Most real estate investment trusts (REITs) own properties, but it is the building on the property that takes center stage, not the land. Safehold (SAFE) turns that view upside down. The business model is actually quite attractive, but there are a couple of small problems when it comes to investing in the stock.
If you think of REITs like Boston Properties, AvalonBay, or Host Hotels, the key story is that they are office, apartment, and hotel landlords, respectively. In fact, investing based on property type is pretty common in the REIT sector.
By contrast, Safehold is diversified, with assets across all three of the above sectors, getting around 55% of rents from offices, 30% from apartments, and 15% or so from hotels. Only diversification is not the real story here.
Safehold has a weighted average lease term of 90 years, with over 90% of its portfolio sporting leases of 60 years or more. That's an incredible figure and way out of line with what most other REITs. The reason is that Safehold owns the land under the buildings, not the buildings themselves. It's what's known as a land lease, which generally involves incredibly long terms. A land lease is basically a way for a company to raise capital without the need to actually sell the asset that is generating income (the building).
The interesting thing for Safehold is that it doesn't really care what's on top of the property as long as the rent gets paid. The building owner could even demolish the property and put something else up. Safehold basically wants to own property located where there will always be a desire for something to be on the lot.
That said, if there is a default or the lease doesn't get renewed, Safehold gets to take over the building. So there's a benefit to having a great asset on the land, too. All in, it's a fairly boring, safe business model, even in a worst-case scenario outcome.
At first blush, Safehold sounds like a great business. And it is. The issue is that even a great business can be a bad investment if you pay too much for it, to paraphrase Wall Street legend Benjamin Graham, the man who helped to train Warren Buffett.
Some numbers will help. For starters, Safehold's dividend yield is a miserly 1.1%. The yield on the S&P 500 index is historically low today, but at 1.3%, it's still higher than what you'd get from Safehold. The REIT only came public in mid-2017, so there isn't much of a history to go on here, but that 1.1% yield is actually toward the high end of its historical range. The yield has never been above 2%.
Then there's the dividend growth rate. Safehold started paying a dividend in the third quarter of 2017, sending investors $0.15 per share per quarter. The most recent dividend was $0.17 per share per quarter. So over roughly four years, the dividend has grown 13% or so. As the chart shows, that's not annualized -- that's over the entire four-plus years.
While that's not terrible and compares favorably to other REITs, it isn't exactly huge growth when you consider the extremely low dividend yield. Prologis, an industrial REIT with a sub-2% yield, has grown its dividend by more than 40% over the same span. Basically, Safehold is priced like a growth REIT but isn't really coming through on the dividend growth.
Buy it on a sell-off?
The big story here is that Safehold's business model is highly conservative, making the REIT pretty close to a bond alternative, given the massively long lease terms on its properties. What it offers over bonds is the dividend growth, even if it's relatively modest. In fact, this is a fine combination for a conservative investor that's OK with a very low yield.
However, most investors will probably prefer to be paid a little bit more than 1.1%. But, given the rising interest rate environment, you might want to keep this unique land lease REIT on your radar. Just like a bond, it is likely to see its price fall as rates rise, and that could, assuming rates get high enough, make it an attractive investment opportunity for a lot more investors.