Safehold Inc. (NYSE:SAFE) Q4 2023 Earnings Call Transcript
Safehold Inc. (NYSE:SAFE) Q4 2023 Earnings Call Transcript February 13, 2024
Safehold Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning and welcome to Safehold’s Fourth Quarter and Fiscal Year 2023 Earnings Conference Call. [Operator Instructions] As a reminder, today’s conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to Pearse Hoffmann, Senior Vice President of Capital Markets and Investor Relations. Please go ahead, sir.
Pearse Hoffmann: Good morning, everyone. Thank you for joining us today for Safehold’s earnings call. On the call, we have Jay Sugarman, Chairman and Chief Executive Officer; Brett Asnas, Chief Financial Officer; and Tim Doherty, Chief Investment Officer. This morning, we plan to walk through a presentation that details our fourth quarter and fiscal year 2023 results. The presentation can be found on our website at safeholdinc.com by clicking on the Investors link. There will be a replay of this conference call beginning at 2 p.m. Eastern Time today. The dial-in for the replay is 877-481-4010 with a confirmation code of 49838. [Operator Instructions] Before I turn the call over to Jay, I’d like to remind everyone that statements in this earnings call which are not historical facts maybe forward-looking.
Our actual results may differ materially from these forward-looking statements and the risk factors that could cause these differences are detailed in our SEC reports. Safehold disclaims any intent or obligation to update these forward-looking statements except as expressly required by law. Now, with that, I’d like to turn it over to Chairman and CEO, Jay Sugarman. Jay?
Jay Sugarman: Thanks, Pearse and thank you to everyone for joining us today. It’s a new year and we want to make it a good one with a clear focus and the expectation of a more favorable interest rate backdrop. If the consensus is correct and rates begin to finally fall this year, we are optimistic that we can return to solid growth in EPS, restart the deal in capital market engines, and recapture the interest that was building in Caret. As most of you know and experienced with us, 2023 was a frustrating year. We reached a lot of key milestones and added important long-term positives for the company. But rapidly rising interest rates overshadowed these positives, slowing deal flow and hurting our share price. But as you will see in today’s presentation, 2023’s achievements have set the table for us going forward as we wait for the headwinds we have been dealing with to begin to turn into tailwinds.
Now, let’s have Brett take you through the fourth quarter and the year.
Brett Asnas: Thank you, Jay. Good morning, everyone. Let’s begin on Slide 3. 2023 was an important year for CFO. While the overall operating environment was challenged by rate uncertainty and volatility, both of which weighed on transaction activity and our stock price. We are able to achieve a number of positive outcomes that we believe have the company positioned for success as stability and growth return. Internalizing management simplified our corporate architecture. Improved ownership dynamics brought all competitive advantages in-house meaningfully improved governance and put a cost structure in place that we believe should achieve long-term synergies as we scaled the business. On the investor front, we were pleased to add MSD Partners as a large investor in the business.
Not only did they invest $200 million into our common stock when the internalization closed, but they also let our second Caret investment round at a $2 billion valuation. On the credit side, both Moody’s and Fitch appreciated the cleaner corporate structure and consistency in our strategy, which led to positive action from both. Fitch changed our outlook to positive and Moody’s upgraded us to A3, which elevates our credit profile and is expected to result in improved cost and access to capital over the long-term. On the capital raising front, we raised $152 million through the issuance of common equity to a diverse investor base, again led by MSD Partners who participated at their pro rata ownership level. We accessed the bank market early in 2023, increasing the size of our revolving credit facilities to $1.85 billion, adding a new bank partner and underscoring our deep relationships with our banking group.
We also put in place a $500 million joint venture with a sovereign wealth fund partner that adds liquidity and flexibility to pursue new ground lease opportunities. At year end, the total portfolio was $6.4 billion, UCA was estimated at $9.8 billion, GLTV was 44%, and rent coverage was 3.6x. We ended the year with $752 million of liquidity, which was further enhanced by the unused capacity in our joint venture. Slide 4 provides a snapshot of our portfolio growth. During the fourth quarter, we originated three new multifamily ground leases for $56 million. All three originations were fully funded at closing. Two of the originations are wholly owned. One was done in the joint venture. The credit metrics associated with these deals are in line with our portfolio targets: GLTV of 39%, rent coverage of 2.8x, and an economic yield of 7.4%.
In the fourth quarter, we funded a total of $122 million across three categories, $46 million of Q4 new originations earning a 7.4% economic yield, that figure is net of our partners’ $10 million JV interest in one deal, $68 million of ground lease fundings on pre-existing commitments that have a 6.3% economic yield, and lastly, $8 million related to our 53% share of the leasehold loan fund, which earned interest at a weighted average spread of SOFR plus 604 for the quarter. For the full year, we closed on 7 multifamily ground leases for a gross commitment of $204 million. Safehold’s share is $177 million, of which $63 million remains unfunded. The credit metrics associated with these deals are consistent with our portfolio targets, with a weighted average GLTV of 34%, rent coverage of 2.7x, and an economic yield of 7.4%.
For the full year, we funded a total of $529 million across 5 categories: $114 million of new ground lease originations earning a 7.4% economic yield; $227 million of ground lease fundings on pre-existing commitments that have a 5.6% economic yield; $43 million related to our 53% share of the leasehold loan fund, which earned interest at a weighted average spread of SOFR plus 508 for the year; $29 million related to our 53% share of the ground lease plus fund, which earns a 7.2% economic yield and the $115 million Star Holdings term loan earning 8%. Our ground lease portfolio now has 137 assets and the portfolio has grown 19x since the IPO, while the estimated unrealized capital appreciation sitting above our ground leases has grown 22x. In total, the UCA portfolio is comprised of approximately 35 million square feet of institutional quality commercial real estate, consisting of approximately 18,000 units of multifamily, 12.5 million square feet of office, over 5,000 hotel keys, and 2 million square feet of life science and other property types.
Continuing on Slide 5 let me detail our quarterly and annual earnings results. For the fourth quarter, GAAP revenue was $103 million, net income was $41.2 million and earnings per share was $0.58. For the full year, GAAP revenues was $352.6 million, net income was negative $55 million, and earnings per share was negative $0.82. 2023 was a noisy year for the P&L with several non-recurring items, primarily merger-related obscuring true run-rate earnings. After backing out one-time items, net income for the fourth quarter was $25.5 million and earnings per share was $0.36, making the same adjustments for the full year along with backing out merger and carrier related costs, which weren’t incurred in Q4, net income was $96.8 million and earnings per share was $1.45.
I won’t spend time on adjustments from Q3 that were discussed on previous calls, but did want to highlight one notable non-recurring item in the fourth quarter. During the quarter, we realized the $15.2 million hedge gained through other income and our GAAP financials. We employ hedge accounting to reduce P&L volatility, because it allows us to attach specific hedges to debt instruments and therefore recognize any gains or losses over the life of the debt rather than on a mark-to-market basis each quarter. In order to qualify for this accounting, we are required to attach the hedge to debt through defined forecast date. In this case, we allowed a hedge forecast date to expire without attaching debt. And we are required to recognize the value of the gain on that hedge all at once.
I will provide more detail in our overall hedging shortly, but I want to be clear that this is strictly an accounting requirement and we remain economically hedged at an appropriate level. This gain has been excluded from our previously mentioned adjusted earnings. Moving to Q4 and full year EPS, excluding non-recurring items of $0.36 and $1.45, I will highlight a few reasons for the year-over-year decreases. First total G&A net of the Star Holdings management fee was approximately $0.8 million higher in the fourth quarter 2023 and approximately $4.4 million higher for the full year 2023 than the same respective periods in 2022. This increase was expected and has been communicated to the market prior to and when we internalize. Over time, we expect our cost structure to provide meaningful savings versus the previous growing and uncapped external management structure.
I will return to G&A after highlighting two more variances. Next, as we mentioned on the last quarter’s earning call, in the third quarter, we recognized a $1.9 million GAAP loss related to terminating an option to purchase a $215 million ground lease beneath a spec office development in the Greater Seattle area. Lastly, interest expense for the fourth quarter and full year 2023 was higher due to elevated SOFR and a larger average drawn balance. Over the last 18 months, we have mitigated the impact of higher rates by putting in place $500 million floating to fixed swaps, fixing SOFR at approximately 3% as well as legging into $400 million of long-term hedges for permanent debt that are meaningfully in the money, but not yet flowing through the P&L.
With that, let me now return to our cost structure and provide color on where we stand relative to initial projections. We initially message at the time of internalization that target G&A would be approximately $50 million per year net of SPHL management fees. That cost structure was intended to support growth and benefit from strong operating leverage, given the lack of variable costs required to manage a ground lease portfolio. Over the course of 2023, costs trended better than projections. Post internalization results indicated that net G&A was approximately 10% lower than expectations. Due to a pullback in overall real estate transaction activity, we have seen our origination volumes slow accordingly. While we believe that this is a temporary slowdown, we are beholden to stakeholders and want to be responsive in how we manage items in our control, including taking a critical view of costs.
As such, we made certain headcount reductions during the fourth quarter in areas that we believe we have grown to be more efficient in. We expect additional savings from these changes. We are expecting net G&A in 2024 to be reduced by approximately 5% from what we incurred in 2023. While we are forecasting a lower cost structure, and we’ll be emphasizing efficiency, this in no way alters our growth ambitions. We will continue to invest in developing talent and growing productivity. Our goal remains to be the best in this large and underserved market and we have a fantastic team in place to get us there. On Slide 6, we detail our portfolio’s yields. Our ground leases have two different components of value. The first is a rent stream of compounding cash flows, which is akin to a high grade bond, except our leases have additional inflation protection on top of that bonds do not provide.
The second value component is the future ownership rights in the building at lease expiration. As we discussed in depth last quarter, there is a significant disconnect between what we recognized for GAAP versus what we underwrite and expect to earn economically. On our $6.3 billion portfolio, this yield delta equates to real earnings power and we will continue to speak about this difference and highlight the value components within our business that are less apparent in the financials. Portfolio currently earns a 3.5% cash yield and a 5.2% annualized yield for GAAP earnings. That GAAP annualized yield is punitive for certain legacy style ground leases that we acquired that have a variable rent components such as fair market value resets, percentage rent, or CPI-based escalators.
For GAAP, we are required to assume zero go-forward growth and zero go-forward inflation for these components over the term of the lease. As such, we have a number of assets earning unrealistic or atypically low yields relative to our underwriting. To put a finer point on it, approximately 17% of our portfolio earns a 3.0% for GAAP annualized yields, although we expect to earn 5.8% under standard 2% CPI or growth assumption. The second box utilizes basic bond or IRR math that applies conservative underwriting and standard growth expectations of 2%. That approach generates an expected 5.7% economic yield on the portfolio, which is in line with how we have underwritten these assets. The 50 basis point delta between the 5.2% GAAP yield versus the 5.7% economic yield on a $6.3 billion portfolio is a meaningful value component over time.
Our yields have further upside when you layer in our periodic CPI look backs. Under the Federal Reserve’s current long-term breakeven rate of 2.24%, our 5.7% economic yield increases to a 5.8% inflation adjusted yield. The second component of value in the portfolio is our future ownership rights, which is the unrealized capital appreciation we track quarterly. Caret is the subsidiary that owns UCI and Safe’s shareholders own 82% of Caret. Caret adjusted yield uses the inflation adjusted yield as a starting point and enumerates the estimated yield benefit from Safehold’s 82% interest in Caret at its latest $2 billion valuation. This adjustment produces a 7.4% Caret adjusted yield, which is an illustrative metric intended to highlight this important value component that remains largely unrecognized by the market today.
Turning to Slide 7, we show a geographic breakdown of our portfolio. The slide highlights the portfolio’s diversification by location and underlying property type. Our top 10 markets by GBV are highlighted on the right, representing approximately 70% of the portfolio. We include key metrics such as rent coverage and GLTV for each of these markets and we have additional detail at the bottom of the page separating the portfolio by region and property type. It is clear that office as an asset class is going through a period of structural change and revaluation. And as a result, we are not surprised to see our office GLTVs increase. Based on the natural timing lag from the appraisal process, we would expect these figures to continue to increase over the coming quarters, even after certain assets reached their cyclical bottom.
Conversely, when certain assets begin to see more capital flows and better valuation prospects, we would expect a delay in recognizing that benefit. We continue to believe that investing in well located institutional quality ground leases in the top 30 markets that have attractive risk adjusted returns will benefit the company and its stakeholders over long periods of time. Lastly, on Slide 8, we provide an overview on our capital structure. At the end of the fourth quarter, we had approximately $4.4 billion of debt, comprised of $1.5 billion of unsecured notes, $1.5 billion of non-recourse secured debt, $1.1 billion drawn on our unsecured revolver, and $272 million of our pro rata share of debt on ground leases, which we own in joint ventures.
Our weighted average debt maturity is approximately 22.2 years and we had no corporate maturities due until 2026, which was our revolving credit facility. At quarter end, we had approximately $752 million of cash and credit facility availability. We look to manage interest rate risk on floating rate borrowings appropriately. And I have put a number of hedges in place to do so. Of the approximately $1.1 billion revolver balance outstanding, $500 million of swap to fix SOFR at 3%. This is a 5-year swap that we have projection on through April 2028. We currently receive swap payments on a current cash basis each month and at today’s rates produces cash interest savings of approximately $3 million per quarter that is currently flowing through the P&L.
Of the remaining approximately $600 million drawn, we have $400 million of long-term treasury locks at a weighted average rate of approximately 3.6%. Today, our long-term hedges are approximately $55 million in the money. The outstanding hedges are mark-to-market so no cash changes hands each month. And while we do recognize these gains on our balance sheet in AOCI, they are not yet recognized in the P&L. While these hedges can be utilized through the end of 2025, they can be unwound for cash at any point prior. As we look to term out revolver borrowings with long-term debt, we may unwind the hedges and attach the gains to the debt, lowering the effective economic rate we pay while amortizing the gain over a long period of time. The remaining unhedged exposure is largely offset by our higher yielding investments connected with the internalization, including the floating rate income we receive on our leasehold loan fund interest.
The weighted average credit spread we earn on those loans exceeds what we pay on our line by 405 basis points. We are levered 1.9x on a total debt to book equity basis. The effective interest rate on permanent debt is 3.9%, which is 138 basis points spread to the 5.2% GAAP annualized yield on the portfolio. The portfolio’s cash interest rate on permanent debt is 3.3%, which is an 18 basis points spread to the 3.5% annualized cash yield. On the credit ratings front, we have previously discussed the Moody’s A3 upgrade, which was a strong outcome at a difficult time that underscores the fundamental credit strengths of the business and we believe it should have long-term benefits for the company. Subsequent to quarter end, Fitch, who had put us on positive outlook in the beginning of 2023, recently affirmed our positive outlook.
While we have accomplished numerous key drivers for an upgrade and the credit has improved in many important facets, we will continue to work with their team to accomplish our goal of reaching an A minus rating. So to conclude, 2023 was a busy year that brought its fair share of challenges. But we took a number of important steps to solidify the business and position ourselves for success as markets begin to stabilize and inevitably rebound. We remain focused on delivering value to our customers through our attractive capital solution and look forward to what 2024 has to offer. And with that, let me turn it back to Jay.
Jay Sugarman: Thanks, Brett. As Brett mentioned, organizationally, we have tightened the ship and have been working to run leaner and more efficiently. We will of course add talent as growth justifies it, but feel very good with the team we have in place today. Ultimately, serving our customers and seeking to generate strong risk adjusted returns for investors is the path forward. So we will focus on these two missions to help get the value of our business more appropriately recognized in the marketplace. And with that operator, let’s open it up for questions.
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