Safehold: A Quintessential 'Pandemic-Proof' REIT

Oct. 26, 2020 7:00 AM ET

by: Brad Thomas

Summary

Since we initiated a Buy rating on Safehold, shares have returned 99% annualized.

I am glad that I jumped on the Safehold train when we did, as shares have returned 124% annually since we made the initial investment back in August 2019.

If there’s one REIT to own during a global pandemic, it has to be Safehold!

We first began touting Safehold Inc. (SAFE) back in February 2018, when I explained in an article titled "Crack Open The SAFE":

“After speaking with Jay Sugarman (SAFE’s CEO) and taking a closer look at SAFE we are initiating a BUY rating. We believe this REIT is trading at a modest discount and we consider $16.50 a reasonable Fair Value Target. We will include SAFE in the “Other” classification within the Intelligent REIT Lab.”

(Source: Koyfin)

To be clear, since we initiated a Buy rating on SAFE, shares have returned 99% annualized. And in October 2019, in an article titled "Safehold: The Ultimate Sleep Well At Night REIT," I explained:

“Although the dividend yield of 1.84% appears paltry for a REIT, the growth potential is compelling. It’s forecasted for 25% in 2020 and 20% in 2021.

The economics of the business model are driven by the most durable income generators in the real estate sector – with rent growth of 2x inflation. And at some point, the residual value will provide icing on the cake. Just remember: You’re buying an AAA bond in a REIT wrapper. Here’s to sleeping well at night!”

(Source: Koyfin)

As I reflect on the success of our Small Cap REIT portfolio, that has returned an average of 28% per year since April 2016, I am glad that I jumped on the Safehold train when we did, as shares have returned 124% annually since we made the initial investment back in August 2019.

(Source: Sharesight)

When you look at the company’s year-to-date performance (below), you would not even know that we’re living in the midst of a global pandemic:

(Source: Koyfin)

And the more I ponder Safehold and its uniquely positioned business model, I began to realize that this misunderstood REIT could be the only pandemic-proof REIT in the world.

Just take a look at its year-to-date performance, compared with other well-known stalwarts such as Realty Income (O), Digital Realty (DLR) and Prologis (PLD).

(Source: Koyfin)

And over the last 5 years, the performance is simply stunning (see below)!

(Source: Koyfin)

I was curious as to whether Safehold had outperformed two other iREIT recommendations - Innovative Industrial (IIPR) and Hannon Armstrong (HASI) - and as can be seen below, this pandemic-proof player once again demonstrates that it deserves that (pandemic-proof) title. SAFE has outperformed IIP and HASI year to date.

(Source: Koyfin)

So now that my curiosity is increasing (and hopefully yours too), it’s time to take a deeper dive and determine whether or not Safehold is the quintessential pandemic-proof pick.

(Source)

The Business Model

I spotted this very interesting quote by Charles Pryor (published in 1928) on the SAFE website:

The lessor desires to see his property improved, and yet he makes it as easy as possible for the lessee to make the improvement, for the success of the one means the success of the other as well.”

That, my friends, is the value proposition of the ground lease. As I pointed out in my article from February 2018:

“there are good reasons why a ground lease is advantageous to all parties involved.

Perhaps the biggest advantage for tenants is that a ground lease provides access to well-located land that otherwise could not be bought. This is why ground leases are widely used by many big retail tenants such as McDonald’s, Chick-fil-a, and Starbucks.

Another advantage of a ground lease is that the tenant does not have to come up with the upfront cash required to purchase the land in a deal. This lowers the upfront equity required in an investment, freeing up cash for other uses, and also improving the yield.”

As a developer, I have constructed numerous buildings on ground lease contracts, and I have found them to be extremely useful. But there are also benefits for the landowner, as the “ground lease provides a stable income stream typically from a creditworthy tenant, while still allowing the landlord to retain ownership of land.”

One extremely important benefit for the landowner, and SAFE as I will address in this article, is the fact that “ground leases normally have a reversionary clause, which transfers ownership of the improvements to the landlord at the end of the lease.”

The Most Powerful Benefit

As a REIT, SAFE makes real estate ownership more efficient, as the unique vehicle provides three distinct advantages to building owners:

Better capital efficiency
Better cost efficiency
Material risk reduction

These three ingredients enable building owners to generate higher returns, avoid unnecessary transaction costs and significantly reduce maturity risk in their capital structures.

SAFE has provided ground leases during the development phase, at the point of refinancing/recapitalization and during the purchase or sale of a property.

While one ground lease can offer up to 99 years of increasing and compounding cash flows, Safehold is building a portfolio of ground leases around the country underneath some of the highest-quality office buildings, apartment buildings and hotels.

As you can see below, SAFE’s portfolio is well-diversified with a total of $1.9 billion of investment value (was just $138 million in June 2018).