Why Ground Leases Are An Opportunity For Innovation Amid The CRE Downturn

Liquidity in short supply, more than $2T in commercial real estate debt maturing and an office sector struggling to find its foothold in a new world of hybrid work. It would be difficult to recall a time when CRE was buffeted by so many headwinds at once.

“Economists are going to have a field day making sense of these almost tectonic shifts,” said Marcos Alvarado, president and chief investment officer of Safehold, which bills itself as the pioneer of the modern ground lease. “It will probably take another five or 10 years from now to make sense of the permanent systematic change.”

Smart investors know to think long-term, and many are looking for ways to not only ride out the turmoil but prosper. Alvarado said Safehold provides a potential solution for them.

Bisnow spoke with Alvarado about ground leases and why he thinks they can provide a tremendous opportunity for the industry to innovate and solve some of the obstacles posed by the current environment.  

Bisnow: What are you hearing from customers about the state of CRE?

Alvarado: I think people are trying to figure out what to do. Some of our owners and customers are in asset classes where the fundamentals are actually pretty positive. And then at the other end of the spectrum, office operators and owners are sort of scratching their heads and struggling. 

Bisnow: How do ground leases provide an opportunity for the CRE industry to address the challenges of today’s market?

Alvarado: In this environment, a ground lease is a phenomenal alternative for our customers as they think about developing, acquiring new assets or recapitalizing a distressed asset. We want to provide capital solutions to our customers so that they can potentially recap and execute on a business plan and recover some of the equity value that may be impaired today.

Bisnow: Let’s go back to when the company was founded. What was the fundamental problem Safehold set out to solve in 2017?

Alvarado: Ground leases have been around for centuries and have generated great wealth for institutions such as universities. But in 2017, we saw that there was no market to actually own ground leases. They never came up for sale. We thought, “How can we create this product and give investors access to it while creating an efficient capital solution for building owners?” We viewed ground leases as a natural extension of the net lease space.

We started off with a handful of assets as a kind of seed portfolio, and the first two years of getting our story out there were pretty difficult. But we've since gained momentum, and I think of us as the leading brand now in the ground lease space. We went from around 10 assets to more than 130 today, and our lease portfolio has grown from a couple hundred million dollars to $6.3B as of Q2. 

Bisnow: How do you account for Safehold’s exponential growth?

Alvarado: If you look at the arc of what we did, again, the first two years were an education phase. And then we hit an inflection point in 2019 when people started to understand and appreciate what we were trying to do, and our brand awareness grew. 

The things that we point to are customer satisfaction and our repeat customer stats, which are almost at the 70% level. If the product didn't work, people wouldn't be coming back to us. 

We're also constantly trying to improve on how quickly we go from sourcing prospective customers to closing actual transactions. When we started, that process took almost two years. We've since tightened the time frame down to about 14 months. 

Bisnow: It sounds like CRE has become more comfortable with ground leases.

Alvarado: Yes, but we’re still in the early innings of adoption. There's approximately $7T of commercial real estate, and among the top 30 MSAs, in a functioning capital market, there's probably a trillion dollars of capital decisions made every year. That's what gets us excited: the overall opportunity. 

When we started the business and were making calls, nobody knew what the product was, and there was a ton of skepticism. Five or six years later, people see that it is financeable and that you can sell your asset and create real value.

The other thing I think about is that when we started, there was never a page about ground leases in the pitch decks of the big investment sales brokerage shops. Now, there is a ground lease page in almost every investment sales pitch, which leads me to think we have made significant inroads.

Bisnow: More specifically, how does Safehold give its customers a competitive advantage? 

Alvarado: Our product provides permanent capital at a lower cost than the equity alternative. We're driving customers’ cash-on-cash returns and reducing friction costs, because every time we enter into a transaction, the transfer tax, mortgage recording tax and other costs related to land disappear. We’re also reducing risk during this downturn because we give our customers permanent capital that they don't have to pay back. 

Bisnow: How do leasehold sales of assets on Safehold ground leases compare to traditional fee simple sale comps?

Alvarado: We've seen about 30 sales and refinancings behind our ground leases since we started, so the proof of concept is there. In these transactions, the cap rates have been very comparable, both on multifamily and office assets, with a range of no spread on cap rate to about 50 basis points. 

Our customers recognize the value proposition of our product. From a refinancing standpoint, there have now been plenty of transactions that support the liquidity of ground lease assets.

Bisnow: What does the near-term future look like for Safehold and ground leases?

Alvarado: We're focused on the housing space because of the structural supply-demand imbalance and liquidity from government agencies. You'll see us playing in the multifamily/student housing space, and then we believe in the recap opportunity in distressed capital structures, where we're spending time across all asset classes as an efficient capital solution while values are reset.

This article was produced in collaboration between Safehold and Studio B. Bisnow news staff was not involved in the production of this content.

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