How Safehold reinvented the ground lease to add value for building owners

How Safehold reinvented the ground lease to add value for building owners

6 min read

A Q&A with Safehold Chairman & CEO Jay Sugarman reveals how their new take on ground leases is delivering higher returns for property owners

Jay Sugarman had spent more than 20 years using sale-leasebacks to provide more efficient capital to corporations when he realized he could do the same for commercial real estate owners. Here, in a Q&A interview, Safehold’s Chairman & CEO discusses how the company’s modern ground lease model solves a major inefficiency inherent in real estate ownership.  

Safehold was founded because the general approach to real estate ownership was inefficient. Talk about how the initial idea for Safehold and the company’s approach to ground leases came about.

Jay Sugarman (JS): At iStar, which is the external manager and largest shareholder of Safehold, we’ve been working with companies to do sale-leasebacks of their real estate for over two decades. And the thinking behind that for CFOs in the corporate world is the realization that combining a high-return core operating business and a low-return passive piece of real estate is inefficient. Those are two different investments that should be owned by two different investors. The idea of separating those two different investments and creating more efficient capital structures for corporations had a pretty direct analogy in the real estate world.

You explain why archaic ground leases are value-destroying – what are the benefits of Safehold™ ground leases that make them value-enhancing?

JS: First is capital efficiency. Untethering a high-return core operating business from a low-return passive real estate component is a tried and true way to be more capital efficient in the corporate world, and it’s the same in real estate. By capital efficiency, we mean that you can earn higher returns on the skill sets and capital deployed.

The second piece is cost efficiency. Using a ground lease can effectively eliminate a lifetime of unnecessary costs. With a Safehold™ ground lease in place, customers eliminate sizable financing fees, transfer fees and mortgage recording fees, as those costs are no longer applicable to the land component, representing approximately a third of the capital structure.

The third component is risk-reduction. Ground leases materially reduce one of the primary risks real estate owners face, which is maturity on a large amount of debt. Historically, that’s one of the most problematic moments for a building owner. A large maturity during a weak economic environment creates most of the credit problems in real estate.

What does separating the land from the building equate to as far as cost savings?

JS: If a building sells for $100 million and we come in and execute a $35 million ground lease, the building becomes a $65 million investment. If you sell that building five years later for $75 million, you’ll pay all the transaction costs on the value of the building, but not on the value of the land. If you hold a property for around 10 years but don’t separate the land from the building, and the next owner does the same and so on, that land will trade along with the building 10 times, and you’ll get hit with those unnecessary fees 10 times.

By separating the land from the building, you’ve effectively taken a third of the capital structure that’s going to get hit 5, 10, 20 times with fees in the future and eliminated that lifetime of inefficient, unnecessary costs.


You noted that Safehold’s ground leases reduce maturity risk. Can you elaborate on that idea?

JS: The simple way to see that is, if every building was 100 percent equity financed, you’d almost never have a default. So leverage creates risk, and maturity risk on that leverage is the moment of truth. It’s the moment where real estate owners often are exposed to the most risk.

Without a ground lease, if you had a $100 million building and borrowed $70 million, all that debt would come due one day five years from now.

If you do a ground lease, instead of a $70 million loan on your $100 million building, we will take $35 million of that $70 million out through the ground lease, and give it a 99-year maturity. So five years from now, instead of $70 million being due, you only have $35 million due. You’ve cut your maturity risk in half. Add these three things up – capital efficiency, cost efficiency, and risk reduction – and you can see how building owners can use ground leases to earn higher returns with less risk and fewer costs.

Why did it take so long for someone to correct what you make sound like very obvious inefficiencies?

JS: With the old ground leases, nobody ever talked about capital efficiency, or cost efficiency, or risk reduction. The industry of the past created ground leases with many provisions that don’t fit with the modern capital markets, and those inefficiencies destroy value. So ground leases got the reputation that they hurt the building owner’s ability to finance or sell the asset.

As an example, one of the most damaging provisions in many old ground leases is the fair market rent reset, which creates all sorts of problems for building owners. If you have a fair market value reset in the ground lease’s rent in 10 years, then you have no idea how much rent you’re going to have to pay 10 years from now. A leasehold lender – the building owner’s lender – could say, “Well, your ground rent’s $3 million today, but it could go up to $10 million in 10 years. Therefore, I’m going to have to assume it’s going to go to $10 million, and I’m going to lend you less money at a higher price.”

We heard horror stories from decades of these bad ground lease experiences – but realized that was exactly why there was such a big opportunity. By fixing all the flaws, we’re going to reinvent the ground lease business to make it value-enhancing for building owners instead of value-destroying. And as soon as you eliminate all the value-destroying features, what’s left are all the benefits we just talked about.

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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