Ground leases an opportunity for innovation amid CRE downturn

Ground leases an opportunity for innovation amid CRE downturn

6 min read
Multifamily building

Liquidity in short supply, more than $2T in commercial real estate debt maturing and an office sector struggling to find its foothold in a new world of hybrid work. It would be difficult to recall a time when CRE was buffeted by so many headwinds at once.

“Economists are going to have a field day making sense of these almost tectonic shifts,” said Marcos Alvarado, president and chief investment officer of Safehold, pioneer of the modern ground lease. “It will probably take another five or 10 years from now to make sense of the permanent systematic change.”

Smart investors know to think long-term, and many are looking for ways to not only ride out the turmoil but prosper. Alvarado said Safehold provides a potential solution for them.

Bisnow spoke with Alvarado about ground leases and why he thinks they can provide a tremendous opportunity for the industry to innovate and solve some of the obstacles posed by the current environment.  

Bisnow: What are you hearing from customers about the state of CRE?

Alvarado: I think people are trying to figure out what to do. Some of our owners and customers are in asset classes where the fundamentals are actually pretty positive. And then at the other end of the spectrum, office operators and owners are sort of scratching their heads and struggling. 

Bisnow: How do ground leases provide an opportunity for the CRE industry to address the challenges of today’s market?

Alvarado: In this environment, a ground lease is a phenomenal alternative for our customers as they think about developing, acquiring new assets or recapitalizing a distressed asset. We want to provide capital solutions to our customers so that they can potentially recap and execute on a business plan and recover some of the equity value that may be impaired today.

Bisnow: Let’s go back to when the company was founded. What was the fundamental problem Safehold set out to solve in 2017?

Alvarado: Ground leases have been around for centuries and have generated great wealth for institutions such as universities. But in 2017, we saw that there was no market to actually own ground leases. They never came up for sale. We thought, “How can we create this product and give investors access to it while creating an efficient capital solution for building owners?” We viewed ground leases as a natural extension of the net lease space.

We started off with a handful of assets as a kind of seed portfolio, and the first two years of getting our story out there were pretty difficult. But we’ve since gained momentum, and I think of us as the leading brand now in the ground lease space. We went from around 10 assets to more than 130 today, and our lease portfolio has grown from a couple hundred million dollars to $6.3B as of Q2. 

Bisnow: How do you account for Safehold’s exponential growth?

Alvarado: If you look at the arc of what we did, again, the first two years were an education phase. And then we hit an inflection point in 2019 when people started to understand and appreciate what we were trying to do, and our brand awareness grew. 

The things that we point to are customer satisfaction and our repeat customer stats, which are almost at the 70% level. If the product didn’t work, people wouldn’t be coming back to us. 

We’re also constantly trying to improve on how quickly we go from sourcing prospective customers to closing actual transactions. When we started, that process took almost two years. We’ve since tightened the time frame down to about 14 months. 

Bisnow: It sounds like CRE has become more comfortable with ground leases.

Alvarado: Yes, but we’re still in the early innings of adoption. There’s approximately $7T of commercial real estate, and among the top 30 MSAs, in a functioning capital market, there’s probably a trillion dollars of capital decisions made every year. That’s what gets us excited: the overall opportunity. 

When we started the business and were making calls, nobody knew what the product was, and there was a ton of skepticism. Five or six years later, people see that it is financeable and that you can sell your asset and create real value.

The other thing I think about is that when we started, there was never a page about ground leases in the pitch decks of the big investment sales brokerage shops. Now, there is a ground lease page in almost every investment sales pitch, which leads me to think we have made significant inroads.

Bisnow: More specifically, how does Safehold give its customers a competitive advantage? 

Alvarado: Our product provides permanent capital at a lower cost than the equity alternative. We’re driving customers’ cash-on-cash returns and reducing friction costs, because every time we enter into a transaction, the transfer tax, mortgage recording tax and other costs related to land disappear. We’re also reducing risk during this downturn because we give our customers permanent capital that they don’t have to pay back. 

Bisnow: How do leasehold sales of assets on Safehold ground leases compare to traditional fee simple sale comps?

Alvarado: We’ve seen about 30 sales and refinancings behind our ground leases since we started, so the proof of concept is there. In these transactions, the cap rates have been very comparable, both on multifamily and office assets, with a range of no spread on cap rate to about 50 basis points. 

Our customers recognize the value proposition of our product. From a refinancing standpoint, there have now been plenty of transactions that support the liquidity of ground lease assets.

Bisnow: What does the near-term future look like for Safehold and ground leases?

Alvarado: We’re focused on the housing space because of the structural supply-demand imbalance and liquidity from government agencies. You’ll see us playing in the multifamily/student housing space, and then we believe in the recap opportunity in distressed capital structures, where we’re spending time across all asset classes as an efficient capital solution while values are reset.

This article was produced in collaboration with Bisnow’s Studio B. Bisnow news staff was not involved in the production of this content.

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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