iStar Financial: Takeaways from Meeting with CEO Jay Sugarman
Posted on Thu, Jul 11th, 2013 at 8:39 am
by Mark Palmer
Buy-rated iStar Financial (SFI) took a significant step toward greater transparency this week when CEO Jay Sugarman met with BTIG clients at the company’s office in New York. (The presentation from the meeting can be found here.)
As we noted after SFI CFO David DiStaso met with investors at the NAREIT Conference at Chicago last month, we believe the company’s renewed willingness to meet with investors is an important step as it transitions from a period of distress and struggle to one of renewed growth and a potential return over time to being a profitable, dividend-paying REIT. Indeed, the move from the defensive to the offensive has been a key theme promoted by SFI management.
Among the many takeaways from the meeting are these:
Sugarman said there is very little left for SFI to do on the right side of its balance sheet. Investors should expect the company’s leverage to increase as it deploys capital. And SFI has the opportunity to deploy capital given that SFI had approximately $700mm of cash as of 30-Apr-13. The CEO said the company is in no rush to put that $700mm to work and that it is looking for projects that return in the mid-teens on an unlevered basis. Any project with a return of less than 10% is not worth it, Sugarman said.
Near the end of the meeting, Sugarman said that he had experienced some seller’s remorse following the sale of LNR Property LLC, which was completed in April. However, owning only 24% of the entity was not, in Sugarman’s words, “the iStar way.” The company either owns everything associated with a company, he said, or nothing. Sugarman said that LNR had been taking up a significant chunk of his work
Sugarman explained that the Real Estate Finance unit’s nonperforming loans (NPLs) have been reduced from approximately $500mm at the beginning of 2013 to $359mm of carrying value (carried at about 40% of principal value). The NPLs generate very little GAAP income, but they still have economic value accreting, and not just on a GAAP basis, Sugarman said. He added that there is about $25mm of economic potential on the low end of the range if all the NPLs were stabilized.
Among the examples that Sugarman highlighted was a recent investment in Landmark Apartment Trust, in which SFI has a two-thirds stake with Blackstone holding a one-third stake. He said he expected a mid-teens return on the project.
Sugarman emphasized that SFI likes to pursue projects in which the client “doesn’t know how much we need, or when we need it” from a return standpoint. These types of situations are not typical projects in which a developer has a set plan in place and a set budget with which to develop the property. The types of borrowers in such projects will usually pay more and offer SFI better structure.
Sugarman offered as a case study the Axis Tower in San Jose, California. The project had 264 units sold, including 58 units sold in 2012 at an average price of $480,000 per unit. However, the project’s sponsors were unable to continue supporting it. “The borrower just ran out of steam,” Sugarman said. iStar took title to the remaining 65 units in March 2013 at a basis of $405,000 per unit. Assuming that SFI sells out in 2014 at current average pricing, it expects to realize an attractive IRR over its holding period.
Sugarman discussed how buyers of properties often “run out of steam” and sell while units are under construction. Lower-priced units on the lower levels sell well, while higher-priced units towards the top usually sell later/last. In the midst of such a transition a company often needs to launch a new marketing campaign to se
sell those units, something it is positioned to do because it has the available capital.
Since March SFI has closed on 11 units at Axis Tower and has over 20 units currently under contract at an average price of $558,000. Axis was originally a 7% loan for SFI that is becoming an attractive project with an IRR north of 40%. Another way to look at this project, Sugarman said, was that it went from an NPL to a project with a high IRR.
“We’re working on a number of situations like this in the NPL book,” Sugarman said. He did, however, caution that not all projects are exactly like this one.
Sugarman said SFI has a net lease portfolio of $1.7bn based on its original cost. The net leasing space has been on fire, he said. SFI has 95% of its properties leased out with a weighted-average duration of 12 years. The net leasing business was structured as a “long-duration fixed income business for iStar that has inflation protection”. The current portfolio delivers a 7.5% unlevered yield, as occupied projects generate an average annualized yield of 7.9%. Most of these leases are longer-lived and privately underwritten.
SFI’s presentation showed that 77.8% of its leases expire in 2022 or later. From 2013 to 2021 the expiration rate is 4.5%, 0.3%, 1.6%, 4.1%, 2.8%, 2.6%, 0.6%, 2.6%, and 3.1%.
Sugarman was asked by a client about whether or not the company would consider selling part of its net lease portfolio. “At the right price, we’re a seller,” he said. “A lot [of the net lease portfolio] is in a secured structure. Does retiring 4% debt make sense?”
Sugarman pointed out that the rates of other triple-net REITs and of recent high-profile sales indicate value in SFI’s portfolio above book. “Cap rates have been driven down into the low 6s” and in some cases as low #$%$8%, he noted.
Sugarman pointed to Universal Technical Institute (UTI) as a net-leasing case study.
“This is a situation in which where iStar happened to have land nearby,” Sugarman said. The co