Stigma becomes opportunity: Safehold changing ground lease perception

Stigma becomes opportunity: Safehold changing ground lease perception

8 min read

In a Q&A with The Ground Up, President & Chief Investment Officer Marcos Alvarado discusses Safehold’s investment strategy and overcoming barriers inherent in redefining an industry

Since January 2018, Marcos Alvarado has served as President and Chief Investment Officer of Safehold and its founder, manager and largest shareholder, iStar. At that time, Safehold had just begun promoting its vision for a new type of ground lease designed to work seamlessly with the modern capital markets and function as a value-enhancing product for commercial real estate owners, rather than one that historically destroyed value. Here, he discusses the evolution from then to now, and how Safehold is changing the perception of what was once an outdated product class.

Talk about how Safehold has evolved since you joined the company.

When the business launched we had a thesis around our value proposition of Safehold for both customers and investors but we were not entirely sure how to demonstrate and execute on our idea. Like any start up you go through an education phase which is quite humbling. Lots of failure and frustration but as we told the team when truth is on your side logic will prevail and we kept iterating and learning from our mistakes across the entire business. Fast forward and you wake up a few years later, and there’s been a lot of progress and growth, which has led to a sense of excitement and accomplishment. Morale is different. It’s a combination of us understanding our value proposition, failing a fair amount, and changing the mindset internally on how we approach the business and translating those learning to our customers and investors That being said it is still early days for us and the last few years have given us greater conviction in our mission.

Talk about some of the obstacles you encountered along the way, and what lessons were learned from them.

At the beginning, we underestimated the psychological bias against ground leases, and the challenge of convincing real estate owners that a Safehold ground lease was a better product in the capitalization of real estate. So, it was a matter of gathering feedback and understanding the pain points, then honing our message, over and over and over again. This is ultimately what got us to where we are now, and it’s reflected clearly when we look at the trajectory of the company over the last two-and-a-half years.

In the first six months after launching the business, we did one deal. The next six months, one more deal. And then it just sort of hit. We shifted the way our internal sales force interacted with their clients. They were used to selling a well-understood commodity where they didn’t have to be creative in pitching the product. But you must be innovative and listen and learn when you’re pitching a brand-new concept that happens to be associated with an archaic, stigmatized product. It’s been fun for us to learn along the way, and gratifying to see our efforts generating positive results for the business and creating value for customers and shareholders.

Was there one particular deal where you started to see a change in the trajectory?

As we worked to hone our message and refine the product, we developed a greater understanding of who we are and what our value proposition is, and that gave us the confidence to be more aggressive. To that end, there was a large deal we did in Washington, D.C. at 1111 Pennsylvania Avenue, which was a $150 million transaction. Given its location and the quality of the real estate, that was the first large transaction where people started to pay attention. Then, we started to do a better job of leveraging our success to drive greater awareness and market adoption.

As a result of these efforts, we’re now seeing an evolution and diversification in the types of customers we’re working with. Whereas we’d previously been working primarily with experienced local operators, we’re now dealing with an increasing number of large multinational sources of capital, including European pension funds, Asian asset managers, and domestic core and opportunistic funds, which represent a completely different growth opportunity for us.

What does Safehold look for in an investment?

The first thing we look for might sound cliché, but it’s always location, location, location. We’re making 100-year investments, and nobody has a crystal ball, so investing in the right location is critical. We want to be in the 30 top markets in the U.S. and we want to be on Main and Main with high-quality assets.


At a portfolio level, we’re ultimately trying to create a broadly diversified pool of assets where no single market or asset class can hurt us. And as it relates to asset classes, we’re mostly agnostic. We’re not investing in retail at this time, we’ve had a lot of success with office and multifamily, and we’ve cracked some of the more niche asset classes, like student housing. From an investment standpoint, we’re trying to create AAA-like or AAA-equivalent risk, because that’s ultimately what we’re pitching as the value proposition to our shareholders. It’s the safest investment in the capital stack, it has built-in inflationary-like growth, and unrealized capital appreciation at the end.

Where does Safehold come down on the question of originating new ground leases versus acquiring existing ones?

Slightly more than 80 percent of our business is creating new ground leases, which is the real market opportunity. We’ve acquired a few existing ones over the last two years, but those transactions are generally event-driven. As I say to our investors, the reason we can’t just go buy these is because they never come up for sale.  For the same reason that we are excited about the value we are creating for our investors is why this great wealth creating product is not sold. When they do become available, we pounce.

What excites me most about the acquisition opportunity for existing ground leases is a program we launched in September 2019 called SAFE x SWAP, where we can help clients acquire and change existing leases. We basically say, what is causing value destruction? Let’s come up with a solution. It could be changing some of the economic provisions, or extending terms. There are multitudes of nuanced provisions in a 100+ page document that can be revised to create value. A recent example of this is a large deal we did at a resort in Hawaii by partnering with the leasehold owner to buy the existing ground lease. We provided the capital and changed the structure of the lease, and in doing so we believe we created a tremendous amount of value for them.

How do ground leases affect liquidity?

That’s the psychological bias we’ve been fighting against. A bad, archaic ground lease does impact liquidity; it is value-destructive. The modern Safehold structure is value-enhancing. That’s the simple thesis behind the business. But perception becomes reality, and the perception that ground leases are value-destructive has become reality. That’s the biggest hurdle we fight on the client side, but we’re making progress.

The fact that we’ve grown from 10 assets to close to 60, and that there are 50+ providers of financing and liquidity behind that, is proof of concept. What we’ve found is that the network effect is real, and it’s been a force behind our ability to rapidly scale in the markets we penetrate. When you see your competitor figure out how to buy an asset with a Safehold structure, you’re going to call us.

Which markets have been the most active for Safehold so far?

Eighteen months ago we had a concentration of activity in Los Angeles, because we had a large asset there. Then we did a bunch of deals in Washington, D.C. including some large deals, so we had concentration there. Now, we’ve had a lot of success in New York City. So there’ll be some concentration there. It ebbs and flows, but the key is to concentrate these pockets of exposure in locations where we think there is long-term value to be gained.

What are some of the markets you still hope to establish for Safehold?

We need to crack Boston and Seattle, and we need a larger presence in the San Francisco/Silicon Valley area. Those are our top three growth targets for 2020.

Despite your success in major markets like New York and Washington, D.C., do you find you still have to provide proof of concept?

Yes, though it’s getting easier to convince people of the value proposition than it used to be. We went from a couple hundred million in assets under management to over ~$3 billion, and our stock is up significantly from our IPO. Those facts are catalysts, so people are starting to pay attention, but we have around 1 percent market penetration today. The opportunity is enormous, and we haven’t come close to achieving our potential.

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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