10-K: Safehold Inc. Reports Full Year 2023 Results, Impacted by Goodwill Impairment

Safehold Inc.'s 2023 annual report reveals a net loss due to a significant goodwill impairment, despite growth in lease income.

Summary

• Safehold Inc. reported a net loss of $54.6 million for the year ended December 31, 2023, a significant downturn compared to a net income of $144.7 million in 2022.
• The company's financial results were heavily impacted by a $145.4 million goodwill impairment charge related to its merger with iStar Inc.
• Despite the net loss, the company saw an increase in interest income from sales-type leases to $235.5 million, up from $202.3 million in the previous year.
• Operating lease income also increased to $71.3 million, compared to $66.8 million in 2022, driven by a rise in percentage rent and recovery income.
• The company's total revenues reached $352.6 million, an increase from $270.3 million in 2022, but total costs and expenses also rose to $430.1 million.
• The company's unrealized capital appreciation in its owned residual portfolio was estimated at $9.8 billion as of December 31, 2023, down from $10.5 billion in 2022.
• The company's gross book value as a percentage of combined property value was 44% as of December 31, 2023.

Sentiment

Score: 4

Explanation: The document presents a mixed picture. While there is growth in revenue and lease income, the significant net loss due to the goodwill impairment and the various risks outlined create a negative sentiment. The company's reliance on external capital and the potential conflicts of interest also contribute to a cautious outlook.

Positives

• Interest income from sales-type leases increased by $33.2 million year-over-year.
• Operating lease income increased by $4.5 million year-over-year.
• The company's total revenues increased by $82.3 million year-over-year.
• The company has $733 million of undrawn capacity on its unsecured revolvers.

Negatives

• The company reported a net loss of $54.6 million, a significant decrease from the previous year's net income.
• A $145.4 million goodwill impairment charge significantly impacted the company's profitability.
• Total costs and expenses increased by $239.6 million year-over-year.
• The company's unrealized capital appreciation in its owned residual portfolio decreased from $10.5 billion to $9.8 billion.

Risks

• The market for Ground Lease transactions and the availability of investment opportunities may not meet the company's growth objectives.
• The company's operating performance and the market value of its properties are subject to risks associated with real estate assets.
• Rental payments under the company's leases may not keep up with changes in market value and inflation.
• The company may be unable to renew expiring Ground Leases, re-lease the land or sell the properties on favorable terms or at all.
• Counterparty, geographic and industry concentrations may expose the company to financial credit risk.
• Certain tenant rights under the company's Ground Leases may limit the value and the UCA the company is able to realize upon lease expiration, sale of its land and Ground Leases or other events.
• The company relies on Property NOI as reported to it by its tenants.
• The company's estimates of Combined Property Value are based on various assumptions and information supplied to it by its tenants, and accordingly may not be indicative of actual values.
• There can be no assurance that the company will realize any incremental value from the UCA in its owned residual portfolio or that the market price of its common stock will reflect any value attributable thereto.
• Ground Leases with developers expose the company to risks associated with property development and redevelopment that could materially and adversely affect it.
• The company may be materially and adversely affected by the exercise of leasehold mortgagee protections.
• The company is subject to the risk of bankruptcy of its tenants.
• The company may directly own one or more commercial properties, which will expose it to the risks of ownership of operating properties.
• Competition may adversely affect the company's ability to acquire and originate investments.
• Cybersecurity risk and cyber incidents may adversely affect the company's business.
• The company's business and growth prospects could be adversely affected by future epidemics, pandemics or other health crises, as they were during the peak of the COVID-19 pandemic.
• The company's estimated UCA, Combined Property Value and Ground Rent Coverage, may not accurately reflect the current market value of the properties and may decline materially in future periods.
• The company's success depends in part on its ability to attract, retain and develop talented employees, and its failure to do so, including the loss of any of its key employees, could adversely impact its business.
• The company is party to several agreements with Star Holdings, and may be unable to collect amounts to which it is contractually entitled, which could negatively affect its performance, financial condition, results of operations and cash flow.
• Star Holdings owns a significant amount of the company's common stock, all of which serves as collateral for a margin loan.
• The concentration of the company's voting power may adversely affect the ability of investors to influence its policies.
• There are various potential conflicts of interest in the company's relationship with Star Holdings, which could result in decisions that are not in the best interest of its shareholders.
• The company's management agreement with Star Holdings and other effects from the Spin-Off could distract management time and attention and give rise to disputes or other unfavorable effects, which could materially and adversely affect its business, financial position or results of operations.
• The company's debt obligations, which include the substantial amount of indebtedness it assumed in connection with the Merger, will reduce cash available for distribution and expose it to the risk of default.
• The company's failure to hedge interest rates effectively could materially and adversely affect it.
• Joint venture investments could be adversely affected by the company's lack of sole decision-making authority, its reliance on partners or co-venturers financial position and liquidity and disputes between the company and its co-venturers.
• The company's depreciation expenses are expected to be limited for financial and tax reporting purposes, with the result that it will be highly dependent on external capital sources to fund its growth.
• The company's credit ratings will impact its borrowing costs and its access to debt capital markets.
• The company is a holding company and will rely on funds from Portfolio Holdings to pay its obligations and distributions to its shareholders.
• Certain provisions of Maryland law and the company's organizational documents could inhibit changes in control of the company.
• Certain provisions of the company's organizational documents limit shareholder recourse and access to judicial fora.
• Cash available for distribution may not be sufficient to make distributions to the company's shareholders at expected levels, or at all.
• The availability of shares for future sale could adversely affect the market price of the company's common stock.
• Distributions to holders of Caret units will reduce distributions to the company upon certain transactions, and sales of additional Caret units may dilute the economic interests of the company's common stockholders.
• The changes to the Caret program in connection with the Merger may fail to improve the recognition of the company's two distinct components of value by market participants.
• The terms of Caret units could result in conflicts of interest between holders of the company's common stock and holders of Caret units.
• The company's managements ownership of Caret units creates potential conflicts of interest.
• The Portfolio Holdings LLCA sets forth certain limitations on the company's ability to make changes to such agreement that could be beneficial to the company and its stockholders without the consent of certain of the Caret unitholders.
• The Portfolio Holdings LLCA contains provisions that may delay, defer or prevent a change in control.
• Future issuances of debt or preferred equity securities could adversely affect the company's common shareholders and result in conflicts of interest.
• Following the Merger and the Spin-Off, the Company may not continue to pay dividends at or above the rate previously paid by it or Old SAFE.
• The company's failure to remain qualified as a REIT would subject it to taxes, which would reduce the amount of cash available for distribution to its shareholders.
• The REIT distribution requirements could require the company to borrow funds or take other actions that may be disadvantageous to its shareholders.
• Even if the company qualifies as a REIT, it may incur tax liabilities that reduce its cash flow.

Future Outlook

The company expects to make quarterly cash distributions to its shareholders sufficient to meet REIT qualification requirements and expects to meet its liquidity requirements over the next 12 months and beyond.

Management Comments

• The company believes that owning a portfolio of Ground Leases affords its investors the opportunity for safe, growing income.
• The company believes that the Ground Lease structure provides an opportunity for potential value accretion through the reversion to the Company, as the Ground Lease owner, of the buildings and improvements on the land at the expiration or earlier termination of the lease, for no additional consideration from the Company.

Industry Context

The report highlights the impact of the COVID-19 pandemic and rising interest rates on the commercial real estate market, particularly the office sector, which could negatively impact the company's tenants, Ground Rent Coverages and estimated Combined Property Values. The rise in interest rates and increased investment spreads to treasury bonds in the Ground Lease market may attract new competitors, which may result in higher costs for properties, lower returns and impact the company's ability to grow.

Comparison to Industry Standards

• The company's focus on Ground Leases is a niche strategy within the broader real estate investment trust (REIT) sector, which typically includes a mix of property types and financing structures.
• Compared to traditional REITs that own and operate properties, Safehold's business model is more akin to a fixed-income investment with unique features such as contractual rent escalations and the potential for capital appreciation through residual rights.
• The company's target leverage of approximately 25% of the aggregate Combined Property Value is generally lower than that of many other REITs, which may indicate a more conservative approach to financial risk.
• The company's reliance on external capital sources for growth is common among REITs, but its limited depreciation expenses make it particularly dependent on these sources.
• The company's Caret program, which separates the bond component and the capital appreciation component of its Ground Leases, is a unique feature not typically found in other REITs.

Related Party Transactions

• The company has various related party transactions with Star Holdings, including a management agreement and a term loan facility.
• The company has related party transactions with MSD Partners, including the purchase of shares and Caret units.
• The company has related party transactions with the Ground Lease Plus Fund and the Leasehold Loan Fund, in which it has noncontrolling equity interests.
• The company has related party transactions with its former manager, SFTY Manager, LLC, including management fees and expense reimbursements.

Stakeholder Impact

• Shareholders may be concerned about the net loss and the decrease in unrealized capital appreciation.
• Shareholders may be concerned about the potential conflicts of interest and the concentration of voting power.
• Employees may be affected by the company's performance and any potential changes in compensation or benefits.
• Tenants may be affected by the company's financial stability and its ability to provide capital for development and redevelopment.
• Creditors may be concerned about the company's debt levels and its ability to meet its obligations.

Next Steps

• The company will continue to monitor the impact of the COVID-19 pandemic and rising interest rates on its business.
• The company will continue to pursue its investment strategy of acquiring, managing and capitalizing Ground Leases.
• The company will continue to manage its exposure to interest rate volatility by using interest rate hedging arrangements.
• The company will continue to evaluate its level of indebtedness from time to time.

Key Dates

Keywords

Ground Leases, Real Estate, REIT, Unrealized Capital Appreciation, Lease Income, Merger, Goodwill Impairment, Caret Units, Financial Results, Commercial Property