It's not super common for real estate investment trusts (REITs) to reinvent themselves midstream, but that's exactly what iStar Financial (NYSE: STAR) is doing. iStar, which started out as a finance company, is slowly retiring its old portfolio and ramping up its net lease activity through its subsidiary Safehold (NYSE: SAFE).
This transition into a blend of the two investment sectors may lead investors to wonder whether the company is a worthwhile buy in today's market. Let's take a closer look at iStar Financial and, ultimately, whether it's a buy today.
Its future in ground leases
Its old portfolio, which the company refers to as its legacy assets, includes both short- and long-term land and development and operational properties in the commercial sector. The company has widely advertised its effort to reduce its legacy portfolio recycling capital into its ground lease operations and has successfully done so, reducing its total legacy portfolio by 18% since the first quarter of 2020.
iStar's new focus is on ground leases secured by single-asset commercial real estate. This special type of lease structure allows iStar to lease the land to a third-party tenant on a long-term lease. The tenant has all rights to develop the commercial asset as they see fit, and when the lease term expires, the tenant can either purchase the land from iStar or the land reverts to iStar.
Ground leases are generally a secure method of real estate investing because of the equity coverage in the development as it relates to the value of the land and the position of the lease. As of Q1 2021, iStar had a rent coverage ratio of 3.8x, which means the company's rent is covered 3.8 times by the property's cash flows.
During the pandemic, 100% of the company's ground lease rents were collected while portfolio occupancy remained at 99% and 100%, respectively. Its ground lease operation through Safehold makes up 39% of iStar's portfolio as of Q1 2021, and its legacy assets make up only 11% of its portfolio.
iStar also has a financing branch made up of mostly commercial mezzanine debt (both senior and junior liens). As of Q1 2021, iStar had a total loan balance of $539 million, including $56 million of nonperforming loans, which netted a roughly 7.5% yield. Of its debt portfolio, 26% is backed by hotels, a sector that has fared terribly over the past year during the global pandemic, adding a layer of vulnerability to that portion of their portfolio.
Is iStar a buy today?
There's no denying iStar's ground lease business is doing very well and shows a lot of potential for investors. The company is cleaning up its legacy portfolio, which is undoubtedly its greatest weakness. iStar has improved a number of financial metrics as of Q1 2021, including its leverage ratio (1.1x), adjusted earnings per share ($0.16 increase year over year), and net income ($0.01 loss) and increased its cash holdings to $194 million.
Share prices are currently trading at record highs for the company, meaning investors are receiving just over a 2% return right now, a low return by most REIT standards. I like the direction iStar is headed and feel the company is making the right moves to improve its balance sheet, portfolio makeup, and business model, which will benefit them in the long run.
But I think the company's pricing for its performance and dividend return is reflective of where the company is headed versus where the company is today. I believe iStar is a buy for a patient investor with a somewhat higher risk tolerance. While it's headed in the right direction, it still has a ways to go before a lot of its portfolio risks are eliminated.