Company Reports

The US REIT sector remains significantly undervalued, in our perspective. While the pandemic hurt REIT valuations in 2020, the recovery of fundamentals across most sectors combined with low interest rates led to strong total returns in 2021 and early 2022. However, despite fundamentals continuing to perform well over the past two years, with many REITs reaching historical levels of net operating income growth, the sector has underperformed the broader equity markets over the past two years. We believe that the cause has been the sector’s negative correlation with interest rates as income-oriented investors rotate out of the sector, higher rates lower the value REITs can create with external growth, and property valuations fall in line with higher rates. However, we don’t believe that higher rates significantly change our fair value estimates for the sector. Additionally, interest rates are down from the October 2023 highs, and REIT share prices have generally inversely followed the movements of the US 10-year Treasury.

No-moat-rated Vornado Realty reported a weak set of numbers in the first quarter, as adjusted funds from operations, or FFO, was reported at $108.8 million ($0.55 per share), which was around 7% lower than the $116.3 million FFO ($0.60 per share) reported in the first quarter of the previous year. The year-over-year decline in FFO can mostly be attributed to lower net operating income, or NOI, from higher interest expenses and lease expirations. Management expects 2024 comparable FFO to be affected by higher interest rates and increased vacancies. The impact of higher interest rates on FFO is estimated to be about $0.30 per share and the impact from increased vacancies is estimated to be around $0.25-$0.30 per share. The impact of higher rates on the bottom line of the company should reverse when interest rates start to decline. For upcoming vacancies, management suggested that most of the impact should be temporary, as a good percentage of this space has already been leased up, but the effect of new leases would not begin to show up until sometime in 2025. We are maintaining our $28.50 per share fair value estimate for Vornado Realty after incorporating first-quarter results.

We believe that there are several attractive opportunities across the US REIT sector for investors to consider. Following the recovery of many REIT sector fundamentals from the pandemic by mid-2021, we viewed the REIT sector as fairly valued through early 2022. However, the past two years have seen the rapid rise in interest rates and a slowing economy, which has led to major valuation declines across the sector. Our analysis of the REIT sector over the past 25 years suggests that the relative stock performance of REITs is negatively correlated with interest rate movements. The second and third quarters of 2023 saw large interest rate increases with the 10-year Treasury approaching 5%, which led to the sector underperforming. This occurred even as many REITs reported same-store net operating income, or NOI, growth at historical highs in 2022 due to high inflation. Higher interest rates, lower liquidity, tighter capital market conditions, and decelerating same-store NOI growth all led to a significant correction in the stock price for many REITs.

No-moat-rated Vornado Realty reported middling fourth-quarter results as adjusted funds from operations were reported at $123.8 million or $0.63 per share, which was around 11% lower than the $139.0 million or $0.72 per share FFO reported in the fourth quarter of the previous year. The decline in FFO on a year-over-year basis can be attributed to a $4.8 million impact from accrual adjustments recorded in fourth quarter 2022 related to changes in the tax-assessed value of the Mart, $6.4 million from higher development fee pool bonus expense, $6.0 million from higher stock compensation, and a $2.9 million from the impact of properties sold. The important thing to note is that the results from the core business were flat and the entire decrease in FFO on a year-over-year basis was driven by increased general and administrative expenses and lower FFO from sold properties. We think that the current results are decent as the company's core Manhattan office portfolio has been holding up relatively well.

Vornado Realty is a fully integrated real estate investment trust with interests in high-quality office and retail properties located principally in Manhattan. The portfolio of the company is around 85% New York-centric and 80% office-centric. It owns 57 Manhattan properties consisting of 20.4 million square feet of office space, 2.4 million square feet of street retail space, 1,662 residential units, and a 32.4% interest in Alexander’s, which owns six properties in the New York area. Vornado also owns two non-New York properties in well-located central business districts of Chicago and San Francisco that have benefited from healthy tech office demand in supply-constrained regions. The strategy of the company is to maintain a high-quality portfolio by investing in markets that have a high likelihood of capital appreciation through acquisition, new development, and redevelopment opportunities.

No-moat-rated Vornado Realty’s third-quarter results were largely in line with our expectations as the firm reported funds from operations, or FFO, of $127.2 million or $0.66 per share, which was around 19% lower than the $157.4 million or $0.81 per share FFO reported in the third quarter of the previous year. The approximately $30 million decline in FFO on a year-over-year basis can be attributed to $11.9 million impact from accrual adjustments recorded in third-quarter 2022 related to changes in the tax assessed value of the Merchandise Mart, $7.3 million from higher interest rates, $6.1 million from higher stock compensation, and $4.9 million from the impact of properties sold. We note that the $11.9 million and $6.1 million impact from the Mart and stock compensation are largely nonrecurring in nature and should not impact year-over-year growth in the next year. The demand for Manhattan office real estate remains muted due to macroeconomic factors and a slower recovery in physical office utilization rates. We expect the firm will continue to feel a disproportionate impact of higher interest rates due to its significantly leveraged capital structure. Its leveraged capital structure also makes the equity valuation highly sensitive to movements in interest rates and cap rates. We are maintaining our $29 per share fair value estimate for Vornado Realty after incorporating third-quarter results.

The share prices of U.S. real estate investment trusts have fallen by approximately 30% from their 2021 highs because of higher interest rates and stress in some commercial real estate sectors. We think that the correction is overdone and the current valuations offer an attractive entry point for patient investors. Our core REIT coverage is trading at a discount of approximately 25% to our fair value estimate. We estimate that the average REIT within our U.S. coverage is currently trading at a dividend yield that is 126 basis points higher than the historical average. We see marked differences in valuation across different REIT sectors in the United States. For instance, the industrial sector is fairly valued, with stock valuations already accounting for future growth, but other sectors like offices, hotels, and malls are trading at attractive discounts.

No-moat-rated Vornado Realty’s second-quarter results were largely in line with our expectations as the firm reported funds from operations, or FFO, of $140.7 million, or $0.72 per share, in the second quarter, which was around 12% lower than the $160.1 million, or $0.83 per share, reported in the second quarter of the previous year. The demand for Manhattan office real estate remains muted because of macroeconomic factors and a slower recovery in physical office utilization rates. The FFO decreased by about $20 million year over year, mostly because of higher interest expenses. As we have highlighted earlier, the company will continue to feel a disproportionate impact of higher interest rates due to its significantly leveraged capital structure. This structure also makes the equity valuation highly sensitive to movements in interest rates and cap rates. We are maintaining our $29 per share fair value estimate for Vornado Realty after incorporating second-quarter results into our model.

Vornado Realty is a fully integrated real estate investment trust with interests in high-quality office and retail properties located principally in Manhattan. The portfolio of the company is 88% New York-centric and 79% office-centric. It owns 67 Manhattan properties consisting of 20.6 million square feet of office space, 2.7 million square feet of street retail space, 1,674 residential units, and a 32.4% interest in Alexander’s, which owns six properties in New York area. Vornado also owns two non-New York properties in well-located central business districts of Chicago and San Francisco that have benefited from healthy tech office demand in supply-constrained regions. The strategy of the company is to maintain a high-quality portfolio by investing in markets that have a high likelihood of capital appreciation through acquisition, new development, and redevelopment opportunities.

We are increasing our Uncertainty Rating for no-moat-rated Vornado Realty to Very High from High to reflect the significant uncertainty in the office market outlook and the highly leveraged capital structure of the company. Vornado owns high-quality commercial real estate properties, principally office properties in the Manhattan area. The economic uncertainty emanating from the remote work dynamic has created a challenging environment for office owners. Employees are still hesitant in returning to the office as office utilization remains around 50% of the prepandemic level. The vacancy rate for office spaces in Manhattan was recorded at 22.2% in the first quarter of 2022, which is roughly 1,000 basis points higher than prepandemic levels. On the supply side, approximately 10 million square feet of office space, which amounts to around 2.3% of the total inventory, is currently under construction in Manhattan and will be added to the market in upcoming years. We expect this additional supply to further pressure fundamentals in the market. The Manhattan net absorption rate remained negative as of the first quarter of 2023, and rental growth figures are disappointing, especially given the inflationary environment.

No-moat-rated Vornado Realty reported lackluster first-quarter results as the demand for office real estate remains muted due to macroeconomic factors and a slower recovery in physical office utilization rates. The firm reported funds from operations, or FFO, of $116.3 million, or $0.60 per share, in the first quarter, which was around 24% lower than the $152.3 million, or $0.79 per share, FFO reported in the first quarter of the previous year. We note that the FFO decreased by $36 million on a year-over-year basis and approximately $30 million of the decrease was on account of higher interest expenses. As we have highlighted earlier, the company will continue to feel a disproportionate impact of higher interest rates due to its significantly leveraged capital structure. The leveraged capital structure of the company also makes the equity valuation highly sensitive to movements in interest rates and cap rates. We are reducing our fair value estimate for Vornado Realty to $29 per share from $35.50 per share after moderating our long-term rent growth, occupancy, and Manhattan office sector recovery expectations.

Vornado is a fully integrated real estate investment trust with interests in high-quality office and retail properties located principally in Manhattan. The portfolio of the company is 88% New York-centric and 79% office-centric. It owns 67 Manhattan properties consisting of 20.6 million square feet of office space, 2.7 million square feet of street retail space, 1,674 residential units, and a 32.4% interest in Alexander’s, which owns six properties in New York area. Vornado also owns two non-New York properties in well-located central business districts of Chicago and San Francisco that have benefited from healthy tech office demand in supply-constrained regions. The strategy of the company is to maintain a high-quality portfolio by investing in markets that have a high likelihood of capital appreciation through acquisition, new development, and redevelopment opportunities.

No-moat-rated Vornado Realty reported underwhelming fourth-quarter results and reduced its quarterly dividend by 29% to $0.375 per share from $0.53 per share. The stock is currently trading at a forward dividend yield of 6.4%. The firm reported adjusted funds from operations, or FFO, of $0.72 per share, 11% lower than the $0.81 in adjusted FFO during the fourth quarter of 2021. The year-over-year decrease in adjusted FFO was mainly on the back of higher interest expenses and was partially offset by rent commencement and other tenant-related items. The company will continue to feel a disproportionate impact of higher interest rates due to its significantly leveraged capital structure. Its leveraged capital structure also makes the equity valuation highly sensitive to movements in interest rates and cap rates. We are maintaining our $35.50 per share fair value estimate after incorporating the fourth-quarter results.

Vornado is a fully integrated real estate investment trust with interests in high-quality office and retail properties located principally in Manhattan. The portfolio of the company is 88% New York-centric and 79% office-centric. It owns 67 Manhattan properties consisting of 20.6 million square feet of office space, 2.7 million square feet of street retail space, 1,674 residential units, and a 32.4% interest in Alexander’s, which owns six properties in New York area. Vornado also owns two non-New York properties in well-located central business districts of Chicago and San Francisco that have benefited from healthy tech office demand in supply-constrained regions. The strategy of the company is to maintain a high-quality portfolio by investing in markets that have a high likelihood of capital appreciation through acquisition, new development, and redevelopment opportunities.

No-moat-rated Vornado Realty reported third-quarter results that were largely in line with our expectations. The firm reported adjusted funds from operations, or FFO, of $0.81 per share, 14% higher than the $0.71 in FFO during the third quarter of 2021. The year-over-year increase in FFO was mainly on the back of accrual adjustments for the tax-assessed value of the MART, rent commencement on new office and retail leases, and continued recovery of variable businesses, which was partially offset by higher interest expenses. After removing the impact of accrual adjustments for the tax-assessed value of the MART, the adjusted FFO was relatively flat on a year-over-year basis. Same-store cash NOI for the New York portfolio was up 1.1% compared with the previous year's third quarter. The new office leases signed by the company in New York had 1.8% higher cash rents than the previously escalated rents in the third quarter. We have reduced our fair value estimate for Vornado Realty to $35.50 per share from $38 per share after moderating our long-term rent growth and occupancy expectations for the company.

Vornado is a fully integrated real estate investment trust with interests in high-quality office and retail properties located principally in Manhattan. The portfolio of the company is 88% New York-centric and 79% office-centric. It owns 67 Manhattan properties consisting of 20.6 million square feet of office space, 2.7 million square feet of street retail space, 1,674 residential units, and a 32.4% interest in Alexander’s, which owns six properties in New York area. Vornado also owns two non-New York properties in well-located central business districts of Chicago and San Francisco that have benefited from healthy tech office demand in supply-constrained regions. The strategy of the company is to maintain a high-quality portfolio by investing in markets that have a high likelihood of capital appreciation through acquisition, new development, and redevelopment opportunities.

No-moat-rated Kilroy Realty’s high-quality office portfolio now looks appetizingly cheap amid the steep selloff of office REITs in the last few weeks. We recognize the uncertainty surrounding the future of the office and believe that the environment will remain challenging for office owners in the near to medium term. Having said this, we also believe that the selloff has been overdone and the current implied valuation of Kilroy’s shares is completely divorced from the current private market valuations of its office portfolio. We think that long-term-oriented investors can consider this stock for their portfolios as the company is currently trading at approximately 40% below our fair value estimate of $69 per share. Our U.S. office REIT coverage is approximately 30%-40% undervalued. Kilroy Realty is our preferred pick in this sector given its risk-return profile.

With the United States experiencing historically high inflation growth, many investors are wondering if real estate provides a natural hedge against inflation and if the REIT sector should therefore outperform the broader equity market. Many REITs in our coverage have reported rent and revenue growth at or near historic peaks over the past several quarters, with inflation being one of the largest reasons for the high growth. Given this and some historical evidence that REITs outperformed in the 1970s and early 1980s when inflation was similarly high, some investors are questioning why REITs have not outperformed in 2022.

No-moat-rated Vornado Realty Trust reported middling second-quarter results as the workers remain reluctant in returning to offices. The physical attendance in restaurants, movies, and other entertainment-related events has reached pre-pandemic levels but the recovery in physical office occupancy levels has remained tepid. We believe that employee behavior is primarily driven by preference and flexibility with regard to returning to the office. This is different from the early stages of the pandemic where the risk of getting the coronavirus was the main reason for lower office utilization. We would like to highlight that this dynamic does not bode well for the owners of office real estate as it points to a more permanent shift in worker and employer behavior. Remote work has now become a norm in corporate America, and we are also seeing increasing signs of employers accepting remote work and becoming comfortable with the new normal.

Vornado is a fully integrated real estate investment trust with interests in high-quality office and retail properties located principally in Manhattan. The portfolio of the company is 88% New York-centric and 79% office-centric. It owns 67 Manhattan properties consisting of 20.6 million square feet of office space, 2.7 million square feet of street retail space, 1,674 residential units, and a 32.4% interest in Alexander’s, which owns six properties in New York area. Vornado also owns two non-New York properties in well-located central business districts of Chicago and San Francisco that have benefited from healthy tech office demand in supply-constrained regions. The strategy of the company is to maintain a high-quality portfolio by investing in markets that have a high likelihood of capital appreciation through acquisition, new development, and redevelopment opportunities.