© 2024 Alpha Spread Limited. All Rights Reserved.
www.alphaspread.com is not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on www.alphaspread.com represent a recommendation to buy or sell a security. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. In no event shall Alpha Spread Limited be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on www.alphaspread.com, or relating to the use of, or inability to use, www.alphaspread.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance.
You don't have any saved screeners yet
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 Second Quarter 2018 Earnings Conference Call. [Operator Instructions]. At this time, for opening remarks and introductions, I would like to turn the conference 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 second quarter 2018 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer; and Andy Richardson, Chief Financial Officer; Marcos Alvarado, our President & Chief Investment Officer. This morning, we plan to walk through a presentation that details our second 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 the conference call beginning at 1:00 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 the call over to our Chairman and CEO, Jay Sugarman. Jay?
Thanks, Jason. During the second quarter, we continued to focus on reinventing ground lease industry by developing a modern ground lease structure that eliminates the negative features found in old-fashioned ground leases and by focusing on providing innovative capital solutions that are custom-tailored to meet our customers’ needs. We developed a powerful way for building owners to meaningfully enhance their returns and be more efficient than their competitors in deploying capital.
Second quarter activity outgrew the portfolio another 7.5% and Value Bank another 6%, with smaller deal sizes, longer lead times and the unexpected exercise of a purchase option by a third-party at 635 Madison Avenue, kept total volume below our targets.
Mix of new and repeat customers feels good at this point and the pipeline of deals we are working on suggest larger future volumes. If the education process remains a governor on growth, then we can reach a critical mass of owners and advisors who have worked with us and seeing the power of the SAFE Ground Lease to boost their returns and to help them execute their plans.
We are also working on ways to deploy more resources and expand our outreach further and faster, and look forward to seeing the results of those initiatives in the coming quarters as we seek to reach the $1 billion portfolio mark by year-end.
With that, I will turn it over Andy to walk through the quarter in more detail. Andy?
Thank you, Jay. And good morning, everyone. My remarks this morning will refer to the slides from our earnings deck that we posted on our website today. Let me begin with Slide 3.
For the second quarter 2018, net income was $0.09 per share, FFO was $0.22 per share and AFFO was $0.17 per share. Earnings this quarter included, $1.5 million of income or $0.08 per share that was related to a cash termination fee we received after a third-party exercise its purchase option on a New York City property that we put under contract in the second quarter.
Turning to Slide 4. The main theme for the quarter is the continued investment activity, as we put capital to work and expand our footprint by closing transactions with new and existing customers.
To that end, we saw sequential revenue growth of 12% from the first quarter this year with portfolio cash rent of $6.2 million for the second quarter. During the quarter, we closed four new ground leases totaling $44 million, which brings our portfolio to $631 million and Value Bank to $1.3 billion as of June 30th.
Turning to Slide 5, we recently marked our one year anniversary as a public company. Since the IPO, we’ve closed 291 million of ground leases and grown the portfolio by 86%. In addition, annualized cash rents increased by 69% to $29.4 million and Value Bank increased 188%.
Slide 6 and 7 present our income statement and the reconciliation of AFFO or FFO and AFFO to GAAP net income. Slide 8 contains a detailed breakdown of our G&A.
Note that even though iStar waived all management fees and reimbursable expenses during the second quarter, we still recorded the expense on our P&L, which is then offset with an increase to equity in a like amount. In the second quarter, net income and FFO included $1.3 million or $0.07 per share and expenses associated with these waived late fees.
Beginning in the third quarter, we will begin to pay iStar's management fees in stock and reimburse iStar for expenses in cash.
Moving ahead to Slide 9. You can see our dividend coverage. For the second quarter, we paid a $0.15 per share dividend or $0.60 annualized. During the last four quarters, we generated $0.64 of AFFO per share, resulting in a payout ratio of 94%. As we continue to invest, we expect to be able to grow the dividend.
Let’s turn to our portfolio on Slide 11. Slide 11 provides metrics on the four ground leases we originated in the second quarter. We invested a total of $44 million during the quarter at a weighted average going in cap rate of 4.25%. These ground leases have weighted average fixed annual rent escalations of 2% in all four leases that CPI looked back to provide periodic inflation projection. The investments also feature credit protection in line with our targets with a weighted average ground rents underlying property NOI coverage of 4.1 times and our weighted average cost basis as a percentage of combined property value was 35.2%.
Slide 12 highlights the deals we closed during the quarter. The Glenridge Point transaction is a new ground lease on two office buildings, 100 and 200 Glenridge Point in the Central Perimeter submarket of Atlanta, Georgia. We are very pleased that this transaction marks the third time our client has utilized the SAFE Ground Lease solution and represents SAFE’s fourth Ground Lease investment in Atlanta. This is an example of a transaction in which we offered our client a one-stop shop solution with iStar providing the leasehold financing alongside our Ground Lease.
Promenade Crossing is a 212 unit garden style multifamily community in Orlando, Florida, which utilizes SAFE Ground Lease along with a third-party leasehold financing. We remain enthusiastic about our continued ability to penetrate the multifamily sector in our current investment pipeline to reflect future growth in this property type.
In June, SAFE announced that it originated two new ground leases on adjoining industrial properties adjacent to the Miami Airport Intermodal. Properties were owned fee simple by iStar, we sold with ground leases and leaseholds because the two separate transactions generated more proceeds than broker estimates of the fee simple valuation. This deal serves as a good example of our core thesis of bifurcating a property with a well structured ground lease that can create more value than a fee simple structure.
On Slide 13 and 14 you can see some details on the diversification in our portfolio. And on Slide 15, you can see some of the key metrics that we believe set 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 $29.4 million or 4.7% current return on our basis. When you include straight-line rent, our annualized GAAP rent is $46.4 million.
All of our leases have some sort of rent escalators embedded in their structure, such as fixed rent bumps, CPI-based bumps, percentage rents or combination of these. Of the leases with fixed bumps, the average annual bump is 1.8%. Safety derived from our ground leases is highlighted in the credit metrics shown on the bottom part of the slide.
Annual cash flow of the properties is sitting on top of our land, covers our annual cash rent by 4.7 times and our cost basis represents 33.4% of combined property values.
Moving to Slide 16, which presents our pipeline. As of last week, we had $620 million of deals in our pipeline comprised of $480 million of transactions, for which we are in discussions or negotiating term sheets with our clients and $141 million of deals were signed LOIs.
Slide 17 provides an update on our Value Bank. As already discussed, Value Bank grew 6% during the second quarter to $1.3 billion or $69 per share. Recall, at the expiration of a ground lease, buildings and all improvements revert to SAFE. Since our investment -- our initial investment was only the cost of the ground, value of the building less the historical purchase price of the land, is what we refer to as Value Bank. CBRE provides appraisals on all of our properties annually.
In effect, Value Bank tracks the embedded capital appreciation potential at lease maturity and 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 long-term fixed rate debt due 2027 secured by our initial $340 million portfolio and $71 million of asset-specific debt against our Hollywood investments.
In addition, we have a $300 million revolver, of which $10 million was drawn at the end of the quarter. Cash on hand plus undrawn availability on the revolver, provided $122 million of equity liquidity at June 30th, representing over $300 million of buying power based on 2-to-1 leverage and revolver capacity. We continue to be conservatively levered at 0.8 times debt-to-equity below our 2 times target and our debt represents 16.3% of combined property value, below our 25% target.
On slide 20, let me discuss our interest rate protection. Our policy is to put in place interest rate hedges when we originate investments to protect us from interest rate fluctuations. We have $227 million of long-term fixed rate financing.
In addition, we $213 million of rate lock hedges covering the next 12 years associated with all of the investments we have closed that have not yet been leveraged with long-term fixed rate financing.
In conclusion, SAFE had another strong quarter. A combination of continued deal flow and a sizable pipeline of diverse asset classes continue to make us optimistic about achieving our objectives to reinvent the ground lease market.
And with that, I’ll turn it back to Jay.
Thanks, Andy. So we remain excited with the path we are on and the reception we are seeing from owners of properties who realize that investing capital in both the physical building and the land is very inefficient and materially drive down their target returns.
By enabling in owners’ capital, we’re highly focused and only require to fund the properties’ building components. SAFE Ground Lease maximizes owners’ returns and enables them to reap the full benefit of the increased value they create.
Logically, providing more efficient capital and unlocking higher returns for owners should fundamentally change the way real estate owners think about investing in real estate.
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. Go ahead, your line is open.
First question, I mean clearly there's been more execution thus far on the origination front compared to acquisitions over the last year. That said, are you seeing the flow of acquisition opportunities to increase at all?
There're still deals coming to market. I’d say it’s spotty and fast. And when they do come, we do see them. And I would say that part of the business is going to be a relatively small part of the business, and come in lumpy sort of fashion, so we have been focused more on the origination side.
Okay, that's helpful color. And then just maybe along that theme of focusing more on originations and as you think about those opportunities, has the geographic focus evolved at all? I mean the mix of some of the larger MSAs has declined, and now markets like Indianapolis are showing up on that pie chart. The various bucket is growing a little bit. So can you maybe just talk a little bit about if there's any evolution in the geographic focus on opportunities?
Yes. I think we are still targeting the top 25 markets, but we are following our customers where they are playing. So the initial folks who have already worked with us and seen the power of the Ground Lease to unlock their returns are taking it into different markets that historically we’ve looked at but working on our initial list in terms of the gateway cities. We think there's going to be a nice mix of both. But again, the customer -- meeting the customer need is going to drive this business. So we are going where they need us.
Okay, one last one from me, and I'll turn it over. Just in that -- can you just maybe characterize what's in that entertainment bucket in terms of the opportunities you're looking at?
Yes. We don’t want to go too deep into some of those things. But again, we look at the real estate. We look at the evaluation of the improvements and try to figure out where we are really getting real value. So I think if you look historically at our net lease business, there were pretty good practice in a couple areas. So that’s one of the things that we’re trying to level off with some of those relationships to find ground leases in.
Your next question comes from the line of Anthony Paolone with J.P. Morgan. Your line is now open.
Thanks. Good morning, I think 635 Madison was pretty sizable and I think in the past you all have contemplated some other large transactions. Can talk about just what your appetite and/or the pipeline looks or some that are just much larger chunk of your deals?
Hi good morning. It's Marcos Alvarado. As Jay mentioned, the acquisition front is a little bit lumpy. If you look at our pipeline, I would say there's probably another $1 billion of transactions that don't show up in that $620 million number that we’re pursuing and they are more difficult to execute but we continue to pursue them. I would call them gateway markets core, core assets. And we’re optimistic that this “Where Else” will hit over the coming quarters.
Okay. And in the past you talked about getting some traction with the multifamily and on the development side given that you're able to structure these that fit sort of the Fannie Freddie criteria. Any additional updates there or how that's coming along?
It’s continuing to proceed really well. As we’ve discussed it, our both Fannie and Freddie have done leasehold financing behind us. Yesterday, a new client emailed me and they saw that we have executed on a transaction with -- on a deal that they had did and they said how did you guys do this. And so, that’s sort of feedback in the market that gives us a lot of excitement about the future potential in the multifamily space.
And then in terms of just you talked about educating the market on SAFE Ground Lease. But when it comes down to it, I mean there are pretty sophisticated counterparties. The structure of your offering which seemingly be pretty straightforward there. Is it just competition from other sources of capital, is it a cost matter or is it that at the first it’s just not quite interesting enough given a little bit of that in complexity or what does it really come down to on this?
I wouldn't say that’s alternative capital because I think the numbers are pretty compelling. I think one of the biggest challenges we faced and continue to face is there’s just a lot of skepticism from the negative history of what we call the old fashioned ground lease market. Everybody has got a horror story. Everybody has got a negative story. But when you really dig under the cover, it’s almost every one of the issues that they are focused on, are things we've eliminated from the SAFE Ground Lease. So it’s hard to fight against the ghost of past bad ground leases. You really have to do a very good job of sitting in front of somebody, as I mentioned, their advisors, their lawyers, their mortgage brokers, their sales broker, advisors, all have some bad baggage from the past. The numbers on their face are really compelling and I think we typically did a very good initial impression and then essentially lose that momentum as we go through the nitty-gritty because people down the chain have not heard the pitch directly from us, they don't really understand how our ground leases are fundamentally different. They don’t really understand that we have built our entire business as a customer business, not just as a capital business. So we're really looking to help our customers make more money. And so, this is not something that I think has ever been really existed in the marketplace before and it takes time to fit and walk with all the parties that actually participate in these kinds of transactions.
Once they're done, you're right, they're actually relatively straightforward. I think Andy mentioned we have a number of repeat customers coming back. It's just getting through that trial phase. The adoption piece of it has actually been really good. So when you have a trial problem, not an adoption problem, how do you solve that? Will you put more boots on the ground to get in front of more people and more places? And you just tell the story to all the people who need to hear it. And that's taking time and it takes up a lot of our internal resources. But we think we're planting the seeds farther and more deeply each time we do a deal, each time actually we don't even get a deal done. More people actually see what we're talking about and can start to articulate. Actually this is very different than the ground leases most of us are thinking about or have seen in our past. And the business they're running is actually a long-term customer focused business. They're very good at figuring out how to solve problems and needs. This is something that if you do once with us, you're going to find you want to do it again and again.
Okay. And then just last question on overhead. When we look at, you get the management fee and the reimbursables but the public company and other costs are $1.25 million this quarter. Where do you expect that to be on just run rate basis going forward?
I think that's a pretty good run rate there. I think that's a pretty good run rate for that number. As you know some of those fees will grow just as our equity capital base grows the management fee but the public company costs stay relatively stable.
Okay, thank you.
Your next question comes from the mind of Rich Anderson with Mizuho, your line is open.
So, when you think about how you're growing right now and kind of juxtapose that with the growth profile of the company, should we kind of think of the acquisitions as kind of a zero-sum game for now and that the real -- the growth comes from the escalators and sort of the second year of ownership or is there some small amount of accretion that you see that you're getting at the point of the investment as well.
Yes, I think there's two things in there. One, we're continuing to create and explore ways to create new ground leases. We're seeing ways to open and unlock value for owners in ways that are -- continue to expand from where we just started which will tell you we can buy these and we can create them. There’s panoply of ways to really unlock that value and you'll see us use all the tools we can to create these new ground leases. So I think we see the ability to jump step the portfolio in a number of different ways.
In terms of the value creation, it is a function of two things. One, we think as we build a portfolio of people, we will start to understand the characteristics of the two components better. The income stream, a long-term compounding growing income stream that should beat inflation nicely and then this embedded long-term ownership position in high quality real estate where you’ve got these really talented owner operators owning the leasehold, committing their capital to try to improve the value of that leasehold property.
Those two dynamics I think have been undervalued, frankly, because there hasn’t really been a portfolio with a visibility we are providing. We are telling you what Value Bank is. We are showing you how the fast stream dynamics are, the bump structures and some of the things that when you have a large diversified portfolio you can start doing some interesting liability management off of those.
So I think we are still in our early days right now. But in terms of each time we do a deal -- and we do think value is being created in both of those areas. In the rent stream component, we think we are creating value and obviously in Value Bank we think we are building something quite unique.
And then as we are in the midst of at least a questionable interest rate environment, do you sense that there is incremental interest in your land lease or ground lease products as an alternative to debt financing? Is that something that’s come up in conversation?
Yes, I think that is one of the things owners look at is how can they lock in the things that don’t -- they don't control and really let themselves focus on the things they do well which are designing, managing, building, constructing, leasing, marketing, taking the interest rate equation out of it for them with these long-term relatively constant ground rent on a big chunk of their capital, is a powerful tool. It reduces the uncertainty on “the interest rate” but it also takes a big chunk of term maturity risk off the table. Two benefits, two uncertainties that go away.
I understand that in theory, but is it part of -- like increasingly part of the dialogue as you try to -- unintended I guess new deals?
Yes. I would say two things. One, I think when each of it gets more volatile, yes, it becomes -- moves up in the hierarchy of things people are talking about. But I think ultimately we are trying to make sure people understand that as the whole complex of costs go up and down, the benefits of what we're doing is not like it's a 10 or 15 basis point move changes those dynamics. So, yes, if their alternative costs go up, it makes it even easier to have the conversation. We try to stress all the other benefits as well. It’s just -- it’s not just the short-term interest rate arbitrage opportunity.
Got you. In terms of the cost basis as a percentage of CPV at 33%, is there any reason why that will settle out at some other number or is that kind of the target that you're thinking about long-term for SAFE?
Yes, I think we have said in the past that we try to be pretty scientific about where is the optimal place in the cap stock. I think in the gateway urban core cities it can be a little higher, and in some of the other top 25 markets it should be a little bit lower. It seems though to settle down at 35-ish percent range. But if you had a strong quarter where you had a very large number of the urban deals, it might be a little higher. And within the rest of the top 25 markets, it could be a little bit lower.
Right, okay. And last question. As far as the G&A kind of shift now to SAFE actually paying iStar for their services in the form of stock, not much changes to the income statement except now one should maybe assume or not maybe -- should assume some incremental share issuance on a quarter-by-quarter basis, but otherwise the P&L should not change much. Is that correct in the way I’m thinking about it?
That’s absolutely correct.
Your next question comes from the line of John Massocca with Ladenburg Thalmann. Your line is now open.
So kind of roughly speaking, what portion of the opportunities in the pipeline are deals that involve iStar in some capacity of providing some other type of financing the tenant or being involved in the leasehold, either selling it or being the owner of it?
I think we have kind of said we will eat our own cooking which is when we sell something we want to see the dynamics between a fee process and a bifurcated ground lease and leasehold process. So part of our initial activity in that area has been both for our own purposes, but ultimately it's because we think it's creating more value. iStar has announced that it’s moving through its legacy portfolio and selling. So that will come to an end at some point. But we have been doing a lot of R&D work to try to understand why is it that people have not done this bifurcation. And what we're seeing is there's no reason they shouldn't. If the debt markets function, the cap rate markets function with their properly structured ground lease, value can be created. So we're continually refining how to make that processes smooth and efficient. The best way to do that is test it on our own properties, and that's been very effective, both in giving us the information we need to get better and better, but also to create more value for the leasehold buyers and for iStar to seller.
Would it be kind of safe to assume that the majority of the portfolio doesn't involve iStar earning?
No, we’re not looking at that as a core business. That’s really -- and it has helped to get us off the ground to see that all the pieces of the puzzle but that’s not core piece of the pipeline.
Understood. And then within the multifamily section of the pipeline, are you seeing more kind of garden style type properties in the pipeline, all kind of the deal you closed in 2Q ‘18 or has it been more of the traditional kind of CBD located properties?
I think as Marcos said we continue to play in both places and it’s -- obviously the CBD stuff is much, much larger. And so, in quarters where we do land, some of those, you'll see a decided shift towards the urban cores. But the flow business where our customers are taking us, we are seeing some guys in the multifamily space get very excited about working with us. Again we’re trying to stick to those top 25 markets, the NFL cities. We won't go much beyond that, because we just don't have the capacity to help them there. But end markets that we think are still the top 25 NFL-like throwing dynamics, good real estate characteristics; we think the multifamily space is pretty right.
Your next question comes from the line of Joshua Dennerlein with Bank of America. Your line is now open.
How are ground leases, are they more or less popular as interest rates rise? I am just trying to think about how the pipeline will change as interest rates go up and give me the economics of partners?
Yes, I think the natural answer would be yes, they get more attractive. But actually it hasn't been on the top of the two or three reasons why they're happening or not happening in situations. I think the economics of ground leases are compelling. If you understand that we stay for in the business of enhancing returns and trying to help make sure that the ground lease is a additive piece of the puzzle, and won’t detract from the return profile for that leasehold owner, now that's the -- that’s where we spend most of our time, focused on that.
We are responsive to interest rates. So we will continue to have an advantage whether rates are up or down or sideways, because ultimately the economic base for us is to be a better, more efficient way to deploy capital. So we're never going to create a higher cost option for our customers, it’s always a lower, better, less risk option. But as interest rates move around, so do cap rates on ground leases. So we will stay inside that umbrella.
But I think the main drivers of the business are getting people understand that it is a value enhancing tool. We are a business that is focused on building long-term customer relationships. We are a lender. We are an owner, operator and seller of real estate. So we’ve pressure-tested this idea on our own portfolio to make sure that the lending community gets and likes what we're providing. But the cap rate buyers out there like and accept that the Ground Lease is a value enhancing tool, not a negative. And that's where we will have to spent most of the time. When they look at the actual economics, it's a pretty one-sided competition. We almost always have better economics than their fee-based alternatives.
I guess to like further that question like, if there was like a 100 point rise in interest rates, what do you think happens to the ground lease cap rate that you would see in the market for -- that you're underwriting too?
That'll definitely go up. We have to finance our purchases, our ground leases as well. So, we will be trying to maintain the same sort of margins in our business. But if you start with an umbrella that we are inside of and that umbrella moves up a 100 basis points, we will move up as well, but maintain that differential. So we remain a better than market alternative.
Okay. And then on your repeat versus new users of ground leases, like what percent of your overall acquisitions since IPO have been from like, repeat customers or like new users?
Yes, I think volume-wise it's been about a third of the business. We are following our customers closely now and we see the pipeline with them growing. It could be as much as half the business we think. But again it's not by volume. So, I think that's not a good metric, it's by number of deals, because right now the repeat customers are -- tend to be on the smaller side. We haven't built a repeat customer in an urban core situation yet, that obviously will from a dollar standpoint materially shift the balance.
Mr. Fooks, we have no further questions at this time.
Thank you. And thanks everyone for joining us this morning. If you have any additional question on today's earnings release, please feel free to contact me directly. Operator, could you please give the conference call replay instructions once again? Thanks.
Certainly. Ladies and gentlemen, please note that a replay of this call will be available beginning today at 1:00 P.M. Eastern Time. You may access this replay by dialing 1855-859-2056 and referencing code 9168977. Thank you. And this concludes today's conference call. You may now disconnect.