Transparency, liquidity driving modern ground lease adoption

Transparency, liquidity driving modern ground lease adoption

5 min read
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The inflexible ground lease of old has been rendered obsolete by Safehold, just over four years after the company effectively created a new industry by creating a modern, client-friendly structure. Commercial Observer’s Partner Insights spoke with Doug Heitner, Safehold’s Chief Legal Officer, about how ground leases and the industry’s response to them have evolved over that time.

Commercial Observer: Talk about some of the key structural innovations that Safehold brought to the ground lease sector.

Doug Heitner: The first would be transparency around the economics. That’s the biggest change from old ground leasing – a transparent rental calculation that allows owners to really plan. The second innovation was creating leaseholds that are financeable and sellable in a way that aligns with the modern capital markets. Those are the two main innovations, transparency and liquidity for our leasehold owners.

We’re also beginning to use ground leases in ways they’ve never really been used before. For example, our Ground Lease Plus program focuses on the development stage of an asset’s life cycle. Some of the environmental initiatives we hope to roll out in the next year are also novel ways of using a ground lease.

Has market feedback influenced the iteration of Safehold’s ground lease structure?

A lot, actually. Since we aren’t a family or institution that owns land, we had to create something that the market would accept and want. That’s a major difference from the old ground leases, which were more of a “take it or leave it” proposition. We have to be responsive to the market, including leaseholders and lenders. We’ve solicited a lot of feedback, and we incorporate aspects of it as we evolve. We’re fortunate to have worked with thoughtful customers and legal counsel, tremendous partners who have helped us refine our product into an even more attractive tool for building owners.

How has the legal community’s perspective towards ground leases evolved over the four-and-a-half years since Safehold was founded?

Every real estate lawyer was taught to hate ground leases for their complexity, and also to love them for their complexity because complexity leads to higher billings. There’s been an education process with the market as to what we’re doing and how it’s different from what they grew up hating/really loving, and it’s been an interesting trajectory.

Someone called me six months ago and said, you guys are really messing up my negotiations. I asked what he was talking about. He said, I’m representing a family and arguing that we should have fair market value rent resets periodically, throughout the term of the lease. And they keep saying to me, that’s not the market anymore because Safehold is the market for ground leases, and they don’t do fair market value ground lease resets.

The education process has been very much hand-to-hand combat – one deal at a time, one customer at a time, one lawyer at a time.

How has the leasehold lender community’s view of ground leases changed?

Similar, in that there has had to be a re-education, but overall, they view ground leases as a new, modern product in the market. The smart ones realize that there’s an opportunity to distinguish themselves as leasehold lenders, and the ones that are a little more retrograde are still looking at their old checklists and scratching their heads.

In talking about modern ground leases, not all modern ground leases are alike. How do they differ? And are there any red flags that leasehold owners should be aware of?

I think they’re more alike than the question assumes, in that many of the people who style themselves as our competitors are using our playbook. The real differences to me are in who’s providing it – what’s the track record of the ground lease provider in closing deals and solving problems? Also, in range of experience. Have you done a construction deal in Nashville? Have you done a condo deal in Seattle? If I am a sponsor, I have to ask myself, can these people really execute?

One other difference to note, especially as it relates to development deals: we are fortunate to have the entire suite of construction expertise in-house. Construction, environmental, insurance – my legal colleagues are all on staff. For a sponsor trying to answer that execution question, I think that makes a large difference.

Building owners often ask about how a ground lease will impact the liquidity and the financeability of their leasehold. What are the key considerations there for them?

Because we’ve been in the market now for over four years, we’re starting to see our assets get refinanced and sold, and we’re able to show people data that validates our thesis – that they finance the way we’ve told customers they would, and sell maybe even better than we suggested. They sell at a proper cap rate. It’s important for building owners to ask themselves whether they’re working with a group that knows how to structure a ground lease to make it financeable and sellable.

Is there anything else you think people should understand about modern ground leases?

People should know that this product fits all stages of development, all stages of the life cycle of a project, and pretty much all asset classes. When you’re buying, selling, refinancing or developing something, it’s worth a call to Safehold just to see what our capital solution looks like, because it’s a new alternative in the market. That call is costless, but it could be worth quite a lot to you.

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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