Followers of the super glamorous publicly traded office REIT space don't really know how to make sense of Vornado Realty Trust (NYSE:VNO). On the one hand they have 40mm square feet of office space in NYC and Washington DC, but on the other hand they have a huge retail portfolio and a hodgepodge of other real estate related investments. Breaking this down further, people tend to grasp their retail portfolio, but the aforementioned "hodgepodge" still throws them for a loop.
In this article, I will try to untangle the web of assets that is VNO, and through that try to demonstrate its inherent value.
In order to begin untangling VNO we need to get a grasp on its history so we can see how they built the different real estate platforms in their portfolio. Specifically, we can break down VNO into three big parts - retail, NYC office, and DC office. In this section we will explore VNO's history in these markets, which will put us on firmer footing when trying to grasp VNO's current property portfolio.
Many people recognize the Vornado brand from the electric fans in their houses, and true to form Vornado has its roots in those very appliances. In short, Vornado started as regional retailer Two Guys that went public in 1957. After their entrance into the public markets they bought O.A. Sutton Corp, a maker of electronic appliances, among them, the Vornado Fan. On the heels of this purchase, Two Guys changed its company name to Vornado, presumably to raise its profile. Vornado continued to grow, expanding its footprint to include 25 stores in 5 states. In 1967, Vornado acquired Food Giants Market - adding multiple retailers to the portfolio. This transaction included the following:
a 70 supermarkets
b 241 Foster's Freeze
c 14 Unimart
d 5 package liquor stores
e 20 Builders Emporium Store (similar to Home Depot (NYSE:HD))
Vornado continued its growth into the late 1970s until it hit a rough patch and needed to sell most of the retailers it picked up in the Food Giants transaction. Shortly after this episode Steve Roth (current chairman and interim CEO) began building a stake in Vornado, eventually taking control of the company. After he gained control, Mr. Roth liquidated the remaining retail stores and leased out properties to better performing retailers. These assets formed the core of the Vornado Retail portfolio.
However, Mr. Roth didn't stop there. In the mid-1980s he began buying up shares in Alexander's (ALX), another former retailer that owned a full square block of prime midtown NYC real estate, and other outer borough real estate sites. With this acquisition, Mr. Roth formed a beachhead in the NYC real estate market, but he still had big plans. In the early 1990s Mr. Roth bought the buildings owned by Mendick Realty Corporation, giving him control of 4mm square feet of prime NYC real estate.
DC Office and Merchandise Mart
After establishing himself in the NYC market Mr. Roth set his sites further south to Washington DC. In the early part of this century, Vornado acquired Charles E. Smith realty, giving it a huge position in the DC real estate market. Around this time, VNO bought Merchandise Mart, giving it a presence in Chicago and to a smaller extent the NYC real estate markets.
The above three form the core of Vornado's portfolio, but they have ventured into other activities many times, sometimes to the benefit and sometimes to the detriment to shareholders. Currently, the following make up the biggest chunks of VNO's "other activities":
a 32.6% interest in Toys R' Us
b 10.5% interest in Lexington Realty Trust (NYSE:LXP)
c 6% interest in JC Penney (NYSE:JCP)
d 70% interest in 555 California Street, a 1.8mm sqft office complex in San Francisco.
e 25% interest in Vornado Capital Partners - an $800mm real estate fund.
I think this history gives us a strong foundation in beginning to shed some light on Vornado's sprawling operations. Understanding they started as a retailer and built their retail platform from there, until building two other platforms in the NYC and DC office markets allows us to understand the current makeup of the portfolio. Truthfully, I think a lot of the confusion lays at the feet of the "other activities segment," but I think it's important to realize that this segment only makes up 20% of EBITDA and around 10% of total assets. While this small part of the portfolio might distract investors, and more importantly management from the core of their activities, we must remember that these assets have a relatively minor effect on shareholders.
VNO "Value Proposition"
As we just saw valuing VNO can prove a daunting task. With this in mind, I think investors only give credit to VNO for their NYC and DC office portfolio, as I will now show.
Boston Properties (NYSE:BXP) occupies a prominent position in the office REIT world. They have established themselves as an owner of "A" buildings in "A" markets in five markets across the US:
Square Feet (in thousands)
% of portfolio
New York City
Considering their "double class A portfolio" their buildings command premium rents.
New York City
While VNO only operates in two of these five markets, the office portfolio bears a lot of similarities to BXP's portfolio.
Sq Ft (in thousands)
New York City
As you can see, despite the fact that VNO doesn't operate in all of the markets they have pretty much the same amount of total office space. But, does their office space also command premium prices? A side-by-side chart will be instructive
Avg Rent (per sq ft)
New York City
Sub Weighted Avg
How do their debt levels compare?
Company (figures in mms)
Mortgages in DC and NYC
Company Level Debt
I don't want to get into too much of a discussion in this area, I understand VNO holds a comparatively higher level of debt, but the structure here is important, and that mitigates some of the difference. I don't want to get into a wide ranging discussion of the companies and their debt levels in all its flavors, suffice to say considering total portfolio size and the different tactics they have taken they are very roughly in the same ballpark.
Now, let's total everything up:
Total Weighted Avg for office properties rents ($/per sq ft)
Total Office Space (sq ft), 000's
As you can see, quite clearly, both BXP and VNO have pretty much identical office portfolios with VNO's office space falling squarely in markets BXP has deemed prime. Whatever VNO lacks for in total square footage they make up with their higher rents. But you are probably now wondering, why am I telling you all of this? One more table:
Wow. Using BXP as a proxy, we have shown that for the same $16bn you could either buy BXP's 40mm square foot portfolio, or VNO's 40mm sq ft portfolio, and get a free call on 20mm sq ft of retail, 4mm sq ft of Merchandise Mart, 32.6% of Toys R Us, a real estate fund, a 1.8mm sq ft building in San Francisco, and two large stakes in LXP and JCP. Which would you take?
I don't want to go through each free call in depth but these items gave VNO the following EBITDA in FY 2012:
a 20mm retail portfolio - $200mm
b 4mm Merchandise Mart - $154mm
c 32.6% Toys R Us - $281mm
d Other (RE fund, SF office building, LXP and JCP) - $100mm
This totals $750mm in EBITDA, not bad, and even better you get it for free.
I can understand why investors would discount the "other" activities, but I find it strange that this discount extends to the more meaty portions of VNO's portfolio such as the retail portfolio. VNO has announced they will move to monetize some of the retail portfolio, and they already pared down their stake in JCP. However, even without these moves, I think it is only a matter of time before investors begin raising the price of this call from nothing to something a bit more.
Additional disclosure: I may take a long position in VNO in the near future.