Tuesday, April 11, 2017

Safety, Income & Growth Inc: iStar's Ground Net Lease REIT

This is a pretty ridiculous name/logo right?  It's pretty clear the target market is yield hungry dividend investors who are looking "to sleep well at night".
Despite the awful name, I think iStar (STAR) has a chance to make this work (for iStar) as its a good sales pitch and would be a unique REIT in the market, plus they're selling 12 of their assets for $340MM or a ~5% cap rate.

This week, iStar filed the registration statement for a new REIT, Safety, Income & Growth Inc (SFTY), they've been kicking around quietly since last August.  According to the filing, it would be the first REIT targeted at ground net leases, a structure where the company would own the land, but not the building/improvements, and enter into very long term leases (30-99 years) with the building owner.  The safety part comes from the ground net lease structure, in the event of a default, despite only owning the land, the lessor can foreclose on both the land and the structure built on it.  The leasee and the mortgage lender (if there is one) on the property have every incentive to make the lease payment.  In effective, there's a significant overcollateralization built into the lease, the value of the lease is worth 30-45% of the combined value of the land/buildings, so often times in a foreclosure scenario a ground net lessor can make more than a full recovery.

At first I thought this was a public listing of the net lease JV iStar has setup with a sovereign wealth fund (GIC), however it appears to be a separate portfolio, but with investors in that fund participating in the SFTY IPO.  Safety, Income & Growth Inc will start out life with 12 assets from iStar's net lease portfolio, all 12 are either ground leases or at least look/function similarly if you squint.  The two primary assets will be One Ally Center which is the largest office building in Michigan, leased out to Ally Financial and PwC, and a portfolio of 5 Hilton branded hotels leased to the recent spinoff, Park Hotels & Resorts.
A good strategy in recent years has been buying net lease REITs that are discounted because of concentrated tenant exposure (GPT, FCPT, CSAL)  before they make deals to diversify their rent roll.  iStar says they're looking at a pipeline of over $500MM ground net lease deals, so expect them to diversify fairly quickly after listing.  They're starting with $227MM in debt at a rate of 3.773%, after the deal is done they'll enter into a new $300MM credit facility giving them additional room to add ground leases.

iStar will be the external manager of SFTY, it'll have one of the more unique external management agreements I've seen: 1) waiving their fee altogether for the first year, 2) no incentive fee or termination fee, 3) base management fee of 1% on equity up to $2.5B and 0.75% above, 4) the management fee will be paid in stock.  Granted, there's little work in managing a lease that expires in 2114 (doesn't even look like a valid year), but it's another reason this entity should be an easy to sell to the masses.

Safety, Income & Growth is paying about a 5% cap rate for iStar's assets (combination of cash and stock), the company argues that ground net leases should trade even lower than that:
This seems somewhat reasonable given the overcollateralization built into the structure, if it trades anywhere near a 4.5% cap rate, iStar should be able to source a lot of deals that make sense, especially early on when they can do small individual deals that still move the needle.

We're still waiting on an IPO date, but again, I think this has potential to do well and gather a decent amount of assets.

What does this all mean for iStar?
At year end, they had a $1.5B net lease portfolio (includes accumulated depreciation added back) that generated an NOI yield of 9.1%, in my initial post last summer I argued the net lease portfolio should be valued at 6.5% cap rate, which adds about $600MM mark-to-market above the carrying value on iStar's balance sheet.  It's probably incorrect to assign a 5% cap rate to the entire portfolio, but that would produce a $1.2B mark-to-market gain, quite significant for a company with a market cap of $1B.  But now iStar monetizes some assets at an attractive valuation by putting them in a simpler vehicle the market will be able to digest and assign a higher multiple to -- all while earning a (small) carry on their remaining investment going forward.  It's hard to argue iStar is anything but very cheap, hopefully they use some of the proceeds to buyback stock.

Thanks to the commenter in the original iStar post for bringing this deal to my attention.

Disclosure: I own shares of STAR

13 comments:

  1. When you say that iStar is the manager of the new entity, are we referring to our REIT iStar, or to the external manager of that entity. In other words, does this management fee accrue to us or to Jay Sugarman?

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    1. iStar is an internally managed REIT, the new entity will be managed by iStar, so the management fee accrues to iStar the company, not Jay Sugarman personally.

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  2. you waste no time! I have been following iStar as I consider Sugarman a master of sorts with out he managed capital allocation through the crisis. I still struggle to see a favorable risk / reward on the STAR business given liquidity/leverage levels but this newco is interesting. It is a way to sort of revalue a portion of the book to a higher multiple while receiving cash flows to delever but struggling to quantify benefit at Star. Any thoughts? See analysis here

    https://twitter.com/IveBeenHad/status/852176539429023744

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    1. You view STAR as a forced seller? Seems harsh or a mischaracterization of their situation in my mind. I do like that they're a seller generally, seems like the right time in the cycle and would help unveil the value. But given they have access to the capital markets -just recently refinanced their term facility like everyone else - I think they can be more opportunistic.

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  3. Maybe forced seller is too harsh a word but liquidity this year is tight while timing of cash flows from development book is lumpy. Interest expense alone consumes up nearly their entire cash income from the "stable" assets including pref. payments. Cash G&A adds another $80 million plus guided capex of $100M+. I realize prefs can be deferred but still looks harsh. The gap needs to come from land production, remaining condos, and asset monetizations from its existing stable book (e.g. net leases).

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  4. Agree maturities this year are a concern and will require some monetizations but should be manageable.

    This should help a bit:

    http://www.bizjournals.com/southflorida/news/2017/04/10/lennar-to-restate-earnings-after-losing-140m-to.html


    Plus, sale of Apple Silicon Valley GNL for total of $75-$100 million in total (~$35 million GNL to SFTY) should also help.

    -KH

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  5. any idea when istar will reinstate dividends? and how much?

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    1. No, but I would be surprised if it was any time soon.

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  6. any idea with all the recent transations, settlements and spin off, what's the leftover NOLs carrying over? And do iStar shareholders get any new shares for the GNL?

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    1. The latest NOL number in the 10-K was $902.9MM.

      Shareholders won't get shares directly, its not a true spinoff, iStar has created a new entity and is selling some of their assets into SFTY. As part of the transaction, iStar is receiving some stock in SFTY, so shareholders will indirectly benefit that way if its well received by the market. There's a part of me that is interested in SFTY if it trades cheaply initially, might take a little time for the market to warm up to the idea.

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  7. Hey MDC, I love the write-ups. Very interesting stuff. Any new thoughts on DFIN? Thanks!

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    1. I'm still holding DFIN, it's pretty clear they were completely unprepared for the spinoff and operating separately, management has been all over the place on expense guidance and that Form 10 bothers me a bit, misleading how much of their revenue was really recurring in nature. But the IPO market seems to be picking back up, so maybe they have a bounce back year on the transactional side of the business, its cheap and all of the near term cash flow is earmarked at debt reduction which I view as a positive. Thanks for reading.

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  8. isn't istar's leverage low? 2x? many reits out there are way more leveraged. and they are profitable, no? a bit confused from comments. If it wasn't for their NOL's, they would be paying dividends now? they only issue now is the remaining land porfolio which has improved a lot.

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