A little more than three years ago, Sears Holdings (SHLDQ) spun off real estate investment trust Seritage Growth Properties (SRG -2.17%) and sold more than 250 real estate assets to Seritage. The idea was that Sears would receive some much-needed cash to pay down debt, while Seritage would be able to gradually recapture space from Sears and Kmart and redevelop some of its real estate for higher-paying tenants.

However, over the past two years, Sears Holdings has closed dozens of the stores it transferred to Seritage. Since Sears Holdings filed for bankruptcy earlier this week, the REIT may have to move even faster to find new tenants. Yet while a slower transition away from Sears and Kmart would have been ideal, Seritage is well positioned even if its top tenant soon goes bust.

Seritage tries to calm investors

On Monday -- the day of Sears' bankruptcy filing -- Seritage put out a press release to reassure shareholders. First, it noted that nearly 70% of its signed lease income comes from third-party tenants (i.e., excluding Sears Holdings), up from around 20% at the time of the spinoff.

The exterior of a Sears full-line store.

Image source: Sears Holdings.

Second, Seritage highlighted its strong balance sheet. It had $580 million of cash on hand as of Sept. 30. It can also borrow another $400 million under a new term loan arranged with Berkshire Hathaway a few months ago. Importantly, the loan is structured so that a Sears bankruptcy wouldn't cause Seritage to default on its terms.

The first statistic deserves some caveats, though. The majority of Seritage's signed leases with third parties are for tenants that have not opened their doors yet -- and thus aren't paying rent.

These leases will all commence within the next year or two, diversifying Seritage's revenue sources. But for now, the revenue coming in from tenants other than Sears Holdings is a much smaller proportion of the REIT's total. Furthermore, third-party tenants represent a bigger percentage of a smaller pie. Seritage's total revenue was $49.3 million last quarter, compared with $59.5 million in its first full quarter as an independent company.

Steady progress

While Seritage's current revenue from third-party tenants is relatively modest, the REIT is on the right track in terms of replacing lost income from Sears and Kmart.

In a letter to shareholders (also released on Monday), CEO Benjamin Schall noted that Seritage has leased over 7 million square feet of space since its inception in mid-2015. That's up from 6.1 million square feet as of June 30, implying that the third quarter was very productive in terms of leasing activity.

Seritage has also become more aggressive about paring noncore real estate from its portfolio. Schall disclosed that the company has sold 10 of the 74 stores that have been terminated from the master lease by Sears Holdings. Only five such stores had been sold as of June 30. Schall also noted that Seritage is under contract to sell another four assets in smaller markets. These moves provide immediate cash injections, improve near-term cash flow by passing off the property operating expenses to the new owners, and allow management to focus on Seritage's biggest opportunities.

A rendering of The Mark 302 in Santa Monica, California.

Seritage is making progress on redeveloping its premier assets. Image source: Seritage Growth Properties.

Speaking of big opportunities, Seritage is just starting to lease up its three flagship properties in Santa Monica and La Jolla, California, and Aventura, Florida. Earlier this year, the company estimated that these premier assets could bring in more than $40 million of annual rent. (The total for Seritage will be a bit lower now, as it sold 50% joint venture interests in both California properties earlier this year.)

Looking even further ahead, Seritage's management sees room for larger-scale mixed-use developments at dozens of its properties. Two such projects recently received the necessary local government approvals, paving the way for redevelopment to begin.

Ready for any outcome

Sears Holdings filed to reject the leases for more than 200 properties -- mainly vacant stores -- in one of its first actions after declaring bankruptcy. None of these are owned by Seritage, though. That's not surprising, as Sears Holdings has already made liberal use of a provision in the master lease between the two parties that allows it to terminate the leases of unprofitable stores.

On the other hand, of the 142 stores that Sears Holdings plans to close by year-end, 51 are owned by Seritage or one of its joint ventures. This is probably a precursor to Sears trying to restructure the master lease -- or rejecting it entirely.

Sears and Kmart won't necessarily disappear from Seritage's portfolio immediately. Indeed, Eddie Lampert (Sears Holdings' chairman and controlling shareholder) still hopes to keep the company afloat by buying about 400 of its most profitable stores in a bankruptcy auction. That number includes plenty of stores leased from Seritage Growth Properties.

But if Lampert's efforts fail and Sears goes bust, it won't be a big setback. Seritage can more than replace its current revenue from Sears Holdings just by completing the projects already in its redevelopment pipeline. Its cash on hand and $400 million of incremental borrowing capacity can fund that work. And by 2020, Seritage will have completely diversified its revenue base, putting it in good position to raise capital for the next phase of its redevelopment strategy.