Good day, and welcome to Safety Income and Growth's First Quarter 2018 Earnings Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Jason Briggs, 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 Q1 2018 earnings report. With me today are Jay Sugarman, Chairman and Chief Executive Officer and Andy Richardson, our Chief Financial Officer. This morning, we will plan to walk through a presentation that details our Q1 2018 results. Corresponding presentation can be found on our website at safetyincomegrowth.com in the Investor Relations section. There will be a replay of this 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. Safe'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 disclaims any intent or obligation to update these forward looking statements except as expressly required by law. With that, I'd like to turn it over to our Chairman and CEO, Jay Sherman.
Jay?
Thanks, Jason. Thanks to those of you joining us today. The Q1 continued our steady progress forward as we modernize and reinvent the ground lease industry. Portfolio growth of 18% and value bank growth of 21% were both solid and we still believe we have just scratched the surface of what is possible in this space. Earnings benefited from the strong year over year growth in the once a year percentage rent payments from our Park portfolio, And we look forward to a solid bump in the coming quarter on the North Complex in our Hollywood multifamily round lease.
With significant dry powder still available and a growing dialogue with potential customers, we are well positioned to continue scaling the portfolio and establishing our unique value proposition for owners of high quality real estate and for investors seeking safety, income and growth. And 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. I'm very pleased to be joining you today. In the short time that I've been with the company, I've seen SAFE gaining traction with property owners and building momentum in the market. 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.
To assess performance at SAFE, we look at GAAP's net income along with non GAAP financial measures such as funds from operations or FFO and adjusted funds from operations or AFFO. For the quarter, net income was $0.20 per share, FFO was $0.33 per share and AFFO was $0.30 per share, including receipt of percentage rent from the Park Hotels portfolio, which is recognized annually during the Q1. Turning to Slide 4, I would like to highlight 3 themes from the quarter. We had meaningful revenue growth stemming from a larger asset base and recognition of the annual Park Hotels percentage rent. Our quarterly portfolio cash rent, excluding the Park Hotels percentage rent, grew by 9% from the 4th quarter to $5,600,000 driven by our new investment activity.
In addition, we were pleased to see annual percentage rent at our Park Hotels portfolio also grow by 11% to 3,300,000 dollars We've continued to build investment momentum closing 3 new transactions totaling $91,000,000 Of note, all of our post IPO customers for whom we've structured a safe ground lease have returned to explore further opportunities for ground leases with us. Our portfolio grew by 18% during the Q1 and now totals $588,000,000 which is up more than 70% from IPO. And as the asset base grows, so does Value Bank, which is now $1,200,000,000 or $66 per share, representing 21% growth from the prior quarter and 173% growth from our IPO. Slide 56 give further details on our income statement, FFO and AFFO, which I previously discussed. So moving ahead to Slide 7.
Slide 7 shows the quarterly earnings impact of both the Park Hotels percentage rent recognition as well as the waived portion of G and A expenses. As I mentioned before, because percentage rent from the Park Hotels is recognized annually in the Q1, we think it is helpful for comparative purposes to show the impact to our earnings as if we recognized it evenly over the year. Doing so would result in a $2,500,000 or $0.13 per share reduction to our Q1 earnings. Secondly, and as a reminder, Istar waives all management fees and reimbursable expenses through June 30, 2018. That said, under GAAP, both the management fee and reimbursables are still recorded as G and A expenses during the wafer period and as an increase to stockholders' equity in a like amount.
In the Q1, this amount represented $0.07 per share or a $1,300,000 cash benefit to the company. Slide 8 provides more of the details behind the G and A breakdown I just discussed. Moving ahead to Slide 9, which illustrates our dividend payments. We paid a $0.15 per share quarterly dividend for our first three quarters as a publicly traded company. We expect to be able to grow the dividend over time as we continue to invest more capital in new ground leases.
Let's turn to our portfolio on Slide 11. Slide 11 gives metrics on 3 ground lease investments we originated during the quarter. We invested a total of $91,000,000 during the quarter at an average going in cap rate of 4.2%. These leases have an annualized fixed escalation of 2% over the life of the lease and all three included CPI based adjustments to provide periodic inflation projection. The deals also featured credit protection in line with our targets with a weighted average ground rent to property net operating income coverage of 4.4 times and a weighted average basis as a percentage of combined property value of 33.5%.
Slide 12 highlights some of the features of the deals we closed during the quarter. The Onex transaction is a 14 storey, 2 60 unit multifamily project in Washington DC. In this transaction, our customer utilized the safe ground lease combined with agency financing to create a highly efficient capital solution that allowed them to submit the winning bid for the property. We are very pleased with this transaction, not only because it represents a solid investment for SAFE, but also because it has opened the doors to the universe of agency funded multifamily assets. Since closing this investment, we have received many reverse inquiries from other multifamily investors about how a safe ground lease structure can be potentially utilized for their benefit.
In February, we also closed 2 other ground leases with a repeat customer who also recognized the benefits of SAFE's custom tailored ground leases. This customer was able to successfully recapitalize Regency Lakeview, a 27 Acre Office Campus Located in Cary, North Carolina, as well as acquire Pershing Point, a 7 story office building located in Midtown Atlanta, Georgia. These safe ground leases provided low cost, long duration solutions to unlock value and achieve better returns for this customer at both of these properties. Overall, the safe ground lease is designed to help our customers unlock value and maximize their returns. This is why we have experienced strong repeat business.
We've seen that once we overcome the initial education process and our clients understand the power of the safe ground lease, they are excited to bring us more opportunities. On Slides 13 and 14, you can see some details on the diversification overall composition of our portfolio. And on Slide 15, we provide key metrics about our portfolio that we believe sets 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 $27,400,000 or 4.7 percent current return on is all have some form of rent escalators in them.
Of the ones which have fixed rent bumps, the weighted average annualized bump is 1.7%. This excludes any leases whose escalators are solely based on percentage rent or CPI. On the bottom part of this slide, I'd like to highlight that the annual cash flow of the properties sitting on top of our land covers our annual cash rents by 4.7 times and our cost basis represents 33% of combined property value. Moving to Slide 16, which presents our pipeline. Presently, we have $472,000,000 of deals in our pipeline comprised of $391,000,000 of transactions for which we are negotiating term sheets with our clients and $81,000,000 of deals with signed LOIs.
Of note, we narrowed our pipeline to 2 categories this quarter from the 3 previously discussed. We eliminated the category of in review in order to focus the pipeline disclosure to just deals that are further along in the funnel. Note that the multifamily opportunity represents approximately half of our pipeline right now. Slide 17 provides an update on our value bank. Our value bank grew 21% during the Q1 to $1,200,000,000 or $66 per share from $54 at year end.
Recall, at the expiration of a ground lease, the building and all improvements revert back to safe. Since our initial investment was only the cost of the ground, the value of the building less our historical purchase price of the land is what we refer to as Value Bank. CBRE provides appraisals on all of our properties and reappraises every asset annually. In effect, Value Bank tracks the embedded capital appreciation potential at lease maturity and it will grow with every ground lease we acquire. On to Slide 19, let me discuss debt and leverage.
Our debt is relatively straightforward, dollars 227,000,000 of fixed rate debt due in 2027, secured by our initial $340,000,000 portfolio and $71,000,000 of asset specific debt against our Hollywood investment. In addition, we have a $300,000,000 revolver of which $10,000,000 was drawn at the end of the quarter. We continue to be conservatively leveraged at 0.9x debt to equity below our 2x target and our debt represents 17.3 of combined property value below our 25% target. Finally, just a word on Slide 20. To mitigate the impact of interest rate fluctuations, we have put in place interest rate hedges for all of our ground leases that are not yet financed or that are financed with floating rate debt.
These hedges, which represent shorter term hedges through October 2020 and longer term forward starting hedges through October 2030, give us 12.5 years of protection. In sum, this was a strong quarter for the company and the combination of customer response to our ground leases compounded by how the pipeline is shaping up makes us very optimistic about the future. With that, I'll turn it back to Jay.
Thanks, Andy. I think it's fair to say we don't believe our share price comes close to reflecting the potential of the company yet. The 2 main components of value, the ultra safe, long duration growing rent streams we receive and the future potential for capital gains that we track via the value bank should both generate significant value for shareholders, and we continue to work on ways to highlight and capture the true value of both components. As our business grows and as we continue finding ways to demonstrate the size of this opportunity, we believe the market will reward our innovative approach to the real estate market and we're focused on making that happen as soon as possible. With that, operator, let's go ahead and open it up for questions.
Thank you. Your first question comes from the line of Collin Mings with Raymond James.
1st question from me, just in February, you guys indicated your goal was to get to roughly 1,000,000,000 dollars of assets by year end. Is that still the goal or has that come down a little bit just given where things stand here at the end of April?
That's still the goal.
Okay. I guess maybe along those lines, maybe expand a little bit more with the $81,000,000 of deals under LOI. How close are those ones that you would expect here to close in the Q2 still? Or you think it could drift a little bit into later in the year? And then, just specifically when thinking about that bucket, maybe just put a little bit more color around that because I believe that slide, depicts kind of the pipeline in aggregate.
Yes. I think we've got a number of deals in process that we feel good about. Always tricky on timing, given we're 3rd into the quarter. We'd expect a good chunk of those to close, but right now we're still not exactly sure the closing dates on a couple of them. So I don't want to go too far in overstating that.
The dynamic we've seen and this is probably the thing we've learned the most over the 1st 8 months of our existence is we're making a lot of progress because the logic of what we're doing is so compelling to owners. They understand that splitting the building where the talents they bring to the table can earn very high returns away from the much lower risk, but also lower return piece of land is definitely a smart trade for them. But what we're finding is that first meeting where we sit with a deal person, an owner of real estate, we make that progress. There's a whole another chain of people behind that, that we also need to really share with them how we're reinventing the business, why it's different than the historical ground lease business. I think a lot of people think about when they hear this.
And so we spent a lot of time trying to figure out how do we get past that first meeting to the partners, the lieutenants, the lawyers, the mortgage brokers, all parties to transactions that I think on first blush are looking at ground leases in the way historically they've been used, which is really a value destroying proposition for owners. And they have to really see the merits of what we're talking about, which is a value creating ground lease structure. And I think as Andy said, we've had a lot of repeat customers, which tells us if we can touch all those parts of the puzzle, we're going to get a lot of business in the future. But that lead up time that 4 or 5 meetings we have to have with all the parties involved to help explain that we are fundamentally reinventing this business. It has nothing to do with the old fashioned family's business that they're probably used to.
That's taking a little bit of time. So again, we feel pretty optimistic that the more we do, the more we'll be able to do. But getting through those first couple of points of resistance is taking quite a bit of time and effort on our part.
Okay. That's fair. I guess switching back to just the value bank, the increase obviously a big jump in that relative to year end, was that just reflecting kind of the deals completed in 1Q or was there any other moving pieces that drove that? Or was it just again, just largely reflecting the overall combined property value stepping up pretty big?
Yes. We like to split Value Bank into 2 pieces. These quantum jumps that happen each time we add a deal, that creates a quantum jump. And then we have the organic growth, which is the underlying property values increasing this quarter because again we're still quite new and we haven't gone through a full cycle of reevaluation, it's almost all that quantum jumps. We haven't really added in the organic growth that's taking place in the portfolio.
Okay. Last one for me and I'll turn it over. Just, Jay, maybe if you could comment on the search for a permanent CFO. I know obviously Andy is fulfilling that on an interim basis, but maybe just talk about that. I recognize it's obviously relevant to both Safety and iStar, but just any thoughts there?
Well, as we suspected, Andy is doing an incredible job for us right out of the box. So we got the luxury of having somebody who is really wonderful at it. So our first goal is really to build this business and we'll turn our attention to the other pieces of the puzzle throughout the rest of the year. But right now, I would tell you it's all hands on board to really get this business out into the marketplace and Andy is certainly helping us do that.
Appreciate the color. Thank you.
Your next question comes from the line of Jason Maslach with Ladenburg Thalmann. Your line is open.
It's John, but okay. So kind of the first question, is it fair to say that the when you look at the portfolio, the stuff that is now called in discussion is the same as what was in ongoing negotiations in the prior presentation?
Yes. We're trying to find a metric that's really useful for you and for us. I think we have a lot of deal dialogue going on. As I said, we get through the front door pretty easily with the compelling logic of what we're presenting and the long history of what we have done in working with customers and owners of real estate find ways to help them do their business better. And that can be a very productive meeting and we'll leave that meeting with a handshake that let's go work on some stuff together.
As we sort of tailor this pipeline and try to understand why things are happening and why things aren't happening, again, we think there is several layers that we have to win to really get a transaction all the way from that initial very compelling first meeting through a transaction. And so we think the LOIs obviously have made it through that path. But the in discussion, I think, is really our deal team's view of something where they go, look, not only is the idea makes sense and really does unlock value, But we also have buy in from some key decision makers and there seems to be a momentum to try to get a deal done. The wider funnel, the, hey, we've had a good meeting, we're not going to highlight as much, because we still have a lot of work to move those into these two baskets. So I think better for us at this point and for you frankly to see the deals that we think we have traction on, not all of them will happen, but we're making a deeper inroads into an organization or an owner's thought process where they're saying, yes, I want to do this.
And still, I think there's a lot of territory out there we haven't even touched, but it doesn't really make sense to tell you we're working on tons and tons of deals that frankly we've had one really good conversation with a decision maker. We found that does not lead to a guaranteed deal. So we're being a little more cautious about how we show you and how we think about ourselves, how this funnel really works.
Okay. But so those 2 categories are kind of comparable, right? And if so, what kind of caused the it's pretty big growth, right? It's almost $300,000,000 Is that just a lot of that just reverse inquiries from multifamily for the Onyx deal? Or is there something else maybe that drove the growth in that category?
Yes, I think, look, we continue to believe there's sort of the flow business in the multifamily space and some of the other property types. And then there's some of these larger transactions in the gateway cities. And those are the ones that come in and out that we have a harder time sort of knowing whether they're going to happen. Obviously, a ton of competition in those markets. We've seen finance markets get very, very aggressive in certain circumstances and we're being pretty disciplined about where we want to go.
So right now, I think the mix of the 2 feels pretty good, but I wouldn't read too much into the absolute dollar number. I'd look more at the number of deals because that for us is really a sense of how fast we're getting traction with our customer base and with new customers that we're reaching out to.
Understood. And then within the current pipeline, how much kind of roughly speaking of those are existing ground leases and how many of those kind of percentage wise are ground leases you would create?
Yes. The majority are things we're creating. But again, don't look so much at the dollar value because some of the things we're working on will skew that. But just in terms of the number of deals we're working on, the majority are things either we are creating directly or we are creating in conjunction with an acquisition or a new transaction.
And then, kind of specifically on the 3 transactions you closed in the quarter, What was the term on those lease term? 99.
On all of them? All 3,
Okay. That's it for me. Thank you guys very much.
Thank you.
Your next question comes from the line of Anthony Paolone with JPMorgan. Your line is open.
Thank you. Can you talk about just yields and sensitivity around yields as you talk to folks in the market given just what's happened to interest rates in I guess last month or
so? Yes. I think people are always testing their alternatives. And as the LIBOR continues to move up, I think the idea of longer term non maturity capital is becoming increasingly attractive. I think the market understands that there's likely significant future moves in LIBOR coming.
So the idea that today's rate is tomorrow's rate, I don't think holds anymore and people are looking out over the curve and saying over the next 2 years, what are my real cost of funds and what risks am I taking? And I think they like the idea of locking in at least a portion of their capital structure on a more stable basis and not having a refi risk in the future where they really can't predict where interest rates are going to be. So we think right now, people are starting to rethink their assumptions given where at least the Fed has told us they are going to take short term rates and any floating rate debt right now has a material increase in cost built into it.
Okay. And then so the deals in the quarter were at about 4.2%, but they were all basically office deals. If we look at your pipeline and you've got a decent amount of apartments in the mix, Do you think those deals could dip below back dip back below 4% or do you think those yields could stay above 4% as we look
ahead? Yes. I'd say the highest quality deals in the best markets are kind of in that 4 percent range right now, and it can get wider than that for things that have some less positive dynamics in terms of the locations. But it's going to be hard to get much below 4 right now unless something changes.
Okay. And then just one off on the quarter, the other income bounced up. What was in there? And is that going to stay at that level?
You're talking about percentage rent or different line item?
No, the actual like other income number there is
$499,000
$400,000 just over $400,000 Yes. I think that's interest income on our cash.
We're more efficiently holding the cash.
Our next question comes from the line of Joshua Dennerlein with Bank of America Merrill Lynch. Your line is open.
Hey, good morning guys. Saw that the land under the Lipstick building in New York City was for sale. Is that something you're looking at or would consider looking at purchasing?
Yes. Unfortunately, that is a classic old fashioned ground lease, probably represents 90% of the value of the overall building. So it's not really a ground lease. It's really a very high in the capital structure, very low coverage piece of paper. So it's probably not something we would pursue, although inside of it, there's probably a very good modern new ground lease that we'd love to put on the building.
But the one that exists today is not doesn't really fit our goals.
Okay. And then just kind of a follow-up. For the multifamily, how it's 56% of your pipeline, what do you think makes multifamily maybe more attractive to folks to put a ground lease under? Or is that just you think you've just got more traction with developers on that front?
Great question. There's 2 things. And I think when we first started 2 years ago looking at this, there was a question mark of, is this just financial moment in time? And really, I think we've redirected a lot of folks to the idea of they are trying to make low teens, mid teens, high teens or higher returns on the things they do well, the leasing, the marketing, the design, construction, and ultimately the sale. And that business should generate mid teens returns.
The business that they shouldn't be in is trying to own very long duration 4% instruments like a ground lease. And so we've seen the take up really be less about this financial difference between their cost today and their cost tomorrow. As much as it is just psychologically, yes, I want to use my money most efficiently, my capital most efficiently, I want to make the highest returns for the skill set I have. And that actually works really well in multifamily. It's a competitive market.
Cap rates have been driven down where absolute returns are difficult to make unless you're really efficient as a buyer, as an owner, as a manager and as a seller. And we think we've touched a nerve on a couple of transactions in the pipeline where people are seeing very explicitly they can do their business better, make better returns by not having to own this long term piece of ground lease. And so that's one big component is just the psychological understanding of what they do really well and what they can make the most returns on is benefited by what we do well. The second thing I'd say and this is goes to the point I made earlier is because the agencies are relatively consistent in how they view the financing piece of the puzzle, we can move very quickly through that process. So the idea that we have to convince sort of the can you borrow on a leasehold at certain rates at certain is taken off the table.
We've already done it. They've already seen it. The agencies have already blessed it. So suddenly it becomes a very straightforward opportunity for them to look at their alternatives of do I do a ground lease with a leasehold financing or do I do a straight fee financing? And more and more we're seeing people gravitate to the former and say, that's a lot more efficient for my capital.
It allows me to do what I do best and generate the maximum returns possible from my success and lets us do what we do well at Safety, Income and Growth, which is on these very long duration ultra safe ground positions. So I think that's one of the exciting things we've seen over the 1st 6 months here is just a mental shift from the old fashioned ground lease, why would I ever do this, to wow, this actually makes more sense, generates higher returns, takes my refinancing risk on a big chunk of my capital off the table. In a lot of ways, this is just superior and a smarter way for them to capitalize their deals. And that's what we're really going to press on here as we go forward is finding more and more owners who see what we've already done and say, yes, why aren't I doing that? Why isn't that a lot better way for me to invest in the things I do really well, which is leasing, managing, designing, constructing and selling?
So we think we're we haven't reached the tipping point. I don't want to go too far out. But I think more and more meetings we have, the more aggressive we've been able to reach out to people and say, don't think about the old fashioned ones. They really aren't what we're talking about. Let us walk you through how we're going to help you make more money, a 1 plus one equals more than 2.
That's starting to sink in. And I think the fact that we can do it in multifamily should have a positive impact on owners of other property types.
Great. Thank you. I'll yield the floor.
There are no further questions.
Thank you, Jack, and thanks everyone for joining us this morning. As a reminder, we have our Annual Meeting of Shareholders coming up on May 9 at the Harvard Club of New York City at 9 a. M. And all shareholders are welcome to join us. Otherwise, if you should have any additional question on today's earnings release, please feel free to contact me directly.
Would you please give the conference call replay instructions once again? Thanks.
Certainly. Today's call will be available for replay from 1 pm Eastern Standard Time today to 11:59 pm Eastern Standard Time, May 10, 2018. The number to contact is 855-859-2056 and the conference ID number is 5,688,969. This concludes today's call.