How modernized ground leases fixed archaic structures of the past

How modernized ground leases fixed archaic structures of the past

6 min read

[Article updated December 7, 2020]

You joined Safehold in March 2019. Talk about your experience so far.

I joined Safehold at the start of what was a transformational year. When I joined, we had around $1 billion of ground leases, and we closed the year around $3 billion. I came on board at the tail end of the research and development (R&D) period – although R&D really never stops when you’re starting a business – and I experienced the first wave of real success and market recognition that we all enjoyed. While 2020 has been a challenging time for the whole commercial real estate industry, it’s been encouraging to see the market begin to come back and our transaction activity pick up significantly over the last 60 days.

Talk about some of the legal innovations Safehold has brought to ground leases.

The first, on the business side, was simply to eliminate all elements of variable rent. In old ground leases, there were options to revalue the rental stream, to the benefit of the fee owner and the detriment of the leasehold owner. These fair market value resets were the death knell of all the busted ground leases you’ve ever heard about. On the legal side – and this is less an innovation than a consolidation – we removed all the unnecessary covenants that impaired the leaseholder’s ability to execute their business plan, or required them to come back to their fee owner when they really shouldn’t have to. For example, in traditional ground leases, there were limitations on the type of financing that a leaseholder could get. They couldn’t get too much, and they couldn’t get it from a person who wasn’t approved by their fee owner. There were hoops to jump through. We said, “Well, we hope they don’t over lever themselves into default, but more people with more money invested in the leasehold means more people to protect and pay our ground rent.” So, we eliminated pretty much every covenant related to the leaseholder’s ability to finance their position.

Similarly, we eliminated the covenants around who they could sell to. And this is all funneling up to the idea of making sure the leasehold is liquid and financeable. Other ground leases say that you have to sell to an institutional owner. No one knows what that means, so obviously they have to come back to their fee owner for consent. There’s no reason we should care. We should let the market work.

What provisions commonly found in old ground leases were problematic?

Larger tenants require a non-disturbance agreement from the fee owner which says, in essence, that if the leasehold owner stops paying rent such that the fee owner terminates the ground lease and now owns the building, the fee owner will recognize their lease and won’t disturb their tenancy. That’s a critical piece for larger tenants to have in order to commit to their spaces. In the past, fee owners were very difficult on their leasehold owners about this. They wanted to approve every lease. We give our leasehold owners a structure where if their lease fits into a very broad definition, we will give them non-disturbance rights, because we want tenants in the space and we want them paying rent.


So it comes down to leasehold owners having more freedom to run their buildings the way they see fit.

Yes. Here’s another example, about the ability to alter the building. In old ground leases, fee owners had a very low threshold above which they had to approve all alterations. For example, a large hotel asset we bought in September 2019 had an existing ground lease where the threshold was $500,000. But that was for a multi-hundred million dollar property. If they sneezed, it would cost them $500,000. That threshold is absurdly low. It creates an administrative burden for everyone, and hold-up value for a fee owner.

Our position is, if we own the ground under an apartment building and the leasehold owner wants to upgrade all the kitchens – new fridges, new ovens, new countertops – that’s great. We don’t need to consent to that. That’s not construction. So, we took that threshold and bumped it way, way up to a number that basically represented a new construction job, such as a scenario in which 10 floors will be added to the top of a building. At that point, we check in with our tenant, because we want to make sure the work is going to be completed if it’s started. But we alleviated the stress around an ordinary part of operating high-quality real estate.

The last and most important thing – and this speaks to the liquidity and financeability of the leasehold – we gave leasehold lenders every cure right and every protection they need. So, let’s say JPMorgan Chase is lending to our leaseholder. Lenders want to know that if our leaseholder doesn’t pay the rent to us, that they can pay the rent, because otherwise we would technically terminate the lease and wipe both of them out. This was a major problem in pre-Safehold ground leases, where lenders weren’t given the proper opportunity to cure defaults before they got wiped out. The way I always explain it to leasehold lenders is that we have eight pages of cure rights in the ground lease. We have rights for you to get a new lease if the tenant goes bankrupt. We have every protection you want, and if you think we’re missing something, tell us and we’ll put it in.

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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