A New York-based publicly traded real estate firm is embarking on a dramatic strategic shift, selling nearly $500M in properties to finance growth in a niche type of investment it claims will transform commercial real estate ownership.
IStar, a REIT with a market capitalization of nearly $700M, has already reduced its portfolio of land, offices, apartments and hotels from $3.5B to $1B over the last three years. It has now identified 42 assets with an estimated value of $485M that it plans to sell over the next 12 to 24 months, iStar announced Monday.
The move is designed to allow iStar to aggressively grow its ground lease business through Safehold, a REIT iStar manages and in which it owns a controlling interest. Safehold — until recently named Safety, Income and Growth — buys the land underneath a building, called the fee interest, and collects income on a long-term ground lease with the building’s owner.
“We are narrowing our focus to really strategically build around this ground lease innovation,” iStar CEO and Chairman Jay Sugarman told Bisnow in an interview. “We think we are revolutionizing how real estate is owned.” Sugarman is also the CEO of Safehold.
While operating properties and land and development will be de-emphasized, the firm’s lending business will co-originate leasehold loans alongside Safehold ground leases, and its net lease business will continue. Land and buildings are two very different investments, Sugarman said, and separating them is a more effective way to do business.
round leases have burned tenants in the past, and Sugarman knows the company has a stigma to overcome.
“The general perception of ground leases, historically, has been ‘No thanks,’ [but] we are going to change that perception to, ‘Wow, my peers and competitors are using it … I need to pay attention to this,” he said.
While it hopes to reduce its portfolio of legacy assets significantly, iStar plans to keep three projects — with a total value of around $515M — that do not make economic sense to sell. But by the end of the year, iStar is aiming to have reduced that side of the business, which includes the Ilikai Hotel in Honolulu and the 469-unit apartment building at 1000 South Clark in Chicago, from 20% of its portfolio to less than 15%. It has already sold a 60-acre development site, Highpark development in San Pedro, California, and a master-planned community, Spring Mountain Ranch, in Riverside last year.
Reducing those investments frees up human resources and capital to dedicate to locking down what Sugarman calls modern ground leases with real estate owners.
“Right now we are the only one doing it, in conjunction with Safehold,” he said. “It is a reinvention of a business sector that nobody else is involved in.” Sugarman said ground leases have been damaging to value in the past because they often include “fair-market value” provisions, which allow the landlord to hike up rents seemingly overnight because of escalated land values.
The arrangements often require building owners to seek approval from the landlord anytime they want to make a change. Safehold’s leases don’t include such provisions, Sugarman said.
“We don’t have fair market value resets … you know what your rent is going to be for the duration of that lease term, plus or minus a very small margin, so you can plan, your lenders can plan, your future buyers can plan,” he said. “Anything that creates uncertainty is bad.”
IStar launched Safehold in 2017 as the only publicly traded REIT to focus solely on ground leases. Since its initial public offering a little over a year and half ago, the company has built up a $1B portfolio of ground leases. It now plans to grow Safehold’s ground lease portfolio to as much as $5B, Sugarman said.
“The first 18 months, it was us banging on doors, saying ‘We think there’s a way to do this’ … It took us a while to educate the market,” he said. “In about six months we started to get the first customers who said ‘I want to do more with you.'”
Safehold has grown by teaming up with buyers looking to purchase a property. Its first purchase was the land underneath two multifamily properties at Hollywood Boulevard in Los Angeles. Late last year, it joined PRP Real Estate Investment Management to buy the land underneath 1111 Pennsylvania Ave. NW, providing $150M on the $338M purchase. Safehold expects to close on a deal in the New York metropolitan area soon, though the company declined to provide to further details.
To a lesser extent, the REIT also looks to buy existing ground leases — it attempted to buy the fee interest on 635 Madison Ave. last year, but lost the bid to L&L Holding Co., which had right of first refusal — and to approach owners of existing brick-and-mortar buildings and pitch them on selling off the land beneath the structure in the event of recapitalization.
Safehold has closed deals in 18 markets so far, and wants to be in the top 25 cities around the country. It targets most asset types with value of between $15M and $500M.
There are several high-profile cases of ground leases causing major headaches for the tenants in New York City. At the Chrysler Building, for example, the Abu Dhabi Investment Council and Tishman Speyer reportedly paid $32.5M in annual rent to fee interest owner Cooper Union, four times what it paid the year before. Cooper Union has owned the land since 1859, according to The Real Deal, and the ground lease payment will transfer to whoever Tishman Speyer and ADIC sell the building to. The lease expires in 2147.
SL Green pays $4.6M in ground rent to Ashkenazy Acquisition Corp. right now at 625 Madison Ave. — but is likely to see a steep increase in 2022. RFR Realty has faced difficulty refinancing Lever House at 390 Park Ave., which it ground leases from the Korein family. The lease expires in 2023 and rent could increase threefold at renewal.
“The tenant gets screwed coming and going,” Fried Frank Real Estate Litigation Practice Group co-head Janice Mac Avoy said, adding these types of deals are most prevalent in New York City and London. She said many of the ground leases coming up for fair value reset or renewal in New York City right now were signed in the 1960s and 1970s, a time when there had not been dramatic land value jumps. The fair market value is typically assessed on the “highest and best” use of the land — which is often condominiums that ground lessors are not able to build, Mac Avoy said.
“These fair market-value resets have in essence become ticking time bombs,” Cushman & Wakefield Capital Markets Group Chairman Doug Harmon told the Wall Street Journal last month.
But Sugarman said those deals are examples of an outdated model, and real estate buyers and developers are coming around to the idea that modern ground leases are a far more efficient way to build, develop and operate a property.
“In the early 1990s, [we] helped create the mezzanine lending market, and we really did change the way people thought about net leases when we bought the largest publicly traded net lease company and fundamentally changed the way we went about that business,” Sugarman said. “This is an opportunity to do something similar: to take an enormous market and say, ‘We have something better for you’ … The more we transact, the more other people will see it.”
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