- iStar has more than doubled in value over the past year.
- Even then, it remains deeply discounted due to the rapid growth of its ground lease venture.
- It could be the (insert successful tech company name) of the REIT industry and priced at just around half of its NAV, the shares are still a steal.
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We then doubled down at ~$17.50 per share in March 2021.
Will we triple down at $24 per share?
The answer is yes.
Generally, such a large and rapid surge in share price would give me pause, but not in this case.
I just tripled down and bought more shares of STAR with my company's brokerage account, which is separate from the HYL model portfolio.
Below, I explain why STAR remains one of the best investment opportunities in today's market.
But before that, here is a quick recap of our investment thesis:
Quick Recap Of Our Investment Thesis
iStar is a mortgage REIT that's in a middle of a major transformation.
Three years ago, it founded Safehold (NYSE:SAFE), which is the first and only publicly-listed ground lease REIT, and to this day, STAR owns two-thirds of its equity and takes care of its management against fees.
Turns out that SAFE was a major success. It has been one of the best-performing REITs since its inception and has grown its assets more than 11x in just a few years. Moreover, we think that this is just the beginning for SAFE. It has the potential to change how we invest in real estate and disrupt a $7 trillion industry. This short clip explains how:
Since STAR is its manager and biggest shareholder, it directly benefits from SAFE's success, but to this day, this success still isn't correctly reflected in its share price, causing it to be undervalued.
Below, I explain why I just tripled down on STAR:
The Discount Remains Intact As a Result of SAFE's Surging Value
With the share price more than doubling over the past year, you would expect the discount to have disappeared.
But that isn't the case because of one main reason: SAFE, which is 2/3 owned by STAR, has also nearly doubled in value over the past year:
When we first invested in STAR, it had a $0.9 billion market cap, and the value of its stake in SAFE was $1.8 billion, meaning that it was 50% undervalued based on its stake in SAFE alone.
Today, STAR has a 2x times larger market cap at $1.8 billion, but the value of its stake in SAFE is $3.1 billion, meaning that the discount is almost intact.
If the value of its stake in SAFE had not grown, then STAR would now trade much closer to fair value, but as a result of SAFE's success, STAR remains deeply discounted.
The Wealth-Creating Portfolio They Call "UCA" Has Grown Dramatically
Based on SAFE's market cap, STAR is still nearly 50% undervalued.
But does SAFE's market cap properly reflect its fair market value?
In the past, we have argued that SAFE also is undervalued, which means that STAR is even more discounted than it may first seem.
And as SAFE continues to scale, this discount grows even larger as a result of the portfolio-embedded unrealized capital appreciation or "UCA" in short.
What is that?
Under the terms of a typical SAFE ground lease, at the end of the lease term, SAFE will own whatever is on top of the land.
Since SAFE will eventually own it, they track the estimated present value of whatever is on top of their land and call this the "UCA."
Typically, the building is worth a lot more than the land, and therefore, each new ground lease investment grows the UCA exponentially.
In the first quarter, this was estimated to be worth $5.6 billion.
In the second quarter, it grew to $6 billion.
At this pace, it could well be in the $8-10 billion range in a year from now:
SAFE's market cap is today only half of that, and therefore, the growth in UCA is not properly factored into its valuation or that of STAR.
Since that STAR owns two-thirds of SAFE, the $374 million added over the last quarter mostly belongs to STAR. That's a lot of value creation in a single quarter for a company with a $1.8 billion market cap.
As STAR/SAFE continue to educate the market on the value of ground leases, we expect this value to be better reflected in SAFE/STAR's share price in the future. SAFE presents the math behind its UCA in slides 15 to 20 of its investor presentation.
SAFE Is Still Just Getting Started and The Hardest Is Now Behind
SAFE was created in 2017. It went public with a $0.43 billion portfolio, mostly contributed by STAR, and since then, it has grown 11x its portfolio size and gained strong market adoption:
That was by far the hardest part.
Back then, no one knew what the "modern ground lease" was, and SAFE had to educate the market to convince the first property owners to partner with them.
Now SAFE has proven itself and the real scaling of its platform is just getting started. SAFE could do another 10x and it would still be scratching the surface of its $7 trillion dollar market.
If it could grow so fast from 2017-2021, despite (1) having to educate everyone, (2) having poorer access to capital, and (3) not being nationally scaled, then we think that SAFE will do a lot more over the next five years.
Here's what they noted in their second quarter earnings call:
"I will tell you that we are busier than we've ever been. We're seeing this kind of thought that we've talked about really start to happen, the awareness of our product, our cost of capital, customer satisfaction, network effect. So as Jay alluded to, I think the second half of this year, going into early next year feels really good right now."
Put simply, the risk of SAFE becoming a failure has come down significantly, and the odds of it becoming the next big thing have risen sharply.
That justifies a higher valuation for both, SAFE and STAR.
The Attempt to Sell Net Lease Properties Has a Hidden Message
Recently, STAR announced that it was exploring a potential sale of its net lease portfolio, which is worth nearly as much as its stake in SAFE.
Selling those assets would be great because it would simplify STAR's portfolio and make it even more focused on ground leases.
But the hidden message here is that they have so much demand for ground leases that they need to unlock capital elsewhere to take advantage of the opportunity that's presented to them.
Coincidentally (or not), STAR announced a few weeks later that it had developed a new product that it calls "Ground Lease Plus" that will aim to accelerate SAFE's growth even further.
Essentially, STAR will originate ground leases earlier in the life cycle of assets on pre-development projects, and once the development meets shovel-ready criteria, it will sell those ground leases to SAFE.
This is a great win-win for both because:
- It will provide SAFE a new origination channel that will increase its pipeline and accelerate its growth.
- While it also will provide STAR with an opportunity to earn higher returns than it would with net lease properties, increase its focus on ground leases, and potentially also speed up the monetization of its legacy assets.
Just last quarter alone, STAR already lined up nearly half a billion worth of opportunities through "Ground Lease Plus."
This is a great opportunity for STAR, and given that they may have billions worth of such opportunities in the near term, selling the net lease properties makes a lot of sense.
The Story is Finally Getting Out to The Mainstream and More Analyst Coverage is On Its Way
We have been covering the opportunity in STAR since the summer of 2020. Back then, the story was a lot more complex, and STAR's management had not been nearly as vocal about their intentions.
Today, this is changing and analysts are finally seeing it unfold. Recently, B. Riley, a major investment firm, initiated coverage with a Buy rating and a $35 target price. They also made the following comment:
STAR is a diversified mortgage real estate investment trust trading well below net asset value "with multiple catalysts to erase that discount." The company is undergoing a "major transformation" to focus on growing its ground lease business.
In addition to that, they also initiated coverage of SAFE with a $100 price target. They added that:
"SAFE creates 40c for every $1 of equity it deploys, or effectively a 40% accretion to its investment. When this "value-creating" operating model is coupled with SAFE's "substantial premium to GAAP book value," a "virtuous cycle" is created in which "substantial accretion can be realized by issuing stock. We expect SAFE and STAR to merge by mid 2023 with SAFE being the surviving entity, which will likely create further synergies.
This news was significant enough to move STAR's share price by 10%.
As STAR (potentially) sells its net lease properties and reinvests in ground leases, its story will become even simpler, and the opportunity will be even clearer to a larger number of analysts.
Jay Sugarman Has Not Sold a Single Share
Jay Sugarman, CEO of STAR and SAFE, owns 2.5 million shares of STAR, and 105k shares of SAFE.
His stake in STAR is now worth over $60 million, and his stake in SAFE is worth an additional $10 million.
With STAR more than doubling in value over the past year, you would think that selling some of those shares would be the reasonable thing to do.
That's especially true when you consider that these shares represent the bulk of his net worth.
Even then, he has not sold a single share.
Jay has often talked about STAR/SAFE as a "generational opportunity" and clearly, this is not just talk. His personal wealth is on the line.
STAR is a generational opportunity that has the potential to reinvent how commercial real estate is owned and I want to be a part of it.
I know it is up a lot already, but this could very well be the beginning of a multi-year (decade?) streak of significant value creation for its shareholders.
In some ways, STAR could be the (insert successful tech company name) of the REIT industry and priced at just around half of its NAV, the shares are still a steal. In the recent SAFE conference call, Jay said that they hope "this is a trillion-dollar business." No other REIT (VNQ) talks about trillions, especially so early on in their growth path.
After my recent additions, my position in STAR has become nearly as large as my position in STORE Capital (STOR), but at this pace, STAR will soon become my largest holding.
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This article was written by
Jussi Askola is the President of Leonberg Capital, a value-oriented investment boutique that consults hedge funds, family offices, and private equity firms on REIT investing. He has authored award-winning academic papers on REIT investing, has passed all three CFA exams, and has built relationships with many top REIT executives.He is the leader of the investing group High Yield Landlord, where he shares his real-money REIT portfolio and transactions in real-time. Features of the group include: three portfolios (core, retirement, international), buy/sell alerts, and a chat room with direct access to Jussi and his team of analysts to ask questions. Learn more.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of STAR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.