ISTAR INC. 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,iStar Inc.'s (the "Company's") 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. 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-Q and the uncertainties and risks described in Item 1A-"Risk Factors" in our Annual Report and in this Report, all of which could affect our future results of operations, financial condition and liquidity. For purposes of Management's Discussion and Analysis of Financial Condition and Results of Operations, the terms "we," "our" and "us" refer toiStar Inc. and its consolidated subsidiaries, unless the context indicates otherwise. The discussion below should be read in conjunction with our consolidated financial statements and related notes in this quarterly report on Form 10-Q and our Annual Report. These historical financial statements may not be indicative of our future performance. We have reclassified certain items in our consolidated financial statements of prior periods to conform to our current financial statements presentation. Executive Overview InAugust 2020 , we took advantage of favorable interest rate and liquidity conditions to refinance debt through the issuance of$400 million of unsecured notes dueFebruary 2026 . Proceeds from the issuance were used to repay unsecured notes dueSeptember 2022 . We have no corporate debt maturities throughSeptember 2022 (refer to Note 11). The coronavirus (COVID-19) outbreak has continued to impact the US and global economies. The US financial markets have experienced disruption, with heightened stock market volatility and constrained credit conditions within most sectors, including real estate. We are focused on ensuring the health and safety of our personnel and the continuity of business activities at iStar and SAFE, monitoring the effects of the crisis on our and SAFE's customers, marshalling available liquidity at both companies, implementing appropriate cost containment measures and preparing for the eventual resumption of more normalized activities. At this time, we cannot predict the full extent of the impacts of the COVID-19 crisis on our or SAFE's business. We will continue to monitor its effects on a daily basis and will adjust operations as necessary. Our portfolio is well diversified by business, property type and geography. Our portfolio includes investments in the entertainment/leisure (20.2% of gross book value) and hotel (5.6% of gross book value) sectors, which have been particularly stressed by the pandemic. SAFE reported that it received 100% of the ground rent due under its leases for the third quarter. We collected 98% of the rent due from our net lease tenants during the quarter (excluding one net lease tenant with whom we entered into lease modifications in the second and third quarter 2020 - refer to Note 5), 92% of the interest payments due in our real estate finance portfolio and 80% of the rent due in our operating properties portfolio. We may continue to experience disruptions and collections of rent and interest payments until more normalized business conditions resume. We increased our allowance for loan losses and may continue to do so in future quarters while the COVID-19 pandemic continues to materially affect the US economy. The COVID-19 crisis has adversely affected our strategies of monetizing legacy assets and materially scaling SAFE's portfolio for the time being. Equity and debt financing for real estate transactions generally is constrained. In addition, the crisis has made it more difficult to execute transactions as people 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 strategy while they persist. See the Risk Factors section of this report for additional discussion of certain potential risks to our business arising from the COVID-19 crisis. 43 -------------------------------------------------------------------------------- Table of Contents Portfolio Overview
As of
Real
Net Estate Operating Land & % of
Property/Collateral Types Lease Finance Properties Development Corporate Total Total
Office $ 944,023 $ 51,447 $ 91 $ - $ - $ 995,561 20.8 %
Entertainment / Leisure 946,098 - 16,188 - - 962,286 20.2 %
Ground Leases 878,438 - - - - 878,438 18.4 %
Land and Development - 83,777 - 399,123 - 482,900 10.1 %
Industrial 300,859 - 97,663 - 62,961 461,483 9.7 %
Condominium - 169,190 18,903 122,194 - 310,287 6.5 %
Hotel - 184,540 83,020 - - 267,560 5.6 %
Multifamily - 147,825 58,381 - - 206,206 4.3 %
Retail 57,348 68,807 41,424 8,271 - 175,850 3.7 %
Other Property Types - 24,631 - - 9,258 33,889 0.7 %
Total $ 3,126,766 $ 730,217 $ 315,670 $ 529,588 $ 72,219 $ 4,774,460 100.0 %
Percentage of Total 65 % 15 % 7 % 11 % 2 % 100 %
Real
Net Estate Operating Land & % of
Geographic Region Lease Finance Properties Development Corporate Total Total
Northeast $ 915,585 $ 296,320 $ 93,587 $ 285,291 $ - $ 1,590,783 33.2 %
West 494,722 208,970 56,959 40,414 - 801,065 16.8 %
Mid-Atlantic 521,147 13,296 6,170 112,706 - 653,319 13.7 %
Central 425,558 79,330 44,191 31,500 - 580,579 12.2 %
Southwest 398,264 16,404 104,304 42,975 - 561,947 11.8 %
Southeast 362,152 26,663 10,459 16,702 - 415,976 8.7 %
Various 9,338 89,234 - - 72,219 170,791 3.6 %
Total $ 3,126,766 $ 730,217 $ 315,670 $ 529,588 $ 72,219 $ 4,774,460 100.0 %
_______________________________________________________________________________ (1)For net lease, operating properties and land and development, gross book value is defined as the basis assigned to physical real estate property (land and building), net of any impairments taken after acquisition date and net of basis reductions associated with unit/parcel sales, plus our basis in equity method investments, plus lease related intangibles, capitalized leasing costs and excluding accumulated depreciation and amortization, and for equity method investments, excluding the effect of our share of accumulated depreciation and amortization. For real estate finance, gross book value is defined as principal funded including any deferred capitalized interest receivable, plus protective advances, exit fee receivables and any unamortized origination/modification costs, less purchase discounts and specific reserves. This amount is not reduced for CECL allowances.Net Lease Our net lease business seeks to create stable cash flows through long-term net leases primarily to single tenants on our properties. We target mission-critical facilities leased on a long-term basis to tenants, offering structured solutions that combine our capabilities in underwriting, lease structuring, asset management and build-to-suit construction. Leases typically provide for expenses at the facility to be paid by the tenant on a triple net lease basis. Under a typical net lease agreement, the tenant agrees to pay a base monthly operating lease payment and most or all of the facility operating expenses (including taxes, utilities, maintenance and insurance). We generally intend to hold our net lease assets for long-term investment. However, we may dispose of assets if we deem the disposition to be in our best interests. 44 -------------------------------------------------------------------------------- Table of Contents The net lease segment includes our Ground Lease investments made primarily through SAFE and our traditional net lease investments. As ofSeptember 30, 2020 , our consolidated net lease portfolio totaled$2.1 billion . Our net lease portfolio, including the carrying value of our equity method investments in SAFE and Net Lease Venture II, exclusive of accumulated depreciation, totaled$3.1 billion . The table below provides certain statistics for our net lease portfolio. Total Net Lease Consolidated Net Lease Wholly-Owned Venture I Real Estate(1) Venture II SAFE Ownership % 100.0 % 51.9 % - 51.9 % 65.8 % Gross book value (millions)(2)$ 1,234 $ 906 $ 2,140 $ 249 $ 2,845 % Leased 97.8 % 100.0 % 98.6 % 100.0 % 100.0 % Square footage (thousands) 9,998 5,707 15,705 2,273 N/A Weighted average lease term (years)(3) 15.2 16.2 15.6 12.9 89.1 Weighted average yield(4) 7.4 % 8.0 % 7.7 % 9.9 % 4.6 %
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(1)We own 51.9% of the Net Lease Venture which is consolidated in our GAAP financial statements (refer to Note 4). (2)Gross book value represents the acquisition cost of real estate and any additional capital invested into the property by us.Consolidated Real Estate includes amounts recorded as net investment in leases (refer to Note 5) and financing receivables in loans and other lending investments (refer to Note 7). SAFE includes its 54.8% pro rata share of its unconsolidated equity method investment. (3)Weighted average lease term is calculated using GAAP rent and the initial maturity and does not include extension options. SAFE includes its 54.8% pro rata share of its unconsolidated equity method investment. (4)Yield for SAFE is calculated over the trailing twelve months and excludes management fees earned by us.Net Lease Venture -InFebruary 2014 , the Company partnered with a sovereign wealth fund to form a venture to acquire and develop net lease assets and gave a right of first refusal to the venture on all new net lease investments that met specified investment criteria (refer to Note 4 in our consolidated financial statements for more information on ourNet Lease Venture ). The Net Lease Venture's investment period expired onJune 30, 2018 and the remaining term of the venture extends throughFebruary 13, 2022 , subject to two, one-year extension options at the discretion of us and our partner. We obtained control over the Net Lease Venture when the investment period expired onJune 30, 2018 and consolidated the assets and liabilities of the venture, which had previously been accounted for as an equity method investment. Net Lease Venture II-InJuly 2018 , we entered into Net Lease Venture II with similar investment strategies as the Net Lease Venture (refer to Note 8). The Net Lease Venture II has a right of first offer on all new net lease investments (excluding Ground Leases) originated by us. We have an equity interest in the new venture of approximately 51.9%, which is accounted for as an equity method investment, and are responsible for managing the venture in exchange for a management fee and incentive fee. SAFE-SAFE is a publicly-traded company that originates and acquires Ground Leases in order to generate attractive long-term risk-adjusted returns from its investments. We believe its business has characteristics comparable to a high-grade fixed income investment business, but with certain unique advantages. Relative to alternative fixed income investments generally, SAFE's Ground Leases typically benefit from built-in growth derived from contractual rent increases, and the opportunity to realize value from residual rights to acquire the buildings and other improvements on its land at no additional cost. We believe that these features offer us the opportunity through our ownership in SAFE to realize superior risk-adjusted total returns when compared to certain alternative highly-rated investments. As ofSeptember 30, 2020 , we owned approximately 65.8% of SAFE's common stock outstanding. We account for our investment in SAFE as an equity method investment (refer to Note 8). We act as SAFE's external manager pursuant to a management agreement, and we have an exclusivity agreement with SAFE pursuant to which we agreed, subject to certain exceptions, that we will not acquire, originate, invest in, or provide financing for a third party's acquisition of, a Ground Lease unless we have first offered that opportunity to SAFE and a majority of its independent directors has declined the opportunity. Real Estate Finance Our real estate finance business targets sophisticated and innovative owner/operators of real estate and real estate related projects by providing one-stop capabilities that encompass financing alternatives ranging from full envelope senior loans to mezzanine and preferred equity capital positions. Our real estate finance portfolio consists of senior mortgage loans that are secured by commercial and residential real estate assets where we are the first lien holder, subordinated mortgage loans that are secured by second lien or junior interests in commercial and residential real estate assets, leasehold loans to Ground Lease 45 -------------------------------------------------------------------------------- Table of Contents tenants, including tenants of SAFE, and corporate/partnership loans, which represent mezzanine or subordinated loans to entities for which we do not have a lien on the underlying asset, but may have a pledge of underlying equity ownership of such assets. Our real estate finance portfolio includes loans on stabilized and transitional properties, Ground Leases and ground-up construction projects. In addition, we have preferred equity investments and debt securities classified as other lending investments. As ofSeptember 30, 2020 , our real estate finance portfolio, including securities and other lending investments, totaled$775.9 million , exclusive of general loan loss allowance. The portfolio, excluding securities and other lending investments, included$551.7 million of performing loans with a weighted average maturity of 1.3 years.
The tables below summarize our loans and the allowance for loan losses associated with our loans ($ in thousands):
September 30, 2020
Allowance for Loan
Losses as a % of
Gross Carrying Allowance for Gross Carrying
Number of Loans Value Loan Losses Carrying Value % of Total Value
Performing loans 17 $ 551,674 $ (9,615) $ 542,059 70.9% 1.7%
Non-performing loans 2 87,277 (22,600) 64,677 8.5% 25.9%
Other lending investments 3 159,569 (1,232) 158,337 20.6% 0.8%
Total 22 798,520 (33,447) 765,073 100.0% 4.2%
December 31, 2019
Allowance for Loan
Losses as a % of
Gross Carrying Allowance for Gross Carrying
Number of Loans Value Loan Losses Carrying Value % of Total Value
Performing loans 22 $ 665,460 $ (6,933) $ 658,527 79.6% 1.0%
Non-performing loans 1 37,820 (21,701) 16,119 1.9% 57.4%
Other lending investments 3 153,216 - 153,216 18.5% -%
Total 26 856,496 (28,634) 827,862 100.0% 3.3%
Performing Loans-The table below summarizes our performing loans exclusive of
allowances ($ in thousands):
September 30, 2020 December 31, 2019
Senior mortgages $ 433,352 $ 534,765
Corporate/Partnership loans 106,877 119,818
Subordinate mortgages 11,445 10,877
Total $ 551,674 $ 665,460
Weighted average LTV 63 % 61 %
Yield - quarter to date(1) 7.6 % 8.7 %
Yield - year to date(1) 7.9 % 9.0 %
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(1)Yields presented are for the three and nine months endedSeptember 30, 2020 and 2019. Non-Performing Loans-We designate loans as non-performing at such time as: (1) the loan becomes 90 days delinquent; (2) the loan has a maturity default; or (3) management determines it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan. All non-performing loans are placed on non-accrual status and income is only recognized in certain cases upon actual cash receipt. As ofSeptember 30, 2020 andDecember 31, 2019 , we had two non-performing loans with a carrying value of$64.7 million and one non-performing loan with a carrying value of$16.1 million , respectively. We expect that our level of non-performing loans will fluctuate from period to period. 46 -------------------------------------------------------------------------------- Table of Contents Allowance for Loan Losses-The allowance for loan losses was$33.4 million as ofSeptember 30, 2020 , or 4.2% of total loans, compared to$28.6 million , or 3.3%, as ofDecember 31, 2019 . We expect that our level of allowance for loan losses will fluctuate from period to period. Due to the volatility of the commercial real estate market, the process of estimating collateral values and allowances requires the use of significant judgment. We currently believe there is adequate collateral and allowances to support the carrying values of the loans. The allowance for loan losses includes an asset-specific component and a formula-based component. An asset-specific allowance is established for an impaired loan when the estimated fair value of the loan's collateral less costs to sell is lower than the carrying value of the loan. As ofSeptember 30, 2020 andDecember 31, 2019 , asset-specific allowances were$22.6 million and$21.7 million , respectively. We estimate the formula-based component based on historical realized losses experienced within our portfolio and take into account current economic conditions affecting the commercial real estate market. We estimate the formula-based component on our construction loan portfolio based on historical realized losses experienced within our portfolio and third-party market data that includes historical loss rates on commercial real estate loans and forecasted economic trends, including interest and unemployment rates. We estimate the formula-based component on our other loans using a loan loss forecasting tool developed byTrepp LLC that utilizes loan level data including each loans position in the capital structure, interest rates, maturity dates, unfunded commitments, debt service coverage ratios, etc. which also utilizes forward looking macroeconomic variables and pool-level mean loss rates to produce an expected loss over the life each loan. The general allowance increased to$10.8 million or 1.5% of performing loans and other lending investments as ofSeptember 30, 2020 , compared to$6.9 million or 1.0% of performing loans and other lending investments as ofDecember 31, 2019 . The increase was due to a$0.7 million general allowance recorded upon the adoption of ASU 2016-13 onJanuary 1, 2020 (refer to Note 3) and an increase in the general allowance of$3.2 million during the nine months endedSeptember 30, 2020 . Operating Properties
Our operating properties represent a pool of assets across a broad range of
geographies and property types including office, retail, hotel and residential
properties. As of
Land and Development The following table presents a land and development portfolio rollforward for the nine months endedSeptember 30, 2020 . Land and Development Portfolio Rollforward (in millions) Asbury Ocean Club and Asbury Park Magnolia All Total Waterfront Green Others Segment
Beginning balance(1) $ 234.6$ 112.9 $ 233.0 $ 580.5 Asset sales(2) (35.1) (15.0) (60.8) (110.9) Capital expenditures 11.1 10.9 3.2 25.2 Other - (1.8) (4.1) (5.9) Ending balance(1) $ 210.6$ 107.0 $ 171.3 $ 488.9
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(1)As of
47
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Results of Operations for the Three Months Ended September 30, 2020 compared to
the Three Months Ended September 30, 2019
For the Three Months Ended
September 30,
2020 2019 $ Change
(in thousands)
Operating lease income $ 46,370 $ 44,110 $ 2,260
Interest income 14,270 19,701 (5,431)
Interest income from sales-type leases 8,360 8,339 21
Other income 25,552 18,270 7,282
Land development revenue 20,502 54,918 (34,416)
Total revenue 115,054 145,338 (30,284)
Interest expense 42,407 46,522 (4,115)
Real estate expense 16,935 23,187 (6,252)
Land development cost of sales 21,358 48,101 (26,743)
Depreciation and amortization 14,621 14,199 422
General and administrative 19,868 24,110 (4,242)
Recovery of loan losses (1,976) (3,805) 1,829
Provision for losses on net investment in leases 175 - 175
Other expense 73 407 (334)
Total costs and expenses 113,461 152,721 (39,260)
Income from sales of real estate 6,055 3,476 2,579
Loss on early extinguishment of debt, net (7,924) - (7,924)
Earnings from equity method investments 6,805 7,617 (812)
Income tax expense (78) (84) 6
Net income $ 6,451 $ 3,626 $ 2,825
Revenue-Operating lease income, which primarily includes income from net lease
assets and commercial operating properties, increased $2.3 million , or 5%, to
$46.4 million during the three months ended September 30, 2020 from $44.1
million for the same period in 2019. The following table summarizes our
operating lease income by segment ($ in millions).
Three Months Ended September 30,
2020 2019 Change
Net Lease(1) $ 41.1 $ 38.0 $ 3.1
Operating Properties(2) 5.2 6.0 (0.8)
Land and Development 0.1 0.1 -
Total $ 46.4 $ 44.1 $ 2.3 ______________________________________________________________
(1)Change primarily due to new acquisitions, partially offset by asset sales. (2)Change primarily due to a decrease in percentage rent at certain properties.
48
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The following table shows certain same store statistics for our consolidated Net
Lease segment. Same store assets are defined as assets we owned on or prior to
July 1, 2019 and were in service through September 30, 2020 (Operating lease
income in millions).
Three Months Ended September 30,
2020 2019
Operating lease income(1) $ 44.7 $ 42.7
Rent per square foot $ 11.79 $ 11.12
Occupancy(2) 98.6 % 99.3 %
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(1)For the three months endedSeptember 30, 2020 and 2019, includes$9.3 million and$9.5 million , respectively, of lease income from one net lease tenant that was recorded to "Interest income from sales-type leases" in our consolidated statements of operations. (2)Occupancy as ofSeptember 30, 2020 and 2019. Interest income decreased$5.4 million , or 28%, to$14.3 million during the three months endedSeptember 30, 2020 from$19.7 million for the same period in 2019. The decrease was due primarily to a decrease in the average balance of our performing loans and other lending investments, which was$703 million for the three months endedSeptember 30, 2020 and$866 million for the three months endedSeptember 30, 2019 . The weighted average yield on our performing loans and other lending investments was 7.6% and 8.7%, respectively, for the three months endedSeptember 30, 2020 and 2019. OnJanuary 1, 2019 , we adopted new accounting standards and classified certain of our leases in 2019 as sales-type leases. Under sales-type leases, we accrue interest income from sales-type leases under the effective interest method as opposed to recognition of operating lease income under the straight-line rent method for our leases that do not qualify as sales-type leases. Interest income from sales-type leases increased to$8.4 million for the three months endedSeptember 30, 2020 from$8.3 million for the same period in 2019. Other income increased$7.3 million , or 40%, to$25.6 million during the three months endedSeptember 30, 2020 from$18.3 million for the same period in 2019. Other income during the three months endedSeptember 30, 2020 consisted primarily of mark-to-market gains on an equity investment, management fees, other ancillary income from our land and development projects and loan portfolio, income from our hotel properties and interest income on our cash. Other income during the three months endedSeptember 30, 2019 consisted primarily of income from our hotel properties, lease termination fees, other ancillary income from our operating properties and land and development projects and interest income on our cash. The increase in 2020 was primarily due to a$14.0 million mark-to-market gain on an equity investment (refer to Note 8) and an increase in management fees from SAFE, partially offset by a decrease in income from our hotel properties and other operating properties. Land development revenue and cost of sales-During the three months endedSeptember 30, 2020 , we sold residential lots and units and recognized land development revenue of$20.5 million which had associated cost of sales of$21.4 million . During the three months endedSeptember 30, 2019 , we sold residential lots and units and recognized land development revenue of$54.9 million which had associated cost of sales of$48.1 million . Costs and expenses-Interest expense decreased$4.1 million , or 9%, to$42.4 million during the three months endedSeptember 30, 2020 from$46.5 million for the same period in 2019, due primarily to a decrease in our weighted average cost of debt, which was 4.8% for the three months endedSeptember 30, 2020 compared to 5.3% for the three months endedSeptember 30, 2019 . The balance of our average outstanding debt, inclusive of loan participations and lease liabilities associated with finance-type leases, decreased to$3.47 billion for the three months endedSeptember 30, 2020 from$3.50 billion for the same period in 2019. 49 -------------------------------------------------------------------------------- Table of Contents Real estate expenses decreased$6.3 million , or 27%, to$16.9 million during the three months endedSeptember 30, 2020 from$23.2 million for the same period in 2019. The following table summarizes our real estate expenses by segment ($ in millions). Three Months Ended September 30, 2020 2019 Change Operating Properties(1) $ 4.4$ 9.4 $ (5.0) Land and Development(2) 5.4 7.4 (2.0) Net Lease(3) 7.1 6.4 0.7 Total $ 16.9$ 23.2 $ (6.3)
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(1)Change primarily due to a decrease in expenses at certain operating properties due to COVID-19. (2)Change primarily due to asset sales and a decrease in expenses at some of our properties. (3)Change primarily due to new acquisitions and an increase in expenses at certain properties, partially offset by asset sales. Depreciation and amortization increased$0.4 million , or 3%, to$14.6 million during the three months endedSeptember 30, 2020 from$14.2 million for the same period in 2019, primarily due to new acquisitions, partially offset by asset sales. General and administrative expense includes payroll and related costs, performance based compensation, public company costs and occupancy costs. General and administrative expenses decreased$4.2 million , or 18%, to$19.9 million during the three months endedSeptember 30, 2020 from$24.1 million for the same period in 2019. The decrease in 2020 from 2019 was due primarily to a$3.6 million decrease in performance based compensation. The recovery of loan losses was$2.0 million for the three months endedSeptember 30, 2020 as compared to a recovery of loan losses of$3.8 million for the same period in 2019. The recovery of loan losses for the three months endedSeptember 30, 2020 resulted from the reversal of CECL allowances on loans that repaid in full in the third quarter 2020 and a more favorable economic outlook on commercial real estate markets in the third quarter 2020 as compared to the second quarter 2020. The recovery of loan losses for the three months endedSeptember 30, 2019 was due to a decrease in the general reserve. The provision for losses on net investment in leases for the three months endedSeptember 30, 2020 included an allowance resulting from the macroeconomic impact of COVID-19 on commercial real estate markets. Other expense decreased to$0.1 million during the three months endedSeptember 30, 2020 from$0.4 million for the same period in 2019. Income from sales of real estate-During the three months endedSeptember 30, 2020 , we recorded$6.1 million of income from sales of real estate from the sale of a Ground Lease to SAFE (refer to Note 8). During the three months endedSeptember 30, 2019 , we recorded$3.5 million of income from sales of real estate from the sale of net lease assets. Loss on early extinguishment of debt, net-During the three months endedSeptember 30, 2020 , we incurred losses on early extinguishment of debt of$7.9 million resulting from the repayment of senior notes prior to maturity. Earnings from equity method investments-Earnings from equity method investments decreased to$6.8 million during the three months endedSeptember 30, 2020 from$7.6 million for the same period in 2019. During the three months endedSeptember 30, 2020 , we recognized$9.3 million of income from our equity method investment in SAFE and$0.8 million from our equity method investment in Net Lease Venture II, which was partially offset by$3.3 million of net aggregate losses from our remaining equity method investments. During the three months endedSeptember 30, 2019 , we recognized$8.2 million resulting from the sale of an asset in an operating property venture,$2.9 million of income from our equity method investment in SAFE and$3.5 million of net aggregate losses from our remaining equity method investments. Income tax expense-Income tax expense of$0.1 million was recorded during both the three months endedSeptember 30, 2020 and 2019 and related primarily to state margins taxes and other minimum state taxes. 50 -------------------------------------------------------------------------------- Table of Contents Results of Operations for the Nine Months EndedSeptember 30, 2020 compared to the Nine Months EndedSeptember 30, 2019 For the Nine Months Ended September 30, 2020 2019 $ Change (in thousands) Operating lease income$ 140,529 $ 158,210 $ (17,681) Interest income 46,925 60,417 (13,492) Interest income from sales-type leases 25,010 12,157 12,853 Other income 56,212 43,133 13,079 Land development revenue 116,254 76,691 39,563 Total revenue 384,930 350,608 34,322 Interest expense 127,748 136,851 (9,103) Real estate expense 53,708 71,165 (17,457) Land development cost of sales 114,704 71,785 42,919 Depreciation and amortization 43,407 43,586 (179) General and administrative 73,138 72,512 626 Provision for (recovery of) loan losses 4,093 (3,792) 7,885 Provision for losses on net investment in leases 2,001 - 2,001 Impairment of assets 6,491 4,953 1,538 Other expense 351 12,798 (12,447) Total costs and expenses 425,641 409,858 15,783 Income from sales of real estate 6,118 233,406 (227,288) Loss on early extinguishment of debt, net (12,038) (468) (11,570) Earnings from equity method investments 26,003 16,566 9,437 Selling profit from sales-type leases - 180,416 (180,416) Income tax expense (165) (323) 158 Net income (loss)$ (20,793) $ 370,347 $ (391,140) Revenue-Operating lease income, which primarily includes income from net lease assets and commercial operating properties, decreased$17.7 million to$140.5 million during the nine months endedSeptember 30, 2020 from$158.2 million for the same period in 2019. The following table summarizes our operating lease income by segment ($ in millions). Nine Months Ended September 30, 2020 2019 Change Net Lease(1) $ 124.0$ 136.2 $ (12.2) Operating Properties(2) 16.2 21.8 (5.6) Land and Development 0.3 0.2 0.1 Total $ 140.5$ 158.2 $ (17.7)
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(1)Change primarily due to the reclassification of certain operating leases to sales-type leases inMay 2019 (refer to Note 5) and asset sales, partially offset by new acquisitions. (2)Change primarily due to asset sales. 51 -------------------------------------------------------------------------------- Table of Contents The following table shows certain same store statistics for our consolidatedNet Lease segment. Same store assets are defined as assets we owned on or prior toJanuary 1, 2019 and were in service throughSeptember 30, 2020 (Operating lease income in millions). Nine Months Ended September 30, 2020 2019 Operating lease income(1)$ 121.4 $ 120.0 Rent per square foot$ 10.98 $ 10.70 Occupancy(2) 98.5 % 99.3 %
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(1)For the nine months endedSeptember 30, 2020 and 2019, includes$24.1 million and$11.2 million , respectively, of lease income from one net lease tenant that was recorded to "Interest income from sales-type leases" in our consolidated statements of operations. (2)Occupancy as ofSeptember 30, 2020 and 2019. Interest income decreased$13.5 million to$46.9 million during the nine months endedSeptember 30, 2020 from$60.4 million for the same period in 2019. The decrease was due primarily to a decrease in the average balance of our performing loans and other lending investments, which was$716 million for the nine months endedSeptember 30, 2020 and$880 million for the nine months endedSeptember 30, 2019 . The weighted average yield on our performing loans and other lending investments for the nine months endedSeptember 30, 2020 and 2019 was 7.9% and 9.0%, respectively. OnJanuary 1, 2019 , we adopted new accounting standards and classified certain of our leases in 2019 as sales-type leases. Under sales-type leases, we accrue interest income from sales-type leases under the effective interest method as opposed to recognition of operating lease income under the straight-line rent method for our leases that do not qualify as sales-type leases. Interest income from sales-type leases increased to$25.0 million for the nine months endedSeptember 30, 2020 from$12.2 million for the same period in 2019. The increase was due primarily to a full period of interest income for sales-type leases during the nine months endedSeptember 30, 2020 (refer to Note 5). Other income increased$13.1 million to$56.2 million during the nine months endedSeptember 30, 2020 from$43.1 million for the same period in 2019. Other income during the nine months endedSeptember 30, 2020 consisted primarily of mark-to-market gains on an equity investment, management fees, other ancillary income from our operating properties, land and development projects and loan portfolio, income from our hotel properties and interest income on our cash. Other income during the nine months endedSeptember 30, 2019 consisted primarily of income from our hotel properties, other ancillary income from our operating properties and land and development projects and interest income on our cash. The increase in 2020 was primarily due to$23.9 million of mark-to-market gains on an equity investment (refer to Note 8) and an increase in management fees from SAFE, partially offset by a decrease in income from our hotel properties and other operating properties. Land development revenue and cost of sales-During the nine months endedSeptember 30, 2020 , we sold residential lots and units and recognized land development revenue of$116.3 million which had associated cost of sales of$114.7 million . During the nine months endedSeptember 30, 2019 , we sold residential lots and units and recognized land development revenue of$76.7 million which had associated cost of sales of$71.8 million . The increase in 2020 was due primarily to the sale of a 430 acre site inCalifornia for$36.0 million which had associated cost of sales of$35.4 million . Costs and expenses-Interest expense decreased$9.1 million to$127.7 million during the nine months endedSeptember 30, 2020 from$136.9 million for the same period in 2019 due primarily to a decrease in our weighted average cost of debt, which was 4.8% for the nine months endedSeptember 30, 2020 compared to 5.4% for the nine months endedSeptember 30, 2019 . The balance of our average outstanding debt, inclusive of loan participations and lease liabilities associated with finance-type leases, decreased to$3.51 billion for the nine months endedSeptember 30, 2020 from$3.52 billion for the same period in 2019. 52 -------------------------------------------------------------------------------- Table of Contents Real estate expenses decreased$17.5 million to$53.7 million during the nine months endedSeptember 30, 2020 from$71.2 million for the same period in 2019. The following table summarizes our real estate expenses by segment ($ in millions). Nine Months Ended September 30, 2020 2019 Change Operating Properties(1) $ 16.6$ 28.8 $ (12.2) Land and Development(2) 17.6 24.2 (6.6) Net Lease(3) 19.5 18.2 1.3 Total $ 53.7$ 71.2 $ (17.5)
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(1)Change primarily due to asset sales and a decrease in expenses at certain operating properties, partially offset by an asset beginning operations during 2019. (2)Change primarily due to a decrease in legal and marketing costs at some properties and asset sales. (3)Change primarily due to new acquisitions, partially offset by asset sales. Depreciation and amortization decreased$0.2 million to$43.4 million during the nine months endedSeptember 30, 2020 from$43.6 million for the same period in 2019, primarily due to asset sales and the reclassification of certain operating leases to sales-type lease (refer to Note 5), partially offset by new acquisitions. General and administrative expense includes payroll and related costs, performance-based compensation, public company costs and occupancy costs. General and administrative expenses increased$0.6 million to$73.1 million during the nine months endedSeptember 30, 2020 from$72.5 million for the same period in 2019. The increase in 2020 was due primarily to an increase in performance based compensation, which was partially offset by a decrease in payroll and related costs and a decrease in travel and entertainment costs. The provision for loan losses was$4.1 million for the nine months endedSeptember 30, 2020 as compared to a recovery of loan losses of$3.8 million for the same period in 2019. The provision for loan losses for the nine months endedSeptember 30, 2020 resulted from the macroeconomic impact of COVID-19 on commercial real estate markets. The recovery of loan losses for the nine months endedSeptember 30, 2019 was due to a decrease in the general reserve of$4.3 million offset by an increase in the specific reserve of$0.5 million . The provision for losses on net investment in leases for the nine months endedSeptember 30, 2020 included an allowance resulting from the macroeconomic impact of COVID-19 on commercial real estate markets. During the nine months endedSeptember 30, 2020 , we recorded an aggregate impairment of$6.5 million in connection with the sale of net lease assets and impairments on a real estate asset held for sale and a land and development asset. During the nine months endedSeptember 30, 2019 , we recorded an aggregate impairment of$5.0 million which included an impairment of$3.3 million on a commercial operating property based on an executed purchase and sale agreement, a$1.1 million impairment on a land and development asset due to a change in business strategy and$0.6 million of impairments in connection with the sale of residential condominium units. Other expense decreased to$0.4 million during the nine months endedSeptember 30, 2020 from$12.8 million for the same period in 2019. The decrease was due primarily to expenses associated with derivative contracts that were terminated during the nine months endedSeptember 30, 2019 . Income from sales of real estate-During the nine months endedSeptember 30, 2020 , we recorded$6.1 million of income from sales of real estate from the sale of a Ground Lease to SAFE (refer to Note 8). During the nine months endedSeptember 30, 2019 , we recorded$233.4 million of income from sales of real estate, primarily from the sale of a portfolio of net lease assets and operating properties. Loss on early extinguishment of debt, net-During the nine months endedSeptember 30, 2020 and 2019, we incurred losses on early extinguishment of debt of$12.0 million and$0.5 million , respectively, resulting from the repayment of senior notes prior to maturity. Earnings from equity method investments-Earnings from equity method investments increased to$26.0 million during the nine months endedSeptember 30, 2020 from$16.6 million for the same period in 2019. During the nine months endedSeptember 30, 2020 , we recognized$36.9 million of income from our equity method investment in SAFE, which included a dilution gain of$7.9 million resulting from a SAFE equity offering inMarch 2020 ,$1.6 million from our equity investment in Net Lease Venture II, which were partially offset by$12.5 million of net aggregate losses from our remaining equity method 53 -------------------------------------------------------------------------------- Table of Contents investments. During the nine months endedSeptember 30, 2019 , we recognized$14.1 million from our equity method investment in SAFE and$8.2 million from the sale of an asset in an operating property venture, partially offset by$5.7 million of net aggregate losses from our remaining equity method investments. Selling profit from sales-type leases-During the nine months endedSeptember 30, 2019 , we entered into a transaction with an operator of bowling entertainment venues, consisting of the purchase of nine bowling centers for$56.7 million and a commitment to purchase up to$55.0 million of additional bowling centers over the next several years (refer to Note 5). The new centers were added to our existing master leases with the tenant. In connection with this transaction, the maturities of the leases were extended by 15 years to 2047. As a result of the modifications to the leases, we accounted for the leases as sales-type leases and recognized$180.4 million in "Selling profit from sales-type leases" as a result of the transaction. Income tax expense-Income tax expense of$0.2 million was recorded during the nine months endedSeptember 30, 2020 as compared to an income tax expense of$0.3 million for the same period in 2019. The income tax expense for the nine months endedSeptember 30, 2020 and 2019 related primarily to state margins taxes and other minimum state taxes.
Adjusted Earnings
In 2019, we announced a new business strategy that would focus our management personnel and our investment resources primarily on scaling our Ground Lease platform. As part of this strategy, we accelerated the monetization of legacy assets, reducing our legacy portfolio to approximately 17% of our overall portfolio as ofSeptember 30, 2020 , and deployed a substantial portion of the proceeds into additional investments in SAFE and new loan and net lease originations relating to the Ground Lease business. Management has determined that, effective for the first quarter 2020, a modified non-GAAP earnings metric, designated "adjusted earnings," is the metric it uses to assess our execution of this strategy and the performance of our operations. Adjusted earnings reflects impairment charges and loan provisions in the same period in which they are recognized in net income (loss) prepared in conformity with generally accepted accounting principles inthe United States of America ("GAAP"), rather than in a later period when the asset is sold. We believe this change is appropriate as legacy asset sales become less central to our business, even though sales may be material to particular periods when they occur. Adjusted earnings is used internally as a supplemental performance measure adjusting for certain items to give management a view of income more directly derived from operating activities in the period in which they occur. Adjusted earnings is calculated as net income (loss) allocable to common shareholders, prior to the effect of depreciation and amortization, including our proportionate share of depreciation and amortization from equity method investments and excluding depreciation and amortization allocable to noncontrolling interests, stock-based compensation expense, the non-cash portion of loss on early extinguishment of debt and the liquidation preference recorded as a premium above book value on the redemption of preferred stock ("Adjusted Earnings"). All prior periods have been calculated in accordance with this definition. 54 -------------------------------------------------------------------------------- Table of Contents Adjusted Earnings should be examined in conjunction with net income (loss) as shown in our consolidated statements of operations. Adjusted Earnings should not be considered as an alternative to net income (loss) (determined in accordance with GAAP), or to cash flows from operating activities (determined in accordance with GAAP), as a measure of our liquidity, nor is Adjusted Earnings indicative of funds available to fund our cash needs or available for distribution to shareholders. Rather, Adjusted Earnings is an additional measure we use to analyze our business performance because it excludes the effects of certain non-cash charges that we believe are not necessarily indicative of our operating performance. It should be noted that our manner of calculating Adjusted Earnings may differ from the calculations of similarly-titled measures by other companies. For
the Three Months Ended
2020 2019 2018
(in thousands)
Adjusted Earnings
Net loss allocable to common shareholders $ (2,069) $ (7,343) $ (18,984)
Add: Depreciation and amortization 15,795 14,266 19,873
Add: Stock-based compensation expense 5,661 6,740 3,651
Add: Non-cash portion of loss on early extinguishment of debt 2,672
- 911
Adjusted earnings allocable to common shareholders $ 22,059 $ 13,663 $ 5,451
For
the Nine Months Ended
2020 2019 2018
(in thousands)
Adjusted Earnings
Net income (loss) allocable to common shareholders $ (46,850) $ 337,807 $ 50,698
Add: Depreciation and amortization 46,526 44,008 52,153
Add: Stock-based compensation expense 26,675 20,694 16,245
Add: Non-cash portion of loss on early extinguishment of debt 3,470
468 3,447
Adjusted earnings allocable to common shareholders $
29,821
Liquidity and Capital Resources
During the three months endedSeptember 30, 2020 , we invested an aggregate$148 million into new investments, prior financing commitments and real estate development. Investments included$117 million in net lease, loan, and strategic investments,$14 million in the repurchase of our common stock,$9 million of capital expenditures on legacy assets and$8 million in SAFE common stock. These amounts are inclusive of fundings from consolidated investments and our pro rata share from equity method investments and includes$83 million of investments made within the Net Lease Venture II, of which we own 51.9%. The following table outlines our capital expenditures on operating properties, net lease and land and development assets as reflected in our consolidated statements of cash flows, by segment ($ in thousands): For the Nine
Months Ended
2020 2019
Operating Properties $ 2,037 $ 5,965
Net Lease 9,624 15,116
Total capital expenditures on real estate assets $ 11,661 Land and Development$ 33,488 $ 93,395 Total capital expenditures on land and development assets$ 33,488
As ofSeptember 30, 2020 , we had unrestricted cash of approximately$88 million and$330 million of borrowing capacity available under the Revolving Credit Facility. The COVID-19 crisis has for the time being adversely affected our strategies of monetizing legacy assets and materially scaling SAFE's portfolio as its Manager. These conditions will adversely affect our 55 -------------------------------------------------------------------------------- Table of Contents strategies while they persist. Our primary cash uses over the next 12 months are expected to be funding of investments, capital expenditures, distributions to shareholders through dividends and share repurchases and funding ongoing business operations. In the near term we plan to limit non-investment cash expenditures to the extent practicable. The amount we actually invest will depend on the full impact of COVID-19 on our business and the pace of the economic recovery. We also had approximately$136 of maximum unfunded commitments associated with our investments of which we expect to fund the majority over the next two years, assuming borrowers and tenants meet all milestones, performance hurdles and all other conditions to fundings (see "Unfunded Commitments" below). We also have approximately$502 million principal amount of scheduled real estate finance asset maturities over the next 12 months, exclusive of any extension options that can be exercised by our borrowers. Our capital sources to meet cash uses through the next 12 months and beyond are expected to include cash on hand, Revolving Credit Facility borrowings, income from our portfolio, loan repayments from borrowers and proceeds from asset sales. We cannot predict with certainty the specific transactions we will undertake to generate sufficient liquidity to meet our obligations as they come due. We will adjust our plans as appropriate in response to changes in our expectations and changes in market conditions. Contractual Obligations-The following table outlines the contractual obligations related to our long-term debt obligations, loan participations payable and operating lease obligations as ofSeptember 30, 2020 (refer to Note 11 to our consolidated financial statements). Amounts Due By Period Less Than 1 1 - 3 3 - 5 5 - 10 After 10 Total Year Years Years Years Years (in thousands) Long-Term Debt Obligations: Unsecured notes$ 2,012,500 $ -$ 287,500 $ 1,325,000 $ 400,000 $ - Secured credit facilities 491,875 - 491,875 - - - Revolving credit facility 20,000 - 20,000 - - - Mortgages 724,836 72,439 162,037 160,408 323,856 6,096 Trust preferred securities 100,000 - - - - 100,000 Total principal maturities 3,349,211 72,439
961,412 1,485,408 723,856 106,096
Interest Payable(1) 620,462 132,344 243,831 184,724 50,143 9,420
Loan Participations Payable(2) 41,941 41,941 - - - -
Lease Obligations(3) 1,628,887 8,570 24,570 24,365 33,465 1,537,917
Total $ 5,640,501 $ 255,294 $ 1,229,813 $ 1,694,497 $ 807,464 $ 1,653,433 _______________________________________________________________________________
(1)Variable-rate debt assumes one-month LIBOR of 0.15% and three-month LIBOR of 0.23% that were in effect as ofSeptember 30, 2020 . Interest payable does not include payments that may be required under our interest rate derivatives. (2)Refer to Note 10 to the consolidated financial statements. (3)We are obligated to pay ground rent under certain operating leases; however, our tenants at the properties pay this expense directly under the terms of various subleases and these amounts are excluded from lease obligations. 56 -------------------------------------------------------------------------------- Table of Contents Credit Metrics-The following table presents metrics that management reviews as indicators of the strength of our balance sheet and credit profile. Metrics are shown both excluding ("Without SAFE MTM") and including ("With SAFE MTM") our unrealized gain on the shares of common stock of SAFE that we own. Readers are cautioned that there can be no assurance that the asset values used to calculate these metrics could be realized on the sale of such assets in a liquidation or otherwise. As of September 30, 2020 December 31, 2019 Without With Without With SAFE MTM SAFE MTM(1) SAFE MTM SAFE MTM(1) ($ in millions) Unencumbered assets(2)$ 3,399 $ 4,633 $ 3,585 $ 4,112 Unencumbered assets / Unsecured debt(3) 1.6x 2.2x 1.6x 1.8x Leverage(4) 2.2x 1.2x 2.0x 1.5x Unsecured debt / Total debt(5) 68 % 68 % 69 % 69 % _______________________________________________________________________________ (1)As ofSeptember 30, 2020 andDecember 31, 2019 , we owned 33.7 million shares and 31.2 million shares, respectively, of SAFE common stock. SAFE mark-to-market is calculated using the SAFE share price of$62.10 as ofSeptember 30, 2020 and the SAFE share price of$40.30 as ofDecember 31, 2019 . (2)Unencumbered assets represents the gross book value of our assets, including the gross book value of our equity method investments, that are not pledged as collateral to any of our debt obligations plus intangible assets/liabilities for all other assets pledged as collateral. As ofSeptember 30, 2020 , unencumbered assets includes$610.8 million gross book value of assets held by entities whose equity interests are pledged as collateral for the Revolving Credit Facility that had$20.0 million outstanding as ofSeptember 30, 2020 . (3)Represents the amount of unencumbered assets as a percentage of our unsecured debt obligations. (4)Leverage represents our total debt obligations, net of cash, divided by our adjusted total equity. Adjusted total equity equals total equity, adjusted to add the following, each as determined under GAAP: accumulated depreciation and amortization, CECL allowances and our proportionate share of accumulated depreciation and amortization from our equity method investments. (5)Represents the principal amount of our unsecured debt as a percentage of the principal amount of our total debt and excludes debt attributable to noncontrolling interests. Debt Covenants-Our outstanding unsecured debt securities contain corporate level covenants that include a covenant to maintain a ratio of unencumbered assets to unsecured indebtedness, as such terms are defined in the indentures governing the debt securities, of at least 1.2x and a covenant restricting certain incurrences of debt based on a fixed charge coverage ratio. If any of our covenants are breached and not cured within applicable cure periods, the breach could result in acceleration of our debt securities unless a waiver or modification is agreed upon with the requisite percentage of the bondholders. The Senior Term Loan and the Revolving Credit Facility contain certain covenants, including covenants relating to collateral coverage, restrictions on fundamental changes, transactions with affiliates, matters relating to the liens granted to the lenders and the delivery of information to the lenders. In particular, the Senior Term Loan requires us to maintain collateral coverage of at least 1.25x outstanding borrowings on the facility. The Revolving Credit Facility is secured by a borrowing base of assets and requires us to maintain both borrowing base asset value of at least 1.5x outstanding borrowings on the facility and a consolidated ratio of cash flow to fixed charges of at least 1.5x. The Revolving Credit Facility does not require that proceeds from the borrowing base be used to pay down outstanding borrowings provided the borrowing base asset value remains at least 1.5x outstanding borrowings on the facility. To satisfy this covenant, we have the option to pay down outstanding borrowings or substitute assets in the borrowing base. Under both the Senior Term Loan and the Revolving Credit Facility we are permitted to pay dividends provided that no material default (as defined in the relevant agreement) has occurred and is continuing or would result therefrom and we remain in compliance with our financial covenants after giving effect to the dividend. We declared common stock dividends of$24.6 million , or$0.32 per share, for the nine months endedSeptember 30, 2020 . Derivatives-Our use of derivative financial instruments is primarily limited to the utilization of interest rate swaps, interest rate caps or other instruments to manage interest rate risk exposure and foreign exchange contracts to manage our risk to changes in foreign currencies. Refer to Note 13 to the consolidated financial statements. Off-Balance Sheet Arrangements-We are not dependent on the use of any off-balance sheet financing arrangements for liquidity. We have made investments in various unconsolidated ventures. Refer to Note 8 to the consolidated financial statements for further details of our unconsolidated investments. Our maximum exposure to loss from these investments is limited to the carrying value of our investments and any unfunded commitments (see below). 57 -------------------------------------------------------------------------------- Table of Contents Unfunded Commitments-We generally fund construction and development loans and build-outs of space in net lease assets over a period of time if and when the borrowers and tenants meet established milestones and other performance criteria. We refer to these arrangements as Performance-Based Commitments. In addition, we have committed to invest capital in several real estate funds and other ventures. These arrangements are referred to as Strategic Investments. As ofSeptember 30, 2020 , the maximum amount of fundings we may be obligated to make under each category, assuming all performance hurdles and milestones are met under the Performance-Based Commitments and assuming that 100% of our capital committed to Strategic Investments is drawn down, are as follows (in thousands): Loans and Other Lending Other Investments(1) Real Estate Investments Total Performance-Based Commitments $ 83,423$ 14,726 $ 27,902 $ 126,051 Strategic Investments - - 9,967 9,967 Total $ 83,423$ 14,726 $ 37,869 $ 136,018
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(1)Excludes$8.0 million of commitments on loan participations sold that are not our obligation. Stock Repurchase Program-We may repurchase shares in negotiated transactions or open market transactions, including through one or more trading plans. During the nine months endedSeptember 30, 2020 , we repurchased 3.7 million shares of our outstanding common stock for$41.4 million , for an average cost of$11.32 per share. During the nine months endedSeptember 30, 2019 , we repurchased 6.2 million shares of our outstanding common stock for$58.8 million , for an average cost of$9.44 per share. InAugust 2020 , our board of directors authorized an increase to the stock repurchase program to$50.0 million . As ofSeptember 30, 2020 , we had remaining authorization to repurchase up to$40.8 million of common stock under our stock repurchase program. Critical Accounting Estimates The preparation of financial statements in accordance with GAAP requires management to make estimates and judgments in certain circumstances that affect amounts reported as assets, liabilities, revenues and expenses. We have established detailed policies and control procedures intended to ensure that valuation methods, including any judgments made as part of such methods, are well controlled, reviewed and applied consistently from period to period. We base our estimates on historical corporate and industry experience and various other assumptions that we believe to be appropriate under the circumstances. For all of these estimates, we caution that future events rarely develop exactly as forecasted, and, therefore, routinely require adjustment.
For a discussion of our critical accounting policies, refer to Note 3 to the consolidated financial statements and our Annual Report on Form 10-K.
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.
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