Stepping into the West 42nd Street office of Jay Sugarman, the longtime CEO of iStar, is disorienting.
On the mantels and windowsills, Sugarman flaunts his collection of bowling pins. Then there are the UFO-inspired, surround-sound speakers scattered around the room. (Sugarman designed them himself with the help of an Italian pro he hired.) And if you look carefully, you might spot the small, black and white, album-cover-quality portrait of Sugarman leaning against a truck with someone who looks like an old frie—but wait…isn’t that Bruce Springsteen?
It’s all enough to make you wonder whether Sugarman’s day job as a real estate titan is nothing more than, as The Boss would say it, a “brilliant disguise.”
But setting aside the disguise part for a moment, Sugarman sure is in the midst of doubling down on brilliant. He’s leading iStar into a staggering bet on the much-maligned ground-lease sector—a type of deal in which ownership of a commercial building is neatly snipped away from ownership of the underlying land. The operator keeps the building and pays iStar to lease the land for 99 years, and, in theory, each player gets one of the most precisely calibrated risk-return profiles in the real estate finance world.
But the ground-lease game has been tarnished by some extremely high-profile deals gone awry in recent years. RFR Realty owns Lever House, at 390 Fifth Avenue, under a ground-lease structure. The landlord has been outright shunned by lenders because banks don’t think RFR—which narrowly escaped foreclosure on the building in 2017—will be able to afford payments on the 99-year ground lease once automatic ground-rent hikes go into effect. (In January, an undisclosed entity purchased RFR’s debt.) A ground lease disaster also sealed the fate of the Chrysler Building, which Tishman Speyer and the Abu Dhabi Investment Council were forced to sell to RFR last week at an 81 percent discount to their acquisition cost.
And the optics of ground leases themselves aren’t the only challenge; iStar is still staggering under the weight of an asset portfolio that the financial crisis thwacked like a cannonball, and it announced last year a plan to slough off nearly the entirety of its prior holdings. To make matters dicier yet, the one high-profile asset that iStar is still committed to is itself an intrepid scheme: a massive mixed-use development in the sleepy New Jersey beach town of Asbury Park—there’s the Springsteen connection—where Sugarman hopes to sell condominium units for as much as $6 million a pop.
But Sugarman has always had a thing for using transformations to his advantage. As a young corporate climber in the 1980s, he often raced home after work, traded his power tie for a ripped T-shirt and slunk into a Midtown bowling alley, where he passed himself off to other regulars as an unemployed boob—the better to persuade them to stake a few bucks on the next 10 frames.
It’s hard to say whether Sugarman could pull off that exact ruse today—though iStar does happen to own a portfolio of bowling alleys. Now in his mid-50s, the CEO is deeply settled into his identity as a leading light of real estate finance, wearing the responsibilities of his position as comfortably as an old suit. (Not surprising, given that he’s had the same title since 1997.) Married to his high-school sweetheart—they have two sons, one at university and one in high school—and a committed New Yorker since college, he’s not an especially fickle character. But then again, Sugarman, a tall and graceful figure, still has the affable, protean physicality of a stage actor at rest, waiting for the cue to become someone else. And as his office paraphernalia indicate, he has quite a few tricks up his sleeves.
Commercial Observer: Your ground-lease subsidiary business is called “safehold,” but that’s also the noun you use for the leases themselves: You call each individual deal a “safehold.” Why do your deals earn that proper noun?
Jay Sugarman: We think the idea of separating the two investments, the land investment from the building investment, absolutely is a way for owners to really efficiently use their capital. But we kept running into people who had a bad experience with some of the old-fashioned ground leases. And when we started to really highlight the differences—no fair-market-value resets, no fees, no ambiguity—you start to see that these are fundamentally two very different things. The safehold ground lease was very different than what people were perceiving as the historic ground-lease business. We really only came up with the name because it does what it says. It’s a very safe, quiet way for an owner to efficiently run his business. Shouldn’t we really distinguish this from old-fashioned ground leases that are value destroyers, since we’re building something that’s a value enhancer?
How did ground leases get stuck with such a lousy reputation?
If you start by looking at who actually did ground leases, it was typically folks who are not in the business of real estate. You had hospitals and churches and universities: It was never really a customer business. Nobody treated the building owners, their customers, as somebody they had a long-term relationship with. Everything we are doing is trying to understand how can we make the value of the entire real estate more valuable, and nobody’s ever had that perspective. We know what works and what doesn’t work. We know what our peers in the finance world want to see in a ground lease. We know what we would pay if we were buying a leasehold—and you have to create the structure and the sizing and the pricing that actually unlocks value for the building owner. And so, we’re coming at it just from a fundamentally different way than anybody else has.
None of that sounds like rocket science. Why haven’t other finance companies caught on?
If you’re a university and somebody wants to build on your land, you’re not in the business of saying, “Well, I’m going to do that all over the country.” So, ground-lease holders had no reason to say, “Let’s figure out a format that works really well for you and works really well for all the lenders you might run into and works really well for all of the future buyers who might show up.” When you’re trying to build a national enterprise, across multiple markets, multiple property types, at multiple stages of the real estate cycle—whether it’s refinancing, recapitalization, or acquisition or sale—you have to come at it with the mindset we have. We’re in a customer business, we’re in a relationship business and the building owner is our customer. And that is just fundamentally different than anything you will ever hear described in what I’ll call the old-fashioned business.
Do you mean that the sector was full of more-or-less unsophisticated lessors?
Nobody has ever wanted to do business with somebody owning the land who didn’t understand the building business. You know, we’ve had a 25-year relationship with folks and customers in the finance world and in the net-lease world. And we’re always thinking about, how can we make the pie bigger? And so this is a great opportunity to do it on a very large scale.
Let’s say I’m a major urban landlord looking at financing options and my image of a ground lease is that it’s just a way to get a fast-food franchise built—or that it’s what sunk the Chrysler Building. What do you say to persuade me to hear you out?
I’m giving you a better solution: lower-price capital that eliminates a lot of your maturity risk and generates higher returns for you, if you do what you say you’re going to do with the building. Why do you want to tie your money up in this lower-return asset [i.e., land] that has no skills involved, right? If you really want to maximize your return on your skillset, this is a much more efficient way for you to put out capital.
Real estate finance players are generally used to thinking, at most, 10 years out. Have you gotten many funny looks from potential customers when you start talking about 99-year lease terms?
This idea really came about as a reaction to a market that has gotten so short-term focused. We’ve forgotten that there’s a huge part of the market that’s looking for long, steady compounding returns. If [Warren] Buffett has taught us anything, it’s that’s were much too short-term focused. He’s built an incredible franchise by doing business with smart people and just letting the compounding effect take place. We think safehold’s structure is exactly that for the next generation. It is a long, powerful compounding return engine.
And your customers have been willing to jump on board with that?
Think about it. When people are refinancing every five years, they’re paying legal fees, transfer fees, mortgage fees and mortgage recording taxes, and you’re paying it on the entire capital stack. We’re taking 35 percent of the capital stack and putting it in a very quiet, safe place for 99 years. All those other payments go away. When you actually just look at it you go, “Wow, this is a fundamentally better way. This is more logical.”
This idea of conceptually splitting the physical asset into a high-return segment and a low-return segment—is that a phenomenon that occurs in other areas of finance, outside of real estate?
This is common practice in the corporate world and has been for 30 years. Almost every corporate entity, whether voluntarily or involuntarily, has had to figure out which are its most productive assets, and which are the ones that can trade at a higher multiple that can just be leased. We looked at it and asked, “Why hasn’t real estate done the same thing? This is completely natural.” It was one of those eureka moments where you go, “Why aren’t we doing this?”
If it’s so natural, why wasn’t iStar doing this 20 years ago?
We just couldn’t we couldn’t crack the code back then. We had a very clear view that if we were an investment-grade financing and net-lease company, that that was a big business—and it turned out to be a great business. After the downturn, we lost some of the competitive advantages we had in those businesses, and we started to look around and say, where else can we take our toolkit and do something that’s a win-win, that has enormous market opportunity? And that represents for us potentially attractive risk-adjusted return? And that’s where we kind of went back and said, “you know, we’ve been doing these ground leases off and on. We had done about 12 of them over two decades.” But we couldn’t really figure out, okay, how does it fit? And then all of a sudden, this light bulb went off. It was like, “I know how to do this!”
So what was step one?
There’s almost no data about this industry. There’s no place you can go: the brokers didn’t really have a database. We had to build it ourselves. It actually cost us a lot of money. We hired a bunch of interns, and we had them pour through every filing that was made to create our own databases around ground leases, to prove to ourselves that they can be financed when they’re properly sized.
And the data was enough to convince you to throw real weight behind the idea?
We actually tested it on iStar’s portfolio. We would take things to market, and then we would take them to market split apart [i.e., with the building split from the land]. And we realized we were getting more money when we split them apart than we were when we left them together. And anytime I see that, anytime you find a business where you’re creating more money from both sides of the trade, we get excited by that. That is making the market more efficient.
What was the reaction when you first rolled out these deals?
Our first year, we were telling people, it’s more logical. It makes more sense. Here are the numbers. It brings higher returns and less risk for you as the building owner. And they would go, “Intellectually, absolutely. Makes sense. Financially, it absolutely makes sense. But philosophically, I just can’t do it.” And our view was that anything that’s intellectually and financially better will win. And people are starting to come around. We’ve seen it. Most of the people who’ve done a deal with us come back and want to do more. But it’s that first deal [that’s tricky]. “How do I get over the fact that my friend had a ground lease and it was a problem?” Or, “I’m reading about Lever House, and it’s a problem.” But we can take our $40 billion of experience in the transaction world and go introduce [ground leases] to a lot of people very quickly. And that’s what’s happening right now.
The Ally building in downtown Detroit is one of the biggest deals iStar’s pulled off as a ground lease. Can you walk me through how that came together?
This was a really interesting transaction for us. It was actually completed a little bit before we launched Safehold, but it played an important role in helping us develop our central thesis. We owned the building fee simple and had decided to market it for sale. We received a number of bids but weren’t satisfied, [so] we decided to see if [a ground lease] would work in this case on a larger property. We went to market on just selling a leasehold and we found that the bids we received, combined with the value of the ground lease we had created, [represented] a sizable premium, approximately 10 percent higher, to the fee simple bids with land and building together. That was really eye-opening at the time.
When is this ground-lease approach a bad fit for a potential customer?
Our idea is that ground leases are very flexible and would work in any of the top 25 markets on most well-located, institutional-quality property types … office, multi, hospitality, industrial, retail, et cetera. But they’re not always a good fit. Obviously, it wouldn’t work in the case of a residential condominium project, because you have so many individual owners. If a property isn’t well located, that can be a problem, because it messes with the value proposition of the land-building split. And if you have an owner intent on still being in control of the entire asset a century from now, he probably wouldn’t want a ground lease, either.
eBay was founded in 1995, so iStar’s name shows some vintage mid-1990s capitalization style. How did you name the company?
The name goes back to when we started Starwood Capital in the early 90s. Soon thereafter, I recognized there was an opportunity to provide mezzanine capital, common in the corporate credit world, to the real estate markets for the first time in a customer-friendly, problem-solving structure. We wound up launching a private investment vehicle in 1993 focused on that opportunity and took the portfolio and debt business public in 1998. We eventually named the business iStar to keep the connection to the brand we had built in the private markets. The “i” was to symbolize our “innovative” approach to create value by disrupting traditional real estate finance conventions.
Your way of thinking reminds me of the changes that have happened in baseball over the last decade, with teams pulling all kinds of strategies that are more efficient, but that simply weren’t done before people began analyzing the numbers.
I’m a huge Moneyball fan. [The book, by Michael Lewis, is about the disruptive strategies used by the Oakland Athletics.] You tear things apart and see what they really are, as opposed to just accepting what they’ve been.