Writer’s Observe: This text was revealed to iREIT on Alpha in Mid-Could of 2023.
Safehold (NYSE:SAFE) is an fascinating REIT. We very not too long ago had an replace article by Brad Thomas in regards to the firm, which you will discover right here. He showcased his varied returns over totally different intervals of time – optimistic from 2018, detrimental since 2021, and considerably optimistic, although underperforming, since April of 2023.
My very own final piece on SAFE was revealed again in October of final yr. I’ve a modest place within the enterprise, and I will clarify to you right here why I am shopping for extra – some comparable causes to Brad, but in addition another issues.
Let’s get going.
SAFE stays beautifully protected – here is why and why I am at a “BUY”
SAFE is not the simplest REIT to grasp and requires some in-depth studying earlier than what to anticipate and what the corporate does.
It is a “Land lease REIT”. Not a lot of them on the market, however that is what Safehold does and the enterprise it is in. SAFE is New York-based, it is externally managed (extra on that later), and comes with an fascinating enterprise concept. It is the one public floor lease firm out there at the moment, and it focuses strictly on investment-grade floor lease corporations, so as to improve its security and handle solely an institutional quality-level portfolio.
So what precisely is a Land-lease REIT?
The corporate acquires, manages, and capitalizes on floor leases. On this enterprise concept, the tenants personal their buildings, however not the land that the constructing is constructed upon. The lease includes undeveloped business land that in flip is leased to tenants, given the correct to develop the property all through the lease.
An excellent instance of an organization that makes use of floor leases is Macy’s (M). The corporate’s buildings are owned by Macy’s, together with issues like parking, however the tenant nonetheless pays hire on the land.
Structurally and organizationally, a floor lease is similar to another type of lease. The tenant makes month-to-month hire funds. With a floor lease REIT like Safehold, the leases are internet leases, which implies that tenants assume accountability for taxes, insurance coverage, and CapEx/OpEx all through the lease.
It would not take a lot explaining past this as to why that is a pretty enterprise mannequin. The corporate, in contrast to many different REITs in workplaces, residences, or different segments, additionally would not maintain any large overexposure to anyone space.
The enhancements that may very well be made contain extra publicity to sunbelt and central – however apart from that, that is a pretty mannequin.
The attraction of the mannequin for the tenant is that it would not require the corporate leasing the land to place up large quantities of capital for the land itself. As a result of these leases include very lengthy leasing phrases – not unusual to see over 50 years right here – it allows corporations to basically optimize their capital combine by not having to make use of vital quantities of its personal capital or debt to develop – whereas the homeowners of the lands, the REIT, get vital and long-term security from recurring hire checks. They get a long time’ price of revenue safety and may ultimately, normally manner off sooner or later, gather a lump sum fee for the property.
The tenant may also get entry to land that they in any other case would haven’t any entry to. This is the reason the mannequin is utilized by retail tenants similar to Macy’s, but in addition McDonald’s (MCD) and Starbucks (SBUX).
I am going extra into the varied lease sorts and why landlords need unsubordinated versus subordinated leases from their tenants. However that’s how floor leases work, and why they’re enticing. And Safehold has been rising massively.
Over the previous few quarters, Safehold has been managing fairly nicely. The quarterly outcomes must be taken with a fair proportion of salt, as a result of present prices of the incoming merger with iStar, inc.
There appear to be two methods to view this play. One aspect, the extra bearish aspect, views SAFE as uncovered to what are basically Workplace-type properties in an actual property bubble/atmosphere that’s not conducive to workplaces, as we have seen from the valuations for Workplace REITs. They are saying regardless of the corporate declining considerably in worth, this firm is just not going anyplace close to an upside, and the corporate’s elevated publicity to floating-rate debt along side its merger makes your complete play an unappetizing potential.
On the opposite aspect, extra a optimistic notice, say (and level out) that SAFE lacks the fairness danger of managing actual property – it is a capital supplier with none precise property obligations, making the comparability to an Workplace-type firm or REIT utterly moot. Whereas the leases it holds may very well be mentioned to be beforehand particular to workplaces, it would not dictate that workplaces must be constructed there.
Moreover, any debt danger must be put within the context of its maturities – and these are a few of the longest within the business, at a debt-to-book fairness of under 2x and a complete debt to Fairness market cap of under 2.5x. The common maturities listed here are over 22 years, and no maturities coming due till 2026.
So, as is considerably typical with me, I say that the pessimist is just too pessimistic, and the unbridled optimism is just too optimistic. The reality is, as I see it, someplace in between.
Over the previous couple of quarters, SAFE earnings have been under the forecasted charge. 1Q got here in at ~80% decrease YoY, however after all, this was principally as a consequence of merger prices, which we will internet out. Other than these, the earnings decline was principally a product of accelerating publicity to floating charges and debt load.
Anybody investing in SAFE wants to concentrate on what occurs when financing prices change as a consequence of rate of interest adjustments, no matter lengthy maturities, both as a consequence of float publicity or as a consequence of refis. That is certain to supply some downward stress in earnings, each GAAP and FFO, that might see the corporate go even decrease right here.
Whereas I will not declare that I foresaw the precise nature of this again 1-2 years in the past once I bought my eyes opened to SAFE, I did see the danger in rates of interest, and this induced me to remain out of the inventory till it fell under $26/share. The bubble we noticed in 2020-2022, which ended when SAFE fell from grace and from a share worth of over $60/share was by no means one thing I noticed as sustainable.
Nonetheless, claiming in the identical vein that the corporate’s present debt combine/composition is untenable and can trigger a downfall goes too far. The argument is being made as a result of near-billion in debt that SAFE has placed on an unsecured revolver – not sometimes the ability you’d need to use for that quantity as a result of rate of interest price of such an answer. These latest strikes have left the corporate a bit cash-strapped and with rates of interest going up. We’re seeing notes at over 5%, and one more $100M revolver at LIBOR + 1.5%, which is important on this atmosphere. LIBOR was nicely under 3% a yr in the past, and the corporate’s curiosity funds at the moment are over 6% on common for that barely north of $1B.
If a criticism could be levied on the analysts following SAFE and their forecasts from march-April 2022, is that they anticipated rates of interest to remain the identical, and utterly didn’t forecast this large delta in debt-related funds.
The present rate of interest atmosphere additionally implies that something the corporate tries to do on the debt combine/finance aspect goes to be influenced by present market circumstances. There aren’t any “good” or “simple” hedges to get out of this case, similar to floating to mounted swaps or some refinancings. The dangers financiers take will come at a value, and that leaves me with the next expectation for earnings for the subsequent few years – that they will not be massively rising.
On the similar time, the bearish aspect takes far too detrimental a view and infrequently forgets what the corporate has really achieved – and the way it operates – such because the essential variations in its principal security.
The corporate’s working mannequin entails an AAA-like place within the capital construction, just about immune from the sorts of dangers you see in single-asset CMBS. Even with contractual inflation captures, the corporate’s inflation-adjusted yield is over 6% at 3% long-term inflation.
Bears additionally neglect, or underestimate (in our opinion) the worth of the CARET construction and the worth it gives – each by way of monetization and different considerations. For these unfamiliar with it, the CARET program is an innovation by way of making an attempt to worth future cap appreciation, with CARET unit reflecting unrealized capital appreciation the corporate expects to obtain as soon as leases terminate or expire.
Who would need to purchase these, you could ask?
Clearly, loads of educated traders, on condition that 3% have been bought to institutional traders, similar to sovereign wealth funds and household workplaces that are identified to spend money on long-term strong development and security potential. These holders are entitled to take part in any proceeds above the associated fee foundation as soon as belongings are bought.
The maybe greatest “downside” I see by way of danger is the focus of its land portfolio to Manhattan, which nonetheless makes up round 24% of the corporate’s gross e book worth or GBV. SAFE has been diversifying right here, nevertheless it nonetheless has lots of work to do so as to discover worth in areas that I might contemplate to be “enticing” relative to considerably riskier west and east-coast areas.
Bears additionally characterize the corporate as an workplace landholder – that is false. 44% is Workplace, however multifamily is over 35%. This makes the corporate a diversified holder with a tilt towards Workplace.
The corporate’s sturdy fundamentals, together with its BBB+, give a very totally different image than a few of the bears telling us to not spend money on the corporate want to convey. They’re additionally rated otherwise than a REIT, which can be not coated in a few of the bearish reviews.
Let’s take a look at valuation.
Safehold – The valuation could be very tough
Each time somebody says “Properly, this firm cannot be measured historically“, I are inclined to take about nineteen steps again.
Sometimes, I actually do not belief any enterprise that claims that so as to worth it “correctly”, you must do X and Y.
Why? As a result of there are 100 enticing funding alternatives that don’t require us to take distinctive approaches to one thing so simple as a valuation for a enterprise.
So, perceive that once I say this firm is enticing and could be purchased, it comes with a sure danger profile that can be thought of otherwise than your conventional corporations – and by totally different, I imply increased in some methods.
In terms of SAFE, there’s some sound reasoning behind why it would want some variations by way of its metrics – and a few of the ones are talked about above. The corporate’s debt is sky-high – over 12.5x internet debt/EBITDA. However on the similar time, SAFE has no obligations to its properties within the type of CapEx. The idea is that after that extraordinarily long-maturity debt comes due in over 25-30 years, the compounding nature of its money flows may have completed wonders. It isn’t a incorrect assumption to have both.
As a way to see the protection, you want solely take a look at what the corporate has completed already to enhance its metric. Again 5 years in the past, the payout was 90%+ of internet. That’s now lower than 35% of internet at a yield of virtually 5%.
Submit the merger, and given its difficult peer scenario (no different direct friends exist), evaluating this firm is probably the toughest a part of this text and of wanting on the firm.
We are able to take a look at some analyst estimates. In terms of S&P World, estimates right here put the corporate at round $24-$25/share on common, however given the low protection, I are inclined to ascribe this to a lack of awareness of the corporate’s revenue potential and upside.
That isn’t to say that I anticipate SAFE to return to $60/share or anyplace near it, at the very least not within the close to time period. With the latest internalization of its administration and the method is presently in, coupled with the near-zero years of precise publicly-traded historical past, I are inclined to say that SAFE is difficult to conservatively forecast expectations from – however a 13-16x P/FFO charge, coming to a 2025E of round $29-$33/share appears the baseline minimal of what I might anticipate from the corporate right here.
After I final wrote in regards to the firm, we had been at lower than $26/share, which I seen as fairly enticing with a possible long-term upside within the triple digits. I nonetheless view this as being completely attainable. And I’m removed from alone on this. Right here is the anticipated internet revenue development past the 2023E dip.
And you may see the identical developments in different measures – be it income, EBITDA, EBIT, EBT – seller’s alternative, it is forecasted to rise. The curiosity expense I discussed, that is anticipated to remain at or in regards to the stage it presently is, anticipating administration to type it out at or barely above the degrees we’re presently at, with rising bills as the corporate grows. (Supply: S&P World)
If this seems to be the case, then I consider this to be a catalyst for additional upside. Many analysts have very optimistic targets for the enterprise – upwards of $50/share. If sure optimistic views materialize, that is completely attainable. However I are inclined to view this with a wholesome dose of skepticism and would common it out to a PT of round $32/share, which might nonetheless be a double-digit upside from present ranges.
One other argument, and one well-covered in Brad’s latest article, is insider data and CEO information.
Coupling all of this, I see a little bit of danger and maybe not as unerringly a powerful purchase as for another qualitative REITs on the market – however I undoubtedly see an upside to the corporate.
My place in SAFE is not large – nevertheless it’s within the inexperienced, and I am open to increasing it right here.
I am at a “BUY”, and I give it a present PT of $32/share.
Questions? Let me know!