Safehold offers building owners a profitable alternative to traditional financing

Safehold offers building owners a profitable alternative to traditional financing

6 min read
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Safehold invented the modern ground lease in 2017, creating a customer-friendly structure that unlocks previously hidden value for building owners. Commercial Observer spoke to Steve Wylder, Safehold’s Executive Vice President of Investments in Los Angeles, to get an update on how the Safehold ground lease can create value in a high-rate environment, and to see how this breakthrough investment instrument is being utilized on the West Coast and nationwide.

Commercial Observer: How does a modern ground lease help building owners win competitive bids, fund projects, generate better returns and manage risk?

Steve Wylder: We like to think of our capital and structure as a tool for our customers, and a means to drive a significantly stronger return profile while reducing risk. Whether it’s an asset being purchased, recapitalized or even developed from the ground up, we purchase the fee interest or land component and enter into a 99-year lease with our sponsor, the operator of the asset. Our ground rent is set at a level that’s very accretive to equity returns, with no variable rent or fair market resets, and our form of lease is highly financeable and liquid.

It’s an alternative or supplement to traditional financing on any cash flowing asset. The ground lease helps to drive a lower blended cost of capital, reduce debt and equity requirements, enhance cash-on-cash and round-trip returns, and drive significant tax advantages. We’ve developed a number of key customer relationships around the country, many of whom have closed multiple transactions with us. What we’re seeing through those relationships is that our structure and capital can provide a real competitive edge. At times it can be the difference in an acquisition bid process, or just a smart way to drive a lower cost of capital and better return on recapitalizations or development.

Can you go a bit deeper into what makes Safehold’s structure so attractive relative to traditional financing?

Through the bifurcation – that is, sale of the land component – our customers are able to manufacture a higher unlevered yield. Our capital is highly accretive. From there, stacking a leasehold loan behind our purchase of the fee interest will help to drive a blended cost of capital that’s below traditional financing, and likely with a reduced equity requirement. So you’ve created a higher unlevered cap rate, reduced your blended cost of capital, and reduced your debt and equity. The combination of those factors is what helps to drive much stronger cash flow yields. Our sponsors are able to realize more of their equity return from cash flow and then drive meaningfully higher round-trip returns on exit, where the financeable and saleable nature of our lease (with 99 years of term and no fair market resets) is critically important.

Is there a difference in how Safehold is received on the West Coast compared to other regions around the country?

We feel great about the traction we’ve established on the West Coast, and it feels like we’re just getting started. There’s definitely less familiarity with the structure compared to a few of the East Coast markets, and in some cases a negative bias towards ground leases in general. That bias is understandable – there are lots of examples of poorly structured leases out there. That is both the challenge and the opportunity for us. We are educating the market on the nature of our lease and capital – how it works, why it works, and how it’s different than archaic ground leases from yesteryear. We’ve closed transactions in each of the major markets out here, and it feels like we’re turning heads with each new deal and sponsor relationship.

Which sectors seem to most favor Safehold ground leases?

We’ve closed a wide range of transactions this year across multifamily, office and hospitality, but our volume has skewed towards multifamily over the last 12 to 24 months. That’s certainly been the sector with the most liquidity and transaction volume. We’ll do more multifamily, but we’ll also stay active on high-quality office and hospitality assets.

Are there any recent deals you can discuss to show how customers are taking advantage of Safehold’s capital solution?

We recently funded a ground lease on the acquisition of a large value-add multifamily asset here in Southern California. It’s an institutional-quality asset in a submarket with strong rent growth and great long-term supply and demand characteristics. We were approached by a group while they were bidding to acquire the property. They ultimately paired our ground lease capital with an agency leasehold loan behind us, and they were able to win a very competitive bid process, manufacture a higher cap rate, and drive a better cash-on-cash yield. It was a win-win, and a good example of how we’re working with acquisition and development teams around the country.

Safehold’s ground lease has a lot of financial advantages for owners, operators and developers. How have inflation and rising interest rates affected those advantages in an environment where capital is scarce and expensive?

There’s no question deals are getting harder to capitalize, and the cost of debt is up dramatically. Our solution and capital look quite attractive relative to fixed-rate financing alternatives, and appeal to groups that would have otherwise considered floating-rate capital in this kind of market. Introducing a low-cost, predicable, long-term ground lease brings stability and reduces the amount of debt required, which helps with the risk of refinancing down the road.

How do Safehold ground leases affect the liquidity of a leasehold?

A big part of liquidity and how a leasehold trades ties back to financeability. We’ve proven that our form of lease is highly financeable through a wide range of transactions with different types of leasehold lenders. There’s 99 years of term, no fair-market resets, and fixed-rent increases. We track leasehold trades very closely, and what we are seeing is that, on good quality real estate and with our form of lease, leasehold interests trade at cap rates that are commensurate with fee simple cap rates.

Customer feedback has led to Safehold innovations such as the Ground Lease Plus program, which focuses on development deals. How have these innovations unlocked opportunity for Safehold’s customers?

Ground-up development has been a key part of our business, and I think you’ll see us continue to do more there. The Ground Lease Plus product, which has us entering deals before they break ground, is another innovation that helps us problem-solve with our customers. That’s a good example of our firm being solution-oriented and listening to customer needs throughout the life cycle of an asset.

What other considerations are top of mind for Safehold’s customers?

Right now we’re in a turbulent market, where stability in a capital provider matters. We’ve got the benefit of being a publicly traded company with a long track record and nearly $6 billion of ground leases closed to date. We feel great about our business and the relationships we’ve built. You’ll see us continue to expand those relationships and add new customers while we navigate through this market.

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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