Safety, Income & Growth Inc. hopes to gain a lot of ground in the often-maligned ground lease sector. Executives at the publicly-traded REIT believe ground leases have been underused and undervalued components of the commercial real estate industry, so they’ve set out to modernize them.
Since being founded in 2016 and going public in 2017, the New York City-based REIT—the only publicly-traded company that specializes in the ownership and management of ground leases—has closed a number of ground-lease deals for institutional-quality industrial, multifamily, office and hospitality properties, primarily in top 25 U.S. markets like Atlanta and Miami.
Safety, Income & Growth is managed by New York City-based REIT iStar Inc., its largest shareholder.
During Safety, Income & Growth’s second-quarter earnings call in late July, executives reported the REIT’s ground lease portfolio had grown to $631 million, with another $141 million worth of deals in the pipeline. By year’s end, the portfolio is projected reach the $1 billion mark.
REIT Chairman and CEO Jay Sugarman estimates the market potential for the sector is in the hundreds of billions of dollars. (Sugarman also serves as chairman and CEO of iStar.)
“We’re continuing to create and explore ways to create new ground leases,” Sugarman told Wall Street analysts during the earnings call. “We’re seeing ways to open and unlock value for owners…”
In a Q&A with NREI, Sugarman critiques the “outdated” and “very one-sided” ground lease sector, pinpoints how it can be revitalized and offers his outlook on the sector’s future.
This Q&A has been edited for length, style and clarity.
NREI: Why don’t ground leases get more attention?
Jay Sugarman: Ground leases obviously have been around for a long time, but they have not changed or evolved over the last 30 years and, frankly, have become outdated and incompatible with the modern capital markets. In a lot of respects, the traditional or old-fashioned ground leases normally don’t enhance value, but have actually destroyed value. So that’s cast a little bit of a negative perception around the industry.
Ground leases historically were done in a very non-customer-friendly way. Somebody owned a piece of land and said, “You want to build on it? Here are my terms.” We’re turning that on its head and saying that if you really want to make it part of the modern real estate landscape, it has to be a customer-focused business, it has to actually increase the returns of the building owner, it has to be more efficient for their capital. That’s how you can change an entire sector, [it’s] really by rethinking what its purpose is and how it works. To me, it’s a very fundamental need.
NREI: How do you change the mindset about ground leases?
Jay Sugarman: We spent about a year really studying the marketplace. We’ve looked at this industry over a very long period of time and had never quite figured out how to put all the pieces together, and about two years ago we started to see a path to do that.
It came down to a simple idea, that when you own a property, you really own two things, you’re making two separate investments. You’re investing in the building—buying, managing, leasing, designing, constructing, marketing and selling. This is a very valuable skill set that requires a lot of time and attention, and most people are trying to make mid-teens returns on their equity.
That’s paired up with this other investment, which is an investment in the land. The land tends to be a lower-return, low-intensity piece of the puzzle. If you think about the entire history of the capital markets over the last couple of decades, efficiency is all about making sure that everybody owns the risk-reward that they’re really good at owning. We’ve seen it in all parts of the capital markets: There are higher-risk, higher-return pieces and lower-risk, lower-return pieces, and rarely are they owned by the same entity. But in real estate, every time you buy a building, you’re effectively making a higher-risk, higher-return investment in the building and a lower-risk, lower-return investment in the land, and that’s really not very efficient. It needs to be more efficient.
NREI: How big is the untapped market for ground leases?
Jay Sugarman: We think that if we turn it into a customer-focused, value-enhancing, capital-friendly business, there’s a very significant part of the market that should and probably will look at this as a better way to own and operate real estate. If you think about $7 trillion of real estate in the top 25 to 30 markets, we think a significant portion of that would benefit from having a customer-focused, capital-friendly ground lease as part of their capital stack. We’ve slowly but surely begun spreading that message. Once that message gets out, we think this can apply to a big slice of that $7 trillion marketplace.
It’s a small marketplace today. We’re the only public company focused on it, and we’re approaching $1 billion in portfolio size. But we think there are significant multiples of that in terms of the opportunities that are in front of us. We actually think the market opportunity is somewhere in the order of hundreds of billions of dollars.
NREI: What’s in it for property owners when they pursue ground lease deals?
Jay Sugarman: If they’re trying to make well over 13 percent or 15 percent on their equity, what we show them is that if they separate the land from the building and they do exactly the same thing they were going to do when they owned both of them together, they can promise their investors 20 percent instead of 15 percent. In almost every instance under this structure, they make higher cash-on-cash returns, higher IRRs, and we’ve taken away a significant portion of their maturity risk, since we typically do 99-year ground leases.
