Reinvented ground lease industry is revolutionizing real estate ownership

Reinvented ground lease industry is revolutionizing real estate ownership

4 min read

Chairman & CEO Jay Sugarman on how Safehold unlocks hidden value for property owners by delivering a more efficient, customer-focused ground lease solution

Throughout much of the history of commercial real estate, buying a property automatically meant buying both the building and the land underneath it.

But common practice isn’t always best practice. Safehold, a publicly-traded company (NYSE: SAFE) designed to help owners unlock the value of the land beneath their buildings via a new, modernized ground lease structure has built a rapidly growing, multibillion-dollar business in just two years based on a crucial flaw in that thinking.

By recognizing the different investment propositions represented by owning a building as opposed to its land, Safehold has reinvented the ground lease, delivering a significant newvalue-enhancing tool to the industry. Bringing a customer service, relationship-focused orientation to ground leases, Safehold is making the separation of the building investment and the land investment a powerful new way to unlock sizable value for owners.

Every property investment is two investments – an investment in the higher return operating business – the building – where the leasing, managing, marketing, desinging, constructing, buying and selling take place, and an investment in the lower-return passive assets – the land – which is a long term, low volatility, lower return investment.

Sugarman notes that owning a building and owning land are “two very different investments, with different risk and return profiles, requiring different skill sets, and really should be owned by two different investor bases.”

“Many investors in commercial real estate have short term holding periods – five, 10, 15 years. But the land holding period is typically 99 years,” Sugarman says. “Building investors shoot for higher returns, looking for 15 percent-plus returns on their equity, but the land is looking for returns just over five percent. It doesn’t make sense to force investors to always buy these two investments together.”

Sugarman realized that the traditional ownership structure, bundling the land and building investments together, was inefficient in many ways, and negatively impacted the return potential for building investors. Safehold was started in 2017 to not only address this problem, but to do so in a way that made building owners better off, raising their returns and lowering their maturity risk.

“With traditional ground leases, there was no sense of a customer focus, or a relationship orientation,” he says. “With our business, having customers like the outcome is really critical. Creating a better mousetrap so building owners actually make more money with less risk is not something you would have ever heard from the traditional owners of ground leases.”

The reasons for this are unsurprising, as traditional holders of ground leases showed little interest in furthering the return potential of building owners.

“The historical providers of ground leases were churches, hospitals, universities, municipalities, and monarchies, none of which had as its primary focus real estate, and none of which were trying to build a national ground lease platform, institutionally-scaled and professionally-managed, in order to provide highly efficient capital to building owners,” Sugarman says. “They were people who happened to own land, and if you wanted to build on it, they were happy to structure something that, candidly, offered the land owner the highest value they could extract from the building owner, with little concern for the impact on the building owner’s future ability to finance or sell the asset.”

Viewing it from this perspective, Safehold’s goal of building a modern, large scale ground lease company with expertise in both finance and sale-leasebacks begins to make a lot of sense. And with over $40 billion of real estate finance, sale-leaseback and ground lease transactions under their belt, Safehold management also looks well positioned to execute on this novel reinterpretation of the ground lease structure.

“We’re just allowing the markets to be more efficient by separating the building from the land, and letting building operators focus on the part that they do best and letting investors choose the risk/reward that’s right for them.”

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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