Vornado Realty Trust (VNO) Earnings Call Transcript & Summary

Good morning. This is Jamie Feldman, the senior office and industrial REIT analyst on BofA's U.S. REIT team. I'm joined today by Elvis Rodriguez and Nicole Phang on our team, and we want to welcome you to this Bank of America Global Real Estate Conference virtual roundtable discussion with the senior management team from Vornado Realty Trust. Vornado Realty Trust is a New York-based owner of mostly office properties and a retail portfolio. Joining us today from Vornado are Michael Franco, President; Joe Macnow, Executive Vice President, Chief Financial Officer and CAO; and Glen Weiss, Executive Vice President, Office Leasing and Co-Head of Real Estate. We have a large global audience joining us today. So management will spend the first 5 to 10 minutes of our discussion providing an introduction to the company and update on operating conditions. We'll then move on to Q&A. We hope to make this an interactive discussion, so please add your questions on the Veracast platform so we can weave them into the discussion. I'd now like to turn the call over to Michael to get us started.

Thanks, Jamie, and good morning, everybody. I hope everybody is safe and doing well and starting to get back in the office and back to work in whatever respective city you're in. Jamie, maybe what I'll do is just -- I think everybody knows a fair amount about Vornado, so I'm not going to go into the metrics of square footage, et cetera. I'll talk a little bit about some of the highlights, and then Glen and I will talk about conditions. We are a Manhattan-focused company but also in the premier office asset in San Francisco and in Chicago. And I would say just in terms of a few key highlights about Vornado that I think are important as we sit today. First is we have great assets with great tenants. We have a portfolio of Class A assets. And if you look at the tenant rosters up and down each asset, they are outstanding tenants with great credit. Two is all of our buildings have been modernized in terms of the infrastructure. This is a program that goes back a decade. And so when we get into an environment like we're in today, where the safety and health of the buildings is so critical to giving comfort to tenants, we've already done all that work. And so we can compete very effectively going forward, given the nature of our buildings as they sit today. All that work is done. Three, obviously, we're in a choppy marketplace. There's uncertainty in the world, and we have a portfolio with 24 million feet of office and a little over 2 million feet in retail, where we have minimal near-term roll. So we're well protected from near-term market fluctuations. I think over the next -- through '22, we've got about 10%, 11% on both office and retail, so fairly minimal roll as we look out. Fourth is we think we have the largest and best development opportunity and growth opportunity in the country with the Penn District. We are in the center of New York City with 10 million square feet, with the ability to expand that to 15-plus million square feet over time. And as everything has improved to the West, to the South, we're now the hole in the donut on top of the biggest transit hub not only in the city but in the country, where there is significant government investment in that infrastructure with further plans to improve and expand that. And we own all the real estate around it. The first piece of that redevelopment story is the Farley Building, which is the 850,000 square foot redevelopment of the former Post Office. That will be completed at the end of this year. The train station will open at the end of this year, which is going to be spectacular for New York City, I think coming at an ever more important time, this grand infrastructure delivered to the city, making commuters' daily life much better and us with the office adjacent to that. And as everyone knows, we leased the office component to Facebook back in early August. And so that's put to bed and a tremendous execution led by Glen and the team and quite a bit of activity on the retail, even further bolstered knowing that they've got such an important tenant above them. So the first piece is Farley with Facebook. You now have a district anchor. And if you think about it, on the East Side with Apple, on the West Side with Facebook in our district, and we are underway on the redevelopment of PENN1 and PENN2. So I couldn't think of a better landscape. If we would have sat in our conference room, and we did, thinking about how we would like to have that district develop and who we would like to attract, those 2 tenants were at the top of the list. We were successful. They're our anchors now. And so as we build around that and other tenants see that this is going to be the place to be, we're confident in the future execution there. The last thing I would say before we turn to tenor of the market and so on is, we have always planned for to manage our balance sheet with one eye on looking to take advantage of opportunities, but importantly, always being mindful of where we are in the cycle and positioning ourselves to be able to weather any storm. And we did that leading into this. We sit with cash as of the second quarter of a little bit more than $1.8 billion. We've got another $700 million plus coming in from 220 Central Park South for the remainder of this year, $500 million of which has already closed. So there's no risk in that, and all those closings have gone as scheduled since the start of the pandemic. So we have a balance sheet that is outstanding with manageable maturities on a secured basis over the next couple of years. Financing markets continue to get better day by day, and we're in the midst of financing and refinancing some assets now at very attractive rates. So again, we have a balance sheet that's outstanding. We have an asset base that's outstanding and a growth opportunity that's outstanding. And so notwithstanding the current environment and the uncertainty, we feel quite good about our position. Maybe I'll touch for 1 minute on the buildings. I'm going to turn to like Glen to talk about the tenor of the market, and we can talk about work from home and anything else you want to talk about, Jamie. I would say, and just in terms of the tenor of the city, I think, first of all, it's a credit to our team. I think the protocols we instituted at our buildings are second to none. They are robust. They are thorough. I think tenants that have been back in our buildings feel comfortable, and their employees feel safe. And so there is no issue with tenants coming back because of concern over, is the building safe. That's not a hindrance in terms of the city gearing back up. And so again, I think our team did an outstanding job there, and the feedback from tenants has been outstanding. And they're -- the tenants that are back or their portion of employees that are back feel good about being back. And I would say, in general, in terms of the tenor of the city, I think each day gets better. I think -- and it's self-reinforcing. I think schools restarting is a critical element. Seeing school kids on the street last week was a nice thing, and that's continued to get a little more populated each day. I think that's going to pick up steam next week and then as we get into end of September. And so that obviously brings people back to the city and results in a more normal environment. And I think it's just -- there's -- we've never done this before, right? We've never gone on hiatus for an extended period of time like this. And I think people have sort of forgotten about working in the office, being back in the city. And as they come back in, as they reengage with their teams, notwithstanding it may have worked fine on Zoom because they knew everybody, but they recognize how much better it is and that, frankly, the city is fine. The stories that the newspapers write, they're trying to sell papers. But the reality is the city feels good. There's more and more daily population. That's self-reinforcing. The more that happens, the better the streets will feel, the more populated the restaurants will get, so on and so forth. So it's going to take some time. Today, the utilization rates remain in the low double digits. That's up from the summer, but we expect that to be 20%, 25% probably as we get further on the year as companies are going to remain conservative. But at the same time, we're also selectively starting to hear companies that had planned to come back January 1 that are now saying, "You know what, let's make that October, right?" Maybe it's only for 1/3. Maybe it's for 1/2. But I think as some comfort develops and as they see others doing it and the animal instincts kick in, they'll be like, "Jeez, those 5 private equity firms are in. Why aren't our guys in? And those banks are in. And why aren't we in?" And so on. I think you're going to see that start to result in a pickup. So anyway, I'm going to turn to Glen to talk about maybe the leasing conditions on the ground. And then we're happy to take questions, Jamie.

Good morning. It's Glen. How is everyone doing? So in terms of leasing conditions in the market, it's definitely picking up week to week. Obviously, it's not near where we were pre-COVID. But I will tell you we're starting to see tours in most of the buildings. I will say from an industry-specific standpoint, financial service activity has certainly picked up with the boutique tenants, the small- to medium-sized tenants in our buildings like 888 Seventh, 650 Madison, 280 Park, 90 Park. Those buildings have seen an uptick in activity. Some proposals have come in. The brokerage community is coming back. A lot of the brokers are back. We've been seeing a lot of the brokers getting together for socially distanced lunches, et cetera, just to start really breaking bread and get back at it. One thing that we're doing as a company is really getting ready to get back into leasing mode, which is prepping our spaces, getting them ready for leasing. So as the market continues to rebound, we're ready to lease space. So we don't have further downtime on the spaces that are not yet ready from a build-out standpoint. A lot of the activity we have right now are renewals, where -- and a lot of tenants right now are being cautious. So we're in renewal discussions, 1-year, 2-year, 3-year renewals, although we do have a few renewal discussions that are longer term, 5 to 10 years. So we're seeing strong renewal activity. We do have good pipeline in the buildings, good activity. One thing Michael said which is really important, I mean, we've leased a lot of space during the last 5, 6, 7 years. Our occupancy rates have been 96% -- 97% consistently for a while now. So we feel very well positioned no matter what's going to happen here. We don't have a real large block in our lap right now to lease, and we feel good about where we are in terms of space availability. We feel great about our buildings. We feel great about our tenant roster, and we feel great about our future in Penn. And obviously, the Facebook deal was a huge win for us, the Penn District and the city at large. So that's kind of my color on the marketplace in terms of what's happening on the ground.

Great. Thank you both. I guess just digging a little bit deeper into the conversations you're having. Can you provide any color in terms of, are tenants thinking about taking more space, less space per employee? Are they talking about building out their spaces any differently, whether it's -- I assume over the near term, it's less density. But just kind of thinking longer term, have you -- can you -- any read so far on what this is going to mean for actual space design?

I think it's way too early to tell. All the discussions we're having right now, no one has said to us, "We have changed our design based on the world and what has happened here in the last 6 months." I think it's very early in the game to see how people are ultimately going to design their spaces. I do think this densification mode will certainly stop for now. I think people are going to say to themselves, "Okay, let's relook at that." But I don't -- I have not heard any of our prospective tenants nor have any of our tenants where we've signed the lease previous ripped up their plans and started over based on what has happened here with the pandemic. We have, as a company, focused hard on our plans for PENN1 and PENN2. And we have diligence-d those plans since all this started in March. And we feel very good about what we had designed previous, and we've made no changes to those plans in terms of that product that we're going to bring to the market here over the next couple of years. But I think it's early, Jamie. I think people, they're right now trying to get their employees back into the office as step 1, getting people comfortable, getting them back on public transportation, seeing how their employees feel. I mean, we've brought back a lot of our employees by now. I mean, my whole leasing team is now back. People feel great about being here. They feel very comfortable with the protocols we've put in place, and our hope is that our tenants in our buildings follow the same suit shortly. We've seen some uptick in population. The population in our buildings is now north of 10%. So as Michael said, week-to-week, it is improving. And we hope to see that continue because the key to everything and all the questions that are around is we need everyone back first, get back in the seat, get comfortable in New York.

On that note, there's a letter that went out to the mayor really pushing to kind of get the city to help companies come back and create a safer feeling environment. That seems like a contrast to your comment on New York feels like it's doing fine. Can you just talk about your views and your participation in that letter and what you think the city really does need to get right and what you might be concerned about in terms of coming out of this, especially given the fiscal concerns and the strain?

Look, I think that -- a couple of things, Jamie. Clearly, when there's no one in the city, there's a number of factors that were -- that occurred, right? Some are driven by everything, from how the subways were clean at night, which frankly forced more people, homeless people under the streets in certain areas, concern about the spread of COVID moving people out of shelters, right? I mean, I think it was a little bit of panic mode at the outset just because the unknown and not certain of what we're really dealing with. So there were some incidents, either in terms of what it looked like down the streets, what it looked like in terms of maybe there were certain incidents in terms of assaults or whatnot, drug usage. But again, I think when you actually look at the numbers, on all those things, particularly on crime, the numbers are still pretty close to historic lows. And obviously, there were protests back in, I think, May. And for 2, 3 days, there was civil unrest. And a number of the retailers, there's looting and stores were boarded up. I think that's largely over with. I think all the boards have generally been taken down. There hasn't been that in months. And again, as I said -- so that quality of life is critical to making everybody feel comfortable. I do think it's self-reinforcing, as I said, where the more people that are in the city, some of those elements just get pushed away because that's how and the others and more people out in the open, and people don't want to act out or maybe certainly, it's get pushed more of the fringe, et cetera. So -- and there's fewer people on the street, and some people may feel more comfortable doing certain things. So I think it's self-reinforcing in terms of coming back. And I think the business community is commenting that, look, that quality of life, making sure the cities are clean, which the mayor just announced a pickup back in service there, things like that are very important. So that continues to be the case. The business community is prepared to work with the city, with the state to improve the city on a number of different fronts. And I think there's some ideas in the early stages that people have to coalesce around. But that's the focus. It's that we need the government doing what it can do. The business community is prepared to be helpful, and that's that. I think from a fiscal situation, obviously, the pandemic has taken a toll on, I think, every major city and is looking to the federal government for some help. We'll see whether that happens or not. Obviously, if that happens, it's going to facilitate the city dealing with some its fiscal issues much easier. If not, there'll be some difficult choices to make. But New York will get back on its feet street. And part of that is just business returning to the business. And it doesn't mean we're not in recession for some short period of time, but the city will get back on its feet.

When you talk to tenants about concerns over New York City, what are they saying? I mean, obviously, Facebook took a while to get their lease signed. Was there any discussion around just kind of broader concerns about where New York City might be heading? Or if not Facebook, just about some of your other discussions you have with tenants lately about -- on this topic.

There haven't been specific tenant discussions regarding New York City. A lot of the discussions we've been having have been with the brokerage community, with other leaders in our industry. That's been the talk, industry-specific. We've obviously been speaking to REBNY, BOMA, all the big New York City partnership, taking a leading role, as we should be, as a leading landlord in the city. But I don't -- there haven't been any specific tenant discussions with us as it relates to the conditions that are sitting up.

I don't think, Jamie, and to carry on, right, I mean, I don't think there's a tenant discussion we've had where the tenant said, "While I'm worried about New York, I'm not going to go forward," right? And I think there's a view that we're in a cycle. While it's different than prior cycles, New York is New York, the depth of talent here remains totally unique. And it obviously is what drove Facebook and frankly some of the other tech guys that have landed here in scale recently. And so I think New York continues to be a differentiator in that regard. So I don't think that's really driven any of the leasing discussions. That doesn't mean tenants aren't concerned about their own businesses, given what's going on in the broader world, right? And they're not pausing, which is impacting leasing. But I haven't heard, talking to Glen and others, of specific situations where tenants said, "Boy, now I'm worried about New York."

Okay. That's fair. I wanted to take some of the questions we're getting from the audience here. So I guess just to start, can you talk about net effective rents? How much have face rents moved? How much have concessions moved? What do you think this means for leasing spreads?

Sure. I'll take that one. It's Glen. So look, I think it is early to project what's going to happen with net effective rents. I think thus far, what you're seeing are face rents have not moved much at all. I do think concessions have risen, particularly TIs. Landlords have increased their TIs in order to get deals done, but I think it's too early to tell what can happen with face rents. But certainly, I think the headwind will be concessions, where tenants will be more apt to try to have us use our capital for deals versus them using their capital for deals, particularly with the build-outs. But in terms of the face rents, we haven't seen much change there. And to be fair, I mean, look, there hasn't been a lot of volume or transaction volume in the last 6 months or so. So I think really, until transaction volume picks up on new deals, we will see what happens with net effective rents in terms of the mix of face rent, TIs and free rent.

But Jamie, like it's -- we'd all be kidding ourselves if I said net effective rents are going to be down near term, given all the factors that Glen said. But to predict today what that's going to be, too early. But tenants, to lease space, they're demanding more concessions. And so obviously, that's got an impact on net effectives.

Okay. And then Aimco announced their reverse spin this week. It seems like it was pretty well received by the market. I know you guys have been in simplification mode for many years now, including discussing a potential tracking stock. Thinking about what they've done and how the market reacted, does it -- how do you think about the potential to move forward with something like this for Vornado?

We're waiting to see if we get a royalty fee, Jamie. So we are sort of intrigued in terms of how the market reacts. That was obviously an idea that Steve laid out in the Chairman's letter, given the different risk profiles of the business. So look, it's -- nothing really more to comment on. It's something that we're studying, and we'll see where it goes. But no conclusions at this point. But we are curious to see how that plays out. But that's more just curiosity than anything else. I think the rationale for why we've contemplated is probably why they contemplated it. And so right now, our focus is just blocking and tackling. But we continue to study the idea, and there may well be a time for it.

Is there anything in their structure that was new to you? Or that was pretty much what you guys had in mind?

They are different in the sense of they are actually doing a hard separation between the 2 businesses, right? I mean, there's some linkages, if you will, but it's a straight spin, albeit taxable. And so these are 2 distinct companies when that transaction is all said and done, 2 separate management teams, 2 separate boards, et cetera, whereas I think anything is possible if we were to do something. I think what Steve alluded to more specifically in the letter was potentially a tracking stock, which separates them economically but allows the same team, the same board, et cetera, to continue to oversee that. So there's more G&A efficiency, management talent efficiency, et cetera. So that, I think, is the prior distinction between what they did and at least what our initial thinking has been.

And what's held you back from moving forward?

I think, first and foremost, with pandemic hit and -- right, you got to look at what the impact to the overall business is and make sure that -- I think separating, splitting the company in the midst of this is -- it's a riskier proposition, right? You got to make sure that you feel good about everything, how you do that. And so that was the main thing. And then two, albeit they may not be 2 distinct companies, you have to set them up in the right way. So you have to think through how to do that, and so -- whether that's balance sheet, allocation of costs, et cetera. So yes, it takes time. And then we have to determine it's the right thing. So we think it's an interesting idea. We're studying it, but we haven't made any final conclusions.

All right. That's helpful. I guess shifting gears here to retail. You talked about office getting a little bit -- feeling a little bit better in recent weeks. How would you characterize what's going on with retail?

Yes. I'd say in terms of just the operating environment, that's more challenging, right? Without people on the streets in terms of office workers and particularly with tourism down to a trickle, it's very difficult for retailers to generate much in the way of sales. So their business is challenged, and that colors our thinking. I think that there's a lot of lessons learned coming through this. And obviously, there's many retailers that thrived, and then there's many that have struggled, and some have failed and will fail. I think that the successful ones recognize the importance of that omnichannel approach of physical stores with a robust e-commerce platform. And that's still a process that they're learning in terms of how many stores and the right size and so on, just given that the cities aren't fully open. But they are distribution mechanism for the retailers, and so -- albeit the market is challenging, there are certain retailers that are looking. They recognize that the cities are still one of the best avenues to grow their businesses. And so even in the midst of this, there are certain tenants that are looking. Is it a robust leasing dynamic? Absolutely not, but there is some. Obviously, we signed a lease with Target on the Upper East Side. That's a company that said this is a great time to get into some key locations in New York City, and there's a couple of other large tenants like that, that are kicking the tires on a few things. So I think the strong balance sheets are looking at the market saying, "We're going to have an opportunity to pick up some great real estate at much more attractive prices." And even I would say, Madison Avenue, where rents are down significantly, pricing is inducing a little bit of demand there. So there's trickles, Jamie. I would still categorize the market as tough. I think difficult to call market rents because there's just not a lot of demand right now. I think you'll see probably both sides orient towards shorter-term leases, whether it's, give or take, 5 years, because either landlords don't want to sign maybe what's viewed as bottom prices, and tenants don't want to commit because the world is still very uncertain. But at the end of the day, we do think that the best streets will be winners, will perform well, the Fifth Avenues, the Time Squares, the Union Squares, on top of trends, heavily tourist-oriented, but it's going to remain slow near term.

Jamie, this is Joe. Just to echo one factoid. We published in the second quarter that we collected 72% of our retail rents or 78%, including deferrals. That's stronger in July and August, principally because 2 major tenants with very strong balance sheets started to pay rent and their arrearages that hadn't been paid in Q2.

Thanks, Joe. So what does that take your number up to?

First digit now is an 8 instead of a 7.