Commercial Observer’s Partner Insights spoke to Jay Sugarman to get more insight into his firm’s approach to ground leasing in the modern markets. Sugarman is the Chairman and CEO of Safehold, a publicly-traded real estate investment trust that redefined the ground lease landscape and is creating meaningful economic opportunities for building owners and investors with a reinvented ground lease structure. Safehold has been in business since 2017 and has amassed a portfolio valued over $6.5 billion while working primarily in the top 30 MSAs in the country.
Part I of the conversation with Mr. Sugarman can be viewed here.
Commercial Observer: For somebody who is not familiar with a ground lease or only knows about the traditional model, how would you explain the concept?
Jay Sugarman: Historically, ground leases were created when a real estate developer came to a landowner and asked about putting a new building on their land. Instead of selling the land to them, the landowner might choose to lease it to them, usually on a long-term basis. A ninety-nine-year ground lease became fairly common, but the rest of the ground lease terms were almost never the same, depending on the negotiations between the landowner and the developer.
We thought this non-standardized, “never know what you are going to get” model was archaic and out of touch with the modern commercial real estate industry, and the sophisticated equity and capital markets that had been built up around it.
With Safehold, we knew we could build a better, more modern ground lease. We’ve taken everything we learned from the CRE finance world, combined with our expertise creating triple net leases, and developed a whole new, standardized model for ground leasing. The goal is to unlock value for property owners by giving them a low-cost, more efficient source for the capital that would normally need to go towards financing the cost of the land.
This new ground lease can be used any time a property owner is looking for capital. If they’re building from scratch, we buy the land from them, so they only have to capitalize the building construction costs. If they’re refinancing, we take the land component out of the equation for them. If they’re buying a property, we go in simultaneously and fund the land component, which is typically 35% to 40% of the total purchase price of the property.
Commercial Observer: Why does the new model of the ground lease make so much sense for multifamily owner-operators in particular?
Jay Sugarman: In a competitive market like multifamily, where cap rates are tight and efficient capital is a must, the modern ground lease offers several valuable benefits: it can be used to lower a sponsor’s overall cost of capital, it can provide additional proceeds above traditional financing alternatives, and it can free up capital that can be invested at higher rates than the ground lease return. In addition, since multifamily is one of the largest and most active real estate markets, there are always a lot of transactions happening. As we have penetrated the market, many of our customers have already seen the benefits of our longer-term, lower-cost capital and been able to generate better returns than many of their peers.
Commercial Observer: Safehold has recently become a tool for affordable housing developers as well. What are the advantages of adding ground leases to the capital stacks of affordable housing communities?
Jay Sugarman: In a lot of ways the benefits of our ground lease model are even easier to understand for affordable housing developers because their business is based on meeting very specific capital requirements. They are used to working to deliver the maximum volume of housing units possible in markets where it’s needed most.
We’ve structured a number of deals utilizing ground leases that have helped affordable developers and owners build more units for the same amount of equity investment. It’s a powerful new solution in the affordable arena, given the limited tax credit capital available.
Commercial Observer: Shifting gears, when you look at the macro-economic climate and its impact on commercial real estate, what are some of the factors you’re closely tracking?
Jay Sugarman: We like to focus on things that drive supply and demand. Oftentimes, that’s the most important part of the whole real estate analysis. Where’s supply going in any given market on any given property type? Where’s demand going?
Drilling further down, there are three main things we look at. First is replacement costs. Right now, replacement costs keep going higher, whether it’s insurance, labor, tariffs – there are a lot of factors adding to the cost of new supply, which will act as a constraint.
Part of the replacement cost analysis is interest rates and cost of capital can certainly impact supply, but I think more importantly, interest rates can be an important variable for demand, so we keep an eye on long term interest rate dynamics. In the ground lease world, long term rates are a more important metric to us than what the Fed is going to do next quarter.
The third macro thing we track is alternative places to invest your money, and what kind of risk-adjusted returns can you make in other markets outside of real estate? Ultimately, the flow of funds into and out of real estate can have a large impact on the industry’s performance.
Commercial Observer: How is Safehold thinking about the adoption of AI to improve its business?
Jay Sugarman: Let’s talk about the impact AI will have over time, because that’s how we think it’s going to be most beneficial for us. One of the things we struggle with sometimes is helping people see or imagine how things will be in the future, thirty, fifty, a hundred years from now. AI can help predict that future better than many of the tools we have today and will likely accelerate value creation in many of the cities we invest in.
If you consider commercial real estate, you can go to any major city in this country and track the values over the last hundred years. Crunch those numbers and you’ll see how a staggering amount of value has been created in top cities over that time frame. The growth comes from expansion and innovation in our economy in general and the entrepreneurship of the commercial real estate industry in particular.
We think AI will introduce new and powerful innovations beyond what we can imagine today. Given the speed of progress, it’s hard not to be excited by what the future benefits can be for someone in our investment position.
Ground leases are the ultimate bet on the future and have created some of the greatest fortunes in the history of the world. Now that they have been modernized and transformed into a value-enhancing tool for building owners, operators and developers, we expect significant continued growth of Safehold’s business and widespread adoption of ground leases as a source of long-term, cost-efficient capital.
