Vornado Realty Trust

Good morning and welcome to the Vornado Realty Trust's second quarter 2019 earnings call. My name is Michelle and I will be your operator for today's conference. This call is being recorded for playback purposes. All lines are in listen-only mode and our speakers will address your questions at the end of the presentation during the question and answer session. At that time, please press star then one on your touchtone phone. I will now turn the call over to Ms. Kathy Cresswell, Director of Investor Relations. Please go ahead, Kathy.

Thank you. Welcome to Vornado Realty Trust's second quarter earnings call. Yesterday afternoon, we issued our second quarter earnings release and filed our quarterly report on Form 10-Q with the Securities and Exchange Commission. These documents, as well as our supplemental financial information package, are available on our website, www.vno.com, under the investor relations section. In these documents and during today's call, we will discuss certain non-GAAP financial measures. Reconciliations of these measures to the most directly comparable GAAP measures are included in our earnings release, Form 10-Q, and financial supplement. Please be aware that statements made during this call may be deemed forward-looking statements and actual results may differ materially from these statements due to a variety of risks, uncertainties, and other factors. Please refer to our filings with the Securities and Exchange Commission, including our form 10-K, for more information regarding these risks and uncertainties. The call may include time-sensitive information that may be accurate only as of today's date. The company does not undertake a duty to update any forward-looking statements. On the call today from management for our opening comments is Michael Franco, President. In addition, Steven Roth and our senior team are present and available for questions. I will now turn the call over to Michael Franco.

Thank you, Kathy, and good morning, everyone. Let me start with a few comments on our second quarter financial results before giving some thoughts on the markets and our portfolio and the important new disclosure we provided on our Penn District redevelopments and our earnings release and supplement. While FFO has adjusted on a gap basis for the second quarter, it was 91 cents per share, seven cents lower than last year's second quarter. Cash basis FFO was up 2.1%, reflecting the underlying strength of our core business with strong same-store results, which I will review shortly. Let me explain the gap numbers as they contain a little noise. First, this year so far, we have sold assets which aggregated almost $3 billion, notably the 45.4% stake in our upper Fifth Avenue and Times Square assets and our stock interest in Lexington Realty Trust and Urban Edge Properties. Even though these sales were applauded by all and they were done at NAV and should have been accretive to our share price, earnings go down as a result. As an aside, we were surprised and disappointed by the stock market's ho-hum reaction. FFO decreased by $10 million or $0.05 per share in the second quarter due to these sales, partially offset by $5 million or $0.02 per share of interest savings from the retirement of the 5% $400 million unsecured notes. So that accounts for a $0.03 per share net decrease. Next, FFO was reduced by almost $0.02 per share from the non-cash impact of one-time equity awards issued to the new leadership group, net of the savings from the accelerated vesting of restricted stock awards in the first quarter. We also had a couple of retail tenant issues impact our second quarter results. At the end of June, Topshop closed all its U.S. stores including our two locations at 608 Fifth Avenue and 478 Broadway following the Top Shop U.S. retail operating entity being placed in U.K. administration in the commencement by the U.K. administrators of a Chapter 15 case in New York. While we were paid rent to the end of June, we wrote off the straight line rent balances associated with this tenant. The increase in the straight line write-offs in this year's second quarter over last year's second quarter amounted to $9.9 million or 5 cents per share. which is included in both same-store NOI and comparable FFO results, primarily attributable to Topshop at Broadway. We treat it as non-comparable the write-off at 608 Fifth Avenue of the straight-line rent and the write-of-use asset at this location. Under the new lease accounting standard, on January 1st of this year, we recorded as an asset the present value of the rents we pay under this 14-year non-recourse building and ground lease. We have the right to cancel this non-recourse ground lease. In terms of the bottom line impact of Topshop, upon such a cancellation of the ground lease at 608 Fifth Avenue, we will no longer have the asset, and in such event, FFO will be permanently reduced by $10 million per year, which will nick our NAV by roughly $1 per share. At 478 Broadway, FFO will be temporarily reduced by $8 million per year from the vacancy. This is great space which we will release in the ordinary course. We may convert some of the upper floors to office given the attractiveness of this bullseye location in SoHo to creative types. So to summarize, the aggregate of all these items that affected second quarter comparable results was a $0.10 per share decrease. This was partially offset by $0.03 of growth from the core business which I will cover in a minute. In our July 12th press release, we cover the details of the non-comparable items in the quarter, which includes a $2.559 billion net gain on the retail joint venture, the previously discussed non-cash charge on 608 Fifth Avenue, which was $77.2 million, and an $88.9 million after-tax net gain on unit closings at 220 Central Park South. Speaking of 220 Central Park South, sales continue apace. To date, we have closed on 38 units for net proceeds of $1.03 billion, and earlier this month paid off the remainder of the $950 million loan. The property is now debt-free. Closings will continue throughout 2019 and 2020, and importantly from here, we will retain all future net proceeds, which will be redeployed primarily into the Penn District redevelopments, turning this capital into highly accretive earnings. On July 11th, just after the close of the second quarter, we sold our 25% interest in 330 Madison Avenue to our partner at a $900 million valuation, netting us approximately $100 million after our share of the mortgage. This asset was the subject of a buy-sell, and of the pricing offered, we concluded it was a better sale than a buy. Over our 20-year hold period, we made eight times our investment. And by the way, we have quite a few like this. The taxable gain related to this sale coming on top of the big retail deal will increase the special dividend requirement at year end, which as of now looks like it will be approximately $1.75 per share. To give you some visibility into comparable FFO for the second half of the year, the aforementioned asset sales after the unsecured note repayment will reduce FFO by approximately $21 million or $0.10 per share. and the lost rent from Topshop will reduce FFO by approximately $13 million or six cents per share. We expect 2019 will represent a trough year for comparable FFO per share. As we continually say, cash NOI is the most important metric in our business. That's how real estate is traditionally valued. Companywide, our second quarter cash basis, same store NOI increased by a healthy 4.3%, broken down as follows. New York office was up 3.3%, street retail was up 4.2%, the Mart was up 15.5%, and 555 California Street was up 12.9%. Let me now turn to the New York market. New York's deep pool of talent and the fact that they want to live and work here coupled with record venture capital investment has led to enormous technology sector employment growth of 80% since 2009. This has played an important role in attracting large tech tenants to the city and continues to feed their insatiable appetite to grow their footprints in Manhattan. These tenants not only want to be in New York, they need to be in New York. Just think of the names in the last 90 days who have either committed or are actively looking for space. It's a who's who. In fact, almost all the well managed companies in every other industry are copying this template in their efforts to attract the best talent. As a result, The New York City economy continues to enjoy sustained job growth, driving strong tenant demand for office space. Private sector jobs increased 54,000 in the first six months as compared to 76,000 for all of 2018, with six-month office sector jobs increasing 12,000 as compared to 20,000 again for all of 2018. Overall, our office portfolio is in great shape and continues to perform well. occupancy stands at 96.7% with only 132,000 square feet of remaining expirations in 2019. Our midtown portfolio, which has been completely modernized and redeveloped for the long term, remains very resilient and highly sought after by tenants. In the second quarter, our leasing team completed 221,000 square feet of office leases and 29 separate transactions in New York at a very healthy average starting rent of $83.54 per square foot. Our mark-to-market rents were positive 3.3% cash and 5.9% gap. While the first half leasing activity of 617,000 square feet is on the lighter side for us historically, realistically, our portfolio is substantially full. But there is more to the story. We have a robust leasing pipeline with more than 2 million square feet of deals in various stages of negotiation. We are experiencing strong leasing activity across all submarkets from tenants in all industry sectors. We have our first leases out at the recently delivered 512 West 22nd Street, including one with a leading media company, all at triple-digit rents. Now, turning to the next major driver of growth and value creation in our business, the Penn District. First and most importantly, yesterday we published on page 8 of our earnings release and page 30 of our supplement the projected costs and returns for the Farley Building, Pen 1, and Pen 2 redevelopments. In total, these three projects comprise 5.2 million square feet consisting of an 845,000 square foot new build at Farley and 4.3 million square feet of renovated and new space at Pen 1 and Pen 2. The redevelopments will be transformative for these buildings and for the district overall. Please see our latest renderings and videos of these projects on our website. We are projecting to spend $2.2 billion to redevelop these assets along with other district-wide improvements, of which we have spent $514 million to date. We project these redevelopments will generate $183 million of incremental cash NOI upon stabilization, a very strong 8.3% initial stabilized yield on cost. This is before ground lease rent reset on PEN1 in 2023, which will be comfortably absorbed by that asset's increased NOI. Overall, we expect to replace $60 plus per square foot office rents at PEN1 and PEN2 with $90 plus per square foot rents and expect to achieve triple digit rents at Farley. These redevelopments will begin to contribute to earnings in 2022 and accelerate over time as the projects are finished and leased up. As we have mentioned previously, the capital for these projects will be funded from the net proceeds of 220 Central Park South without the need for any new debt, which will be very accretive to earnings. We expect that this will put our earnings growth at the head of the pack. Notably, the projected returns in these projects do not include the knock-on effects on all of our other existing assets in the Penn District and the multiple additional development opportunities we control. All will clearly benefit enormously. As the Penn District transformation takes hold, we believe that the Hotel Pennsylvania will be one of the best development sites in the city. Once redeveloped, we are confident the Penn District, which is located directly on top of all major transportation serving the city and region, will become the heart of the New West Side where companies will plant their flag in order to attract and retain talent by creating new workplace environments in our buildings. Looking towards 2020, our lease expirations stand at 1.1 million square feet with 560,000 of this amount coming at Penn II, primarily McGraw-Hill, which will be taken out of service as this redevelopment kicks into high gear. It is here at Penn I and Penn II where we are creating a unique campus and will be providing today's workforce with the office of tomorrow. The scale of our 4.3 million square foot campus at these buildings enables us to provide our tenants with an unrivaled amenity package. These buildings will operate and feel much like a full service hotel with fitness and wellness centers, abundant conferencing facilities, large town hall spaces, food and beverage facilities, as well as many communal spaces to work alongside colleagues. Anticipating our redevelopment program during the second quarter, We signed a 38,000 square foot lease at Penn One with a Fortune 200 company at a starting rent of $93 per square foot, a sign of things to come. This is a first generation lease. If this lease would have been included in our mark to markets, the mark to market for New York office would have been approximately 20% on a cash basis. In addition, both at Farley and Penn Two, we are deep in negotiations with multiple large users for anchor spaces, all in the triple digits. All of this validates the unique nature of what we're delivering here and our underwritten pricing for space in the new Penn District. In addition to the capital we are spending on the Penn District, the government is also investing an estimated $3 billion on various infrastructure improvements, including the Moynihan Train Hall, the West End Concourse, 34th Street subway station improvements, and the new 33rd Street train station entrance. In addition, we have entered into a memorandum of understanding with New York State to redevelop the Long Island Railroad concourse under Pen 1. This redevelopment will tie together 7th and 8th avenues underground, dramatically widen the corridor and raise the ceiling height, allow natural light into the concourse, and substantially improve the user experience. Overall, we couldn't be more excited about what we're doing here. At the Mart in Chicago, Occupancy was 94.8% at quarter end. We have strong leasing activity with term sheets in negotiation for much of the 125,000 square feet of vacant space on floors four and five, in addition to discussions with two large tenants regarding early renewals fueled by their expansion needs. During the quarter, we completed 30,000 square feet of showroom leases and an average starting rent of $63.83 per square foot, Our mark-to-market rents were positive 6% cash and 14.9% gap. At our 555 California Street complex in San Francisco, we are 100% leased. During the quarter, we completed a 30,000 square foot renewal with one of our blue chip financial services tenants at an initial starting rent of $86 per square foot. Our mark-to-market rents were positive 12.8% cash and 32.2% gap. As an aside, we believe rents at 555 California are under market by, say, 25%, which will result in continued strong growth over the next few years as leases roll. Finally, turning now to our New York Street retail business. Overall, the retail market continues to be challenging, with leasing velocities slow and assets prone to negative surprises, a la Topshop. I will also point out Forever 21 has hired restructuring advisors and is working with the mall owners to provide rent relief to help stabilize the company. They are a continuing tenant of ours at 1540 Broadway and 435 7th Avenue. Their lease at 4 Union Square expires this November and we chose not to renew them. We have re-released a portion to Whole Foods for an expansion of its store and are actively negotiating to release the balance of their space at higher rents. 435 7th Avenue is a new five-year lease where they recently opened. At 1540 Broadway, we will likely participate with the mall owners for rent relief in some small measure. Retail occupancy was 94.7% a quarter and down from 97.1% last quarter, all due to Top Shop and the Four Seasons Restaurant. In the second quarter, we leased a total of 70,000 square feet of retail space, achieving mark-to-markets of 18.7% cash and 44.4% gap. The highlight was the significant 20-year, 61,000-square-foot renewal and expansion with Whole Foods at 4 Union Square South, the premier asset in that submarket. They are enlarging and remodeling this high-volume store. To conclude, we continue to maintain a fortress balance sheet with reasonable leverage and an abundance of liquidity today and growing over the next few years. Our current liquidity is $3.77 billion. comprised of $1.1 billion in cash, restricted cash and securities, and $2.6 billion undrawn on our revolving credit facilities. With that, I'll turn it over to the operator for Q&A.