Note 6 – Leases

Master Lease

On July 7, 2015, subsidiaries of Seritage and subsidiaries of Sears Holdings entered into the Master Lease. The Master Lease generally is a triple net lease with respect to all space which is leased thereunder to Sears Holdings, subject to proportional sharing by Sears Holdings for repair and maintenance charges, real property taxes, insurance and other costs and expenses which are common to both the space leased by Sears Holdings and other space occupied by unrelated third-party tenants in the same or other buildings pursuant to third-party leases, space which is recaptured pursuant to the Company recapture rights described below and all other space which is constructed on the properties. Under the Master Lease, Sears Holdings and/or one or more of its subsidiaries will be required to make all expenditures reasonably necessary to maintain the premises in good appearance, repair and condition for as long as they lease the space.

The Master Lease has an initial term of 10 years and contains three options for five-year renewals of the term and a final option for a four-year renewal. As of December 31, 2016 and December 31, 2015, the annual base rent paid directly by Sears Holdings and its subsidiaries under the Master Lease was approximately $134.0 million. In each of the initial and first two renewal terms, annual base rent will be increased by 2.0% per annum for each lease year over the rent for the immediately preceding lease year. For subsequent renewal terms, rent will be set at the commencement of the renewal term at a fair market rent based on a customary third-party appraisal process, taking into account all the terms of the 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.

Revenues from the Master Lease for the year ended December 31, 2016 and for the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015 are as follows (in thousands and excluding the effect of straight-line rent):

			July 7, 2015
			(Date Operations
	Year Ended		Commenced) to
	December 31, 2016		December 31, 2015
Rental income	$	133,237	$	64,838
Tenant reimbursements		55,823		25,204
Total revenue	$	189,060	$	90,042

The Master Lease provides the Company with the right to recapture up to approximately 50% of the space occupied by Sears Holdings at the 224 Wholly Owned Properties initially included in the Master Lease (subject to certain exceptions). While the Company will be permitted to exercise its recapture rights all at once or in stages as to any particular property, it will not be permitted to recapture all or substantially all of the space subject to the recapture right at more than 50 Wholly Owned Properties during any lease year. In addition, Seritage has 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 the parking areas and common areas. Upon exercise of these recapture rights, the Company will generally incur certain costs and expenses for the separation of the recaptured space from the remaining Sears Holdings space and can reconfigure and rent the recaptured space to third-party tenants.

The Company also has the right to recapture 100% of the space occupied by Sears Holdings at each of 21 identified Wholly Owned Properties by making a specified lease termination payment to Sears Holdings, after which the Company can reposition and re-lease those stores. The lease termination payment is calculated as the greater of an amount specified at the time the Company entered into the Master Lease with Sears Holdings and an amount equal to 10 times the adjusted EBITDA attributable to such space within the Sears Holdings main store which is not attributable to the space subject to the separate 50% recapture right discussed above for the 12-month period ending at the end of the fiscal quarter ending immediately prior to recapturing such space.

As of December 31, 2016, the Company had exercised certain recapture rights with respect to 27 properties as follows:

Property	Recapture Type		Notice Date
Braintree, MA		100%	November 2015
Honolulu, HI		100%	December 2015
Memphis, TN		100%	December 2015
San Antonio, TX	Auto center		March 2016
Bowie, MD	Auto center		May 2016
Hagerstown, MD	Auto center		May 2016
Albany, NY	Auto center		May 2016
Fairfax, VA	Partial + auto center		May 2016
Wayne, NJ	Partial		May 2016
Ft. Wayne, IN	Out parcel		July 2016
Orlando, FL		100%	July 2016
Anderson, SC	Partial		July 2016
West Jordan, UT	Partial		July 2016
Madison, WI	Partial + auto center		July 2016
North Hollywood, CA	Partial		July 2016
Warwick, RI	Auto center		October 2016
Rehoboth Beach, DE	Partial		October 2016
Charleston, SC	Partial		October 2016
West Hartford, CT		100%	October 2016
St. Petersburg, FL		100%	October 2016
Roseville, MI	Partial		November 2016
Troy, MI	Partial		November 2016
Santa Monica, CA		100%	December 2016
Santa Cruz, CA	Partial		December 2016
Guaynabo, PR	Partial		December 2016
Saugus, MA	Partial		December 2016
Carson, CA	Partial		December 2016

The Master Lease also provides for certain rights to Sears Holdings to terminate the Master Lease with respect to Wholly Owned Properties that cease to be profitable for operation by Sears Holdings. In order to terminate the Master Lease with respect to a certain property, Sears Holdings must make a payment to the Company of an amount equal to one year of rent (together with taxes and other expenses) with respect to such property. Sears Holdings must provide notice of not less than 90 days of their intent to exercise such termination right and such termination right will be limited so that it will not have the effect of reducing the fixed rent under the Master Lease by more than 20% per annum.

During the year ended December 31, 2016, Sears Holdings provided notice that it intended to exercise its right to terminate the Master Lease with respect to 17 stores totaling 1.7 million square feet of gross leasable area. The aggregate annual base rent at these stores was approximately $6.0 million. Sears Holdings continued to pay Seritage rent until it vacated the stores in January 2017 and also paid Seritage a termination fee of approximately $10.0 million, an amount equal to one year of aggregate annual base rent plus one year of estimated real estate taxes and operating expenses.

The 17 properties are as follows:

Property	Square Feet
Cullman, AL		98,500
Sierra Vista, AZ		86,100
Thornton, CO		190,200
Chicago, IL		118,800
Springfield, IL		84,200
Elkhart, IN		86,500
Merrillville, IN		108,300
Houma, LA		96,700
New Iberia, LA		91,700
Alpena, MI		118,200
Manistee, MI		87,800
Sault Sainte Marie, MI		92,700
Kearney, NE		86,500
Deming, NM		96,600
Harlingen, TX		91,700
Yakima, WA		97,300
Riverton, WY		94,800
Total square feet		1,726,600

Subsequent to December 31, 2016, Sears Holdings provided notice that it intended to exercise its right to terminate the Master Lease with respect to 19 additional stores totaling 1.9 million square feet of gross leasable area. The aggregate annual base rent at these stores is approximately $5.9 million. Sears Holdings will continue to pay Seritage rent until it vacates the stores which is expected to occur in April 2017, and also will pay Seritage a termination fee equal to one year of aggregate annual base rent plus one year of estimated real estate taxes and operating expenses.

The 19 properties are as follows:

Property	Square Feet
El Paso, TX		103,657
Paducah, KY		108,244
Henderson, NV		122,823
Jefferson City, MO		92,016
Riverside, CA		94,500
Kissimmee, FL		112,505
Mount Pleasant, PA		83,536
Chapel Hill, OH		187,179
Concord, NC		137,499
Sioux Falls, SD		72,511
Platteville, WI		94,841
Muskogee, OK		87,500
Elkins, WV		94,885
Layton, UT		90,010
Detroit Lakes, MN		79,102
Hopkinsville, KY		70,326
Owensboro, KY		68,334
Leavenworth, KS		76,853
Kenton, OH		96,066
Total square feet		1,872,387

Lessor

The Company generally leases space to tenants under non-cancelable operating leases. The leases typically provide for the payment of fixed base rents, as well as reimbursements of real estate taxes, insurance, maintenance and other costs. Certain leases also provide for the payment by the lessee of additional rents based on a percentage of their sales.

As of December 31, 2016, future base rental revenue under non-cancelable operating leases, excluding extension options and signed leases for which rental payments have not yet commenced, is as follows (in thousands):

2017		164,242
2018		163,598
2019		163,537
2020		162,174
2021		163,442
Thereafter		622,419
	$	1,439,412

These future minimum amounts do not include tenant reimbursement income or additional rents based on a percentage of tenants’ sales. For the year ended December 31, 2016, the Company recognized $62.5 million of tenant reimbursement income, as well as approximately $0.1 million of additional rent based on a percentage of tenants’ sales which was included in rental income. For the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, the Company recognized $26.9 million of tenant reimbursement income, as well as approximately $0.1 million of additional rent based on a percentage of tenants’ sales which was included in rental income.

As Lessee

In connection with the Transaction, the Company acquired a ground lease for one property. During the year ended December 31, 2016, the Company recorded rent expense of approximately $0.2 million, which is classified within property operating expenses on the consolidated statements of operations. During the period from July 7, 2015 (Date Operations Commenced) through December 31, 2015, the Company recorded rent expense of less than $0.1 million. The ground lease requires the Company to make fixed annual rental payments and expires in 2073 assuming all options are exercised.