Safehold Inc. (SAFE) Earnings Call Transcript & Summary

Great. Thanks, everyone, for joining us. I'm Caitlin Burrows, and I cover REITs at Goldman Sachs. Today, we have Jay Sugarman, Chairman and CEO of Safehold with us. Jay, thanks for joining us.

Hey, Caitlin.

This is your first time joining us at this conference. And so maybe for those people who are not familiar with Safehold, you can start by introducing the company.

Sure. Well, Safehold fits in the financial services world because we are a financial innovator, and we've developed what we think is a much more efficient way for commercial real estate owners around the country to separate the way they capitalize the land from the building that sits on top of the land. We think this is a $7 trillion inefficiency that has lasted far too long in the industry. We've seen most other parts of the capital markets eliminate this inefficient way of financing 2 very different investments with 1 capital structures -- and 1 capital structure. And so Safehold has really taken on the opportunity to reinvent the ground lease industry and give commercial real estate owners a much more efficient capital tool to fund the land under their buildings. It lowers their cost of capital, it increases their returns. We think it lowers the risk and lowers the cost of doing business in the real estate world, makes it much more efficient. So we think we've come up with a big solution to a big problem, and the company has been growing nicely as a result.

Great. And so you've laid out Safehold's mission as you want to provide a more efficient way for real estate owners to unlock the value of land under their buildings. Could you discuss what makes Safehold's modern ground lease different than historical ground leases?

Sure. If you think back to history, the ground lease industry was really a result of major landowners having developers come to them and say, I want to build on your land. And so it was a very one-sided conversation, the landowner had all the power. And oftentimes, the deals were structured in a way that actually destroyed value for the building owner. There were a lot of provisions that were one-sided. There were a lot of provisions that were really out of sync with the modern real estate finance and investment markets. So about 5 years ago, we took a look at that and said, "Geez, look what net lease has done for corporations all across the world over the last 20 years, separating their operating businesses from their underlying fixed real estate assets." It became very clear to CFOs in the corporate world that there was a better way to capitalize the fixed assets and separately capitalize the operating business. What we saw in the old ground lease world is that there really was no symbiotic relationship that allowed the building owner to actually access better capital for their land. So those old ground leases had really poisoned the business for building owners and nobody had really modernized the real estate ground lease business for decades and decades and decades. So we came along and said, "Look, let's take everything we know about real estate finance, everything we know about real estate investment, everything we know about what net lease has done for corporations." And we were in a good position. We've been doing that net lease business for about 20 years. We just took all the lessons we learned and said we can recreate the modern ground lease business to do the same thing for corporate CFOs. We can now do it for building owners in the commercial real estate world. And I think the easiest way to explain it is we made a ground lease that fits within the modern real estate finance markets, the modern real estate investment markets and really started with the building owner as our customer. So all the provisions, all the ways the ground lease works are really meant to help our customers do their business better. And that had never been -- obviously, if you owned a bunch of land hundreds of years ago, you didn't really care about your customer. They weren't a customer. They just wanted to build on your land. We flipped that around and said, "No, no, this is a customer business. We're going to provide and a capitalization instrument that is really created for the benefit of the building owner." And that has opened up a whole new world of opportunities for us that never really existed before.

Great. And so you're the first and only publicly traded company to focus on ground leases. But at the same time, like you just went through, ground leases have existed in the private domain for a long time. So why do you think no one has built a ground lakes business before?

Yes. It's an interesting question. Commercial real estate is upwards of a $7 trillion industry. It tends to move somewhat slowly. When you do find a better solution, there are always going to be skeptics. We happen to be in a unique position. We have been in the finance business for 30 years. We've been in the net lease business for 20 years. We have scaled a bunch of businesses that were true financial innovation. So we knew the path we would have to take, and we committed resources that I think, candidly, most others would have never committed. We spent over $100 million on the R&D of the business. We committed over 50 professionals to the business. That makes us one of -- by far and away, maybe 10x larger than anybody else who's really ever focused on this business. So it was a combination of our belief that this was a fundamental and revolutionary change to this big industry, but then having the resources and the experience and expertise to actually be able to execute it on a large scale.

Got it. And actually on scaling. So you talked a lot about the importance of scaling the business and earlier this year, you gave a goal of doubling the portfolio from year-end 2020 to 2023. So why is that so important for Safehold? And now that we're 1 year in, how do you feel about that goal?

Yes. I mean when you think about fast-growing businesses, they tend to get the benefit of economies of scale. They tend to get that on the asset side, the customer side and the liability side. When we started this business, we looked at a lot of the other dominant players in different areas of the commercial real estate world, the largest tower companies, the $125 billion market cap, the largest data center company is a $75 billion market cap. And we realized if we could dominate and be the best at this particular segment, it could be a $50 million, $100 million -- $100 billion business. Scale in ground leases gives you diversification. It gives you the ability to really show this long-term compounding dynamic that we think most investors want. It allows us to serve our customers in lots of ways that if you're a small scale, you probably can't do. We have in-house teams of professional lawyers, architects, engineers, so we can work with our customers in ways that I think small scale operators will just won't be able to do.

Got it. And maybe then moving to the valuation side. We think of it like there's 3 buckets that can be recognized. So 1 is the value of the in-place leases. Two is the value of the leases corresponding to investments or acquisitions over the next 12 months. But then 3 is the unrealized capital appreciation or the value of properties on top of the ground leases you have. And I know this UCA portfolio is a huge focus of yours, and you've mentioned your mandate is to get its value recognized in the share price. So could you go through some of the options that Safe might be considering?

Yes, I think you laid it out nicely. I think when you build a large scaling ground lease business, you get 2 very, very valuable assets. One is the cash flow streams that are both call protected and inflation protected over long periods of time. That compounding value tends to create a very much above-market return relative to its risk. And I think the market has actually done a good job of understanding that piece of the puzzle. But I think we've now, after 4.5 years, have demonstrated the growth and the stability of the business that we can start talking about the other major asset that comes out of a big growing ground lease business. And we call it UCA unrealized capital appreciation because it's something you can measure. It's embedded value that we can measure today, how big it's grown. It's grown from $400 million at IPO to almost $7 billion today. And I think it's a function of another piece of the puzzle how we've not only made ground leases better for customers, we've made them dramatically better for investors. So if you think back in history, if you owned ground in the middle of London or a major gateway city in the United States, you're probably extremely wealthy at this point. But nobody could really invest in it and it tended to be a single asset or a single market. What we've done is take that concept and exploded it across the entire nation into the top 30 markets, multiple property types. And we think we've built this in effect, it's almost like a very powerful trust fund. Today, with $7 billion of high-quality commercial real estate in it, it continues to grow at multiples of what other portfolios of high-quality real estate are growing at. And so I think as the market begins to realize what is happening here, it's almost like AWS inside of Amazon. As Amazon was growing, they have this other asset, this other business growing that nobody was paying attention to. And then when they finally unveiled it, it turned out to be one of the most valuable components. And it could only be there when you scaled the first business. So as we scale our ground lease business, we think we have this very, very valuable second asset growing in the background, which we just started talking about this year because it has now reached a size and scale at $7 billion, where it's hard for us to believe that investors are not going to want to spend a lot of time understanding its value. And when you ask how we can unlock that value, we certainly consider both private and public ways to do that. It is a different asset. It is a separate part of the business. And it may turn out that the best way to unlock it is to sell a component or a piece of that to a different set of investors and let them market to market for us. But right now, we're just educating the market, kind of giving us a sense of what they own. We believe it's, to us, one of the most valuable parts of our story, it's tangible, it's transparent. We've been tracking its growth. And it has this unique dynamic of there's actually $7 billion sitting that we will be the future owners of that is growing twice or more faster than any other portfolio of high-quality real estate. So even that should get even you excited, Caitlin, because I think when you have something that's tangible and growing much more quickly than everything else like it, investors should start to take notice and it shouldn't just trade, it should trade at a premium.

Yes. And I guess when we talked about this, I think it was a couple of weeks ago, you mentioned how much of a priority it is for you guys. So I guess you just mentioned that this year, you've been educating people about it in terms of kind of ideas or actions that you might take in the future. Do you think we should expect to see some decisions in 2022? Or are you already working on something? Or what can we think might change in the next year in terms of education and action?

Yes. Look, we want to be very deliberate in how we do this, and there are multiple steps between here and what we think is the best execution. But yes, we're already thinking about it. We're already putting the pieces in place to be able to execute on multiple paths. So 2022 will be an important year. Again, the best news here is while we're doing that, we think the value of that piece of the portfolio just continues to expand. So we're not putting any artificial time frame on it, we're just saying this is a critical part of the Safehold story. And you will see us continue to move forward on it fairly deliberately through 2022.

Got it. Maybe switching gears. Inflation has been a topic recently. So given your ultra long-term leases, how should investors think about the company given inflation?

Yes. I think there was a misconception actually out there that ground leases are a very similar to just a fixed rate, long-duration bond which, in some respects, they are long-term cash flows, call-protected cash flows. But in most of our ground leases, we do have an inflation protector, something we call CPI look-backs, which every 10 years look back and see if our rent bumps have increased along with inflation. And if they haven't, we have the ability to reset the rents to catch up. This is a really powerful point that I think a lot of people haven't really focused on. So when we cite statistics like we have a 5% ROA in a market where comparable things have a 3% ROA. We're not actually excluding or including that inflation protection component. So if you think inflation is rising, actually, our returns will actually go up on the revenue side. And most people know we finance ourselves on a long-term fixed rate basis. So our cost of money stays flat. Our income stream will actually go up with inflation. So rather than be just a straight negative, we actually think there's a number of positives if you really believe in a longer-term inflationary trend north of 2%. Anywhere between 2% and 3% is actually a pretty good day for us. And then this other second asset, which is essentially a large pool of high-quality real estate, we think has positive correlation with inflation. So in some respects, we actually think the market reacted negatively. We spent quite a bit of time now beginning to tell people why both from the cash flow side and the ownership interest side, inflation is potentially a fairly big positive.

Got it. Maybe shifting over to making acquisitions and investments. I think your business relies pretty heavily on an active real estate transaction market. So just wondering if you can talk about the origination process and what you've been seeing in the market recently.

Yes, it's been a good market. I mean last year, COVID obviously shut down a lot of the parts of the market that we participate in, development, refinancing the purchase and sale of real estate. We've seen it open up materially this year. We recently announced we closed our 100th ground lease deal, which is a major milestone for us, really proving out the idea that this is a better mousetrap. This is a -- this modern ground lease is fundamentally different than the old ground leases, something our customers want. Our repeat customers are now making up almost 50% of our business. So once they try it, they really like it, they come back again and again. So when we think about the dynamics around our business, it's a $7 trillion addressable market, about a $1 trillion of that does something every year, either gets developed, financed, bought or sold. So there's a big, big, big market out there for us to attack. We think we're still in the early innings. We get better at this business every day. As I said, I think we're 10x larger than anybody else who's even looked at the industry and is trying to follow in our shoe steps. But right now, the goal is to serve our customers with the best capital we can. As we get bigger, as our cost of capital comes down, we're able to lower our cost of capital for them. And so that's driving a lot of the origination activity as people start to see that our capital is better for them, whether it's multifamily, whether it's office, whether it's hospitality, we're actually starting to see a little bit of traction in life science. These are all exciting sort of dynamics for us that really augur well for the future.

You just gave some property types there. But could you expand on that on what types of properties you're most interested in owning the land under and maybe what your outlook is for those transaction markets? You mentioned life science, and, yes, that's definitely something that was in our office coverage has become very topical.

Sure. I mean, last year, I think everybody realized that the market was reopening, and we saw a real push into multifamily. So we made a big push as well. It's our fastest growing by number of deals. And we're seeing it across the country, whether it's Seattle or Portland or Sun Belt states or even the gateway cities, multifamily opportunities seem to be coming at us pretty fast and furious. Office is a little slower. We do still like gateway cities. We still like high-quality office. We think it will have to adapt over time. Sometimes all the way into a life science product, but more importantly, just taking space and making it more amenable and more usable by the tenants for this new go-forward way of working. But I think as we look at it, there's almost every product type that is located in a dense urban or near-urban location is a potential user of our capital. So we don't really limit ourselves. But right now, I'd say multifamily going very, very strong. And life sciences is very much in the news, and so we're starting to see opportunities there as well.

Got it. Maybe we'll shift over to iStar. Safehold has a very close relationship with iStar, who is the founder, largest shareholder and external manager. So can you talk about that relationship and how you think it will evolve over time, maybe in the medium term?

Yes. So we really spun out Safehold to be its own pure play, but iStar has been a huge believer in this business really as a way to revolutionize this enormous marketplace that we've played in for 30 years. So wanted to keep a heavy investment hand in it. It owns north of $2 billion of stock in Safehold. It continues to invest because it believes the story only continues to get better. I think some people have looked at that and said that was great to get it up and running and to help it scale. But is there a point at which that's not the best thing for Safehold? And what we've told the market publicly is about $5 billion of ground leases, we think there should be a conversation about that architecture. This external management has been incredibly valuable to Safehold. It's allowed Safehold to really have the benefit of iStar's 30-year network of financing sources, net lease expertise. But it's starting to build itself to a scale where maybe that should be in-house at Safehold. So that's one thing we've talked to the market about it. At $5 billion, we would have that conversation with both companies to see if there was a better architecture to unlock the full value. And then in terms of its shareholding position, I think, again, it's a huge believer in this company. We think if you do the NAV of the 2 components, these 2 assets, it's maybe 2 to 3x where the stock is trading. So they have certainly been a buyer, not a seller of the story over the last couple of years. At some point, I think the rest of the market would like a shop to own meaningful positions. And we've been able to dial their purchasing back a little bit. But at least in the near term, I would say iStar still loves the stock. It's just also thoughtful about how do we unlock the most value and that may be creating more liquidity in the public markets for Safehold shareholders to benefit from.

I guess maybe somewhat on the liquidity topic, given the acquisition volumes that you guys do, your business is relying on equity issuance, either via follow-on deals or you do have an ATM now. So what metrics are you predominantly looking at to assess when is the right time to raise equity?

Yes. So when we went public, we said we would use a liability structure to be about 2 parts debt, 1 part equity. We've actually been running significantly lower than that. So we do still have quite a bit of capacity there. We've got a fairly sizable revolver that gives us a lot of flexibility to close transactions and come back to market when it's appropriate. Most of our long-term financings, I think we have a weighted average maturity right now north of 25 years, one of the longest in the entire marketplace. So we have a lot of components that allow us to be thoughtful about when to raise capital. But typically, when we get in a position where we see a large pipeline building, and we never want to be able to tell a customer that we can't do a deal because we don't have the capital. So you'll see us be thoughtful about making sure we have the money to keep this fast-growing engine going. We've done a number of follow-on equity raises. We've gotten investment-grade ratings from Fitch and Moody's at BAA1 and BBB+. So we have a lot of flexibility on how we raise capital. And the win is usually driven by our pipeline and how active we see the business. We recently did an offering and have quite a bit of liquidity right now. And again, we'll come back to market when it makes sense to accretively raise capital.

I guess on that, it ends up being more accretive, the higher the share prices. I know we talked earlier about having people recognize the value there is, especially in the UCA. But as you look to issue equity, how sensitive are you to the share price when issuing equity? And if the stock remains where is, do you have other options or just wait for it to improve? I think you kind of said that you could use some more debt, but what are some of the options that you have?

Yes. I mean I think the challenge for us is we do think the stock is materially undervalued, but we also understand we're trying to grow a business not from $0 to $5 billion, but really from $0 to $50 billion. So our goal is to continue to focus on the customer side of the business, build this intellectual property, competitive moat that allows us really to be the dominant player. Those are things that really drive the value for shareholders. Scale will allow us to unlock the value of both these large assets that we're building, the cash flow asset and the ownership asset. But we are sensitive to the share price. We have had the good fortune every follow-on offering has been at a higher price than the previous one. So we've been thoughtful about it. We want to make sure our shareholders benefit from the steps we're taking and so far, so good.

Got it. The recent earnings call indicated that a 30-year unsecured bond offering could make sense for Safehold. I guess, could you go through how 30-year debt makes sense when compared to a 99-year lease? Is there a risk that ends up coming out for Safehold there?

Yes. I think the -- maybe again, the misconception is when you have 30-year debt, and you've locked that in, I think we've captured most of the upside. We stress test under a bunch of Monte Carlo's what interest rate scenarios could happen after 30 years. And the truth of the matter is it doesn't really impact our overall return profile. So that 30-year sort of 25- to 30-year maturity is really predicated on that captures the majority of the value. When we close a ground lease deal, we think we're creating significant accretive value, like creating a 30-year liability structure against it locks it in. Again, if inflation happens, actually, we do a little better over the next 30 years. So there's not a lot of "interest rate risk embedded in the business." Some day, could we do 100-year bonds? Probably, but we're still a young company. We're still growing. We're still scaling. So right now, we think the sweet spot really is to try to keep our weighted average maturity between 20 and 30 years.

Got it. I wanted to know if anybody here wanted to ask the question. Can we have a mic over here? But then the webcast can't hear you.

So you briefly talked about your competition. I think you said you're 10x larger than your next player. I guess, do you see any risk that some of these smaller players kind of grow exponentially and really start to take share? And then, I guess, just more broadly, how do you think about competition? Is it really just other ground lease players? Or is it an alternative forms of financing? Yes, any color you can provide?

Yes. Look, when you're talking about a $7 trillion addressable market, there's going to be more than 1 player. We want to kind of own the center. We think that's where most of the business will happen, and we've been an innovator. Even off the center, we've already begun to create products like Ground Lease+, SAFE/STAR, which give our customers something that nobody else has really been able to offer them. So there will definitely be other players. We welcome that in the sense that it will help expand this business faster. But we want to dominate the center, which is where I think 80% of the action will be in. There's going to be plenty of room for others to participate around that center if they'd like to, but we want to have the best proposition for our customers. When you think about the biggest alternative to what we're doing, it is the traditional financing markets. I think that's both financially and psychologically. People like to do what they've already done. A lot of people in the past had bad experiences with old archaic ground leases and it's hard to get them off of that. The good news, as I said, when you have a repeat customer metric like we do, it tells us everything we need to know. Once people actually cross over into this modern ground lease, they tend to use it a lot. It's because once you get past some of the sort of prejudice and bias that's built in against ground leases, and it was deserved. The old ground lease model was screwed up and probably cost a lot of people a lot of money, but it has nothing to do with what we're doing. We're really looking at it more like what net lease did for corporations. And that's a trend that's still accelerating. It's not decelerating, it's accelerating. More and more corporations are trying to separate their operating businesses from the lower return fixed assets. I think you'll see the same thing happen in the commercial real estate world. So I think the market opportunity is going to continue to grow. I think we will capture market share from the traditional financing methods. And there will be other players who will help that progression take place, but we want to be the leading voice across the top 30 markets. There may be other places we want to go in the future, but right now, there's enough business for us just to do that sort of the core business that we are very focused on scaling as fast as we can in the things we know we can execute in very successfully.

I think you mentioned here that one of the kind of ways you're different or things you can do different. You have the Ground Lease+ and the SAFE/STAR. Maybe you could just give some brief background on what those are and why you think it differentiates you guys from what others might be doing.

Yes. I think it's really interesting when you think about when should somebody be talking to us. So there's $7 trillion of commercial real estate owners around the country in the top 30 markets. When they're buying or selling, when they're financing or when they're developing, they should come talk to us. And we've seen more and more customers use us for all 3 of those points in the life cycle of the real estate. But we also started to get request of what if I buy a great piece of land in a great market, can you work with me up front to develop a lower-cost alternative to sort of the short-term land bridge loans that are very expensive and basically put a gun to my head. I know I'm going to build it. It's fantastic land. Is there a product that can bridge me from a small ground lease to start in a full ground lease when I actually have built the building? And Ground Lease+ was really an opportunity to work on these very high-quality sites with top-notch developers in products that we know are going to be spectacular. But there's a development process. There's a permitting process or there's a government interaction process that's going to take a little bit of time. What we found is working with our customers early on, we could craft not only a properly sized ground lease for the start but also give them the flexibility to have Safehold grow that ground lease over time. So what we've seen in just the 4 short years, we've been doing this, is a lot of product extensions already where our customers are actually coming to us and telling us what they want, what they need, and we're finding a way to make this new modern ground lease actually be a better solution for those as well.

Got it. Maybe going back to the UCA bucket because I know that's a passion. I know one of the questions we often get is how to think about its value today given that those properties aren't something that Safehold owns today. So kind of what's your response to that and how people should think about that? Maybe timing, perceived mismatch or actual mismatch?

Yes, yes. Look, when I first started 30 years ago in this business, I worked for 2 ultra high-net worth families that were setting up trust funds for their grandkids. And if you had told me I could put $7 billion of real estate. Real estate worth $7 billion today into one of those trust funds and would have a manager that could grow it twice as fast as any other real estate portfolio. I can tell you that I wouldn't trade for $7 billion, it would trade for a premium to $7 billion. And that's what we're trying to get people to understand is after 4.5 years, we've grown UCA from $400 million to $7 billion. It's just the real estate portfolio. We are unequivocally going to be the owners of it. You can think of it in effect as sitting in your trust fund as a shareholder, growing faster than any other pool of high-quality real estate in this country. And to me, that's a pretty simple proposition to understand its value. It's worth $7 billion. It's growing very fast, faster than almost anything else like it, and you're the unequivocal owner of it. So we know its value today, we know it's growing really fast, and we know you're the owner, the fact that we won't monetize it over -- until the end of the lease term to me is kind of the least important piece of that. The value creation is very evident. It's very trackable, it's very tangible. And what we've seen throughout the entire capital markets is when you own something and you can track its value and it is unequivocally yours, there are lots of ways to create liquidity in that without actually selling the underlying asset, whether you take that into a securitized form or a share form or a partnership interest that you can trade. The hard part is creating a massively value-creating asset, not how do you create liquidity around it. So we would like the market to focus on the value proposition, the fact that you own something that is third parties are saying it's worth $7 billion today, look at the track record of growth, it's growing faster than anything else that looks like it. It looks like it has the prospects to continue to do that. And if you gave me a chance to invest in that, I would want to own as much of that as I could, and I would pay you a premium to buy that extra growth. Today, you can buy that inside of Safehold at almost nothing, almost for free. That is the -- probably the most mispriced asset I've seen in the entire capital markets right now. And so not surprisingly, we are buyers of that opportunity, and we will figure out how to unlock it for shareholders.

Got it. Maybe last one on acquisition activity because that's how you grow the business. I think that, that kind of volume that you guys do from quarter-to-quarter can be relatively volatile, which makes sense but you guys have obviously grown over the past couple of years. So as we look forward, do you think that kind of recurring volume from quarter-to-quarter can continue to somewhat regularly increase? Or do you expect it to be volatile given property type and transactions in a quarter?

Yes. I think you always ask us, can we define this down to quarters, and it's kind of tricky. We feel really comfortable with our public statement that we will double the size of the portfolio over 3 years. We feel comfortable with what people have done without to say, well, you guys -- that sounds like you'll do $1 billion a year. We said we're very comfortable with that. But when you try to take us down to an individual quarter, it's harder to do that. This year, we did $166 million in the first quarter, $222 million in the second quarter, $330 million in the third quarter, and we announced we've done $500 million in the first 2 months of the fourth quarter. So the trajectory looks good. There's a little bit of seasonality to the business. The fourth quarters have been our strongest quarters the last couple of years, but we feel really confident that we're delivering and actually over delivering on what we said we would do. And I don't see any reason why we can't continue to do that over the next 2 years.

Well, I like you mentioned that, trajectory for this year is encouraging. So that's good. Okay. Well, I think we'll stop there. Thanks, Jay, for joining us and for those of you here and everyone on the virtual webcast. So thanks, everyone.

Thanks, everyone.