Vornado Realty Trust (NYSE:VNO) Q4 2022 Earnings Call Transcript

Vornado Realty Trust (NYSE:VNO) Q4 2022 Earnings Call Transcript February 14, 2023

Operator: Good morning and welcome to the Vornado Realty Trust Fourth Quarter 2022 Earnings Call. My name is , and I will be your operator for today. This call is being recorded for replay purposes. All lines are in in a listen-only mode. Our speakers will address your questions at the end of the presentation during the question-and-answer session. I will now turn the call over to Mr. Steve Borenstein, Senior Vice President and Corporate Counsel. Please of ahead.

Steven Borenstein: Welcome to Vornado Realty Trust fourth quarter earnings call. Yesterday afternoon, we issued our fourth quarter earnings release and filed our annual report on Form 10-K 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-K and financial supplements. 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, 2021, 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. It’s Valentine’s Day. As Michael will cover in a moment, 2022 was a strong year with comparable FFO up 10%. Fourth quarter FFO was down 11% due to higher interest rates. Ex-rising interest rates, our core business is performing quite well. Not surprisingly, we expect 2023 will be a down year, negatively impacted by a full year of higher rates. I’d like to share with you a few other thoughts. Notwithstanding all the noise, New York continues to be the most important city in America. We continuously survey dozens and dozens of our tenants all of whom reaffirm their commitment to stay and grow in New York. And that goes for our clients who are headquartered in other cities who are making New York their, so to speak, second home.

And it’s not by chance that the New York area is the tightest residential market in the country. People want to live here. Steel, concrete and curtain wall are important, but in our business capital is the essential raw material. We are now in the middle of a Federal Reserve’s tightening cycle, the result of which is interest rates are up and capital is scarce. And that’s an understatement. Notwithstanding Fed funds at 5% most run of the mill real estate operators can’t borrow at 10% or can’t borrow at all. So here’s what we have done. Several years ago, when we began the Farley Facebook PENN 1 and PENN 2 projects and are all important PENN district. We loaded in over $2 billion in cash to pre fund 100% of our development and construction course.

We didn’t know then how precious this would be. So Farley Facebook is now finished and paid for. And PENN 1 almost so and PENN 2 will finish the round year end. All three of these assets will be free and clear and unencumbered. And that’s quite a feat. We handled all of our 2023 and 2024 maturities. We put on a series of swaps in caps, but found very helpful. They provide only partial protection. And I would observe that there really is no protection against loans that mature in a rising interest rate market. And a further observation is that the stock market prices at then current interest rates, giving no credit to a company which might have lower rate loans, even if they’re locked in for term. Beginning first quarter of this year, we declare a right size dividend allowing us to retain 128 million of cash annually.

And by the way, our stock chose trades still trades at a too high 6.5% yield. In January, we completed an important deal with Citadel at our 350 Park Samuel building, which involved their master leasing the entire 585,000 square foot building, essentially relieving us of 225,000 square feet of vacancy. This deal will almost certainly result in a tear down at a new build of a grand 1.7 million square foot tower on a larger assembled site. Please see our press release of December 9, 2022 explaining the transaction. We have lots of friends on Wall Street and I might venture that by any measure return on equity or return per employee or whatever Citadel is at the head of the class, intensely focused and aggressively growing. This deal validates the quality of our site, our development team, as new.

Interestingly, Ken tells me that a significant differentiator for his firm is the simple fact that everybody comes to work every day, five days a week. I think they start at 7:30 There is a learning here, call me crazy, but I think companies that embrace work from home will be left behind. And I think it’s absurd to think that years from now 10s of millions of Americans will be working from home alone at their kitchen table. And by the way, Zoom may be a disrupter. But his stock is down from 588 to a still high 75 today. You will notice in our supplement that we updated our development projections for Farley PENN 1 and PENN 2 raising our aggregate projected returns. This based on the fact that in 2022 we’d be sorted 25,000 square feet of Penn2 an average fighting rates in the 90s.

And based as well on the outstanding market reaction we are getting to PENN 1 and PENN 2. Our strategy here is to achieve very strong returns at rents well below those required for new construction. The PENN 1 ground lease process is now kicking off as required by GAAP accounting convention. In the first quarter of 2022 we estimated a ground lease of 26 billion and reflected that in our statements. Based on current market conditions, we now think that numbers should be quite a bit lower. We expect 2023 will be challenging as business and consumers continue to feel the effect of the Feds aggressive rate increases and generally tighten their belts and act with caution. This will likely be reflected at lower leasing volumes at frozen capital markets.

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We believe quality product wins today. Just look at our new bills, new lobbies, amenities at Penn1, new scale at PENN 2 etc. Not long ago, new construction commanded a $20 premium. Now it commands a $100 premium or more. Does anybody think that’s too high and that the market will adjust? One more point and this is an important one. In the history of legal real estate all great upward landlord markets followed a period of constrained supply and here we are. Capital markets are now making it almost impossible to build new, which will be the fourth pillar to the next bull market and landlords market. Now over to Michael.

Michael Franco: Thank you, Steve. And good morning, everyone. As Steve mentioned, we had a strong year despite experiencing headwinds from rising interest rates. For the year comparable FFO as adjusted was $3.15 per share up $0.29 or 10.1% from 2021. Fourth quarter comparable FFO as adjusted was $0.72 per share, compared to $0.81 for last year’s fourth quarter, a decrease of $0.9 or 11.1%. While earnings for the quarter were down driven primarily by higher net interest expense from increase rates and the non-cash straight line impact of the estimated 2023 PENN 1 ground and expense. Our core business had strong performance from the rent commencement and new office and retail leases. We have provided a quarter-over-quarter bridge in earnings released in our financial supplement.

We have several non comparable items in the quarter from early gains from 220 Central Park, South sales and other non-core asset dispositions, which in total increased FFO by an $0.18 per share. As previously announced we recorded 595 million of non-cash impairment charges during the fourth quarter of which approximately 483 million was released for equity investment in the Fifth Avenue and Times Square retails joint venture. It should be noted as impairment charges not included and FFO. Companywide same store cash NOI for the fourth quarter increased by 7.9% over the prior year’s fourth quarter. Our overall same store office business was up 8% compared to the prior year’s fourth quarter. Our New York same store office business was up 5.4% primarily due to cash rents at Farley coming online.

Our retail same store cash NOI was up a very strong 7.9% primarily due to the rent commencement on several important leases. Now turning to 2023. While the current economic environment makes forecasting more difficult than usual, we expect our 2023 comparable FFO to be down from 2022 given the known impact of certain items. These include roughly $0.40 from additional interest expense as a result of a full year of higher rates on a variable rate debt net of higher interest income and capitalized interest assuming the current silver curve. $0.10 from the prior period property tax accrual at the mark was recognized during the second half of 2022 and $0.5 of lower FFO from the sale of assets in 2022. These reductions could potentially be offset by a lower result on the PENN 1 ground rent reset that’s currently running through earnings, which Steve mentioned earlier.

Now turning to the leasing markets. We see 2023 as the year both challenges and opportunities. The pace of leasing has slowed in the past few months and the activity is lumpier as businesses generally are feeling cost pressures, and are exercising more caution. Companies are still grappling with hybrid work policies and the right level of flexibility. But overall sentiment is shifting more closely at pre-pandemic norms. We are seeing a real pickup in the return to office throughout our portfolio, particularly Tuesday through Thursday. Utilization rates are approaching 60% and momentum is improving month by month. Both employers and employees clearly recognize the productivity, collaboration, creativity and cultural benefits of working in the office together.

Flight to quality continues to be the prevalent theme for tenants. However, leasing activity is broadening out. We are seeing a pickup in activity in the traditional multi-tenant Class A buildings as tenants are dealing with the aforementioned cost pressures and are not all willing to pay new construction rents. One thing we do think will begin to emerge this year is a heightened focus on the quality of the landlord. Many landlords particularly private ones are beginning to struggle with high leverage levels, which may limit their ability to invest capital in their buildings or in some cases even retain their assets. Tenants and their brokers are smart enough to figure out which buildings these issues are at and avoid them. Strong well capitalized landlords like Coronado will benefit.

A perfect example of flight to quality with strong sponsorship as the previously announced 350 Park Avenue transit action with Citadel. We began our relationship with Citadel 350 Park in the beginning of 2020 with an initial 120,000 square foot lease, and are proud of the relationship we have built with our team, which has culminated in this master lease in the future potential partnership for a new 1.7 million square foot world class building at the site. Our overall leasing pipeline in New York remains healthy at almost 1.2 million square feet of leases, with 275,000 square feet of leases being finalized in another 900,000 square feet of activity in various stages in negotiation. The financial sector in particular continues to be active. Turning to retail.

With the rebound and tourism and daily workers we’re continuing to see more retailers search Manhattan for new store locations. Retailer sales, generally back in the pre-pandemic levels, which is spurring retailers to become more confident and active and taking new spaces. They’re still concerned about inflation the overall economy but are starting to lock in deals given rents are much more attractive levels. Turning to the capital markets now. The financing markets remain highly constrained, driven by the volatility from the feds sharp rate increases. Thanks for dealing with an increase in problem loans and remain cautious and lending and the CMBS market is still largely close. But financing is available for the highest quality sponsors and properties the markets will take some time to thaw, which likely won’t happen until the Fed ends its tightening cycle.

On the asset sale front that continues to be active interested investors in New York office and retail asset. But without a stable financing market it remains difficult to transact large assets without in place debt right now. In these volatile times, we remain focused on maintaining balance sheet strength. Our current liquidity is a strong $3.4 billion, including 1.5 billion of cash, restricted cash and investments in U.S. T-Bill and 1.9 billion undrawn under our $2.5 billion revolving credit facilities. In addition, as a result of our refinancing activities early last year, we have no significant maturities through mid 2024. With that, I’ll turn it over the operator for Q&A.

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Q&A Session

Operator: Thank you. We will now begin the question and answer session. Our first question comes from Steve Sakwa with Evercore ISI. Please go ahead.

Steve Sakwa: Thanks. Good morning. I guess I wanted to start with the developments and the yield, Steve, that you talked about. I guess I can understand maybe the PENN 1 return going up a bit since you’ve got kind of active leasing and maybe good mark to market and a little more visibility there. But I guess I was a little curious about PENN 2. You didn’t take the yield up there. But I don’t think you’ve done any incremental leasing. But maybe that’s part of the pipeline that Michael talked about. So could you maybe just sort of address those two?

Steven Roth: We took the yield of PENN 1 and PENN 2. We took the yield down very marginally on Farley. We did that based upon now we have a year, year and a half even two years of experience with these assets. We know what the market’s reaction is. We have signed 220,000 square feet of leases in PENN 1. We know what the bid ask is for PENN 1. We know what the bid ask is for PENN 2 and it exceeds our initial underwriting and that’s why we made, we adjusted the returns.

Steve Sakwa: Okay, and then maybe as a follow up, Michael. I just when you talked about some of the headwinds to growth in ’23 I kind of get the interest expense in the $0.5 of sales. Sounds like the ground lease maybe a little bit better. I didn’t quite understand that $0.10 from the property taxes. I was just hoping you could maybe clarify that because I thought in the first half of the year, that might have been a bit of a tailwind but just wanted to make sure I understood that point properly.

Michael Franco: We had a prior period accrual and obviously it benefited us at the end of ’22. We didn’t have it in the first half of ’22. And so that gets reversed at the beginning of this year and that’s a ding. So it’s a timing difference of benefit last year get hurt the beginning of this year net-net there was a reduction. But we it affects us the beginning half of 2023.

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

John Kim: Hi, thank you. I wanted to ask about the write down details, particularly at 650 Madison, that’s an asset where it was pretty well occupied, there’s no loan upcoming. I was wondering why you decided to impair it now? And what are your plans for the asset?

Steven Roth: Good morning John. The accounting for joint venture assets is different from wholly owned assets. And as a result of that process and if you look at what’s happened, since we bought the asset resulted in impairment this quarter. So retail rents are obviously not what they were at the time we bought the asset and what we underwrote. We had a large tenant move out unexpectedly in hospital last year and so you run it through the accounting model, and that’s the conclusion. Again keep in mind to non cash item, we still own the asset, the value could recover. We have debt with term on that asset at very favorable rate, and we’ll continue to work the asset and hopefully create value, but on a, as we sit here today, based on the accounting methodology that’s the byproduct.

Michael Franco: John, you use the words, in your question, why we decided to take impairment. The impairment process is rigorous and is to a large degree formulaic, and is to a large degree overseen by our independent accountants. So we tried to keep as much subjective judgment as possible out of it and make it more of an academic formulaic kind of an exercise. And they may have showed that the right that was appropriate there.