Keep Vornado Realty Trust On Your Radar

Mar.23.07 | About: Vornado Realty (VNO)

Last Friday, Vornado Realty Trust (NYSE:VNO), one of the largest US REITs run by Steven Roth, announced that it would acquire 70% interest in two coastal office locations, 1290 Ave of the America in NYC and 555 California in San Francisco, also known as the Bank of America building/complex.

VNO also agreed to protect the foreign-based sellers from future litigation associated with Donald Trump. Trump had sued the group, alleging that they withheld compensation from him in a previous sale of joint owned property and used the proceeds to purchase the buildings now sold to VNO. The NY Supreme Court ruled in the group's favor, but Trump chose to appeal. To complete the transaction, VNO had to assume any Trump-related legal risk. Trump also still owns the other 30% stake.

It's a big purchase, but VNO investors have become accustomed to this activity along with several opportunistic investments in faltering retailers that own valuable real estate.  The company began as a remnant of the old Two Guys chain on the East Coast, which went out of business in the 1980's but lives through its former real estate properties.  In the 1990's, Roth decided to purchase a majority stake in another declining retailer, Alexander's. The deal further increased VNO's property portfolio, allowed it to enjoy the real estate boom of the last 10 years, and thus transformed the firm into a multi-billion dollar operation. 

Recently, VNO has made investments in Sears prior to Eddie Lampert's merger of the company into Kmart Holdings (NASDAQ:SHLD), and in the private buyout of Toys R' Us in which it still owns a stake.  It also attempted but failed to partially acquire Equity Office (EOP) that would have expanded its portfolio on the West Coast.

Although Roth decided to cap his offer for EOP, he later commented that every uncompleted deal was a mistake and that he should have offered more for the properties he has missed. He now has to compete with large private equity firms and their pension fund investors. In order to pay for their retiree liabilities, these funds have searched, and stretched, for yield-producing, stable assets that provide an income stream and hopefully will appreciate in value.

Most importantly, Roth also noted the accelerating rise of 4 or 5 US "megacities" or large metropolitan areas to which much of the population has been migrating, including the NYC region, Washington DC, and Northern and Southern California. Because of this, he likely believes that investors continue to undervalue real estate in these areas, specifically office properties. When Roth had the opportunity to scoop up two premier locations in NYC and SF, he decided that the premium will be worth it.

I agree with his assessment of these areas and their respective real estate values. Each region has become a very popular destination around the globe to live, work, and visit, and available real estate and buildable land has become more difficult to find. Owners will not sell existing properties and require a significant premium and low cap rate when selling.

Zoning requirements have become onerous for new construction, and leasing at most premier locations exceeds 90%. Rental rates will thus steadily rise in these areas, and large pension funds will continue to bid strongly for assets. The large property owners, such as VNO, will benefit over the long term.

That said, I wouldn't rush to buy VNO or many other office REITs currently; the yields remain at historic lows, current prices discount property appreciation well into the future, and Sam Zell, seller of EOP, may serve as contrary indicator of real estate value. Also, because REIT's have been discovered by mainstream investors and will be relied upon for income by retiring baby boomers, large REIT stocks may never trade at the lower-than-book prices of the late 1990's.

They won't attract the value crowd. However, in any potential mortgage-fear or inflation-fueled panic in which REIT stocks decline 10-20%, VNO's stock would definitely be worth a look. Its shares and irreplaceable portfolio of coast-based properties may not stay discounted for long.

VNO 1-yr chart: