Earnings Call Transcript - SAFE Q2 2022

Operator, Operator

Good morning, and welcome to Safehold's Second Quarter 2022 Earnings Conference Call. 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, Senior VP of Investor Relations and Marketing

Good morning, everyone, and thank you for joining us today for Safehold's earnings call. On the call today, we have Jay Sugarman, Chairman and Chief Executive Officer; Marcos Alvarado, President and Chief Investment Officer; and Brett Asnas, the Chief Financial Officer. This morning, we plan to walk through a presentation that details our second quarter results. The presentation can be found on our website at safeholdinc.com by clicking on the Investors link. There will be a replay of this conference call beginning at 2:30 PM Eastern time, and the dial-in for the replay is 866-207-1041, with the confirmation code of 7436202. 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 may be forward-looking. Our 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. Safehold disclaims any intent or obligation to update these forward-looking statements, except as expressly required by law. Lastly, I want to highlight that yesterday, iStar filed an amended 13D disclosing that a special committee of the Board of Directors of iStar and a special committee of the Board of Directors of Safehold are in advanced discussions regarding a potential strategic corporate transaction, and they are proceeding to negotiate definitive agreements. However, because no definitive agreements have yet been executed and there can be no assurance that definitive agreements will be executed, we won't be able to discuss the potential transaction on this call. With that, I'd like to turn the call over to Chairman and CEO, Jay Sugarman. Jay?

Jay Sugarman, Chairman and Chief Executive Officer

Thanks, Jason. Thanks to all of you for joining us today. The second quarter was a busy one for Safehold. Earnings and revenues continue to grow strongly, engagement with customers remains high, and conversations between iStar and Safehold regarding the future progressed significantly. As Jason said, we won't be able to share details on those conversations until they are completed, but hope to be able to do so in the near future. For the quarter, year-over-year earnings were up over 30%, and new investment volumes remain strong at over $350 million. Pricing has moved up with interest rates, and inflation-adjusted yields still feel quite compelling to us. Transaction activity in commercial real estate has started to slow, so we'll need to watch our overall markets stabilize in the second half of the year. We also continue to explore ways to align our long-term contractual cash flows and long-term liability structures. And you'll hear from Brett about a recent stairstep coupon innovation that enabled us to access 30-year financing that more closely matches the growing cash flow streams of the company. As we approach $6 billion in ground leases and $10 billion in UCA, we remain focused on three things: expanding the use of modern ground leases by providing low-cost and attractive capital solutions for building owners and developers in top cities around the country; simplifying our corporate structure, so more of the market can participate in our equity and debt offerings; and importantly, getting the full value of the company's portfolio reflected in the share price. Interest rates certainly play a part in that calculation, but so do inflation protection and Caret’s value. And we will use the back half of the year to continue highlighting the sizable value of Caret inside Safehold's portfolio and the positive impact of inflation on our asset returns. The cost of capital we can provide to customers is tied to our success on the last two points. So we'll be working hard to help the market see the full value of what Safehold has built and the value it can create as it continues to scale. With that, let's turn over to Brett and Marcos. Marcos?

Marcos Alvarado, President and Chief Investment Officer

Thank you, Jay, and good morning, everyone. Let's begin on Slide 4. The second quarter was characterized by solid earnings results, meaningful investment activity, and continued UCA growth. Additionally, during the quarter, we raised fresh debt capital through a new innovative structure, which left us with ample liquidity. Brett will get into the details of this quarter's earnings results. First, let me discuss our investment activity, beginning on Slide 5. During the quarter, we originated seven new ground leases totaling $381 million, of which we funded $338 million during the quarter and expect to fund the $43 million balance in the coming quarters. Additionally, we funded $37 million during the quarter associated with prior ground lease commitments. These seven new originations spanned four different markets, five new customers and across all five of the property types we focus on as we continue to expand the utilization of ground leases throughout the major markets in the US. As we mentioned last quarter, we've increased our pricing as rates have moved. The new ground leases we originated during the quarter generated a weighted average yield of 5.5%, assuming zero percent inflation, which is 70 basis points higher than the 4.8% yield for the investments we made in the first quarter, again, under a zero percent inflationary scenario. Of note, two of the investments we made during the quarter totaling $49 million were the acquisition of existing ground leases that do not feature the typical Safehold fixed rent bumps with CPI lookbacks, but rather have rent escalators, primarily based on CPI for most of the life of the leases. And as a result of the variable rent component, they show a much lower yield under GAAP. Excluding these investments, our yield for the quarter would be 5.8% on the $332 million of originations, which is reflective of our pricing levels today. We have previously discussed that we believe the inflation protection built into our ground leases captures meaningful value for our portfolio that is not recognized by the market, nor reflected under GAAP in our financial statements. For example, assuming the St. Louis Fed's latest 30-year inflation expectation of 2.22%, the contractual inflation capture in our second quarter investments would result in a 5.7% yield. The credit metrics associated with the originations this quarter are in line with our targets, with a ground lease to value of 38% and rent coverage of 4.6 times. Slide 6 provides a snapshot of our growth for the quarter. At the end of the quarter, our aggregate portfolio stood at approximately $5.9 billion, representing 17 times growth since our IPO just over five years ago. Underscoring the widespread adoption of our modern ground lease product, the seven high-quality ground leases we closed during the second quarter are comprised of five different property types, including multifamily, office, hotel, life science, and mixed-use. You can see the quality of the assets we originated during the quarter on the right side of the slide. Moving to Slide 7, we show a geographic breakdown of our portfolio as we continue to diversify across the US, focusing on the top 30 markets. And with that, let me turn it over to Brett to go through the financials. Brett?

Brett Asnas, Chief Financial Officer

Thank you, Marcos. Good morning, everyone. Continuing on Slide 8, I will outline our quarterly earnings results. Revenues for the second quarter were $64.9 million, reflecting a 47% increase from $44.2 million during the same quarter last year. Our net income stood at $22.7 million, which is a 54% rise from $14.7 million earned in the previous year. Earnings per share reached $0.37, a 32% increase from $0.28 last year. This quarter's results include an annual stock-based compensation expense of $1.1 million for Independent Directors. Furthermore, the Board of Directors approved a 4.12% increase in the common dividend, adjusting the annualized rate to $0.708 per share. Additional portfolio metrics are available on Slide 9. At the quarter's end, our portfolio's weighted average ground lease to value was 40%, and our weighted average rent coverage stood at 3.8 times. By property type, our portfolio comprises 46% office, 33% multifamily, 13% hotel, 5% life science, and 3% mixed-use and other properties. Our weighted average lease term is 92 years. On Slide 10, we explore our portfolio's yield under different inflation scenarios. There has been extensive conversation about inflation and its effects on our portfolio. The market primarily assesses our cash flows in relation to long-term high-grade bonds. Year-to-date, we have observed a strong correlation between our stock price and the yield on these bonds. However, as Marcus noted, this close correlation does not account for the fact that our cash flows are not fixed; rather, they are positively correlated with inflation as about 95% of our portfolio includes some inflation protection mechanisms. Currently, our portfolio yields a cash yield of 3.3% and an annualized yield of 5.1%. These figures are based on a 0% inflation scenario over the length of our ground leases. Based on the most recent 30-year inflation expectations of 2.22% from the St. Louis Fed, our inflation-adjusted rent increases could elevate the portfolio yield to 5.6%. If inflation settles down to 2.0% over the next 99 years, our portfolio would yield 5.5%. Conversely, if it rises to 3.0%, our portfolio yield would be 6.1%. This added yield is significant when compounded over 99 years, resulting in a notably different valuation that the market has yet to reflect, which is crucial for investors to recognize. In simpler terms, while higher inflation leads to increased rates, meaning investors should use a higher discount rate for our cash flows, the cash flow generated by our portfolio will also rise. These cash flows are not fixed like comparable long-term bonds, so maintaining a static cash flow assumption is not appropriate. Slide 11 shows an overview of our capital structure. At the conclusion of the second quarter, we had $3.6 billion in debt, which includes roughly $1.5 billion in nonrecourse secured debt, $1.4 billion in unsecured notes, and $272 million in debt associated with our proportionate share of debt secured by ground leases we co-own. Additionally, we had $445 million drawn on our unsecured revolver. Together with available cash, we had $930 million in liquidity at the end of the quarter. Our leverage ratio was 1.8 times on a total debt to book equity basis and 1.4 times on a debt to equity market cap basis. The effective interest rate on our non-revolver debt is 3.7%, with a spread of 134 basis points to the 5.1% annualized yield on our portfolio. The weighted average cash interest rate on our non-revolver debt is 3.2%, which is a positive spread over the current cash yield of 3.3% from our portfolio. Also, during the quarter, despite volatile market conditions, Safehold successfully innovated in the capital markets by raising long-term debt to better align with the cash flow characteristics of our long-duration assets. Specifically, we secured $150 million in 30-year structured unsecured notes at a 5.5% interest rate, due in 2052, priced at the 30-year U.S. treasury plus 195 basis points, significantly under the spread of our 10-year public bonds. Importantly, this financing features a unique Stairstep coupon rate structure whereby the company will pay cash interest of 2.5% in the first ten years, 3.75% in years eleven through twenty, and 5.15% in years twenty-one through thirty. The difference between the stated 5.15% rate and the cash interest rate will accumulate to our principal balance following each semiannual payment, to be fully repaid at maturity in 2052. In preparation for this financing, Safehold entered a $150 million treasury lock agreement with a 2.91% strike rate, yielding 4.92% after factoring in the hedge. This innovative transaction marks another important advancement for Safehold, showcasing that credit investors are increasingly receptive to long-dated unsecured financing structures for our high-quality assets as we continue to grow our presence in the unsecured credit markets. Finally, on Slide 12, we provide an update on UCA. As of June 30th, the estimated value of all unrealized capital appreciation above our land increased by $543 million to approximately $9.9 billion, representing an 86% compound annual growth over the past five years since our IPO. The UCA portfolio includes about 32 million square feet of institutional-quality commercial real estate, made up of 14 million square feet of multifamily, 13.1 million square feet of office, 3.8 million square feet of hotels, 700,000 square feet of life science, and 700,000 square feet of mixed-use and other property types. In conclusion, although the year has presented significant challenges regarding stock performance, it was a solid quarter, and we are focused on strengthening our leadership position in the ground lease industry. I will now turn it back to Jay.

Jay Sugarman, Chairman and Chief Executive Officer

Thanks, Brett. Lots of good progress on the right side of the balance sheet there, so let's just go ahead and turn it over to questions. I know many of you will want to ask about the Safehold iStar conversations, but I hope you understand we can't say anything at this point. So we'll stick to questions about the business during Q&A. Operator?

Operator, Operator

Thank you. Our first question comes from the line of Rich Anderson, SMBC. Please go ahead.

Rich Anderson, Analyst

Okay. Jay, chomping at the bit, but I'll try to play nice here. So on the liquidity, you mentioned $930 million, okay? Let's say you bring that out over the course of the next six to 12 months. Do you feel in terms of optionality to raise additional capital to grow the platform might involve more in the way of joint ventures, perhaps full asset sales? What would be the game plan assuming we don't have kind of a reasonable recovery in the stock price going forward?

Jay Sugarman, Chairman and Chief Executive Officer

Hi Rich, yeah, I think all those ideas are on the table. We'll try to find the best capital source. We still think the transactions we're doing are very compelling and accretive, but obviously not happy with the share price. So there are other ways to bring capital in. There's been a lot of interest from third parties. Frankly, we would rather not give up any of the ground leases that we're creating, but certainly, there's an alternative if they are better that we have access to.

Rich Anderson, Analyst

And what about for new investments or newly created ground leases? I know you have, you talked a lot about the CPI protection. But investors do have to wait for that in terms of present-day cash flow. Is there any talk about maybe stepping up the inflation protection to have it be perhaps closer to the present day, or is this going to be the model and you're just going to ride out the current macro environment as you're currently running the business?

Jay Sugarman, Chairman and Chief Executive Officer

Well, we are firm believers that inflation protection is very valuable over the life of the ground lease. I think rather than push our customers, what you've seen rent in the capital markets can do is really try to line up the liabilities to look more and more like the same structure on the assets. So I think there's more opportunity there frankly than to go back to customers and try to push them into a different mindset. We feel like we found the right balance right now that gives us the benefit of that inflation protection but also gives our customers a chance to execute their business plans with pretty strong certainty around what their cost of rent will be with us. So I don't see a lot of changes coming on that front, but I do see a lot of opportunity with the liability side.

Rich Anderson, Analyst

Okay. Last question for me and not to get too close to the discussions about the collapsing the two companies. But at STAR, where do you feel like you are in terms of getting through the things you want to get through at iStar in terms of additional asset sales and the like? We've gotten through the net lease platform. What needs to be done in the next 12 months in your mind, just from the point of view of iStar?

Jay Sugarman, Chairman and Chief Executive Officer

Yeah. Look, as you know, we're having an iStar call, we think the net lease transaction was a milestone transaction. That's something we can talk about. Everything else, Rich, I can't really talk about yet. But we are excited about where this ground lease ecosystem is going. And I think both Safehold and STAR ultimately having created it will be the beneficiaries of our future success. So where we can, we will share those details, but we can't do that on this call.

Rich Anderson, Analyst

Okay. Fair enough. Thanks very much.

Operator, Operator

Our next question comes from Adam Kramer, Morgan Stanley. Please go ahead.

Adam Kramer, Analyst

Hey guys, thanks for the time. Appreciate it. Just wanted to kind of maybe drill in on the new ground leases from this quarter, right? So ignoring the total portfolio, and just focusing on this quarter's new originations, maybe just remind us, I know you disclosed for the whole portfolio, but just remind us the spread between the yields on the new originations and the spread between that and your financing costs, and how that spread may compared to two, three, four quarters ago before the run-up in financing costs?

Brett Asnas, Chief Financial Officer

Hi, Adam. We view our Q2 originations in two segments. We originated $381 million, with approximately $50 million coming from an existing ground lease portfolio, which has variable rent and doesn't appear in GAAP. This leaves us with a balance of $332 million, where our cash cap rates are around 3.8% and our returns on assets are about 5.8%. Before considering inflation, we are achieving a spread of about 75 to 80 basis points over our current debt costs. We also view inflation as a key factor in determining value.

Adam Kramer, Analyst

That's super helpful, guys. Thanks. And so maybe just drilling down a little bit on kind of that model of buying existing ground leases. Is that something that as the product matures, do you think there will be more opportunities out there to kind of buy existing portfolios rather than kind of new ground leases the way hopefully kind of thinking the way you phrased it? Is that something where maybe more portfolios out there?

Brett Asnas, Chief Financial Officer

It's been about 10% to 15% of our business over the last five years. It's extremely episodic. As you know, these ground leases are extremely hard to create. And therefore, the owners of existing ground leases very rarely sell. It's usually an event, in a family somebody passes away or a municipal institution is selling for some other purpose, which was actually the case here. This was a university selling some land. So very episodic when those assets come for sale, we are obviously part of the process along. I think fit our profile.

Adam Kramer, Analyst

Awesome. For my last question, I hope I'm not getting too close to a topic we can't discuss. I'm curious about Safe stock today. What are some of the reasons things might change? Whether it's the flow or other factors that investors may not be considering, what aspects of the transaction could potentially improve the stock from a technical perspective?

Jay Sugarman, Chairman and Chief Executive Officer

Yes, I think you've hit on an important point, as I mentioned, both on the equity side and the debt side, we've heard from investors consistently load on the equity side, the external management structure, the controlled shareholder structure are not things that people would naturally like to see. And in some cases, they literally make it impossible for them to invest in Safehold. So those are constraints we laid out at the beginning of the year that we felt like if we could tackle with iStar, both parties would benefit. So that's been a little bit of the North Star in terms of thinking about the future, how do we make Safehold reach its full potential? Well, those are two constraints that we would hope to be able to eliminate because the underlying business in our minds, is undervalued and has tremendous potential. And the last thing we want is for investors to be precluded from participating because of corporate architecture.

Adam Kramer, Analyst

All right. Thanks for the time, guys.

Jay Sugarman, Chairman and Chief Executive Officer

Thank you.

Operator, Operator

Our next question comes from the line of Connor Siversky, Berenberg. Please go ahead.

Connor Siversky, Analyst

Thanks for having me on the call. Really just one quick question, considering the forward rate curve and where the dot plot is right now and the duration of some of these ground lease terms. Are you seeing in real time any upward drift in these kind of initial yields that you're seeing on potential acquisitions?

Brett Asnas, Chief Financial Officer

Yes, I believe that if you compare Q1 to Q2, our GAAP effective yield has increased by 70 basis points. Excluding the $50 million of existing ground leases we've acquired, that pricing has actually risen by 100 basis points. We are seeing this trend in real time, with a positive response from our customers regarding the transactions we completed in Q2 and encouraging feedback on our upcoming pipeline. However, I want to emphasize Jay's points about the slowdown happening right now, which is reflected in the gap between our asset values. As we consider the second half of the year, we anticipate a possible slowdown compared to the first two quarters.

Connor Siversky, Analyst

Understood. But in the same context, do you expect maybe more levered buyers might be stepping away from similar transactions, opening up some more opportunities for you?

Brett Asnas, Chief Financial Officer

Yes, we consider our competitive advantage to be the comparison between using a ground lease and traditional fee financing. Our product appears to be in a better position than it was at the end of last year. We are a part of a capital solution, and currently, there remains a significant disparity in the valuations of our assets. We've noticed some positive momentum in the past few weeks, but we anticipate that transaction volume will slow down somewhat.

Operator, Operator

And our next question comes from the line of Stephen Laws, Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi, good morning. I wanted to start by noting that the presentation highlighted seven new deals in Q2, with five being with new clients. Could you discuss how the transition is going now that you have more of a track record? When you bring on a new client with their first ground lease, how many typically go on to secure a second, third, and fourth lease? How do you approach building those relationships? It seems like there have been strong additions of new clients at the start of the year.

Jay Sugarman, Chairman and Chief Executive Officer

Hey, Stephen. Yes, we're really excited about the quality of our clients. They are large, domestic fund managers, so we are very enthusiastic about that. If you look back to our last equity raise, we found that 65% of the clients who engage with us return for another transaction, and around 45% of those have completed second or more transactions with us. The stability of our buildings is crucial. Although the first deal can take almost two years to finalize, we are improving in that area, and we are observing immediate benefits in scaling our overall business and growth by fostering relationships with our existing clients.

Stephen Laws, Analyst

Appreciate the color there. Jay, to touch base, I'll stay away from the STAR, SAFE situation, but another big initiative. I know you've talked about a lot of the Caret’s and providing some liquidity there. I think we're now six months into a two-year window from that February transaction to do some type of liquidity event or provide some liquidity. Can you maybe provide us some updates on your current thoughts on that and what your outlook is on that?

Jay Sugarman, Chairman and Chief Executive Officer

Sure, Stephen. It is a big focus because we see it as an enormous catalyst and probably one of the most misvalued things we see in the marketplace. Our initial goal was to bring investors to the table. I think the first round did that. We have a lot of engagements that we're very positive on. Certainly, gives us comfort that more and more people are digging in and trying to understand how an asset that on a mark-to-market basis, we have been tracking for the last 20 quarters, with the kind of growth rates and the tangibility of value that it expresses. How do we capture that value? And how can they be part of that? So I think those dialogues are good, positive, and constructive. Our goal ultimately, as you know, is to see that full value reflected that probably requires an ability to eliminate any liquidity discount. That's getting ahead of ourselves a little bit. We'll start with the folks who are digging in now. But long-term, our goal is to see that value reflected in Safehold stock, and to really get the full value, I think we need to address the liquidity around Caret, and that's something we'll be working on certainly next year.

Stephen Laws, Analyst

Great. Thanks for the comments, Jay. And I appreciate your time this morning.

Operator, Operator

Our next question comes from the line of Harsh Hemami, Green Street. Please go ahead.

Harsh Hemami, Analyst

Hey. Thanks for taking my question. So you mentioned that in the back half, you expect transaction volume to slow down a little bit and the bid ask in the market on ground leases as guidance. So, just claiming that differently, does it mean that if you were to try to increase acquisition volume that you couldn't achieve pricing that's as good as, say, 100 basis points on just the ground lease originated by Safehold?

Marcos Alvarado, President and Chief Investment Officer

Hey Harsh. Just to clarify, when I talk about bid ask, I'm not referring to a bid ask between our customers. I'm referring to the bid ask regarding asset valuations in general. Over the past six months of volatility, I can make a broad statement that asset values have decreased, and we are part of a capital solution when someone is deciding to refinance, recapitalize, or buy or sell. That’s the bid ask I mean, which is why we anticipate a potential slowdown in the latter half of the year. It’s not an issue with how receptive the market is to our pricing on the ground lease side.

Harsh Hemami, Analyst

Understood. So if you were to try to increase volume, you could still maintain the 100 basis points spread to pricing today?

Marcos Alvarado, President and Chief Investment Officer

Yes. I think where we are today, kind of this 75 to 80 basis point spread pre-inflation feels pretty good today.

Harsh Hemami, Analyst

Great. And then just one more from me. Given that you're having more and more repeat GP transactions with your tenants and there was some conversation of maybe giving tenants some tariffs in the future so that they can participate in this future growth. Have you had any conversation with these repeat relationship tenants on this topic?

Jay Sugarman, Chairman and Chief Executive Officer

I love the way you're thinking, Harsh, but it's a little premature to engage in that until we, a, demonstrate the value and b, create a little bit more liquidity around it, but we still think that's a very powerful idea. A couple of steps away still.

Operator, Operator

And our next question comes from the line of Ki Bin Kim, Truist. Please go ahead.

Ki Bin Kim, Analyst

Hi, good morning. Can we talk about the balance sheet for a little bit? I noticed you guys raised some $150 million of unsecured notes. Just curious, what is the GAAP interest rate on that because I know the stated coupon seems like it's 5.15%, but when you look at the cash bridge over time, obviously, it's a little bit different?

Brett Asnas, Chief Financial Officer

Sure. Yes. So, on our P&L, what will be booked is the 5.15% stated rate. We did enter into a hedge prior to that transaction. So, there's a offsetting gain, which was close to $7 million that will be amortized over the life. So, as we said in the remarks, 4.92% is the effective rate that will flow through the P&L, and then from a cash flow standpoint, from cash flow from operations, you'll see 2.5% paid over the first 10 years. And then over the next 10 years go up to 3.75%, and then in the last 10 years, go up to 5.15%. That's where it flows through in GAAP in terms of effective yield and cash.

Ki Bin Kim, Analyst

And on your revolver, I noticed the balance increased to almost $450 million this quarter. I guess, a couple of questions. What is the rate on the revolver today? I know that you put it in the Q, but it's just not out yet? And any plans on refinancing that balance?

Brett Asnas, Chief Financial Officer

Yes. Right now, it's LIBOR plus 100 basis points. I think from our perspective, we certainly like to term out some of those borrowings. I want to make sure we maintain our margins. So, we'll look to hedge at the appropriate times. And we'll look to the debt markets going forward, as Jay alluded to in his remarks. I think there's additional room and talking to lots of capital providers to continue this innovation. And that's what we're currently excited by, we'll definitely look to make sure we're prudent with our leverage and footprint with our capital availability to continue to serve our customers.

Ki Bin Kim, Analyst

I have one final question regarding earnings. Considering the significant volume you achieved this quarter, I expected your EPS to be slightly higher. Is there a timing factor related to when the deal is finalized or other aspects that we may not be aware of?

Brett Asnas, Chief Financial Officer

Yes, you hit the nail on the head there. The average day outstanding for the quarter is 22 days. So, it was pretty back-ended and the largest origination we had was closed on June 28. So, you'll see that flow through in the upcoming quarter when we capture a full quarter's worth of rent or income.

Ki Bin Kim, Analyst

Okay. Thank you.

Operator, Operator

And our next question is from the line of Matthew Howlett, B. Riley. Please go ahead.

Matthew Howlett, Analyst

Good morning. Thanks for taking my question. First question, was there any one-time expenses in the G&A from this strategic process?

Brett Asnas, Chief Financial Officer

For the second quarter in G&A, we have our annual stock-based compensation for our Independent Directors. And then there was some expense that flowed through related to our announcement in the other expense line item.

Matthew Howlett, Analyst

Okay. So there's some advisers or some of that in the numbers?

Jay Sugarman, Chairman and Chief Executive Officer

Yes, some accrued legal tax and other fees through other expense.

Matthew Howlett, Analyst

Okay. Great. Second question, Jay, when I look at long-term originations, are we discussing $1 billion a year or $2 billion a year? You've mentioned some significant numbers regarding the size of this market in the long run. After we move through this product cycle, how are you approaching annual originations, let's say, over the next five years?

Marcos Alvarado, President and Chief Investment Officer

Yes. We put out a number to get to $7.5 billion by the end of 2023 simple math, that was about $1.3 billion, $1.4 billion a year. We felt quite comfortable with that. I think, Matt, really the variable we've got to solve here is we think there's so much more opportunity on the equity and debt market side that we're not capturing because of the corporate architecture, because we're still educating, frankly, meaningful parts of the market about what is the modern ground lease industry. Why is it so compelling? So I would say we feel very comfortable in that $1 billion-$1.5 billion range with the constraints. And if you take those constraints off, obviously, we think we should be able to do more. So $7 trillion of commercial real estate in the top 30 cities. We think we are providing a very attractive capital solution across multiple property types. There's no reason this business can't grow substantially from here. And it's our job to continue to provide low-cost capital to our customers, and part of that is creating the best conditions in the debt and equity markets, to drive down our own cost of capital, and that's been a big exercise this year, and it should unleash additional potential.

Matthew Howlett, Analyst

Theoretically, does the ground lease investment become more beneficial for borrowers in a high interest rate environment with wider mortgage spreads? I mean, is it more appealing to your clients today?

Jay Sugarman, Chairman and Chief Executive Officer

Definitely. But I think, as Marcos said, customers who are looking at transactions are seeing a pretty wide bid-ask when they bring their projects to market or when they're trying to develop a budget for building something. So you're just seeing a little bit of uncertainty flow through the transaction market. We're better when markets are stabilized. You're right, we are getting calls from people who probably had a solution not working. They need the efficiency that a ground lease can provide. So we are picking up some incremental conversations. But I'd say macro, we prefer a more stable market than a highly volatile market. It just means more real estate transactions happen. And we have a better solution in many cases. So we like to see overall transaction volume in real estate be high and steady, we will get our fair share. And right now, we feel good about the engagement levels, but we definitely look forward and see some of our customers pulling back from doing anything. And we've seen that in the past, and it's just a little bit harder for us to push on that string. But I know our guys are all engaged, and there are transactions happening. And our team is continuing to spread the gospel, and it's finding a very receptive audience.

Matthew Howlett, Analyst

Got you. That makes a lot of sense. For my last question, I want to ask about the relationship between SAFE and STAR, particularly in how it's externally managed. It has been quite successful; for SAFE, the stock tripled, and we performed exceptionally well over three years. Clearly, there has been an ongoing strategic process, which seems to be a significant undertaking that is still in progress. Can you comment on whether the investment case for a strategic transaction still makes sense for SAFE, considering the previous successes?

Jay Sugarman, Chairman and Chief Executive Officer

Yes, it's a great question. I mean, we think long and hard about what is the future potential in this business. And as we said, we think this can be an enormous business. There's no question an externally managed structure with the right structure to launch the business. I think it's becoming pretty clear to us and to most investors that it is not the best structure long-term to really capture the full potential of the business. Whether it's today, tomorrow, or at some point, it's just not the right structure. So from our standpoint, as managers, let's get along with it, let's show the world clarity. Let's point everybody in the direction we're pointing. There's so much good happening in the business. We'd like to have fewer and fewer conversations about corporate architecture and external management and controlled shareholder. That's a positive conversation. That always feels like a bit of a constraint to us. So I take your point. I think it's actually a good one. We do believe this architecture was the right architecture for the first five years. As we look forward and say, how do we go from $5 billion to $10 billion to $20 billion to $50 billion, we're pretty clear in our minds that there's a better architecture if both sides can come to an agreement on it.

Matthew Howlett, Analyst

Got you. And the official communication, as you said, near term, that will some type of conclusion to this process.

Jay Sugarman, Chairman and Chief Executive Officer

I'll just say the sooner, the better.

Operator, Operator

I would just like to take this opportunity to remind everyone, if you would like to ask a question, please press star one on your telephone keypad.

Rich Anderson, Analyst

Thanks. I have a question regarding the termination of the management contract. I understand it involves a fee that is three times the average annual management fee. Is that correct? Additionally, is this fee open for discussion, or is it a cost that Safehold will likely have to bear?

Jay Sugarman, Chairman and Chief Executive Officer

The contract cannot be terminated until later in 2023, so any discussions about it will take place if they happen before then. I can't provide any more details on that.

Rich Anderson, Analyst

Am I right about the three times annual average annual management fee, is it terminated?

Jay Sugarman, Chairman and Chief Executive Officer

Post-2023, there need to be additional conditions for termination, so three times is indeed accurate, but it won’t take effect for another seven years.

Rich Anderson, Analyst

Got you.

Jay Sugarman, Chairman and Chief Executive Officer

In terms of the only issue. So I think there's – I wouldn't fixate too much on that.

Rich Anderson, Analyst

Okay. Fair enough. Thanks very much.

Operator, Operator

And at this time, there are no other questions in queue.

Jay Sugarman, Chairman and Chief Executive Officer

Okay. Great. Thank you, everyone, for joining us. Roshal, would you please give the conference call replay instructions again? Thanks.

Operator, Operator

Certainly. Ladies and gentlemen, this conference will be available for replay after 12:30 p.m. Eastern today through August 17, 2022 at midnight. You may access the AT&T replay system at any time by dialing 866-207-1041 and entering the access code of 7436202. International participants may dial 402-970-0847. Again, the toll-free number is 866-207-1041 and 402-970-0847 for International and the access code is 7436202. That concludes our conference today. Thank you for your participation and for using AT&T conferencing service. You may now disconnect.