Up until now, the relationship between the real estate investment trust Seritage Growth Properties (SRG) - Get Report and Sears Holdings (SHLD) , its top tenant, has worked out reasonably well. Seritage's portfolio of some 266 retail properties spanning 42 million square feet in space was 99.3% leased at the end of the second quarter. Of the properties leased to Sears, 170 operated under the Sears brand and 82 flew the Kmart banner.

Seritage -- a spin-off formed in 2015 by Sears that netted it $2.7 billion in badly needed cash -- has collected a cool $91.2 million in rental income this year, of which 79%, or $72 million, came from Sears. The remainder of Seritage's income stems from third-party tenants, such as other retailers.

For Seritage, relying on the Sears has allowed it to follow in the footsteps of much larger REITs such as Simon Property (SPG) - Get Report and reimagine what a mall or shopping center should be in the age of digital shopping and cautious consumer spending. But Seritage could find out very quickly that being shackled to the troubled retail icon is not without serious downside.

The steady stream of cash funneled in from Sears has fueled Seritage's redevelopment of stores that Sears has chosen to exit due to their poor performance or which Seritage exercised its rights to reclaim. A redevelopment consists of first leasing out the space to other retailers such as Nordstrom (JWN) - Get Report Rack or restaurants like Bloomin' Brands' (BLMN) - Get Report Outback Steakhouse and then re-configuring the confines to meet their needs. After all, an Outback Steakhouse isn't going to occupy a former three-story Sears store that opened sometime in 1970.

Seritage's wholly owned development pipeline consists of 21 total projects, including six projects that were in various stages of development when the REIT was formed last year and 15 new redevelopments that have been inked since. Seritage has an estimated total investment of $172.5 million in the 15 new projects.

A prime example of what Seritage has been up to is in the busy King of Prussia mall in Pennsylvania. The company has signed leases with restaurants Yard House and Outback Steakhouse to occupy a former Sears Auto Center. Fast-fashion house Primark and sporting goods retailer Dick's Sporting Goods (DKS) - Get Report opened in 2015 and occupy the first and second floors, respectively, of a former Sears store.

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Seritage has had some success at developing abandoned Sears and Sears Auto Center sites. Source: Brian Sozzi

Third-party tenants such as Dick's, Nordstrom and various restaurants and retailers now occupy over 3.4 million square feet within the Seritage portfolio.

Indeed, the very existence of Seritage as a publicly traded REIT -- an entity that shells out no corporate income tax in exchange for paying out 90% of its taxable income to shareholders through dividends -- rests on several basic pillars.

The first assumption is that Sears will be around and doing business so that it can continue to pay its rent to Seritage, which currently amounts to a $150.9 million annual obligation. Another consideration is that Seritage then takes the funds from Sears and reinvests it in the redevelopment of underperforming Sears and Kmart stores for other retailers or businesses that could pay more in rent.

According to Seritage's latest 10-Q filing with the Securities & Exchange Commission, 239 third-party leases presently in place pay Seritage $11.98 in rent per square foot compared to a paltry $4.30 per square foot for 252 leases held by Sears. Those that have recently signed leases with Seritage, 46 in total, have inked rent of $22.79 per square foot, according to the filing.

Then, as the thinking goes, Seritage puts itself in a position to pay out even juicier dividends to shareholders. There is likely also a belief among investors that Seritage could turn lagging Sears and Kmart sites into more productive uses fairly quickly, moving at its own pace to secure new tenants while at the same time collecting predictable streams of rent from Sears.

But two fresh developments related to Sears suggest what is tantamount to a house of cards is on ever shakier ground. On Friday, Seritage disclosed that Sears exercised its right under its master lease arrangement with Seritage to exit 17 unprofitable stores -- mostly Kmart -- totaling 1.7 million in square feet. Sears will continue to pay Seritage rent until it vacates the stores by January next year.

As a result of Sears' decision, it must pay Seritage about $5.8 million, or the equivalent of one year of rent for the 17 properties, as well as an undisclosed amount of estimated operating expenses. Sears apparently couldn't wait to dump the stores onto Seritage; under its agreement detailed in Seritage's annual report, it couldn't execute such termination rights for any stores prior to Aug. 1, 2016.

It's unclear from Friday's filing the condition of the 17 stores, their locations or the specifics behind their closures other than that they were unprofitable. Several attempts by TheStreet to reach Seritage via phone went unanswered. Sears' primary spokesman, Howard Riefs, has yet to respond to an email request for comment.

What is clear, however, is that Seritage now has 17 stores that could no longer be relied upon for a predictable stream of long-term revenue. That's a problem, as Seritage will still have to absorb mortgage payments, real estate taxes, insurance, and repair and maintenance expenses levered to the sites. Seritage noted in its annual report: "If income from a property declines while the related expenses do not decline, our income and cash available to us would be adversely affected."

Considering Seritage is sitting on more than $1.1 billion in mortgage payments (a liability on the balance sheet) that has helped to rack up $31.3 million in interest expenses this year, and causing it to be unprofitable, it's imperative that every property is generating income.

Seritage only had $63 million in cash and equivalents at the end of the second quarter (excluding $87 million in restricted cash) and access to $100 million via an undrawn credit line. Cash has to keep coming into the business so as not to disrupt the delicate balance of Seritage.

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A Sears bankruptcy could instantly create hundreds of zombie (empty) locations. Source: Brian Sozzi

That ultimately leads to one of the biggest questions of them all: What happens to Seritage should Sears file for bankruptcy protection?

Certainly, unloading 17 unprofitable stores sends a worrying signal, particularly that Sears is in full-on cash-preservation mode. The likelihood of a bankruptcy filing happening soon is far greater than when Seritage shares began trading in July last year. Sears reported a staggering second-quarter loss of $2.03 a share as it felt intense competitive pressure in businesses such as appliances and apparel from Home Depot (HD) - Get Report , Lowe's (LOW) - Get Report , J.C. Penney (JCP) - Get Report , Best Buy (BBY) - Get Report and Walmart (WMT) - Get Report . A year ago, the company delivered a loss of $2.40 a share, and net sales plunged 8.8% to $5.7 billion.

Perhaps more concerning than the sales declines were the dangerously low cash levels for Sears as it gears up for the holidays. Cash and equivalents declined to $276 million from $1.8 billion a year ago. As a result, Sears was forced to accept $300 million in financing from CEO Eddie Lampert's investment vehicle, ESL Investments.

The precarious financial situation of Sears has caught the ire of ratings agency Moody's.

Moody's slashed its speculative-grade liquidity rating on Sears one notch to SGL-3 from SGL-2. The new rating reflects the likelihood that Sears will continue to need outside financing to stay in business, and that it may require covenant relief in order to maintain orderly access to funding lines.

"We recognize the risks associated with relying on these sources and continued shareholder support to finance its negative operating cash flow which is estimated by Moody's to be approximately $1.5 billion this year," said Christina Boni, a Moody's vice president.

But the ratings downgrade took a backseat to what Moody's had to say about Sears' struggling discount chain Kmart: "The ratings also reflect our view on the uncertainty of the viability of the Kmart franchise in particular given its meaningful market share erosion."

A non-viable Kmart, at least in the eyes of the reputable Moody's, calls into question the income-generating potential of the 82 Kmart sites Seritage owns, as well as the company's ability to redevelop the locations or sell them outright for a decent price.

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A closed Sears store doesn't produce rental income for Seritage. Source: Brian Sozzi

A Sears bankruptcy filing could be devastating to Seritage. It would likely severely diminish the rental revenue that Seritage generates from Sears, and force it to take back a good number of properties as a result of a default or a rejection of leases by Sears in a bankruptcy proceeding.

Furthermore, claims for unpaid rent would be subject to statuary limitations that would probably lead to Seritage receiving substantially less rent than it is owed. Or, it could lead to no rent collected at all.

Making matters worse for Seritage, it wouldn't be able to re-lease the space quickly given what promises to be a prolonged trip through the bankruptcy court for a legacy retailer like Sears. Meanwhile, Seritage could get low-ball offers for properties as other businesses look to take advantage of its tough spot.

The cash squeeze caused by a Sears bankruptcy filing would probably force Seritage to stop development of its properties, and have it looking to sell out for a song to larger, better-capitalized REITs such as Simon Property or General Growth Properties.

So far, investors appear to be wearing blinders about what is tantamount to a swirling, black vortex. Shares of Seritage have gained about 20% this year, outperforming the S&P 500's 5% increase.

Suffice it to say, a Sears bankruptcy would be one of the dreariest days in the overhyped career of Lampert, who owns 49.4% of Sears and 3.9% of Seritage through ESL Investments and is chairman of Seritage. Not only would Lampert wipe out shareholders in one company (Sears) and materially hurt those at another (Seritage) with one electronic filing to the bankruptcy courts -- and that includes major losses for ESL -- but he will have played a key role in bringing down one of the most iconic American retailers of all time.

To boot, there could be loads of zombie (non-occupied) Sears and Kmart properties that hit the commercial real estate market, affecting property values and sales at other retailers that will have to deal with the disruption caused by Sears' nationwide liquidation sales.

Editor's Note: This article was originally published on Real Money at 2:10 p.m. on Sept. 21.

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