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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to Safety, Income & Growth's First Quarter 2018 Earnings Conference Call. [Operator Instructions]. At this time, for opening remarks and introductions, I would like to turn the call over to Jason Fooks, Vice President of Investor Relations and Marketing. Please go ahead, sir.
Good morning, everyone, and thank you for joining us today to review SAFE's first quarter 2018 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer; and Andrew Richardson, our Chief Financial Officer. This morning, we will plan to walk through a presentation that details our first quarter 2018 results. Corresponding presentation can be found on our website at safetyincomegrowth.com in the Investor Relations section. There'll be a replay of this conference call beginning at 1 p.m. Eastern time today.
Before I turn it over to Jay, let me point you to our forward-looking statements disclaimer on Slide 1. I'd like to remind everyone that statements made on our conference call, which are not historical facts may be forward-looking. SAFE's actual results may differ materially from these forward-looking statements, and the risk factors that cause these differences are detailed on this slide as well as in our SEC reports. SAFE disclaims any intent or obligation to update these forward-looking statements, except as expressed or required by law.
With that, I'd like to turn it over to our Chairman and CEO, Jay Sugarman. Jay?
Thanks, Jason. Thanks to those of you joining us today. The first quarter continued our steady progress forward as we modernize and reinvent the ground lease industry. Portfolio growth of 18% and Value Bank growth of 21% were both solid. And we still believe we have just scratched the surface of what's possible in the space.
Earnings benefited from the strong year-over-year growth in the once a year percentage rent payments from our Park portfolio, and we look forward to a solid bump in the coming quarter on the north complex in our Hollywood multifamily ground lease. The significant dry powder is still available and a growing dialogue with potential customers. We are well-positioned to continue scaling the portfolio and establishing our unique value proposition for owners of high-quality real estate and for investors seeking safety, income and growth.
And with that, I'll turn it over to Andy to walk through the quarter in more detail. Andy?
Thank you, Jay, and good morning, everyone. I'm very pleased to be joining you today. In the short time that I've been with the company, I've seen SAFE gaining traction with property owners and building momentum in the market. Our remarks this morning were referred in the slide from our earnings stack that we posted on our website today.
Let me begin with Slide 3. To asses performance at SAFE, we look at GAAP net income along with non-GAAP financial measures such as funds from operations, or FFO; and adjusted funds from operations, or AFFO. For the quarter, net income was $0.20 per share, FFO was $0.33 per share and AFFO was $0.30 per share, including receipts of percentage rent from the Park Hotel's portfolio, which is recognized annually during the first quarter.
Turning to Slide 4. I would like to highlight 3 themes from the quarter. We had meaningful revenue growth stemming from a larger asset base and recognition of the annual Park Hotels percentage rent. Our quarterly portfolio cash rent, excluding the Park Hotels percentage rent grew by 9% from the fourth quarter to $5.6 million, driven by our new investment activity.
In addition, we were pleased to see annual percentage rent at our Park Hotels portfolio also grow by 11% to $3.3 million. We've continued to build investment momentum, closing 3 new transactions totaling $91 million. Of note, all of our posts IPO customers for whom we've structured a SAFE ground lease have returned to explore further opportunities for ground leases with us. Our portfolio grew by 18% during the first quarter and now totals $588 million, which is up for more than 70% from IPO. And as the asset base grows, so does Value Bank, which is now $1.2 billion or $66 per share, representing 21% growth from the prior quarter and 173% growth from our IPO.
Slide 5 and 6 give further details on our income statement, FFO and AFFO, which I previously discussed. So moving ahead to Slide 7.
Slide 7 shows the quarterly earnings impact of both the Park Hotels percentage rent recognition as well as the waived portion of the G&A expenses. As I mentioned before, because percentage rent from the Park Hotels is recognized annually in the first quarter, we think that it's helpful for comparative purposes to show the impact to our earnings as if we recognized it evenly over the year. Doing so would result in a $2.5 million or $0.13 per share reduction to our first quarter earnings.
Secondly, and as a reminder, iStar waives all management fees and reimbursable expenses through June 30, 2018. That said, under GAAP, both the management fee and reimbursables are still recorded as G&A expenses during the waiver period and as an increase to stockholders' equity in a like amount. In the first quarter, this amount represented $0.07 per share or a $1.3 million cash benefit to the company.
Slide 8 provides more of the details behind the G&A breakdown I just discussed. Moving ahead to Slide 9, which illustrates our dividend payments. We've paid a $0.15 per share quarterly dividend for our first 3 quarters as a publicly traded company. We expect to be able to grow the dividend over time as we continue to invest more capital in new ground leases.
Let's turn to our portfolio on Slide 11. Slide 11 gives metrics on 3 ground lease investments we originated during the quarter. We invested a total of $91 million during the quarter at an average going in cap rate of 4.2%. These leases have an annual annualized fixed escalation of 2% over the life of the lease and all 3 included CPI-based adjustments to provide periodic inflation projection. The deals also featured credit protection in line with our targets with a weighted average ground rent to property net operating income coverage of 4.4x and a weighted average basis as a percentage of combined property value of 33.5%.
Slide 12 highlights some of the features of the deals we closed during the quarter. The Onyx transaction is a 14-storey, 266-unit multifamily project in Washington, D.C. In this transaction, our customer utilizes SAFE ground lease combined with agency financing to create a highly efficient capital solution that allowed them to submit the winning bid for the property. We are very pleased with this transaction, not only because it represents a solid investment for SAFE, but also because it has opened the doors to the universe of agency-funded multifamily assets.
Since closing this investment, we have received many reversed inquiries from other multifamily investors about how a SAFE ground lease structure can be potentially utilized for their benefit. In February, we also closed 2 other ground leases with a repeat customer, who also recognized the benefits of SAFE's custom-tailored ground leases. This customer was able to successfully recapitalize Regency Lakeview, a 27-acre office campus located in Cary, North Carolina; as well as acquire Pershing Point, a 7-storey office building located in Midtown Atlanta, Georgia.
These SAFE ground leases provided low-cost, long-duration solutions to unlock value and achieve better returns for this customer at both of these properties. Overall, the SAFE ground lease is designed to help our customers unlock value and maximize their returns. This is why we have experienced strong repeat business. We've seen that once we overcome the initial education process and our clients understand the power of the SAFE ground lease, they are excited to bring us more opportunities.
On Slide 13 and 14, you can see some details on the diversification, overall composition of our portfolio.
And on Slide 15, we provide key metrics about our portfolio that we believe sets our brand of ground leases apart from other investment opportunities in terms of safety and relative value. Just a few things that I would like to highlight. Our annualized cash rent including percentage rent is $27.4 million or 4.7% current return on our bases. Our leases all have some form of rent escalators in them. Of the ones which has fixed rent bumps, the weighted average annualized bump is 1.7%. This excludes any leases whose escalators are solely based on percentage rent or CPI.
On the bottom part of this slide, I'd like to highlight that the annual cash flow of the properties sitting on top of our land covers our annual cash rent by 4.7x, and our cost basis represents 33% of combined property value.
Moving to Slide 16, which presents our pipeline. Presently, we have $472 million of deals in our pipeline comprised of $391 million of transactions for which we are negotiating term sheets with our clients and $81 million of deals with signed LOIs. Of note, we narrowed our pipeline to 2 categories this quarter from the 3 previously discussed. We eliminated the category of in review in order to focus the pipeline disclosure to just deals that are further along in the funnel. Note that the multifamily opportunity represents approximately half of our pipeline right now.
Slide 17 provides an update on our Value Bank. Our Value Bank grew 21% during the first quarter to $1.2 billion or $66 per share from $54 at year-end. Recall, at the expiration of a ground lease, the building and all improvements revert back to SAFE. Since our initial investment was only the cost of the ground, the value of the building less our historical purchase price of the land is what we refer to as Value Bank. CBRE provides appraisals on all of our properties and reappraises every asset annually. In effect, Value Bank tracks the embedded capital appreciation potential at lease maturity and it will grow with every ground lease we acquire.
On to Slide 19. Let me discuss debt and leverage. Our debt is relatively straightforward, $227 million of fixed rate debt due in 2027, secured by our initial $340 million portfolio and $71 million of asset-specific debt against our Hollywood investment. In addition, we have a $300 million revolver of which $10 million was drawn at the end of the quarter. It continue to be conservatively leveraged at 0.9x debt-to-equity below our 2x target, and our debt represents 17.3% of combined property value, below our 25% target.
Finally, just a word on Slide 20. To mitigate the impact of interest rate fluctuations, we have put in place interest rate hedges for all of our ground leases that are not yet financed or that are financed with floating rate debt. These hedges which represent shorter-term hedges through October 2020 and longer-term forward starting hedges through October 2030 give us 12.5 years of protection. In sum, this was a strong quarter for the company. And the combination of customer response to our ground leases compounded by how the pipeline is shaping up makes us very optimistic about the future.
And with that, I'll turn it back to Jay.
Thanks, Andy. I think it's fair to say we don't believe our share price comes close to reflecting the potential of the company yet. The 2 main components of value, the ultrasafe, long-duration growing rent streams we receive and the future potential for capital gains that we track via the Value Bank, should both generate significant value for shareholders. And we continue to work on ways to highlight and capture the true value of both components. As our business grows, and as we continue finding ways to demonstrate the size of this opportunity, we believe the market will reward our innovative approach to the real estate market. And we're focused on making that happen as soon as possible.
With that, operator, let's go ahead and open it up for questions.
[Operator Instructions]. Your first question comes from the line of Collin Mings with Raymond James.
First question from me. Just in February, you guys indicated your goal was to get to roughly $1 billion of assets by year-end. Is that still the goal or has that come down a little bit just given where things stand here at the end of April?
That's still the goal.
Okay. I guess maybe along those lines, maybe just expand a little bit more with -- the $81 million deals under LOI. How close was -- are those ones that you would expect here to close in the second quarter still? Or do you think it could drift a little bit until later in the year? And then just specifically when thinking about that bucket, maybe just put a little bit more color around that. I believe that's what depicts kind of the pipeline in aggregate.
Yes, I think we've got a number of deals in process that we feel good about, always tricky on timing, given where -- third end of the quarter, we'd expect a good chunk of those to close. But right now, we're still not exactly sure of the closing dates on a couple of them. So I don't want to go too far in overstating that. The dynamic we've seen, and this is the -- probably the thing we've learned the most over the first 8 months of our existence is, we're making a lot of progress because the logic of what we're doing is so compelling to owners. They understand that splitting the building where the talent they bring to the table can earn very high returns, away from the much lower risk, but also lower return piece of land is definitely a smart trade for them. But what we're finding is that first meeting where we did sit a deal person, an owner of real estate, we make that progress. There's a whole another chain of people behind that, that we also need to really share with them how we're reinventing the business, why it's different than the historical ground lease business. I think a lot of people think about when they hear this.
And so we spend a lot of time trying to figure out how do we get pass that first meeting to the partners, the lieutenants, the lawyers, the mortgage brokers. All parties to transactions that, I'd say, on first blush, are looking at ground leases. In a way, historically, they've been used, which is significant value destroying proposition for owners and they have to really see the merits of what we're talking about, which is a value-creating ground lease structure. And I think as Andy said, we've had a lot of repeat customers, which tells us if we can touch all those parts of the puzzle, we're going to get a lot of business in the future. But that [indiscernible] time that 4, 5 meetings we have to have with all the parties involved to help explain, and we are fundamentally reinventing this business. It has nothing to do with the old-fashioned families business that they're probably used to. That's taking a little bit of time. So again, we feel pretty optimistic that the more we do, the more we'll be able to do. But getting through those first couple of points of resistance is taking quite a bit of time and effort on our part.
Okay, that's fair. I guess switching back to just the Value Bank, the increase, obviously a big jump in that relative to year-end, was that just reflecting kind of a deal completed in 1Q? Or was there any other kind of moving pieces of that growth that it was just again largely reflecting the overall combined property value stepping up pretty big?
Yes, we like to split Value Bank into two pieces. These quantum jumps that happen each time we add a deal, that creates a quantum jump. Now we have the organic growth, which is the underlying property values increasing. This quarter, because, again, we're still quite new and we haven't gone through a full cycle of reevaluation, it's almost all of that quantum jumps. We haven't really added in the organic growth that's taking place in the portfolio.
Okay. Last one for me, and I'll turn it over. Just Jay, maybe, if you could comment on the search for a permanent CFO. I know, obviously Andy is fulfilling that on an interim basis but maybe just talk about that. I recognize it's obviously relevant to both Safety and iStar. But just need thoughts there?
As we suspected, Andy is doing an incredible job for us right out of the box. So we've got the luxury of having somebody who is really wonderful at it. So our first goal is really to build this business. And we'll turn our attention to the other pieces of the puzzle throughout the rest of the year. But right now, I will tell you, it's all hands on board to really get this business out into the marketplace, and Andy is certainly helping us do that.
Your next question comes from the line of John Massocca with Ladenburg Thalmann.
It's John, but okay. So kind of the first question, is it fair to say that the -- when you look at the portfolio, the stuff that is now called in discussion is the same as what was in ongoing negotiations in the prior presentation?
Yes, we're trying to find a metric that's really useful for you and for us. I think we have a lot of deal dialogue going on. As I said, we get through the front door pretty easily with the compelling logic of what we're presenting and the long history of what we have done in working with customers and owners of real estate to find ways to help them do their business better. And that can be a very productive meeting, and we'll leave that meeting with a handshake then let's go work on some stuff together. As we sort of tailor this pipeline and try to understand why things are happening, and why things aren't happening, again, we think there is several layers that we have to win to really get a transaction all the way from that initial, very compelling first meeting through a transaction. And so we think the LOIs, obviously, have made it through that path. But the in-discussion I think is really our deal team's view of something where they go look, not only is the idea makes sense and really does unlock value, but we also have buy-in from some key decision-makers.
And there seems to be a momentum to try to get a deal done. The wider funnel, the -- hey, we've had a good meeting. We're not going to highlight as much, because we still have a lot of work to move those into these two baskets. So I think better for us at this point and for you, frankly, to see the deals that we think we have traction on. Not all of them will happen, but we're making a deeper inroad into an organization or owners, the thought process where they're saying, yes, I want to do this. And still, I think there's a lot of territory out there we haven't even touched. But it doesn't really makes sense to tell you we're working on tons and tons of deals that, frankly, we've had 1 really good conversation with a decision-maker. We found that does not lead to a guaranteed deal. So we're being a little more cautious about how we show you and how we think about ourselves how this funnel really works.
Okay. So those two categories are kind of comparable, right?
Yes.
And if so, what kind of caused the -- it's pretty big growth, right? It's almost $300 million. Is that just -- a lot that just reversing inquiries from multifamily, for the Onyx deal? Or is there something else, maybe, that drove the growth in that category?
Yes. I think, look, we continue to believe there's sort of a flow business in the multifamily space and some of the other property types. And then there's some of these larger transactions in the gateway cities. And those are the ones that come in and out that we have a harder time sort of knowing whether they're going to happen. Obviously, a ton of competition in those markets. We've seen finance markets get very, very aggressive in certain circumstances. And we're being pretty disciplined about where we want to go. So right now, I think the mix of the 2 feels pretty good. But I wouldn't read too much into the absolute dollar number. I'd look more to the number of deals, because that for us is really a sense of how fast we're getting traction with our customer base and with new customers that we're reaching out to.
Understood. And then, within the current pipeline, how much, kind of roughly speaking, of those are existing ground leases? And how many of those kind of percentage-wise are ground leases you would create?
Yes, the majority are things we're creating. But again, don't look so much at the dollar value because some of the things we're working on will skew that. But just in terms of the number of deals we're working on, the majority are things either we are creating directly or we are creating in conjunction with an acquisition or a new transaction.
And then kind of specifically on the 3 transactions you closed in the quarter, what was the term on those lease term?
99.
On all.
All three, yes.
Your next question comes from the line of Anthony Paolone with JPMorgan.
Can you talk about just yields and sensitivity around yields as you talk the cost in the market given just what's happened in interest rates, I guess, last month or so.
I think people are always testing their alternatives. And as the LIBOR continues to move up, I think the idea of longer-term, non-maturity capital is becoming increasingly attractive. I think the market understands that there's likely significant future moves in LIBOR coming. So the idea that today's rate is tomorrow's rate, I don't think holds anymore. And people are looking out over the curve and saying over the next two years, what are my real cost of funds and what risk am I taking? And I think they like the idea of locking in at least a portion of their capital structure on a more stable basis and not having a refi risk in the future where they really can't predict where interest rates are going to be. So we think right now, people are starting to rethink their assumptions given where -- at least the Fed has told us they are going to take short-term rates and any floating rate debt right now has a material increase in cost built into it.
Okay. So the deals in the quarter were at about 4.2%, but they were all basically office deals. If we get your pipeline and you've got a decent amount of apartments in the mix, do you think those deals could get below back -- get back below 4%? Or do you think those could stay above 4% as we look ahead?
I'd say the highest quality deals in the best markets are kind of in that 4% range right now, and it can get wider than that for things that have some less positive dynamics in terms of the locations. But it's going to be hard to get much below 4% right now unless something changes.
Okay. And then just a one-off on the quarter. The other income bounced up. What was in there? And does that kind of stay at that level?
Are you talking about percentage rent or a different line item?
No, the actual like other income number there is 499?
Just over $400,000.
Yes.
I think that's interest income on our cash.
So more efficiently holding the cash.
[Operator Instructions]. Our next question comes from the line of Joshua Dennerlein with Bank of America Merrill Lynch.
I saw that the land under the Lipstick Building in New York City was for sale. Is that something you're looking at or would consider looking at purchasing?
Yes. Unfortunately, that is a classic, old-fashioned ground lease, probably represents 90% of the value of the overall building. So it's not really a ground lease. It's really very high in the capital structure, very low coverage piece of paper. So it's probably not something we would pursue. Although inside of it, there's probably a very good modern new ground lease that we'd love to put on the building. But the one that exists today is not, doesn't really fit our goals.
Okay. And then just kind of a follow-up. For the multifamily, you hold 56% in your pipeline. What do you think makes multifamily maybe more attractive to folks to put a ground lease under -- you think you just got more traction with the developers on that front?
A great question. There's two things, and I think when we first started two years ago looking at this, there was a question mark of, is this just financial moment in time? And really, I think we've redirected a lot of folks to the idea. They are trying to make low teens, midteens, high teens over higher returns on the things they do well, the leasing, the marketing, the design, construction and ultimately the sale. And that business should generate midteens returns. The business that they shouldn't be in is trying down very long duration, you know 4% instruments like a ground lease. And so we've seen the takeup really be less about this financial difference between their cost today and their cost tomorrow, as much as it is just psychologically, yes. I wanted to use my money most efficiently, my capital most efficiently. I want to make the highest returns for the skill set I have. And that actually works really well in multifamily.
The competitive market, cap rates have been driven down where absolute returns are difficult to make, unless you're really efficient as a buyer, as an owner, as a manager and as a seller. And we think we've touched a nerve on a couple of transactions in the pipeline where people are seeing very explicitly. They can do their business better, make better returns by not having to own this long-term piece of ground lease. And so that 1 big component is just a psychological understanding of what they do really well and what they can make the most returns on is benefited by what we do well. The second thing I'd say, and this is -- it goes to a point I made earlier is, because the agencies are relatively consistent in how they view the financing piece of the puzzle, we can move very quickly through that process. So the idea that we have to convince sort of the -- can you borrow on a lease hold at certain rates, at certain -- it's taken off the table. We've already done it. They've already seen it.
The agencies have already blessed it. So suddenly it becomes a very straightforward opportunity for them to look at their alternatives of do I do a ground lease with a leasehold financing? Or do I do a straight fee refinancing? And more and more, we're seeing people gravitate to the former and say, that's a lot more efficient for my capital. It allows me to do what I do best and generate the maximum returns possible for my success and lets us do what we do well at Safety, Income & Growth, which is only very long duration, ultra-safe ground position. So I think that's one of the exciting things we've seen over the first 6 months here is just a mental shift from the old-fashioned ground lease, why would I ever do this, to wow this actually makes more sense, generates higher returns, takes my refinancing risk on a big chunk of my capital off the table, in a lot of ways, this is just superior and a smarter way for them to capitalize their deals. And that's what we're really going to press on here, as we go forward is, finding more and more owners who see what we've already done and say, yes, why aren't I doing that? Why aren't I doing that? which -- that a lot better way for me to invest in the things I do really well, which is leasing, managing, designing, constructing, and selling.
So we haven't reached a tipping point. I don't want to go too far, but I think more and more meetings we have, the more aggressive, we've been able to reach out to people and say don't think about the old-fashioned ones. They really aren't what we were talking about. Let us walk you through how we're going to help you make more money, a 1 plus 1 equals more than 2, that's starting to sink in. And I think the fact that we can do it in multifamily should have a positive impact on owners of other property types.
There are no further questions.
Thank you, Jack, and thanks, everyone, for joining us this morning. As a reminder, we have our annual meeting of shareholders coming up on May 9th at the Harbor Club of New York City at 9 a.m. And all shareholders are welcome to join us. Otherwise, if you got -- if you should have any additional question on today's earnings release, please feel free to contact me directly. Would you please give the conference call replay instructions once again? Thanks.
Certainly. Today's call will be available for replay from 1 p.m. Eastern Standard Time, today to 11:59 p.m. Eastern Standard Time, May 10, 2018. The number to call us at is 855-859-2056 and the conference ID number is 5688969. This concludes today's call.