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In a recent edition of Value Investor Insight, Murray Stahl of Horizon Asset Management describes why he sees unrecognized value in Vornado Realty Trust (NYSE:VNO).

Real estate companies also appear to have attracted your attention. What do you see in Vornado Realty Trust [VNO]?

MS: The core element of the story is Vornado’s ownership of a great deal of commercial real estate in New York City, specifically around Madison Square Garden. New York State is currently pursuing a plan to move the Garden and build on the existing site an $18 billion office tower complex that would be more or less the size of the Empire State Building. Vornado is bidding on that business, but whether they get it or not, their buildings in the vicinity will significantly benefit from rising rents as the area is completely revitalized. I think it will be the equivalent of what happened 40-odd years ago on the Upper West Side with the construction of Lincoln Center. Also interesting as a hidden call optionis the company’s one-third interest in the leveraged buyout of Toys R Us. It might work as a leveraged buyout, but Vornado’s involvement was based primarily on all the real estate the company owned that could be redeveloped. While nothing much has happened on that front, this could eventually be a huge land-bank opportunity for the company, whether the Toys R Us retail business succeeds or not.

Are you making any bets on where New York or other commercial real estate markets are in their cycles?

MS: This is the first up cycle in the postwar era in which there hasn’t been a lot of construction in New York City. The market is actually very tight, and doesn’t at all have the over-capacity we’ve seen in earlier cycles. We don’t see anything happening in the next few years to make the market less robust.

How exciting are Vornado’s ongoing operations?

MS: The existing business is quite stable. There are always things a clever landlord can do in upgrading or renovating existing properties, but the growth in funds from operations is not likely to be high – say 4-5% per year.

How well does the share price, at just over $90, incorporate the future potential you see?

MS: The way we look at it is that the current price and yield of 3.7% provides fair value for the ongoing operations. You’re paying nothing for the potential upside from the Madison Square Garden-area development or for anything good happening with Toys R Us. If either of those meet even our conservative expectations, we’d expect the share price to at least double within five years. With the yield, that’s a nice annual rate of return.

Source: The Long Case for Vornado Realty Trust