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Vornado Is Getting Simpler, But This 'Big Kahuna' Is No SWAN


Also, the company recently completed the transfer of Springfield Town Center to Pennsylvania Real Estate Investment Trust, or PREIT (NYSE: PEI). The proceeds of the transfer were $465 million, comprised of $340 million in cash and 6.25 million common units ...


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Sign in / Join NowGO»Market NewsStock IdeasDividendsMarket OutlookInvesting StrategyETFs & FundsEarningsPROREITsDividend IdeasDividend StrategyDividend NewsDividend Quick PicksEditor's Picks(function(w, d) { var getParam = function (name) { name = name.replace(/[\[]/, "\\[").replace(/[\]]/, "\\]"); var regex = new RegExp("[\\?&]" + name + "=([^&#]*)"), results = regex.exec(window.location.search); return results === null ? "" : decodeURIComponent(results[1].replace(/\+/g, " ")); }; var rc = function(n) { var c = document.cookie.match(new RegExp('(^|;)\\s*' + escape(n) + '=([^;\\s]*)')); return (c ? unescape(c[2]) : null); }; var pLimit = 2, pages = 13, log = rc('user_id'), p = parseInt(getParam('page'), 10) || 1, page = (p Vornado Is Getting Simpler, But This 'Big Kahuna' Is No SWANJul.25.16 | About: Vornado Realty (VNO) Brad Thomas Follow Dividend growth investing, REITs, newsletter provider, valueSend Message|The Intelligent REIT InvestorSummaryHistory tells us that investors should favor simplicity over complexity.As companies increase their complexity, they often fail to pay attention to their flaws and become more vulnerable to risk of loss.As a value investor, we must always wait for shares that we can purchase at a margin of safety, and Vornado is now priced like a hot potato.I'm warming up to Vornado, but I'm maintaining a HOLD until there is more clarity in regards to the "big kahuna".Over the last few weeks, I have written several articles on the so-called KISS REITsIn case you missed it, KISS stands for "keep it simple, stupid", and the purpose for my series was to examine the universe of REITs that, in my opinion, were the simplestIn the equity REIT sector, I selected Realty Income (NYSE:O) as the least complex REIT, and of course, MrMarket tends to agree with me - the shares closed on Friday at $70.41(See article here.) In the mortgage REIT sector, I selected Blackstone Mortgage (NYSE:BXMT), viewed as the simplest of the mREITs based upon its focus on senior secured loans(See article here.) While O and BXMT are viewed as near opposites as it relates to risk, I view them collectively as sound securities that are easiest to understand, and arguably command a higher premiumThat does not mean, however, that you should rush out and buy a simple REIT that's expensive - that's a recipe for failureHistory tells us that investors should favor simplicity over complexityThere are hundreds of examples of corporate failures that were caused by complicated business strategies and no true circle of competenceAs companies increase their complexity, they often fail to pay attention to their flaws, and they become more vulnerable to risk of lossIn other words, catastrophic events are guaranteed to occur with more complex businesses, and generally, the risk-adjusted returns do not adequately compensate investors for stepping outside of their comfort zoneToday, I am going to tell you about one such REIT that has experienced adversity - it was once a highly complex enterprise - and has evolved into a simpler, KISS-like operation. Once a High-Flying REIT That Looked Like a Hedge Fund Vornado Realty (NYSE: VNO) was founded over 53 years ago (in 1962) and became a REIT in 1993The company's chairman and CEO is Steve Roth, a veteran financier who was named by Barron's magazine as one of the World's Thirty Most Respected CEOsRoth was the CEO of Vornado from May 1981 through May 2009, and was reappointed on April 15, 2013Roth is the co-founder and Managing General Partner of Interstate Properties and the chairman and CEO of Alexander's Inc(NYSE:ALX)(See article here.) Vornado owns a portfolio 195 properties, primarily located in the New York and Washington, DC areasThe company's core businesses include New York; Washington, DC; and, retail properties primarily in the northeast states, California and Puerto RicoAbout 90 percent of Vornado's earnings come from properties in Washington, DC, and New York City Click to enlarge In the early 2000s, the company made frequent plays "outside its wheelhouse of prestige office and retail leasing", which is unusual for a REITIn doing so, Vornado made debt and/or equity investments in numerous companies that it did not control (or have sole control over), including investments in Alexander's Inc., Toys 'R' Us, J.CPenney Company (NYSE: JCP), LNR Property Corporation, and other equity investmentsHowever, many of these bets didn't paid off for Vornado, and the company was forced to shed itself of non-core assetsIn September (2013), the company sold its remaining 13.4 million shares in J.CPenney for $13 a share, ending a three-year investment in the struggling department store operator it had pushed to renew itselfVornado owned 6.1 percent of shares, which it sold in a block trade to Citigroup (NYSE:C). Vornado's original tender was for 9.9 percent in Penney concurrently with activist investor William Ackman's Pershing Square Capital Management, and both pushed the retailer to offer trendier merchandise and try to attract a younger shopperObviously, that bet didn't pay off, and that $250 million hit translated to a 40 percent loss in Vornado's original investment in PenneyAlso, back in April (2013), Vornado reaped around $241 million as net proceeds from the sale of LNR Property LLC, a company in which it owned a 26.2 percent stakeThe deal that LNR Property penned was disclosed in January 2013 and saw Starwood Property Trust Inc(NYSE: STWD) and Starwood Capital Group acquiring LNR Property for $1.05 billionBoth deals - Penney and LNR - were initiated as a means for the company to focus on improving its core real estate businessVornado's non-core approach to investing - likened to a mutual fund strategy - was originally structured to diversify its revenueBy investing in higher-risk marketable equity securities or companies that have significant real estate assets, such as J.CPenney and Toys 'R' Us, Vornado was hoping to become the first REIT to "crack the code" for conglomerationConversely, because Toys 'R' Us is also a retailer, its operations are subject to the same risks of a retail company that are different than those presented by other lines of businessAlso, the business of Toys 'R' Us is highly seasonal, and historically, the Toys 'R' Us fourth-quarter net income accounts for more than 80 percent of its fiscal year net incomeAs you can see below, Vornado still has a stake in Toys 'R' Us, but the bleeding has stopped: (VNO Has a 32.5% interest in Toys "R" Us) Click to enlarge Complexity is often viewed as the cost of doing business, even as a means to obtaining a competitive advantage, but clearly, Vornado's investments outside of its circle of competence served as a significant setbackWhere Vornado Was In 2011 Click to enlarge Also in another bold move, Vornado separated the shopping center business in January 2015 by completing a tax-free spin-off into Urban Edge Properties (NYSE: UE), a portfolio of 79 properties, three malls, and a warehouseAs part of the spin-off, VNO shareholders received 94.6% of the shares, and Vornado retained a 5.4% ownership interest in the form of 5,712,000 UE operating partnership unitsIn December 2014, the REIT sold 1740 Broadway for $605 million - $1,000 per square footThe financial statement gain on the sale was $439 millionThe tax gain of $484 million was deferred in a like-kind exchange for the acquisition of the StRegis Fifth Avenue retailAlso, the company recently completed the transfer of Springfield Town Center to Pennsylvania Real Estate Investment Trust, or PREIT (NYSE: PEI)The proceeds of the transfer were $465 million, comprised of $340 million in cash and 6.25 million common units valued at $20 per share (current market value is $23.38)As you can see below, Vornado is a much simpler REIT today: Where Vornado Is In 2016 Click to enlarge The New York City Portfolio Around 70 percent of Vornado's EBITDA is generated in New York CityThe company owns a portfolio of 23.8 million square feet of office in Manhattan (39 properties), and it is the largest owner of street retail space (3.2 million square feet in 71 properties)Vornado also owns 995 residential units and 1.2 square feet of lodging space (in NYC). Asking rents in Midtown continue to increase quarter over quarter, having now eclipsed the $80 per square foot markThe overall availability rate continues to hover around 10% - importantly, which includes sub-let availability, which is now down to a nominal 1.5%, representing the lowest rate since the first quarter of 2008 Click to enlarge New York City's job growth continues to be solid, with total private sector employment growth of 24,200 jobs, including 7,100 office-using jobs, both on par with strong job growth realized in 2015In the first quarter, Vornado outperformed the market as it relates to deals of $100 per square foot or greaterThe company executed six leases totaling 340,000 square feet, with starting rents averaging $116 per square foot Click to enlarge Driving these numbers, Level 3 (NYSE:LVLT) renewed at 60,000 square feetFacebook (NASDAQ:FB) added another 80,000 square feet at 770 Broadway, and Bloomberg extended its lease in the tower office floors at 731 Lexington Avenue to 2029As you can see below, Vornado owns quite a few dominating office towers in Manhattan, including 1290 Avenue of the Americas (Donald Trump owns 30 percent with VNO)I write extensively about the partnership with Trump in my upcoming book, The Trump Factor. Click to enlarge Vornado recently broke ground on the 61 Ninth development and will be delivering the iconic 170,000-square foot building (designed by Rafael Viñoly) by the end of the quarterIt owns several other high-profile properties in the Chelsea/Meatpacking district Click to enlarge Vornado has been quite active in leasing retail storefronts along Fifth Avenue, as the REIT also owns properties on Fifth Avenue, including 697-703 Fifth Avenue, 689 Fifth Avenue, 666 Fifth Avenue, 655 Fifth Avenue, 640 Fifth Avenue, 608 Fifth Avenue, and 510 Fifth Avenue Click to enlarge Vornado's Manhattan street retail platform is the largest in New York CityThe company has the best collection of street retail assets in the best corridorsUp and down Fifth Avenue, Times Square at the bowtie, Madison Avenue, SoHo, Union Square, and Penn Plaza Click to enlarge Vorando's DC Portfolio The company owns 49 office and retail properties in Washington, DC, that consist of 13.9 million square feet in DC, including 7.2 million square feet in Crystal City, Arlington, VA (23 properties and 2,414 residential units) In downtown DC, Vornado owns approximately 3.2 million square feet of office space in 11 buildings that are now 96.8% leasedIt has a roster of high-quality tenants that include Baker Botts, General Electric (NYSE:GE), Facebook, Hewlett-Packard (NYSE:HPQ), APCO Worldwide, Cooley, EMD Serono, Treasury's Office, and WeWork (Private:VWORK) Click to enlarge DC represents around 21 percent of Vornado's revenues, and there have been rumors surrounding a possible separation (spin-off) of the DC businessHere's what Steve Roth, VNO's CEO, said on the recent earnings call: Notwithstanding that we have said repeatedly and hinted that we are studying, analyzing separating WashingtonSo, while we are not announcing that and it may or may not happen, you could read into that whatever you care toRoth went on to say: ..we have a history in doing this; we have done it beforeSo, we are sort of experienced hands at thisSo, we will do it with major speed, so that's step oneStep two is that as we did with Urban Edge, it was properly capitalized; it had fine assets; it had enough money; it had enough capital and credit in its entity to complete its mission; it had a well-defined mission; it had basically inherited our management team plus the addition of one very, very talented CEO that we recruited on the outside, and then he added a CFO et ceteraSo, the business will be, if as and when we make that decision and launch, it will be set up for success from a balance sheet point of view, from a capital plan point of view, from a team point of view Click to enlarge Roth added more insight on DC: If we do separate Washington, it will be for the reasons that we have already enunciatedAnd that is to have a focused management team with a very specific mission in Washington, which may or may not involve capital partners et cetera and will have its own report card, namely its own stock price, and basically have its own board and be able to make its own decisionsSo, we are capitalists, we believe in incentive, we believe in report cards et ceteraSo, we think that the Washington business, not that much unlike the Urban Edge business, will benefit enormously from being its own man and woman, so to speakWe also believe that the New York business will benefit by being a focused New York business, so that global investors can invest in the New York platform, the New York assets, and our New York activities, separately from Washington or shopping centers or whateverSo that's what our objectives would beThere is nothing - there are significant things that will be accomplished, in our mind by investors being able to choose Washington or New York as opposed to having to take both of them in the current structure Two Outliers Assuming Vornado does proceed with a spin-off of its DC portfolio, the company will still own two outliers: Chicago theMART, a 3.6-million sqfttech hub and 555 California Avenue in San FranciscoThe Chicago asset is productive (97.8 percent leased) and has tenants such as Motorola (NYSE:MSI), Yelp (NYSE:YELP), PayPal (NASDAQ:PYPL), and Allstate (NYSE:ALL) Click to enlarge 555 California Avenue is also owned with Donald Trump (Trump owned 30 percent), and is leased (93.3 percent) to a number of high-quality tenants, such as Bank of America (NYSE:BAC), Microsoft (NASDAQ:MSFT), Morgan Stanley (NYSE:MS), Wells Fargo (NYSE:WFC), UBS Group (NYSE:UBS), Sidley Austin, and AllianceBernstein (NYSE:AB)(In my book, The Trump Factor, I provide details of this property and how Trump was able to acquire an ownership interest) The Big Bet Just as things are getting simpler, it seems Vornado is preparing to tackle a "big bet" in New York CityHotel Pennsylvania is a rare, grand-scale hotel with over 1,700 rooms and some of the most significant public space of any hotel in ManhattanThe hotel is directly facing Penn Station and is within steps of Macy's, Madison Square Garden, and the Empire State BuildingAlong with Hotel Pennsylvania, Vornado has assembled a number of properties in which the company is hoping to transform the area into a Two Penn PlazaRoth and his team intend to transform the 48-year old building into a modern age building for today's office users with a new floor-to-ceiling glass curtain wall Click to enlarge The main event here is the massive, undulating canopy (in spots, it's 85 feet high and extends out 65 feet) inspired by the iconic photograph of Marilyn Monroe standing over a subway grate holding down her skirt, which will provide grand entrances for Penn Station, Madison Square Garden and Vornado's Two Penn Plaza office building. Vornado intends to cluster the 1.6-million square foot Two Penn Plaza and the 2.6-million square foot One Penn Plaza (currently connected underground via Penn Station) into a 4.2-million square foot complexIn the 2015 Annual Report, Roth writes: This is an ambitious and long-term project and the first of many to transform our vast Penn Plaza holdingsPenn Plaza is Vornado's big kahunaThis "big kahuna" is arguably a big bet for Roth, and when one analyst asked about the cost for the project he said: Obviously we will be spending hundreds and hundreds of millions of dollars in Penn Plaza to accomplish our objectives thereBut until we're prepared to make full disclosure of what our plans are in a very reasoned way, I'm not going to speculate Click to enlarge The Balance Sheet Vornado is investment grade rated by all three major rating agencies, and the company has around $4.4 billion of liquidity available ($1.9 billion in cash) Click to enlarge In March, the company completed a $300 million refinancing of One Park Avenue, a 947,000-square foot Manhattan office building in which VNO owns a 55% interestIn February, the company completed a $700 million refinancing of 770 Broadway, a 1,158,000-square foot Manhattan office buildingExcluding the financing of VNO's 220 Central Park South project, the consolidated debt metrics are fixed rate accounted for 77% with a weighted average debt of 3.99% and a weighted average term of 4.8 years, and floating rate debt accounted for 23% of debt with a weighted average interest rate of 2.18% and a weighted average term of 5.1 years. The company's debt-to-enterprise value is 31%, and the debt-to-EBITDA ratio is 7.5xThe Latest Results In Q1-16, VNO's comparable FFO was $1.08 per share, compared to $1.07 for Q1-15The company's New York business produced $14.9 million of comparable EBITDA growth, or $0.08 per share, and also produced a 5.5% same-store increaseHere's a snapshot of its AFFO per share: Click to enlarge (Source: F.A.S.TGraphs) Here's a snapshot of VNO's dividend history: Click to enlarge Here's a snapshot of the company's FFO Payout Ratio: Click to enlarge Getting Simpler, Should We BUY? It's now plain to see that Vornado is getting simpler, and assuming that the DC portfolio is spun off, the New York-based REIT could become a KISS alternativeLet's see what MrMarket thinks.. Click to enlarge As you can see, I used a broad office peer group, and as much as I love NYC, I don't believe there's value in a 2.4 percent dividend yieldPerhaps there is an argument for price appreciationLet's take a look at the P/FFO: Click to enlarge JeezMaybe MrMarket thinks Vornado is already priced for perfectionIn other words, the market is suggesting VNO is already a simple REIT, when in fact, there are still a few complexity attributes - mainly DC and Penn PlazaAs a value investor, we must always wait for shares that we can purchase at a margin of safety, and Vornado is now priced like a hot potato Click to enlarge The Bottom Line I'm warming up to Vornado, but I'm maintaining a HOLD until I can see value being unlocked in the DC business, and also until there is more clarity with regard to the "big kahuna"There are plenty of other private equity funds that I can invest in that offer the same level of complexity, and as you know, I prefer to stick with my trademark strategy - aka the KISS model - that means I sleep well at nightNote: VNO maintains an 8.1 percent interest in Pennsylvania Real Estate Investment Trust and a 7.9 percent interest in Lexington Realty Trust (NYSE:LXP)See my article on PEI here and my latest article on LXP hereAuthor's Note: Brad Thomas is a Wall Street writer, and that means that he is not always right with his predictions or recommendationsThat also applies to his grammarPlease excuse any typos, and I assure you that he will do his best to correct any errors if they are overlookedFinally, this article is free, and the sole purpose for writing it is to assist with research (Thomas is the editor of a newsletter, Forbes Real Estate Investor), while also providing a forum for second-level thinkingIf you have not followed him, please take 5 seconds and click his name above (top of the page). Sources: F.A.S.TGraphs, SNL Financial and VNO Investor PresentationREITs mentioned: City Office REIT, Inc(NYSE:CIO), Columbia Property Trust (NYSE:CXP), Boston Properties, Inc(NYSE:BXP), Kilroy Realty Corp(NYSE:KRC), Piedmont Office Realty Trust (NYSE:PDM), Brandywine Realty Trust (NYSE:BDN), Highwoods Properties, Inc(NYSE:HIW), Cousins Properties Inc(NYSE:CUZ), Government Properties Income Trust (NYSE:GOV), and Easterly Goverment Properties (NYSE:DEA)Disclaimer: This article is intended to provide information to interested partiesAs I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. 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 opinionsI 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.About this article:ExpandAuthor payment: $35 + $0.01/page viewAuthors of PRO articles receive a minimum guaranteed payment of $150-500Become a contributor »Tagged: Dividends & Income, REITs, Financial, REIT - Diversified, Alternative Investing, Editors' Picks, Expert InsightProblem with this article? Please tell usDisagree with this article? Submit your own.{"author_name":"Brad Thomas","author_image":"https://staticseekingalpha.a.ssl.fastly.net/images/users_profile/000/330/973/big_pic.png?1461968132","id":"3991040","primary_ticker":"vno","publish_time":"2016-07-25T06:45:00.000-04:00","published_time":"2016-07-25T06:45:00.000-04:00","expiration_time":"2016-10-25T06:45:00.000-04:00"}.st0{stroke:#FFFFFF;stroke-width:2;stroke-miterlimit:10;} .st1{fill:#FFFFFF;} .st2{clip-path:url(#XMLID_2_);} .st3{fill:url(#XMLID_3_);} .st4{fill:url(#XMLID_4_);} .st5{fill:url(#XMLID_5_);} .st6{fill:url(#XMLID_6_);} .st7{fill:#FFFFFF;fill-opacity:0.2;} .st8{fill:#3E2723;fill-opacity:0.1;} .st9{fill:url(#XMLID_7_);} .st10{fill:none;}Top Authors|RSS Feeds|Sitemap|About Us|Contact UsTerms of Use|Privacy|Xignite quote data|

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