New breed of ground leases create value for building owners

New breed of ground leases create value for building owners

6 min read
a tall building with lots of windows against a blue sky.

Tim Doherty, Safehold’s Head of Investments, recently spoke with Commercial Observer’s Partner Insights team about how Safehold has transformed the ground lease into a value-creating tool for building owners and what it means to be the creator and leader of an emerging market sector.

Historically, the term “ground lease” was a dirty word in real estate. Why have ground leases been so problematic?

Because no two ground leases were alike. People like certainty and consistency, so they know what to expect. The fact that no two ground leases were alike made them impossible to understand and predict. Every document had different economic circumstances and structural differences. So, the lack of simplicity made the horror stories float to the top.

Since the leases were confusing, were the advantages to ground leases obscured?

Yes. I think “obscured” is a good word there, because the structure has always worked. It was there, it just needed to be improved. That is what Safehold has done. It really was about providing simplicity and clarity, because the structure was there.

So, Safehold recognized all of this and created a better model. Talk about how Safehold identified the opportunity and what makes the company’s new, modern ground lease different?

What it came down to was simplicity, clarity, efficiency, and transparency. Those attributes are the keys to the innovation. This is a AAA-like bond. It should look and feel like one. The pricing should be structured efficiently, and the rent structure should have clarity. That is what Safehold has done. We provide efficient and low cost of capital that the ground lease deserves, and we provide simple and clear rent payments. You know what your rent is tomorrow, and you know what your rent is going to be in year 81.

The old ground leases had fair market value resets and percentage rents, and “if this, then that” economic structures. Just delete all that. It didn’t add liquidity for anyone and was too ambiguous. In addition, the rights of the tenant and the landlord throughout the term of the lease, as well as the leasehold lender’s rights, have to be made clear. This is a 99-year document. It’s going to outlive us all. So, it needs to be super clear and concise, so that people know what the rules are throughout the lease term.

This is all about creating an efficient model, so building owners can make the returns they deserve for operating the property. We’re here to create a proper ground lease to unlock the operating value, so they can achieve those returns.

If Safehold was able to simplify these leases, why were they so complicated throughout their history?

Ground leases were traditionally created by institutions, universities, cities, as well as high-net-worth families that already owned the land. Someone came to them and said, “I want to build on your land, or I want to own that building. I want to buy it from you.” And the owner said, “Well, I don’t want to sell, but what if I gave you a ground lease?” It was a take-it-or-leave-it type of proposition, so the landlord controlled the negotiation and, therefore, the documents were very landlord-centric.

Safehold’s modern ground lease is a three-party agreement with the client, a lender and Safehold. Someone is inviting us to their transaction to provide the capital and make it more efficient. The Safehold ground lease is very client-focused, because we’re providing efficient capital to the capital stack versus us owning the land prior. Give the tenant the ability to do what they do best: operate, improve and modify, finance and ultimately sell the property.

Safehold’s ground lease ensures that operation remains seamless and provides the very low cost and efficient capital, so the operator can execute their business plan, both operationally and economically.

Safehold went public in June of 2017. How has industry sentiment evolved over that time, and do you find that easier now than you did over the first few years?

It’s easier now than it was when we started. People don’t like hypothetical; they like to see execution. What deals have you done? Where have you done them? What types of properties? What stage of the asset life cycle? We can answer all of them, because we have closed on transactions all across the country on nearly all property types in all life cycles of an asset.

We have built a team and a portfolio of ground lease experts from the backbone of the real estate experts at iStar. But it all started with going out into the market and educating every part of the capital stack, not just the client and the lenders. And obviously, the fruits of our labors have shown their value. Being able to show real-life yields shows people that the execution works, and then there’s a snowball effect.

Since then, new players have entered the market to capitalize on this opportunity. What does your success and the emergence of new competitors mean for the evolution of the ground lease space as an institutionalized commercial real estate sector?

It shows that education works, that we are doing the right thing and doing it well. These ideas that we put into action have generated a portfolio of nearly $4 billion of transactions. So, when someone repeats the same pitch, it’s a great testament to what we’ve been able to execute. It also shows the growth of the market. We think there’s room for other people. We have a very efficient structure to be able to provide the cheapest capital out there and continue to be the leader that we’ve been.

Has there been any thought within Safehold about what it means to segue from being a pioneering lone wolf to being the leader in a full-blown market sector?

When we started, we knew this innovation would bring about the growth of a new sector. The idea was to continue evolving. Don’t just sit still. You have to keep thinking ahead and making sure you’re growing — not just in terms of deals and new clients and markets, but regarding new ideas, and how we can provide our clients with the right capital and the right structure to match their transaction and business plan.

Is there anything else that you’d like to say about this that we haven’t mentioned yet?

The biggest thing for us is execution for our clients. We’ve done this across the country, throughout every region, and on nearly all property types. So, for us, it’s what we’ve been able to accomplish in a short period of time, and the certainty of execution we provide to our clients.

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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