Safehold Inc

Good morning and welcome to I-STAR's third quarter 2021 earnings conference call. If you need assistance during today's call, please press star zero. If you'd like to ask a question, please press one zero. That's one zero to ask a question. 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 Jason Fuchs, Senior Vice President of Investor Relations and Marketing. Please go ahead, sir.

Good morning. Thank you for joining us today to review I-Star's third quarter 2021 earnings. With me today are Jay Sugarman, Chairman and Chief Executive Officer, and Marcos Alvarado, our President and Chief Investment Officer. This morning, we published an earnings presentation highlighting our results, and our call will refer to these slides, which can be found on our website at istar.com in the Investors section. There'll be a replay of the call beginning at 2.30 p.m. Eastern time today. The replay is accessible on our website or by dialing 1-866-207-1041 with a confirmation code of 1463546. 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 will be forward-looking. ISTAR's 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. ISTAR disclaims any intent or obligation to update these forward-looking statements, except as expressly required by law. Now, I'd like to turn the call over to I-STAR's Chairman and CEO, Jay Sugarman.

Jay? Thanks, Jason. I appreciate everyone joining us today. I-STAR's third quarter was highlighted by strong success in monetizing legacy assets and continued progress in scaling Safehold. Earnings benefited from both of these strategic initiatives, with EPS for the quarter topping $1.50 a share and adjusted EPS over $1.75. On the legacy asset side, our asset management team has been working hard to simplify our portfolio, and those efforts paid off nicely last quarter, bringing in almost $250 million of proceeds and generating almost $50 million of gains in the process. Legacy assets now make up well less than 10 percent of the overall portfolio and are rapidly moving into the rearview mirror. Turning to Safehold, our investment team continues to drive new business in the ground lease sector. delivering over 320 million of new ground leases into Safehold's portfolio during the quarter and exploring further ways to help expand the customer base. We continue to believe the ground lease ecosystem represents a rich area of opportunity going forward. We also continue to make progress on our net lease exploration process and have been positioning ourselves to be able to execute efficiently as we evaluate various alternatives. As we are mid-process, we can't provide any details just yet, but look forward to updating you on the process in the future. And with that, let's have Marcos take you through the details. Marcos?

Thanks, Jay, and good morning, everyone. Let's begin on slide three. During the third quarter, we made meaningful progress on our two-year strategy we laid out at the beginning of the year. We continued to scale and build momentum at Safehold with solid investment activity and capital raising, expanding the ground lease ecosystem. In terms of simplifying the business, We were pleased with the progress this quarter, with legacy assets now down to 7% of our portfolio. Altogether, this success produced $125 million of gains, which drove strong third quarter earnings results. Slide four provides more details on Safehold. We continue to grow our investment in ground leases, and over the past year, the value of our interest has increased by approximately a half a billion dollars. During the quarter, Safehold saw EPS growth of 36% from the prior year period and strong investment momentum with 321 million of originations. Alongside with new originations, UCA grew by an additional 624 million and stood at approximately 6.7 billion at quarter end. Additionally, during the quarter, Safehold raised 242 million of equity at a price of $76 per share, Based on strong institutional demand, the offering was upsized by 10% from launch. Notably, iStart took a smaller position in this equity race, representing 25% of the initial base offering. While we continue to believe that Safehold at these levels is materially undervalued, we felt it was important to focus on long-term value creation and pare back our participation so that Safehold could attract new investors, increase its float, and enhance trading liquidity in the stock. As a result of our smaller participation, our ownership position decreased from 66% to 64%. US GAAP treats this reduction in percentage ownership as if I-Star sold a pro rata share of its investment in Safehold. This resulted in a gain of $60 million, which was recorded in earnings from equity method investments. In effect, the gain accretes into book value a portion of the unrealized gain we have been highlighting for the past two years. And so for investors who have been thinking about I-Star's intrinsic value, inclusive of Safehold's market value, these gains have no net effect. At the end of the quarter, we held approximately 36 million shares of Safehold with a market value of $2.6 billion, a $1.4 billion unrealized gain above our $1.1 billion gross book value. On slide five, we provide an update on our legacy assets. We're very pleased with the progress on our legacy asset strategy this quarter, as we were able to generate proceeds of $246 million and record $49 million of gains. This included the previously announced sale of Grand Vista, which posted a $26 million gain this quarter. Over the past year, we have reduced our legacy asset portfolio by 42%, from $803 million to $464 million, which is now down to 7% of our total portfolio. As you can see on the right side of the slide, our legacy asset portfolio includes 14 short-term assets totaling $113 million. The long-term assets are comprised of two remaining assets, Asbury Park and Magnolia Green, which totaled $351 million. While there are no near-term plans to sell these assets outright, we expect to see the balance at Asbury Park continue to decrease as we sell our remaining condo inventory at the Ocean Club. To date, we've sold approximately 70% of the inventory, and our basis in the remaining condos is approximately $69 million. Slide six summarizes our investment activity for the quarter. I-Star invested a total of $175 million during the third quarter. This included $53 million in safehold, of which $50 million was our participation in safe equity offering, and the remaining $3 million was open market stock purchases. This quarter, we also repurchased 2.4 million shares of I-Star stock for $60 million. Our remaining stock buyback authorization stood at $31 million at quarter end. In addition, we invested $54 million associated with loan, net lease, and other fundings that were primarily associated with prior commitments. And lastly, we invested $8 million of capital expenditures related to our legacy assets. Slide 7 shows the makeup of our portfolio. At the end of the third quarter, our total portfolio stood at 6.3 billion, with safehold, net lease, and cash on hand representing nearly 85% of our portfolio. In July of this year, we announced that we had engaged Eastill to explore a potential sale of our net lease portfolio. That process is ongoing, and we look forward to updating you in the future after concluding the process. Slide eight details our earnings results. For the quarter, net income was $121.9 million, or $1.51 per diluted common share. And adjusted earnings were $141.3 million, or $1.76 per diluted common share. Earnings were driven in large part by $125 million of gains this quarter, including the previously discussed $60 million gain related to the safehold equity offering and the $49 million of gains associated with sales of legacy assets. In addition, we recorded $16 million of gains on strong performance from other investments. Lastly, slide nine shows our book value per share on a GAAP basis and as adjusted to illustrate the value created through SAFEL but not recognized in our reported financial statements. As of September 30th, our common equity per share was $7.12, and when adjusted for depreciation, amortization, and CECL allowance, adjusted common equity per share was $12.23 per share. Including SAIF's mark-to-market value, our common equity value per share stood at $25.75 per share, and adjusted common equity was $30.47 per share. Of note, the third quarter included the dilution impact of our convertible bonds. Based on the average stock price during the third quarter, those bonds had a dilutive impact of 9 million shares, whereas they were non-dilutive in that comparative period a year ago. We have sought to mitigate some of that dilution from the convert with our open market stock repurchases. In conclusion, the third quarter represented strong progress on our two-year strategy with solid investment activity at Safehold, and we're encouraged with the advancement of sales in our legacy asset portfolio. And while we're pleased with the progress to date, we still have a lot of work to accomplish our objectives. With that, let me turn it back to Jay.

Great, Marcus. Good progress on a number of fronts and more to come as we expand our ground lease business and streamline I-Star. Operator, let's go ahead and open it up for questions.

Thank you. Today's question and answer session will be conducted over the phone. To ask a question, please press 1-0 at this time. We will take as many questions as time permits. Once again, please press 1-0 to ask a question. We will pause a moment to assemble the roster. Our first question comes from Nate Crossett with Barenburg. Please go ahead.

Hey, good morning, guys. Just on the portfolio sale, and I know you can't say much, but it looks like you made an announcement yesterday that you received the consent from the bondholders as it relates to the solicitation. And so I was just kind of wondering, is that kind of the last procedural move needed before any sale announcement? And then two, let's just say hypothetically, a large sale occurs within the next couple months. Can you kind of remind us near term use of proceeds of such a sale?

Yeah, sure. Yeah, the consent process was really to eliminate any barriers on timing, sequencing, sizing, and give us the ability to execute efficiently on any of the various potential alternatives. Not in a position to talk about them yet, but it was a major step to really make sure we can execute efficiently when and if we want to. I think in terms of the process and getting through the other side, You know, we're not going to specifically be able to talk about what we're going to do until we know exactly what we're going to do. But we've begun analyzing a number of different alternatives for each of the outcomes we think is possible and certainly be in a position on our next call to start talking about that. Okay, that's helpful.

And then if I could just ask one on, you know, maybe just an update on the ground lease plus product. I think that was a big topic on the last quarter's call. You know, maybe you can just touch on, you know, what does the pipeline look for that product heading into 22? And then just maybe remind us on kind of the yields and returns that you get for that product.

Hey, Nate. So, as you remember, we – closed our first two ground lease plus transactions in the prior quarter. We have our third transaction under letter of intent and is in the closing process. And we have a reasonable pipeline going into 22 for the product, which I think is a fantastic outcome for both Star and Safe. As you kind of think about returns, high single digits, low double digits IRR is what we're looking for.

Okay, I'll get back into the queue.

Thank you.

Our next question comes from Steven Laws with Raymond James. Please go ahead.

Hi, good morning. You know, you mentioned in the, you know, Asbury and Magnolia Green. I'm curious to get a little more detail there if you think you guys will look at completing those on your own or if you're looking to bring in some partners there. And then as I think about other long-duration investments, I know the senior loans are, I think, 0.7-year weighted average maturity, but the MES and other loans in the real estate finance bucket look like they have 7- and 9-year weighted average maturity. Can you talk about, you know, what you may elect to do there as you think about, you know, potential combination of the company in a much shorter timeframe than those expected maturities?

Hey, Stephen, thanks for the question. Asbury and Magnolia stories continue to move in a positive direction. We will anticipate bringing in others to take down pieces of the puzzle. We don't intend to be building all those out to the bitter end. There's an opportunity. We've seen a lot of interest from third-party builders in both markets. So as we get closer to the finish line, we'll certainly see transactions where chunks of those properties will be sold to third parties. In terms of the senior debt book, you're right, it's running off on a relatively short maturity basis. And the MES and any longer dated assets, we are looking at opportunities to monetize those where appropriate. We feel pretty good about most of the book in terms of You know, sort of the end of 22 being, you know, just a round sort of target for having the book in a nice, streamlined, simplified shape. There's going to be some assets left. There's no question. But we feel pretty good about the direction everything's headed.

Great. And, you know, very active on the stock repurchase front. You know, glad to see you guys focus on that, Jay, given the discount to the mark-to-market book value. You know, 31 million remaining authorization. Can you talk about, you know, your appetite for more repurchases at the current price, whether or not, you know, you continue those repurchases in October? I don't think the queue is out yet.

Yeah, it's part of our strategy to recycle gains into, you know, smart investments. We think Safehold and Star both represent significant value. So that's sort of core to our thesis of recycling some of the proceeds and gains out of legacy assets into more productive uses, and that's been taking place. You know, historically, our board has approved, you know, prudent levels of repurchases, and, you know, I would expect that to continue. I'm not going to talk about exactly what we're doing, but we have been historically an active buyer when we think our securities are undervalued.

I appreciate the comments this morning, Jay. Thank you.

Our next question comes from Jade Romani with KBW. Please go ahead. One moment, please. It looks like Jade knocked out. I do apologize. Our next question comes from Matt Howlett with the Riley. Please go ahead.

Okay, thanks for everyone. Yeah, I don't need to, you know, ask, you know, a question about the portfolio, but I mean, could you tell us whether there's been an LOI out there and anything, you know, in terms of what's going on in terms of negotiations at this point within that lease portfolio?

Yeah, I wish I could, Matt. We're mid-process, can't really do that at this moment, but You know, we're, we're trying to move the process along, uh, and continue to work with our advisor on a very productive basis. So, uh, we should definitely have some information for you, uh, by the next call coming around.

Gotcha. Well, just thinking ahead to potentially a sale in the excess capital being freed up, you know, I look at some of that, some of the secured debt, like most of that's tied a billion tied to the portfolio. Am I right to assume that's likely to go with the sale, be paid down? Two, would you be in a position to pay back some senior notes? Three, you're out there buying safe shares every day through these form fours. What is the appetite in conjunction with you're continuing to buy back your own stock to buying those same shares? Just talking about this capital transformational event and what you plan on doing with it.

Yeah. Sure. Look, you know, I think the The goal with any transaction is to simplify our balance sheet and strengthen it. Retiring debt is definitely going to be part of that calculus. How deep and how far and where it goes, you know, we'll save for our next call. But, you know, that's certainly one of the alternatives that's something we're going to have to evaluate. If a transaction happens, what do we do with the proceeds most effectively? But debt retirement will definitely be part of that thought process. And when we think about Safehold and the opportunity set over there, we did pare back our investment in the most recent offering. You know, if the market gives an opportunity to buy, you know, below what we think is fair value, it's always a good alternative. But, you know, I don't think we have signaled to the market that we'll be trying to increase our ownership dramatically. We just think we have quite a bit of liquidity at I-Star today. and we're looking for parts of the capital structure that we think are really attractive. So, as I said, historically, we've been thoughtful about how to deploy capital to keep a strong balance sheet, do everything prudently, but certainly safe trading below the last offering price seemed unusually attractive.

And then, of course, weighing that against share repurchases, I mean, assuming there could be a dividend requirement when you sell, and all this is just part of the capital management process that you'll convey to us when you're ready?

Yeah, no, there are a lot of pieces to the puzzle. That's why the process, we need to be prudent and thoughtful as we go through it. We have tried to make it as efficient as possible, but it's still going to take a little bit of time to be able to come back to you on all that.

Great. Thanks, Jake.

Our next question comes from Jade Romani with KBW. Please go ahead.

Thank you very much. I was wondering if you could quantify what percentage of corporate G&A relates to the net lease business?

Yeah, we don't break out specifically. There's obviously a lot of cross-functionality throughout the iStore organization, so people work on lots of different things to add expertise, but You know, in terms of just general direction, Jay, it's not a huge part of the G&A. It's a, you know, piece of the puzzle, but I wouldn't allocate an enormous amount to it.

Thank you. In the short-term legacy asset bucket with the low average price per asset of $1 billion, do you think that there are decent gains in that portfolio?

Sorry, which part of the bucket?

The short-term legacy asset bucket, which has an $8 million average value per asset.

Yeah, and I think we've historically guided you to, you know, there'll be some winners, there'll be some losers. Overall, we feel book is comfortable. You know, in a good market, that might surprise us to the upside, but I wouldn't be programming that in just yet.

And in the strategic investments area, Can you give any color as to what those are composed of, and does it include any PropTech investments?

Michael Heaney Yeah, look, we have used our balance sheet to seed areas where we thought they could be really interesting. We had an interesting opportunity in cold storage. That's been successful. We do have a small investment in the PropTech world just to keep our eyes and ears to see what's coming next. But again, not material amounts.

Thank you. And lastly, any update on the Park Hotels portfolio or assets within SAFE's portfolio that could have a near-term catalyst?

No active discussions, Jade. I think the portfolio is recovering, so I think there could be an opportunity in the future when things are more stabilized. But right now, I think they're still focused on this recovery mode from COVID So we've not had any active dialogue.

Thank you.

Ladies and gentlemen, to ask a question, please press 1-0 at this time. One moment while we wait for further questions. Once again, if you do have a question, please press 1-0 at this time. Mr. Fuchs, we have no further questions. Oh, I do apologize. I spoke too soon. Our next question comes from Rich Anderson with SMBC. Please go ahead.

Hey, Rich.

Rich, your line is open.

I thought I was on mute. So when you guys think about, you know, a hypothetical collapsing or recombination of STAR and SAFE, what do you, obviously there will be something in STAR today that would follow along in that type of sort of hypothetical arrangement. But how small does the asset base have to be in STAR for it to start to make logical sense to bring the two companies back together?

Yeah, you know, I think it's probably premature to start focusing on that. We've got a lot of work to do between here and there, and we've told the market we'll have that conversation when we think it has reached a scale where it makes the most sense. And the good news here, Rich, and you know this, is, you know, both companies are very much aligned on maximizing the value. of the Safehold ecosystem that it's building, that's going to accrue significant benefits to I-Star and to Safehold shareholders. So, you know, that's the kind of question that'll have to be sorted out. It'll determine the whens, ifs, and hows, and whether it's, you know, what's the highest and best execution and architecture going forward. There are a lot of steps between here and there, so let us focus on those first, and then we'll have a much clearer sense of how to maximize value for both sets of shareholders. That's the good news because I think you've got a very much alignment of interest in terms of the ultimate goal. How we get there is a number of steps on each side that we've said Safehold needs to scale further. I-Star needs to continue to streamline and keep its balance sheet strong and liquid. Those are the steps we're most focused on now. But if it's appropriate and there's a value uplift from having a conversation That's certainly one that both companies are prepared for and should be in good alignment for.

Yeah, so let me maybe ask it this way, and I respect the, you know, the process and everything, but would the assets, the current star assets that would remain in this, you know, sort of this combined entity, have some form of business relationship with the ground lease entity? execution or could there be distinct stuff that would stay in the combined company? In other words, would there, would there, you know, the star plus business obviously would follow along, but would there be other forms of business potentially that would, that would stay even if they don't have any real connection with the ground lease business?

We, we, we structured the safehold, uh, you know, business as a pure play. We think that was the absolute right strategy. You know, I don't think anything's changed in our thinking there. Ultimately, in terms of, you know, timing, sequencing, sizing, all those questions, you know, tax, we're going to have to kick those to further out when we have more clarity around what both companies are trying to achieve and how to maximize both companies' outcomes. So, at least at this point, can't give you a lot of guidance on the what-ifs and how big, you know, anything might be. Just let us have that conversation when we've, you know, further executed at both companies along their business plans. And I think the answer will be, you know, the right one for everybody. At least at this point, you know, having Safehold as a pure play still, at least in our minds, makes a lot of sense.

So if I ask it a third time, you're still not going to answer? All right. Thanks, guys.

All right, Rich. All right. Well, thank you, everyone. If you have any additional questions on today's earnings release, please feel free to contact me directly. Tiffany, would you please give the replay instructions again?

Absolutely. Thank you. Ladies and gentlemen, this conference will be available after 2.30 p.m. Eastern Time today through November 16th at midnight. You may access the executive replay system at any time by dialing 1-866-207-1041 and entering the access code 1-4-6-3-6. Those numbers again are 1-866-207-1041 with the access code 1-463-546. That does conclude our conference for today. Thank you for your participation. You may now disconnect.