iStar Inc. (NYSE:STAR) Q3 2022 Earnings Conference Call November 3, 2022 10:00 AM ET
Company Participants
Jason Fooks – Senior Vice President of Investor Relations and Marketing
Jay Sugarman – Chairman & Chief Executive Officer
Marcos Alvarado – President & Chief Investment Officer
Brett Asnas – Chief Financial Officer
Conference Call Participants
Stephen Laws – Raymond James
Jade Rahmani – KBW
Matthew Howlett – B. Riley Securities
Operator
Good morning ladies and gentlemen and welcome to iStar’s Third Quarter Earnings Call. At this time, all participants have been placed on a listen-only mode. And the floor will be open for questions and comments after the presentation. [Operator Instructions]. As a reminder, today’s conference is being recorded.
At this time, for opening remarks and introductions, I would like to turn the conference over to Jason Fooks, Senior Vice President of Investor Relations and Marketing. Please go ahead, sir.
Jason Fooks
Thank you, and good morning, everyone. Thank you for joining us today to review iStar’s third quarter 2022 earnings. With me today are Jay Sugarman, Chairman and Chief Executive Officer; Marcos Alvarado, President and Chief Investment Officer; and Brett Asnas, our Chief Financial Officer.
This morning, we published an earnings presentation highlighting our results, and our call will refer to these slides, which can be found on our website at istar.com in the Investors section. There’ll be a replay of the call beginning at 2:30 p.m. Eastern Time today. And the replay is accessible on our website or by dialing 1-877-481-4010 with the confirmation code of 46958.
Before I turn the call over to Jay, I’d like to remind everyone that statements in this earnings call, which are not historical facts will be forward-looking. iStar’s actual results may differ materially from these forward-looking statements, and the risk factors that could cause these differences are detailed in our SEC reports. iStar disclaims any intent or obligation to update these forward-looking statements, except as expressly required by law.
Now, I’d like to turn the call over to iStar’s Chairman and CEO, Jay Sugarman. Jay?
Jay Sugarman
Thanks, Jason, and thank you all for joining us today. During the third quarter, iStar Safehold announced an agreement on a strategic combination, and took another major step forward in building the first fully integrated pure play ground lease company in the public markets. The proposed combination will add a new anchor investor in the company when completed, and help highlight the valuable cared component of the combined company’s growing ground lease portfolio.
Unfortunately, a highly volatile market marked by historic interest rate increases has made near-term conditions very challenging. We continue to work through those challenges, and believe the long-term prospects for our modern ground lease business remain compelling. In addition, our asset management and capital markets teams made continued progress in the quarter, simplifying the balance sheet and monetizing non-core assets. We do expect these tougher market conditions to slow the expected timing of certain asset sales. As a result, we now expect the timing of the merger to fall at the end of the first quarter are early in the second quarter.
Moving to the core ground lease business, Safehold closed on $280 million in new ground leases on a half a dozen high quality multi-family assets, giving customers a clear capital advantage and helping them execute their business plan. UCA continue to grow and now exceeds $10 billion and Safehold sold the ground lease and an off-market opportunity looking at a sizable capital gain. All positives in an otherwise challenging market. But as slowed real estate transaction activity and limited capital availability to the industry. We expect ground lease volumes in the fourth quarter to reflect a slowing backdrop.
With that, let’s take a look at the quarter in more detail with Marcos and Brett. Marcos?
Marcos Alvarado
Thank you, Jay. And good morning, everyone. Let’s begin on Slide 3 to discuss the quarter’s activity. During the third quarter, we continue to make progress on asset monetization and generated meaningful proceeds through asset sales and loan repayments. As Jay alluded to the uncertain economic environment and reduced real estate transaction volume could potentially slow the pace of go-forward asset sales.
Despite the current choppy markets, Safehold saw steady growth during the third quarter both through new originations along with recognizing a significant gain from the sale of a ground lease. Additionally, we continue to streamline our balance sheet by extinguishing debt and ended the quarter with approximately $1.3 billion of cash on hand.
Turn to Slide 4, which details our earnings results. For the quarter net income was $12.1 million or $0.14 per diluted common share and adjusted earnings were $28.5 billion or $0.33 per diluted common share. Of note, during the quarter we negotiated with certain holders of our convertible notes on an early redemption of $81 million of those notes in exchange for 3.3 million shares of stock — common stock and $43 million of cash. These transactions resulted in a $12 million of non-cash losses on early extinguishment of debt during the quarter, which also resulted in a net increase to equity of $38 million.
Slide 5 shows an overview of our business with a simplified presentation of our balance sheet. As mentioned before, at the end of the third quarter, we had approximately $1.3 billion of unrestricted cash, a carrying value of Safehold stock ground lease plus and leasehold loan investments of $1.55 billion and $637 million of legacy assets and other assets, getting us to a total assets on the simplified version of the balance sheet of $3.5 billion.
On the right side of the balance sheet, we had $1.7 billion remaining debt, $305 million of preferred equity and $144 million of other liabilities and non-controlling interests, including the accrued balance of iPIP, leaving us with common equity of $1.4 billion. When adjusting for Safe’s mark-to-market value, and our estimate of the incremental unaccrued iPIP amounts or common equity per share as adjusted is approximately $1 billion or $12.33 per share.
The significant decrease in this balance from last quarter is due to the pullback and saves market value. And given our meaningful stock ownership safe market value will continue to be the biggest driver of value to high starch shareholders. As you can see on the slide, we’ve provided a sensitivity analysis on this adjusted common equity value per share metric. Should safe stock price go up or down by $10 from here.
And with that, let me turn it over to Brett to go through the portfolio in more detail. Brett?
Brett Asnas
Thank you, Marcos. And good morning everyone. Let’s walk through our portfolios businesses beginning with Safehold on Slide 6. During the third quarter Safehold made steady progress originating 284 million of new ground lease transactions. Also during the quarter Safehold sold one ground lease from its portfolio located in the Washington DC, MSA, which generated an approximately $46 million net gain.
Separately, as we previously announced, MSD partners has committed to purchasing carrot at a 2 billion valuation, which is a substantial mark for the underappreciated asset and should serve as a good data point as we continue to seek to unlock current value per shareholders.
And lastly, Moody’s has recognized the benefits of the merger transaction and puts a fold on positive outlook. With a path to becoming an A rated borrower. Safehold ended the quarter with more than 750 million of liquidity for future investments. However, the current elevated rate environment has had a significant impact on safe stock price. And you could see that reflected on the left side of the slide, as the market value has fallen to $1.2 billion, which is below our carrying value.
On Slide 7, we detail our investments in the ground lease ecosystem. As we previously discussed, iStar has two separate funds centered on investing in the ground lease ecosystem, which enables us to pursue additional ground lease opportunities. One is for pre development phase ground leases, while the other is providing leasehold loans that are combined with the Safehold ground lease.
During the third quarter based on milestones being met, iStar sold one ground lease asset to Safehold for $36 million from its ground lease plus portfolio. Our net carrying value for these investments totaled 90 million and is made up of seven assets with targeted returns between 9% to 12%. Additionally, we have 147 million of unfunded commitments associated with these ground leases — ground lease related investments.
Slide 8 highlights what remains of our non-ground lease assets. These are the assets that will either be monetized or moved over to spin cap. In our real estate finance portfolio, during the quarter we received proceeds from loan repayments and sales totaling $33 million and recognized $3 million of gains associated with these sales. Remaining in this portfolio is six loans carried out $177 million. We anticipate the majority of these loans to be repaid prior to merger closer.
Regarding our legacy and strategic assets, we received 35 million of proceeds and distributions from asset sales during the quarter, which generated an additional 11 million of gains. What remains is a total of $394 million of carrying value of which Asbury Park in Magnolia Green represent the two long-term assets totaling 270 million as well as 13 short-term assets, which totaled a $124 million.
In total during the quarter, iStar generated $105 million of proceeds from asset sales, loan repayments, and a ground lease plus sale the Safehold. Slide 9 shows an overview of our corporate debt. Continuing on our strategy to simplify the balance sheet, reduce outstanding debt and preserve cash. During the third quarter iStar extinguished a total of $155 million of debt, including $93 million of convertible notes, and $62 million of open market purchases of our bonds at a price close to par.
At quarter end, we had approximately 1.7 billion of total outstanding debt with a weighted average maturity of 3.2 years. In conclusion, we continue to execute on our stated strategies to strengthen and streamline our portfolio. Additionally, we are also making significant progress in the business combination with Safehold and look forward to providing you more details as they unfold.
With that, let me turn it back to Jay.
Jay Sugarman
Thanks, Brett. I know a number of you have asked when the merger proxy is expected to be filed. There are a lot of documents and different parties in the mix. So it’s been time consuming to say the least. And I think we’re near in the homestretch on getting those documents filed.
Now, let’s open up for questions. Operator?
Question-and-Answer Session
Operator
Thank you. [Operator Instructions]. Thank you. Your first question is coming from Stephen Laws of Raymond James. Stephen, please ask your question.
Stephen Laws
Hi, good morning. Jay, I guess first, let me start with the asset sales. I think in the original announcement, it was $400 million was the number provided? When you look at the sales that took place this quarter. Does that kind of all work against that number? Or is there an update on how many more asset sales from here? And then kind of on that topic, any sales in October? And is it anything chunky or is it really just the loan payoffs and smaller assets?
Jay Sugarman
Hey, Stephen, yes you think you got a right way of. I think about a dozen smaller operating assets we need to work through. Those are might suspect processes where you market to get bids, you’ve got to go through the process, sometimes the top bid falls out, if you go back. So that process is a bit frustrating, but team continues to make progress.
On the long payoffs, yes, those are more chunky, we have better visibility on those. But again, this is a market that we take nothing for granted. So our team continues to work hard with our customers to make sure those get to the finish line. And then we one or two sizable assets that we’re working on, but we can just feel by where the market is. But our original timeframes are probably going to slip here.
Stephen Laws
Along those lines, kind of — on the timing, you mentioned the proxy. As you look at the past, I think it’s a vote and maybe it’ll take time for SEC to review the documents. Can kind of lay down the — lay out the path or timeframe, the events kind of up to the end of Q1 early Q2 as far as maybe a targeted closing. And is it correct that I think there’s two extension options that actually could allow this to push through September 30 at the latest if the market doesn’t co-operate?
Jay Sugarman
Yes, you’re right. The real outside date is September 30th. And we continue to have a lot of time and effort going into trying to get this done by the end of the first quarter, beginning of second quarter. There’s some small penalties involved if we missed the first quarter and the larger ones if you missed the second quarter, so a lot of motivation to try to get it done.
The process from here to the finish line is file the proxy, get the SEC comments, work through that process with them. There are multiple documents going at once, so we’ll probably have some work to do with them. And then the asset sales in parallel are taking place. So yes, we certainly believe the timeframe works to get this done by the end of the first quarter, early second quarter.
Stephen Laws
Thanks for laying that out. Sounds like everybody will have a busy holiday on your side. We’ll follow that. Last question on the liabilities now you retired, extinguished a lot of debt during the convert, the quarter converts and then can you talk about the pace of how you think about retiring debt, you know how you look at relative to the attractiveness of what to retire first and kind of how we’re going to see that shrink between now and closing?
Jay Sugarman
Yes, Brett, I will let you, you want to lay out how we’ve been looking at the market right now?
Brett Asnas
Sure. Absolutely. Hey, Stephen.
Stephen Laws
Hey, Brett.
Brett Asnas
Yes, we definitely retired a decent amount in the third quarter. Opportunistically, I think as Jay alluded to, once we kind of get through our filings and get through our process, we’ll continue to shrink down the balance. I think the bonds right now are trading slightly below par. And we’re earning a decent rate on our cash. So I think the ARB there is a lot less than we need to get through our process to kind of to the merger to shrink down that debt balance. During the quarter, we obviously took out the $93 million of converts, we’re able to issue what is today, quite accretive equity. And then on the bonds, we will continue to look to get approvals to continue to shrink those balances as well.
Stephen Laws
Thanks for the color, Brett. Appreciate the comments this morning.
Operator
Thank you very much. Your next question is coming from Jade Rami — Rahmani, apologies at KBW, Jade your line is live.
Jade Rahmani
Thank you very much. The follow-up on the liabilities. The weighted average duration is 3.2 years, the weighted average cost is 4.79%. Even excluding the troughs, the cost is between 475 and 550. I mean, given the turmoil playing out today, and recently in the capital markets, and just extreme levels of interest rate volatility. Wouldn’t you choose to keep those liabilities and look at that as an asset?
Jay Sugarman
Yes, hey Jade. No, definitely in a market like this, we’re looking at all sources of capital. And definitely those look attractive on their face. They do have a different covenant package, given they sit at Star and not Safehold. So got to take that into account. As you saw as part of the transaction, we are keeping the troughs in the system, so that definitely was a piece of paper, both from duration and where it sits and pricing that made sense. But I think ultimately, it all has to line up to make sense. And we think the structure we’ve come up with is still the best. But definitely, if the market continues to deteriorate, I’m sure those special committees will be taking that into consideration.
Jade Rahmani
Thank you. So I guess just to put a finer point on that, whose decision is it to repurchase and be buying back bonds? Is it management’s decision or is it special committees decision?
Jay Sugarman
That typically is a board decision. And we have authorizations that have to be approved by the board. The actual execution would obviously be in management’s stance of that, any meaningful transaction like that would have board authorization.
Jade Rahmani
Okay. On the ground beside, are you all looking to do anything different? I see the appeal of offering a cash cost that’s below where real estate investors can get a mortgage today. So clearly that is compelling for them. But what about on the Safe and iStar investing side. Anything different to extract higher economics other than just repricing for where the bond market is today?
Jay Sugarman
Marcos, do you want to give some thoughts on that?
Marcos Alvarado
Hey, Jade. So yes, I think you hit the nail on the head, there’s obviously a shift going on in pricing. We’re sort of balancing that with our customers’ needs. As you can imagine, there’s a little bit of a sticker shock going across the board, not just from our cost of capital, but ultimately, the fee financing alternatives where the cap rates today in the market. Think you’ve heard us on the Safe call, our expectation that there’s going to be a slowdown, given all of those dynamics. So we’re trying to be clever and figure out how to meet our customers’ needs and ultimately meet our needs and create value for our shareholders. So we’re thinking about some different structures and alternatives. But as of right now, we’ve just moved at our base pricing.
Jade Rahmani
Curious about how you’re thinking of the office market, is it a sector you’re avoiding, that’s an area where we’re seeing the most extreme liquidity shortfall. A lot of the commercial mortgage REITs have been booking surprisingly, large loan loss provisions, even on office deals that are well leased that they previously rated class or rated risk rated 2 Class A type office deals. Those deals aren’t even being able to refinance right now. So if you were positively inclined toward office, there could be a massive opportunity, probably stepping there, not sure how you feel, how they feel about the office market?
Jay Sugarman
I think we share the broad sentiment that there’s potentially a decent amount of value disruption in the office space, as a broad generalization as you know, Jade that’s asset specific and market specific, credit quality and ultimately demand in certain markets. And you can bifurcate that from San Francisco to one end to potentially some of the Southeast and Sunbelt markets where there’s probably a better demand. It will be extremely selective. On office, we are looking at it, our rule of thumb is a little bit different. We’ve certainly hit values.
In our underwriting process, we look at alternative use, we look at land value, and ultimately we look at where the land is. And so I would say for the right asset, for the right location, we will do some office transactions going forward.
Jade Rahmani
Thank you very much.
Operator
Thank you. Your next question is coming from Matthew Howlett of B. Riley. Matthew, please ask your question.
Matthew Howlett
Hey, everyone. Thanks for taking my question. Just on the sensitivity, I realized, how dependent iStar is on the price of Safe common stock. But when you just stripping that out, when you look at when you gave the number, even the merger, I think it was 1845 of iPIP Safe to that 4345, if holding that constant as anything means a lot of moving parts with iPIP with non-core assets, with debt repurchases, has anything move one way or the other, ex the movement of Safe share price?
Jay Sugarman
Right, we’ve run an analysis since then that shows any kind of material variance, iPIP has clearly come down. But that is tied directly to Safe’s share price at this point. Couple the assets sales, I think you’ll see some marginal degradation in realized values, but we’re seeing — we’re still seeing modest numbers relative to the overall scale of that transaction. So I think at this point, it’s more a function of getting to the finish line. Having as much cash as we have on the balance sheet is a bit of a negative drag. So having that run out longer is not good. So we’re trying to move everything along as quickly as we can. But I’d say that that’s probably the biggest delta we see is just the friction cost of waiting to close the transaction.
We certainly hope to close by year-end, I don’t think that’s reasonable anymore. So an extra three months, four months, and does have a cost to us.
Matthew Howlett
Got you. Okay, understood, certainly in this environment, but certainly, I was pleased with the gains you had the $11 million gains you had on the legacy stuff. And I guess that’s my other question. You look at SpinCo, what’s going to go in there ultimately, obviously is dominant by Asbury and Magnolia green. I get a lot of questions about potential of SpinCo, clearly, it’s going to take a while to monetize, there would be some expenses in there, any update on but then again, it’s a drag. I mean people don’t want to give you a full credit for the book value today on SpinCo. Any update on Asbury Park and Magnolia that’s worth pointing out and then I read an article on the trade brags that said you’re developing apartments of Coney Island. Is that going to be SpinCo, just curious what you can give us an update on those two assets of SpinCo in general?
Jay Sugarman
I think the [indiscernible] do as good a job as they can. But in that particular instance, we’re actually selling the land to somebody who’s doing the development. So for liquid portfolio, so we’re not the developer there.
Brett Asnas
Okay. Marcos, anything specific, I mean we continue to have a number of projects in process to sell to third-parties in Asbury Park. Again, that’s a fairly long development process that we have to shepherd for them. So I’m certainly hopeful that short-term bumps in the road in the marketplace, don’t change long-term investment thesis around why Asbury is special and why these particular parcels we think are fit very well into their the buyers strategic plan. So we’re going to continue to execute that business plan. Marcos, I’m thinking of a latest on Magnolia Green?
Marcos Alvarado
Yes, let me just give you some high level color. In Q3, we sold eight units at Asbury Ocean Club. So we’re sort of winding down on our inventory there, which is great. Asbury Ocean Club in the Asbury had their best two years from a RevPAR standpoint. So they’re performing well. As I think about the longer term picture for both Mag Green and Asbury, they’re obviously susceptible to the rate environment we’re in. So I do expect some slowdown in the monetization over the short-term on those assets. But they’re still playing along through Q3 in the early days of Q4.
Matthew Howlett
Great. Well, we’ll look for an update and good luck. I know, it’s a lot of work. Good luck with getting everything closed. I think there’s obviously a lot of potential upside once you get through this, but appreciate all the hard work.
Marcos Alvarado
Thank you.
Operator
Thank you very much, Mr. Fooks, we have no further questions.
Jason Fooks
Okay, thank you. If anyone should have any additional questions on today’s earnings release, please feel free to contact me directly. Jenny, would you please give the conference call replay instructions again.
Operator
No problem. There will be a replay of the call beginning at 2:00 p.m. Eastern time today. The replay is accessible on our website or by dialing 1-877-481-4010 with a confirmation code of 46958. Thank you, ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.
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