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Dr. Duru, One-Twenty Two (112 clicks)
Long/short equity, event-driven, homebuilders, currencies
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I quickly caught a Bloomberg headline about plans from Vornado Realty Trust (VNO) to sell more than it buys. I went to the VNO 2012 annual report to see for myself the entire context of statement. It comes at the end of the financial highlights section. Here is the full context from page page 14 (emphasis mine):

It feels to me that we are on the footholds of a major economic expansion in America. What's going on in the real economy - housing, autos, innovation, etc. is the real McCoy. It also feels to me like interest rates will stay lower for longer than the pundits expect and that we are near the tipping point where market participants will start to believe and act as if it's their God-given right to zero-bound interest rates. I don't expect cap rates to rise anytime soon.

We are, after all, in an extended period of easy money, worldwide - central bankers as Santa Claus. I have no idea, and doubt that anyone does, how to unwind this easy money feast.

I can see the bubble on the horizon; the fat lady entering the building. In our industry and in our city, highly leveraged players are back, facilitated by new credit market participants - 85-90% loans are again available, the whole menu of PIK, mezz, participating this-and-that, are back.

A dear friend and real estate legend commented to me that recent events in Cyprus should increase the value of New York real estate by 10%.

Our basic instinct is to build, acquire and grow. But, my belly tells me that prices are now higher than future prospects and therefore, we will buy carefully and likely sell more than we buy.

Maybe low multiple businesses are low multiple for a reason. And…maybe low multiple businesses don't belong inside high multiple businesses.

I worry a lot about the Internet's accelerating effect on commodity retail. I don't worry too much about officing at home, and such. I cannot worry about densification (more workers in less space); it is a trend that is here to stay and that we will deal with.

A lot is packed into this statement. Typically, a bubble comes at the END of a tremendous economic expansion. So I find it a bit strange for Vornado to observe both a foothold of a major economic expansion AND a bubble on the horizon. Moreover, the statement indicates a belief that housing is a part of this expansion and that it is real. Vornado also implies that easy money is an important enabler and that low rates will last a lot longer than expected. Low rates should not persist in a major expansion.

Putting this all together, I am assuming that Vornado is anticipating a long-lasting strength in the economy where monetary authorities will be quite reluctant to take their collective feet off the pedal out of fear that the economy would immediately go into reserve. This stickiness of low rates will drive the bubble in real estate prices. The desire to sell more than buy is a natural approach to locking in profits as the process unfolds while maintaining exposure to some upside in a high-risk environment. The risks consist of uncertainty in the potentially damaging impact of an unwind of easy money and the timing of it. Profits taken from the good times should act as a buffer if the bubble suffers a massive collapse.

The most immediate bubble Vornado probably sees is in commercial real estate in New York City, a center of a major portion of Vornado's operations and investments. Vornado also has major properties in Washington D.C. and California, also hot real estate markets. These are all special cases in an overall real estate market that is still just at the beginnings of a recovery. Even within states like California, only specific markets like the coast, are showing any signs of the rapid price increases that might remind observers of a bubble. Currently, estimated increases are at 10% for California's 2013 residential real estate market. Going forward, it will be interesting to watch Vornado's deal-making (and lease rates) for potential clues on the health of all these markets.

Now on to the fear of the pressure from e-commerce on "commodity retail." It just so happens that Jeff Bezos referenced the competition in his recently released letter to investors in Amazon (AMZN):

As regular readers of this letter will know, our energy at Amazon comes from the desire to impress customers rather than the zeal to best competitors. We don't take a view on which of these approaches is more likely to maximize business success. There are pros and cons to both and many examples of highly successful competitor-focused companies. We do work to pay attention to competitors and be inspired by them, but it is a fact that the customer-centric way is at this point a defining element of our culture.

One advantage - perhaps a somewhat subtle one - of a customer-driven focus is that it aids a certain type of proactivity. When we're at our best, we don't wait for external pressures. We are internally driven to improve our services, adding benefits and features, before we have to. We lower prices and increase value for customers before we have to. We invent before we have to. These investments are motivated by customer focus rather than by reaction to competition. We think this approach earns more trust with customers and drives rapid improvements in customer experience - importantly - even in those areas where we are already the leader.

Vornado has reason to worry. Amazon's implicit focus here is to move fast, stay ahead of the competition, and never get caught reacting to competitive pressures. This is the exact opposite position of commodity retail where the current focus is figuring out how to react to the internet. Best Buy (BBY) and Wal-Mart (WMT) are perhaps most recognized for fighting this battle. Best Buy has been rolling out store-in-store concepts and price guarantees. Wal-Mart is supposedly toying with the risky idea of paying shoppers to deliver packages to their neighbors as a part of a same-day delivery strategy. Wal-Mart is following Amazon's lead in testing out lockers for storing online orders for later pick-up. Such features remove the risk of the theft of packages from exposed doorsteps.

A lethargic economic recovery is of course intensifying the pressures to develop strategies to counter Amazon. In a major economic expansion, we should expect to see a rapid proliferation of innovative ideas as the retail opportunities become particularly lucrative.

But first things first. The last U.S. jobs report was a great disappointment and several other economic reports have come in soft. Perhaps rates will remain low for longer than expected because the recovery will take longer than expected to deserve such accolades as "major expansion." Time will tell as always.

Be careful out there!

Source: Vornado Anticipates A Major Economic Expansion And A Bubble; Fears The Internet