Vornado Realty Trust (NYSE:VNO) Q1 2024 Earnings Call Transcript

Vornado Realty Trust (NYSE:VNO) Q1 2024 Earnings Call Transcript May 7, 2024

Vornado Realty Trust isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the Vornado Realty Trust First Quarter 2024 Earnings Call. My name is MJ, and I will be your operator for today’s call. This call is being recorded for replay purposes. All lines are in a listen-only mode. Our speakers will address your questions at the end of the presentation during the question-and-answer session. [Operator Instructions] I would now like to turn the call over to Steven Borenstein, Executive Vice President and Corporation Counsel. Please go ahead.

Steven Borenstein: Welcome to Vornado Realty Trust’s first quarter earnings call. Yesterday afternoon, we issued our first quarter earnings release and filed our quarterly report on Form 10-Q with the Securities and Exchange Commission. These documents, as well as our supplemental financial information packages are available on our website, www.vno.com, under the Investor Relations section. In these documents and during today’s call, we will discuss certain non-GAAP financial measures. Reconciliations of these measures to the most directly comparable GAAP measures are included in our earnings release, Form 10-Q, and financial supplement. Please be aware that statements made during this call may be deemed forward-looking statements and actual results may differ materially from these statements due to a variety of risks, uncertainties, and other factors.

Please refer to our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2023, for more information regarding these risks and uncertainties. The call may include time-sensitive information that may be accurate only as of today’s date. The company does not undertake a duty to update any forward-looking statements. On the call today from management for our opening comments are Steven Roth, Chairman and Chief Executive Officer; and Michael Franco, President and Chief Financial Officer. Our senior team is also present and available for questions. I will now turn the call over to Steven Roth.

Steven Roth: Thank you, Steve, and good morning, everyone. We’ve been busy. Let’s start with Bloomberg. As a reminder, 731 Lexington Avenue, the mixed-use tower, whose 950,000 square foot office condo is Bloomberg’s global headquarters, is owned by Alexander’s, a separately traded public REIT. Vornado owns 32.4% of Alexander’s. The background facts are Bloomberg lease expires in February 2029, $500 million — and $500 million of debt on the office condo is due next month, June 2024. Yesterday, we announced that we renewed and extended the Bloomberg lease for an 11-year term to begin in February 2029 and take us through February 2040. So, 16 years of term from now. As you can imagine, every developer in town tried to poach Bloomberg.

And of course, they looked at every opportunity, as they must. We are delighted that they chose to stay with 731 Lexington. By the way, the Bloomberg — the building is as much Mike’s creation as mine. He had significant input into the design of the original building. The design of the building and Bloomberg’s internal fit-out are on a par with what we would have built today, but of course, now they don’t need to. The terms of the lease are spilled out in yesterday’s SEC filings. Tenant concessions in the form of TIs and free rent have been established, and the net rent will be the subject of an appraisal in 2029 with the then rent adjusted up or down no more than 10% either way, based on the then market conditions. We’re in the process of refinancing this asset, but I must say I am not excited about paying today’s market rate of 7% or even 8% for debt with all the trappings of leasing reserves, cash sweeps and such, which are admittedly protective of the lender, but don’t do much for our equity value.

As we speak, my personal favorite is to pay the debt down and maybe even pay the debt off, we shall see. Now, let’s focus on our credit lines. Traditionally, we’ve had two separate but similar credit lines with staggered maturities. One credit line for $1.25 billion has been renewed through 2027 and the renewal of the second credit line was finalized last Friday at a reduced amount of $915 million with the term extended to April 2029. As expected in these times, several banks dropped out. We use our credit lines very sparingly, generally for short-term requirements with a known source of repayment, and rarely have we exceeded 25% drawdowns. Now to 280 Park Avenue. We own 50% of 280 Park Avenue. Since our joint venture partner has already reported, I’m guessing you are all pretty much up to date on the details.

What we did here was extend the maturity of the senior loan for four years, keeping the rate constant with no paydown, but posting significant cash reserves for future leasing. Several analysts have commented that the loan and the equity value pretty much cancel out. And that fact allowed us to DPO the mezz loan at $0.50 on the dollar, realizing a $31.3 million gain at share, which we will recognize in the second quarter. This is not yet a big win, but it does create a cheap warrant on a wonderful asset located in prime Park Avenue, where there is already a very low 7% vacancy and a shortage of space. We think it’s a first-class bet. By the way, we are leasing very well here. We continue to protect our balance sheet with interest rate caps and swaps, but when a 3% loan matures into a 7% market, there really is no place to hide.

We continue to prospect for good real estate in distress, where our best-in-class operating platform can be helpful to the lender. We expect these opportunities to accelerate. The gold rush on the part of the luxury brands to own, control, and dominate the very best locations is accelerating and the knock-on effect on prime New York City retail space is palpable. It should be noted that in New York, we have much more prime retail space than anyone else by a wide margin. Some commentators have noted that the Fifth Avenue and Times Square values seem to have recovered to the pricing of our retail JV sale five years ago. It would seem so. I continue to strongly believe the contrarian bull case I made in my annual shareholders letter that basically with frozen supply, i.e., no new developer office starts and none in — on the horizon, tenant requirements picking up and vacancies shrinking, I couldn’t be more optimistic about the future.

And also note that while the New York market has a huge 422 million square feet, when you cancel out the non-prime space, we really only compete in a much smaller 177 million square foot market. Great things are happening in our PENN District. Come by and take a look. Our team here at Vornado couldn’t be more optimistic. Now, over to Michael.

Michael Franco: Thank you, Steve, and good morning, everyone. As expected, the financial results for the quarter were down from last year due to items that we previously forecasted. First quarter comparable FFO, as adjusted, was $0.55 per share compared to $0.60 per share for last year’s first quarter, a decrease of $0.05. This decrease was primarily driven by lower NOI from higher net interest expense and no move-outs, partially offset by lower G&A expense. We have provided a quarter-over-quarter bridge in our earnings release and our financial supplement. Our overall New York business same-store cash NOI was down 5.1%, primarily due to the aforementioned expirations. As we indicated on our last earnings call, we expect our 2024 comparable FFO to be down from 2023 comparable FFO of $2.61 per share, primarily due to higher projected net interest expense of about $0.30 per share and the impact of known vacancies at certain of our properties, primarily at 1290 Avenue of the Americas, 770 Broadway, and 280 Park Avenue.

We anticipate the impact of these expirations in 2024 to be roughly $0.25 to $0.30 per share. We expect this impact to be temporary as we have already leased up a good chunk of this space, but the GAAP earnings from these leases won’t begin until sometime in 2025. We then expect earnings to increase as income from the lease-up of PENN and other vacancies comes online and as rates trend down. Now, turning to leasing markets. The New York office market continues to show signs of strengthening. While first quarter office leasing in New York took a bit of a breather from the strong year-end, there is a healthy backlog of activity with a number of large deals in the works. Overall, tenant space requirements continue to trend upward, sub-lease space continues to fall, best-in-class renovated and amenitized product located in transit hubs continues to dominate leasing and the new supply pipeline is close to zero.

These dynamics set the table for continued improvement in conditions in the upper tier of the market, which we are already experiencing in our best-of-class portfolio. Overall, asking rents are stable, even rising in the top-tier properties, but concessions remain stubbornly high across all submarkets. The financial services and legal sectors are continuing to drive the leasing activity, as both are in growth mode. We are also seeing the first signs of life in the tech sector again after a couple of years of being on pause or downsizing. And our experience is, when they grow, they tend to lease big chunks of space. The Midtown and New West Side markets are outperforming as leasing activity in Midtown is strong, not only on Park Avenue, but also on Sixth Avenue and the Fifth Avenue, Madison Avenue corridor.

On the West Side, tenant demand continues apace. If you walk from Seventh Avenue to the Hudson River, you will see why. Turning now to our leasing activity. After completing a slew of large leases in December 2023 and finishing last year with a market-leading 2.1 million square feet of deals, we expected a more muted first quarter of completed transactions, given where our deal pipeline stood in the negotiation process. In the first quarter, we leased 291,000 square feet at a healthy $89 per square-foot, reflecting the overall quality and premium locations of our properties. The highlight of the quarter was our 125,000 square foot headquarters lease with Major League Soccer at the new PENN 2. MLS had been in the market for some time, looking mainly in the Midtown core until late in their process when they toured PENN 2 and were wowed by what we’ve done with the building and the district.

The project is now complete and really shows terrifically. Our new town hall events space is open. By the way, we hosted our first event just two weeks ago, attended by 300 people. And the rooftop pavilion and park are truly spectacular. Tenants are responding positively to everything that we’ve done and what’s still to come. We have a significant pipeline at PENN 2 and are busy negotiating proposals with tenants across a variety of industry sectors. In addition to the significant Bloomberg lease renewal of almost 1 million square feet we just completed, our leasing pipeline is strong, with 370,000 feet of leases in negotiation and another 2.5 million feet of proposals out on the street in different stages. Much of this activity is not only addressing current vacancy, but also forward-looking expirations.

As discussed on the fourth quarter call, we foreshadowed an occupancy decline due to the known Q1 move-outs at properties such as 1296 Avenue and 280 Park. We are pleased to report that we have already taken care of half the 2024 and 2025 expirations in these properties, with more activity on the horizon at each. Turning to retail. The retail leasing market continues to recover. As we discussed on our last call, Prada and Kering’s blockbuster retail deals on Fifth Avenue that occurred in December demonstrated their long-term commitment to Manhattan and has further energized the market. And there are other potential sales rumored to be in the works. Vacancy rates are now below pre-pandemic 2019 levels in most Manhattan submarkets, and retailers are willing to pay top dollar for the best locations.

Our retail leasing activity has picked up meaningfully in the last couple of quarters, with almost all our assets seeing significant interest. As evidence of the rebound, this quarter, in addition to signing many leases in the PENN District, we completed an important long-term renewal at one of our Times Square assets at the highest annual dollar rent we’ve achieved in our portfolio since pre-COVID, over $15 million per year. Turning to the capital markets now. While the financing markets still remain challenging, we are starting to see some stability for high-quality product. The CMBS market has begun to selectively reopen for office, lending at conservative metrics on quality assets with long weighted average lease term. Unsecured bond spreads for office continue to tighten.

The market is much more open for high quality retail. That being said, coupons are still high. Banks remain on the sidelines and generally in workout mode, and there’s more pain to come for all lenders, given the volume of office maturities in the next few years. This will create opportunities for us. We have been and continue to be very active on the capital markets front. In addition to the recent extensions on 280 Park and 435 Seventh, we’re also in the process of extending our other 2024 maturities, which we expect to complete soon. Finally, and importantly, as Steve mentioned, just a few days ago, we finalized the recast of our revolver that was scheduled to mature in 2026 for $915 million. Completing this refinancing solidified a key portion of our liquidity through 2029 and gives us significant runway to deal with any challenges over the next few years.

It also highlights the continued support of our key banks in this challenging environment. We thank them for their support. Our balance sheet remains in very good shape with strong liquidity. Pro forma for the new revolver size, our current liquidity is a strong $2.7 billion, including $1.1 billion of cash and restricted cash and $1.6 billion undrawn under our $2.17 billion revolving credit facilities. With that, I’ll turn it over to the operator for Q&A.

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Q&A Session

Operator: [Operator Instructions] Today’s first question comes from Steve Sakwa with Evercore ISI. Please go ahead.

Steve Sakwa: Yes. Hi, good morning. Michael, I was wondering if you could just follow up a little bit on the comments you made about the pipeline and just maybe help us think through how much of that 2.5 million square feet is maybe earmarked for PENN 2 and the development and how much is geared for, I guess, future rollovers, and how much is geared to kind of current vacancy in the portfolio?

Michael Franco: Good morning, Steve. Glen, you want to take a lead on that?

Glen Weiss: Sure. Hi, Steve, it’s Glen. How are you doing? So, I would say it’s a very, very balanced mix of what you just described. We’re seeing a surge in proposals coming in on PENN, both PENN 1 and PENN 2, coming off the heels of our Major League Soccer lease. We’re seeing expirations, outbound expiration tenants coming to us to early renew, just like we did with Bloomberg this week. And in addition, much of the pipeline is attacking expirations at the buildings where we have space available today. So I’d say it’s a healthy mix across the portfolio of PENN and otherwise.

Steve Sakwa: Okay. Thanks. And as a follow-up, Michael, just to, I guess, go back to some of the information you provided on kind of, I guess, the earnings drag from the lost occupancy this year, just to be clear, if you took the $0.30 hit from the interest expense and now you’re sort of quantifying this $0.25 to $0.30 hit from the known vacates, some of which I know has been re-leased and will rebound maybe in ’25 and beyond, you’re kind of suggesting that there is sort of a $0.60 drag this year as we think about ’24 and then are there other positive offsets that might sort of take that number a little bit up from, say, the $2 level?

Michael Franco: Yeah. So, look, in terms of your — the sort of detail there, I think that’s accurate, right? We talked about interest last quarter and sort of reaffirmed the $0.30 this quarter. Yeah, the $0.25 to $0.30 are sort of the known vacates. And as we’ve mentioned, we backfilled a lot of that already at 1290 and 280. Look, we have a lot that we’re working on. There’s some things that could certainly make that number more positive, but I think we’re trying to give you the downside version today. And so, I can’t tell you where exactly it’s going to come out. But I think if you say, look, let’s take sort of worst case scenario, the $0.30 plus the $0.25 to $0.30 gets you down $0.55 to $0.60. I think that’s a good baseline, and our objective is to beat that, but there’s still a lot moving around.

Steve Sakwa: Great. Thanks. That’s it for me.

Steven Roth: Steve, let me just tack on on that for a second. So, I mean, the numbers that you mentioned that and that Michael just mentioned are accurate for this year. Let’s build from there and see what the company’s future looks like on an almost certain basis. So, if you start with re-renting the vacancies and we get back from whatever we are now to our normal, 96%, 97%, 98% occupancy, that adds a big number to our earnings. When 1 PENN — 2 PENN comes online, that’s another $100 million give or take of earnings that comes online that is brand new. If interest rates settle down into some kind of stabilized number, that also improves earnings enormously. So the company has the earnings potential of being, we think, pretty spectacular, and that’s what we’re shooting for.

So we’re looking at it now not on one month or one quarter basis, we’re looking at what the company’s earning power would be, pick a number, two years, three years out. And we are extremely excited about that.

Operator: Thank you. The next question is from John Kim with BMO Capital Markets. Please go ahead.

John Kim: Thank you. Michael, in your prepared remarks, you talked about tech sector coming back to the market in Manhattan and also referenced retailers potentially looking to purchase their flagship stores similar to Prada. Is your commentary more of a market commentary, or do you see Vornado involved in either one of those two?

Michael Franco: I mean, like I think it’s both, John. I mean, we’ve got some of the best product in town in both categories. I think we’ve done more tech leasing than any other landlord in the city. We have all the big four in our portfolio. So, we maintain an active dialogue with all those players. So I would expect that if the tech sector becomes active again, we’re going to get more than our fair share. And in terms of the pipeline, I think the tech sector was pretty dormant for the last 18 months, 24 months either on pause or, in some cases, downsizing space. And we’ve seen in the last 90 days a real pickup there, started small and now we’re seeing some more significant requirements. So, we do think some of those will convert to activity and we’re quite optimistic about that sector turning on again.

On the retail side, I think you know better than anybody, given the discussions we’ve had in the past, we own the best retail in the city. So if you want to be on Fifth Avenue, particularly given the shrinking amount of availability that can be leased, we’re the first, second, third, call it, Times Square, we own both sides of the bow tie. So, activity level has picked up significantly in both those submarkets. The animal spirits are alive and well amongst retailers. They see that Manhattan is thriving again, their sales numbers reflect it. And Prada and Kering’s announcements obviously garner worldwide attention and I think make every other retailer question, what are we doing, right, both from a leasing standpoint and buying standpoint. There’s obviously been other transactions rumored, but I don’t think you’ve seen the last of the retailer purchases and, obviously, given our portfolio, we are a fertile ground.

So, we expect to be in the mix there.

John Kim: Okay. And my follow-up is on 350 Park Avenue. The leasing environment and interest rate environment or the outlook has changed a lot in the past year and a half since you struck the deal. What is the likelihood that either Citadel or you exercise your options at this point?

Steven Roth: There’s always a likelihood, but right now, we’re on full steam ahead to build a world-class headquarters for Citadel. We’ve started the public approval process and it’s a couple of year process to design the building, complete the drawings, get through the public approval process. And obviously, we will reappraise the financial markets at that time. Citadel is growing, they want the space, they’re committed to the deal, as are we.

John Kim: And can you confirm the starting rent for Citadel is reported at $35 million?

Steven Roth: No, sir, we can’t. It’s a formulaic rent, which depends upon what the cost of financing is at the time that we — at the time we go into the financing market.

John Kim: Got you. Okay. Thank you.

Operator: Thank you. The next question is from Michael Griffin with Citi. Please go ahead.