Q3 2022 Safehold Inc Earnings Call
[music].
Good morning, and welcome to Safe holds third quarter 2022 earnings conference call if.
If you need any assistance during todays call. Please press star Zero, if you would like to ask a question. Please press star one that's.
One to ask a question.
As a reminder, today's conference is being recorded at this time for opening remarks, and introductions I would like to turn the conference over to adjacency Senior Vice President of Investor Relations and marketing. Please go ahead Sir.
Good morning, everyone and thank you for joining us today for safe holds earnings call on the call today, we have Jay Sugarman, Chairman and Chief Executive Officer, Marcos Alvarado, President and Chief Investment Officer, and Brett Atlas Chief Financial Officer.
This morning plan to walk through a presentation that details our third quarter results. The presentation can be found on our website at Staples, Inc. Dot com and by clicking on the investors like there'll be a replay of this conference call beginning today at two P M Eastern time and the dialing for replay is 877.
8140.
010, with the confirmation code of 46957.
Before I turn the call over to Jay I'd like to remind everyone that statements in this earnings call, which are not historical facts may be forward looking.
Actual results may differ materially from these forward looking statements and the risk factors that could cause. These differences are detailed in our SEC reports.
<unk> disclaims any intent or obligation to update these forward looking statements, except as expressly required by law.
Now with that I'd like to turn it over to Jeremy to Chairman and CEO , Jay Sugarman Jay.
Thanks, Jason Thanks to everyone for joining us today.
The third quarter was marked by two important events with opposite impacts unsafe hold.
Our announcement of an agreement with <unk> to create a better platform for expanding our modern ground lease business with a strong plus on a number of fronts.
And address several key constraints in the minds of equity and debt investors.
Unfortunately, the third quarter was also a period of historic volatility.
Interest rate and credit markets.
The impact on stapled share price has been painful.
Higher rates and spreads will impact both asset and liability pricing.
While we remain focused on expanding our footprint through this period.
We're also willing to be patient for markets to eventually stabilize and.
And we believe the impact on our share price and future projected rate declines and less volatile markets should be quite favorable.
In the meantime, well worth to highlight that while the contractual cash flows from our $6 billion ground lease portfolio are certainly impacted by higher discount rates for assets with a similar credit profiles.
Also need to continue drawing attention to the benefits, we're now below market long term debt.
Trachsel inflation kickers in many of our assets.
And our portfolio of embedded capital appreciation, but over the long term will act as a powerful inflation hedge.
We've included a few updates on carried in the deck.
It remains an important catalyst for our long term vision.
And we're pleased to continue taking small steps in the right direction and pointing towards success.
Okay, let's turn to the quarter with Brent Marcus Marco.
Thank you Jay and good morning, everyone, let's begin on slide four.
As a quick recap of the merger, we announced during the quarter Safe Holden I Star reached a definitive agreement to combine their businesses to create the largest and only self managed pure play ground lease company in the public markets.
This transaction should achieved several goals for new stapled.
First we believe new staples will be better positioned for its next phase of growth by putting into place a more efficient and stable long term cost structure as.
As opposed to the costs, we would incur with the existing externally managed architecture.
And as new safe scales over time, these potential cost savings become more substantial.
While we acknowledged the disruption in the capital markets has had an impact on everyone's cost of capital. We believe over the long term new safe should have enhanced access to capital by addressing many of the concerns around governance, we've heard both from debt and equity investors along with the rating agencies.
Notably this new transaction will significantly increase our free float, which should allow us to broaden.
And diversify our shareholder base and create greater liquidity and access to our company.
And finally, we are excited about bringing in MST as a strategic investor.
At merger closing MST will become one of the largest investors in new safe and the largest third party investor in carrot.
Our next step is to file our proxy statement with the SEC, which will subsequently goes through the SEC approval process.
We are presently well into the documentation drafting process. It is not yet completed and so we will be limited to what we can say today regarding certain specifics of the merger transaction until the proxy is filed.
Moving on to slide five we provide highlights for the quarter.
During the third quarter, we delivered strong earnings driven by new investment activity as well as the gain from the sale of one ground lease, which we recently announced.
Brett will discuss this in more depth, but this sale demonstrates the power and value of owning high quality land.
As we often say internally, it's not always what sits on top of our land today, but rather with someone envisions in the future. We're excited about being able to recycle the net proceeds from the sale of Accretively, while simultaneously, creating a positive data point for care.
Additionally, originations during the quarter continued to grow both the portfolio and UCA and we ended the period with ample capital sources to fund our pipeline.
With that let me discuss our investment activity on slide six.
During the third quarter, we originated six new ground leases totaling $284 million across the six ground leases, we funded $255 million and expect to fund the $29 million unfunded balance in the near term. Additionally.
Additionally, we funded $48 million associated with prior ground lease commitments.
The six new originations were all multifamily properties spanning five different markets.
The new ground leases originated during the quarter generate a weighted average yield of five 8% assuming zero percent inflation, which is approximately a 30 basis point 30 basis points higher than the five 5% yield for the deals we closed in the second quarter also with the zero percent inflation assumption.
The credit metrics associated with these investments are in line with our targets with a ground lease to value of 37% and rent coverage of three times.
As rates continue to rise over the last few weeks and the recent pricing is in the mid to high 6% effective yield range before our inflation look backs.
Base rates and credit spreads move we continue to monitor and shift pricing that works for our customers and for our business.
It's our belief that creating ground leases at the current market levels will lead to significant long term value creation. However.
However, given the volatility in the capital markets, we expect a slowdown in originations in the coming quarters as assets in the private markets re price.
Slide seven provides a snapshot of our portfolio growth for the quarter.
We hit another milestone with our aggregate portfolio crossing the $6 billion threshold ending the quarter at $6 1 billion, representing 18 times growth since our IPO.
The six institutional quality multifamily assets, which we originated during the period can be seen on the right side of this slide.
And with that let me turn it over to Brett to go through the financials right.
Thank you Marco and good morning, everyone.
Continuing on slide eight let me detail our quarterly earnings results.
Revenues were $71 7 million for the third quarter net income was $66 1 million and earnings per share was $1 <unk>.
However, it should be noted that the third quarter of both periods included onetime gains associated with ground leases and this year also included costs related to the merger transaction excluding.
Excluding those items net income for the third quarter would have been $25 5 million an increase of 40% versus the same period last year and earnings per share was <unk> 41.
20% above the 34, we earned in the prior year period.
Slide nine provides more detail about the sale of a ground lease during the quarter.
As we previously mentioned during the third quarter, we sold a ground lease in the Washington D C MSA for $136 million.
We were not actively marketing this property rather the buyer came to us with a compelling unsolicited offer at a price, 77% above where we purchased the ground lease approximately two years ago.
After evaluating the software with our board of directors, we felt that the negotiated price represented an attractive value and agreed to the sale.
Based on Staples, 83% ownership in carat, we recognized a $46 4 million gain.
Additionally, say foldable net $126 million cash proceeds from this transaction, which will be reinvested in creating more value for our stakeholders.
On slide 10, we detail our portfolio's yield under several inflation scenarios.
As we've previously discussed the market generally values, our cash flows relative to long term high grade bonds and what we've seen year to date is a high correlation between our stock price and the yield on those notes.
As our benchmark discount rates have moved higher.
It's been a corresponding decrease in the present value of our contractual cash flows and by extension and our stock price.
However, this does not take into account that our cash flows are not fix at 95% of our portfolio has some form of inflation protection built in thereby creating a positive correlation between portfolio cash flow and inflation.
The current portfolio generates a cash yield of three 3% and an annualized yield of five 1%.
However, these metrics presume a zero percent inflationary environment for the duration of our ground leases.
If you take into account the latest long term inflation expectations of $2 two 7%.
Our inflation based rent increases will push the portfolio yield five 7% if.
If inflation drops back down to 2.0% for the next 99 years.
Our portfolio will yield five 5%.
And if it moves up to 3.0% our portfolio will yield six 1%.
This additional yield significant when compounded over the long duration of our ground leases and it's an essential calculation for investors the price into value our stock appropriately.
Additional portfolio metrics can be seen on slide 11.
At the end of the third quarter, our portfolio has a weighted average ground lease to value of 40% and a weighted average rent coverage of three nine times.
By book value. The portfolio consists of 45% office, 35% multifamily, 12% hotel, 5% life science at 3% mixed use another.
By asset count the portfolio is comprised of 66 multifamily ground leases 36 office.
<unk> hotel.
<unk> life science, and five mixed use and other.
Our weighted average lease term is 93 years.
On Slide 12, you can see the geographic breakdown of the portfolio as we continue to expand our nationwide footprint.
We have 35 ground leases in the West 29 in the southeast 22 in the northeast 22 in the mid Atlantic 14 in the southwest and six in the Central region.
Moving onto slide 13, we provide an overview on our capital structure.
At the end of the third quarter, we had $3 8 billion of debt comprised approximately of $1 5 billion of nonrecourse secured debt $1 4 billion of unsecured notes and $272 million of our pro rata share of debt on ground leases, which we own in partnership.
Our weighted average debt maturity is 24 years.
In addition, we had $630 million drawn on our unsecured revolver combined.
Combined with cash on hand, we had $756 million of liquidity at quarter end.
We are Levered, one eight times on a total book to total debt to book equity basis and.
And the effective interest rates booked on our non revolver debt is three 7%, which is a 138 basis points spread to the five 1% annualized yield on our portfolio.
The portfolio's annualized cash yield is three 3%.
<unk> basis point spread to our three 2% cash interest rate.
Notably during the quarter in response to our combination transaction with I start Moody's upgraded say false positive outlook.
Opening the path to a potential upgrade to become an a credit as we continue to deliver on the benefits and value of our franchise.
On slide 14, we present, an update on estimated UCI.
Including the sale of a ground lease during the quarter the estimated value of all of the unrealized capital appreciation above our cost basis grew to an estimated $10 5 billion.
$597 million increase from our last update at the previous quarter.
Waiting to an 80% compound annual growth rate since our IPO in 2017.
That being said it is worth noting that cbre's appraisals, which for each asset are completed on an annual basis do not yet fully reflect potential impacts from higher rates for an uncertain economic backdrop on commercial real estate values.
As a result, we could see quarterly fluctuations in this balance strip commercial real estate values reprice.
The assets that sit on top of our land consist of approximately $32 7 million square feet of institutional quality commercial real estate located in the top markets throughout the country comprised of $14 4 million square feet of multifamily $13 2 million square feet of office.
$3 8 million square feet of hotels.
100000 square feet of life Science, and 700000 square feet of mixed used in other property types.
And with that let me turn it back over to Jack Jack.
Thanks, Brett.
I think we can go ahead and open it up for questions operator.
Okay No problem at all I will now read the instructions for asking any questions.
Please press star one on your phone keypad, if you wish to ask a question we will take as many questions as time permits once again. Please press star one to ask a question it will pose a moment to assemble the roster.
Thank you. Your first question is coming from Anthony <unk> from J P. Morgan Anthony Please ask your question.
Yeah. Thanks, good morning.
I guess my first question is can you talk about just how much of the change in interest rates and discount rates was reflected in the deal volume in the third quarter or where we should expect those to go as we look at Mexico quarters.
Marcos.
Yeah, Hey, Anthony I don't think the third quarter volumes fully reflect the slowdown I think our anticipation.
Is that we will have slower origination volumes in the coming quarters.
The private markets re price.
And as hopefully some liquidity comes back in the system. So I don't think.
Youll see us in Q4 Q1, hitting the swap these volumes.
Yeah, I'm, sorry, I guess, maybe I was unclear on the question I'm just trying to think through.
What looks like about a call it 4% cash yield 6% IRR on the deals in the third quarter, what does that number look like in the next couple of quarters I'm guessing some of that activity was may be entered into before some of sort of the bigger moves in rates in the last couple of months.
Yeah.
Sorry about that Tony I misunderstood. The question I think pricing today is as I said in the.
My remarks is probably in the kind of mid six range.
But we do expect volumes to slow down.
So call it four and a half cash six five IRR.
But probably on lower volumes going forward.
Okay, and where do you think your your incremental debt costs are I mean, we could see kind of where your bonds trade, but I don't know if you have access to other instruments or how youre thinking about.
Financing on that side and also just general capacity.
Given kind of where the balance sheet is today and cost of equity.
Yeah, I'm happy to take that it's Brett pay Tony.
Yeah, when we look at our existing.
That cap structure, I mean right now it's.
Yes, we have $3 billion, plus that's 100% fixed rate termed out.
Three 2% cash rate.
So it's certainly a low cost I think what you've seen us do more recently is.
Some more structured unsecured issuances.
Keeping our cash costs lower.
And from an effective standpoint, obviously, we've all seen.
Or or REIT or single, a or triple b credit spreads widened so the cost of debt that we do see on the screen is.
Wider than what wed like but I do think we've been able to show that.
Especially as you point out using other liquidity tools or even what we've done this year in the private markets have been able to price.
Inside of what is on the screen.
We're at a moment here now where we're going to let our.
Credit story and the momentum we have.
Exhibited here over the last couple of years within both sides of the balance sheet.
Work itself out as the market finds equilibrium.
But we have lots of tools at our disposal for sure.
Okay. Thank you.
Thank you very much. Your next question is coming from rich Anderson from <unk>.
Rich please ask your question.
Rich I'm not sure if you're on mute.
Sorry about that.
Good morning, everyone first a potentially.
Perhaps ignorant question I'm famous for these but I think it might be on the minds of people the carrot.
The asset sale and you know a portion of that going to carry it. If this is a transaction involving land and the carrot.
<unk> is an entity that monitors the value of the lease hold on top of the land why would a gain on the land be a carrot event.
Okay rates are showing up so go ahead Jay.
Yeah.
Third as a mentor.
I meant to capture the capital appreciation above the bond economics.
The underlying cash flows.
So we really do think the embedded values reflect two.
Two different components, one is the cash flows contractual.
Inflation protected.
Capital appreciation, we're building up which can be realized in a number of ways.
In this case somebody was willing to pay.
A significant premium.
And so we think there are two assets that can be monetized inside of safe hold.
The best way to capture them as could be really clear on what each is one there's a bond women's capital appreciation. This was an unusual one off I don't this is not something that's going to happen very often but it does highlight a couple of key things.
It shows a lot of the embedded value.
But we think people are completely undervalued the capital appreciation component.
Right now it looks like.
Our shares are very much pricing Josephine.
The contractual bond cash flows.
So we think can help to highlight.
The two components.
As you know, we're trying to capture that larger second component.
Fundamentally separate ways.
And so capital appreciation.
And.
Bonds will be kind of highlighted a separate investment in this one we're really highlighting the capital appreciation possibilities in the portfolio.
Okay.
Maybe off maybe we'll take it offline, but the carrier is not only is the value that $10 5 billion is not just the.
Yes.
Is that just the the the assets are top to land, but if you have an event where the land Depreciates. Then that's also a carrot event as is.
Obviously, that's that's that answers correct, but I mean, I guess I don't know that that's abundantly clear to people listening to this call.
Okay, well look we've just begun talking about Karen I think so.
Again its capital appreciation.
Hum.
We're going to make it as clear as possible in these documents that you'll see coming out.
So I think the rules of the road will be really clear I think this was an unusual opportunity.
But I think if you see what comes in our filings.
Well it'll be clear, how we and Dell and somebody other investors in carrot.
See how to monetize this.
<unk>.
Very large embedded value, we think existing table.
Okay, and then on the actual transaction itself I know, it's a one off ish thing that you don't expect but you know the the purchaser you know it's sort of a reverse inquiry event for you.
Is <unk>.
Put it pretty low cap rate, even you know even when when the deal was it was.
With announced relative to what was going on in the macro environment. I mean do you have any idea what the what the game plan is there for this investor and why they would be willing to take such a small return in in light of what's going on around.
You know around them.
Yes.
Sure.
We always say, we try to find landowners.
The valuable sometimes it's.
By virtue of what's around it sometimes it's by virtue of where it is in the city.
Hum.
Strategic land.
A lot of different value to different people, we think when there's compelling.
Compelling.
Dynamics.
Surrounding a piece of our land, we can capture value lots of different ways.
Certainly one of those.
So this was not a just a random third party investor. This is somebody who had a long term vision.
Fair enough last question for me.
On slide 15, there's a footnote that says subject to carat modifications.
I'm wondering what those potential modifications might be and in the case of M. S. D are they still getting safe stock at $37 or is that being adjusted in light of the market. Thanks.
Yes, theres been no proposed changes.
Clarifications and modifications, a carrot or really the next step two.
The vet with a third party investor how to make this valuable asset we believe it is.
You can see those in the proxy and we think they are in another.
Step forward and giving people a clear vision of how we're going to capture this value for them in a unique way.
We think it's a.
Valuable asset, but more than that we think are.
Its something that once people have clear clarity around how it works well and certainly delta.
Work on this so I think we're in.
The point.
Point, where.
We can answer all the questions that I think you and others have had with a lot more.
Clarity and a lot more view towards how we're going to get this.
Our value capture per stapled shareholders.
And on the MST question.
Are they still getting Jim say stuck at 37 Bucks.
Yes, nothing has changed.
I'll just tag that nothing has changed as it relates to any of the merger documents. Okay wonderful thanks very much guys.
Your next question is coming from Stephen laws of Raymond James Steven Your line is now.
Hi, Thanks, Good morning, Jay touched on this a little bit but wanted to follow up on the on the sales as we think about.
The portfolio seasoning over time, I mean, how many of these sales do you think we'll see annually does it does it depend on cost capital elsewhere versus.
Recycling and harvesting gains how should we think about that more on up.
Medium term annual type basis.
Yes. This is not part of our business plans are just to be clear.
When we are presented with opportunities to recycle capital and do so we think it's a highly accretive way we will certainly consider those.
As you know, we think you know ground leases or.
Yeah.
Something that's just beginning to be understood by the market and customers. So.
We're not really planning to turn around and turn the portfolio that was never part of the business plan.
But we're thoughtful about capital I'd just caution everybody. This was a fairly unique set of circumstances. So it's not part of our core business plan.
Great.
To the core portfolio on that you know you look at the Q3 volumes all multifamily Q2, I think it was five investments from five different property types, but can you talk about how pricing is on different types of collateral how how youre viewing things is there a risk reward that makes office more attractive in some scenarios.
Or maybe some stress there that would push those those people to look for other ways that they havent considered previously like ground leases for liquidity in capital maybe some sum up.
Our updated thoughts on those topics.
Mercury.
Good question for you.
And so naturally you can sort of see where there is liquidity in the market, but through kind of the asset classes that we originated in Q3 and in Q2.
There is still lending going on in the multifamily space.
So we're able to capture.
Some share with our existing customers and new customers in the multi space.
As you start to kind of go to the some of the other asset classes. There is a fair amount of illiquidity.
And you're sort of at the beginning of this what I would call. It re pricing of the assets and I am not saying that the assets haven't repriced in the multifamily space, there's just a little bit better clarity there.
So we have selectively looked at some office assets that are infill at the right basis.
But ultimately those transactions.
Haven't come together.
So I think you'll see us continuing to question in the multi space in the coming quarters.
Great. Thanks Marcos.
Your next question is coming from Spenser I'll away of Green Street Spencer. Please ask your question.
Oh yeah.
Coming back to the slowdown you cited in the transaction market how confident are you guys.
Cheating or investment targeted at $7 5 billion portfolio by the end of 'twenty three.
Yes.
I think where the.
A moment, where we should be patient and thoughtful here.
<unk>.
Certainly one of the most difficult markets we've seen.
I think we are.
Well trying to be heroes here. We think this is another moment, where we're going to prove.
Went through a lot of our customers why it makes sense to have long term locked in capital for their land.
We think it's going to help a lot of our customers move through this period in a in a fundamentally better way.
Then somebody alternatives that they might have.
Oh, well otherwise considered so.
I think we're going to be patient and thoughtful with our customers.
There's certainly going to be demand.
Little bit of it dependent Spencer all of our cost of capital or access to.
What we think is appropriately priced debt and equity, but I don't think we're going to.
<unk> told.
We don't think we can meet that number but I'd also tell you, we're being thoughtful and patient here because these markets.
Drawn from volatile to extremely volatile.
We have quite a line of sight, we've had before.
Okay that makes sense, so if I'm understanding correctly too I mean, it seems as though you might not be as aggressive then perhaps spreads tend to be kind of a little bit more attractive again, considering disney are quite considerably in recent quarters.
Yes, I think we have to look at both sides of the equation, where our customers are transacting Tam they transact.
Mark as you know it was likely to be some slowdown here as the overall markets transition to this higher short term rate environment.
Brendan talked.
<unk> talked a lot about how we're trying to match our liability structure to our asset structure.
That's a process we have done some really.
Our innovative structure deals, but we're still early in that process.
We don't like where our share prices.
That's a factor as well so I think we're just we're looking at this market certainly as we go into the end of the last two months of this year.
I'm thinking it's.
Why is to be patient here and we're in the middle of a merger we need to get.
That worked through.
So.
The business is going to be here.
We want it to be we know we're providing a solution.
Our solution that lots of customers want.
So we just need to get things the lineup on our side and when it when they do we will continue to be.
The best provider, whose modern ground lease capital.
And then maybe just one on ranked comprehends three two acquisitions that you know it was around three times what.
Which I believe was the lowest we've seen in the portfolio can you just remind us of where your cut off.
And in terms of rent coverage and how youre kind of thinking about that in terms of your positions.
<unk>.
Hey, Spencer I'll take that.
Generally.
That three threshold high twos is probably as low as we'll go.
We always quote you everything on a blended basis historically the multi.
Assets.
Been closer to that lower three level range and other assets with potentially more volatility hospitality and office are wider which sort of push up the overall averages.
So I think it's still consistent with our with our benchmarks also when we cite coverages, there either TTM or our underwritten coverages.
And as you would know better than I do the some of the inflation numbers that are ripping through the rental market.
Should increase that coverage overtime.
Okay. Thank you guys.
Thank you very much. Your next question is coming from Jade Rahmani of K B W. Jade. Please ask your question.
Thank you very much I was wondering if you could give your view as to how much commercial real estate prices will decline and what implications there are for the value of Cabot in that scenario.
Yeah look Mark was probably can give you.
On the ground viewpoint, I think again long term we looked at.
Uh huh.
Hard assets are generally are positively correlated with inflation over long periods of time.
That in the short term.
Disrupted by the correlation between inflation rate.
And interest rates so.
As we see the rates moving much higher.
Clearly going to have an impact on financing cost, which is going to have an impact on cap rates.
Hum.
Team.
15%, 20%, 10% various people who have come out and said look just.
Take the impact of.
Interest rates on values.
Depending on the asset class and the growth of revenues.
People are coming out with some.
Meaningful.
Meaningful declines.
In the short term.
I would caution you Karen has always meant to be a long term compound or a well.
And what we have seen over long periods of time.
Inflation replacement cost.
He's a very good predictor of long term value in these core infill urban locations that we tend to focus on.
So I can't tell you there won't be.
Moments in time during carrots growth, but there will be blips, but as you've seen and I think in the first.
Couple of years.
Hum.
Growth from both the internal and external.
Give us quite a bit of confidence that over any meaningful period of time.
Carriage trajectory will continue to be a very positive one.
Yeah, just add to that I'll give you some direct data points in the multi space because we've obviously closed some transactions.
This is a rough estimate, but roughly 15% down.
On the multi space on the new originations.
From where kind of the <unk> work.
At the beginning of the year on.
I'm not going to say that.
Across every single asset, but that feels like a good benchmark, we havent seen a fair amount of office trades as you know.
So so much liquidity in that asset class.
And sort of buyer sellers.
At somewhat of an impact, but Brett Brett alluded to this.
We appraise our assets on an annual basis.
So we do expect some some down decreases, especially in the in the office portfolio.
As the year progresses.
Thank you very much.
The merger is there anything in the capital markets pricing dynamics that could change the construct of the merger. It seems to me that with the shape and structure of borrowing costs. Today I started liabilities could have potentially more value than what was contemplated when the merger was conceived.
Have any comment on that thank you very much.
Oh, that's a good thought Jay we have no proposed changes at this time I am sure. The special committees are both watching the markets.
At this point there's.
Theres nothing to report.
Thank you.
Thank you very much Mr. Sandra P.
To be no further questions.
Sounds good.
Any additional questions on today's earnings release, please feel free to contact me directly.
Jenny would you please give the conference call replay instructions once again.
Absolutely no problem at all.
<unk>.
The replay.
You need to call.
7481.
Zero, one theorize with confirmation code.
All 6957.
I repeat 8774814.
010 confirmation code 4695.
The replay will be available at two P M eastern time today.
You very much ladies and gentlemen, this does conclude the conference call. You may disconnect. Your phone lines at this time and have a wonderful day. Thank you for your participation.