Two or three years from now, when the first residents move into four affordable housing communities in Northern California, they may not know they are the beneficiaries of a financial structure that dates back to feudal days: land lease.
Through its participation in development projects, Safehold Inc. (NYSE: SAFE) is proving that land leases nowadays provide a mutually beneficial solution for all types of property owners and often their tenants as well.
“Modern land leases are based on the idea that the land itself is an asset and that it makes sense to separate the land from the development above the land,” says Tim Doherty, chief investment officer at Safehold. “Stability and simplicity create liquidity, and before we got into this space, land leases were neither liquid nor illiquid.”
Doherty says the concept of Safehold is to view land as similar to a corporate bond. “Land leases can use the land as a valuable asset, separate from the real estate development that sits above it,” he says.
Since Safehold became a public company seven years ago, their process of harmonizing and simplifying ground leases has grown their portfolio from $350 million with 12 assets to $6.5 billion with over 145 assets. They operate in the top 30 markets in the United States with transactions across all product types. Multifamily assets make up approximately half of their ground lease portfolio, while the rest includes hospitality, office, life sciences, and mixed-use assets.
Land leasing and affordable housing
Safehold’s land lease structure can be an effective tool for the development, acquisition and rehabilitation of affordable housing.
In July, the REIT signed ground leases to facilitate the ground-up development of 781 affordable units in San Jose and Concord, California. The projects will be built by The Pacific Companies, an Idaho-based developer of affordable housing in the western U.S.
“Financing affordable housing has always been challenging, but it has become even more challenging in this high interest rate environment,” says Bjorn Doskland, executive vice president (finance) at The Pacific Companies.
As interest rates rose, the Pacific companies faced a financing shortage which became necessary to meet.
“We would have either had to raise money from another source or reduce costs, which would have impacted what we could pay tenants,” says Doskland. “What SafeHold has done for us is provide capital at a lower overall cost than we would have gotten from traditional financing mechanisms.”
Safehold buys the land and leases it back to the project, without the project needing to take out a large permanent loan to purchase the land, Doskeland explains.
“For example, instead of a $1 million permanent loan that would otherwise have been used to purchase the land, obtaining a ground lease at an initial cost of capital that is 50 basis points lower can provide an additional $150,000 in upfront revenue to the project,” says Doeskland. On larger projects, this can result in millions of dollars being used to fill gaps in the budget caused by rising interest rates and construction costs, he adds. “Our favorite thing about Safehold is that they enable us to build affordable housing using a private, market-based solution, rather than relying on public subsidies.”
Bridging the gap
The demand for affordable housing is very high, but ensuring its supply is also a challenge.
“Affordable housing developers often face difficulties capitalizing deals and have gaps in their budgets,” says Doherty. “Our structure can help bridge those gaps. Similar to market rates, Safehold’s ground lease provides capital at an attractive price that reduces the overall cost of capital and ultimately moves projects forward.”
He said the land lease structure works the same for development, acquisition and refinancing of land in an affordable context as it does for development at market rates.
“We have generally focused on large format 4% Low Income Housing Tax Credit (LIHTC) deals in higher cost coastal markets where there is an acute affordability imbalance and a real need for attractively priced capital to help developers close the gaps in their capital structures,” says Steve Wilder, Safehold’s executive vice president and head of investments.
He added, “We have now done several deals with tax credit investors, lenders and developers with this profile – and we intend to do more. We are positioning our capital as a tool for developers and owners and are excited to continue expanding our presence in the affordable sector.”
For example, Safehold worked with The Pacific Companies for the ground-up development of 80 Saratoga, a 200-unit community in Santa Clara, California, due to open in 2023. The LIHTC lender was Bank of America and Citibank was the permanent lender.
“80 Saratoga is in a high-cost infill market where there is tremendous demand for affordable product, and The Pacific Company is a top-tier developer and a firm that is very innovative,” Wilder says. “We are educating the market on how our framework works for affordable housing to support the acquisition and development pipelines and provide the housing that is needed.”
