These Kind of Investments Are On the Rise

This past week was REITweek – the biggest real estate investment trust-specific event of the year.

Put on by industry advocate Nareit, REITweek features a flurry of presentations from dozens of REIT management teams all in the space of three days.

In my world, it’s a big deal, and I make sure to attend it every single time. More importantly, it gives me the opportunity to share insights with you – our reader – that very few investors ever hear.

There’s no way to go to every seminar since so many of them overlap. So, you have to pick and choose. And even then, I’m often powerwalking (or flat-out running) from one to the next.

Somehow, though, I always manage to schedule a slew of interviews along the way. And, this year, one of them was with Jay Sugarman, CEO of Safehold (SAFE), the only pure-play ground-lease REIT in existence.

In full disclosure, I do own shares of SAFE. And with good reason. Its portfolio of properties and the contracts they operate on are pretty impressive.

If you’re like most investors, you’ve probably never considered ground leases as an investment. But as Jay shared, there’s an awful lot to like.

Own the Land
Ground leases are a fascinating business and investment prospect, but very few are aware of them.

They involve landowners granting very long-term leases – typically for 50-99 years – to secondary parties, who then get to build on that property to their exact specifications.

Once that contract ends, the facilities belong to the landowner.

Personally, I’ve always been intrigued by ground leases. As a former real estate developer, I’ve even utilized them – both from the landlord and tenant sides of the equation. So, I understand the value on both ends.

Odd as this real estate relationship might sound, there’s a lot to be said for it, especially in today’s crazy real estate market. That’s why more and more entities are recognizing its value.

And why I’m telling you about it today.

Most businesses would like to have it all – the land and the buildings that sit on it – but that’s almost never possible.

So, compromises are made, such as the ground lease.

Tenants find this kind of contract attractive because they don’t have to fork out substantial money to buy land. This lowers their upfront equity and enhances their yields on cost.

Meanwhile, the landowner has absolutely no building maintenance whatsoever to worry about – a bonus that’s hard to overstate.

As any homeowner knows, maintenance is an enormous cost. Maybe the fence needs to be repaired. The AC just went out. Or the trim needs a new coat of paint.

There’s always something. And that “something” is usually expensive.

Those issues and their costs only skyrocket when you’re the owner of a commercial building. Avoiding them, therefore, is extremely appealing.

Better still for landlords, ground leases usually have built-in escalation clauses that provide them with sufficient payment increases over the years. And it’s normally very stable companies that want to sign ground leases, making them very good tenants.

What does all this mean from an investment perspective?

Very Safe
Sugarman pointed out how, in his company’s case:

There’s a very, very low probability for default, since SAFE’s ground leases typically represent the senior-most 25%-40% of a real estate capital structure. So, the debt sits in an even more senior position.

Ground-lease landlords are essentially taking the lowest risk in the capital stack. Their business model is actually more comparable to an AAA bond than a typical investment in some ways.

All this to say that Safehold is a stand-up REIT with the ability to invest across the top 50 U.S. cities. Together, those metropolitan areas make up a multi-trillion-dollar opportunity set.

Here’s Safehold’s top 10 markets across the country:

Source: SAFE investor deck

And there’s room to grow further with the overall cost of doing business so high these days.

Land isn’t cheap. Building materials are just as bad. And banks are becoming more and more selective in who they lease to, especially in the real estate department.

They know so many landlords are distressed, and they want as little part in that drama as possible… prompting many businesses to consider alternative funding options.

Further Proof of Ground-Lease Growth
Last March, Safehold issued a press release highlighting how the company had closed $1.3 billion in modern ground leases in 2022, helping it to achieve a total $6 billion in holdings.

To this, its head of investments, Tim Doherty, added that the REIT “went from 12 deals in 2017 to over 130 in 2022.” And that window of growth hasn’t shut since.

“It’s really unlike anything that we’ve seen [before],” Sugarman told me last week. “But also expand that well beyond just dedicated core real estate investors to a much wider audience that’s looking for growth, that’s looking for safety, that’s looking for long-term capital appreciation.”

There’s plenty of room for the proverbial little guy, too.

There are many organizations out there that operate ground-lease rental contracts. Sugarman mentioned the historic Trinity Church as just one example. It made a negative splash a few years back for holding over $6 billion worth of real estate properties, including some it rents.

But that’s a non-profit (or at least it’s supposed to be). It’s closed to market investors like us.

Being the only pure-play ground-lease REIT out there, Safehold is the natural choice for those interested in capitalizing on the ground-lease resurgence. And again, I highly approve of this company – both before and after talking to its CEO last week.

Agree Realty (ADC) is another interesting consideration. While only 12% of its portfolio is in ground leases, that number has been rising in recent years – another indication that these kinds of investments are on the rise.

I know I’ll keep an eye out for companies that are opening up to this growing opportunity. And I hope you’ll keep an eye out for tomorrow’s issue.

I have plenty more insights to share about my time at REITweek!

Regards,

Brad Thomas
Editor, Intelligent Income Daily

Source: Wide Moat Research