Seritage Growth Properties Reports Third Quarter 2018 Operating Results

Seritage Growth Properties (NYSE: SRG) (the “Company”), a national owner of 237 retail properties totaling approximately 37.5 million square feet of gross leasable area (“GLA”), today reported financial and operating results for the three and nine months ended September 30, 2018.

Summary of Financial Results

For the three months ended September 30, 2018:

• Net loss attributable to common shareholders of $23.4 million, or $0.66 per diluted share
• Total Net Operating Income (“Total NOI”) of $35.7 million
• Funds from Operations (“FFO”) of ($0.4) million, or ($0.01) per diluted share
• Company FFO of ($0.8) million, or ($0.01) per diluted share

For the nine months ended September 30, 2018:

• Net loss attributable to common shareholders of $22.3 million, or $0.63 per diluted share
• Total NOI of $109.1 million
• FFO of $17.1 million, or $0.31 per diluted share
• Company FFO of $20.2 million, or $0.36 per diluted share

“Our strong execution this quarter demonstrates the power of our platform to substantially increase rents upon re-leasing and deploy significant capital at industry leading returns. Since inception, we have now leased 7 million square feet at 4 times the prior rents paid by Sears Holdings, and have completed or commenced 79 projects, with total capital of $1.4 billion at targeted unlevered returns of approximately 11 percent on an incremental basis,” said Benjamin Schall, President and Chief Executive Officer. “We have a diversified roster of growing tenants, now with 70 percent of our income, on a signed lease basis, coming from non-Sears tenants after our highest quarterly leasing volume to date, with over 930,000 square feet leased in the third quarter. We closed a $2 billion term loan this quarter and now stand with access to $1 billion of cash on hand and committed capital. We feel well positioned to drive substantial future growth from our next pipeline of projects, which include many of our larger scale and mixed-use development opportunities, where we expect to meaningfully densify sites by integrating retail with multi-family, office and hotels. Our go-forward strategy remains consistent – to unlock substantial value through the investment of capital and the intensive leasing and redevelopment of our national portfolio of well-located buildings and land.”

Operating Highlights

During the quarter ended September 30, 2018, including the Company’s proportional share of its unconsolidated joint ventures:

• Signed new leases totaling 933,000 square feet, including new retail leases totaling 546,000 square feet at an average rent of $13.71 PSF. Since the Company’s inception in July 2015, new retail leasing activity has totaled nearly 6.5 million square feet at an average rent of $17.29 PSF.
• Achieved releasing multiples of 3.8x for space currently or formerly occupied by Sears Holdings Corporation (“Sears Holdings” or “Sears”), with new retail rents averaging $13.26 PSF compared to $3.46 PSF paid by Sears Holdings. Since inception, releasing multiples have averaged 4.1x, with new retail rents at $17.38 PSF compared to $4.27 PSF paid by Sears Holdings.
• Increased annual base rent from diversified, non-Sears tenants to 60.1% of total annual base rent from 45.4% in the prior year period, including all signed leases and net of rent attributable to associated space to be recaptured. Diversified, non-Sears rental income has increased by over 210% since inception to $136.6 million, including all signed leases.
  • Including the effect of all previously exercised recapture and termination activity and properties under contract for sale, annual base rent from diversified, non-Sears tenants accounted for approximately 69% of total annual base rent as of September 30, 2018, including all signed leases.

During the quarter ended September 30, 2018:

• Announced six new redevelopment projects and expanded three previously announced projects representing an aggregate incremental investment of $101.6 million. Total redevelopment program to date includes 94 projects completed or commenced representing over $1.4 billion of estimated capital investment.
• Received governmental approvals in Redmond, WA for one million square feet of residential, office, retail and hotel development.
• Received governmental approvals in Dallas, TX for two million square feet of residential, office, retail and hotel development.
• Identified 40 existing properties that are located in qualified opportunity zones (QOZs) as defined in the 2017 Tax Act.
• Sold eleven properties in three transactions that generated gross proceeds of $42.2 million. The properties were generally located in smaller markets and five of the properties were vacant at the time of sale.
• Entered into a new $2.0 billion term loan facility with Berkshire Hathaway Life Insurance Company. The term loan facility, which matures on July 31, 2023, provided for an initial funding of $1.6 billion at closing and includes a committed $400 million incremental funding facility.

Sears Holdings Bankruptcy Filing

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”). Bankruptcy proceedings are subject to uncertainty and there can be no assurance how the Bankruptcy Court’s or other parties’ actions or decisions may affect Sears Holdings. There can be no assurance as to whether or when Sears Holdings will successfully reorganize and emerge from bankruptcy proceedings or how the Master Lease will be impacted by the bankruptcy proceedings. Any of various outcomes may occur, any of which could have a material and adverse impact on our business, results of operations and financial condition. Seritage is monitoring, and will continue to monitor, Sears Holdings’ bankruptcy proceedings and the impact on its business. For more information regarding the same, refer to the risk factors relating to Sears Holdings in the Company’s periodic filings with the Securities and Exchange Commission (the “SEC”).

For additional information from the Company regarding the Sears Holding bankruptcy filing, please see the press release and letter from our CEO filed on Form 8-K with the SEC on October 15, 2018 and available in the Investors section of the Company’s website, www.seritage.com.

Financial Results

Net Income / Net Loss

For the three months ended September 30, 2018, net loss attributable to Class A and Class C shareholders was $23.4 million, or $0.66 per diluted share, as compared to net income of $10.5 million, or $0.31 per diluted share, for the prior year period. For the nine months ended September 30, 2018, net loss attributable to Class A and Class C shareholders was $22.3 million, or $0.63 per diluted share, as compared to a net loss of $30.5 million, or $0.91 per diluted share, for the prior year period.

Total NOI

For the three months ended September 30, 2018, Total NOI, which includes the Company’s proportional share of NOI from properties owned through investments in its unconsolidated joint ventures, was $35.7 million as compared to $43.6 million for the prior year period. For the nine months ended September 30, 2018, Total NOI was $109.1 million as compared to $135.2 million for the prior year period.

The decrease in Total NOI in both periods was driven primarily by reduced rental income under the master lease with Sears Holdings as a result of recapture and termination activity at our wholly-owned properties. In addition, the Company sold its interests in five unconsolidated joint venture properties during the fourth quarter of 2017 and, to date in 2018, has sold 16 wholly-owned properties and 50% interests in three wholly-owned properties, which contributed to the decrease in Total NOI.

Since inception, nearly 20.0 million square feet of leased space, representing approximately $80.0 million of annual base rent, has been, or will be, taken offline through recapture and termination activity. To date, the Company has signed new leases with diversified, non-Sears tenants for an aggregate annual base rent of $115.3 million across 7.0 million square feet of space. The majority of our newly signed leases are categorized as “signed but not opened” (“SNO”) leases and are expected to begin paying rent throughout the next 24 months.

FFO and Company FFO

For the three months ended September 30, 2018, FFO, as calculated in accordance with NAREIT, was ($0.4) million, or ($0.01) per diluted share, as compared to $25.8 million, or $0.46 per diluted share, for the prior year period. For the nine months ended September 30, 2018, FFO was $17.1 million, or $0.31 per diluted share, as compared to $80.6 million, or $1.45 per diluted share, for the prior year period.

The decrease in FFO in both periods was driven by the same factors driving the decrease in Total NOI, as well higher interest expense (including the write-off of deferred financing costs associated with debt repaid in the third quarter of 2018), higher G&A expenses driven by the outperformance of targets related to performance-based restricted stock, lower termination fee income and dividends related to the $70 million preferred equity raise that was completed in the fourth quarter of 2017.

For the three months ended, September 30, 2018, Company FFO was ($0.8) million, or ($0.01) per diluted share, as compared to $17.6 million, or $0.32 per diluted share, for the prior year period. For the nine months ended September 30, 2018, Company FFO was $20.2 million, or $0.36 per diluted share, as compared to $70.3 million, or $1.26 per diluted share, for the prior year period.

The decreases in Company FFO in both periods were driven by the same factors driving the decrease in Total NOI, as well higher interest expense, higher G&A expenses driven by the outperformance of targets related to performance-based restricted stock and dividends related to the $70 million preferred equity raise that was completed in the fourth quarter of 2017.

Portfolio Summary

As of September 30, 2018, the Company’s portfolio included interests in 237 retail properties totaling approximately 37.5 million square feet of gross leasable area, including 211 wholly-owned properties and 26 properties owned through investments in unconsolidated joint ventures. The Company’s portfolio includes 119 properties attached to regional malls and 118 shopping center or freestanding properties.

The portfolio was 81.0% leased, including unconsolidated joint ventures at the Company’s proportional share, and included 65 properties leased only to diversified, non-Sears tenants, 77 properties leased to Sears Holdings and one or more diversified, non-Sears tenants, and 74 properties leased only to Sears Holdings; 21 properties in the portfolio were vacant as of September 30, 2018. Of the properties leased to Sears Holdings, 115 operated under the Sears brand and 36 operated under the Kmart brand.

The unleased space as of September 30, 2018 included approximately 1.9 million SF of remaining lease-up at announced redevelopment projects, and approximately 4.8 million SF of additional leasing opportunity at properties throughout the Company’s portfolio.

As of September 30, 2018, there were 46 properties subject to previously exercised recapture or termination notices, and four properties under contract for sale, for which Sears was still making rental payments. Taking into account this recapture, termination and transaction activity, we leased space at 82 wholly-owned properties and 19 JV properties to Sears Holdings as of September 30, 2018.

Leasing Update

During the quarter ended September 30, 2018, the Company signed new leases totaling 933,000 square feet, including new retail leases totaling 546,000 square feet at an average rent of $13.71 PSF. On a same-space basis, new retail rents averaged 3.8x prior rents for space currently or formerly occupied by Sears Holdings, increasing to $13.26 PSF for new tenants compared to $3.46 PSF paid by Sears Holdings across 529,000 square feet.

The table below provides a summary of the Company’s leasing activity since inception, including unconsolidated joint ventures presented at the Company’s proportional share:

During the quarter ended September 30, 2018, the Company added $9.4 million of new diversified, non-Sears income and increased annual base rent attributable to diversified, non-Sears tenants to 60.1% of total annual base rent from 45.4% as of September 30, 2017, including all signed leases and net of rent attributable to the associated space to be recaptured.

The table below provides a summary of all the Company’s signed leases as of September 30, 2018, including unconsolidated joint ventures presented at the Company’s proportional share:

As of September 30, 2018, there were 46 properties subject to previously exercised recapture or termination notices, and four properties under contract for sale, for which Sears was still making rental payments. Taking into account this recapture, termination and transaction activity, annual base rent from diversified, non-Sears tenants accounted for approximately 69% of total annual base rent as of September 30, 2018, including all signed leases.

Development Update

Wholly-Owned Properties

During the quarter ended September 30, 2018, the Company commenced six new redevelopment projects representing an estimated total investment of $55.9 million and expanded three previously announced project representing an estimated incremental and total investment of $45.7 million and $65.2 million, respectively.

The table below summarizes project commencements in the Company’s wholly-owned portfolio since inception:

As of September 30, 2018, the Company had originated 79 wholly-owned projects since the Company’s inception. These projects represent an estimated total investment of $1,384 million ($1,281 million at share), of which an estimated $940 million ($880 million at share) remains to be spent, and are expected to generate an incremental yield on cost of approximately 11.0%.

The table below provides additional information regarding the Company’s wholly-owned development activity from inception through September 30, 2018:

The tables below provide brief descriptions of each of the redevelopment projects originated on the Company’s platform since its inception:

Balance Sheet and Liquidity

As of September 30, 2018, the Company’s total market capitalization was approximately $4.2 billion. Total market capitalization is calculated as the sum of total debt and the market value of the Company's outstanding shares of common stock, assuming conversion of operating partnership units. Total debt to total market capitalization was 37.6% and net debt to Company EBITDA was 9.5x.

As of September 30, 2018, the Company had nearly $1.0 billion of liquidity, including $581.6 million of cash on the balance sheet and the $400 million incremental funding facility described below.

New Term Loan Facility

On July 31, 2018, the Company entered into a $2.0 billion term loan facility (the “Term Loan Facility”) with Berkshire Hathaway Life Insurance Company of Nebraska.

The Term Loan Facility, which matures on July 31, 2023, provided for an initial funding of $1.6 billion at closing (the “Initial Funding”) and includes a committed $400 million incremental funding facility (the “Incremental Funding Facility”). Funded amounts under the Term Loan Facility bear interest at a fixed annual rate of 7.00%, while amounts available under the Incremental Funding Facility will be subject to a 1.00% annual fee until drawn.

The Company used a portion of the proceeds from the Initial Funding to fully repay its outstanding mortgage loan and unsecured term loan. The Company expects 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.

Dividends

The Company expects annual common dividends to adhere to REIT requirements with respect to taxable income which includes both ordinary income and capital gains from the sale of real estate. To the extent estimated taxable income falls meaningfully below current distribution levels, the Board of Trustees may consider adjustments to common stock dividend amounts. Any reduction of the common dividend would be made to allow the Company to reinvest the capital retained into future redevelopment projects at accretive returns.

On October 23, 2018, the Company’s Board of Trustees declared a third quarter common stock dividend of $0.25 per each Class A and Class C common share. The common dividend will be paid on January 10, 2019 to shareholders of record on December 31, 2018. Holders of units in Seritage Growth Properties, L.P. (the “Operating Partnership”) are entitled to an equal distribution per each Operating Partnership unit held as of December 31, 2018. On October 23, 2018, the Company’s Board of Trustees also declared a preferred stock dividend of $0.4375 per each Series A Preferred Share. The preferred dividend will be paid on January 14, 2019 to holders of record on December 31, 2018.

On July 24, 2018, the Company’s Board of Trustees declared a second quarter common stock dividend of $0.25 per each Class A and Class C common share. The common dividend was paid on October 11, 2018 to shareholders of record on September 28, 2018. Holders of units in the Operating Partnership were entitled to an equal distribution per each Operating Partnership unit held as of September 28, 2018. On July 24, 2018, the Company’s Board of Trustees also declared a preferred stock dividend of $0.4375 per each Series A Preferred Share. The preferred dividend was paid on October 15, 2018 to holders of record on September 28, 2018.

Supplemental Report

A Supplemental Report will be available in the Investors section of the Company’s website, www.seritage.com.

Non-GAAP Financial Measures

The Company makes reference to NOI, Total NOI, EBITDAre, Company EBITDA, FFO and Company FFO which are financial measures that include adjustments to accounting principles generally accepted in the United States (“GAAP”).

None of NOI, Total NOI, EBITDAre, Company EBITDA, FFO or Company FFO, are measures that (i) represent cash flow from operations as defined by GAAP; (ii) are indicative of cash available to fund all cash flow needs, including the ability to make distributions; (iii) are alternatives to cash flow as a measure of liquidity; or (iv) should be considered alternatives to net income (which is determined in accordance with GAAP) for purposes of evaluating the Company’s operating performance. Reconciliations of these measures to the respective GAAP measures we deem most comparable have been provided in the tables accompanying this press release.

Net Operating Income ("NOI”), Total NOI and Annualized Total NOI

NOI is defined as income from property operations less property operating expenses. The Company believes NOI provides useful information regarding Seritage, its financial condition, and results of operations because it reflects only those income and expense items that are incurred at the property level.

The Company also uses Total NOI, which includes its proportional share of unconsolidated properties. This form of presentation offers insights into the financial performance and condition of the Company as a whole given the Company’s ownership of unconsolidated properties that are accounted for under GAAP using the equity method. The Company also considers Total NOI to be a helpful supplemental measure of its operating performance because it excludes from NOI variable items such as termination fee income, as well as non-cash items such as straight-line rent and amortization of lease intangibles.

Annualized Total NOI is an estimate, as of the end of the reporting period, of the annual Total NOI to be generated by the Company’s portfolio including all signed leases and modifications to the Company’s master lease with Sears Holdings with respect to recaptured space. We calculate Annualized Total NOI by adding or subtracting current period adjustments for leases that commenced or expired during the period to Total NOI (as defined) for the period and annualizing, and then adding estimated annual Total NOI attributable to SNO leases and subtracting estimated annual Total NOI attributable to Sears Holdings’ space to be recaptured.

Annualized Total NOI is a forward-looking non-GAAP measure for which the Company does not believe it can provide reconciling information to a corresponding forward-looking GAAP measure without unreasonable effort.

Earnings before Interest Expense, Income Tax, Depreciation, and Amortization for Real Estate ("EBITDAre") and Company EBITDA

EBITDAre is calculated in accordance with the definition set forth by the National Association of Real Estate Investment Trusts ("NAREIT"), which may not be comparable to measures calculated by other companies who do not use the NAREIT definition of EBITDA. EBITDAre is calculated as net income computed in accordance with GAAP, excluding interest expense, income tax expense, depreciation and amortization, gains (or losses) from property sales and impairment charges on depreciable real estate assets. The Company believes EBITDAre provides useful information to investors regarding our results of operations because it removes the impact of the Company’s capital structure (primarily interest expense) and its asset base (primarily depreciation and amortization). Management also believes the use of EBITDAre facilitates comparisons between us and other equity REITs and real property owners that are not REITs.

The Company makes certain adjustments to EBITDAre, which it refers to as Company EBITDA, to account for certain non-cash and non-comparable items, such as termination fee income, unrealized loss on interest rate cap, litigation charges, acquisition-related expenses and certain up-front-hiring and personnel costs that it does not believe are representative of ongoing operating results.

Funds from Operations ("FFO") and Company FFO

FFO is calculated in accordance with NAREIT which defines FFO as net income computed in accordance with GAAP, excluding gains (or losses) from property sales, real estate related depreciation and amortization, and impairment charges on depreciable real estate assets. The Company considers FFO a helpful supplemental measure of the operating performance for equity REITs and a complement to GAAP measures because it is a recognized measure of performance by the real estate industry.

The Company makes certain adjustments to FFO, which it refers to as Company FFO, to account for certain non-cash and non-comparable items, such as termination fee income, unrealized loss on interest rate cap, litigation charges, acquisition-related expenses, amortization of deferred financing costs and certain up-front-hiring and personnel costs, that it does not believe are representative of ongoing operating results. The Company previously referred to this metric as Normalized FFO; the definition and calculation remain the same.

Forward-Looking Statements

This document contains forward-looking statements within the meaning of the federal securities laws. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” or “potential” or the negative of these words and phrases or similar words or phrases that are predictions of or indicate future events or trends and that do not relate solely to historical matters. Forward-looking statements involve known and unknown risks, uncertainties, assumptions and contingencies, many of which are beyond the company’s control, which may cause actual results to differ significantly from those expressed in any forward-looking statement. Factors that could cause or contribute to such differences include, but are not limited to: our significant exposure to Sears Holdings and the effects of its recently announced bankruptcy filing; Sears Holdings’ termination and other rights under its master lease with us; competition in the real estate and retail industries; risks relating to our recapture and redevelopment activities; contingencies to the commencement of rent under leases; the terms of our indebtedness; restrictions with which we are required to comply in order to maintain REIT status and other legal requirements to which we are subject; and our relatively limited history as an operating company. For additional discussion of these and other applicable risks, assumptions and uncertainties, see the “Risk Factors” and forward-looking statement disclosure contained in our filings with the Securities and Exchange Commission, including the risk factors relating to Sears Holdings. While we believe that our forecasts and assumptions are reasonable, we caution that actual results may differ materially. We intend the forward-looking statements to speak only as of the time made and do not undertake to update or revise them as more information becomes available, except as required by law.

About Seritage Growth Properties

Seritage Growth Properties is a publicly-traded, self-administered and self-managed REIT with 211 wholly-owned properties and 26 joint venture properties totaling approximately 37.5 million square feet of space across 48 states and Puerto Rico. The Company was formed to unlock the underlying real estate value of a high-quality retail portfolio it acquired from Sears Holdings in July 2015. Pursuant to a master lease, the Company has the right to recapture certain space from Sears Holdings for retenanting or redevelopment purposes. The Company’s mission is to create and own revitalized shopping, dining, entertainment and mixed-use destinations that provide enriched experiences for consumers and local communities, and create long-term value for our shareholders.

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