Good day, and welcome to Safety Income and Growth's 2nd Quarter 2018 Earnings Conference Call. At this time, for opening remarks and introductions, I would like to turn the conference over to Jason Fooks, Vice President of Investor Relations and Marketing. Please go ahead, sir.
Good morning, everyone, and thank you for joining us today to review SAFE's Q2 2018 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer Andy Richardson, Chief Financial Officer and Marcos Alvarado, our President and Chief Investment Officer.
This morning, we plan to
walk through a presentation that details our second quarter 2018 results. A corresponding presentation can be found on our website at safetyincomegrowth.com in the Investor Relations section. There'll be a replay of the conference call beginning at 1 pm Eastern Time today. Before I turn it over to Jay, let me point you to our forward looking statements disclaimer on Slide 1. I'd like to remind everyone that statements made on our conference call, which are not historical facts, may be forward looking.
Today's actual results may differ materially from these forward looking statements and the risk factors that could cause these differences are detailed on this slide as well as in our SEC reports. SAFE's disclaims any intent or obligation to update these forward looking statements except as expressly required by law. With that, I'd like to turn the call over to our Chairman and CEO, Jay Sugarman.
Jay? Thanks, Jason. During the Q2, we continued to focus on reinventing the ground lease industry by developing a modern ground lease structure that eliminates the negative features found in old ground leases and by focusing on providing innovative capital solutions that are custom tailored to meet our customers' needs, we've developed a powerful way for building owners to meaningfully enhance their returns and be more efficient than their competitors in deploying capital. 2nd quarter activity helped grow the portfolio another 7.5% and Value Bank another 6%, but smaller deal sizes, longer lead times and the unexpected exercise of a purchase option by a third party at and the pipeline of deals we are working on suggest larger future volumes. But the education process remains a governor on growth till we can reach a critical mass of owners and advisors who have worked with us and seen the power of the safe ground lease to boost their returns and to help them execute their plans.
We're also working on ways to deploy more resources and expand our outreach further and faster and look forward to seeing the results of those initiatives in the coming quarters as we seek to reach the $1,000,000,000 portfolio mark by year end. With that, I'll turn it over to Andy to walk through the quarter in more detail. Andy?
Thank you, Jay, and good morning, everyone. My remarks this morning will refer to the slides from our earnings deck that we posted on our website today. Let me begin with Slide 3. For the Q2 2018, net income was $0.09 per share, FFO was $0.22 per share and AFFO was $0.17 per share. Earnings this quarter included $1,500,000 of income or $0.08 per share that was related to a cash termination fee we received after a third party exercised its purchase option on a New York City property that we put under contract in the second quarter.
Turning to Slide 4, the main theme for the quarter is the continued investment activity as we put capital to work and expand our footprint by closing transactions with new and existing customers. To that end, we saw sequential revenue growth of 12% from the Q1 this year with portfolio cash rent of $6,200,000 for the Q2. During the quarter, we closed 4 new ground leases totaling $44,000,000 which brings our portfolio to $631,000,000 and Value Bank to $1,300,000,000 as of June 30. Turning to Slide 5. We recently marked our 1 year anniversary as a public company.
Since the IPO, we have closed $291,000,000 of ground leases and grown the portfolio by 86%. In addition, annualized cash rent increased by 69 percent to $29,400,000 and Value Bank increased 188 percent. Slide 67 present our income statement and a reconciliation of AFFO or FFO and AFFO to GAAP net income. Slide 8 contains a detailed breakdown of our G and A. Note that even though Istar waived all management fees and reimbursable expenses during the Q2, we still recorded the expense on our P and L, which is then offset with an increase to equity in a like amount.
In the second quarter, net income and FFO included $1,300,000 or $0.07 per share of expenses associated with these waived fees. Beginning in the Q3, we will begin to pay Istar's management fees in stock and reimburse Istar for expenses in cash. Moving ahead to Slide 9, you can see our dividend coverage. For the Q2, we paid a $0.15 per share dividend or $0.60 annualized. During the last four quarters, we generated $0.64 of AFFO per share, resulting in a payout ratio of 94%.
As we continue to invest, we expect to be able to grow the dividend. Let's turn to our portfolio on Slide 11. Slide 11 provides metrics on the 4 ground leases we originated in the 2nd quarter. We invested a total of $44,000,000 during the quarter at a weighted average going in cap rate of 4.25 percent. These ground leases have weighted average fixed annual rent escalations of 2% and all four leases have CPI look backs to provide periodic inflation protection.
Investments also featured credit protection in line with our targets with a weighted average ground rent to underlying property NOI coverage of 4.1 times and our weighted average cost basis as a percentage of combined property value was 35.2%. Slide 12 highlights the deals we closed during the quarter. The Glenwood Point transaction is a new ground lease on 2 office buildings, 102 100 Glenwood Point in the Central Perimeter submarket of Atlanta, Georgia. We are very pleased that this transaction marks the 3rd time our client has utilized the SAFE ground lease solution and represents SAFE's 4th ground lease investment in Atlanta. This is an example of a transaction in which we offered our clients a one stop shop solution with Istar providing the leasehold financing alongside our ground lease.
Promenade Crossing is a 212 unit garden style multifamily community in Orlando, Florida, which utilizes safe ground lease along with a 3rd party leasehold financing. We remain enthusiastic about our continued ability to penetrate the multifamily sector and our current investment pipeline reflects future growth in this property type. In June, SAFE announced that it originated 2 new ground leases on adjoining industrial properties adjacent to the Miami Airport Intermodal. Properties were owned fee simple by Istar, We sold them as ground leases and leaseholds because the 2 separate transactions generated more proceeds than broker estimates of the fee simple valuation. This deal serves as a good example of our core thesis that bifurcating a property with a well structured ground lease can create more value than a fee simple structure.
On Slides 13 and 14, you can see some details on the diversification in our portfolio. And on Slide 15, you can see some of the key metrics that we believe set our brand of ground leases apart from other investment opportunities in terms of safety and relative value. Just a few things that I would like to highlight. Our annualized cash rent including percentage rent is $29,400,000 or 4.7 percent current return on our basis. When you include straight line rent, our annualized GAAP rent is 46,400,000 All of our leases have some form of rent escalators embedded in their structure such as fixed rent bumps, CPI based bumps, percentage rent or a combination of these.
Of the leases with fixed bumps, the average annual bump is 1.8%. Safety derived from our ground leases is highlighted in the credit metrics shown on the bottom part of the slide. Annual cash flow of the properties sitting on top of our land covers our annual cash rent by 4.7 times and our cost basis represents 33.4 percent of combined property value. Moving to Slide 16, which presents our pipeline. As of last week, we had $620,000,000 of deals in our pipeline comprised of $480,000,000 of transactions for which we are in discussions or negotiating term sheets with our clients and $141,000,000 of deals with signed LOIs.
Slide 17 provides an update on our Value Bank. As already discussed, Value Bank grew 6% during the Q2 to $1,300,000,000 or $69 per share. Recall at the expiration of a ground lease, building and all improvements revert to safe. Since our investment our initial investment was only the cost of the ground, value of the building less the historical purchase price of the land is what we refer to as value bank. CBRE provides appraisals on all of our properties annually.
In effect, Value Bank tracks the embedded capital appreciation potential at lease maturity and will grow with every ground lease we acquire. On to Slide 19, let me discuss debt and leverage. Our debt is relatively straightforward. $227,000,000 of long term fixed rate debt due 2027 secured by our initial $340,000,000 portfolio and $71,000,000 of asset specific debt against our Hollywood investments. In addition, we have a $300,000,000 revolver of which $10,000,000 was drawn at the end of the quarter.
Cash on hand plus undrawn availability on the revolver provided $122,000,000 of equity liquidity at June 30, representing over $300,000,000 of buying power based on 2:one leverage and revolver capacity. We continue to be conservatively levered at 0.8x debt to equity below our 2x target On Slide 20, let me discuss our interest rate protection. Our policy is to put in place interest rate hedges when we originate investments to protect us from interest rate fluctuations. We have $227,000,000 of long term fixed rate financing. In addition, we have $213,000,000 of rate lock hedges covering the next 12 years associated with all of the investments we have closed that have not yet been leveraged with long term fixed rate financing.
In conclusion, SAFE had another strong quarter, The combination of continued deal flow and a sizable pipeline of diverse asset classes continue to make us optimistic about achieving our objectives to reinvent the ground lease market. And with that, I'll turn it back to Jay.
Thanks, Andy. So we remain excited with the path we're on and the reception we're seeing from owners of properties realize that investing capital in both the physical building and the land is very inefficient and materially drags down their target returns. By enabling an owner's capital to be highly focused and only required to fund a property building component, safe ground lease maximizes owners' returns and enables them to reap the full benefit of the increased value they create. Logically, providing more efficient capital and unlocking higher returns for owners should fundamentally change the way real estate owners think about investing in real estate. Operator, let's go ahead and open it up for questions.
Thank you. Your first question comes from the line of Collin Nings with Raymond James. Go ahead. Your line is open.
Thank you. Good morning.
Good morning.
First question from me. Clearly, there's been more
There's still deals coming to market. I would say it's spotty at best. And when they do come, we do see them. And I would say that part of the business is going to be a relatively small part of the business and come in lumpy sort of fashion. So we've been focused more on the origination side.
Okay. That's helpful color. And then just maybe along that theme of focusing more on originations as you think about those opportunities, has the geographic focus evolved at all? I mean, the mix of some of the larger MSAs that decline and now markets like Indianapolis are showing up on that pie chart. The various bucket is growing a little bit.
So can you maybe just talk a little bit about if there's been any evolution in the geographic focus of opportunities?
Yes. I think we're still targeting those top 25 markets, but we're following our customers where they're playing. So the initial folks who have already worked with us and seen the power of the ground lease to unlock their returns are taking us into different markets that historically we've looked at, but we're not on our initial list in terms of the gateway cities. We think there's going to be a nice mix of both. But again, the customer meeting the customer needs is going to drive this business, so we're going where they need us.
Okay. One last one for me and I'll turn it over. Just in that can you just maybe characterize what's in that entertainment bucket in terms of the opportunities you're looking
at? Yes. I mean, we don't want to go too deep into some of those things. But again, we look at the real estate and we look at the valuation of the improvements and try to figure out where we're really getting real value. I think if you look historically at our net lease business, they were pretty big practice in a couple of areas.
So that's one of the things that we're trying to lever off of some of those relationships to find ground leases in.
Okay, fair enough. I'll turn it over. Thank you.
Your next question comes from the line Tony Pallona with JPMorgan. Your line is open.
Hey, thanks. Good morning. I think 635 Madison was pretty sizable. I think in the past you all contemplated some other large transactions. Can you talk about just what your appetite and or the pipeline looks like for some of the just much larger, chunkier deals?
Sure. Hi, good morning. It's Marco Salvarado. As Jay mentioned, the acquisition front is a little bit lumpy. If you look at our pipeline, I would say there's probably another $1,000,000,000 of transactions that don't show up in that $620,000,000 number that we're pursuing.
I think they are more difficult to execute, but we continue to pursue them. I would call them gateway markets, core, core assets. And we're optimistic that these whales will hit over the coming quarters.
Okay.
And in the past, you talked about getting some traction with the multifamily and on the development side, given that you're able to structure these that fit sort of the Fannie Freddie criteria. Any additional updates there or how that's coming along?
It's continuing to proceed really well. As we've discussed it prior, both Fannie and Freddie have done leasehold financing behind us. Yesterday, a new transaction with on a deal that they had bid. And they said, how did you guys do this? And so it's that sort of feedback in the market that gives us a lot of excitement about the future potential in the multifamily space.
And then in terms of just you talked about educating the market on a safe ground lease, but when it comes down to it, I mean, they're pretty sophisticated counterparties. The structure you're offering would seemingly be pretty straightforward. Like is there is it just competition from other sources of capital? Is it a cost matter? Or is the proceeds just not quite interesting enough given a little bit of added complexity like what does it really come down to on these?
I wouldn't say that it's an alternative capital because I think the numbers are pretty compelling. I think one of the biggest challenges we faced and continue to face is, there's just a lot of skepticism from the negative history of what we call the old fashioned ground lease market. Everybody's got a horror story, everybody's got a negative story. But when you really dig under the covers, almost every one of the issues that they're focused on are things we've eliminated from a safe ground lease. So it's hard to fight against the ghost of past bad ground leases.
You really have to do a very good job of sitting in front of somebody. As I mentioned, their advisors, their lawyers, their mortgage brokers, their sales broker advisors, all have some bad baggage from the past. The numbers on their face are really compelling and I think we typically get a very good initial impression and then essentially lose that momentum as we go through the nitty gritty because people down the chain have not heard the pitch directly from us. They don't really understand how our ground leases are fundamentally different. They don't really understand that we have built our entire business as a customer business, not just as a capital business.
So we're really looking to help our customers make more money. And so this is not something that I think has ever been really existed in the marketplace before and it takes time to sit and walk all the parties that actually participate in these kinds of transactions. Once they're done, you're right, they're actually relatively straightforward. I think Andy mentioned we have a number of repeat customers coming back. It's just getting through that trial phase.
The adoption piece of it's actually been really good. So when you have a trial problem, not an adoption problem, how do you solve that? Well, you put more boots on the ground, you get in front of more people in more places and you just tell the story to all the people who need to hear it. And that's taking time and it takes up a lot of our internal resources, but we think we're planting the seeds farther and more deeply each time we do a deal. Each time actually we don't even get a deal done, more people actually see what we're talking about and can start to articulate.
Actually, this is very different than the ground leases most of us are thinking about or have seen in our past. And the business they're running is actually a long term customer focused business. They're very good at figuring out how to solve problems and needs. This is something that if you do once with us, you're going to find you want to do it again and again.
Okay. And then just last question on overhead. When we look at get the management fee and the reimbursables, but the public company and other costs, the $1,250,000 this quarter, where do you expect that to be on just a run rate basis going forward?
I think that's a pretty good run rate base. I think it's a pretty good run rate for that number. As you know, some of those fees will grow just as our equity capital base grows, the management fee. The public company costs should stay relatively stable.
Okay. Thank you.
Your next question comes from the line of Rich Anderson with Mizuho. Your line is open.
So when you think about how you're growing right now and kind of juxtapose that with the growth profile of the company, Should we kind of think of the acquisitions as kind of a zero sum game for now, and that the real the growth comes from the escalators in sort of the 2nd year of ownership? Or is there some small kind of accretion that you see that you're getting at the point of the investment as well?
Yes. I think there's 2 things in there. 1, we're continuing to create and explore ways to create new ground leases. We're seeing ways to open and unlock value for owners in ways that are continued to expand from where we just started, which was, hey, we can buy these and we can create them. There's a panoply of ways to really unlock that value and you'll see us use all the tools we can to create these new ground leases.
So I think we see the ability to jump step the portfolio in a number of different ways. In terms of the value creation, it is a function of 2 things. 1, we think as we build a portfolio, people will start to understand the characteristics of the 2 components better. The income stream that is a long term compounding growing income stream that should beat inflation nicely. And then this embedded long term ownership position in high quality real estate where you've got these really talented owner operators owning the leasehold, committing their capital to try to improve the value of that leasehold property.
Those two dynamics, I think, have been undervalued, frankly, because there hasn't really been a portfolio with the visibility we're providing. We're telling you what value bank is. We're showing you how the cash stream dynamics are, the bump structures, some of the things that when you have a large diversified portfolio, you can start doing some interesting liability management off of those. So I think we're still early days right now. But in terms of each time we do a deal, we do think value is being created in both of those areas.
In the rent stream component, we think we're creating value. And obviously, in value bank, we think we're building something quite unique.
Okay. And then as we're in the midst of at least a questionable interest rate environment, do you sense that there is incremental interest in your land lease or ground lease product as an alternative to debt financing? Is that something that's come up in conversation?
Yes. I think that is one of the things owners look at is how can they lock in the things that they don't control and really let themselves focus on the things they do well, which are designing, managing, building, constructing, leasing, marketing, taking the interest rate equation out of it for them with these long term relatively constant ground rent on a big chunk of their capital is a powerful tool. It reduces the uncertainty on the interest rate, but it also takes a big chunk of term maturity risk off the table. Right. It's 2 benefits, 2 uncertainties that go away.
But I understand that in theory, but is it part of like increasingly part of the dialogue as you try to unearth, pun intended, I guess, new deals?
Yes, I would say 2 things. 1, when interest rates get more volatile, yes, it becomes it moves up in the hierarchy of things people are talking about. But I think ultimately, we're trying to make sure people understand that as the whole complex of costs go up and down, the benefits of what we're doing, it's not like it's a 10 basis point or 15 basis point move changes those dynamics. So yes, if their alternative costs go up, it makes it even easier to have the conversation. We try to stress all the other benefits as well.
It's just not just a short term interest rate arbitrage opportunity.
Got you. In terms of the cost basis as a percentage of CPV at 33%, is there any reason why that will settle out at some other number? Or is that kind of the target that you're thinking about long term for SAFE?
Yes. I think we've said in the past that we try to be pretty scientific about where is other top 25 markets, it should be a little bit lower. It seems like other top 25 markets, it should be a little bit lower. It seems to have settled out in that 35 ish percent range. But if you had a strong quarter where you had a very large number of the urban deals, it might be a little higher.
And if it was in the rest of the top 25 markets, it'd probably be a little bit lower.
Right. Okay. And then last question, as far as the G and A kind of shift now to SAFE actually paying Star for their services in the form of stock, not much changes to the income statement except now one should maybe assume or not maybe, you should assume some incremental share issuance on a quarter by quarter basis. But otherwise, the P and L should not change much. Is that correct in the way I'm thinking about it?
That's absolutely correct.
Okay. Thank you.
Thanks. Your next question comes from the line of John Massocca with Ladenburg Thalmann. Your line is open.
Roughly speaking, what portion of the opportunities in the pipeline are deals that involve Istar either in some capacity of providing some other type of financing to the tenant or being involved in the leasehold, either selling it or being the owner of it?
Yes. I think we have kind of said we will eat our own cooking, which is when we sell something, we want to see the dynamics between a fee, process and a bifurcated ground lease and leasehold process. So part of our initial activity in that area has been both for our own purposes, but ultimately it's because we think it's creating more value. Istar has announced that it's moving through its legacy portfolio and selling. So that will come to an end at some point.
But we have been doing a lot of R and D work to try to understand why is it that people have not done this bifurcation. And what we're seeing is there's no reason they shouldn't. The debt markets function, the cap rate markets function with a properly structured ground lease, value can be created. So we're continually refining how to make that process as smooth and efficient. And the best way to do that is test it on our own properties and that's been very effective both in giving us the information we need to get better and better, but also to create more value for the leasehold buyers and for iStar as a seller.
It would be kind of safe to assume that the majority of the portfolio doesn't involve iStar in any kind of No.
We're not looking at that as a core business. That's really has helped to get us off the ground to see all the pieces of the puzzle, but that's not a core piece of the pipeline.
Understood. And then within the multifamily section of the pipeline, are you seeing more kind of garden style type properties in the pipeline, a la kind of the deal you closed in 2Q 2018 or has it been more of the traditional kind of CBD located properties?
Yes. I think as Marcos said, we continue to play in both places and it's obviously the CBD stuff is much, much larger. And so in the quarters where we do land some of those, you'll see a decided shift towards the urban cores. But the flow business, where our customers are taking us, we are seeing some guys in the multifamily space get very excited about working with us. Again, we're trying to stick to those top 25 markets, the NFL cities.
We won't go much beyond that because we just don't have the capacity to help them there. But in markets that we think are still a top 25 NFL like growing dynamics, good real estate characteristics, we think the multifamily space is pretty ripe.
Understood. That's it for me. Thank you very much.
Your next question comes from the line of Joshua Dennerlein with Bank of America. Your line is open.
Hey, Josh. How
ground leases, are they more or less popular as interest rates rise? I'm just trying to think about how the pipeline will change as interest rates go up and maybe the economics for partners?
Yes, I think the natural answer would be, yes, they get more attractive. But it actually hasn't been on the top of the 2 or 3 reasons why they're happening or not happening in situations. I think the economics of ground leases are compelling. If you understand that we, SAFE, are in the business of enhancing returns and trying to help make sure that the ground lease is an additive piece of the puzzle and won't detract from the return profile for that leasehold owner. That's where we spend most of our time focused on that.
We are responsive to interest rates. So we will continue to have an advantage where the rates are up or down or sideways, because ultimately the economic pace for us is to be a better, more efficient way to deploy capital. So we're never going to create a higher cost option for our customers. It's always a lower, better, less risk option. But as interest rates move around, so do cap rates on ground leases.
So we will stay inside that umbrella. But I think the main drivers of the business are getting people We are a lender. We are an owner operator and seller of real estate. So We are a lender. We are an owner operator and seller of real estate.
So we pressure tested this idea on our own portfolio to make sure that the lending community gets and likes what we're providing, that the cap rate buyers out there like and accept that a ground lease is a value enhancing tool, not a negative. And that's where we're going to have to spend most of the time when they look at the actual economics, it's a pretty one-sided competition. We almost always have better economics than their fee based alternatives.
I guess to like further that question, like if there was like 100 point rise in interest rates, like what do you think happens to the ground lease cap rates that you would see in the market or that you're underwriting to?
Yes, they'll definitely go up. We have to finance our purchases, our ground leases as well. So we will be trying to maintain the same sort of margins in our business. But if you start with an umbrella that we are inside of and that umbrella moves up 100 basis points, we will move up as well, but maintain that differential. So we remain a better than market alternative.
Okay. And then on your repeat versus new users of ground leases, like what percent of your overall acquisitions in IPO have been from like repeat customers versus like new users?
Yes. I think volume wise, it's been about a third of the business. We are following our customers closely now and we see the pipeline with them growing. It could be as much as half the business we think. But again, it's not by volume.
So I think that's not a good metric. It's by number of deals because right now the repeat customers are tend to be on the smaller side. We haven't built a repeat customer in an urban core situation yet. That obviously will from a dollar standpoint materially shift the balance.
Okay, thanks.
Mr. Fooks, we have no further questions at this time.
Thank you, and thanks everyone for joining us this morning. If you have any additional question on today's earnings release, please feel free to contact me directly. Operator, would you please give the conference call replay instructions once again? Thanks.
Certainly, ladies and gentlemen. Please note that a replay of this call will be available and referencing code 9,168,977. Thank you. And this concludes today's conference call. You may now disconnect.