Traditionally, real estate investment trusts (REITs) or real estate stocks will operate in a specific sector of real estate, which could include owning and managing physical real estate like an equity REIT, providing real estate-related services, or investing in real estate-related debt, like a mortgage REIT (mREIT).
There are a select few, however, that offer a hybrid of these services. One of these REITs is iStar (NYSE: STAR), a real estate finance company that also owns, develops, and rents real estate with net leases and ground leases. If you're considering buying iStar, here's what you need to know before you buy.
iStar company profile
iStar originated as a mortgage REIT that offered mezzanine and structured financing options for high-end real estate over 25 years ago. The company has since expanded its portfolio to include ground-up development, management of commercial real estate, net leases, and ground leases through its subsidiary company, Safehold (NYSE: SAFE).
Currently iStar's portfolio is valued at $6.1 billion, with a primary focus on ground leases through Safehold (34% of its portfolio), net leases (37% of its portfolio), and real estate finance (12% of its portfolio). The remaining 17% of its portfolio is broken up as follows:
- land and developments (9% of portfolio)
- operational properties (5% of portfolio)
- strategic investments (9% of portfolio)
- cash (2% of portfolio)
Ground leases are the primary property type for real estate held, financed, or leased in iStar's portfolio, followed by office space and entertainment /leisure, two industries that have been hit hard by the coronavirus pandemic.
Because the company invests in a multitude of sectors, income is earned in different ways. Safehold's ground lease operation is iStar's primary focus at the moment, having provided $38 million in revenues in Q3 2020, holding a market value of $2.1 billion. The company acquires land for development and leases the land to long-term tenants, which provides the tenant with ownership rights to develop and manage the land and property while providing iStar with a senior lien position.
iStar's net lease business often intertwines with its ground lease operations, but revenues are earned by leasing physical real estate or raw land with a long-term net lease. The company currently owns 17,978 square feet of real estate leased through net lease ventures.
The last main income source for the company is its real estate finance portfolio, in which it earns interest on the loan. As of Q2 2020, the company had $730 million in loans with 25% of its financing portfolio being allocated to hotels, 23% condos, 20% multifamily real estate, 12% to land, 10% retail, 7% office, and 3% dispersed among other property types.
The company has three large developments underway: Ashbury park, a beachside resort and residency in New Jersey; Mongolia Green, a single-family residential community in Richmond, Virginia; and Grand Vista, a planned residential/commercial development on 709 acres outside Phoenix, Arizona.
The coronavirus pandemic surely has had an impact on iStar's performance over the past few quarters. Mortgage REITs and several sectors the company holds lease interest or operational interest in, such as hotels, entertainment, and offices, have had a rough few months. But the impact seems to be far less severe than some REIT counterparts. Luckily, the ground lease business has maintained optimal performance with a 100% rental collection rate for Q3 2020.
Additionally, net lease operations achieved 98% rental collections, mortgage and real estate finance collections achieved a 92% collection rate, and operating properties reached 80% collection Q3 2020. Occupancy for consolidated net leases was 98.6%. Of iStar's $730 million loans, $65 million are currently non-performing, and of the $665 million performing loans, the company is achieving an average return of 7.6%.
Adjusted earnings per share (EPS) are up 45% when compared to the same quarter last year but down 92% year to date when compared to year-to-date 2019. Adjusted earnings fall in line with EPS, with a $8.4 million increase in earnings when compared to the same quarter the year prior, but year-to-date earnings compared to the prior year show a $373 million overall decrease.
iStar has been consistently focused on reducing its legacy asset investments, which since Q4 2017 has been reduced by 54%, to $803 million. Despite having a tough quarter, the company is well positioned to continue expansion of ground leases through Safehold while maintaining its debt maturities, which currently isn't set for another payment until September 2022. The company has a leverage ratio of 1.2x and has $88 million in cash or cash equivalents, allowing a lot of flexibility during these uncertain times. Right now, its dividend payment is $0.11 per quarter, meaning it's maintaining a payout ratio of 47.5%, which is quite low for a REIT.
iStar stock price
iStar share prices took a deep dive after the 2008 recession, falling over 97% and has struggled to recover fully since. While share prices have increased from the February 2009 low of $1.13, share prices are still around 70% lower than 2006 and 2007 highs. Investors purchasing shares in iStar can currently achieve around a 3% return at the time of this writing. Jay S. Sugarman, Executive Chairman & CEO, believes there's a gap between current value and potential of iStar, largely due to its ground lease development program through Safehold, with share prices being undervalued.
I believe Safehold has major potential to help boost company performance in the long term, but I also feel the risk exposure in the current market for the other assets held in the company's portfolio is reflective of share prices.
The bottom line on iStar
iStar is clearly focused on consolidating its business model and shifting its focus from operational properties and financing to net leases and ground-lease structures, which over the past several years has performed tremendously. If you look at Safehold's performance, its gross book value has increased $1.3 billion in just a year. Considering its high collection rate, well positioned credit structure, and 56% return to shareholder year to date, it's obvious iStar is on the right track.
I definitely believe growth potential is there, but I don't see share prices increasing overnight. iStar still has a lot of legacy assets and financing to take care of before its balance sheet is more reflective of the company's new direction and the growth potential that comes with it. I expect the next few quarters to remain rocky as the company battles the volatility of the current market and expect to see more consolidation of assets while iStar waits to see how the market will react.