2023-07-12 04:34:31 ET
Summary
- Safehold is a unique REIT that focuses solely on investment grade land leases.
- Its long-term 99-year leases make it very sensitive to interest rate fluctuations.
- I present my thesis for the company and argue that SAFE is one of the best turnaround plays on interest rates.
Dear readers/followers,
today I want to cover a unique REIT - Safehold ( SAFE ) which is the only publicly traded REIT (at least to my knowledge) that focuses solely on investment grade land leases .
As such it has some truly one of a kind characteristics that make it quite volatile in the current high interest rate environment, but can also present one of the best opportunities to profit from a potential decrease in rates.
The company has recently went through a merger with iSTAR, which has made their most recent earnings quite messy. In the long run, however, I really like the fact following the merger management is being internalized, which more often than not leads to better performance due to a better alignment of interests.
Land leases
Before looking into the specifics of the company, let me briefly touch on land/ground leases and how they work. In short, they're exactly what they sound like. The landlord (SAFE in this case) owns land which it leases to tenants that then develop the property themselves.
Lease agreements are generally signed for very long periods, usually 99 years, which has resulted in SAFE having the longest weighted average unexpired lease term of all REITs at a staggering 93 years!
This structure has advantages for both sides. The landlord gets a very predictable source of income for many decades without having the usual equity risks associated with holding real estate. On top of that, from a collection stand point land leases are generally considered much safer than regular leases, because if the tenant doesn't pay, the landlord gets to keep the building. From a tenant's perspective, the structure is also good, because they don't have to incur large upfront costs for land acquisition and spread the cost across time.
Safehold
SAFE's portfolio of 131 land parcels is spread throughout the country, with the Northeast being the most heavily weighted region as Manhattan alone accounts of 24% of the portfolio, followed by D.C. at 11%. The favorite Sunbelt region accounts for 12%.
Heavy exposure to legacy markets on both coasts might scare away a lot of investors, especially when combined with the fact almost half (44%) of parcels are currently leased to office buildings, followed by multifamily at 37%.
But this thinking is wrong. For SAFE it doesn't really matter what type of property is currently build on their land. This is because (1) the rent payment is very low in relation to the value of the building which means that even distressed properties should be able to make it, (2) in case of tenant default the REIT gets to keep the property free of charge which is likely to result in a gain and (3) lastly, the parcel can be redeveloped into another function if all else fails.
These characteristics make SAFE an almost bond-like stock. The flip side of such long safe leases is that they earn a very low - 5.2% and only 3.4% on a cash basis, which makes earnings and valuation very sensitive to interest rate fluctuations, as evident from already narrow spreads.
Their BBB+ rated balance sheet mirrors their extremely long term leases with a weighted average maturity of 23 years. They also have no maturities until 2026, which is when their credit revolver ($1 Billion) matures. Their leverage is very high at 13.5x annualized in-Place net rent, but this is not necessarily a problem in context of their long term safe leases, especially given the lack of debt maturities over the next decade.
Beyond the revolver, the REIT has no further maturities before 2031 and has low interest rate risk as the only floating rate loan is their revolver at SOFR + 1%. With interest rates now near their peak, I don't expect further significant increases to the company's interest expense. In the meantime, their rent revenue will continue to grow by 2-3% annually thanks to build in rent escalators, which will really compound over time.
Valuation
Now that we understand the business model, it should come as no surprise that the stock price has plummeted as interest rates went up from about $90 per share all the way to $25 per share. This is because (1) an increase in interest expense on the revolver and (2) valuation multiple compression.
With that said, the stock is unlikely to go up significantly until interest rates start coming down. I don't know when that will happen, but if you (like me) think that the Fed is closer to the end of the hiking cycle than the beginning, then it might make sense to start averaging into this ultra safe REIT which significant upside potential when rates drop.
I don't think the stock will return to the all-time high anytime soon and frankly, valuing a company that has no direct peers is difficult. What we do know for sure is that the company pays a safe 2.9% dividend . On top of that it currently trades at a reasonable forward FFO multiple of 19x.
The consensus is for FFO to jump up by about 30% YoY next year, largely as a result of the merger with iSTAR. Following that growth will most definitely slow to low single digits. Still, I see by 2025 I think the company could reach $1.80 per share in FFO.
Even with zero multiple expansion, that would imply a price target of $33 per share. That's over 30% of upside, assuming a multiple that frankly is very conservative. If interest rates drop, the upside will most likely be much higher.
My bullish view is confirmed by recent insider purchases as the Chairman and CEO (Jay Sugarman) and one of the main Directors (Barry Ridings) recently added over $500,000 to their already large positions.
SAFE will likely not make you rich and the stock is bound to struggle as long as rates remain elevated due to its long duration. However, if you're after one of the safest REIT out-there in terms of cash flow predictability and are looking for a turnaround play on interest rates, this may be it. Apart from macro risks, the company doesn't really face any company specific risks that are typical for a REIT. I rate SAFE stock as a BUY here with a very conservative price target of $32 per share by 2025.
For further details see:
Safehold: Long Duration REIT With High Interest Rate Sensitivity