If you've ever seen Storage Wars on A&E, then you understand hidden value. On the program, a group of investors are briefly shown the inside of abandoned storage locker, and then they bid on the unit. Similar to valuing a business, what you see goes into the price you pay. What's stuffed behind that dirty old mattress, however, is hidden value.
Likewise, take a quick glance at real estate investment trusts Vornado Realty Trust (NYSE: VNO) and Starwood Property Trust (NYSE: STWD), and you'll see plenty of obvious value. But there are also hidden gems that don't get nearly enough attention.
Vornado Realty Trust
It may surprise you to learn that Vornado, an $18 billion owner and developer of office towers in New York City and Washington, D.C., paid $450 million in March 2005 to acquire a 32.7% interest in Toys "R" Us.
At the time, the global retailer of toys and baby products was struggling to compete with big-box retailers, and the problems have only compounded today with the continued emergence of e-commerce. Vornado has felt the full force of the company's fall from grace, taking $437 million worth of losses on the value of its investment between 2013 and the end of 2014.
In third quarter of 2014, Vornado's losses on Toys "R" Us exceed its original investment. Since then, the investment has been carried at zero on the company's balance sheet. Essentially, this means that the investment is being treated as if it hold no value. Vornado still owns the same 32.7% stake in Toys "R" Us, but until their share of earnings covers their losses Vornado's investment will not be factored into the company's assets. .
However, that doesn't mean Toys "R" Us is worthless. According to the National Retail Federation, Toys "R" Us is the world's 56th largest retailer. And the company still maintains recognition and brand equity along with FAO Schwartz, which the company acquired in 2009. Moreover, Toys "R" Us is in the midst of a transforming its e-commerce platform -- which is now a $1.2 billion business -- and attempting to improve its cost structure.
There is no guarantee that Toys "R" Us will regain its former glory, but if it does, Vornado could be a chief beneficiary.
Starwood Property Trust
Ever since the financial crisis in 2008, Vornado has been attempting to simplify its portfolio. Toys "R" Us is one of the few surviving segments that the company's CEO, Steven Roth, would refer to as "off the fairway" investments. The nation's largest special servicer of commercial mortgage loans, LNR Property LLC, didn't make the cut.
In April 2013, LNR was sold to Starwood Property Trust, which is currently the largest commercial mortgage REIT, and Starwood Capital for $1.053 billion.
The sale included 50% of LNR's equity interest in an online commercial and residential auction house, Auction.com. The site was launched in 2008, and since then it's racked up over 200,000 sales totaling more than $34 billion.
According to Starwood Property Trust's CEO, Barry Sternlicht, during its third-quarter call in 2014, he views the investment as a "kind of a free option [and] value in our stock that probably nobody attributes to the stock." And this free option became considerably more interesting when Google Capital, Google's new venture-capital fund, invested $50 million in the company in March 2014. At the time, the deal valued Auction.com at $1.2 billion.
As a financier of commercial loans, Starwood Property Trust could benefit from a platform that pools together commercial investors. Or perhaps it will eventually sell the position and pay a special dividend. Either way, it's an investment that isn't really being accounted for and could hold value in the future.
See the forest for the trees
As of today, Vornado Realty's investment in Toys "R" Us, and Starwood Property Trust's position in Auction.com shouldn't be high on your list of reasons to invest in either of these companies. However, if you already own one or both of these companies, or you're planning on investing, these potential hidden gems are certainly worth keeping an eye on, as they hold serious upside but aren't getting factored into the price of the stock -- which means you're getting them for free. And who doesn't love free?
Dave Koppenheffer owns shares of Starwood Property Trust. The Motley Fool owns shares of and recommends Alphabet (C shares). Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.