SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|(Mark One)|| |
|☒||ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
|For the fiscal year ended|
|December 31, 2020|
|☐||TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
|For the transition period from to |
Commission File No. 001-38122
(Exact name of registrant as specified in its charter)
|(State or other jurisdiction of|
incorporation or organization)
| ||(I.R.S. Employer|
|1114 Avenue of the Americas||,||39th Floor|
|(Address of principal executive offices)|| ||(Zip code)|
Registrant's telephone number, including area code: (212) 930-9400
Securities registered pursuant to Section 12(b) of the Act:
|Title of each class:||Trading Symbol(s)|| ||Name of Exchange on which registered:|
|Common Stock, $0.01 par value||SAFE|| ||New York Stock Exchange|
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
Indicate by check mark whether the registrant: (i) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports); and (ii) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
|Large accelerated |
|Smaller reporting |
|Emerging growth |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ý
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal controls over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.☒
As of June 30, 2020, the aggregate market value of Safehold Inc. common stock, $0.01 par value per share, held by non-affiliates of the registrant was approximately $955.0 million, based upon the closing price of $57.49 on the New York Stock Exchange composite tape on such date.
As of February 9, 2021, there were 53,205,650 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
1.Portions of the registrant's definitive proxy statement for the registrant's 2021 Annual Meeting, to be filed within 120 days after the close of the registrant's fiscal year, are incorporated by reference into Part III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
Item 1. Business
Explanatory Note for Purposes of the "Safe Harbor Provisions" of Section 21E of the Securities Exchange Act of 1934, as amended
Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements are included with respect to, among other things, our current business plan, business strategy, portfolio management, prospects and liquidity. These forward-looking statements generally are identified by the words "believe," "project," "expect," "anticipate," "estimate," "intend," "strategy," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results or outcomes to differ materially from those contained in the forward-looking statements. Important factors that we believe might cause such differences are discussed in the section entitled, "Risk Factors" in Part I, Item 1a of this Form 10-K or otherwise accompany the forward-looking statements contained in this Form 10-K. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. In assessing all forward-looking statements, readers are urged to read carefully all cautionary statements contained in this Form 10-K.
We are a publicly-traded company that operates our business through one reportable segment by acquiring, managing and capitalizing ground leases. We believe that our business has characteristics comparable to a high-grade, fixed income investment business, but with certain unique advantages. Relative to alternative fixed income investments generally, our ground leases typically benefit from built-in growth derived from contractual base rent increases (either at a specified percentage or consumer price index ("CPI") based, or both), and the opportunity to realize value from residual rights to take ownership of the buildings and other improvements on our land at no additional cost to us. We believe that these features offer us the opportunity to realize superior risk-adjusted total returns when compared to certain alternative highly-rated investments.
Ground leases generally represent the ownership of land underlying commercial real estate projects that is net leased on a long-term basis (base terms are typically 30 to 99 years, often with tenant renewal options) by the fee owner of the land (landlord) to the owners/operators of the real estate projects built thereon ("Ground Lease"), or what we refer to as a SafeholdTM. The property is generally leased on a triple net basis with the tenant generally responsible for taxes, maintenance and insurance as well as all operating costs and capital expenditures. Ground Leases typically provide that at the end of the lease term or upon tenant default and the termination of the Ground Lease upon such default, the land, building and all improvements revert to the landlord. We have become the industry leader in Ground Leases by demonstrating the value of the product to real estate investors, owners, operators and developers and expanding their use throughout major metropolitan areas.
We have a diverse portfolio of properties located in major metropolitan areas. All of the properties in our portfolio are subject to long-term leases consisting of Ground Leases and one master lease (covering five properties) that provide for contractual periodic rent escalations and in some cases percentage rent participations in gross revenues generated at the relevant properties.
We have chosen to focus on Ground Leases because we believe they meet an important need in the real estate capital markets for our customers. We also believe Ground Leases offer a unique combination of safety, income growth and the potential for capital appreciation for investors for the following reasons:
High Quality Long-Term Cash Flow: We believe that a Ground Lease represents a safe position in a property's capital structure. The combined property value subject to a Ground Lease typically significantly exceeds the Ground Lease landlord's investment in the Ground Lease; therefore, even if the landlord takes over the property following a tenant default or upon expiration of the Ground Lease, the landlord is reasonably likely to recover substantially all of its Ground Lease investment, and possibly amounts in excess of its investment, depending upon prevailing market conditions. Additionally, the typical structure of a Ground Lease provides the landlord with a residual right to regain possession of its land and take ownership of the buildings and improvements thereon upon a tenant default. The landlord's residual right provides a strong incentive for a Ground Lease tenant or its leasehold lender to make the required Ground Lease rent payments.
Income Growth: Ground Leases typically provide growing income streams through contractual base rent escalators that may compound over the duration of the lease. These rent escalators may be based on fixed increases, CPI or a combination thereof, and may also include a participation in the gross revenues of the property. We believe that this growth in the lease rate over time can mitigate the effects of inflation and capture anticipated increases in land values over time, as well as serving as a basis for growing our dividend.
Opportunity for Capital Appreciation: The opportunity for capital appreciation comes in two forms. First, as the ground rent grows over time, the value of the Ground Lease should grow under market conditions in which capitalization rates remain flat. Second, our residual right to regain possession of the land underlying the Ground Lease and take title to the buildings and other improvements thereon for no additional consideration creates additional potential value to our shareholders.
We generally target Ground Lease investments in which the initial cost of the Ground Lease represents 30% to 45% of the combined value of the land and buildings and improvements thereon (the "Combined Property Value") as if the Ground Lease did not exist. If the initial cost of a Ground Lease is equal to 35% of the Combined Property Value, the remaining 65% of the Combined Property Value represents potential excess value over the amount of our investment that would be turned over to us upon the reversion of the property, assuming no intervening change in the Combined Property Value. In our view, there is a strong correlation between inflation and commercial real estate values over time, which supports our belief that the value of our owned residual portfolio should increase over time as inflation increases, although our ability to recognize value in certain cases may be limited by the rights of our tenants under some of our Ground Leases, including tenant rights to purchase our land in certain circumstances and the right of one tenant to demolish improvements prior to the expiration of the lease. See "Risk Factors" for a discussion of these tenant rights.
Owned Residual Portfolio: We believe that the residual right is a unique feature distinguishing Ground Leases from other fixed income investments and property types. We track the unrealized appreciation in the value of our owned residual portfolio over our basis in the Ground Leases because we believe it provides relevant information with regard to the three key investment characteristics of our Ground Leases: (1) the safety of our position in a tenant's capital structure; (2) the quality of the long-term cash flows generated by our portfolio rent that increases over time; and (3) increases and decreases in the Combined Property Value of the portfolio that reverts to us pursuant to such residual rights.
We believe that, similar to a loan to value metric, tracking changes in the value of our owned residual portfolio is useful as an indicator of the quality of our cash flows and the safety of our position in a tenant's capital structure, which, in turn, support the Company's objective to pay and grow dividends over time. Observing changes in our owned residual portfolio value also helps us monitor changes in the value of the real estate portfolio that reverts to us under the terms of the leases, either at the expiration or earlier termination of the lease. The value may be realized by us at the relevant time by entering into a new lease reflecting then current market terms and values, selling the building, selling the building with the land, or operating the building directly and leasing the spaces to tenants at prevailing market rates.
We have engaged an independent valuation firm to prepare: (a) initial reports of the Combined Property Value associated with our Ground Lease portfolio; and (b) periodic updates of such reports, which we use, in part, to determine the current estimated value of our owned residual portfolio. We calculate this estimated value by subtracting our original aggregate cost basis in the Ground Leases from the aggregate Combined Property Value determined by the valuation firm.
The table below shows the current estimated unrealized capital appreciation in our owned residual portfolio ("UCA") as of December 31, 2020 and 2019 ($ in millions):(1)
|December 31, 2020||December 31, 2019|
Combined Property Value(2)
|$||8,637 ||$||7,538 |
Ground Lease Cost(2)
|3,177 ||2,708 |
|Unrealized Capital Appreciation in Our Owned Residual Portfolio||5,460 ||4,830 |
(1)Please review our Current Report on Form 8-K filed on February 11, 2021 for a discussion of the valuation methodology used and important limitations and qualifications of the calculation of UCA. See "Risk Factors-Certain tenant rights under our Ground Leases may limit the value and the UCA we are able to realize upon lease expiration, sale of our land and Ground Leases or other events" for a discussion of certain tenant rights and other terms of the leases that may limit our ability to realize value from the UCA.
(2)Combined Property Value includes our 54.8% interest in our unconsolidated venture and $111.9 million and $416.0 million related to transactions with remaining unfunded commitments as of December 31, 2020 and 2019, respectively. Ground Lease Cost includes our 54.8% interest in our unconsolidated venture and $18.2 million and $81.3 million of unfunded commitments as of December 31, 2020 and 2019, respectively. As of December 31, 2020, our gross book value as a percentage of Combined Property Value was 40%.
Market Opportunity: We believe that there is a significant market opportunity for a dedicated provider of Ground Lease capital like us. We believe that the market for existing Ground Leases is fragmented with ownership comprised primarily of high net worth individuals, pension funds, life insurance companies, estates and endowments. However, while we intend to
pursue acquisitions of existing Ground Leases, our investment thesis is predicated, in part, on what we believe is an untapped market opportunity to expand the use of Ground Leases to a broader component of the approximately $7.0 trillion institutional commercial property market in the U.S. We intend to capture this market opportunity by utilizing multiple sourcing and origination channels, including manufacturing new Ground Leases with third-party owners and developers of commercial real estate and originating Ground Leases to provide capital for development and redevelopment. We further believe that Ground Leases generally represent an attractive source of capital for our tenants and may allow them to generate superior returns on their invested equity as compared to utilizing alternative sources of capital. We draw on the extensive investment origination and sourcing platform of iStar, the parent company of SFTY Manager, LLC (our "Manager"), to actively promote the benefits of the Ground Lease structure to prospective Ground Lease tenants.
We are a Maryland corporation and completed our initial public offering in June 2017. Our common stock is listed on the New York Stock Exchange under the symbol "SAFE." We are managed by our Manager pursuant to a management contract. We elected to be taxed as a real estate investment trust ("REIT") for U.S. federal income tax purposes, commencing with the tax year ended December 31, 2017. We are structured as an Umbrella Partnership REIT ("UPREIT"). As such, all of our properties are owned through a subsidiary partnership, Safehold Operating Partnership LP (the "Operating Partnership"). As of December 31, 2020, we owned 100% of the limited partner interests and a subsidiary of ours owned 100% of the general partner interests, in the Operating Partnership. The UPREIT structure may afford us certain benefits as we seek to acquire properties from third parties who may want to defer taxes by contributing their Ground Leases to us.
Our primary investment objective is to construct a diversified portfolio of Ground Leases that will generate attractive high-quality risk-adjusted returns and support stable and growing distributions to our shareholders. We have identified several channels for pursuing Ground Lease investment opportunities which include:
•Create a Ground Lease with a Third Party. We seek to pursue opportunities where a third party acquiror or existing owner of a commercial property may be interested in utilizing a Ground Lease structure to facilitate its options with respect to its interests in the property. We will create the Ground Lease by splitting ownership of the property into an ownership interest and Ground Lease on the land, and a separate leasehold interest of the building and improvements thereon. We will acquire the ownership interest and Ground Lease on the land from the third party.
•Acquire Existing Ground Leases. We seek to acquire existing Ground Leases that are marketed for sale and actively solicit potential sellers and related property brokers of existing Ground Leases to engage in off-market transactions. Our structure as an UPREIT gives us the ability to acquire Ground Leases from owners, particularly estates and high net worth individuals, using Operating Partnership units that may provide the seller with tax advantages, as well as liquidity, portfolio diversification and professional management.
•Originate Ground Leases to Provide Capital For Development or Value-Add Redevelopment or Repositioning. We seek opportunities where we can purchase land and simultaneously lease it pursuant to a new Ground Lease to a tenant who plans to develop a new, or significantly improve an existing, commercial property on the land.
•Acquire a Commercial Real Estate Property to Create a Ground Lease. We seek in select instances, in partnership with our Manager, to acquire commercial real estate properties that have the potential to be converted into an ownership structure that includes a Ground Lease retained by us and a leasehold interest that may be acquired by our Manager or sold to a third party.
•Finance Third Party Ground Leases. Combining our capital resources with our Manager's relationships and Ground Lease expertise, we seek opportunities to originate Ground Lease investments in conjunction with our Manager's origination of a leasehold financing with the same customer.
We generally intend to target Ground Leases that meet some or all of the following investment criteria:
•Properties located in major metropolitan areas;
•Average remaining initial lease terms of 30 to 99 years;
•Periodic contractual rent escalators or percentage rent participations;
•Value of approximately 30% to 45% of the Combined Property Value at the commencement of the lease or the acquisition date;
•Ground Rent Coverage, defined as the ratio of the Property's NOI to the annualized rental payment due us, of approximately 2.0x to 4.5x for the initial 12-month period of the lease. Property NOI is defined as the trailing twelve month net operating income of the building and improvements being operated at the property without giving effect to any rent paid or payable under our Ground Lease, and for this purpose we use estimates of the stabilized Property NOI
if we don't receive current tenant information and for properties under construction or in transition, in each case based on leasing activity at the property and available market information, including leasing activity at comparable properties in the relevant market;
•First year cash return on asset of between 2.5% and 4.0% and effective yields between 4.5% and 5.5%;
•Properties that we believe are well located in markets with high barriers to entry and that have durable cash flow; and
•Transaction sizes up to $500 million.
We utilize and expect to continue to utilize leverage. Our current strategy is to generally target overall leverage at an amount that is approximately 25% of the aggregate Combined Property Value of our portfolio, but not to exceed an overall ratio of 2:1 relative to our total equity. However, our organizational documents do not limit the amount of indebtedness that we may incur. We anticipate that our Manager, under the supervision of our board of directors, will consider a number of factors in evaluating our level of indebtedness from time to time, as well as the amount of such indebtedness that will be either fixed or floating rate. Our board of directors may from time to time modify our leverage policies in light of the then-current economic conditions, relative costs of debt and equity capital, market values of our properties, general market conditions for debt and equity issuances, fluctuations in the market price of our common stock, growth and acquisition opportunities and other factors, including the restrictive covenants under our debt obligations. Subject to our qualification as a REIT, we seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements.
To the extent our board of directors determines to obtain additional capital, we may, without stockholder approval, borrow funds or issue debt or equity securities, including additional Operating Partnership units, retain earnings (subject to the distribution requirements applicable to REITs under the Code) or pursue a combination of these methods. As long as our Operating Partnership is in existence, the proceeds of all equity capital raised by us will be contributed to our Operating Partnership in exchange for additional interests in our Operating Partnership, which will dilute the ownership interests of the then existing limited partners in our Operating Partnership.
We may enter into hedging transactions with respect to one or more of our assets or liabilities. Hedging transactions could take a variety of forms, including interest rate swap agreements, interest rate cap agreements, options, futures contracts, forward rate agreements or similar financial instruments. We intend to structure hedging transactions in a manner that does not jeopardize our qualification as a REIT.
Conflict of Interest Policies
Conflicts of interest may exist or could arise in the future with iStar and its affiliates, including our Manager, our executive officers and/or directors who are also officers and/or directors of iStar, and any limited partner of our Operating Partnership. Conflicts may include, without limitation: conflicts arising from the enforcement of agreements between us and iStar or our Manager; conflicts in the amount of time that officers and employees of our Manager will spend on our affairs versus iStar's other affairs; conflicts in future transactions that we may pursue with iStar; conflicts between the interests of our stockholders and the management holders of CARET Units; and conflicts in allocating investments to a potential iStar-managed investment fund in which we may invest. iStar is our largest shareholder and owned approximately 65.4% of our common stock as of December 31, 2020. In addition, two directors of iStar serve on our board of directors, including Jay Sugarman, who is the chief executive officer of iStar and our chief executive officer. Our Manager is a wholly-owned subsidiary of iStar. As a result of the foregoing relationships, iStar has significant influence over us. We have adopted a policy that all transactions between iStar (and its affiliates) and us must be approved by a majority of our disinterested directors. However, we cannot assure you this policy or other policies and provisions of law will always succeed in eliminating the influence of such conflicts. If they are not successful, decisions could be made that might fail to reflect the best interest of all shareholders. See "Risk Factors – Risks Related to our Relationship with our Manager and its Affiliates – There are various potential conflicts of interest in our relationship with iStar and its affiliates, which could result in decisions that are not in the best interest of our shareholders."
We compete with numerous commercial developers, real estate companies (including other REITs), financial institutions (such as banks and insurance companies) and other investors (such as pension funds, investment funds, private companies and individuals) for investment opportunities and tenants. This competition may result in higher costs for properties, lower returns and impact our ability to grow. Some of these competitors have greater financial and other resources and access to more attractive capital than we do. However, due to our focus on Ground Leases located throughout the U.S., and because some of our competitors are locally and/or regionally focused, we do not always encounter the same competitors in each market.
We believe that we have been organized and have operated in a manner that has enabled us to maintain our qualification as a REIT and our exemption from regulation as an investment company under the Investment Company Act of 1940, as amended, and we intend to continue to do so. In addition, our properties are subject to various laws, ordinances and regulations. Our tenants are generally responsible under our Ground Leases for taxes, maintenance and insurance as well as all operating costs and capital expenditures, including capital expenditures that may result from compliance with environmental and other laws and regulations. Although our tenants are primarily responsible for any damages and claims arising from the leased properties' compliance with applicable environmental and other laws and regulations, a tenant's bankruptcy or inability to satisfy its obligations for these types of damages or claims could require us to satisfy such liabilities. In addition, we may be held directly liable for any such damages or claims irrespective of the provisions of any lease.
Code of Conduct
The Company has adopted a code of conduct that sets forth the principles of conduct and ethics to be followed by our directors, officers, Manager and employees of our Manager who perform services for us (the "Code of Conduct"). The purpose of the Code of Conduct is to promote honest and ethical conduct, compliance with applicable governmental rules and regulations, full, fair, accurate, timely and understandable disclosure in periodic reports, prompt internal reporting of violations of the Code of Conduct and a culture of honesty and accountability. A copy of the Code of Conduct has been provided to each of our directors, officers, the Manager and relevant employees, who are required to acknowledge that they have received and will comply with the Code of Conduct. A copy of the Company's Code of Conduct has been previously filed with the SEC and is incorporated by reference in this Annual Report on Form 10-K as Exhibit 14.1. The Code of Conduct is also available on the Company's website at www.safeholdinc.com. The Company will disclose on its website material changes to its Code of Conduct, or any waivers for directors or executive officers, if any, within four business days of any such event. As of December 31, 2020, there have been no amendments to the Code of Conduct and the Company has not granted any waivers from any provision of the Code of Conduct to any directors or executive officers.
Human Capital Resources
We have no employees and rely on our Manager for our human capital resources. Our management agreement requires that our Manager provide us with a management team, including a chief executive officer, chief financial officer, chief compliance officer and other appropriate support personnel, to manage our business in accordance with the agreement. Our Manager is responsible for directly compensating and providing benefits to its employees who provide services to us, although we have granted equity compensation in the form of CARET Units and other stock-based awards to members of senior management and other iStar employees, and expect to do so in the future. Our Manager has advised us that it had 145 employees as of December 31, 2020 compared to 155 employees as of December 31, 2019. Substantially all of our Manager's employees are full time employees.
Our Manager has publicly announced that scaling our business is one of its principal business strategies and that it has devoted substantial additional personnel and other resources to these efforts beginning in early 2019 when we and iStar announced an expansion of our relationship. Our Manager has reported that in its recruiting efforts, our Manager generally strives to have a diverse group of candidates to consider for roles. In addition, our Manager has reported that it maintains a variety of development, health and wellness and charitable programs for its personnel, including those who provide services to us.
In fiscal 2020, as a result of the COVID-19 pandemic, substantially all of our Manager's workforce worked remotely throughout the initial several months of the COVID-19 pandemic, and our Manager instituted safety protocols and procedures to enable certain employees to work on site in shifts later in the year.
We maintain a website at www.safeholdinc.com. The information on our website is not incorporated by reference in this Annual Report on Form 10-K, and our web address is included only as an inactive textual reference. In addition to this Annual Report on Form 10-K, we file quarterly and special reports, proxy statements and other information with the SEC. Through our website, we make available free of charge our annual proxy statement, annual reports to shareholders, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. These documents also may be accessed through the SEC's electronic data gathering, analysis and retrieval system via electronic means, including on the SEC's homepage, which can be found at www.sec.gov.
Item 1a. Risk Factors
In addition to the other information in this report, you should consider carefully the following risk factors in evaluating an investment in the Company's securities. Any of these risks or the occurrence of any one or more of the uncertainties described below could have a material adverse effect on the Company's business, financial condition, results of operations, cash flows, ability to service our indebtedness, ability to pay distributions and the market price of the Company's common stock. The risks set forth below speak only as of the date of this report and the Company disclaims any duty to update them except as required by law. For purposes of these risk factors, the terms "our Company," "we," "our" and "us" refer to Safehold Inc. and its consolidated subsidiaries, unless the context indicates otherwise.
Risks Related to Our Portfolio and Our Business
Our business and growth prospects have been adversely affected by the COVID-19 pandemic and could be adversely affected in the future by the COVID-19 pandemic or the outbreak of any other highly infectious or contagious diseases.
The COVID-19 pandemic adversely affected our growth in 2020 and could adversely affect our business and growth in the future. At this time, we cannot predict the full extent or duration of the impacts of the COVID-19 pandemic on our business. COVID-19 or another pandemic could adversely affect us due to, among other factors:
•closures of, or other operational issues at, one or more of our properties resulting from government or tenant action;
•deteriorations in our tenants' financial condition and access to capital which could cause one or more of our tenants to be unable to meet their Ground Lease obligations to us in full, or at all;
•the impact on the hotel industry generally and our hotel assets specifically, which accounted for approximately 15.2% and 15.0% of our total revenues for the years ended December 31, 2020 and 2019, respectively, excluding percentage rent;
•the impact on our percentage rent revenues, all of which are based on operating performance at our hotel properties, which constituted approximately 2.5% and 4.6% of our total revenues for the years ended December 31, 2020 and 2019, respectively; we expect a material decline in percentage rent payable to us in 2021 in respect of 2020 hotel operating performance;
•deteriorations in our financial performance which could cause us to be unable to satisfy debt covenants, including cash flow coverage tests in our revolving credit facility, which could trigger a default and acceleration of outstanding borrowings;
•difficulty accessing debt and equity capital on attractive terms, or at all, to fund business operations, growth or address maturing liabilities;
•a deterioration in iStar's business performance and liquidity, which could adversely affect its ability to participate in future capital raising transactions that we may undertake;
•delays in the supply of products or services that are needed for our and our tenants' efficient operations; and
•a deterioration in our Manager's business continuity or the health of its personnel during a disruption.
In addition to the potential adverse effects described above, our business and growth prospects may be adversely affected even after the COVID-19 pandemic ends as a result of ongoing negative business trends in the travel industry, which will adversely affect the hotel properties in our portfolio and the percentage rents that we receive from them, and the possibility that our office properties in urban areas experience less demand and declines in value due to employees working from home or relocation trends away from urban centers. As of December 31, 2020, approximately 56% of the gross book value of our Ground Lease portfolio is comprised of predominantly urban office properties. The lack of certainty as to when the COVID-19 pandemic will significantly subside and its after-effects on certain sectors of the economy and commercial real estate markets preclude any prediction as to the ultimate adverse impact of COVID-19. Nevertheless, COVID-19 or another pandemic presents material uncertainty and risk with respect to our performance, financial condition, results of operations and cash flows.
Our estimated UCA, Combined Property Value and Ground Rent Coverage, may not reflect the full potential impact of the COVID-19 pandemic and may decline materially in future periods.
Certain metrics that we report and monitor may not reflect the full potential impact of the COVID-19 pandemic. Our reported estimated UCA and Combined Property Value are based, in part, on third party appraisals that we obtained on a rolling basis during 2020. In the first through fourth quarters of 2020, we obtained third party appraisals of the Combined Property Value for properties that represented approximately 31%, 8%, 16% and 15%, respectively, of our total portfolio based on the gross book value of the associated Ground Leases as of December 31, 2020. Hence, the estimated UCA and ratio of gross book value to the Combined Property Value of our portfolio, which are metrics that we report and that management tracks, in part, to assess risk and our seniority in capital structures, may not reflect the full effects of the COVID-19 pandemic as of their dates of determination. The unknown duration of the COVID-19 pandemic combined with limited transaction activity makes current
real estate valuations uncertain and our estimated UCA and ratio of gross book value to Combined Property Value could decline in future periods, and any such decline could be material.
Our estimated Ground Rent Coverage represents the ratio of the property NOI of the commercial properties being operated on our land to the Ground Lease payment due to us, as of the date of determination. With respect to properties under development or in transition or for which financial statements are not available, we use our internal underwritten estimates of Ground Rent Coverage at stabilization and third party valuations where available, none of which has been adjusted to take into account any effects of the COVID-19 pandemic. With respect to other properties, the property NOI available to us at December 31, 2020 may not be indicative of future periods, depending on the direction and magnitude of the effects of the COVID-19 pandemic for the entire period. Given the uncertainty surrounding the duration of the COVID-19 pandemic and its effects, and the limitations of the information used in our estimates it is possible that the actual Ground Rent Coverage may be lower than our estimate, now or in the future.
The market for Ground Lease transactions and the availability of investment opportunities may not meet our growth objectives.
The achievement of our investment objectives depends, in part, on our ability to continue to grow our portfolio. We cannot assure you that the market for Ground Leases will enable us to meet our growth objectives. Potential tenants may prefer to own the land underlying the improvements they intend to develop, rehabilitate or own. Negative publicity about the experience of tenants with non-Safehold Ground Leases may also discourage potential tenants. In addition, increases in interest rates may result in a reduction in the availability or an increase in costs of leasehold financing, which is critical to the growth of a robust Ground Lease market.
The COVID-19 pandemic adversely affected our new investment activity in 2020 and is expected to continue to do so in 2021. Equity and debt financing for real estate transactions, including leasehold loans, has been constrained. In addition, transactions have generally been more difficult to execute as people work from home and third parties such as governmental offices, survey, insurance and similar services have more limited capacities.
These and other factors outside our control may materially adversely affect the market for our leases and our ability to grow and meet our investment objectives.
Our operating performance and the market value of our properties are subject to risks associated with real estate assets.
Real estate investments are subject to various risks and fluctuations and cycles in value and demand, many of which are beyond our control. Certain events may adversely affect our operating results and decrease cash available for distributions to our shareholders, as well as the market value of our properties. These events include, but are not limited to:
• adverse changes in international, national, regional or local economic and demographic conditions;
• adverse changes in the financial position or liquidity of tenants and potential buyers of properties;
• competition from other real estate investors with significant capital, including real estate operating companies, other publicly traded REITs, institutional investment funds, banks, insurance companies and individuals;
• potential liability under environmental laws as an owner of real property;
• our tenants' failures to maintain adequate insurance on their properties as is typically required by our leases and the inability to insure against certain events, including acts of God; and
• changes in, and changes in enforcement of, laws, regulations and governmental policies, including, without limitation, health, safety, environmental, zoning and tax laws and governmental fiscal policies.
In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in attractive investment opportunities, the availability of financing for buyers and lessees of our properties or an increased incidence of defaults under our existing leases. As a result of the foregoing, there can be no assurance that we can achieve our investment objectives.
The rental payments under our leases may not keep up with changes in market value and inflation.
The leases at most of our properties provide for rental payments that are CPI-Linked or fixed with future CPI adjustments. These rent adjustments may not keep up fully with changes in inflation. They may also not keep up with increases in market rental rates. As a result, we may not capture the full value of the land underlying our leases at given points in time or the UCA at lease expiration. Future leases that we enter into are likely to contain similar or other limitations on rent increases, which may limit the appreciation in value of our land, our net asset value and our UCA.
We may be unable to renew expiring Ground Leases, re-lease the land or sell the properties on favorable terms or at all.
Above-market lease rates at some of the properties in our portfolio at the time of any Ground Lease renewal or re-lease may force us to renew some expiring leases or re-lease properties at lower rates. We cannot assure you existing tenants will exercise any extension options or that our expiring leases will be renewed or that our properties will be re-leased at lease rates equal to or above their then weighted average lease rates. Tenants may fail to properly maintain their improvements, and certain improvements may become obsolete over the long terms of our Ground Leases, which may impair the value and the UCA that we are able to realize upon a sale or re-leasing, or require us to make significant investments in order to restore the property to a suitable condition.
A lack of recourse to creditworthy counterparties may adversely affect us.
The tenants under our Ground Leases are typically special purpose entities formed to enter into our leases and own the improvements built on our land. If we have to take action to enforce our leases, we may not have access to assets of the tenants other than our lease and the tenant's improvements. We may have limited or no recourse against a separate creditworthy guarantor. Disputes may arise between us and a tenant that result in the tenant withholding rent payments, possibly for an extended period. If a tenant fails to maintain our land and their improvements in accordance with our lease terms, their value may decline materially. Any of these situations may result in extended periods during which there is a significant decline in revenues or no revenues generated by a property, or may impair the value of our properties and the UCA that we may realize from them.
Counterparty, geographic and industry concentrations may expose us to financial credit risk.
For the year ended December 31, 2020, our two largest tenants by revenues, the tenants of our 1111 Pennsylvania Avenue Ground Lease and our Park Hotels Portfolio Ground Lease, accounted for approximately 10.4% and 9.0%, respectively, of our total revenues. For the year ended December 31, 2020, 17.7% of our total revenues came from hotel properties, including 2.5% of our total revenues which represented percentage rent participations in operating revenues at the hotels located on the properties. We could be materially and adversely affected by negative factors affecting such concentrations. We expect a material decline in percentage rent payments from our hotel leases in 2021 (which reflect 2020 operations) versus 2020 due to the impact of the COVID-19 pandemic. Industry experts predict continued declines in corporate budgets and consumer demand for travel even after the COVID-19 pandemic subsides, and such declines may continue for several years. Percentage rent payments under our Ground Leases are likely to continue to be negatively affected while these conditions persist. In addition, as of December 31, 2020, our portfolio had the following regional geographic concentrations based on gross book value: Northeast-40%, West-22%, Mid-Atlantic-18%, Southeast-9%, Southwest-8% and Central-3%.
Percentage rent payable under our master lease relating to the Park Hotels Portfolio is calculated on an aggregate portfolio-wide basis.
The tenant under our Park Hotels Portfolio master lease pays us percentage rent equal to 7.5% of the positive difference between the aggregate annual operating revenues of the five hotels in the Park Hotels Portfolio for any year and a threshold amount of approximately $81.4 million. As a result, a deterioration in the operating performance at any of the hotels in the Park Hotels Portfolio would adversely affect our ability to earn percentage rent under any of the remaining hotels in the Park Hotels Portfolio, and it is possible that poor operating performance at one or more hotels in the Park Hotels Portfolio could reduce or eliminate percentage rent for any annual period notwithstanding stable or improving operating performance at other hotels included in the Park Hotels Portfolio.
We are the tenant of a Ground Lease underlying a majority of our Doubletree Seattle Airport property.
The sum of our cash base rental income in place for our Doubletree Seattle Airport property as of December 31, 2020 and total percentage cash rental income during the year ended December 31, 2020 for such property totaled an aggregate of $5.6 million, or approximately 6.1% of the cash income of our entire portfolio. A majority of the land underlying our Doubletree Seattle Airport property is owned by a third party and is ground leased to us. We are obligated to pay the third-party owner of the Ground Lease $0.4 million, subject to adjustment for changes in the CPI, per year through 2044; however, we pass this cost on to our tenant under the terms of our master lease. If the underlying Ground Lease is not renewed by the landlord on or before its expiration in 2044, our lease of the Doubletree Seattle Airport hotel to our tenant would also terminate which would result in the loss to us of the rental income from this hotel as well as any UCA that had not been realized by that time.
Certain tenant rights under our Ground Leases may limit the value and the UCA we are able to realize upon lease expiration, sale of our land and Ground Leases or other events.
Certain tenant rights under our Ground Leases may limit the value we are able to realize upon lease expiration, sale of our land or other events, including, among others:
•Our Park Hotels master lease gives the tenant the right to purchase one or more of the hotels at fair market value if the hotel suffers a major casualty or condemnation event, as defined under the master lease.
•Prior to the expiration of the Ground Lease relating to an office property that represents 2.3% of the gross book value of our portfolio as of December 31, 2020, the tenant has the right to demolish the building and improvements on the property, although it cannot do so during the last five years of the lease without our prior consent. Rent under our Ground Lease must continue to be paid through the end of the lease, even if the tenant demolishes the building and any improvements on the property.
•The Lock Up Self Storage Facility lease gives the tenant the right to purchase our interest in the underlying land at fair market value as of the expiration of the lease in 2037.
•The tenants under certain of our Ground Leases have a right of first offer or a right of first refusal to purchase the land underlying the Ground Lease should we decide to sell the land together with the Ground Lease to a third party.
The existence of these rights in existing and future leases may adversely affect the value and the UCA we are able to realize upon a sale of our Ground Leases and/or make it more difficult to re-let a property after the expiration of a lease.
We rely on Property NOI as reported to us by our tenants.
In evaluating Ground Rent Coverages and estimating Combined Property Values as indicators of the security of the rent owed to us pursuant to a Ground Lease and the safety of our investment in a Ground Lease, we rely, to a significant degree, on Property NOI as reported to us by our tenants, or as otherwise publicly available, without independent investigation or verification on our part. Our tenants do not, nor do we expect that future tenants will, provide us with full financial statements prepared in accordance with GAAP or that have been audited or reviewed by an independent registered public accounting firm. Our leases generally do not specify the detail upon which such financial information must be prepared. Our leases also generally do not require notice to us or our approval for rent concessions or abatements given by our tenants to their subtenants. We assume the accuracy and completeness of information provided to us by our tenants or that is publicly available and the appropriateness of the accounting methodology or principles, assumptions, estimates and judgments used in its preparation. Accordingly, no assurance can be given that the information provided to us by our tenants, or that is otherwise publicly available, is accurate or complete, which could materially and adversely affect our underwriting decisions. Tenants may also restrict our ability to disclose publicly their Property NOI. In addition, with respect to properties under development or renovation, Ground Rent Coverage reflects our estimated annual rent coverage at the expected stabilization or completion of renovation at the applicable property. There can be no assurance our estimates will prove to be correct.
Our estimates of Ground Rent Coverage for properties in development or transition, or for which we do not receive current tenant financial information, may prove to be incorrect.
Certain of the Ground Leases in our portfolio, including the Ground Leases at 425 Park Avenue and 135 West 50th Street in New York City, relate to properties that are under development or in transition. In such cases, our underwriting and monitoring of the property during development or transition is based on our estimate of the initial net operating income of the building at an assumed stabilization date. Similarly, we use estimates of Property NOI in cases where our tenant is not required to report the actual amount to us on a current basis. Our estimates are based on leasing activity at the building and available market information, including leasing activity at comparable properties in the market. Estimates are inherently uncertain. While we intend to use assumptions that we believe are reasonable when making estimates, our assumptions may prove to be incorrect. No assurance can be given regarding the accuracy of our estimates and assumptions and it is possible that the actual Ground Rent Coverage of these assets may be materially lower than our estimates.
Our estimates of Combined Property Value are based on various assumptions and information supplied to us by our tenants, and accordingly may not be indicative of actual values.
When underwriting a potential investment and monitoring our portfolio, our estimate of Combined Property Value is based on expected lease terms, information supplied to us by our prospective tenant or tenant and numerous assumptions made by us. We do not independently investigate or verify the information provided to us by our tenants and no assurance can be given that the information is accurate. See "—We rely on Property NOI as reported to us by our tenants." The use of different information or assumptions could result in valuations that are materially lower than those used in our underwriting and portfolio monitoring processes.
Our estimates of Combined Property Values represent our opinion and may not accurately reflect the current market value of the properties relating to our Ground Leases. Such estimates are based on numerous estimates and assumptions and not on contractual sale terms or third-party appraisals and, therefore, are inherently uncertain, and no assurance can be given regarding the accuracy or appropriateness of such estimates and assumptions. The application of alternative estimates or assumptions could result in valuations, by us or others, that are materially lower than those used in our underwriting and portfolio monitoring processes.
There can be no assurance that we will realize any incremental value from the UCA in our owned residual portfolio or that the market price of our common stock will reflect any value attributable thereto.
Pursuant to the typical terms of a Ground Lease, we regain possession of the land and generally take title to the building and any improvements thereon, without the payment of any additional consideration by us. We regard the difference between the initial Ground Lease value and the Combined Property Value as UCA in our owned residual portfolio that we may realize at the end of the lease through a releasing or sale transaction, or perhaps by operating the property directly. To the extent we choose to operate a property directly, we will be subject to additional risks associated with leasing commercial real estate, including responsibility for property operating costs, such as taxes, insurance and maintenance, that previously were paid for by our tenant pursuant the Ground Lease. Though we estimate Combined Property Value using one or more valuation methodologies that we consider appropriate, there can be no assurance that this estimate or the amount of any UCA in our owned residual portfolio is accurate at the time we invest in a Ground Lease. Even if we estimate that a UCA exists initially, we will generally not be able to realize that appreciation through a near term transaction, as the property is leased to a tenant pursuant to a long-term lease. While the value of commercial real estate as a broad class has generally increased over extended periods of time and is believed by some to exhibit a positive correlation with rates of inflation, the value of a particular commercial real estate asset is primarily a function of its location, overall quality and the terms of relevant leases. Since our leases are typically long-term (base terms ranging from 30 to 99 years), it is possible that the UCA in our owned residual portfolio will increase in value, but over long periods of time. However, the Combined Property Value of a particular property at the end of a Ground Lease will be highly dependent on its unique attributes and there can be no assurance that it will exceed the amount of our initial investment in the Ground Lease. Moreover, no assurance can be given that the market price of our common stock will include any value attributable to the UCA in our owned residual portfolio. In addition, our ability to recognize value through reversion rights may be limited by the rights of our tenants under some of our Ground Leases. See "—Certain tenant rights under our Ground Leases may limit the value and the UCA were able to realize upon lease expiration, sale of our land and Ground Leases or other events." Moreover, the market price of our common stock may not reflect any value ascribed to the UCA in our owned residual portfolio, as it is difficult and highly speculative to estimate the value of a commercial real estate portfolio that may be realized at a distant point in time.
Ground Leases with developers expose us to risks associated with property development and redevelopment that could materially and adversely affect us.
In Ground Lease transactions with developers, rent may not commence until construction is completed. In such cases, we would be subject to risks that the developer will be unable to complete the project and have it begin paying rent to us. Risks associated with development transactions include, without limitation: (i) the availability and pricing of financing for the developer on favorable terms or at all; (ii) the availability and timely receipt by the developer of zoning and other regulatory approvals; (iii) the potential for the fluctuation of occupancy rates and rents, which could affect any percentage rents that we may receive; (iv) development, repositioning and redevelopment costs may be higher than anticipated by the developer, which may cause the developer to abandon the project; and (v) cost overruns and untimely completion of construction (including due to risks beyond the developer's control, such as weather or labor conditions, or material shortages). In addition, if our tenant has obtained leasehold financing to complete construction, and the construction lender forecloses on the mortgage following a default, there is a risk that the mortgagee or a new tenant may not have necessary or sufficient development experience to complete the project or to do so to the same standards as the original developer. These risks could result in substantial unanticipated delays or expenses and could prevent the initiation or the completion of development, repositioning or redevelopment activities, any of which could materially and adversely affect us.
We may be materially and adversely affected by the exercise of leasehold mortgagee protections.
We typically permit tenants to obtain mortgage financing secured by their leasehold interest and to assign the lease and the tenant's rights under the lease to the mortgagee as collateral. The leasehold mortgagee typically has the right to receive notices and cure tenant defaults under the lease, the right to require us to enter into a new lease with a successor tenant on the same terms as the existing lease and the right to consent to certain actions. We may grant a leasehold mortgagee additional time to cure certain non-monetary defaults and may agree to defer certain remedies while the leasehold mortgagee is endeavoring to cure a default. In addition, some leasehold mortgage lenders may insist, should a casualty, loss or condemnation occur, upon using insurance proceeds to reduce the tenant's debt to it rather than restoring or repairing the casualty, loss or condemnation, although the tenant would likely not be able to generate sufficient revenues from the resulting property to pay ground rent to us. There can be no assurance that we will not be materially and adversely affected by a leasehold mortgagee's exercise of such mortgagee protections.
We are subject to the risk of bankruptcy of our tenants.
The bankruptcy or insolvency of a tenant may materially and adversely affect the income produced by our properties or could force us to "take back" a property as a result of a default or a rejection of the lease by a tenant in bankruptcy, any of which could materially and adversely affect us. If any tenant becomes a debtor in a case under federal bankruptcy law, we cannot evict the tenant and assume ownership of the building and improvements thereon solely because of the bankruptcy if the tenant continues to comply with the terms of our lease. In addition, the bankruptcy court might permit the tenant to reject and terminate its lease with us. Our claim against the tenant for unpaid and future rent would be a general unsecured claim subject to a statutory cap that might be substantially less than the rent actually owed to us under the lease. We may also be unable to re-lease a terminated or rejected space or re-lease it on comparable or more favorable terms. Although our tenants are primarily responsible for any environmental damages and claims related to the properties, a tenant's bankruptcy or inability to satisfy its obligations for these types of damages or claims could require us to satisfy such liabilities. In addition, we may be held directly liable for any such damages or claims irrespective of the provisions of any lease.
It is also possible that a bankruptcy court could re-characterize our Ground Leases as secured lending transactions depending on its interpretation of the terms of the lease. If a lease were judicially recharacterized as a secured lending transaction, we would not be treated as the owner of the property subject to the lease and could lose the legal as well as economic attributes of the owners of the property, which could have a material adverse effect on us.
We may directly own one or more commercial properties, which will expose us to the risks of ownership of operating properties.
There may be instances where we take ownership of a commercial property for a period of time prior to the separating it into fee and leasehold interests. In addition, we may own and operate commercial properties that revert to us upon the expiration or termination of a Ground Lease. The ownership and operation of commercial properties will expose us to risks, including, without limitation, the risks described above under "—Our operating performance and the market value of our properties are subject to risks associated with real estate assets and the real estate industry, which could materially and adversely affect us." Additionally, we may be required to hold a commercial property in a taxable REIT subsidiary ("TRS"), and any gain from the subsequent sale of the property or a leasehold interest in it would be subject to corporate income tax. See "—Tax Risks Related to Ownership of Our Shares—Our TRSs are subject to special rules that may result in increased taxes."
Competition may adversely affect our ability to acquire and originate investments.
We compete with commercial developers, other REITs, real estate companies, financial institutions, such as banks and insurance companies, funds, and other investors, such as pension funds, private companies and individuals, for investment opportunities. Our competitors include both competitors seeking to originate or acquire Ground Lease transactions or acquire properties in their entirety and competitors offering debt financing as an alternative to a Ground Lease. Some of our competitors have greater financial and other resources and access to capital than we do. Due to our focus on Ground Leases throughout the U.S., and because most competitors are often locally and/or regionally focused, we do not always encounter the same competitors in each market.
Cybersecurity risk and cyber incidents may adversely affect our business.
A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or unintentional event and could involve gaining unauthorized access to our or our Manager's information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance cost, litigation and damage to our business relationships. As reliance on technology has increased, so have the risks posed to both our and our Manager's information systems and those provided by third-party service providers. Our Manager has implemented processes, procedures and internal controls to help mitigate cybersecurity risks and cyber intrusions, but these measures, as well as our increased awareness of the nature and extent of a risk of a cyber incident, do not guarantee that we will not be materially and adversely affected by such an incident.
Risks Related to Our Relationship with Our Manager and its Affiliates
Termination of the management agreement would be difficult and costly.
Termination of the management agreement without cause will be difficult and costly. Prior to June 30, 2023, we may not terminate the agreement except for certain cause events. Thereafter, the agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors, based upon unsatisfactory long-term performance by our Manager that is materially detrimental to us and our subsidiaries taken as a whole. The agreement may also be terminated beginning with the seventh annual renewal term after the initial term upon a finding by at least two-thirds of our independent directors that the management fee payable to our Manager is not fair, subject to our Manager's right to prevent any termination due to unfair fees by accepting a reduction of the management fee agreed to by at least two-thirds of our independent directors. We must provide our Manager 180 days' written notice of any termination. Additionally, upon such a termination, or if we are in default of the management agreement and our Manager terminates the management agreement, the management agreement provides that we will pay our Manager a termination fee equal to three times the average annual management fee earned by our Manager during the last completed fiscal year immediately preceding the effective date of termination. These provisions increase the cost to us of terminating the management agreement, adversely affect our ability to terminate the management agreement without cause and may inhibit change of control transactions that may be in the interests of our non-iStar shareholders.
Our Manager's liability is limited under the management agreement, and we could experience poor performance or losses for which our Manager would not be liable.
Our Manager does not assume any responsibility under the management agreement other than to render the services called for and is not responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Additionally, our Manager and its affiliates, personnel, shareholders and others are not liable for acts or omissions performed in accordance with and pursuant to the management agreement, except because of acts constituting bad faith, willful misconduct, gross negligence, or reckless disregard of their duties under the management agreement. We have agreed to indemnify our Manager and its affiliates, personnel, shareholders and others with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of our Manager not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of duties, performed in accordance with and pursuant to the management agreement.
We expect our reimbursement obligations to our Manager to increase further as we grow.
We are required to reimburse our Manager for costs incurred by it on our behalf to operate our business, including our allocable share of the compensation and related costs of certain Manager personnel and, at our Manager's option, rent, utilities and other overhead. Our expenses have grown and our Manager has elected to seek reimbursement of additional expenses, including, without limitation, rent, overhead and certain personnel costs. We intend to continue our efforts to grow materially, which we expect will result in increased reimbursements to our Manager, which may be material in amount.
The loss of our Manager or its key personnel could threaten our ability to operate successfully.
Our future success depends, to a significant extent, upon the continued services of our Manager and its management team. In particular, the Ground Lease experience of the management team and the relationships they have developed with customers, brokers and financing services are critically important to the success of our business. The loss of services of our Manager or one or more members of our Manager's management team, whether as a result of their departure from iStar, a change of control of iStar or iStar's unilateral decision to no longer make them available to our Manager, could threaten our ability to operate our business successfully. The management agreement does not require our Manager to devote all of its resources or for its personnel to devote all of their business time to managing our affairs or for iStar to allocate any specific officers or employees to our Manager for our benefit. The ability of our Manager, iStar and their officers and employees to engage in other business activities may reduce the time our Manager spends managing us.
Transactions between iStar and us were negotiated between related parties and their terms may not be as favorable to us as if they had been negotiated with an unaffiliated third party.
Transactions between iStar and us, including our management agreement (refer to Note 13) and certain other transactions (refer to Note 11 and Note 13) were negotiated between related parties and their terms may not be as favorable to us as if they had been negotiated with an unaffiliated third party. In addition, we may choose not to enforce, or to enforce less vigorously, our rights under agreements with iStar because of our desire to maintain our ongoing relationship with iStar and our Manager.
There are various potential conflicts of interest in our relationship with iStar and its affiliates, which could result in decisions that are not in the best interest of our shareholders.
Conflicts of interest may exist or could arise in the future with iStar and its affiliates, including our Manager, our executive officers and/or directors who are also directors or officers of iStar. Conflicts may include, without limitation: conflicts arising from the enforcement of agreements between us and iStar or our Manager; conflicts in the amount of time that officers and employees of our Manager will spend on our affairs versus iStar's other affairs; conflicts in future transactions that we may pursue with iStar; conflicts between the interests of our stockholders and the management holders of CARET Units; and conflicts in allocating investments to a potential iStar-managed investment fund in which we may invest, as discussed further below. Transactions between iStar and us would be subject to the approval of a majority of our independent directors; however, there can be no assurance that such approval will be successful in achieving terms and conditions as favorable to us as would be available from a third party. As of December 31, 2020, iStar owned approximately 65.4% of our outstanding common stock. Two directors of iStar also serve on our board of directors, including Jay Sugarman, who is the chief executive officer of iStar and our chief executive officer. Additionally, the fiduciary duties of executive officers and our directors who are also directors or officers of iStar to iStar and us may come in conflict from time to time. Our Manager is a wholly-owned subsidiary of iStar. As a result of the foregoing relationships and iStar's significant ownership of our common stock, iStar has significant influence over us. Additionally, although we entered into an exclusivity agreement with iStar, the agreement contains exceptions to iStar's exclusivity for opportunities that include only an incidental interest in Ground Leases and opportunities to manufacture or otherwise create a Ground Lease from a property that has been owned by iStar's Net Lease Venture for at least three years after our initial public offering. Accordingly, the exclusivity agreement will not prevent iStar from pursuing certain Ground Lease opportunities directly or through the aforementioned Net Lease Venture.
iStar is considering the formation of an investment fund in which we would invest, which would be managed by an affiliate of iStar and would target the origination and acquisition of Ground Leases for commercial real estate projects that are in a pre-development phase, unlike the later stage development Ground Leases that fit our investment criteria. iStar may face conflicts of interest in fulfilling its duties to us and the fund. iStar, through our Manager and the manager of such fund, would be responsible for identifying and appropriately allocating investments between the fund and us, based upon the fund's and our respective investment criteria. In addition, iStar would be involved in establishing the price and the conditions of our purchases of assets from any such fund. We expect that the fund would have a different fee structure than the fee structure of our management agreement with iStar, which could potentially be more favorable to iStar than the management fees we pay to iStar. If iStar fails to deal appropriately with these and other conflicts, our business could be adversely affected. There can be no assurance that the terms of our investment in any such fund or transactions we may engage in with such fund will be as favorable as those we may achieve in an arm's length transaction with unaffiliated parties.
There can be no assurance that the potential fund would be successful, and making investments through the fund may be less favorable to us than making them directly.
The potential fund would pursue a new investment strategy targeting pre-development Ground Leases and there can be no assurance that the fund would be successful in pursuing this strategy, in originating investments or in raising third party investment capital. Moreover, there can be no assurance that the pre-development projects underlying the fund's Ground Leases would achieve the conditions necessary to meet our investment criteria for purchase in the future. We currently expect that the
time for a project to move from pre-development to development will range from one to four years. No such fund has been formed and no commitments have been made by any third parties to subscribe for interests in any such fund. We have entered into one letter of intent contemplating a forward commitment by us to purchase a $240 million Ground Lease for an office development project upon that project's meeting our investment criteria from either the potential fund or, if the fund is not formed, from iStar, which would raise additional conflicts of interest, but we have no binding agreement to acquire this Ground Lease or any other asset from the potential fund or iStar. Investments in the potential fund, or financial commitments to fund future Ground Leases, could reduce the amount of available capital for other investments, and could limit our financial flexibility or require us to increase our leverage. Investments in the potential fund, or financial commitments to fund future Ground Leases, could reduce the amount of available capital for other investments, and could limit our financial flexibility or require us to increase our leverage. Moreover, our manager has no track record in completing Ground Lease transactions that would meet any such fund's investment criteria.
As a limited partner in the fund, we would receive only a portion of the returns from the investments while they are held by the fund, and such returns will be reduced by the fees paid to the manager of the fund and such fees may exceed the fee we pay our iStar-affiliated manager. In addition, as a limited partner, we would have no active role in managing the fund and would have only limited approval rights. Our interest in the fund would be illiquid.
If we enter into any forward purchase agreement or other arrangement to purchase a Ground Lease from such fund in the future, any such forward purchase agreement or arrangement to acquire the Ground Lease from the fund may not be priced to appropriately reflect any decline in the value of the Ground Lease which may occur due to changes in interest rates, material adverse changes in the property or the Ground Lease tenant or other factors between the time of its origination and the time that we purchase it from the fund, or other unanticipated events. Furthermore, we may be required to finance such commitments in the future, and there can be no assurance that such financing will be available on attractive terms, or at all.
The management fee payable to our Manager may not provide sufficient incentive to our Manager to maximize risk-adjusted returns on our investment portfolio.
The management fee payable to our Manager is based on the amount of our total equity (as defined in the management agreement) at the end of each quarter, regardless of our performance. Our total equity for the purposes of calculating the management fee is not the same as, and could be greater than, the amount of total equity shown on our balance sheet. The possibility exists that significant management fees could be payable to our Manager for a given quarter despite the fact that we could experience a net loss during that quarter. Our Manager's entitlement to such significant nonperformance-based compensation may not provide sufficient incentive to our Manager to devote its time and effort to source and maximize risk-adjusted returns on our investment portfolio.
Our board of directors will not approve each investment decision made by our Manager, which may result in our Manager making riskier investments on our behalf than would be specifically approved by our board of directors.
Our directors do not review all of our proposed investments, which may result in our Manager making riskier investments on our behalf than would be specifically approved by our board of directors. In addition, in reviewing certain investments, our directors may rely primarily on information provided to them by our Manager. Furthermore, it may be difficult or impossible to unwind transactions by the time they are reviewed by our directors. Our Manager has great latitude, which could result in investment returns that are substantially below expectations or that result in losses. Our Manager may change its investment process without stockholder approval at any time. Decisions made and investments entered into by our Manager may not fully reflect your best interests.
Financing and Investment Risks
Our debt obligations will reduce cash available for distribution and expose us to the risk of default.
Payments of principal and interest on borrowings may leave us with insufficient cash resources to fund investment activities or to make distributions currently contemplated or necessary for us to maintain our qualification as a REIT. If interest rates, and therefore, the costs of our debt rise faster and by greater amounts than any rent escalations and percentage rents under our leases, we may not generate sufficient cash to pay amounts due under our borrowings. Additionally, given the long term of our Ground Leases and the comparatively shorter term of our debt, there may be a misalignment between interest rates at the time of a refinancing and our expected revenue stream under a Ground Lease. Our organizational documents do not contain any limitation on the amount of indebtedness we may incur. Our level of debt, the costs of our debt and the limitations imposed on us by our debt agreements could have significant adverse consequences, including, without limitation, the following:
• our cash flow may be insufficient to meet our required principal and interest payments;
• we may be unable to borrow additional funds as needed on favorable terms, or at all;
• we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;
• increases in interest rates could materially increase our interest expense and adversely affect our growth by significantly increasing the costs of future investments;
• we may be forced to dispose of one or more of our assets, possibly on disadvantageous terms;
• our Revolver prohibits us from paying distributions if there is a default thereunder, subject to limited exceptions relating to the maintenance of our REIT qualification;
• the actions or omissions of our tenants over which we have no direct control, such as a failure to pay required taxes, may trigger an event of default under certain of our mortgages (refer to Note 8);
• if we default on our debt, the lenders or mortgagees may accelerate our debt obligations, repossess and/or take control of the properties, if any, that secure their loans and collect rents and other property income; and
• our default under debt agreements could trigger cross-default or cross acceleration of our other debt.
Our failure to hedge interest rates effectively could materially and adversely affect us.
Subject to our qualification as a REIT, we seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements that involve risk, such as the risk that counterparties may fail to honor their obligations under these arrangements, and that these arrangements may not be effective in reducing our exposure to interest rate changes. Moreover, there can be no assurance that our hedging arrangements will qualify for hedge accounting. Should we desire to terminate a hedging arrangement, we may incur significant costs.
When a hedging arrangement is required under the terms of a mortgage loan, it is often a condition that the hedge counterparty maintains a specified credit rating. If the credit rating of a counterparty were downgraded and we were unable to renegotiate the credit rating condition with the lender or find an alternative counterparty with acceptable credit rating, we would be in default under the loan and the lender could seize that property securing the loan through foreclosure.
Joint venture investments could be adversely affected by our lack of sole decision-making authority, our reliance on partners' or co-venturers' financial position and liquidity and disputes between us and our co-venturers.
We hold our Ground Lease at 425 Park Avenue through a subsidiary REIT owned by us and a third party, and we may co-invest in the future with third parties through partnerships, joint ventures or other entities. Under our stockholder's agreement with an institutional investor that invested in us prior to our initial public offering, we have agreed that it will have the right to participate as a co-investor in real estate investments for which we are seeking joint venture partners. In a joint venture, we may not be in a position to exercise sole decision-making authority regarding material decisions. Investments in partnerships, joint ventures or other entities may, under certain circumstances, involve risks not present were a third party not involved, including the possibility that partners or co-venturers might become bankrupt or fail to fund their share of required capital contributions. Partners or co-venturers may have economic or other business interests or goals which are inconsistent with our business interests or goals, and they may have competing interests that could create conflict of interest issues. Such investments may also have the potential risk of impasses on decisions, such as a sale. In addition, prior consent of our partners or co-venturers may be required for a sale or transfer to a third party of our interests in the partnership or joint venture, which would restrict our ability to dispose of our interest. Disputes between us and partners or co-venturers may result in litigation or arbitration that would increase our expenses and create distractions for our executive officers and/or directors. In addition, we may in certain circumstances be liable for the actions of our partners or co-venturers. Our partnerships or joint ventures may be subject to debt and we could be forced to fund our partners' or co-venturers' share of such debt if they fail to make the required payments in order to preserve our investment.
Our depreciation expenses are expected to be limited for financial and tax reporting purposes, with the result that we will be highly dependent on external capital sources to fund our growth.
As an owner of land, we expect to record limited depreciation expenses for either financial reporting or tax reporting purposes. As a result, we will not have significant depreciation expenses that will reduce our net taxable income and the payment ratio of our distributions to our cash available for distribution to our shareholders or other metrics is likely to be higher than at many other REITs. This also means that we will be highly dependent on external capital sources to fund our growth. If capital markets are experiencing disruption or are otherwise unfavorable, we may not have access to capital on attractive terms, or at all, which could prevent us from achieving our investment objectives.
The replacement of LIBOR may affect the value of certain of our financial obligations and could affect our results of operations or financial condition.
In July 2017, the U.K. Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. In December 2020, ICE Benchmark Association, the administrator of LIBOR, published a consultation regarding its intention to cease publication of US dollar LIBOR after June 2023. As of December 31, 2020, approximately 12.6% of the total principal amount of our outstanding debt was floating rate debt. We are unable to predict the timing or effect of any changes, any establishment of alternative reference rates or any other reforms to LIBOR or any replacement of LIBOR that may be enacted in the United States, the United Kingdom or elsewhere. Such changes, reforms or replacements relating to LIBOR could have an adverse impact on the market for or value of any LIBOR-linked securities, loans, derivatives and other financial obligations or extensions of credit held by or due to us or on our overall financial condition or results of operations.
Risks Related to Our Organization and Structure
We are a holding company and will rely on funds from our Operating Partnership to pay our obligations and distributions to our shareholders.
We conduct substantially all of our operations through our Operating Partnership. As a holding company, claims of shareholders are structurally subordinated to all existing and future creditors and preferred equity holders of our Operating Partnership and its subsidiaries. Additionally, holders of equity interests in our subsidiaries, including joint venture partners and holders of CARET Units, will be entitled to share in liquidation proceeds to the extent of their interests therein. Therefore, in the event of a bankruptcy, insolvency, liquidation or reorganization of our Operating Partnership or its subsidiaries, assets of our Operating Partnership or the applicable subsidiary will be available to satisfy our claims to us as an equity owner therein only after all of their liabilities and preferred equity have been paid in full and only to the extent of the Operating Partnership's interests in the subsidiaries.
The concentration of our voting power may adversely affect the ability of investors to influence our policies.
As of December 31, 2020, iStar owned approximately 65.4% of the outstanding shares of our common stock. We entered into a Stockholder's Agreement with iStar, pursuant to which iStar agreed to limit its aggregate voting power in us to 41.9% and iStar agreed to certain standstill provisions. Consequently, iStar has the ability to influence the outcome of matters presented to our shareholders, including the election of our board of directors and approval of significant corporate transactions, including business combinations, consolidations and mergers. Two directors of iStar also serve on our board of directors, including Jay Sugarman, who is the chief executive officer of iStar and our chief executive officer. Our directors, executive officers and iStar could exercise influence in a manner that is not in the best interest of our other shareholders. The concentration of voting power in iStar might also have the effect of delaying, deferring or preventing a change of control that our other shareholders may view as beneficial.
Certain provisions of Maryland law and our organizational documents could inhibit changes in control of our company.
Certain provisions of Maryland law and our organizational documents could inhibit changes in control of our company that might involve a premium price for our common stock or that our shareholders otherwise believe to be in their best interest, including, among others, the following:
•Pursuant to the Maryland General Corporation Law, or the MGCL, our board of directors has by resolution exempted business combinations between us and any other person from the business combination provisions of the MGCL, and our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. However, there can be no assurance that these exemptions will not be amended or eliminated at any time in the future.
•Our ability as general partner of the Operating Partnership to make certain amendments to the partnership agreement and to cause the Operating Partnership to issue units with terms that could delay, defer or prevent a merger or other change of control of us or our Operating Partnership without the consent of the limited partners.
•The right of the limited partners of our Operating Partnership to consent to transfers of our general partnership interest and mergers or other transactions involving us under specified circumstances.
•Our charter generally prohibits any person from directly or indirectly owning more than 9.8% in value or number of shares, whichever is more restrictive, of the outstanding shares of all classes and series of our capital stock or more than 9.8% in value or number of shares, whichever is more restrictive, of the outstanding shares of our common stock.
•Our board of directors, without stockholder approval, has the power under our charter to amend our charter from time to time to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series that we are authorized to issue, to authorize us to issue authorized but unissued shares of our common stock or preferred stock and to classify or reclassify any unissued shares of our common stock or preferred stock into one or more classes or series of stock and set the terms of such newly classified or reclassified shares. As a result, our board of directors could establish a class or series of preferred stock that could, depending on the terms of such series, delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or that our shareholders otherwise believe to be in their best interest.
Certain provisions of our organizational documents limit shareholder recourse and access to judicial fora.
Our charter limits the liability of our present and former directors and executive officers to us and our shareholders for money damages to the maximum extent permitted under Maryland law. The partnership agreement of our Operating Partnership also limits the liability of our directors, officers and others. Additionally, our bylaws provide that, unless we consent in writing to the selection of an alternative forum, the sole and exclusive forum for: (a) any derivative action or proceeding brought on our behalf; (b) any action asserting a claim of breach of any duty owed by us or by any director or officer or other employee to us or to our shareholders; (c) any action asserting a claim against us or any director or officer or other employee arising pursuant to any provision of the MGCL or our charter or bylaws; or (d) any action asserting a claim against us or any director or officer or other employee that is governed by the internal affairs doctrine shall be the Circuit Court for Baltimore City, Maryland, or, if that Court does not have jurisdiction, the United States District Court for the District of Maryland, Baltimore Division. These provisions of our organizational documents may limit shareholder recourse for actions of our present and former directors and executive officers and limit their ability to obtain a judicial forum that they find favorable for disputes with our company or our directors, officers, employees, if any, or other shareholders.
Conflicts of interest exist or could arise between our shareholders and limited partners.
Conflicts of interest exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our Operating Partnership or any partner thereof, on the other. Our directors and executive officers have duties to us under applicable Maryland law in connection with their management of our company. At the same time, we, as the general partner of our Operating Partnership, have fiduciary duties and obligations to our Operating Partnership and its limited partners under Delaware law and the partnership agreement of our Operating Partnership. Our fiduciary duties and obligations as general partner to our Operating Partnership and its partners may come into conflict with the duties of our directors and executive officers to our company. Our Operating Partnership agreement provides that in the event of a conflict in the duties owed by us to our shareholders and the fiduciary duties owed by us, in our capacity as general partner of our Operating Partnership, to those limited partners, we will fulfill our fiduciary duties to those limited partners by acting in the best interests of our company. No reported decision of a Delaware appellate court has interpreted provisions similar to the provisions of the partnership agreement of our Operating Partnership that modify and reduce our fiduciary duties or obligations as the general partner or reduce or eliminate our liability for money damages to the Operating Partnership and its partners, and we have not obtained an opinion of counsel as to the enforceability of the provisions set forth in the partnership agreement that purport to modify or reduce the fiduciary duties that would be in effect were it not for the partnership agreement.
Risks Related to Our Common Stock
Cash available for distribution may not be sufficient to make distributions to our shareholders at expected levels, or at all.
All future distributions will be made at the discretion of our board of directors and will depend on a number of factors, including our actual or anticipated results of operations, cash flows and financial position, our qualification as a REIT, restrictions in our financing agreements, economic and market conditions, applicable law, and other factors as our board of directors may deem relevant from time to time. Our Revolver prohibits us from paying distributions if there is a default thereunder, subject to limited exceptions relating to the maintenance of our REIT qualification. If sufficient cash is not available for distribution from our operations, we may have to fund distributions from working capital or borrow funds, issue equity or sell assets to pay for such distribution, or eliminate or otherwise reduce the amount of such distribution. Any distributions we make in the future could differ materially from our past distributions or current expectations. If we fail to meet the market's expectations with regard to future operating results and cash distributions, the market price of our common stock could be adversely affected.
The availability of shares and units for future sale could adversely affect the market price of our common stock.
We cannot predict whether future issuances of shares of our common stock or Operating Partnership units or the availability of shares for resale in the open market will decrease the market price of our common stock. We pay management fees to our Manager in cash or in shares of our common stock at the discretion of our independent directors. Under the terms of registration rights agreements, iStar received rights to have shares of common stock issued from time to time registered for
resale under the Securities Act. We may also issue shares of common stock or Operating Partnership units in connection with future acquisitions. Issuances or resales of substantial amounts of shares of our common stock or Operating Partnership units, or the perception that such issuances or resales might occur could adversely affect the market price of our common stock. This potential adverse effect may be increased by the large number of shares of our common stock that are or will be owned by iStar to the extent that it resells, or there is a perception that it may resell, a significant portion of its holdings. In addition, future issuances of shares of our common stock or Operating Partnership units may be dilutive to holders of shares of our common stock and may reduce the market price of our common stock. Existing shareholders have no preemptive rights.
Distributions to holders of CARET Units will reduce distributions to us upon certain capital transactions. The economic interests of the CARET Units will not be diluted by future issuances of common stock. The terms of CARET Units could result in conflicts of interest between our management and our stockholders.
CARET Units generally entitle holders to a share of cash distributions in respect of the capital appreciation above our investment basis in our Ground Lease assets received upon the sale of a Ground Lease, the sale of a combined property and certain non-recourse mortgage debt refinancings of a Ground Lease. The number of authorized CARET Units is a fixed amount. We have established an equity incentive plan providing for grants of CARET Units to our directors, officers and employees of our Manager and other eligible participants representing up to 15% of all distributions made to holders of CARET Units. Such grants are subject to stock price hurdles (all of which have been satisfied as of December 31, 2020) and time-based service conditions. We own the remaining 85% of the CARET Units, and we may choose to sell a portion of them to third parties in the future, which would reduce our current percentage interest (and indirectly the interest of our shareholders) in cash distributions in respect of CARET Units. Additionally, issuances of additional shares of our common stock will reduce an individual stockholder's indirect interest in CARET Units, while the interests of CARET Unit holders are fixed. Conflicts of interest could arise between the interests of holders of CARET Units and holders of our common stock with respect to decisions of whether to invest in Ground Leases that hold greater potential for future distributions to CARET holders versus current distributions to common stockholders, whether to extend, sell, hold or refinance a Ground Lease or combined property in the future and whether to issue new shares of common stock. Thus, holders of shares of our common stock bear the risk that CARET Units will dilute our common stockholders' economic interests and other attributes of ownership in us and may materially and adversely affect the market price of shares of our common stock.
Future issuances of debt or preferred equity securities could adversely affect our common shareholders and result in conflicts of interest.
We may issue debt or equity securities in the future. Upon liquidation, holders of our debt and preferred stock will receive a distribution of our available assets before holders of our common stock. Our preferred stock, if issued, would also likely have a preference on periodic dividends, which could limit our ability to make distributions to holders of shares of our common stock. We cannot predict or estimate the amount, timing, nature or impact of our future capital raising efforts. Thus, holders of shares of our common stock bear the risk that our future issuances or sales of debt or equity securities or our incurrence of other borrowings may materially and adversely affect the market price of shares of our common stock and may result in conflicts of interest.
Tax Risks Related to Ownership of Our Shares
Our failure to remain qualified as a REIT would subject us to taxes, which would reduce the amount of cash available for distribution to our shareholders.
We believe we have been organized and operated and intend to continue to operate in a manner that will enable us to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2017. We have not requested and do not intend to request a ruling from the Internal Revenue Service, or the IRS, that we qualify as a REIT. Qualification as a REIT involves the application of highly technical and complex Code provisions and Treasury Regulations promulgated thereunder for which there are limited judicial and administrative interpretations. The complexity of these provisions and of applicable Treasury Regulations is greater in the case of a REIT that, like us, holds its assets through entities treated as partnerships for U.S. federal income tax purposes. To qualify as a REIT, we must meet, on an ongoing basis, various tests regarding the nature and diversification of our assets and our income, the ownership of our outstanding shares, and the amount of our distributions. Our ability to satisfy these asset tests depends upon the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to manage successfully the composition of our income and assets on an ongoing basis. In connection with such requirements, for so long as iStar or any other stockholder, either individually or together in the aggregate, holds 10% or more of the shares of our common stock, we will be deemed to own any tenant in which, iStar, such stockholder or iStar and such stockholder together own, at any time during a taxable year, a 10% or greater interest, applying certain constructive ownership rules, which could cause us to receive rental income from a related party tenant. We have put in place, together with iStar, procedures to diligence whether we will directly or indirectly receive rental income of a related party tenant, including as a result of our constructive
ownership of a tenant due to ownership of such tenant by iStar. However, due to the broad nature of the attribution rules of the Code, we cannot be certain that in all cases we will be able to timely determine whether we are receiving related party rental income in an amount that would cause us to fail the REIT gross income tests. To the extent we fail to satisfy a REIT gross income test as a result of receiving related party tenant income we could fail to qualify as a REIT or be subject to a penalty tax which could be significant in amount. See—"Certain U.S. Federal Income Tax Considerations—Requirements for Qualification—General—Failure to Satisfy the Gross Income Tests." Moreover, new legislation, court decisions or administrative guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT. Thus, while we believe we have been organized and operated and intend to continue to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, no assurance can be given that we have qualified or will continue to so qualify for any particular year. These considerations also might restrict the types of assets that we can acquire or services that we can directly provide to our tenants in the future.
If we fail to qualify as a REIT in any taxable year, and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income at regular corporate rates, and distributions to our shareholders would not be deductible by us in determining our taxable income. In such a case, we might need to borrow money, sell assets, or reduce or even cease making distributions in order to pay our taxes. Our payment of income tax would reduce significantly the amount of cash available for distribution to our shareholders. Furthermore, if we fail to qualify or maintain our qualification as a REIT, we no longer would be required to distribute substantially all of our net taxable income to our shareholders. In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to qualify as a REIT until the fifth calendar year following the year in which we failed to qualify. In addition, if we are treated as a "successor" of iStar (within the meaning of Treasury Regulations Section 1.856-8(c)(2)) and iStar's REIT status were terminated or revoked, we would be prohibited from electing to be taxed as a REIT until the fifth calendar year following the year in which iStar Inc.'s qualification was lost.
The REIT distribution requirements could require us to borrow funds or take other actions that may be disadvantageous to our shareholders.
In order to qualify as a REIT, we must distribute to our shareholders, on an annual basis, at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gains. In addition, we will be subject to U.S. federal income tax at regular corporate rates to the extent that we distribute less than 100% of our net taxable income (including net capital gains) and will be subject to a 4% nondeductible excise tax on the amount by which our distributions in any calendar year are less than a minimum amount specified under U.S. federal income tax laws. We intend to distribute our net taxable income to our shareholders in a manner intended to satisfy the REIT 90% distribution requirement and to eliminate U.S. federal income tax and the 4% nondeductible excise tax.
Our taxable income may exceed our net income as determined by GAAP because, for example, realized capital losses will be deducted in determining our GAAP net income, but may not be deductible in computing our taxable income. In addition, we may incur nondeductible capital expenditures or be required to make debt or amortization payments. Also, certain Ground Lease transactions we enter into may be determined to have a financing component, which may result in a timing difference between the receipt of cash and the recognition of income for U.S. federal income tax purposes. In addition, we may be required to take certain amounts into income no later than the time such amounts are reflected on our financial statements. As a result of the foregoing, we may generate less cash flow than taxable income in a particular year and we may incur U.S. federal income tax and the 4% nondeductible excise tax on that income if we do not distribute such income to shareholders in that year. In that event, we may be required to use cash reserves, incur debt, issue equity or liquidate assets at rates or times that we regard as unfavorable or make a taxable distribution of our shares in order to satisfy the REIT 90% distribution requirement and to eliminate U.S. federal income tax and the 4% nondeductible excise tax in that year.
Even if we qualify as a REIT, we may incur tax liabilities that reduce our cash flow.
Even if we qualify as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, taxes on income from some activities conducted as a result of a foreclosure, and state or local income, franchise, property and transfer taxes. In order to meet the REIT qualification requirements, or to avoid the imposition of a 100% tax that applies to certain gains derived by a REIT from sales of inventory or property held primarily for sale to customers in the ordinary course of business, we may hold some of our assets through taxable C corporations, including TRSs. Such subsidiary corporations will be subject to U.S. federal, state and local corporate income taxes, including potential penalty taxes, which would decrease the cash available for distribution to our shareholders.
Item 1b. Unresolved Staff Comments
Item 2. Properties
Our principal executive offices are located at 1114 Avenue of the Americas, New York, New York, 10036. See Item 8—"Financial Statements and Supplementary Data—Schedule III for a listing of properties held by us for investment purposes.
Item 3. Legal Proceedings
We are not currently a party to any pending legal proceedings that we believe could have a material adverse effect on our business or financial condition. However, we may be subject to various claims and legal actions arising in the ordinary course of business from time to time.
Item 4. Mine Safety Disclosures
Item 5. Market for Registrant's Equity and Related Stock Matters
Our common stock trades on the NYSE under the symbol "SAFE." Computershare is the transfer agent and registrar for our common stock. We had 19 holders of record of common stock as of February 9, 2021. This figure does not represent the actual number of beneficial owners of our common stock because shares of our common stock are frequently held in “street name” by securities dealers and others for the benefit of beneficial owners who may vote the shares and who would report dividends paid by us in their taxable income.
Unregistered Sales of Equity Securities
In addition to previously reported unregistered sales of equity securities, in October 2020, we issued 49,790 shares of our common stock to our Manager as payment for the management fee for the three months ended September 30, 2020. These shares were not registered under the Securities Act.
Issuer Purchases of Equity Securities
We did not purchase any shares of our common stock during the three months ended December 31, 2020.
Disclosure of Equity Compensation Plan Information
In connection with our initial public offering, we adopted an equity incentive plan (the "2017 Plan") to provide equity incentive opportunities to members of our Manager’s management team and employees who perform services for us, our independent directors, advisers, consultants and other personnel. Our equity incentive plan provides for grants of stock options, shares of restricted common stock, phantom shares, dividend equivalent rights and other equity-based awards up to an aggregate of 907,500 (representing 5% of the issued and outstanding shares of our common stock as of the closing of our initial public offering).
In each of the second quarters of 2017, 2018 and 2019, we issued 40,000 fully-vested shares to our directors who are not employees of the Manager or iStar in consideration for their annual services as directors. In the second quarter 2020, we issued 22,000 fully-vested shares to our directors who are not employees of the Manager or iStar in consideration for their annual services as directors. In the first quarter 2019, we granted 25,000 restricted stock units with a fair value of $0.5 million, or $19.15 per share, to an employee of the Manager, representing the right to receive 25,000 shares of our common stock on January 5, 2022, if the employee is employed by the Manager on that date.
The following table presents certain information about our equity compensation plan as of December 31, 2020:
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
exercise price of
warrants and rights
Number of securities
remaining available for
future issuance under
equity compensation plans
reflected in column (a))
Equity incentive plans approved by shareholders(1)
|— ||— ||740,500 |
|Equity incentive plans not approved by shareholders||— ||— ||— |
(1)Composed of the 2017 Plan.
In the third quarter 2018, we adopted an equity incentive plan providing for grants of interests (called "CARET Units") in a subsidiary of the Operating Partnership intended to constitute profits interests within the meaning of relevant Internal Revenue Service guidance. Our shareholders approved the plan in the second quarter of 2019. Grants under the plan are subject to graduated vesting based on time and hurdles of our common stock price. Once a particular stock price hurdle is met, a portion of the awards becomes vested, but remains subject to being forfeited, in part, if additional time-based service conditions are not satisfied. The awards generally entitle plan participants to cash distributions of up to 15%, in the aggregate, of the capital appreciation above our investment basis in our Ground Lease assets received upon the sale of a Ground Lease, the sale of a combined property and certain non-recourse mortgage debt refinancings of a Ground Lease. We own the remaining 85% of the CARET Units. At the time of plan adoption, awards with an aggregate fair value of $1.4 million were granted to our independent directors and employees of the Manager and will be recognized over a period of four years. As of December 31,
2020, all stock price hurdles were achieved and 50% of each outstanding award is now fully vested while the remaining 50% of each award will become vested upon satisfaction of continuing service conditions. In February 2020 and March 2020, the Company granted awards with an aggregate grant date fair value of $0.5 million and $0.1 million, respectively, to employees of the Manager. The awards granted in February 2020 will cliff vest in December 2022 and the awards granted in March 2020 will vest over three years upon satisfaction of continuing service conditions. During the years ended December 31, 2020, 2019 and 2018, we recognized $0.5 million, $0.4 million and $0.1 million, respectively, in expense from CARET Units.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Please read the following discussion of our consolidated operating results, financial condition and liquidity together with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Our discussion of 2018 results is included in Part II, Item 7 of our 2019 Annual Report on Form 10-K. These historical financial statements may not be indicative of our future performance.
We acquire, manage and capitalize Ground Leases and report our business as a single reportable segment. We believe owning a portfolio of Ground Leases affords our investors the opportunity for safe, growing income and capital appreciation. Safety is derived from a Ground Lease's senior position in the commercial real estate capital structure. Growth is realized through long-term leases with contractual periodic increases in base rent. Capital appreciation is realized though appreciation in the value of the land over time and through our typical rights as landlord to take possession of the commercial buildings on our land at the end of a Ground Lease, which may yield substantial value to us. The diversification by geographic location, property type and sponsor in our portfolio further reduces risk and enhances potential upside. Under our Ground Leases we are typically not responsible for any operating or capital expenses over the life of the lease, making the management of our portfolio relatively simple, with limited working capital needs. We also believe institutional owners of commercial real estate increasingly understand that the structure of our SafeholdTM Ground Lease allows owners of high quality properties to generate higher returns with less risk.
Our financial results for the year ended December 31, 2020 were not adversely impacted by the COVID-19 pandemic to a material degree. We received 100% of the Ground Lease rent due under our Ground Leases through December 31, 2020. This includes the payment of the annual percentage rent under the Park Hotels Portfolio in respect of 2019 hotel operating performance, which we received in full in April in the amount of $3.6 million. We cannot predict that we will continue to receive all rent owed to us when due in future periods. As of December 31, 2020, the percentage breakdown of the gross book value of our portfolio was 56% office, 26% multi-family, 17% hotels and 1% other. The COVID-19 pandemic has hit the hotel sector, including the hotel properties in our portfolio, particularly hard. Excluding percentage rent, for the year ended December 31, 2020, approximately 15.2% of our total revenues came from our hotel leases. During 2020, operations at all of the hotel properties in our portfolio were substantially reduced. In addition to base rent, we are entitled to receive percentage rents under certain of our hotel Ground Leases, based on hotel revenues. For the year ended December 31, 2020, percentage rents constituted approximately 2.5% of our total revenues. In 2021, we expect to experience a material decline in percentage rent revenues in respect of 2020 hotel operating performance. Such decline in percentage rents, as well as any disruptions in the payment of future rents by our hotel or other tenants, would adversely impact our cash flows from operations, and any such impact could be material.
The COVID-19 pandemic adversely affected our new investment activity in 2020, primarily because of the reduced levels of real estate transactions and constrained conditions for equity and debt financing for real estate transactions, including leasehold loans. In addition, the COVID-19 pandemic has made it more difficult to execute transactions as people work from home and are reluctant to visit properties, local governmental offices have reduced operations and third parties such as survey, insurance, environmental and similar services have more limited capacities. These conditions will adversely affect our growth prospects while they persist. At this time, we cannot predict the full extent of the impacts of the COVID-19 pandemic on our business. See the "Risk Factors" section of this 10-K for additional discussion of certain potential risks to our business arising from the COVID-19 pandemic.
Our portfolio of properties is diversified by property type and region. Our portfolio is comprised of Ground Leases and a master lease (relating to five hotel assets that we refer to as our “Park Hotels Portfolio”) that has many of the characteristics of a Ground Lease. As of December 31, 2020, our estimated portfolio Ground Rent Coverage was 3.4x (see the "Risk Factors -Our estimated UCA, Combined Property Value and Ground Rent Coverage, may not reflect the full potential impact of the COVID-19 pandemic and may decline materially in future periods, -We rely on Property NOI as reported to us by our tenants, -Our estimates of Ground Rent Coverage for properties in development or transition, or for which we do not receive current tenant financial information, may prove to be incorrect" in this Form 10-K for a discussion of our estimated Ground Rent Coverage).
Below is an overview of the top 10 assets in our portfolio as of December 31, 2020 (based on gross book value):(1)
|Property Type||Location||Lease Expiration / As Extended||Rent Escalation |
|% of Gross |
425 Park Avenue(2)
|Office||New York, NY||2090 / 2090||Fixed with Inflation Adjustments||10.8%|
|135 West 50th Street||Office||New York, NY||2123 / 2123||Fixed with Inflation Adjustments||9.2%|
|195 Broadway||Office||New York, NY||2118 / 2118||Fixed with Inflation Adjustments||8.8%|
Park Hotels Portfolio(3)
|Hotel||Various||2025 / 2035||% Rent||6.9%|
|Alohilani||Hotel||Honolulu, HI||2118 / 2118||Fixed with Inflation Adjustments||6.3%|
|685 Third Avenue||Office||New York, NY||2123 / 2123||Fixed with Inflation Adjustments||5.8%|
|1111 Pennsylvania Avenue||Office||Washington, DC||2117 / 2117||Fixed with Inflation Adjustments||4.7%|
|Domain Tower||Office||Austin, TX||2118 / 2118||Fixed with Inflation Adjustments||2.5%|
|Anderson Drive||Multi-family||Fairfax, VA||2082 / 2082||Fixed with Inflation Adjustments||2.4%|
|Hollywood Blvd - South||Multi-family||Los Angeles, CA||2104 / 2104||Inflation-Linked||2.3%|
(1)Gross book value represents the historical purchase price plus accrued interest on sales-type leases.
(2)Gross book value for this property represents our pro rata share of the gross book value of our unconsolidated venture (refer to Note 6).
(3)The Park Hotels Portfolio consists of five properties and is subject to a single master lease. A majority of the land underlying one of these properties is owned by a third party and is ground leased to us through 2044 subject to changes in the CPI; however, our tenant at the property pays this cost directly to the third party.
The following tables show our portfolio by region and property type as of December 31, 2020, excluding unfunded commitments:
|Region||% of Gross |
|Mid Atlantic||18 |
|Property Type||% of Gross |
In February 2020, we entered into an aggregate $37.0 million commitment to acquire land for $10.0 million and provide a $27.0 million leasehold improvement allowance for the Ground Lease tenant's construction of a multi-family property. As of December 31, 2020, we had acquired the land and funded $8.8 million of the leasehold improvement allowance. We expect to fund the remaining commitment upon the completion of certain conditions.
Results of Operations for the Year Ended December 31, 2020 compared to the Year Ended December 31, 2019
| ||For the Years Ended December 31,|
| ||2020||2019||$ Change|
|Operating lease income||$||72,340 ||$||72,071 ||$||269 |
|Interest income from sales-type leases||81,844 ||18,531 ||63,313 |
|Other income||1,243 ||2,794 ||(1,551)|
|Total revenues||155,427 ||93,396 ||62,031 |
|Costs and expenses:|
|Interest expense||64,354 ||29,868 ||34,486 |
|Real estate expense||2,480 ||2,673 ||(193)|
|Depreciation and amortization||9,433 ||9,379 ||54 |
|General and administrative||22,733 ||14,435 ||8,298 |
|Other expense||243 ||899 ||(656)|
|Total costs and expenses||99,243 ||57,254 ||41,989 |
|Loss on early extinguishment of debt||— ||(2,011)||2,011 |
|Earnings (losses) from equity method investments||3,304 ||(403)||3,707 |
|Net income||$||59,488 ||$||33,728 ||$||25,760 |
Operating lease income increased to $72.3 million during the year ended December 31, 2020 from $72.1 million for the year ended December 31, 2019. The increase was primarily due to a full period of income for the year ended December 31, 2020 for Ground Leases acquired and classified as operating leases during 2019 and new Ground Leases acquired during 2020, partially offset by a decrease in percentage rent for the year ended December 31, 2020 compared to the year ended December 31, 2019.
Interest income from sales-type leases increased to $81.8 million for the year ended December 31, 2020 from $18.5 million for the year ended December 31, 2019. The increase was primarily due to the origination of Ground Leases classified as sales-type leases in 2020 and a full period of income for the year ended December 31, 2020 for Ground Leases acquired and classified as sales-type leases during 2019.
Other income for the years ended December 31, 2020 and 2019 includes $0.2 million and $2.4 million, respectively, of interest income earned on our cash balances. Other income for the year ended December 31, 2020 includes $0.6 million of other ancillary income. Other income for both the years ended December 31, 2020 and 2019 also includes $0.4 million of other income relating to a Ground Lease in which we are the lessee but our tenant at the property pays this expense directly under the terms of a master lease.
During the year ended December 31, 2020, we incurred interest expense from our debt obligations of $64.4 million compared to $29.9 million during the year ended December 31, 2019. The increase during the year ended December 31, 2020 was primarily the result of additional borrowings to fund our growing investment portfolio.
Real estate expense during the years ended December 31, 2020 and 2019 was $2.5 million and $2.7 million, respectively, and consisted primarily of the amortization of an operating lease right-of-use asset, property appraisal fees and insurance expense. In addition, during both the years ended December 31, 2020 and 2019, we also recorded $0.4 million of real estate expense relating to a Ground Lease in which we are the lessee but our tenant at the property pays this expense directly under the terms of a master lease.
Depreciation and amortization was $9.4 million during the years ended December 31, 2020 and 2019, and primarily relates to our ownership of the Park Hotels Portfolio, our ownership of the Buckler multi-family property and the amortization of in-place intangible assets.
General and administrative expenses include management fees, stock-based compensation, costs of operating as a public company and an allocation of expenses to us from our Manager. The following table presents our general and administrative expenses for the years ended December 31, 2020 and 2019 ($ in thousands):
For the Years Ended
|$||12,684 ||$||7,461 |
|Public company and other costs||3,305 ||3,247 |
Expense reimbursements to the Manager(1)
|5,000 ||2,144 |
|Stock-based compensation||1,744 ||1,583 |
|Total general and administrative expenses||$||22,733 ||$||14,435 |
(1)Refer to Note 13.
During the year ended December 31, 2020, other expense consists primarily of property appraisal fees, fees related to our derivative transactions and state and local taxes. During the year ended December 31, 2019, other expense consists primarily of investment pursuit costs, fees related to our derivative transactions and state and local taxes.
During the year ended December 31, 2019, loss on early extinguishment of debt resulted from the refinancing of two mortgages on existing Ground Leases.
During the year ended December 31, 2020, earnings from equity method investments resulted from our pro rata share of income from a venture that we entered into with an existing shareholder that acquired the existing ground lease at 425 Park Avenue in New York City in November 2019 (refer to Note 6). During the year ended December 31, 2019, losses from equity method investments resulted from costs attributable to transaction structuring activities for the venture.
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, including to pay interest and repay borrowings, fund and maintain our assets and operations, complete acquisitions and originations of investments, make distributions to our shareholders and meet other general business needs. In order to qualify as a REIT, we are required under the Internal Revenue Code of 1986 to distribute to our shareholders, on an annual basis, at least 90% of our REIT taxable income,
determined without regard to the deduction for dividends paid and excluding net capital gains. We expect to make quarterly cash distributions to our shareholders sufficient to meet REIT qualification requirements.
As of December 31, 2020, we had $57 million of unrestricted cash and $343 million of undrawn capacity under our Revolver, with the ability to borrow $176 million of such capacity, subject to the conditions set forth in the applicable loan agreement (refer to Note 8 for more information on our Revolver), without pledging any additional assets to the facility. We refer to this $233 million of unrestricted cash and portion of our Revolver's borrowing capacity as our "equity" liquidity which can be used for general corporate purposes or leveraged (a maximum of 2:1 in the case of our Revolver) to acquire new Ground Lease assets. Our primary sources of cash to date have been proceeds from equity offerings and private placements (refer to Note 11), proceeds from our initial capitalization by iStar and two institutional investors (refer to Note 11) and borrowings from our debt facilities. Our primary uses of cash to date have been the acquisition/origination of Ground Leases, repayments on our debt facilities and distributions to our shareholders.
As noted above, for the year ended December 31, 2020, percentage rents constituted approximately 2.5% of our total revenues. In 2021, we expect to experience a material decline in percentage rent revenues in respect of 2020 hotel operating performance. Such a decline in percentage rents, as well as any disruptions in the payment of future rents by our hotel or other tenants, would adversely impact our cash flows from operations, and any such impact could be material.
We expect our future liquidity requirements to include debt service, distributions to our shareholders, working capital, acquisitions and originations of Ground Lease investments (including in respect of unfunded commitments), debt maturities and payments of fees under our management agreement to the extent we do not elect to pay the fees in common stock. Our primary sources of liquidity going forward will generally consist of cash on hand and cash flows from operations, new financings, unused borrowing capacity under our Revolver (subject to the conditions set forth in the applicable loan agreement) and common and/or preferred equity issuances. We expect that we will be able to meet our liquidity requirements over the next 12 months and beyond.
Mortgages—Mortgages consist of asset specific non-recourse borrowings that are secured by our Ground Leases. As of December 31, 2020, our mortgages are full term interest only, bear interest at a weighted average interest rate of 3.99% (our combined weighted average interest rate of our consolidated mortgage debt and the mortgage debt of our unconsolidated venture, applying our percentage interest in the venture, was 3.96%) and have maturities between April 2027 and November 2069.
Revolver—In June 2017, we entered into a recourse senior secured revolving credit facility with an initial maximum aggregate principal amount of up to $300.0 million (the "Revolver") that has since been increased to $557.5 million as of December 31, 2020. In January 2021, we added a lender to our Revolver bringing total capacity to $600.0 million. The Revolver provides an accordion feature to increase, subject to certain conditions (including the obtainment of additional lender commitments), the maximum availability up to $1.0 billion. The Revolver has an initial maturity of November 2022 with two 12-month extension options exercisable by us, subject to certain conditions, and bears interest at an annual rate of applicable LIBOR plus 1.30%. An undrawn credit facility commitment fee ranges from 0.15% to 0.25%, based on utilization each quarter. The Revolver allows us to leverage Ground Leases up to a maximum 67%. As of December 31, 2020, there was $342.5 million of undrawn capacity on the Revolver and we had the ability to draw $176.1 million of such capacity, subject to the conditions set forth in the applicable loan agreement, without pledging any additional assets to the facility.
Debt Covenants—We are subject to financial covenants under the Revolver, including maintaining: (i) a limitation on total consolidated leverage of not more than 70%, or 75% for no more than 180 days, of our total consolidated assets; (ii) a consolidated fixed charge coverage ratio of at least 1.40x; (iii) a consolidated tangible net worth of at least $632.8 million plus 75% of issuances of net equity after September 30, 2019; (iv) a consolidated secured leverage ratio of not more than 70%, or 75% for no more than 180 days, of our total consolidated assets; and (v) a secured recourse debt ratio of not more than 5.0% of our total consolidated assets. In addition, we may make distributions without restriction as to amount so long as after giving effect to the dividend we remain in compliance with the financial covenants and no event of default has occurred and is continuing. Our other debt obligations contain no significant maintenance or ongoing financial covenants. As of December 31, 2020, we were in compliance with all of our financial covenants.
Critical Accounting Estimates
Basis of Presentation—The preparation of these consolidated financial statements in conformity with generally accepted accounting principles in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods.
Real estate—Real estate assets are recorded at cost less accumulated depreciation and amortization, as follows:
Purchase price allocation—Upon acquisition of real estate, we determine whether the transaction is a business combination, which is accounted for under the acquisition method, or an acquisition of assets. For both types of transactions, we recognize and measure identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree based on their relative fair values. For business combinations, we recognize and measure goodwill or gain from a bargain purchase, if applicable, and expense acquisition-related costs in the periods in which the costs are incurred. For acquisitions of assets, acquisition-related costs are capitalized and recorded in "Real estate, net," "Real estate-related intangible assets, net" and "Real estate-related intangible liabilities, net" on our consolidated balance sheets. If we acquire real estate and simultaneously enter into a lease of the real estate, the acquisition will be accounted for as an asset acquisition.
We account for our acquisition of properties by recording the purchase price of tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The value of the tangible assets, consisting of land, buildings, building improvements and tenant improvements is determined as if these assets are vacant. Intangible assets may include the value of lease incentive assets, above-market leases, below-market Ground Lease assets and in-place leases, which are each recorded at their estimated fair values and included in "Real estate-related intangible assets, net" on our consolidated balance sheets. Intangible liabilities may include the value of below-market leases, which are recorded at their estimated fair values and included in "Real estate-related intangible liabilities, net" on our consolidated balance sheets. In-place leases are amortized over the remaining non-cancelable term of the lease and the amortization expense is included in "Depreciation and amortization" in our consolidated statements of operations. Lease incentive assets and above-market (or below-market) lease value are amortized as a reduction of (or, increase to) operating lease income over the remaining non-cancelable term of each lease plus any renewal periods with fixed rental terms that are considered to be below-market. We may also engage in sale/leaseback transactions whereby we execute a net lease with the occupant simultaneously with the purchase of the asset.
Impairments—We review real estate assets for impairment in value whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The value of a long-lived asset held for use is impaired if management's estimate of the aggregate future cash flows (undiscounted and without interest charges) to be generated by the asset (taking into account the anticipated holding period of the asset) are less than its carrying value. Such estimate of cash flows considers factors such as expected future operating income trends, as well as the effects of demand, competition and other economic factors. To the extent impairment has occurred, the loss will be measured as the excess of the carrying amount of the asset over the estimated fair value of the asset and reflected as an adjustment to the basis of the asset. Impairments of real estate assets, if any, are recorded in "Impairment of assets" in our consolidated statements of operations.
Reserve for losses in net investment in sales-type leases and Ground Lease receivables— We evaluate our net investment in sales-type leases and Ground Lease receivables for impairment under ASC 310. As part of our process for monitoring the credit quality of our net investment in sales-type leases and Ground Lease receivables, we perform a quarterly assessment for each of our net investment in sales-type leases and Ground Lease receivables. We generally target Ground Lease investments in which the initial cost of the Ground Lease represents 30% to 45% of the Combined Property Value. As such, we believe our Ground Lease investments represent a safe position in a property's capital structure. This safety is derived from the typical structure of a Ground Lease under which the landlord has a residual right to regain possession of its land and take ownership of the buildings and improvements thereon upon a tenant default. The landlord's residual right provides a strong incentive for a Ground Lease tenant or its leasehold lender to make the required Ground Lease rent payments and, as such, we believe there is a low likelihood of default on our net investment in sales-type leases and Ground Lease receivables. We consider a net investment in sales-type lease or Ground Lease receivable to be impaired when, based upon current information and events, we believe that it is probable that we will be unable to collect all amounts due under the contractual terms of the Ground Lease. As of December 31, 2020, all of our net investment in sales-type leases and Ground Lease receivables were performing in accordance with the terms of the respective leases.
Any potential reserve for losses in net investment in sales-type leases and Ground Lease receivables will reflect management's estimate of losses inherent in the portfolio as of the balance sheet date. If we determine that the collateral fair value less costs to sell is less than the carrying value of a collateral-dependent receivable, we will record a reserve. The reserve, if applicable, will be increased (decreased) in our consolidated statements of operations and will be decreased by charge-offs. Our policy is to charge off a receivable when we determine, based on a variety of factors, that all commercially reasonable
means of recovering the receivable balance have been exhausted. This may occur at different times, including when we receive cash or other assets in a pre-foreclosure sale or take control of the underlying collateral in full satisfaction of the receivable upon foreclosure or deed-in-lieu, or when we have otherwise ceased significant collection efforts. We consider circumstances such as the foregoing to be indicators that the final steps in the receivable collection process have occurred and that a receivable is uncollectible. At this point, a loss is confirmed and the receivable and related reserve will be charged off. We have one portfolio segment represented by acquiring, managing and capitalizing Ground Leases, whereby we utilize a uniform process for determining our reserve for losses on our net investment in sales-type leases and Ground Lease receivables.
New Accounting Pronouncements—For a discussion of the impact of new accounting pronouncements on our financial condition or results of operations, refer to Note 3 to the consolidated financial statements.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevalent market prices and interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. One of the principal market risks facing us is interest rate risk on our floating rate indebtedness.
Subject to qualifying and maintaining our qualification as a REIT for U.S. federal income tax purposes, we may mitigate the risk of interest rate volatility through the use of hedging instruments, such as interest rate swap agreements and interest rate cap agreements. Our primary objectives when undertaking hedging transactions will be to reduce our floating rate exposure and to fix a portion of the interest rate for anticipated financing and refinancing transactions. However, we can provide no assurances that our efforts to manage interest rate volatility will successfully mitigate the risks of such volatility on our portfolio. Our current portfolio is not subject to foreign currency risk.
Our objectives with respect to interest rate risk are to limit the impact of interest rate changes on operations and cash flows and to lower our overall borrowing costs. To achieve these objectives, we may borrow at fixed rates and may enter into hedging instruments such as interest rate swap agreements and interest rate cap agreements in order to mitigate our interest rate risk on a related floating rate financial instrument. We do not enter into derivative or interest rate transactions for speculative purposes.
As of December 31, 2020, we had $1.5 billion principal amount of fixed-rate debt outstanding and $215.0 million principal amount of floating-rate debt outstanding. In addition, as of December 31, 2020 we were party to derivative contracts to manage our interest rate risk.
The following table quantifies the potential changes in annual net income should interest rates decrease by 10 basis points or increase by 10, 50 and 100 basis points, assuming no change in our interest earning assets, interest bearing liabilities, derivative contracts or the shape of the yield curve (i.e., relative interest rates). The base interest rate scenario assumes the one-month LIBOR rate of 0.14% as of December 31, 2020. Actual results could differ significantly from those estimated in the table.
Estimated Change In Net Income
($ in thousands)
|Change in Interest Rates||Net Income (Loss)|
|-10 Basis Points||$||215 |
|Base Interest Rate||— |
|+10 Basis Points||(215)|
|+ 50 Basis Points||(1,075)|
|+100 Basis Points||(2,150)|
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
|Financial Statement Schedule:|
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Safehold Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Safehold Inc. and subsidiaries (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows, for each of the three years in the period ended December 31, 2020, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 11, 2021, expressed an unqualified opinion on the Company's internal control over financial reporting.
Change in Accounting Principle
Effective January 1, 2019, the Company adopted FASB Accounting Standards Updates 2016-02 and 2018-11, Leases, using the modified retrospective approach.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that weas communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which they relate.
Purchase Price Allocation — Refer to Note 3 to the financial statements
Critical Audit Matter Description
The Company accounts for the acquisition of properties by recording the purchase price of tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The value of the tangible assets, consisting of land, buildings, building improvements and tenant improvements is determined as if these assets are vacant. Intangible assets may include the value of lease incentive assets, above-market leases, below-market Ground Lease assets and in-place leases, which are each recorded at their estimated fair values. Intangible liabilities may include the value of below-market leases, which are recorded at their estimated fair values.
The relative fair value determination of assets acquired required management to make estimates related to the future expected cash flows, including market rent growth rates and expense growth rates, as well as the terminal capitalization and discount rates. We performed audit procedures to evaluate the reasonableness of these assumptions which required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the relative fair value of assets acquired by the Company included the following:
•With the assistance of our fair value specialists, we evaluated the reasonableness of the (1) valuation methodology, (2) current market data, and (3) market rent, expense growth, discount and terminal capitalization rates by developing a range of independent estimates based on market data, and comparing our estimates to those used by management. We also tested the mathematical accuracy of the calculation of management’s analysis.
•We assessed the reasonableness of management’s projections of rental revenue by comparing the assumptions used in the projections to external market sources, in-place lease agreements, historical data, and results from other areas of the audit.
•We tested the effectiveness of internal controls over critical assumptions including management’s controls over:
▪The selection of the methods and valuation techniques used to determine that fair value is appropriate and consistent with industry standards and previous Company acquisitions.
▪Assumptions for allocating tangible and intangible assets.
/s/ DELOITTE & TOUCHE LLP
New York, New York
February 11, 2021
We have served as the Company's auditor since 2018.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Safehold, Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Safehold, Inc. and subsidiaries (the “Company”) as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2020, of the Company and our report dated February 11, 2021, expressed, an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
New York, New York
February 11, 2021
We have served as the Company's auditor since 2018.
Consolidated Balance Sheets(1)
(In thousands, except per share data)
| ||As of December 31,|
|Real estate, at cost||$||752,420 ||$||687,902 |
|Less: accumulated depreciation||(22,314)||(16,286)|
|Real estate, net||730,106 ||671,616 |
|Real estate-related intangible assets, net (refer to Note 4)||242,166 ||242,837 |
|Total real estate, net and real estate-related intangible assets, net||972,272 ||914,453 |
|Net investment in sales-type leases||1,305,519 ||984,598 |
|Ground Lease receivables||577,457 ||397,087 |
|Equity investments in Ground Leases||129,614 ||127,524 |
|Cash and cash equivalents||56,948 ||22,704 |
|Restricted cash||39,519 ||24,078 |
|Deferred operating lease income receivable||93,307 ||58,303 |
|Deferred expenses and other assets, net||34,334 ||37,814 |
|Total assets||$||3,208,970 ||$||2,566,561 |
|LIABILITIES AND EQUITY|| || |
|Liabilities:|| || |
Accounts payable, accrued expenses and other liabilities(2)
|$||76,673 ||$||43,008 |
|Real estate-related intangible liabilities, net (refer to Note 4)||66,268 ||57,333 |
|Debt obligations, net||1,684,726 ||1,372,922 |
|Total liabilities||1,827,667 ||1,473,263 |
|Commitments and contingencies (refer to Note 9)|
|Equity:|| || |
|Safehold Inc. shareholders' equity:|
Common stock, $0.01 par value, 400,000 shares authorized, 53,206 and 47,782 shares issued and outstanding as of December 31, 2020 and 2019, respectively
|532 ||478 |
|Additional paid-in capital||1,412,107 ||1,132,603 |
|Retained earnings (accumulated deficit)||23,945 ||(2,146)|
|Accumulated other comprehensive loss||(57,461)||(39,123)|
|Total Safehold Inc. shareholders' equity||1,379,123 ||1,091,812 |
|Noncontrolling interests||2,180 ||1,486 |
|Total equity||1,381,303 ||1,093,298 |
|Total liabilities and equity||$||3,208,970 ||$||2,566,561 |
(1)Refer to Note 2 for details on the Company's consolidated variable interest entities ("VIEs").
(2)As of December 31, 2020 and 2019, includes $4.7 million and $3.1 million, respectively, due to related parties.
The accompanying notes are an integral part of the consolidated financial statements.
Consolidated Statements of Operations
(In thousands, except per share data)
| ||For the Years Ended December 31, |
|Operating lease income||$||72,340 ||$||72,071 ||$||47,400 |
|Interest income from sales-type leases||81,844 ||18,531 ||— |
|Other income||1,243 ||2,794 ||2,324 |
|Total revenues||155,427 ||93,396 ||49,724 |
|Costs and expenses:|
|Interest expense||64,354 ||29,868 ||15,389 |
|Real estate expense||2,480 ||2,673 ||1,600 |
|Depreciation and amortization||9,433 ||9,379 ||9,142 |
General and administrative(1)
|22,733 ||14,435 ||10,662 |
|Other expense||243 ||899 ||995 |
|Total costs and expenses||99,243 ||57,254 ||37,788 |
|Income from operations before other items||56,184 ||36,142 ||11,936 |
|Loss on early extinguishment of debt||— ||(2,011)||— |
|Earnings (losses) from equity method investments||3,304 ||(403)||— |
|Net income ||59,488 ||33,728 ||11,936 |
| Net income attributable to noncontrolling interests||(194)||(6,035)||(196)|
|Net income attributable to Safehold Inc. common shareholders||$||59,294 ||$||27,693 ||$||11,740 |
|Per common share data:|
|Net income attributable to Safehold Inc. |
|Basic and diluted||$||1.17 ||$||0.89 ||$||0.64 |
|Weighted average number of common shares:|
|Basic||50,688 ||31,008 ||18,218 |
|Diluted||50,697 ||31,008 ||18,218 |
(1)For the years ended December 31, 2020, 2019 and 2018, includes $19.4 million, $11.2 million and $6.0 million, respectively, of general and administrative expenses incurred to related parties that includes management fees, expense reimbursements to the Company's Manager and equity-based compensation.
The accompanying notes are an integral part of the consolidated financial statements.
Consolidated Statements of Comprehensive Income (Loss)
| ||For the Years Ended December 31, |
|Net income||$||59,488 ||$||33,728 ||$||11,936 |
|Other comprehensive income (loss):|
|Cumulative-effect adjustment for cash flow hedges||— ||— ||41 |
|Reclassification of (gains) losses on derivatives into earnings||1,680 ||271 ||(252)|
|Unrealized losses on derivatives||(20,018)||(32,518)||(6,745)|
|Other comprehensive loss||(18,338)||(32,247)||(6,956)|
|Comprehensive income||41,150 ||1,481 ||4,980 |
|Comprehensive (income) attributable to noncontrolling interests||(194)||(2,377)||(196)|
|Comprehensive income (loss) attributable to Safehold Inc.||$||40,956 ||$||(896)||$||4,784 |
The accompanying notes are an integral part of the consolidated financial statements.
Consolidated Statements of Changes in Equity
|Balance at December 31, 2019||$||478 ||$||1,132,603 ||$||(2,146)||$||(39,123)||$||1,486 ||$||1,093,298 |
|Net income||— ||— ||59,294 ||— ||194 ||59,488 |
|Issuance of common stock, net / amortization||54 ||279,504 ||— ||— ||543 ||280,101 |
Dividends declared ($0.6427 per share)
|— ||— ||(33,203)||— ||— ||(33,203)|
|Change in accumulated other comprehensive income (loss)||— ||— ||— ||(18,338)||— ||(18,338)|
|Distributions to noncontrolling interests||— ||— ||— ||— ||(43)||(43)|
|Balance at December 31, 2020||$||532 ||$||1,412,107 ||$||23,945 ||$||(57,461)||$||2,180 ||$||1,381,303 |
|Balance at December 31, 2018||$||183 ||$||370,530 ||$||(8,486)||$||(6,876)||$||2,007 ||$||357,358 |
|Net income||— ||— ||27,693 ||— ||6,035 ||33,728 |
|Issuance of common stock, net / amortization||170 ||509,385 ||— ||— ||356 ||509,911 |
|Investor Unit conversion (refer to Note 11)||125 ||252,060 ||— ||(6,450)||(245,735)||— |
Dividends declared ($0.618 per share)
|— ||— ||(21,353)||— ||— ||(21,353)|
|Change in accumulated other comprehensive income (loss)||— ||— ||— ||(28,589)||(3,658)||(32,247)|
|Contributions from noncontrolling interests||— ||628 ||— ||2,792 ||245,426 ||248,846 |
|Distributions to noncontrolling interests||— ||— ||— ||— ||(2,945)||(2,945)|
|Balance at December 31, 2019||$||478 ||$||1,132,603 ||$||(2,146)||$||(39,123)||$||1,486 ||$||1,093,298 |
|Balance at December 31, 2017||$||182 ||$||364,919 ||$||(9,246)||$||80 ||$||— ||$||355,935 |
|Net income||— ||— ||11,740 ||— ||196 ||11,936 |
|Contributions from iStar Inc.||— ||2,581 ||— ||— ||— ||2,581 |
|Offering costs||— ||1,347 ||— ||— ||— ||1,347 |
|Issuance of common stock to iStar Inc.||1 ||918 ||— ||— ||— ||919 |
|Issuance of common stock to directors/amortization ||— ||765 ||— ||— ||108 ||873 |
Dividends declared ($0.60 per share)
|— ||— ||(10,939)||— ||— ||(10,939)|
|— ||— ||(41)||41 ||— ||— |
|Change in accumulated other comprehensive income (loss)||— ||— ||— ||(6,997)||— ||(6,997)|
|Contributions from noncontrolling interests||— ||— ||— ||— ||1,750 ||1,750 |
|Distributions to noncontrolling interests||— ||— ||— ||— ||(47)||(47)|
|Balance at December 31, 2018||$||183 ||$||370,530 ||$||(8,486)||$||(6,876)||$||2,007 ||$||357,358 |
The accompanying notes are an integral part of the consolidated financial statements.
Consolidated Statements of Cash Flows
| ||For the Years Ended December 31, |
|Cash flows from operating activities:|
|Net income ||$||59,488 ||$||33,728 ||$||11,936 |
|Adjustments to reconcile net income to cash flows from operating activities:|
|Depreciation and amortization||9,433 ||9,379 ||9,142 |
|Stock-based compensation expense||1,744 ||1,582 ||873 |
|Deferred operating lease income||(35,004)||(35,165)||(19,041)|
|Non-cash interest income from sales-type leases||(30,131)||(6,547)||— |
|Non-cash interest expense||10,986 ||2,865 ||— |
|Amortization of real estate-related intangibles, net||2,648 ||2,509 ||2,518 |
|Loss on early extinguishment of debt||— ||2,011 ||— |
|(Earnings) losses from equity method investments||(3,304)||403 ||— |
|Distributions from operations of equity method investments||1,213 ||— ||— |
|Amortization of premium, discount and deferred financing costs on debt obligations, net||2,281 ||2,257 ||1,612 |
|Non-cash management fees||12,684 ||7,461 ||3,643 |
|Other operating activities||2,201 ||1,586 ||789 |
|Changes in assets and liabilities:|
|Changes in deferred expenses and other assets, net||(143)||301 ||(1,163)|
|Changes in accounts payable, accrued expenses and other liabilities||1,615 ||(24,333)||3,219 |
|Cash flows provided by (used in) operating activities||35,711 ||(1,963)||13,528 |
|Cash flows from investing activities:|
|Acquisitions of real estate||(57,879)||(28,816)||(385,897)|
|Origination/acquisition of net investment in sales-type leases and Ground Lease receivables||(474,083)||(1,364,682)||— |
|Contributions to equity method investments||— ||(127,970)||— |
|Other investing activities||1,321 ||693 ||1,392 |
|Cash flows used in investing activities||(530,641)||(1,520,775)||(384,505)|
|Cash flows from financing activities:|
|Proceeds from issuance of common stock||271,206 ||511,900 ||— |
|Proceeds from debt obligations||693,970 ||1,183,739 ||312,353 |
|Repayments of debt obligations||(377,000)||(351,500)||(74,500)|
|Payments for debt prepayment or extinguishment costs||— ||(1,358)||— |
|Payments for deferred financing costs||(6,784)||(18,468)||(2,289)|
|Payment of offering costs||(4,756)||(9,778)||(|