Safehold Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Amounts below are in U.S. dollars; financial statement amounts are rounded to millions unless stated otherwise.
Business context and reporting period
Safehold acquires, manages and capitalizes long-term ground leases. On March 31, 2023, Old Safehold merged into iStar; iStar survived and changed its name to Safehold. The merger was accounted for as a reverse acquisition, so historical financial statements are those of Old Safehold. Safehold became internally managed, while iStar’s remaining legacy non-ground-lease assets were spun off to Star Holdings. Comparisons with 2022 and the six-month 2023 period are affected by the transaction and the resulting changes in operations and expense structure.
At June 30, 2023, the portfolio’s gross book value was 44% office, 37% multifamily, 12% hotels, 4% life science and 3% mixed use and other. Estimated Ground Rent Coverage was 3.7x.
Financial performance and position
- Q2 revenue: $85.7 million, up from $64.9 million. Sales-type lease interest income was $58.2 million; operating lease income was $16.8 million; related-party interest income was $2.4 million; and other income was $8.4 million, including $7.2 million of Star Holdings management fees.
- Q2 earnings: Income from operations before equity-method earnings and taxes was $15.8 million versus $20.5 million. Net income was $22.1 million versus $22.7 million; income attributable to common shareholders was $22.1 million versus $22.7 million. Basic and diluted EPS were $0.35 versus $0.36. Higher equity-method earnings helped offset increased expenses.
- Six-month results: Revenue was $164.0 million versus $125.2 million. Net income was $26.8 million versus $47.6 million, and EPS was $0.42 versus $0.78. The comparison reflects higher interest expense, general and administrative costs, merger-related expense and credit-loss provisioning in 2023; 2022 also included different portfolio and financing activity.
- Expenses and margins: Q2 interest expense increased to $46.1 million from $30.3 million, primarily due to increased borrowings and higher floating rates. General and administrative expense rose to $18.9 million from $10.5 million, including higher public-company costs and stock compensation after the merger. Q2 operating income before equity-method earnings and taxes was approximately 18% of revenue, compared with approximately 32% in 2022.
- Cash flow: For the first six months, operating activities used $9.5 million, versus $46.7 million provided in 2022; investing activities used $355.8 million, and financing activities provided $359.3 million. Reported lease interest includes substantial noncash accretion: $41.1 million for the six-month period.
- Assets and debt: Total assets were $6.42 billion, up from $5.85 billion at year-end 2022. Net debt obligations were $3.98 billion versus $3.52 billion; principal debt was $4.03 billion. Debt includes $1.50 billion of secured mortgages, $2.53 billion of unsecured financing, and $1.05 billion drawn on the 2021 revolver. The company reported $2.9 billion of fixed-rate and $1.1 billion of floating-rate debt.
- Liquidity: Unrestricted cash was approximately $14 million, with $802 million of undrawn capacity across two unsecured revolvers. Safehold reported compliance with its debt covenants. The company expects to meet liquidity requirements over the next 12 months and beyond, but this is management’s expectation, not a guarantee.
- Shareholder distributions: Dividends declared for the six months totaled $22.6 million, or $0.354 per share. The Q2 declared dividend was $0.177 per share.
Material changes, outlook and risks
- The merger and spin-off changed the company’s management structure and added Star Holdings-related assets, liabilities, expenses and income. Goodwill recorded from the acquisition was $149.5 million. Merger expenses for the six months were $18.9 million; the filing also reports $3.0 million of related non-recurring charges and a $2.3 million credit-loss provision on the Star Holdings loan.
- Safehold originated a $115 million secured, related-party term loan to Star Holdings at a fixed 8% rate, maturing March 31, 2027. The loan’s carrying value was $112.2 million after a $2.3 million credit-loss allowance; it generated $2.4 million of interest income during the six-month period.
- Safehold formed a controlled ground-lease joint venture with a sovereign wealth fund. The parties committed approximately $275 million and $225 million, respectively, on a discretionary basis. The venture acquired two ground leases for $38.5 million in aggregate, with $14.5 million funded by period-end.
- Unfunded commitments at June 30 included $250.6 million for tenant improvement allowances, $271.2 million for forward ground-lease acquisitions or additions, and $127.7 million of performance-based commitments through the Leasehold Loan Fund. Conditions may not be met, and funding timing is uncertain.
- Effective January 1, 2023, Safehold adopted the expected-credit-loss standard. It recorded an initial allowance against lease and ground-lease receivables; subsequent estimates depend on market conditions, forecasts and management judgments.
- Key risks include rising interest rates and higher tenant financing costs, office-sector weakness, tenant credit risk, and inflation adjustments subject to caps that may not fully track inflation. A 100-basis-point rate increase was estimated to reduce annual net income by $6.5 million, assuming other factors remain unchanged. The company also cautions that its estimated unrealized capital appreciation (UCA) is not a realized or guaranteed value: estimated UCA was $10.1 billion at June 30, down from $10.5 billion at year-end.
- No numerical earnings or investment guidance was provided. Management describes plans to grow its ground-lease platform and expects to fund liquidity needs through cash flows, financing, joint-venture capital, revolver capacity and potential equity issuance. A $300 million ATM equity program was available, but no shares had been sold through it by June 30.
- The company reported no pending legal proceeding it believes would have a material adverse effect, no material change to previously disclosed risk factors, and effective disclosure controls.
Important facts for investors to verify
- How much of reported lease income converts to cash, given the substantial noncash accretion and negative operating cash flow in the first half.
- The sustainability of earnings after merger-related costs, higher interest expense, new public-company costs and Star Holdings management fees.
- Star Holdings’ ability to service the related-party loan, the adequacy of its collateral and the assumptions underlying the $2.3 million credit-loss allowance.
- Debt maturities, floating-rate exposure, covenant headroom and the availability and conditions attached to revolver capacity.
- The timing and funding requirements of unfunded commitments, and whether acquisition conditions are satisfied.
- The assumptions and limitations in estimated UCA and Ground Rent Coverage, including office exposure, tenant rights and the effect of capped inflation escalators.