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iStar Inc. (STAR) is one of the more interesting REITs in the market today. The trust was formerly a commercial property lender, but after the financial crisis saw significant credit quality deterioration, iStar became primarily a landlord, not a lender. Since then, it has transformed into a vehicle that owns an enormous percentage of a much larger stock, Safehold (SAFE), and is literally betting its future on Safehold. However, it appears that may be the best course of action for iStar, and as a result, the stock appears to be somewhat undervalued, and with an attractive yield to boot.

Understanding iStar

iStar is certainly an unusual REIT. I mentioned briefly its somewhat forced journey from lender to landlord, and now, it owns about two-thirds of a stock that has a market capitalization that is ~3X its own.

Source: Investor presentation

Apart from iStar’s interest in Safehold, which I calculate at just over $1.8 billion based on Friday’s closing price for Safehold of $54.94, iStar owns a further ~$4 billion in other assets. These assets are concentrated in the Northeast and Western parts of the US, with ground leases making up 36% of the portfolio, office and industrial 23%, and the balance from a variety of other subsectors. The net lease portfolio is about the same size as the trust’s investment in Safehold, so both are highly significant and provide some level of diversification for iStar shareholders.

Since Safehold is a ground lease platform, iStar’s total portfolio is certainly highly leveraged to ground leases. However, this is no accident as iStar believes ground leases provide superior safety to the trust over time, along with benefits to the building owners that lease the land from iStar.

Source: Investor presentation

This illustration of how a ground lease works for the tenant is indicative of why iStar has built its future around this concept. In this example, a $100 million building can be built by the developer for $65 million as the value of the land is said to be $35 million of the $100 million total. That means buildings can be developed more cheaply, which makes ground leasing an attractive option.

On iStar’s side, land has a very long holding period where little or no upkeep is required. The trust simply holds the land and collects ground lease payments with principal secure in the land beneath the building, irrespective of the building on top of it. While returns are generally lower on this sort of investment versus owning the property itself, the added safety and ability to spread the same amount of capital around multiple properties rather than just one has a diversifying effect as well.

Strong recent performance

iStar really is a lot about Safehold and less about iStar itself. Indeed, the trust spends the bulk of its digital ink in its investor presentations extolling the virtues of Safehold, not its own portfolio.

Source: Investor presentation

The first pillar in the trust’s strategy is to scale its Safehold position, which, as I mentioned, is worth about $1.8 billion today with a swift selloff in Safehold at the end of the week. Still, iStar is sitting on over a billion dollars of unrealized gains in Safehold shares, so the position is enormously important.

iStar has strong liquidity with cash in excess of $300 million and a relatively small revolver, adding up to more than $400 million in total liquidity, which it has been using in the past to build its Safehold position further, among other things.

Finally, iStar has been working to reduce legacy assets that were from prior to its transformation from lender to landlord, and continues to dwindle down those assets to recycle the capital into other things, like more Safehold shares.

Source: Investor presentation

Safehold has continued to scale its portfolio and iStar is doing the same thing with its own investment in Safehold. The stock of Safehold has rocketed higher in recent months, returning 56% in the first quarter of 2020 alone. This has done wondrous things for iStar since it owns roughly two-thirds of outstanding shares of Safehold, as you can see above. For obvious reasons, iStar is continuing to invest more and more in Safehold, adding $105 million during Q1.

Safehold is not what I’d call a cheap stock, however. Below, we can see estimates for FFO-per-share for this year and next year, and the resulting valuation is quite sizable indeed.

Source: Seeking Alpha

Safehold trades for 38 times this year’s FFO estimate and 36 times next year’s estimates, up enormously from a couple of years ago when the stock traded for FFO multiples in the high-teens. That skyrocketing valuation has led to enormous shareholder returns for iStar, but it looks like the trust’s own stock isn’t reflecting that.

The valuation looks favorable

iStar reported adjusted book equity value per share of $12.82 at the end of the first quarter.

Source: Investor presentation

That means that even without pricing in any sort of recovery in prices or performance of iStar’s portfolio since the height of the panic – which was when this book value was calculated – iStar is still trading significantly below its book value at $11.71 today. On a valuation basis, then, iStar looks fairly attractive, even considering its enormous debt load of $3.2 billion.

In addition to that, iStar raised its dividend recently during a time when REITs cutting dividends has become commonplace. iStar sees no such reason to do so and is instead returning more capital to shareholders.

Source: Seeking Alpha

The result is a yield that is near 4% once more after spending time in the area of ~2.5% pre-COVID-19. That’s nearly twice the yield of the broader market, and what you don’t get with the broader market is exposure to a clear market leader in Safehold.

While you could just buy Safehold yourself, that stock has a microscopic yield. Thus, if it is income you’re after, you’re much better off with iStar. The stock is priced below book value, has huge exposure to ground leasing, which improves capital safety, and pays a very respectable yield. Given this, I think iStar is worth a look if you’re in the market for an income stock.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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2020-06-27