SAFEHOLD INC. This discussion summarizes the significant factors affecting our consolidated operating results, financial condition and liquidity during the two-year period endedDecember 31, 2019 . This discussion should be read in conjunction with our consolidated financial statements and related notes for the two-year period endedDecember 31, 2019 included elsewhere in this Annual Report on Form 10-K. These historical financial statements may not be indicative of our future performance. Executive Overview 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. 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 rent. Capital appreciation is realized though appreciation in the value of the land over time and through our typical rights as landlord to acquire 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 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. We experienced significant customer demand for our SafeholdTM Ground Leases during the year endedDecember 31, 2019 , and we expect that increased customer experience and market recognition should generate greater demand for SafeholdTM Ground Leases from building owners and acquirers going forward. 31
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Table of Contents Our Portfolio 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, including length of lease term, percentage rent participations, triple net terms and strong Ground Rent Coverage (which was 4.0x as ofDecember 31, 2019 on a weighted average basis).
Below is an overview of the top 10 assets in our portfolio as of
Lease
Expiration
Property / As Rent Escalation % of Gross
Name Property Type Location Extended Structure Book Value
Fixed with
425 Park 2090 / Inflation
Avenue(2) Office New York, NY 2090 Adjustments 12.9%
Fixed with
135 West 50th 2123 / Inflation
Street Office New York, NY 2123 Adjustments 10.9%
Fixed with
2118 / Inflation
195 Broadway Office New York, NY 2118 Adjustments 10.5%
Park Hotels 2025 /
Portfolio(3) Hotel Various 2035 % Rent 8.4%
Fixed with
2118 / Inflation
Alohilani Hotel Honolulu, HI 2118 Adjustments 7.5%
Fixed with
2123 / Inflation
685 Third Avenue Office New York, NY 2123 Adjustments 6.9%
1111 Fixed with
Pennsylvania 2117 / Inflation
Avenue Office Washington, DC 2117 Adjustments 5.7%
Fixed with
2118 / Inflation
Domain Tower Office Austin, TX 2118 Adjustments 3.0%
Hollywood Blvd - 2104 /
South Multi-family Los Angeles, CA 2104 Inflation-Linked 2.8%
Fixed with
2114 / Inflation
One Ally Center Office Detroit, MI 2174 Adjustments 2.7%
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(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.
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The following charts show certain statistics of our portfolio as of
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Unfunded Commitments
InOctober 2017 , we entered into a commitment to acquire land subject to a Ground Lease on which a luxury multi-family project is currently being constructed inSan Jose, California . Pursuant to the purchase agreement, we will acquire the Ground Lease onNovember 1, 2020 from iStar for$34.0 million . iStar committed to provide a$80.5 million construction loan to the ground lessee. InAugust 2018 , we entered into an aggregate$30.0 million commitment to acquire land for$12.5 million and provide a$17.5 million leasehold improvement allowance for the Ground Lease tenant's construction of a multi-family property inWashington, DC . We acquired the land inJune 2019 and will fund the leasehold improvement allowance upon the completion of certain conditions. InJanuary 2019 , we acquired land for$13.0 million and simultaneously structured and entered into a Ground Lease as part of the Ground Lease tenant's acquisition of an existing office building located inWashington, DC that is to be converted into a multi-family building. We committed to provide the Ground Lease tenant a$10.5 million leasehold improvement allowance that will be funded upon the completion of certain conditions. InJune 2019 , we acquired land for$8.1 million and simultaneously structured and entered into a Ground Lease as part of the Ground Lease tenant's development of a to-be-built multi-family community located outside ofOrlando, FL. We committed to provide the Ground Lease tenant a$21.4 million leasehold improvement allowance that will be funded upon the completion of certain conditions. As ofDecember 31, 2019 ,$2.1 million of the leasehold improvement allowance had been funded. Results of Operations for the Year EndedDecember 31, 2019 compared to the Year EndedDecember 31, 2018 For the Years Ended December 31, 2019 2018 $ Change (in thousands) Revenues: Operating lease income$ 72,071 $ 47,400 $ 24,671 Interest income from sales-type leases 18,531 - 18,531 Other income 2,794 2,324 470 Total revenues 93,396 49,724 43,672 Costs and expenses: Interest expense 29,868 15,389 14,479 Real estate expense 2,673 1,600 1,073 Depreciation and amortization 9,379 9,142 237 General and administrative 14,435 10,662 3,773 Other expense 899 995 (96 ) Total costs and expenses 57,254 37,788 19,466 Loss on early extinguishment of debt (2,011 ) - (2,011 ) Earnings (losses) from equity method investments (403 ) - (403 ) Net income$ 33,728 $ 11,936 $ 21,792 Operating lease income increased to$72.1 million during the year endedDecember 31, 2019 from$47.4 million for the same period in 2018. The increase in 2019 was primarily due to the origination and acquisition of Ground Leases classified as operating leases. Interest income from sales-type leases (refer to Note 3) was$18.5 million for the year endedDecember 31, 2019 . OnJanuary 1, 2019 , we adopted new accounting standards (refer to Note 3) and, as a result, now classify certain of our Ground Leases as sales-type leases. Under sales-type leases, we accrue interest income under the effective interest method as opposed to recognition of operating lease income under the straight-line rent method for our Ground Leases that do not qualify as sales-type leases. We expect a majority of our newly originated Ground Leases will be classified as sales-type leases. Other income for the year endedDecember 31, 2019 was$2.8 million and consists primarily of$2.4 million of interest income earned on our cash balances and$0.4 million of other income relating to a Ground Lease in which we are the lessee but 34
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our tenant at the property pays this expense directly under the terms of a master lease (refer to Note 3). Other income for the year endedDecember 31, 2018 was$2.3 million and consists of$1.5 million received by us in connection with the termination of a contract for the purchase of the leased fee interest in a property due to the exercise by another entity of a pre-existing pre-emptive right to acquire such property and$0.8 million of interest income earned on our cash balances During the year endedDecember 31, 2019 , we incurred interest expense from our secured financings of$29.9 million compared to$15.4 million in 2018. The increase in 2019 was primarily the result of additional borrowings to fund our growing investment portfolio. Real estate expense was$2.7 million and$1.6 million during the years endedDecember 31, 2019 and 2018, respectively. Real estate expenses consisted primarily of the amortization of an operating lease right-of-use asset in 2019 and a below market lease asset in 2018 at one of our hotel properties, property taxes, property appraisal fees and insurance expense in both periods. In addition, during the year endedDecember 31, 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 (refer to Note 3). Depreciation and amortization was$9.4 million and$9.1 million during the years endedDecember 31, 2019 and 2018, respectively, and primarily relates to our ownership of the Park Hotels Portfolio and our ownership of the Buckler multi-family property. General and administrative includes management fees (which our Manager waived throughJune 30, 2018 ), stock-based compensation, costs of operating as a public company and an allocation of expenses to us from our Manager (which our Manager waived throughJune 30, 2018 ). Although we paid no management fee or expense reimbursements to our Manager throughJune 30, 2018 , we are required under GAAP to record such expenses as non-cash capital contributions from iStar. The following table presents our general and administrative expenses for the years endedDecember 31, 2019 and 2018 ($ in thousands): For the Years Ended December 31, 2019 2018 Management fees$ 7,461 $ 3,643 Public company and other costs 3,247 4,676 Expense reimbursements to the Manager 2,144 1,470 Stock-based compensation 1,583 873
Total general and administrative expenses
During the year endedDecember 31, 2019 , other expense consists primarily of investment pursuit costs, fees related to our derivative transactions and state and local taxes. During the year endedDecember 31, 2018 , other expense consists primarily of costs related to an unsuccessful acquisition (but for which we received a$1.5 million termination fee - see Other Income section above), investment pursuit costs and fees related to our derivative transactions.
During the year ended
During the year endedDecember 31, 2019 , losses from equity method investments resulted from our share of costs attributable to transaction structuring activities from a venture that we entered into with an existing shareholder that acquired the existing Ground Lease at425 Park Avenue inNew York City , partially offset by rental income from the venture upon its acquisition inNovember 2019 (refer to Note 6).
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 stockholders 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 stockholders, 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 stockholders sufficient to meet REIT qualification
requirements.
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As ofDecember 31, 2019 , we had$22.7 million of unrestricted cash,$359.0 million of undrawn capacity and the ability to borrow an additional$118.2 million on our 2017 Revolver, subject to the conditions set forth in the applicable loan agreement (refer to Note 8 for more information on our 2017 Revolver), without pledging any additional assets to the facility. We refer to this$140.9 million of unrestricted cash and additional borrowing capacity as our "equity" liquidity which can be used for general corporate purposes or leveraged (a maximum of 2:1 in the case of our 2017 Revolver) to acquire new Ground Lease assets. Our primary sources of cash to date have been proceeds from equity offerings and private placements (refer to Note 11), proceeds from our initial capitalization by iStar and two institutional investors (refer to Note 11) and borrowings from our debt facilities. Our primary uses of cash to date have been the acquisition/origination of Ground Leases, repayments on our debt facilities and distributions to our shareholders. We expect our future liquidity requirements to include debt service, distributions to our shareholders, working capital, acquisitions and originations of Ground Lease investments, including in respect of the unfunded commitments described above, debt maturities and payments of fees under our management agreement to the extent we do not elect to pay the fees in common stock. Our primary sources of liquidity going forward will generally consist of cash on hand and cash flows from operations, new financings, unused borrowing capacity under our 2017 Revolver (subject to the conditions set forth in the applicable loan agreement) and common and/or preferred equity issuances. Contractual Obligations-The following table outlines the contractual obligations related to our long-term debt obligations and certain other commitments as ofDecember 31, 2019 (refer to Note 8 and Note 9 to the consolidated financial statements). Amounts Due By Period Less Than 1 1 - 3 3 - 5 5 - 10 After 10 Total Year Years Years Years Years (in thousands) Long-Term Debt Obligations(1): Mortgages$ 1,230,143 $ - $ - $ -$ 316,193 $ 913,950 2017 Revolver 166,000 - - 166,000 - - Total principal maturities 1,396,143 - - 166,000 316,193 913,950 Interest Payable(2) 1,731,597 45,889 92,763 90,332 195,981 1,306,632 Purchase Commitments(3) 81,270 70,770 10,500 - - - Total(4)$ 3,209,010 $ 116,659 $ 103,263 $ 256,332 $ 512,174 $ 2,220,582
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(1) Assumes the extended maturity date for all debt obligations.
(2) Variable-rate debt assumes one-month LIBOR of 1.76%. Interest payable does
not include interest that may be payable under our derivatives.
(3) Refer to Note 9 of the consolidated financial statements.
(4) We are also obligated to pay the third-party owner of a property that is
ground leased to us
CPI, per year through 2044; however, our tenant pays this expense directly
under the terms of a master lease through 2035.
Mortgages-Mortgages consist of asset specific non-recourse borrowings that are secured by our Ground Leases. As ofDecember 31, 2019 , our mortgages are full term interest only, bear interest at a weighted average interest rate of 4.06% (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 4.00%) and have maturities betweenApril 2027 andNovember 2069 . 2017 Revolver-InJune 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 "2017 Revolver") that has since been increased to$525.0 million . The 2017 Revolver provides an accordion feature to increase, subject to certain conditions, the maximum availability up to$1.0 billion . The 2017 Revolver has an initial maturity ofNovember 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 2017 Revolver allows us to leverage Ground Leases up to a maximum 67%. As ofDecember 31, 2019 , there was$359.0 million of undrawn capacity on the 2017 Revolver and we had the ability to draw an additional$118.2 million without pledging any additional assets to the facility. 36
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Debt Covenants-We are subject to financial covenants under the 2017 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 future issuances of net equity afterSeptember 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 ofDecember 31, 2019 , we were in compliance with all of our financial covenants. Off-Balance Sheet Arrangements-We are not dependent on the use of any off-balance sheet financing arrangements for liquidity. Critical Accounting Estimates Basis of Presentation-The preparation of these consolidated financial statements in conformity with generally accepted accounting principles inthe 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: Capitalization and depreciation-Certain improvements and replacements are capitalized when they extend the useful life of the asset. Repair and maintenance costs are expensed as incurred. Depreciation is computed using the straight-line method over the estimated useful life, which is generally 40 years for facilities, the shorter of the remaining lease term or expected life for tenant improvements and the remaining useful life of the facility for facility improvements. 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. 37
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Net Investment in Sales-type Leases and Ground Lease Receivables-Net investment in sales-type leases and Ground Lease receivables are recognized when our Ground Leases qualify as sales-type leases. The net investment in sales-type leases is initially measured at the present value of the fixed and determinable lease payments, including any guaranteed or unguaranteed residual value of the asset at the end of the lease, discounted at the rate implicit in the lease. Acquisition-related costs are capitalized and recorded in "Net Investment in Sales-type Leases" and "Ground Lease Receivables" on our consolidated balance sheets. For newly originated or acquired Ground Leases, our estimate of residual value equals the fair value of the land at lease commencement. If a lease qualifies as a sales-type lease, it is further evaluated to determine whether the transaction is considered a sale leaseback transaction. When we acquire land and enter into a Ground Lease directly with the seller that qualifies as a sales-type lease, the lease does not qualify as a sale leaseback transaction and the lease is considered a financing receivable and is recognized in accordance with ASC 310 and included in "Ground Lease receivables" on our consolidated balance sheets. 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 ofDecember 31, 2019 , 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) through "Reserve for losses on receivables" 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. Interest Income from Sales-type Leases-Interest income from sales-type leases is recognized under the effective interest method. The effective interest method produces a constant yield on the net investment in the sales-type lease and Ground Lease receivable over the term of the lease. Rent payments that are not fixed and determinable at lease inception, such as percentage rent and CPI adjustments, are not included in the effective interest method calculation and are recognized in "Interest income from sales-type leases" in our consolidated statements of operations in the period earned. A Ground Lease receivable is placed on non-accrual status if and when it becomes 90-days past due or we consider the Ground Lease receivable impaired. Equity Investments in Ground Leases-Equity investments in Ground Leases are accounted for pursuant to the equity method of accounting if we can significantly influence the operating and financial policies of the investee. We have a 54.8% noncontrolling equity interest in a venture and have shared voting power with our partner. We determined the entity to be a voting interest entity and our equity interest is accounted for pursuant to the equity method of accounting. Our periodic share of earnings and losses in equity method investees are included in "Earnings (losses) from equity method investments" in our consolidated statements of operations. Equity investments are included in "Equity investments in Ground Leases" on our consolidated balance sheets. Operating lease income-Operating lease income includes rent earned from leasing land and buildings owned by us to our tenants. Operating lease income is recognized on the straight-line method of accounting, generally from the later of the date the lessee takes possession of the space and it is ready for its intended use or the date of acquisition of the asset subject to existing leases. Accordingly, increases in contractual lease payments are recognized evenly over the term of the lease. The periodic difference 38
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between operating lease income recognized under this method and contractual lease payment terms is recorded as deferred operating lease income receivable and is included in ''Deferred operating lease income receivable'' on our consolidated balance sheets. We are also entitled to percentage rent, representing a portion of our lessee's gross revenues from the properties, pursuant to some of our leases and record percentage rent as operating lease income when earned. Operating lease income also includes the amortization of finite lived intangible assets and liabilities, which are amortized over the period during which the assets or liabilities are expected to contribute directly or indirectly to the future cash flows of the business acquired.
We estimate losses within operating lease income receivable and deferred
operating lease income receivable balances as of the balance sheet date and
incorporate a reserve based on management's evaluation of the credit risks
associated with these receivables. As of
Fair Values-We are required to disclose fair value information with regard to our financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practical to estimate fair value.The Financial Accounting Standards Board guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. We determine the estimated fair values of financial assets and liabilities based on a hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of us and our own assumptions about market participant assumptions. We determined the carrying values of our financial instruments including cash and cash equivalents; net investment in sales-type leases; Ground Lease receivables; restricted cash; deferred operating lease income receivable, net; deferred expenses and other assets, net; and accounts payable, accrued expenses, and other liabilities approximated their the fair values of the instruments. We determined the fair value of our debt obligations, net as ofDecember 31, 2019 and 2018 was approximately$1.4 billion and$537.8 million , respectively. 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. 39
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