Even before COVID-19 decimated the U.S. retail industry, retail REIT (and Sears Holdings spinoff) Seritage Growth Properties (SRG 0.11%) was struggling to redevelop properties as fast as Sears and Kmart were vacating them. The pandemic has made what was already a tough task even more difficult.

Many of the new tenants that Seritage was counting on to replace income lost due to Sears and Kmart store closings temporarily stopped paying rent this spring. A few even went bankrupt or canceled previous expansion plans.

As a result, Seritage's redevelopment plans have stalled, for the most part, while it continues to burn cash. The REIT has turned to asset sales to get through this period of weakness in 2020. It appears to be continuing this strategy in the third quarter.

Selling assets to fund cash burn

During the first half of 2020, Seritage Growth Properties used $18 million of cash in its operations, despite favorable working capital movements. Seritage simply doesn't have enough tenants in place yet to cover its expenses -- in-place annual base rent totaled $102.5 million as of June 30, whereas annual interest expense alone is approximately $116 million. The REIT also spent about $180 million on redevelopment projects in the first half of the year.

Seritage financed most of this cash burn with asset sales. Through June 30, it had sold 13 properties and three outparcels in 2020 for total proceeds of $158.9 million. Seritage sold another two outparcels for $7.3 million in the first five weeks of Q3, and as of Aug. 4, it had additional assets under contract to be sold for an expected total of $91.5 million.

A rendering of Seritage's Esplanade at Aventura development

Many of Seritage's premier redevelopments have been delayed. Image source: Seritage Growth Properties.

More asset sales on the way

Last fall, Seritage Growth Properties signed a deal to sell a portfolio of 23 outparcel properties to Four Corners Property Trust (FCPT 0.40%) for $68.4 million. FCPT has been willing to pay good money for these outparcels, which carry relatively low risk because they are rented to creditworthy tenants under triple net leases. Last week, the two REITs teamed up again, as FCPT announced that it would purchase an additional nine outparcels from Seritage for $27.3 million. It expects to complete most of the sales by the end of 2020, but a few will trickle into 2021.

As of last week, Seritage and FCPT had closed sales of 14 outparcels for $45 million, while terminating several of the remaining outparcel sales from the original portfolio. That left 13 properties under contract for a total of $36 million. The two REITs closed three additional outparcel sales this week for just over $10 million.

Seritage is also on the verge of selling its interests in two former Sears stores in Chicago. It had previously planned mixed-use redevelopments of these properties in partnership with Tucker Development, potentially adding close to 900 new homes (mainly apartments) along with new retail space. These had been two of Seritage's premier projects, but they're years away from generating revenue -- and time is a luxury Seritage doesn't have right now. Furthermore, the sites' high potential made them relatively attractive to potential acquirers.

How quickly can Seritage get back to business?

Despite the accelerating pace of asset sales, Seritage Growth Properties is hardly in liquidation mode. The REIT has resumed some redevelopment projects that are close to completion. It expects to invest an additional $42.7 million in these projects to bring $12.7 million of annualized rental income on line by mid-2021. It's also moving forward with community meetings to advance proposed mixed-use developments at properties in Hicksville, New York and Bowie, Maryland.

On the other hand, Seritage gave up $8 million of annual income in the asset sales it completed during the first half of 2020. Asset sales set to close in the second half of the year could further deplete its rent roll by several million dollars. In short, Seritage is selling assets to fund operating losses and capital expenditures, and the incremental rent from redevelopments that are being completed is doing little more than offsetting the rent lost from selling income-generating properties.

As of June 30, Seritage Growth Properties had $71.7 million of signed leases for tenants that had not yet opened. If those tenants can commit to opening within the next year or so, then the REIT will be able to resume most of its redevelopment projects and bring that rent on line, getting cash flow to around breakeven by the end of next year. That would buy time for Seritage to ramp up leasing volumes again and make progress on its premier redevelopment projects.

By contrast, if the bulk of Seritage's redevelopment work remains on hold for several quarters, shareholder value will continue to melt away due to the retail REIT's ongoing cash burn.