Safehold’s ground lease remains most efficient capital solution despite headwinds

Safehold’s ground lease remains most efficient capital solution despite headwinds

6 min read
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In the midst of a tumultuous year for the markets, Safehold closed over $1.3 billion of ground leases through the first three quarters of 2022. Partner Insights spoke to Marcos Alvarado, Safehold’s President and Chief Investment Officer, about the company’s progress in 2022, the impact of the current environment, and how the perception of ground leases has shifted over the past five years.

Commercial Observer: Safehold’s modern ground lease portfolio recently surpassed $6 billion, and you’ve closed over $1.3 billion in 2022. Talk a bit about Safehold’s investment activity in 2022.

Marcos Alvarado: 2022 has been a tumultuous year. I don’t think any of us anticipated the reaction to inflation and how that’s rippled through to the capital markets, and our investment arc has tracked that trajectory. Our business works very well when we have functioning capital markets. Over the last few months, those markets have been dysfunctional. When you look at our investment trajectory, at the beginning of 2022 we saw really solid volumes, and we’ve seen those taper off since. I don’t think that’s a reflection on our ground lease product, but a reflection on the broader macro environment. We closed almost $300 million in transactions in Q3 in the middle of that volatility. In Q4, we’ve announced a handful of transactions. We’re active, but we’re being cautious.

What factors have enabled Safehold to continue growing and building momentum despite the market headwinds?

When customers need a capital solution, we are still the most efficient capital in the market, and our customers realize that. We’ve been really focused on maintaining that cost of capital advantage on the liability side of our business, and we’ve been able to translate that back to our customers.

Have these problems with the economy forced Safehold to change the way it does business at all?

Since the beginning of the year, our cost of capital has become more expensive along with the broader market, and correspondingly our ground lease cost has increased for our customers. That being said, when customers look at their alternatives from a capital solution standpoint, they are probably 200 to 250 basis points out. So, we still believe we’re the lowest-cost, most efficient capital solution available to our customers today.

Has this experience been consistent across your customer base? How is it impacting deals?

Yes. We’re all going through this. If you’re a multifamily owner who 12 months ago thought your asset was worth $100, let’s say it’s worth $80 today. They’re going through the psychological impact of, I used to borrow at X, but now I borrow at Y and now my asset is worth less. If you have a view that this is a short-term event, in these volatile moments you may not want to sell or recapitalize your asset. Our customers are going through those sorts of decisions now. But if they decide to, then we’re here to provide them with the most efficient capital solution available.

Safehold has worked hard to educate the industry on the advantages of a modern ground lease relative to traditional capital sources. How would you characterize the understanding and perception of ground leases today?

It’s night and day from where we stood when we started the business. We were a niche and misunderstood product. I think we’re no longer misunderstood, but we’re certainly still in our early stages of adoption. That’s what excites us about the opportunity for our business. We’re seeing it in repeat customers, in the growth of our customer base, in the quality of our customers, and in the quality of our assets. All are trending in the right direction, which gives us tremendous excitement that when we come out of this period, we’ll be able to continue to scale.

What type of feedback do you get from Safehold’s customer base?

The best feedback is proof of concept. I look at how many building owners have done two, three, four, five transactions with us. I also look at our coverage map three years ago and compare it to today — it has dramatically expanded. We’re penetrating new markets. The proof of concept is in the growth. Going from $300 million to north of $6 billion in assets shows you that this is an accretive source of capital.

What’s also encouraging is that customers we transacted with two, three, four years ago are selling and refinancing their assets, and they’re making money. They’re realizing the dream we pitched them a handful of years ago when we put the product in place, and they’re coming back to us. We’re seeing that liquidity being demonstrated even in today’s market, which is extremely difficult, as there’s a dearth of capital across the market.

What are your expectations for Safehold in 2023 and beyond, and what do you see as the company’s biggest strengths and challenges for the new year?

We have ambitions to grow the portfolio substantially, and we’re at $6 billion today. We fundamentally believe in the product. We’re solving both ends of the spectrum. We’re innovating on the liability side of our business, and we’re figuring out new ways to innovate across the way we interact with our customers and the way we capitalize our business. We believe the best is still ahead for Safehold.

Our biggest strengths are our people and the intellectual capital we’ve built up from creating a new market sector and working closely with our customers and partners. The biggest challenge is just the overall market. This is an environment where you must be patient, so we’re going to be.

What message would you share with building owners who have yet to consider a ground lease as a means of executing their business plan?

At a high level, this is not the ground lease of your past, so don’t dismiss it out of hand. Take the time to sit with our team, see what we’ve done, and see the liquidity that’s been demonstrated in the marketplace. There’s no reason not to consider Safehold as an alternative capital solution when thinking about capitalizing your project.

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


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