
|
$
|
68,153
|
|
|
|
|
Gross
|
|
|
Accumulated
|
|
|
|
|
|
|
Lease Intangible Liabilities
|
|
Liability
|
|
|
Amortization
|
|
|
Balance
|
|
|
Below-market leases, net
|
|
$
|
15,912
|
|
|
$
|
(5,264
|
)
|
|
$
|
10,648
|
|
|
Total
|
|
$
|
15,912
|
|
|
$
|
(5,264
|
)
|
|
$
|
10,648
|
|
Amortization of acquired below-market leases, net of acquired above-market leases, resulted in additional rental income of $38 thousand and $0.1million for the three months ended June 30, 2020 and June 30, 2019, respectively and $0.1 million and $0.2 million for the six months ended June 30, 2020 and June 30, 2019, respectively. Future amortization of these intangibles is estimated to increase rental income as set forth below (in thousands):
|
Remainder of 2020
|
|
$
|
106
|
|
|
2021
|
|
|
83
|
|
|
2022
|
|
|
53
|
|
|
2023
|
|
|
110
|
|
|
2024
|
|
|
125
|
|
Amortization of an acquired below-market ground lease resulted in additional property expense of $51 thousand for each of the three months ended June 30, 2020 and June 30, 2019, respectively, and $0.1 million for each of the six months ended June 30, 2020 and June 30, 2019, respectively. Future amortization of the below-market ground lease is estimated to increase property expenses as set forth below (in thousands):
|
Remainder of 2020
|
|
$
|
101
|
|
|
2021
|
|
|
203
|
|
|
2022
|
|
|
203
|
|
|
2023
|
|
|
203
|
|
|
2024
|
|
|
203
|
|
Amortization of acquired in-place leases resulted in additional depreciation and amortization expense of $9.7 million and $5.0 million for the three months ended June 30, 2020 and June 30, 2019, respectively, and $30.7 million and $53.3 million for the six months ended June 30, 2020 and June 30, 2019, respectively. Future estimated amortization of acquired in-place leases is set forth below (in thousands):
|
Remainder of 2020
|
|
$
|
10,342
|
|
|
2021
|
|
|
3,097
|
|
|
2022
|
|
|
3,264
|
|
|
2023
|
|
|
2,325
|
|
|
2024
|
|
|
1,682
|
|
Note 4 – Investments in Unconsolidated Joint Ventures
The Company conducts a portion of its property rental activities through investments in unconsolidated joint ventures. The Company’s partners in these joint ventures are unrelated real estate entities or commercial enterprises. The Company and its joint venture partners make initial and/or ongoing capital contributions to these unconsolidated joint ventures. The obligations to make capital contributions are governed by each unconsolidated joint venture’s respective operating agreement and related governing documents.
- 18 -
As of June 30, 2020, the Company had investments in nine unconsolidated joint ventures as follows:
|
|
|
|
|
|
|
Seritage %
|
|
|
# of
|
|
|
Total
|
|
|
Unconsolidated Joint Venture
|
|
Joint Venture Partner
|
|
Ownership
|
|
|
Properties
|
|
|
GLA
|
|
|
GS Portfolio Holdings II LLC
("GGP I JV")
|
|
Brookfield Properties Retail
(formerly GGP Inc.)
|
|
|
50.0
|
%
|
|
|
4
|
|
|
|
520,500
|
|
|
GS Portfolio Holdings (2017) LLC
("GGP II JV")
|
|
Brookfield Properties Retail
(formerly GGP Inc.)
|
|
|
50.0
|
%
|
|
|
5
|
|
|
|
910,400
|
|
|
MS Portfolio LLC
("Macerich JV")
|
|
The Macerich Company
|
|
|
50.0
|
%
|
|
|
9
|
|
|
|
1,570,200
|
|
|
SPS Portfolio Holdings II LLC
("Simon JV")
|
|
Simon Property Group, Inc.
|
|
|
50.0
|
%
|
|
|
5
|
|
|
|
872,200
|
|
|
Mark 302 JV LLC
("Mark 302 JV")
|
|
An investment fund managed
by Invesco Real Estate
|
|
|
50.0
|
%
|
|
|
1
|
|
|
|
103,000
|
|
|
SI UTC LLC
("UTC JV")
|
|
A separate account advised by
Invesco Real Estate
|
|
|
50.0
|
%
|
|
|
1
|
|
|
|
226,300
|
|
|
SF WH Joint Venture LLC
("West Hartford JV")
|
|
An affiliate of First Washington
Realty
|
|
|
50.0
|
%
|
|
|
1
|
|
|
|
163,700
|
|
|
GGCAL SRG HV LLC
("Cockeysville JV")
|
|
An affiliate of
Greenberg Gibbons
|
|
|
50.0
|
%
|
|
|
1
|
|
|
|
160,200
|
|
|
Tech Ridge JV Holding LLC
("Tech Ridge JV")
|
|
An affiliate of
RD Management
|
|
|
50.0
|
%
|
|
|
1
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
|
|
|
|
4,526,500
|
|
The Company has contributed certain properties to joint ventures in exchange for equity interests in those joint ventures. The contribution of property to a joint venture is accounted for as a sale of real estate and the Company recognizes the gain (loss) on the sale (the “Gain (Loss)”) based upon the transaction price attributed to the property at the closing of the joint venture transaction (the “Contribution Value”). The Gain (Loss) is included in gain on sale of real estate within the condensed consolidated statements of operations.
In certain circumstances, the Contribution Value is subject to revaluation as defined in the respective joint venture agreements, which may result in an adjustment to the Gain (Loss) recognized. If the Contribution Value is subject to revaluation, the Company initially recognizes the Gain (Loss) at the value that is the expected amount within the range of possible outcomes and will re-evaluate the expected amount on a periodic basis through the final determination date.
Upon revaluation, the primary inputs in determining the Contribution Value will be updated for actual results and may result in a cash settlement or capital account adjustment between the joint venture partners, as well as an adjustment to the Initial Gain (Loss).
Each reporting period, the Company re-analyzes the primary inputs that determine the Contribution Value and the Gain (Loss) for those joint ventures subject to a revaluation. The following table presents summarizes the properties contributed to the Company’s unconsolidated joint ventures:
|
|
|
|
|
June 30, 2020
|
|
|
Unconsolidated Joint Venture
|
|
Contribution Date
|
|
Contribution Value
|
|
|
Gain (Loss)
|
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
Mark 302 JV (1)
|
|
March 20, 2018
|
|
$
|
90.0
|
|
|
$
|
38.8
|
|
|
UTC JV
|
|
May 18, 2018
|
|
|
68.0
|
|
|
|
28.3
|
|
|
West Hartford JV (2)
|
|
May 18, 2018
|
|
|
20.3
|
|
|
|
(1.1
|
)
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
Cockeysville JV (3)
|
|
March 29, 2019
|
|
$
|
12.5
|
|
|
$
|
3.8
|
|
|
Tech Ridge JV (4)
|
|
September 27, 2019
|
|
|
3.0
|
|
|
|
0.1
|
|
|
(1)
|
The Mark 302 JV is subject to a revaluation upon the earlier of the first anniversary of project stabilization or December 31, 2020. The primary inputs in determining the Contribution Value for the Mark 302 JV are property operating income and total project costs and the Contribution Value will be recalculated to yield a pre-determined rate of return to the investment fund managed by Invesco Real Estate. The Contribution Value cannot be more than $105.0 million or less than $60.0 million, and the Gain (Loss) will not be more than $53.8 million or less than $8.8 million.
|
|
(2)
|
The West Hartford JV was subject to (i) a revaluation upon the earlier of the first anniversary of project stabilization or December 31, 2019, and (ii) an adjustment based on the timing, method and magnitude of the reassessment of the property for
|
- 19 -
|
|
real estate tax purposes between 2018 and 2022. As of December 31, 2019, the Company revalued the Contribution Value and recorded an additional loss of $2.3 million, and the Company does not expect there to be any additional revaluations.
|
|
(3)
|
The Cockeysville JV is subject to revaluation if an affiliate of Greenberg Gibbons contributes another adjacent parcel of land (the “Additional Land Parcel”) to the Cockeysville JV if certain milestones are met with respect to entitling the Additional Land Parcel for residential use. If the Additional Land Parcel is contributed to the Cockeysville JV, the Company will record an increased investment in the Cockeysville JV in an amount equal to 50% of the fair value of the Additional Land Parcel at the time of contribution. The Contribution Value of the Cockeysville JV is based upon the Company’s assessment of the probability of the Additional Land Parcel being entitled for residential use. The maximum Gain (Loss) is the fair value of the Additional Land Parcel at the time the Contribution Value is revalued, which cannot be less than $3.8 million.
|
|
(4)
|
The Tech Ridge JV is subject to a revaluation primarily based upon the number of residential units constructed by the Tech Ridge JV. The Contribution Value cannot be less than $2.75 million.
|
The following tables present combined condensed financial data for the Company’s unconsolidated joint ventures (in thousands):
|
|
|
June 30, 2020
|
|
|
December 31, 2019
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
Investment in real estate
|
|
|
|
|
|
|
|
|
|
Land
|
|
$
|
336,739
|
|
|
$
|
336,739
|
|
|
Buildings and improvements
|
|
|
528,650
|
|
|
|
517,068
|
|
|
Accumulated depreciation
|
|
|
(75,742
|
)
|
|
|
(86,496
|
)
|
|
|
|
|
789,647
|
|
|
|
767,311
|
|
|
Construction in progress
|
|
|
235,951
|
|
|
|
177,028
|
|
|
Net investment in real estate
|
|
|
1,025,598
|
|
|
|
944,339
|
|
|
Cash and cash equivalents
|
|
|
29,261
|
|
|
|
27,977
|
|
|
Tenant and other receivables, net
|
|
|
2,341
|
|
|
|
3,113
|
|
|
Other assets, net
|
|
|
43,661
|
|
|
|
26,051
|
|
|
Total assets
|
|
$
|
1,100,861
|
|
|
$
|
1,001,480
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND MEMBERS' INTERESTS
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage loans payable, net
|
|
$
|
14,648
|
|
|
$
|
14,218
|
|
|
Accounts payable, accrued expenses and other liabilities
|
|
|
93,152
|
|
|
|
89,110
|
|
|
Total liabilities
|
|
|
107,800
|
|
|
|
103,328
|
|
|
|
|
|
|
|
|
|
|
|
|
Members' Interest
|
|
|
|
|
|
|
|
|
|
Additional paid in capital
|
|
|
997,368
|
|
|
|
934,120
|
|
|
Retained earnings
|
|
|
(4,307
|
)
|
|
|
(35,968
|
)
|
|
Total members interest
|
|
|
993,061
|
|
|
|
898,152
|
|
|
Total liabilities and members interest
|
|
$
|
1,100,861
|
|
|
$
|
1,001,480
|
|
|
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
|
Total revenue
|
|
$
|
4,976
|
|
|
$
|
8,968
|
|
|
$
|
10,317
|
|
|
$
|
20,186
|
|
|
|
Property operating expenses
|
|
|
(1,949
|
)
|
|
|
(2,898
|
)
|
|
|
(4,686
|
)
|
|
|
(5,496
|
)
|
|
|
Depreciation and amortization
|
|
|
(5,192
|
)
|
|
|
(25,510
|
)
|
|
|
(8,879
|
)
|
|
|
(30,763
|
)
|
|
|
Operating income
|
|
|
(2,165
|
)
|
|
|
(19,440
|
)
|
|
|
(3,248
|
)
|
|
|
(16,073
|
)
|
|
|
Other expenses
|
|
|
(478
|
)
|
|
|
(448
|
)
|
|
|
(967
|
)
|
|
|
(1,370
|
)
|
|
|
Net loss
|
|
$
|
(2,643
|
)
|
|
$
|
(19,888
|
)
|
|
$
|
(4,215
|
)
|
|
$
|
(17,443
|
)
|
|
|
Equity in loss of unconsolidated
joint ventures (1)
|
|
$
|
(1,322
|
)
|
|
$
|
(9,944
|
)
|
|
$
|
(2,108
|
)
|
|
$
|
(8,722
|
)
|
|
|
(1)
|
Equity in loss of unconsolidated joint ventures on the condensed consolidated statements of operations includes basis difference adjustments.
|
- 20 -
Each unconsolidated joint venture is obligated to maintain financial statements in accordance with GAAP. The Company shares in the profits and losses of these unconsolidated joint ventures generally in accordance with the Company’s respective equity interests. In some instances, the Company may recognize profits and losses related to investment in an unconsolidated joint venture that differ from the Company’s equity interest in the unconsolidated joint venture. This may arise from impairments that the Company recognizes related to its investment that differ from the impairments the unconsolidated joint venture recognizes with respect to its assets, differences between the Company’s basis in assets it has transferred to the unconsolidated joint venture and the unconsolidated joint venture’s basis in those assets or other items. There were no joint venture impairment charges for the three and six months ended June 30, 2020 and June 30, 2019.
Joint Venture Management and Related Fees
The Company acts as the operating partner and day-to-day manager for the Mark 302 JV, the West Hartford JV, the UTC JV, and Tech Ridge JV. The Company is entitled to receive certain fees for providing management, leasing, and construction supervision services to certain of its joint ventures. Refer to Note 2 for the Company’s accounting policies. The Company also acts as the development manager for one of the properties in the GGP II JV which entitles the Company to receive certain development fees. The Company earned $171 thousand and $1.8 million from these services for the three months ended June 30, 2020 and June 30, 2019, respectively, and $378 thousand and $2.1 million from these services for the six months ended June 30, 2020 and June 30, 2019, respectively.
Note 5 – Leases
On October 15, 2018, Sears Holdings and certain of its affiliates filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code with the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). On February 28, 2019, the Company and certain affiliates of Holdco executed the Holdco Master Lease which became effective on March 12, 2019 when the Bankruptcy Court issued an order approving the rejection of the Original Master Lease. The Company analyzed this transaction under applicable accounting guidance and determined that the termination of the Original Master Lease and entering into the Holdco Master Lease should be accounted for as a modification in accordance with ASC 842.
On June 3, 2020, the Company entered into an amendment to the Holdco Master Lease (the “Amendment”) relating to the remaining 17 Wholly Owned Properties. Pursuant to the Amendment, the Company terminated the Holdco Master Lease at 12 properties, each of which Holdco had the right to terminate without penalty on March 1, 2021 under the terms of the Holdco Master Lease, in return for a termination payment of $5.3 million payable upon the earlier of the completion of going-out-of-business sales or September 30, 2020. In addition, the Company allowed Holdco to defer 100% of base rent at the five remaining stores for six months (April 2020 through September 2020) with the deferred rent payable over a 12-month period beginning October 2020. Holdco will continue to pay all other additional rent (representing real estate taxes, utilities, common area maintenance and other property operating expenses) during the deferral period.
Lease Structure
The structure of the Holdco Master Lease is consistent with the structure of the Original Master Lease in all material respects, including (i) it is a unitary, non-divisible lease as to all properties, pursuant to which the tenant’s obligations as to each property are cross-defaulted with all obligations of the tenant with respect to all other properties; (ii) it is a triple net lease with respect to all space which is leased thereunder to the tenant, subject to proportional sharing by the tenant for repair and maintenance charges, real property taxes, insurance and other costs and expenses which are common to both the space leased by the tenant and other space occupied by other tenants in the same or other buildings, space which is recaptured pursuant to the Company’s recapture rights described below and all other space which is constructed on the properties; (iii) the tenant is required to make all expenditures reasonably necessary to maintain the premises in good appearance, repair and condition for as long as they are in occupancy; and (iv) the tenant is generally prohibited from subleasing any space demised under the lease.
Term and Renewals
Consistent with the terms of the Original Master Lease, the Holdco Master Lease will expire in July 2025, and contains three options for five-year renewals of the term and a final option for a four-year renewal, as was the case under the Original Master Lease.
Rental Revenue
The Holdco Master Lease provides for an initial base rent at the same rates which were in place at the time of the modification for accounting purposes. In each of the initial term and the first two renewal terms, consistent with the Original Master Lease, base rent under the Holdco Master Lease will be increased in August of each year by 2.0% per annum for each lease year over the rent for the immediately preceding lease year. For subsequent renewal terms, consistent with the Original Master Lease, rent will be set at the
- 21 -
commencement of the renewal term for the Holdco Master Lease at a fair market rent based on a customary third-party appraisal process, taking into account all the terms of the Holdco Master Lease and other relevant factors, but in no event will the renewal rent be less than the rent payable in the immediately preceding lease year. The base rent under the Holdco Master Lease will be subject to an adjustment in the form of a rent credit of up to approximately $12 million in each of the first and second years of the Holdco Master Lease. The rent credit is allocated to specific properties based on the trailing twelve- month EBITDA of the particular property as of December 2018. If any such properties are recaptured by the Company or terminated by Holdco, the base rent credit attributable to such property will no longer be applicable. The rent credit is applicable to base rent only and Holdco is responsible for repair and maintenance charges, real property taxes, insurance and other costs and expenses associated with its occupancy of the subject properties.
Revenues from the Holdco Master Lease, as amended by the Amendment, and the Original Master Lease for the three months ended June 30, 2020 and June 30, 2019 are as follows (in thousands and excluding straight-line rental income of $(3.4) million and $1.2 million for the three months ended June 30, 2020 and June 30, 2019, respectively, and $(7.9) million and $1.7 million for the six months ended June 30, 2020 and June 30, 2019, respectively).
|
(in thousands)
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
Fixed rental income
|
|
$
|
-
|
|
|
$
|
5,667
|
|
|
$
|
4,288
|
|
|
$
|
17,955
|
|
|
Variable rental income (1)
|
|
|
(420
|
)
|
|
|
5,853
|
|
|
|
3,419
|
|
|
|
14,251
|
|
|
Total rental income
|
|
$
|
(420
|
)
|
|
$
|
11,520
|
|
|
$
|
7,707
|
|
|
$
|
32,206
|
|
(1)Fixed and variable rental income for the three and six months ended June 30, 2020 include the recognition of rental income deemed uncollectible related to the Amendment which resulted in the termination of the Holdco Master Lease at 12 stores and deferred rent at the five remaining stores.
Seritage Recapture Rights
The Holdco Master Lease provides the Company with the right to recapture up to approximately 50% of the space occupied by the tenant at all properties (other than five specified properties) and the right to recapture any automotive care centers which are free-standing or attached as “appendages” to the properties, all outparcels or outlots and certain portions of parking areas and common areas. Upon exercise of any of these partial recapture rights the Company will generally incur, as applicable, certain costs and expenses for the separation of the recaptured space from the remaining tenant space.
Additionally, in contrast to the Original Master Lease, which permitted the Company to recapture 100% of certain properties upon payment of a specified recapture fee, the Holdco Master Lease provides the Company with the right, beginning in March 2020, to recapture 100% of the space occupied by the tenant at any of the properties included in the Holdco Master Lease (other than five specified properties) without paying a recapture fee. This right to recapture 100% of any property is limited to 10 properties in each year of the Holdco Master Lease term, with carry-over rights if less than 10 properties are recaptured in any given lease year. In the event of a 100% recapture of a property (or termination of a property by Holdco that is subject to a termination fee) and any subsequent redevelopment of such property for retail purposes, Holdco has certain rights of first offer to lease space at specified predefined rates depending on the condition the space is delivered. If the Company does not provide Holdco with a right of first offer on at least one-third of any such properties that are recaptured 100% by the Company (or terminated by Holdco with payment of a termination fee) in a given lease year, then the Company’s 100% recaptures rights are subject to payment of a recapture fee until such time as the Company has complied with the foregoing ratio.
Upon the exercise of any of its recapture rights, the Company can reconfigure and rent the recaptured space to new, diversified tenants on potentially superior terms as determined by the Company and for its own account.
As of June 30, 2020, the Company had previously exercised certain recapture rights with respect to 70 properties under the Original Master Lease prior to its rejection on March 12, 2019, and exercised recapture rights with respect to four properties under the Holdco Master Lease during the year ended December 31, 2019, including three properties where the Company had previously exercised certain recapture rights under the Original Master Lease.
- 22 -
The following table provides a summary of the Company’s recapture activity as of June 30, 2020:
|
(in thousands except property count)
|
|
|
|
|
|
|
|
|
|
|
Year
|
|
Square Feet
|
|
|
Total Number of Properties
|
|
|
100% Recaptures (1)
|
|
|
Partial Recaptures (2)
|
|
|
2019
|
|
|
629
|
|
|
4
|
|
|
3
|
|
|
1
|
|
|
2018
|
|
|
3,428
|
|
|
20
|
|
|
17
|
|
|
3
|
|
|
2017
|
|
|
3,302
|
|
|
27
|
|
|
16
|
|
|
11
|
|
|
2016
|
|
|
1,501
|
|
|
17
|
|
|
4
|
|
|
13
|
|
|
2015
|
|
|
372
|
|
|
3
|
|
|
3
|
|
|
|
—
|
|
|
Total
|
|
|
9,232
|
|
|
|
71
|
|
|
|
43
|
|
|
|
28
|
|
|
(1)
|
Includes properties for which the Company had converted partial recapture rights to 100% recapture rights.
|
|
(2)
|
Partial recaptures include the recapture of (i) up to approximately 50% of the space occupied by the tenant at all properties, (ii) automotive care centers which are free-standing or attached as “appendages” to the properties, and/or (iii) outparcels or outlots and certain portions of parking areas and common areas.
|
Holdco Termination Rights
Under the terms of the Holdco Master Lease, Holdco has the right, at any time, to terminate the Holdco Master Lease with respect to any property upon the payment of a termination fee equal to one year of base rent plus annual taxes and other operating expenses. Additionally, beginning in March 2020, the tenant has the right to terminate without payment of a termination fee: (i) up to 16 properties in the second year of the term of the Holdco Master Lease, (ii) up to 12 properties in the third year, (iii) up to 10 properties in the fourth year, and (iv) thereafter, the remaining properties, in each instance with carry over rights if less than the maximum permitted number of properties are terminated in any lease year.
Sears Holdings exercised termination rights with respect to 87 properties under the Original Master Lease prior to its rejection on March 12, 2019 and Holdco exercised termination rights with respect to 29 properties under the Holdco Master Lease during the year ended December 31, 2019. Pursuant to the Amendment, the Company terminated the Holdco Master Lease at 12 properties for which Holdco had termination rights. For the five remaining Wholly Owned Properties Holdco leases under the Holdco Master Lease, Deferred Rent becomes immediately due and payable if Holdco exercises its termination right.
The following table provides a summary of Sears Holdings’ and Holdco’s termination activity (excluding 31 properties totaling 4.3 million square feet that were rejected on March 12, 2019 as part of Sears Holdings’ bankruptcy filing) as of June 30, 2020:
|
(in thousands except property count)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notice Date
|
|
Termination Date
|
|
Square Feet
|
|
|
Number of Properties
|
|
|
Redevelopments
Announced
|
|
|
Properties
Sold
|
|
|
June 2020
|
|
September 2020 (1)
|
|
|
1,800
|
|
|
|
12
|
|
|
|
2
|
|
|
|
—
|
|
|
November 2019
|
|
March 2020
|
|
|
4,332
|
|
|
|
29
|
|
|
|
7
|
|
|
|
1
|
|
|
August 2018
|
|
December 2018
|
|
|
1,605
|
|
|
|
13
|
|
|
|
6
|
|
|
|
3
|
|
|
June 2018
|
|
November 2018 (2)
|
|
|
1,218
|
|
|
|
9
|
|
|
|
6
|
|
|
|
1
|
|
|
April 2018
|
|
August 2018
|
|
|
1,494
|
|
|
|
9
|
|
|
|
4
|
|
|
|
1
|
|
|
June 2017
|
|
October 2017 (3)
|
|
|
3,812
|
|
|
|
20
|
|
|
|
8
|
|
|
|
4
|
|
|
January 2017
|
|
April 2017
|
|
|
1,872
|
|
|
|
19
|
|
|
|
7
|
|
|
|
8
|
|
|
September 2016
|
|
January 2017
|
|
|
1,727
|
|
|
|
17
|
|
|
|
8
|
|
|
|
6
|
|
|
Total
|
|
|
|
|
17,860
|
|
|
|
128
|
|
|
|
48
|
|
|
|
24
|
|
|
(1)
|
Properties terminated pursuant to the Amendment signed in June 2020.
|
|
(2)
|
Two properties were terminated in October 2018.
|
|
(3)
|
One property was terminated in November 2017 and one was terminated in January 2018.
|
As of June 30, 2020, the Company had commenced or completed redevelopment projects at 46 of the terminated properties, and sold an additional 24 of the terminated properties, and will continue to announce redevelopment activity as new leases are signed to occupy the space formerly occupied by Sears or Kmart.
- 23 -
Lessor Disclosures
Future minimum rental receipts, excluding variable payments and tenant reimbursements of expenses, under non-cancelable operating leases executed as of June 30, 2020 and December 31, 2019 are approximately as follows:
|
(in thousands)
|
|
June 30, 2020 (1)
|
|
|
Remainder of 2020
|
|
|
48,837
|
|
|
2021
|
|
|
112,379
|
|
|
2022
|
|
|
105,271
|
|
|
2023
|
|
|
99,617
|
|
|
2024
|
|
|
95,958
|
|
|
2025
|
|
|
89,902
|
|
|
Thereafter
|
|
|
423,122
|
|
|
Total Lease Payments
|
|
$
|
975,086
|
|
|
(1)
|
Amounts have been adjusted for Rent Deferral Agreements executed during the period.
|
|
(in thousands)
|
|
December 31, 2019
|
|
|
2020
|
|
$
|
113,265
|
|
|
2021
|
|
|
121,909
|
|
|
2022
|
|
|
124,067
|
|
|
2023
|
|
|
119,745
|
|
|
2024
|
|
|
116,607
|
|
|
Thereafter
|
|
|
1,019,054
|
|
|
Total Lease Payments
|
|
$
|
1,614,647
|
|
The components of lease revenues for the three and six months ended June 30, 2020 and 2019 were as follows:
|
(in thousands)
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
Fixed rental income
|
|
$
|
23,151
|
|
|
$
|
23,513
|
|
|
$
|
50,799
|
|
|
$
|
52,502
|
|
|
Variable rental income
|
|
|
1,154
|
|
|
|
9,431
|
|
|
|
9,219
|
|
|
|
20,561
|
|
|
Total rental income
|
|
$
|
24,305
|
|
|
$
|
32,944
|
|
|
$
|
60,018
|
|
|
$
|
73,063
|
|
Lessee Disclosures
The Company has one ground lease and multiple corporate office leases which are classified as operating leases. As of June 30, 2020 and December 31, 2019, the outstanding amount of right-of-use, or ROU, assets were $19.5 million and $18.5 million, respectively.
The Company recorded rent expense related to leased corporate office space of $505 thousand and $401 thousand for the three months ended June 30, 2020 and June 30, 2019, respectively. The Company recorded rent expense related to leased corporate office space of $779 thousand and $686 thousand for the six months ended June 30, 2020 and June 30, 2019, respectively. Such rent expense is classified within general and administrative expenses on the condensed consolidated statements of operations.
In addition, the Company recorded ground rent expense of approximately $11 thousand for each of the three months ended June 30, 2020 and June 30, 2019. The Company recorded ground rent expense of approximately $23 thousand for each of the six months ended June 30, 2020 and June 30, 2019. Such ground rent expense is classified within property operating expenses on the condensed consolidated statements of operations. The ground lease requires the Company to make fixed annual rental payments and expires in 2073 assuming all extension options are exercised.
The following table sets forth information related to the measurement of our lease liabilities as of June 30, 2020:
|
|
|
As of June 30, 2020
|
|
|
Weighted average remaining lease term (in years)
|
|
|
10.46
|
|
|
Weighted average discount rate
|
|
|
7.00
|
%
|
|
Cash paid for operating leases
|
|
$
|
800,000
|
|
- 24 -
Note 6 – Debt
Term Loan Facility
The Term Loan Agreement provides for a $2.0 billion term loan facility (the “Term Loan Facility”) with Berkshire Hathaway Life Insurance Company of Nebraska (“Berkshire Hathaway”) as lender and Berkshire Hathaway as administrative agent. The Term Loan Facility provided for an initial funding of $1.6 billion at closing (the “Initial Funding”) and includes a $400.0 million incremental funding facility (the “Incremental Funding Facility”) subject to certain conditions described below. The Term Loan Facility matures on July 31, 2023.
The Company used a portion of the proceeds from the Initial Funding to (i) repay existing indebtedness and (ii) pay transaction and related costs. The remaining proceeds from the Initial Funding, as well as borrowings under the Incremental Funding Facility, will be used to fund the Company’s redevelopment pipeline and to pay operating expenses of the Company and its subsidiaries.
Funded amounts under the Term Loan Facility bear interest at an annual rate of 7.0% and unfunded amounts under the Incremental Funding Facility are subject to an annual fee of 1.0% until drawn. The Company prepays the annual fee and amortizes the expense to interest expense on the condensed consolidated statements of operations.
As of June 30, 2020, the aggregate principal amount outstanding under the Term Loan Facility was $1.6 billion.
The Company’s ability to access the Incremental Funding Facility is subject to (i) the Company achieving rental income from non-Sears Holdings tenants, on an annualized basis (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the fiscal quarter ending prior to the date of incurrence of the Incremental Funding Facility, of not less than $200 million (ii) the Company’s good faith projection that rental income from non-Sears Holdings tenants (after giving effect to SNO Leases expected to commence rent payment within 12 months) for the succeeding four consecutive fiscal quarters (beginning with the fiscal quarter during which the incremental facility is accessed) will be not less than $200 million, and (iii) the repayment by the Operating Partnership of any deferred interest permitted under the amendment to the Term Loan Agreement dated May 5, 2020 (as further described below).
The Term Loan Facility is guaranteed by the Company and, subject to certain exceptions, is required to be guaranteed by all existing and future subsidiaries of the Operating Partnership. The Term Loan Facility is secured on a first lien basis by a pledge of the capital stock of the direct subsidiaries of the Operating Partnership and the guarantors, including its joint venture interests, except as prohibited by the organizational documents of such entities or any joint venture agreements applicable to such entities, and contains a requirement to provide mortgages and other customary collateral upon the breach of certain financial metrics described below, the occurrence and continuation of an event of default and certain other conditions set forth in the Term Loan Agreement.
The Term Loan Facility includes certain financial metrics to govern springing collateral requirements and certain covenant exceptions set forth in the Term Loan Agreement, including: (i) a total fixed charge coverage ratio of not less than 1.00 to 1.00 for each fiscal quarter beginning with the fiscal quarter ending September 30, 2018 through the fiscal quarter ending June 30, 2021, and not less than 1.20 to 1.00 for each fiscal quarter thereafter; (ii) an unencumbered fixed charge coverage ratio of not less than 1.05 to 1.00 for each fiscal quarter beginning with the fiscal quarter ending September 30, 2018 through the fiscal quarter ending June 30, 2021, and not less than 1.30 to 1.00 for each fiscal quarter thereafter; (iii) a total leverage ratio of not more than 65%; (iv) an unencumbered ratio of not more than 60%; and (v) a minimum net worth of at least $1.2 billion. Any failure to satisfy any of these financial metrics limits the Company’s ability to dispose of assets via sale or joint venture and triggers the springing mortgage and collateral requirements but will not result in an event of default. The Term Loan Facility also includes certain limitations relating to, among other activities, the Company’s ability to: sell assets or merge, consolidate or transfer all or substantially all of its assets; incur additional debt; incur certain liens; enter into, terminate or modify certain material leases and/or the material agreements for the Company’s properties; make certain investments (including limitations on joint ventures) and other restricted payments; pay distributions on or repurchase the Company’s capital stock; and enter into certain transactions with affiliates.
The Term Loan Facility contains customary events of default, including (subject to certain materiality thresholds and grace periods) payment default, material inaccuracy of representations or warranties, and bankruptcy or insolvency proceedings. If there is an event of default, the lenders may declare all or any portion of the outstanding indebtedness to be immediately due and payable, exercise any rights they might have under any of the Term Loan Facility documents, and require the Company to pay a default interest rate on overdue amounts equal to 2.0% in excess of the then applicable interest rate.
As of June 30, 2020, the Company was not in compliance with certain of the financial metrics described above. As a result, the Company must receive the consent of Berkshire Hathaway to dispose of assets via sale or joint venture and, as of June 30, 2020, Berkshire Hathaway had provided such consent for all such transactions submitted for approval. There can be no assurance that the lender will consent to future dispositions of assets. During 2019, Berkshire Hathaway requested mortgages on a majority of the Company’s portfolio which were recorded in accordance with the mortgage and collateral requirement (the “Lender Request”). There
- 25 -
are no other changes to the terms and conditions of the Term Loan Facility, or the Company’s ability to operate thereunder, as a result of providing mortgages against any of the Company’s assets pursuant to the mortgage and collateral requirement. The Company accounted for the Lender Request transaction as a modification of debt as of December 31, 2019.
The Company believes it is in compliance with all other terms and conditions of the Term Loan Agreement.
The Company incurred $2.1 million of debt issuance costs related to the Term Loan Facility which are recorded as a direct deduction from the carrying amount of the Term Loan Facility and amortized over the term of the Term Loan Agreement. As of June 30, 2020 and December 31, 2019, the unamortized balance of the Company’s debt issuance costs were $1.3 million and $1.5 million, respectively.
On May 5, 2020, the Operating Partnership and Berkshire Hathaway entered into an amendment to the Term Loan Agreement by and among the Operating Partnership and Berkshire Hathaway as initial lender and administrative agent that permits the deferral of payment of interest under the Term Loan Agreement if, as of the first day of each applicable month, (x) the amount of unrestricted and unencumbered (other than liens created under the Term Loan Agreement) cash on hand of the Operating Partnership and its subsidiaries, minus (y) the aggregate amount of anticipated necessary expenditures for such period (such sum, “Available Cash”) is equal to or less than $30.0 million. In such instances, for each interest period, the Operating Partnership is obligated to make payments of interest in an amount equal to the difference between (i) Available Cash and (ii) $20.0 million (provided that such payment shall not exceed the amount of current interest otherwise due under the Term Loan Agreement). Any deferred interest shall accrue interest at 2.0% in excess of the then applicable interest rate and shall be due and payable on July 31, 2023; provided, that the Operating Partnership is required to pay any deferred interest from Available Cash in excess of $30.0 million (unless otherwise agreed to by the administrative agent under the Term Loan Agreement in its sole discretion). In addition, repayment of any outstanding deferred interest is a condition to any borrowings under the $400.0 million incremental funding facility under the Term Loan Agreement.
Additionally, the amendment to the Term Loan Agreement provides that the administrative agent and the lenders express their continued support for asset dispositions, subject to the administrative agent’s right to approve the terms of individual transactions due to the occurrence of a Financial Metric Trigger Event, as such term is defined under the Term Loan Facility.
Note 7 – Income Taxes
The Company has elected to be taxed as a REIT as defined under Section 856(c) of the Code for federal income tax purposes and expects to continue to operate to qualify as a REIT. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement to currently distribute at least 90% of its adjusted REIT taxable income to its shareholders.
As a REIT, the Company generally will not be subject to U.S. federal income tax on taxable income that is distributed to its shareholders. If the Company fails to qualify as a REIT or does not distribute 100% of its taxable income in any taxable year, it will be subject to U.S. federal income tax at regular corporate rates (including for any taxable year ended on or before December 31, 2017, any applicable alternative minimum tax) and any applicable state and local income taxes. In addition, if the Company fails to qualify as a REIT, it may not be able to qualify as a REIT for four subsequent taxable years in some cases.
Even if the Company qualifies for taxation as a REIT, the Company is subject to certain U.S. state, local and Puerto Rico taxes on its income and property, and to U.S. federal income and excise taxes on its undistributed REIT taxable income. The Company’s taxable REIT subsidiaries are subject to U.S. corporate income tax.
- 26 -
Note 8 – Fair Value Measurements
ASC 820, Fair Value Measurement, defines fair value and establishes a framework for measuring fair value. The objective of fair value is to determine the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the “exit price”). ASC 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels:
Level 1 - quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities
Level 2 - observable prices based on inputs not quoted in active markets, but corroborated by market data
Level 3 - unobservable inputs used when little or no market data is available
The fair value hierarchy gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company also considers counterparty credit risk in its assessment of fair value.
Assets Measured at Fair Value on a Nonrecurring Basis
Assets measured at fair value on a nonrecurring basis on our condensed consolidated balance sheet consist of real estate assets that have been written down to estimated fair value and are classified as Level 3 within the fair value hierarchy. The Company’s estimates of fair value are determined using discounted cash flow models, which consider, among other things, anticipated holding periods, current market conditions, potential development projects and utilize unobservable quantitative inputs, including appropriate capitalization and discount rates.
For the three and six months ended June 30, 2020, in accordance with ASC 360-10, Property, Plant and Equipment, the Company recorded an impairment loss of $1.8 million on two real estate assets which is included in gain on sale of real estate within the condensed consolidated statements of operations for the three and six months ended June 30, 2020. The most significant inputs utilized in determining the fair value of these assets are capitalization rates which were between 7.0% and 8.0% and discount rates between 8.0% and 9.0%. No impairments have been recorded for the three and six months ended June 30, 2019.
Financial Assets and Liabilities not Measured at Fair Value
Financial assets and liabilities that are not measured at fair value on the condensed consolidated balance sheets include cash equivalents and term loan facility. The fair value of cash equivalents is classified as Level 1 and the fair value of term loan facility is classified as Level 2. Cash equivalents are carried at cost, which approximates fair value. The fair value of debt obligations is calculated by discounting the future contractual cash flows of these instruments using current risk-adjusted rates available to borrowers with similar credit ratings. As of June 30, 2020 and December 31, 2019, the estimated fair values of the Company’s debt obligations were $1.5 billion and $1.6 billion, respectively, which approximated the carrying value at such dates as the current risk-adjusted rate approximates the stated rates on the Company’s debt obligations.
Note 9 – Commitments and Contingencies
In accordance with accounting standards regarding loss contingencies, the Company accrues an undiscounted liability for those contingencies where the incurrence of a loss is probable and the amount can be reasonably estimated, and the Company discloses the amount accrued and the amount of a reasonably possible loss in excess of the amount accrued or discloses the fact that such a range of loss cannot be estimated. The Company does not record liabilities when the likelihood that the liability has been incurred is probable but the amount cannot be reasonably estimated, or when the liability is believed to be only reasonably possible or remote.
On April 18, 2019, at the direction of the Restructuring Sub-Committee of the Restructuring Committee of the Board of Directors of Sears Holdings, Sears Holdings, Sears, Roebuck & Co., Sears Development Co., Kmart Corporation, and Kmart of Washington, LLC filed a lawsuit (the “Litigation”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) against, among others, Edward S. Lampert, ESL Investments, Inc. and certain of its affiliates and investors, Fairholme Capital Management, L.L.C., certain members of the Sears Holdings board of directors, and the Company, the Operating Partnership, and certain of our affiliates and subsidiaries (the Company, the Operating Partnership, and certain of our affiliates and subsidiaries collectively, the “Seritage Defendants”). The Litigation is dual captioned as In re: Sears Holdings Corporation, et al., Case No. 18-23538 (RDD) and Sears Holdings Corporation et al., v. Lampert et al., Case No. 19-08250 (RDD). The Litigation alleges, among other things, that certain transactions undertaken by Sears Holdings since 2011 constituted actual and/or constructive fraudulent transfers and/or illegal dividends by Sears Holdings. The challenged transactions include the July 2015 transactions giving rise to Seritage, the execution of the Original Master Lease with Sears Holdings, and the acquisition of real estate from Sears Holdings. The
- 27 -
Litigation alleges, among other things, that the real estate acquired by Seritage from Sears Holdings in July 2015 was worth at least $649 to $749 million more than the purchase price paid. The Litigation seeks as relief, among other things, declaratory relief, avoidance of the allegedly actual and/or constructive fraudulent transfers and either (i) rescission of the transfers of real estate from Sears Holdings to Seritage in 2015 and return of the proceeds of the transactions between Sears Holdings and Seritage, or, in the alternative, (ii) payment by Seritage to Sears Holdings of damages at least equal to the value of the transferred property.
On October 15, 2019, the Bankruptcy Court entered an order (the “Confirmation Order”) confirming the Modified Second Amended Joint Chapter 11 Plan of Sears Holdings and its affiliated debtors (the “Chapter 11 Plan”). Pursuant to the terms of the Confirmation Order, upon the effective date of the Chapter Plan, a liquidating trust will be formed, and the Litigation will vest in the liquidating trust. The Confirmation Order further provides that, prior to the effective date of the Chapter 11 Plan and the formation of the liquidating trust, the Litigation shall be controlled by five litigation designees selected by Sears Holdings and the Unsecured Creditors’ Committee (the “UCC”). For further information, refer to the Chapter 11 Plan, Confirmation Order and liquidating trust agreement, each of which has been publicly filed with the Bankruptcy Court.
On February 21, 2020, the Seritage defendants filed a partial motion to dismiss seeking dismissal of the claims in the operative complaint in the Litigation relating to the release received in the Sears Holdings derivative litigation, unjust enrichment, and equitable subordination. The Company believes that the claims against the Seritage Defendants in the Litigation are without merit and intends to defend against them vigorously.
In addition to the litigation described above, the Company is subject, from time to time, to various legal proceedings and claims that arise in the ordinary course of business and due to the current environment. 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 condensed consolidated financial position, results of operations, cash flows or liquidity of the Company. As of June 30, 2020, and December 31, 2019, the Company did not record any amounts for litigation or other matters.
Note 10 – Related Party Disclosure
Edward S. Lampert
Edward S. Lampert is the Chairman and Chief Executive Officer of ESL, which owns Holdco, and was Chairman of Sears Holdings. Mr. Lampert is also the Chairman of Seritage.
As of June 30, 2020, Mr. Lampert beneficially owned a 30.9% interest in the Operating Partnership and approximately 6.6% of the outstanding Class A common shares.
Subsidiaries of Holdco, as lessees, and subsidiaries of the Company, as lessors, are parties to the Holdco Master Lease and subsidiaries of Sears Holdings, as lessees, and subsidiaries of the Company, as lessors, were parties to the Original Master Lease (see Note 5).
Unconsolidated Joint Ventures
Certain unconsolidated joint ventures have engaged the Company to provide management, leasing, construction supervision and development services at the properties owned by the unconsolidated joint ventures. Refer to Note 2 for the Company’s accounting policies.
In addition, as of June 30, 2020, the Company had incurred $1.4 million of development expenditures at properties owned by certain unconsolidated joint ventures for which the Company will be repaid by the respective unconsolidated joint ventures. These amounts are included in tenant and other receivables, net on the Company’s condensed consolidated balance sheets. As of December 31, 2019, the Company had incurred $9.7 million of such development expenditures.
Note 11 – Non-Controlling Interests
Partnership Agreement
On July 7, 2015, Seritage and ESL entered into the agreement of limited partnership of the Operating Partnership which was amended and restated on December 14, 2017. Pursuant to this partnership agreement, as the sole general partner of the Operating Partnership, Seritage exercises exclusive and complete responsibility and discretion in its day-to-day management, authority to make decisions, and control of the Operating Partnership, and may not be removed as general partner by the limited partners.
As of June 30, 2020, the Company held a 69.1% interest in the Operating Partnership and ESL held a 30.9% interest. The portions of consolidated entities not owned by the Company are presented as non-controlling interest as of and during the periods presented.
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Note 12 – Shareholders’ Equity
Class A Common Shares
During the six months ended June 30, 2020, 1,650,000 Operating Partnership Units (“OP Units”) were exchanged for an equal number of Class A shares.
As of June 30, 2020, 38,644,689 Class A common shares were issued and outstanding.
Class B Non-Economic Common Shares
During the six months ended June 30, 2020, 1,242,536 Class B non-economic common shares were surrendered to the Company.
As of June 30, 2020, there were no Class B non-economic common shares issued and outstanding. The Class B non-economic common shares have voting rights, but do not have economic rights and, as such, did not receive dividends and are not included in earnings per share computations.
Class C Non-Voting Common Shares
As of June 30, 2020, there were no Class C non-voting common shares issued or outstanding.
Series A Preferred Shares
In December 2017, the Company issued 2,800,000 7.00% Series A Cumulative Redeemable Preferred Shares (the “Series A Preferred Shares”) in a public offering at $25.00 per share. The Company received net proceeds from the offering of approximately $66.7 million, after deducting payment of the underwriting discount and offering expenses, which it used to fund its redevelopment pipeline and for general corporate purposes.
The Company may not redeem the Series A Preferred Shares before December 14, 2022 except to preserve its status as a REIT or upon the occurrence of a Change of Control, as defined in the trust agreement addendum designating the Series A Preferred Shares. On and after December 14, 2022, the Company may redeem any or all of the Series A Preferred Shares at $25.00 per share plus any accrued and unpaid dividends. In addition, upon the occurrence of a Change of Control, the Company may redeem any or all of the Series A Preferred Shares for cash within 120 days after the first date on which such Change of Control occurred at $25.00 per share plus any accrued and unpaid dividends. The Series A Preferred Shares have no stated maturity, are not subject to any sinking fund or mandatory redemption and will remain outstanding indefinitely unless the Company redeems or otherwise repurchases them or they are converted.
Dividends and Distributions
The Company’s Board of Trustees has not declared dividends on the Company’s Class A and Class C common shares during 2020. The Company’s Board of Trustees declared the following common stock dividends during 2019 with holders of Operating Partnership units entitled to an equal distribution per Operating Partnership unit held on the record date:
|
|
|
|
|
|
|
Dividends per
|
|
|
|
|
|
|
|
|
Class A and Class C
|
|
|
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
Common Share
|
|
|
2019
|
|
|
|
|
|
|
|
|
|
February 25
|
|
March 29
|
|
April 11
|
|
$
|
0.25
|
|
- 29 -
The Company’s Board of Trustees declared the following dividends on preferred shares during 2020 and 2019:
|
|
|
|
|
|
|
Series A
|
|
|
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
Preferred Share
|
|
|
2020
|
|
|
|
|
|
|
|
|
|
June 9
|
|
June 30
|
|
July 15
|
|
$
|
0.43750
|
|
|
February 18
|
|
March 31
|
|
April 15
|
|
|
0.43750
|
|
|
2019
|
|
|
|
|
|
|
|
|
|
October 23
|
|
December 31
|
|
January 15, 2020
|
|
$
|
0.43750
|
|
|
July 23
|
|
September 30
|
|
October 15
|
|
|
0.43750
|
|
|
April 30
|
|
June 28
|
|
July 15
|
|
|
0.43750
|
|
|
February 25
|
|
March 29
|
|
April 15
|
|
|
0.43750
|
|
As previously disclosed, the Company declared a dividend on the Company’s Class A and Class C common shares for the first quarter of 2019 and has not declared dividends on the Company’s Class A and Class C common shares since that time, based on our Board of Trustees’ assessment of the Company’s investment opportunities and its expectations of taxable income for the remainder of 2020. The Company intends to, at a minimum, make distributions to its shareholders to comply with the REIT requirements of the Code, which may be satisfied by dividends on the Company’s Series A Preferred Shares.
Note 13 – Earnings per Share
The table below provides a reconciliation of net income (loss) and the number of common shares used in the computations of “basic” earnings per share (“EPS”), which utilizes the weighted-average number of common shares outstanding without regard to dilutive potential common shares, and “diluted” EPS, which includes all such shares. Potentially dilutive securities consist of shares of non-vested restricted stock and the redeemable non-controlling interests in the Operating Partnership.
All outstanding non-vested shares that contain non-forfeitable rights to dividends are considered participating securities and are included in computing EPS pursuant to the two-class method which specifies that all outstanding non-vested share-based payment awards that contain non-forfeitable rights to distributions are considered participating securities and should be included in the computation of EPS.
Earnings per share has not been presented for Class B shareholders, as they do not have economic rights.
|
(in thousands except per share amounts)
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
|
Numerator - Basic and Diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
104
|
|
|
|
(25,885
|
)
|
|
|
(30,871
|
)
|
|
|
(36,779
|
)
|
|
Net income (loss) attributable to non-controlling interests
|
|
|
(32
|
)
|
|
|
8,982
|
|
|
|
10,279
|
|
|
|
12,909
|
|
|
Preferred dividends
|
|
|
(1,225
|
)
|
|
|
(1,225
|
)
|
|
|
(2,450
|
)
|
|
|
(2,450
|
)
|
|
Net loss attributable to common shareholders - Basic
and diluted
|
|
$
|
(1,153
|
)
|
|
$
|
(18,128
|
)
|
|
$
|
(23,042
|
)
|
|
$
|
(26,320
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator - Basic and Diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average Class A common shares outstanding
|
|
|
38,634
|
|
|
|
36,291
|
|
|
|
37,933
|
|
|
|
35,983
|
|
|
Weighted average Class C common shares outstanding
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Weighted average Class A and Class C common shares
outstanding - Basic
|
|
|
38,634
|
|
|
|
36,291
|
|
|
|
37,933
|
|
|
|
35,983
|
|
|
Restricted shares and share units
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Weighted average Class A and Class C common shares
outstanding - Diluted
|
|
|
38,634
|
|
|
|
36,291
|
|
|
|
37,933
|
|
|
|
35,983
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share attributable to Class A and Class C
common shareholders - Basic
|
|
$
|
(0.03
|
)
|
|
$
|
(0.50
|
)
|
|
$
|
(0.61
|
)
|
|
$
|
(0.73
|
)
|
|
Net loss per share attributable to Class A and Class C
common shareholders - Diluted
|
|
$
|
(0.03
|
)
|
|
$
|
(0.50
|
)
|
|
$
|
(0.61
|
)
|
|
$
|
(0.73
|
)
|
- 30 -
No adjustments were made to the numerator for the three and six months ended June 30, 2020 or June 30, 2019 because the Company generated a net loss. During periods of net loss, undistributed losses are not allocated to the participating securities as they are not required to absorb losses.
No adjustments were made to the denominator for the three and six months ended June 30, 2020 or June 30, 2019 because (i) the inclusion of outstanding non-vested restricted shares would have had an anti-dilutive effect and (ii) including the non-controlling interest in the Operating Partnership would also require that the share of the Operating Partnership loss attributable to such interests be added back to net loss, therefore, resulting in no effect on earnings per share.
As of June 30, 2020 and December 31, 2019, there were 389,624 and 349,318 shares, respectively, of share units outstanding.
Note 14 – Share-Based Compensation
On July 7, 2015, the Company adopted the Seritage Growth Properties 2015 Share Plan (the “Plan”). The number of shares of common stock reserved for issuance under the Plan is 3,250,000. The Plan provides for grants of restricted shares, share units, other share-based awards, options, and share appreciation rights, each as defined in the Plan (collectively, the "Awards"). Directors, officers, other employees, and consultants of the Company and its subsidiaries and affiliates are eligible for Awards.
Restricted Shares and Share Units
Pursuant to the Plan, the Company has periodically made grants of restricted shares or share units. The vesting terms of these grants are specific to the individual grant and vary in that a portion of the restricted shares and share units vest in equal annual amounts over the subsequent three years (time-based vesting) and a portion of the restricted shares and share units vest on the third, and in some instances, the fourth anniversary of the grants subject to the achievement of certain performance criteria (performance-based and market-based vesting).
In general, participating employees are required to remain employed for vesting to occur (subject to certain limited exceptions). Restricted shares and share units that do not vest are forfeited. Dividends on restricted shares and share units with time-based vesting are paid to holders of such shares and share units and are not returnable, even if the underlying shares or share units do not ultimately vest. Dividends on restricted shares and share units with performance-based vesting are accrued when declared and paid to holders of such shares on the third, and in some instances, the fourth anniversary of the initial grant subject to the vesting of the underlying shares. See Note 2 for valuation information related to the grants of the awards that are subject to market-based vesting conditions.
The following table summarizes restricted share activity for the six months ended June 30, 2020:
|
|
|
Six Months Ended June 30, 2020
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
Average Grant
|
|
|
|
|
Shares
|
|
|
Date Fair Value
|
|
|
Unvested restricted shares at beginning of period
|
|
|
349,318
|
|
|
$
|
44.88
|
|
|
Share units granted
|
|
|
106,327
|
|
|
|
31.06
|
|
|
Restricted shares vested
|
|
|
(61,136
|
)
|
|
|
43.54
|
|
|
Restricted shares forfeited
|
|
|
(4,885
|
)
|
|
|
35.13
|
|
|
Unvested restricted shares at end of period
|
|
|
389,624
|
|
|
|
41.44
|
|
The Company recognized $626 thousand and $1.4 million in compensation expense related to the restricted shares for the three months ended June 30, 2020 and June 30, 2019, respectively, and $1.8 million and $2.9 million for the six months ended June 30, 2020 and June 30, 2019, respectively.
Such expenses are included in general and administrative expenses on the Company's condensed consolidated statements of operations.
As of June 30, 2020, there were approximately $7.3 million of total unrecognized compensation costs related to the outstanding restricted shares which are expected to be recognized over a weighted-average period of approximately 1.8 years. As of June 30, 2019, there were approximately $9.4 million of total unrecognized compensation costs related to the outstanding restricted shares which were expected to be recognized over a weighted-average period of approximately 1.9 years.
- 31 -