Vornado Realty Trust (NYSE:VNO) looks cheap. Hey, even the executives of this New York City REIT say it's cheap. In September 2017, chief investment officer Michael Franco told an audience at the Bank of America Merrill Lynch Global Real Estate Conference, "We view there is no downside in the stock, and it's cheap."
He continued: "Frankly, we are a little mystified where the stock's trading. We think there's a lot of good things that we've done, that we are continuing to do, and you get it for free today."
Vornado's stock price at the time: around $75. Its stock today: about $72. Factor in the company's dividend, and an investor a year ago is about even today. These figures, of course, don't include the spinoff of JBG Smith Properties (NYSE:JBGS), a REIT focused on the Washington, D.C., market -- a transaction that set up Vornado as a near pure play on New York City real estate.
So with a red-hot Manhattan real estate market, and what looks like a massive value disconnect, Vornado does look cheap. But there's just one thing holding me back from investing, and it's the puzzle to solve before buying the stock.
Just how cheap is Vornado?
New York City is hot right now. With 29 million square feet of new deals and renewals, the third quarter was the strongest in four years, according to Colliers International, and this year so far has been the strongest since 2002. So how come Vornado's stock is just sitting around like a log in Central Park?
Let's put some numbers to the valuation disconnect using sales of comparable properties, as provided in Vornado's investor presentation from September 2018.
Vornado estimates that its New York office properties are receiving a 6.4% capitalization rate. As Franco said at that conference in September 2017: "Our New York holdings, which are best in class, are trading close to a 6 cap. I think anybody would kill to own these assets [at] the 6 cap." In other words, a 6% capitalization rate is way too cheap for Vornado's high-quality assets.
Based on Vornado's figures, what would the stock fetch if it were trading at the same capitalization rates (4.4%) as these comparables? Vornado pegged its net asset value (NAV) at $96 per share at year-end 2017.
Management has been making moves to highlight the value of the company, especially the New York assets, for a while. In 2015, it spun off Urban Edge Properties (NYSE:UE), its chain of shopping centers located primarily in New Jersey, New York, and Pennsylvania. Last year saw the spinoff of JBG Smith, a move that split off the D.C.-area real estate into its own REIT focused on that market. (And if you're looking for retail REITs, have you taken a look at one of Warren Buffett's favorites?)
With the exception of some important but isolated assets in Chicago and San Francisco, it's hard to see how Vornado is going to pare back much more, unless it starts unloading individual assets. Vornado has some absolute plum locations, so it would be a shame to trim any more.
Vornado's key assets include the following:
- 3 million square feet in 36 Manhattan office properties.
- 7 million square feet in 71 Manhattan retail properties.
- More than 2,000 units across 12 residential properties.
Those are the figures in aggregate, but they include some real gems in fast-growing or high-quality locations such as:
- The Penn Plaza district, which is seeing rapid infrastructure investment.
- Times Square.
- The Plaza district.
- Park Avenue.
- Grand Central.
So management has been working to create value by separating the various parts and leaving Vornado's choice Manhattan real estate trading on its own (or nearly so). What else hasn't it tried?
The road not taken
One key avenue Vornado has not tried is stock repurchases. And that's paradoxical, since management has repeatedly said the stock is cheap -- and not just by a little. So where's the buyback?
In February, in response to an analyst's question, CEO Steven Roth explained:
We look at buybacks all the time. We look at it at the management level. We look at it at every board meeting. So a buyback now would be accretive to NAV by a relatively smallish number. But ... it would basically require reducing our balance sheet by a fairly significant number. ... So currently, our board ... basically believes that we'd rather keep that $1 billion of dry powder than ... increase our NAV by a marginal amount. ... The second thing is, and we've discussed this with our bankers and other experts, there is no real evidence that a smallish buyback -- and for us a smallish buyback would be, like for example, $1 billion -- actually increases stock price. So ... the answer to that is that right now, we are not in the buyback business, although we may in the future.
So according to Roth, the short answer is, "We'd rather have the cash to invest." And it's totally fine to hold that cash to invest, since real estate demands a lot of capital, and no place more so than New York City. Repurchasing stock should come only after the other strategic and financial needs of the business are met.
The one sign I'm not seeing
But what I'm not seeing (and it doesn't rely at all on the needs of the business) are insider purchases. According to Form4Oracle, which tracks corporate insiders, no insiders have purchased stock in the open market over the past year. In fact, one director liquidated his entire (small) stake, while Roth exercised some options in May and continued to hold the shares. That's better than nothing, I guess, but not really what I want to see when executives are telling me how cheap the stock is and what a table-poundingly great deal I'm getting.
Make no mistake, Vornado looks cheap. But if the company is not going to take steps to move the stock higher via a buyback (or however) and insiders aren't convinced enough to put their own money on the line, then it's not cheap enough for me. Here's the REIT loophole I use to find attractive long-term stocks.