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The pandemic has had a significant impact on New York City as the virus hit the city hard, causing substantial economic fallout. Many companies shifted to remote work, keeping people in their homes or out of the city. That, along with government-mandated travel bans and non-essential business closures, hurt restaurants, hotels, retail stores, and entertainment venues, causing many to close temporarily. This situation caused many residents to move out of the city to areas offering more space and better affordability. These headwinds have hammered the commercial real estate sector as occupancy levels and rental rates have tumbled.
However, New York City has a history of bouncing back. That leads Vornado Realty Trust (NYSE: VNO), a real estate investment trust (REIT) focused on the city, to believe it will recover from this devastating blow. Because of that, it thinks its stock price is "stupid cheap" these days.
Premier properties at irreplaceable prices
Vornado Realty Trust owns an extensive portfolio of commercial real estate in New York City, including office complexes, retail properties, apartment buildings, and other assets. The "portfolio is populated with the highest quality assets in all of REITland," according to comments by CEO Steven Roth in Vornado's recent annual shareholder letter. Roth pointed out that Vornado owns iconic locations such as its "Fifth Avenue and Times Square retail assets; 1290 Avenue of the Americas; 770 Broadway, etc., etc., to name a few." It also controls "the most exciting development opportunity in all of REITland, The Penn District; and the two best development sites in town, 350 Park Avenue and the Hotel Pennsylvania."
However, despite owning some of the country's highest quality commercial properties, Vornado's shares have lost about a third of their value since the start of 2020. While the pandemic has put some pressure on its financial results -- Vornado's funds from operations (FFO) per share fell 27.5% last year, forcing it to reduce its dividend by 20% -- the underlying value of trophy-office properties has held up quite well. That's because institutional buyers believe these assets will recover as the pandemic subsides, leading them to take advantage of low interest rates to go trophy hunting.
That's leading Roth to pound the table on his belief that Vornado's stock is cheap. He wrote in the shareholder letter:
In investing, buy low, sell high is the golden rule. Our stock is once again stupid cheap, although the first small leg off the bottom may be behind us. My friend Steve Sakwa, the highly regarded REIT analyst, recently published a report that our current stock price values our office buildings in the $500s per square foot. With replacement cost in the $1,200-$1,400 per square foot range, that discount is a bell ringer.
Roth isn't the only CEO of an NYC-focused REIT to believe the market has undervalued its shares. Marc Holliday, the CEO of Manhattan's largest office landlord, SL Green Realty (NYSE: SLG), made similar statements. Last year, he said, "We believe the stock price continues to significantly lag behind the real financial value of the platform."
Taking a step to unlock the value of its premier properties
Aside from the pandemic's impact on the New York City market, Vornado believes another factor weighing on its stock price is The Penn District. Roth continued in the shareholder letter:
The Penn District is different from our other office assets…it is a large multi-building complex, it is long term and it is development focused (development and long-term are two of the dirtiest words in REITland). The Penn District is our moonshot, the highest growth opportunity in our portfolio.
Because many public-market REIT investors prefer not to invest in long-term development projects, Vornado plans to "separate The Penn District through a tracking stock." Roth noted that "it seems to me appropriate that we give investors the ability to choose between the higher growth but longer-term Penn District or our other Class A, traditional core assets, or both." The hope is that separating the higher-risk/higher-reward development assets from the rest of the portfolio should help unlock the entire portfolio's value.
That's a slightly different approach than that of SL Green, which has been selling assets and repurchasing shares to highlight and unlock the value of its high-quality Manhattan real estate portfolio. For example, it sold 410 Tenth Avenue late last year for $952.5 million, indicating the resiliency of Manhattan's office real estate market and the high value institutional investors still placed on high-quality trophy assets in the city. It used some of those proceeds to fund its $3.5 billion share repurchase plan because, according to Holliday, "We believe strongly that using incremental capital to buy our stock provides our shareholders the highest return on investment."
A prime real estate for value investors
The New York City real estate market has been under significant pressure over the past year because of the pandemic's impact on the city. However, the city has bounced back from tough times before. That eventual recovery leads one of the city's largest property owners to believe investors have significantly undervalued its stock price. That makes Vornado and other NYC-focused REITs potentially great investment opportunities for bargain hunters.
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