Customer focus core to Safehold’s ground lease innovation

Customer focus core to Safehold’s ground lease innovation

6 min read
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Four years after modernizing the ground lease, Safehold is seeing increasing evidence of its capital solution unlocking hidden value for building owners across a portfolio approaching $4 billion. Commercial Observer spoke to Marcos Alvarado, Safehold’s President and Chief Investment Officer, to learn more about how the company is pursuing its mission to transform a $7 trillion industry.

Commercial Observer: Safehold’s creation of the modern ground lease industry has given building owners a new tool to unlock hidden value. What key innovations made this evolution possible?

Marcos Alvarado: Ground leases have been around forever. But nobody ever said, “Let’s put the customer first.” That was our primary objective when we launched the business just over four years ago.

We were looking at how we could create incremental value, allow our customers to be more capital efficient, reduce their risks, and reduce the friction costs on their real estate transactions. We removed variables that made it difficult to underwrite ground leases and historically destroyed value. Reinventing ground leases as a customer-focused business was the real innovation.

We want our customers to think about using ground leases at multiple points in the life cycle of an asset, so we’ve evolved our offerings to accommodate each stage. We’ve launched SAFE x SWAP, where we acquire existing ground leases and modernize them. We’re preliminarily exploring a program to help customers who are looking at upgrading their buildings and reducing their carbon footprint, called SAFE Planet. We’ve even started to do ground leases on development transactions, targeting an even earlier part of the life cycle with a product called Ground Lease Plus.

How does a Safehold ground lease provide a competitive advantage for owners and operators?

The way we think about it is threefold: capital efficiency, friction costs and reduced risk.

If you’re an owner of an asset or a fund manager, you want to be the most efficient with your capital structure, and that is fundamentally what our ground lease accomplishes. When you own a piece of real estate, you actually own two things: the building and the land. The building is a high-effort, high-return business — marketing, developing, leasing, managing, and ultimately creating value for your investors. The land investment is a passive investment, and the same investor base shouldn’t own assets that have drastically different risk profiles. Utilizing our ground lease unlocks this value as our customers are more efficient with their capital.

Every time an asset sells or refinances, there are a tremendous amount of friction costs, such as title or recording taxes, hedging costs, lawyers — the list goes on, and they can add up to 3, 4, even 7 percent of the asset value depending on the market. If we buy 35 percent of that building’s value in the land, park it and never sell it, that friction cost is gone. There’s value created.

And the third component is reduced risk. Real estate is a cyclical business. If you’re invested in a quality institutional asset, you can survive a down cycle if you don’t have a liquidity squeeze. A large portion of that capital stack doesn’t come due with a ground lease. These three differentiators have resonated with our customer base.

How have Safehold’s interactions with the market changed over the last few years?

When we started the business, we had a long education phase — a good 18 months to two years. But real estate has a strong network effect. As we made progress with the institutional community, the benefits started to spill over. Now, we’ve got a core customer base. Fifty-nine percent of our existing customers have shown us a second deal, and 47 percent have already done another transaction with us. There’s a ton of customer stickiness — that means it works and customers are satisfied.

Are there certain questions you often receive when introducing the modern ground lease concept to building owners?

The biggest question is always around liquidity: What is my leasehold estate going to trade for with a Safehold ground lease? When we started this business that answer was theoretical, because we had just started and there hadn’t been many Safehold ground leases. It’s exciting times for us four years in, because we’re starting to see our customers refinance and sell assets across the country, and that value creation is now tangible.

When Safehold evaluates deals, given that they often span 99 years, what considerations do you focus on most intently?

Location, location, location is Real Estate 101, but when you’re basically never going to sell an asset, you really have to feel good about where you are. We focus on the top 30 markets in the country, the major gateways, and the high-growth markets. We spend a ton of time on the environmental dynamics: Does it sit on a fault line in California? What does the flood dynamic look like? We must think not about tomorrow or five years from now, but 20 or 30 years from now.

How would you describe Safehold’s current pipeline?

When COVID hit, and for six months or so after, there was a pause in the business. Activity started to thaw in the fourth quarter of last year, and 2021 has been really solid. We have expanded our markets and our asset classes, and we’re busier than we’ve ever been.

Does Safehold favor certain property types?

We’re somewhat agnostic. We haven’t done any retail to date — by design — and we’ve had a pretty good run over the last few months in the multifamily space.

Given how much success Safehold has had in its first four-plus years, what do you envision for the ground lease landscape five to 10 years from now, both for Safehold specifically and the industry in general?

If you think about other asset classes in real estate that were, at one point, considered niche, like data centers or some of these entertainment propcos, they’re massive companies. American Tower has over a $100 billion market cap. We see ourselves, hopefully, on a similar trajectory. We want to continue to be the leader in an asset class the market today considers niche — and we want to make modern ground leases mainstream. If we succeed, we’ll radically change the way real estate is owned and be a very big business five to 10 years from now.

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


Ryan Howard

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