Safehold’s low-cost capital serves as a hedge against volatility

Safehold’s low-cost capital serves as a hedge against volatility

6 min read

Since Safehold invented the modern ground lease in 2017, helping to unlock previously hidden value for building owners, the commercial real estate industry and the economy in general have seen significant upheaval, making capital both more expensive and harder to secure. Given its unique advantages, companies and owners have seized on the Safehold ground lease to work around capital markets challenges. Commercial Observer’s Partner Insights spoke with Steve Wylder, Safehold’s newly appointed head of investments, to discuss how the Safehold ground lease has served as a tool for companies to get creative in securing financing and closing deals.

Commercial Observer: Its no secret that the commercial real estate industry has been navigating a difficult environment of late. How would you describe the current dynamic, and what are you hearing from customers?

Steve Wylder: Capital has become expensive and difficult to source across our industry. The rise in rates, lack of stability, and cloudy macro picture has made it difficult for groups to value assets and transact, forcing many to the sidelines and some to play defense within their portfolios. Our ground lease capital can be very useful in this sort of environment. It’s a tool to help optimize capital structures and drive better returns, whether on refinance of an existing asset, a new acquisition, or even ground-up development. We provide our customers with a low-cost, highly accretive injection of capital, and offer the stability of a publicly traded platform that’s able to take a long view on assets and markets. This is a market that requires some creativity, and we’re seeing groups really spend the time to understand how a ground lease can help improve their capital structure and returns.

Is there a case to be made that the Safehold ground lease can serve as a defense against some of the challenges in the industry right now?

Certainly. We’re seeing groups look to our structure as a way to reduce their equity requirements, drive a lower cost of capital, and take some of the rate risk off the table. It’s a long-term, fixed-rate slug of capital and a great way to reduce the risk of refinance on the other side of their hold period.

Safehold has grown its portfolio to well over $6 billion. How would you assess the firm’s progress in general, and, more specifically, the firms progress toward its stated goal of reinventing the ground lease?

We feel great about the progress we’ve made — both in establishing a large portfolio of assets across the country and in starting to turn the tide on how groups think about our modern ground lease structure. These aren’t the problematic ground lease structures of days past. Our lease is highly financeable and salable, and we’ve got arguably the most attractively priced capital in the market. We’ve planted a flag in each of the major metros around the country, built great customer relationships, and haven’t wavered on our goal of capturing an increasing percentage of the conventional financing market. But at the same time, it feels like we’re just getting started. Ground leases are still a new concept for a lot of folks, which tells us there’s still work to be done in educating the market on how our ground lease capital can be a useful tool, and how it helps to drive better-levered returns, cut down on equity requirements, and realize significant tax advantages.

What areas of the market are seeing the most transaction activity right now?

While we’re active across all asset classes, we’re seeing the most activity in the multifamily space. We’ve done a mix of acquisitions, recapitalizations and ground-up development, including market-rate multifamily, student housing, and in the affordable housing space.

Are there any recent themes you’ve been picking up from your customers, or general takeaways on the advantages of working with Safehold in the market?

We’re definitely seeing groups use our structure on refinance of existing assets — it helps to drive more proceeds (reduced equity requirements) and significantly lower their blended cost of capital. Our capital is attractively priced relative to unlevered yields and the cost of conventional, fee simple financing, where proceeds are constrained and the cost can be dilutive. That can really help to drive our sponsors’ return profile.

Safehold recently announced a ground lease on an affordable housing development in California. How does the Safehold structure fit into the affordable housing world?

We’re relatively new to the LIHTC world, but we know there’s a huge need for affordable housing in California and throughout the U.S. We’re excited to be part of the solution and we’re finding that our structure works very well, much like on conventional multifamily deals. We purchase the fee interest or land component and enter into a 99-year ground lease with the developer. The ground lease helps to drive more proceeds and reduce the developer’s overall cost of capital, which we’re finding is very helpful in getting projects capitalized. We’re helping to plug gaps in capital structures, stretch the efficiency and impact of government resources, and get these projects off the ground.

What impact does Safeholds structure have on leasehold liquidity and cap rates when assets trade?

That’s an area we track very closely. What we’re seeing inside of our own book is that with our lease, with the 99 years of term, the lack of fair market resets and the financeable nature of the lease itself, the leasehold interests are trading at cap rates that are very close to, or on top of, fee simple trades. That’s really encouraging for us. We just saw one of our sponsors exit the leasehold interest on a large student housing asset here on the West Coast. It’s a ground lease we created with them a few years back when they acquired the asset, and they were able to exit at a great number and implied cap rate. It’s a great outcome for them and another very good data point for us.

What is the long-term opportunity for Safehold and the modern ground lease?

Our plan is to continue to scale the platform across the country, and, again, it feels like we’re just getting started. We’re positioning our structure and our capital as a tool for our customers, and we’re here to help them capitalize their deals in a more efficient way. So, our plan is to stay the course, focusing on increasing awareness, expanding our relationship base, and gaining market share as we continue to grow the business around the country.

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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