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VNO - Vornado Realty Trust

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Rates are going up, foreign buyers are becoming sellers, new supply is a coming, market volatility has returned...obviously now is not the most "strategic" time to be buying trophy NYC office buildings / high street retail.


I think VNO is becoming attractive. After the spin-off of its DC area assets, VNO's EBITDA is 90% Manhattan (roughly 70% office, 30% Upper 5th/Times Square Retail & signage). The other 10% is theMART (Chicago Merchandise Mart) and 555 California (trophy San Fran office building). There are some odds and ends as well, most notably $1.2B of cash and an estimated $800mm in after tax/debt repayment proceeds from the sale of 220 CPS, and a 36% stake in ALX which owns the Bloomberg building (731 Lex, yours truly's personal favorite) and some queens real estate.

In its 4Q 2016 supplemental, VNO provides a rough NAV which should be subject to additional scrutiny. It's about $105 / Share, using 4.5% cap rates on NYC office, a steamy 3.75% on NYC retail, 3.5% on NYC resi, 5.0% on theMART and $1.2B for 555 California. Let's call that the bull market/Norges takeout value. So at $67, VNO is at a 37% discount to its bull market value.

A more recent sell side note is less optimistic, placing NAV at $85 / share. Green Street and others also note that high G&A, a development pipeline that is hard to quantify in terms of value, and a negative outlook for supply / demand may warrant a discount. Another sell side note I read said that VNO was trading at an all-in cap rate of about 5.2% when it was in the mid-70's. At $67, VNO is at a 22% discount to its "not quite bearish, not quite bulled up, reasonably rigorous professional sell side appraisal" value.

VNO's 3Q 2017 supplemental backed into a ~6% cap rate for its core assets when the stock was in the mid-70s, but that included some aggressive assumptions for the non-NYC assets to get there (5% cap rate on theMART, some of the public securities have fallen since then).

Before we get too precise about it, let's just assume that mid 70's is at least a 5% cap rate and that mid $60s is getting into the mid 5's, possibly 6 handle if they monetize any of the bigger non-core assets at steamy prices/ sell 220 CPS as expected.

So you're rolling back the clock a few years in terms of cap-rate compression (or perhaps adjusting to new reality) with the stock at $67.

The balance sheet is in great shape. They've got about as much cash as corporate-level liabilities, and the rest is single-asset non-recourse financing that's decently termed out, as well as some perpetual pref's that have decently low coupons on account of the asset quality / IG rating. I need to quantify the rate risk better before I make any statements with respect to the impact on cash flow that rates will have. there's a lot of unencumbered or low leverage assets as well. A conference call notes that the NYC High Street Retail has about 20-30% of LTV of single property debt on it. $488mm of the $1.2B of EBITDA is unencumbered. At a 10% debt yield, that's $5B of incremental borrowing capacity (not that I'd expect them to lever the company to the gills, just pointing out the balance sheet flexibility).

Additionally, you've got plenty of development optionality given that if Penn Station was a color on the monopoly board, Vornado would be the player that owns it. You can go on their website and look at the pretty pictures of their ownership position as well as the Farley Post Office / Moynihan Train Hall development.

220 CPS sales, should they close as expected will be about $4 / share in dividends to shareholders in about a year and doesn't generate any income.

Also, Mr. Roth ain't getting any younger.

So there you have it, perhaps it's fairly valued in the new rate environment or perhaps this will look like an opportunity in retrospect. I need to do more work on sensitizing the thing and parsing out the debt, but at first glance, you've got a bunch of trophy properties, with a decently structured balance sheet, long term development optionality/strategic position around Penn Station, at what I would call a "decent not nosebleed anymore" price. At about 18x FFO, you get a high 3's divvy yield with the rest being used to de-lever, maintain/build NAV.

Let's just assume that over the next 10 years they build NAV/share price to what 1 year ago the company said it was worth ($105). You'd make 4.5% / year +3.6% divvy's = 8.1% / year = a fair equity return. I don't think that's a heroic assumption, even if there's a downturn that starts tomorrow, 10 years is a long time to recover. The key would be avoiding issuance at the bottom which they had to do last time round. It was also a much more complex company then. My point is that absent a major decline in the office market, I think you're getting paid a decent return here to own assets that are part investment / part vanity asset / store of value for SWF's and oil sheiks.

It's very possible the public market is leading the private market lower and that there's more price declines to come, but at this price, I start to get interested and intend to average down, assuming no major negative inflection in fundamentals.   

BG2008, I'm ready and waiting for you to shit on this idea and point out how sensitive to cap rates / cost of financing this is.

Isnít Manhattan Office highly cyclical? I think office space went for less than half what it is priced right now during or after the financial crisis. The office space is very dependent on the financial sector, which is highly cyclical and often ground zero during any recession.

Yes, spot lease rates are highly cyclical. I am still working on quantifying the downside; it's important to note that there are varying degrees of cyclicality given varying lease length and tenant strength. 731 Lexington's office (36% owned, separately traded as ALX) is leased to bloomberg until like 2030. I'd say that's as solid as it gets. Harry Winston's lease (example of retail, owned by Swatch) goes to 2031. There will be other ones at the opposite extreme (rolling into a weakening market). NYC is less finance dependent than in the past, but certainly affected by the industry.

No two crises are alike, of course. According, to VNO's Annual Report (Page 5), RemainCo's (the post spin company) FFO per share fell from $2.31 in 2007 to $1.33 in 2009 (37% peak to trough). In 2013, it was $2.68. I think that 2008/2009 was probably a weak test given that rates collapsed, but also point out they had to issue shares. Occupancy in NYC fell from 97 - 95% and is now 96%. Once again, I don't think that's what a real downturn will look like because there may be more supply in the next downturn.

The top 30 tenants can be found on page 29 of the most recent supplemental. You'll see that the chunkiest leases are in advertising (IPG), tech (Facebook and Google), financial service/data providers (bloomberg, McGraw hill) and 5th avenue/times square flagship retail stores (swatch, victoria's secret).

 There's an insurance company, a big hedge fund (a believe Ziff Brothers is now a family office actually) and not a single bank. Part of the sell-off is fears about the flagship retail.

VNO will have another important insurance company when they deliver Aetna's headquarters, Aetna took down the majority of the building w/ a 13-year lease. They've signed a lease but may not move in, because of CVS merger, so that's an interesting wrinkle. It looks like CVS/Aetna will owe VNO $21mm / year and will probably pay some big break fee.

All that is to say "yes, it's cyclical, but it's not as simple as VNO is  renting to a bunch of banks and hedge funds and shitty retailers on month to month leases". They own the flagship retail stores (part advertising, part store) of shitty and good retailers, they own headquarters of long established financial co's with long term leases. They own space leased to Facebook and Google (google just paid $1,600 / foot for its Chelsea Market HQ, VNO leases to Google nearby, the Aetna HQ that won't be Aetna's HQ is across the street).

EDIT: this isn't correct.

I've attached VNO's leasing stats, which show that the weighted average lease term for office is 9.9 years @ $84 / foot. The weighted average term on the retail is 6.1 years, the rent / foot is more complex and I'm still in the process of understanding that. Note that the office leases expiring over the next 9 or so years are all decently below the weighted average rent / foot; this provides some buffer to declines in spot rates.

This dynamic helped out SLG in the crisis.

See this bearish write-up written at the bottom of the cycle the author thought rents were going to collapse. A commenter pointed out that SLG was getting $45 / foot and market was at $80-$85, in one example. This was a disastrous short (6 bagger to today). Once again, I'm not saying it's all going to go down like it did in the past, just that the devil is in the details. 

--- Quote ---I gave this a 2 because I think several of your key analysis is flawed....

2) you ignore the fact that most of the rents SLG is receiving now is signed YEARS ago and is way below-market market rents.  For example, SLG just renewed its lease with Viacom Inc at Times Square in November 08, terms were not disclosed.  The old lease was less than $50/sf.  Current market rents at Times Square is around $80 - 85.  It would be safe to assume that SLG got more than $50/sf in the new deal.

Currently, SLG gets $45/sf in rents on its portfolio.  So your assumption of a decline of 20% in revenue seems quite impossible.  In fact, I will place my $$ that SLG could increase their top line because of this below-market rent issue.
--- End quote ---

Real estate, big picture is a combination of fixed income (leases = general unsecured claims against the borrower) and equity (you bear the residual risk/own the LT growth). Some of VNO's "bonds" are AAA (long term leases to bloomberg / google / facebook / Amazon), some are junk (Hollister), many are in between.

1. Interpublic                          2.2%
2. Facebook                            1.5%
3. Swatch                               1.5%
4. Macy's                                1.4%
5. Victoria's Secret                  1.4%
6. Bloomberg                          1.3%
7. Equitable Insurance             1.2%
8. Google                                1.2%
9. Ziff Brothers (hedge fund)    1.1%
10. McGraw Hill                      1.1%
11. Oath (AOL)                       1.1%
12. City of NY                        0.9%
13. AMC                               0.9%
14. Topshop                         0.9%
15. Amazon / Whole Foods    0.9%

16-30: Uniqlo, MSG, Forever 21, Neuberger Berman, J Crew, JC Penney, Hollister, Bank of America, PWC, H&M, New York & Co, Sears, Alston and Bird, NYU, US Government

On interest rate risk:
VNO corporate level obligations:
$450mm 3.5% of 1/2025. These were just issued and yield 3.9%, trade for $97 1/4
$400mm 5.0% of 1/2022. These were issued in 2011 as 10 yr bonds @ 300 over. They trade for ~$106, 3.3% yield

It is fair to say their unsecured corporate obligations are more or less at market, even after the rise in rates.

$921mm pref's
5.7% trading at    $97
5.25% trading at  $93
5.4% trading at    $94

So the pref's are below market terms (discount to par). But that's fine since they don't ever mature. They are all callable, leaving VNO with optionality if rates go back down.

The mortgages are another story. There are far more line items and that's where the real risk is.

Thank you for the work on VNO. I followed VNO loosely and was not aware of some of the recent changes. if VNO indeed trades at a 6% carp rate, if they can build value with their development pipeline. It looks lik it trades at a moderate discount to AV, wth above average mangement. This is great if you are bullish on the underlying assets, but I don’t. I am quite afraid of headwinds from higher interest rates, oversupply in the NYC market or a recession that were are going to get at some point almost 10 years intonthr recovery.

You should look at Vornado's submarket in NYC.  Prior to the crisis, Midtown was the hot area for HF and PE shops.  Rent used to be in the $150 range.  After 2009, tech, media, advertising, became a much bigger deal in NYC.  The building that Google just bought would be considered meh 10 years ago.  So, you need to look at VNO's footprint and see if it still resonates today.   The trend is towards newer, Hudson Yards, etc and Cooworking spaces like WeWork. 

For 5th Ave retail, look at the rent/sqft that they are charging.  At $1,000 a year, it's likely under market.  At $5,000, it's way above market. Since 30% is retail, you have to pay attention to it.  If you walk around, there are a lot of empty store fronts and each retail corridor can no longer command the kind of rent that they use to. 

Do a $/SQFT analysis.  You can layer in land cost and construction cost and see where you come out.   


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