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100-year outlook driving Safehold’s business strategy

100-year outlook driving Safehold’s business strategy

7 min read

President & Chief Investment Officer Marcos Alvarado sits down with The Ground Up to reflect on the company’s long-term perspective, the opportunity ahead and an increasing ESG focus

What are your overarching takeaways from the last 12 months?

At the onset of the pandemic, we learned very, very quickly that the teams we had built were strong enough to seamlessly move to a work-from-home environment without impacting our business in any meaningful way. On the support side, if you think about accounting, tax and other parts of our operations, we didn’t miss a beat or compromise our control environment. On the business side, there were disruptions due to the fact that people couldn’t travel to properties to investigate and underwrite them properly. There were industry-wide challenges closing deals in the heart of the pandemic because it wasn’t possible to conduct inspections—and we were slowed down as well—but we really didn’t miss a beat from a people perspective. And as soon as the market started to open, we were driving business again.

Talk a little more about how Safehold was positioned for the pandemic and how the business has fared since.

We take a longer-term perspective than many, as we have a 100-year investment horizon. We expect to see many business disruptions in that time, and many business cycles, for sure. Our business is not predicated on the ups and downs of the business cycle. It’s predicated on a core idea that creates value for customers and investors over that 100-year view.

From an operational perspective, as I said, we didn’t really miss a beat. That’s a testament to the team we built. From a financial perspective, we manage our balance sheet prudently, as befits a company with a 100-year through-cycle mindset. We do not take excessive risk. Therefore, as the pandemic unfolded, we were very secure from a financial perspective. We were fully expecting our customers to continue paying their ground rent. And they did. We received, as of year end 2020, 100% of ground rents payable during this pandemic. Our entire business is built with a view that we will experience many stress situations and credit cycles over time. We like to use the analogy that while there is a storm on the ocean surface, and we certainly had one over the last 12 months, all is calm beneath the storm, which is a core pillar of our business.

What elements of Safehold’s business are most important for the market to understand?

It’s critical for investors to understand three components to get a full sense of the potential of our business. The first is to understand our customer value proposition. Second is to understand the size of our target market. Third is to understand the value to investors of the business that we’re building.

The modern ground lease, which Safehold created, has proven to be particularly beneficial for many different customer types, as evidenced by our early success and our track record of customers coming back to us. Safehold’s ground lease enables customers to generate greater returns on their own business and it significantly reduces their risk. That’s a truly valuable product.

And we’re only just beginning. We estimate a total addressable market of $7 trillion for ground leases on institutional quality properties in the top 30 U.S. markets. As of today, our portfolio stands at $3.4 billion. So, we have a terrific value proposition for our customers and an awful lot of customers to go get. We have a very long runway ahead of us and excellent growth prospects, as we’ve demonstrated in our limited history.

Safehold’s business is also valuable for investors. We’re building a rapidly growing and diversified portfolio of ground leases, which removes any idiosyncratic risk that you might find in a single asset. We believe that such a portfolio should be valued like AAA 100-year credit, and we believe that investors have begun to appreciate this value, reflected in significant share price appreciation over the last two years.

One area we’re just beginning to talk to investors about is the value of our portfolio’s Unrealized Capital Appreciation, which currently stands at $5.5 billion. To date, we don’t think the market has attributed meaningful value to this core part of the Safehold story. We think this is very valuable indeed. We will spend a significant amount of time in 2021 and beyond educating investors as to how valuable we view this asset.

In 2020, the company formed an ESG Advisory Council and a Cultural Equity Council. What roles do each council play?

As is being increasingly recognized across the public and private markets, ESG matters are critical for the long-term success and health of any enterprise. As a business with a 100-year investment horizon, environmental, social and governance concerns are also critical to Safehold’s success. Therefore, ESG concerns are at the heart of how we run our business.

As for the specific councils, the ESG Advisory Council is a governing body containing representatives from many of our business functions, whose job it is to think across those business functions and consider ESG impacts for the company as a whole. The group serves as both an oversight body and an advisory body to senior management and the Board of Directors, to ensure that we are appropriately considering and taking actions against ESG risks and opportunities. It’s also critical to be transparent, both internally and externally, about the work we do and the policies we implement. Transparency breeds trust, an essential component of any highly functioning institution.

The Cultural Equity Council, which we also formed within the last year, is charged with helping us sustain and evolve our culture so that we are as equitable and inclusive as we can be. While there has been significant growth in the number of conversations around diversity, equity and inclusion in recent times, these issues should be at the heart of every well run business – as they are core to enabling our people to work at their very best.

How do you view ESG and DEI in the context of Safehold’s business?

As investors with a 100-year time horizon, long-term environmental impacts are an important part of our underwriting process. It’s difficult to assess exactly what those risks are in a world that does not have accurate, long-range climate and environmental forecasting. There is much public debate over climate models, but any modeler will tell you the range of outcomes is wide. However, we make the best assessments we can using the best predictive tools available. One question we get asked a lot is about investing in coastal areas and we’re especially thoughtful about these investments. We’re also starting to consider the role we can play as stewards of a growing portfolio of land, a proposition we’re eager to explore further.

From a social perspective, inequities can take many forms and historically have been directed against many different individuals and groups. The lived experience of our minority colleagues deserves our focused attention. We should all be vested in creating a culture where people can be themselves and bring their best. At iStar and Safehold, we’re committed to doing just that, not only because it is right but because it is the only way to create a high-performance culture, one that gets the best out of its people and creates the best business outcomes.

DEI is not an adjunct to what we do, it is at the heart of everything we do. Everyone should be valued based on their contributions, not on any other factor. When a company allows microaggressions to go unchecked or doesn’t provide the support and training necessary for its employees to understand how DEI dynamics play out in the workforce, you risk diminishing or losing good people, in turn limiting your potential as a company. Ultimately, we’re focused on creating a company and a culture we’re all proud to work within, one with high aspirations for ourselves and our society.

Unpredictable economic headwinds are creating challenging conditions for owners, lenders and buyers to have conviction in their valuations.

This is leading to a lack of liquidity in the capital markets, where owners are hesitant to sell at higher cap rates. Meanwhile, buyers and lenders are reluctant to execute transactions without a clearer sense of the cost of capital in the near term.

Consequently, the commercial real estate industry is at a crossroads, and building owners that have historically focused on traditional fee simple ownership are becoming increasingly open to more efficient capitalization strategies.

As a leader in the modern ground lease industry, Safehold helps asset owners maximize the efficiency of their capital stacks by providing low-cost capital — all while mitigating development and debt maturity risks and generating a strong return profile, said Tim Doherty, Safehold’s recently appointed Chief Investment Officer.

“Existing owners are facing refinancing at higher costs and potentially lower proceeds,” Doherty told Bisnow’s Studio B. “Developers are also seeing lower debt proceeds and higher pricing, and buyers are struggling to meet the bid-ask spread.”

Bisnow spoke with Doherty to learn more about what he is seeing in the market and the advantages of modern ground leases in all economic conditions.

Bisnow: How would you characterize the mindset of building owners and developers in this market?

Doherty: The volatile market has definitely made it difficult for owners, lenders and buyers to have confidence in their valuations, leading to a standstill in the capital markets. Owners don’t want to sell at higher cap rates, and buyers and lenders are not confident where the cost of capital will be in the near term to execute deals.

But we are seeing market transaction volume increase. People are picking their spots and executing where there is liquidity. They’re going after markets where the valuations have changed, but the fundamentals haven’t. Multifamily and industrial are great examples of product types that continue to have strong fundamentals.

Bisnow: Safehold pioneered the modern ground lease. How has the perception of ground leases changed since then?

Doherty: Pretty dramatically. When we started, the market’s perception was very different from what it is today. Before we created the modern ground lease, they were inconsistent, poorly conceived and overly complicated. We provided consistency and simplicity, taking into account the interests of all participants, including lenders and owners.

We’ve now executed over $6B on more than 135 deals across numerous markets and asset classes for different types of capital needs. This includes development, acquisition and recapitalization. It’s one thing to see the hypothetical concept. It’s another to actually see it working in practice and generating higher returns for owners, operators and developers.

With over seven years of track record, we have seen several round trips and refinancings of leasehold positions, which have demonstrated the liquidity of the leasehold position as well as the increased returns for our clients.

Bisnow: What are the key structural advantages of a modern ground lease relative to traditional real estate capital?

Doherty: It goes back to the cost of capital. We’re a low-cost provider, and cheaper than all other CRE capital available. Simplicity, consistency and a low cost of capital allow us to provide our customers with accretive, passive capital to drive better returns.

Leasehold owners benefit from less equity required upfront, eliminating friction costs throughout the term and significantly reducing refinancing risk.

Bisnow: What is your investment team focused on in the near term?

Doherty: In a volatile market, you’re always looking for sectors and deals that are actionable. You’re going into areas that are impacted on the value side, but not the fundamental side. Office has been hit on both, so that’s a very difficult one for people to peg down. You don’t know what your revenues are or what the valuation method is yet.

Residential, including multifamily, student housing and build-to-rent, is the biggest sector we’re focusing on right now because the fundamentals have not changed, even if certain markets might be seeing near-term deliveries.

Existing owners are facing refinancing at potentially less proceeds than they currently have outstanding. This is creating a capital need that can come in the form of fresh equity, such as cash in from the existing owner or new, high-priced preferred equity.

Alternatively, Safehold’s low-cost, highly accretive capital enables owners to create a more efficient, conservatively priced capital stack that reduces and, in some cases, eliminates the need for additional equity required while driving better returns.

Bisnow: How do Safehold ground leases impact leasehold liquidity when building owners sell their assets?

Doherty: We’ve seen 42 sales and refinancings behind our ground leases, so the proof of concept is there. In these transactions, the cap rates have been very similar to fee simple comparable transactions, both on multifamily and office assets, with a range of no spread on cap rate to about 10 to 15 basis points.

Having a track record on third-party market transactions has been a powerful part of the liquidity story for Safehold’s modern ground lease assets.

Bisnow: How should owners evaluate the option of a modern ground lease structure for their needs?

Doherty: We’re always here to help new clients understand the benefits for their assets as well as the liquidity track record we have seen produced with our existing clients.

In today’s current environment, we are seeing a lot of demand across all property types. The most active market is currently multifamily — acquisitions, development and recapitalization. The ground lease creates a lower blended cost of capital than fee simple stacks for all scenarios.

The added benefit today in the higher-rate environment is in recapitalizations. If an asset was purchased three years ago with 65% leverage, a 100-to-125-basis-point move in cap rates would make the debt now 85%, requiring a cash-in refinance on a fee simple basis of approximately 10% to 25% of the debt balance.

Alternatively, if the same property was recapitalized with a Safehold ground lease and a bank or agency first mortgage, the equity could refinance 100% of the in-place debt and, in some cases, take cash out upon recapitalization.

Overall, we’re still in the early innings of this business with tremendous growth potential for Safehold and our customers.

Connect with Safehold

East Coast

Tim Doherty

Chief Investment Officer

West Coast

Steve Wylder

Southeast

Ryan Howard

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