Vornado Realty Trust

Welcome to the Vornado Realty Trust earnings and webcast for first quarter of 2022. My name is Vanessa and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. During the question and answer session, if you have a question, please press 0 then 1 on your touchtone phone. I will now turn the call over to Mr. Stephen Bornstein, Senior Vice President and Corporate Counsel. Stephen, you may begin.

Welcome to Bernardo Realty Trust's first quarter earnings call. Yesterday afternoon, we issued our first 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.bno.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 annual report on Form 10-K for the year ended December 31, 2021, 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 are Steven Roth, Chairman and Chief Executive Officer, and Michael Franco, President and Chief Financial Officer. Our senior team is also present and available for questions. I will now turn this call over to Steven Roth.

Thank you, Steve, and good morning, everyone. Let me begin by saying I thought we had a very good quarter, with FFO up 22% from last year, reflecting the continued recovery in our business. And we continue to see many positive trends across the business. To my eye, the streets of New York are back to pre-COVID in terms of pedestrian counts and our beloved traffic congestion. Apartments are full, and by full I mean literally full with long waiting lists. Restaurants are booming, and office utilization is climbing. We are now over 46% utilization as we speak. There are a couple of things I'd like to highlight. First, we have more floating rate debt than most, and that strategy is correct nine out of every 10 years, but this is the 10th year. The economy is now in the hands of the Federal Reserve in their role as inflation fighter, and appropriately so. If past is prologue, we expect rates to climb quickly up a mountain, slow the economy and inflation, and then quickly fall down the other side. Second, for the first time this quarter, our GAAP financial statements reflect the balance sheet and income statement effect of the pending June 2023 PEN1 ground lease renewal. We have estimated 26 million as the new ground rent pending the actual arbitration proceeding. While these two numbers are substantial and will slow our growth short-term, we believe that as Farley, PEN1, and PEN2 come online, Those will be very, very substantial. Now over to Michael.

Thank you, Steve, and good morning, everyone. As Steve mentioned, we had another strong quarter. First quarter comparable FFO as adjusted was 79 cents per share compared to 65 cents for last year's first quarter, an increase of 14 cents or 22%. This increase was primarily from rent commencement on new office and retail leases and the continued recovery of our variable businesses. We have provided a quarter-over-quarter bridge in our earnings release on page 2 and our financial supplement on page 5. As Steve mentioned, this quarter, for the first time, we are recognizing in our financials the impact in the pending Pen1 ground lease renewal. Under GAAP, we are required to record the present value of the estimated additional lease liability on our balance sheet and start recognizing the straight-line impact in our earnings. This reduced our earnings this quarter by approximately $4 million and we'll reduce it by $21 million overall in 2022 and $23 million on a full-year basis. The reduction in earnings will not impact cash FFO, however, until we actually start paying an increased rent in June of 2023. Looking ahead, we had initially expected to deliver double-digit percentage FFO for share growth in 2022, driven primarily by previously signed leases in both office and retail, particularly meta platforms at Farley. and the continued recovery of our variable businesses. But we now expect the impact of projected interest rate hikes by the Fed and our variable rate debt to be a greater headwind to this year's growth than we originally anticipated. We had assumed the LIBOR would move up this year when we gave a preview of 2022 last quarter, but it now looks like it will move up more than we expected this year. Keep in mind, we're also earning more in our cash balances as rates increase. We now expect our FFO per share growth for the year to be in the mid to high single digits. With respect to our variable businesses, we continued to see a strong recovery in the first quarter. Our signage business, led by our dominant signs in Times Square and the Penn District, had its strongest first quarter ever, and forward bookings continue to look healthy. Our trade show business at the Mart is continuing to rebound, as we hosted four successful trade shows during the quarter, whereas there were none during last year's first quarter due to the pandemic. Our garages, which we expect to be fully back this year, continue to recover. And finally, our BMS business continues to perform near pre-pandemic levels. We expect to recover most of the income from our variable businesses this year with a full return in 2023. Company-wide, same-store cash NOI for the first quarter increased by 5.8% over the prior year's first quarter. Our overall office business was up 2.2% compared to the prior year's first quarter, while our core New York office business was up half a percent. Our retail same-store cash NOI was up a very strong 32%, primarily due to the rent commencement on new leases at 595 Madison Avenue, 4 Union Square, 770 Broadway, and 689 Fifth Avenue. Our New York office occupancy ended the quarter at 92.1%, which is consistent with the fourth quarter of 2021, and up from the trough in the second quarter of 2021 by 100 basis points. Our New York retail occupancy ended the quarter flat versus year-end at 80.4% after adjusting for our asset sales this quarter and up 380 basis points since bottoming in the first quarter of 2021. We expect both occupancies continue to improve by the end of this year based on our deal pipeline and modest remaining 2022 office expiration schedule. Now turning to leasing markets. During the first quarter of 2022, leasing conditions across Manhattan continue to remain strong. Deal activity is robust, while asking rents, the overall availability rate, and tenant concessions have all stabilized. The combination of office-using job growth, higher space utilization, and continued expansion by tech, financial, and media companies has resulted in market resiliency. Leasing activity is currently indicating a continued trend towards recovery out of the pandemic, with several large leases in the pipeline across all sub-markets. CEOs are placing a high value on securing their long-term workplaces in order to foster teamwork, collaboration, and morale amidst fierce competition for talent in an ever-tightening labor market. As such, flight to quality remains the dominant theme in the leasing market. This is evidenced by 40% of the side leases in the first quarter consisting of relocations to new or redeveloped assets. Accordingly, rents have increased in the new construction or best-in-class redeveloped assets. which provide amenity-rich offerings at transit-centric locations. Our best-in-class New York office portfolio is well positioned to thrive in this environment. Focusing now on our portfolio, during the first quarter, we completed 30 leases, totaling 271,000 square feet, with healthy key metrics, including starting rents at $81 per square foot and a positive mark-to-market of 7.2% cash and 6.5% gap. Leasing highlights during the quarter include a 53,000 square foot expansion with NYU at One Park Avenue, bringing their total footprint in the building to 685,000 square feet. We also completed eight transactions at Penn One, totaling 68,000 square feet, with average starting rent in the 90s per square foot. These early leases validate our plan to take rents at Penn One from the 60s per square foot to the 90s. And we are now starting to push rents in this building into the triple digits, as tenants love this totally unique workspace. A transformation of PennOne has redefined work for all of our Penn District tenants. The unrivaled work-life campus ecosystem located on the building's first three floors is running on all cylinders, including our food and beverage operation, along with a 140,000 square foot amenity offering of health and fitness facilities, conference center, and trophy flex space operation. While the first quarter leasing volume was lower than recent quarters, We anticipate a very strong boost in leasing activity during the forthcoming quarters with several large pending transactions in our pipeline. We currently have 1.2 million square feet in lease negotiation driven by tenant expansions with an additional 500,000 square feet in earlier stages of negotiation across our portfolio. Retail leasing activity in the first quarter consists of six leases totaling 20,000 square feet with average starting rents of $172 per square foot, all of which were new leases. We have an active pipeline and strong interest in the Penn District in particular with the recent commencement of leasing in the Long Island Railroad Concourse. Now turning to Chicago. The office market continues to be challenged with direct vacancy at 19% and tenant concessions at historically high levels. However, as we said last quarter, tenant demand continues to strengthen throughout the city, as indicated by this quarter's positive net absorption. At the mark, we signed 149,000 square feet of new leases during the quarter, including a new 81,000-square-foot headquarters lease with Avant, a fintech lending company, as well as a 34,000-square-foot renewal of Steelcase's showroom, which is an anchor tenant for our contracting and furniture business. Recent tour activity has been strong and is reflected in our growing tenant pipeline. We have 70,000 square feet of leases and negotiation, and our trading proposal is another 250,000 feet of prospects. We look forward to commencing construction of our MART 2.0 building capital program in July. We will bring our New York Work Life Campus ecosystem to Chicago, which will further differentiate the MART as a unique workplace. In San Francisco, leasing activity started slowly at the beginning of 2022 as companies monitored the Omicron variant, but activity picked up towards the end of the quarter and has continued as companies initiated their return to work plans, led by a coordinated effort by the mayor and many large San Francisco employers. While the city's overall vacancy rate is elevated at 15%, the seven-building trophy set, of which 555 California is certainly one, is at 3% and experiencing strong tenant demand and rental rates. As such, our market-leading 555 California complex is effectively fully leased, with the exception of the 78,000 square foot 345 Montgomery building. During the quarter, we completed an important 49,000 square foot renewal with Microsoft in the base of 555, resulting in a significant 19.8% cash mark to market, as well as a new triple-digit rent lease with a global private equity firm and a 7,000 square foot suite in the building's tower. Finally, turning to the capital markets, with the current market volatility and a move up in interest rates, the financing markets have become choppier, with the typical increased focus from lenders on quality, sponsorship, and lease term. Our portfolio is well positioned in this regard, and fortunately, we have only modest debt maturities in 2022 and no material maturities in 2023. after capitalizing on the robust markets last year. We are in the process of refinancing 770 Broadway now, our one significant maturity in 2022 and expect to complete it later this quarter. We also went under contract last week to sell our Long Island City office building for $173 million. After purchasing the asset in 2015, we extended the major leases over the past few years to create value, and so our job here was done. This sale, together with the five small retail assets we recently sold, continues our efforts to monetize our non-core assets, and we have another $750 million planned in the near future. Finally, our current liquidity is a strong $3.962 billion, including $1.787 billion of cash, restricted cash investments in U.S. Treasury bills, and $2.175 billion undrawn under our $2.75 billion revolving credit facilities. With that, I'll turn it over to the operator for Q&A.

Thank you. We will now begin our question and answer session. If you have a question, please dial 0, then 1 on your touchtone phone. If you wish to be removed from the queue, please press the 0, then 2. If you're using a speakerphone, please pick up the handset first before pressing the numbers. Once again, if you have a question, please press 0, then 1. We have our first question from Manny Korchman with Citigroup.

Hey, it's Michael Billerman speaking. Michael, you know, leasing has definitely kept pace to start the year. You talked a little bit about pipeline. I was wondering if you can sort of unpack some of those numbers in terms of where you're seeing the activity, how much of it's on vacant space versus, you know, existing stuff that's going to roll, just to give a little bit more detail about the momentum in leasing that you're seeing.

Yeah, I'll let you take that one.

Hi, Michael. It's Glenn. How are you?

Good.

So, you know, the $1.2 million fee Michael mentioned in his remarks, it's a very healthy mix. I would call it 50-50 of new expansion versus renewals. A lot of the activity is in Penn and a lot more of the activity is in the financial service building. So in terms of looking forward, you know, as we said, we expect occupancy to continue to improve throughout the year. continue to fill spaces. But we're seeing a real good mix across all types of 10 types in the portfolio as we sit here.

Great. And then maybe just on 10-1, Michael, you talked a little bit about the ground lease in terms of recognizing the value that you've put in, which is obviously now it sounds like subject to arbitration. Can you just sort of walk through sort of the map a little bit? It would seem as though that 12-point 2% targeted return would probably come down, call it about 500 basis points for the extra ground lease. But maybe just help us understand what the process is, given the fact that you've gone through 330 with 34th, that's an arbitration and just trying to understand the timing of how all this will work through and ultimately its impact on financials.

So, um, like we, we, uh, As we stated in the opening remarks, we put it on the balance sheet, straight line in earnings. I think it's Steve's comments. He stated that the number we've put down is $26 million. There's a lot of data out there in terms of what the FAR is, et cetera. I'm not going to get into that. The process is going to commence near term, and so we're going to continue to not get into details here publicly. It's our best guess based on where the site on Pen1 is probably one of the largest sites to be valued. It's three times the size of 330. Larger sites tend to be valued at lower prices than smaller sites, just given the nature, the size and what can be built and the risk and so forth, construction costs, et cetera. The process is different on Pen1 versus 330. And, you know, it'll start, as I said, later this year and be finalized by the middle of next year. And so the new rent will take effect in June of 2023. You know, as you stated, we have from the outset on 10-1 put the return gross of any renewal rent because, you know, we don't know exactly what that'll be yet and said it could be material. We've now daylighted our best guess as to what that may be, and it'll be, you know, finalized over the course of the next year.

Is that the right math, though, Michael, just thinking about that?

Michael, hang on for a minute. We chose to disclose our returns on the investment we're making in PEN1 on an incremental basis. Why? Had we not done that, because if we did, The program is going to yield, let's say it's a 2.5 million square foot rentable building, and the rents are going to go up somewhere $35, $40, or something like that. So let's say they go up $30 on 250,000 square feet as the leases roll out over the next four or five years. That's $75 million that approximately drops down to the bottom line. So the ground rent would be, we think it would be $25, $26 million, and so on. we can easily handle that and easily get a return on the 400 odd million dollars we're investing. Furthermore, the building, together with its partner in the campus, 2PEN, creates the nexus of what we're doing in the Penn District. So it's very important. We have a totally unique, largest in town, amenity package, which is now complete and open to rave reviews from our tenants, the brokerage community, and prospects. So we think it was absolutely the right thing to do. Now, the arbitration that is going to proceed, there are two different kinds of, the 330 arbitration was a baseball arbitration, and what that is is very simply one side puts in a number, the other side puts in a number, and the arbitrator, the neutral arbitrator, decides which number is more correct. In other words, the middle, if you're $1 above the middle in the arbitrator's mind, then you win, et cetera. The one-pen arbitration is different. It's two arbitrators in the third. It's more of a negotiation, and so it's a totally different kind of process. We believe that the number that we have selected and chosen is correct for lots of different reasons, including comps in the marketplace, and that will all prove out over the next months and years. I expect the arbitration to start sometime just before the end of the year. So that's the way we look at it.

Michael, just to come back to your comment specifically on the math, right, if you take the 12-2 and you take the incremental rent that the $26 million implies, which, you know, we're paying two and a half today, so your 12-2 would go down to seven. Your math is correct.

Right, and then Steve's point is that, you know, the reality is this is one massive complex where that ground lease supports a lot of other rent that's being generated, and so it has to be looked at in totality rather than an individual basis.

Absolutely, and one other thing, okay? We're in the process now of doing budgeting, which we do all the time. It's my belief and Glenn's belief that if we, that the building as offered to the marketplace now is worth in the 90s, I believe $100 a foot. If you go out and look at what's going on in the market to the west of us at Manhattan West and Hudson Yards, rents are higher and substantially higher. And we believe our nexus with transportation creates a site which is the best in the neighborhood. So we believe that we will start in the 90s at $100 a foot, and three, four, five years from now, this asset will grow in value with rents that will go into the hundreds. So the 7.5% or 5% or 8%, whatever the return is at the opening, is just the beginning of a long, healthy investment period for this asset.

Okay. Thanks, Steve.

Thank you, Michael.

Our next question comes from Jamie Feldman with Bank of America.

Great. Thank you, and good morning. Steve, I want to go back to some of the comments you made in your chairman's letter. First, you said, The last domino will be when employees and employers resolve hybrid work schedules in the office districts or teaming with activity, which will come sooner than you think. You also said tenants tell us they want less formal, creative office west side model. Only half of New York's 400 million square feet of office space fits that description. So as you sit back and think about these comments and think about the future of office in New York City, what else can you tell us about how Vernado plans to invest or maybe how your current portfolio does or doesn't fit this description um and then also just you know what do you think office usage looks like a year from now in terms of you know days of the week and how people are going to use the space i'm going to shift that off to michael and glenn to start so it's a very extensive question i'm glad that you read my letter thank you uh morning jamie um

So in terms of predictions of what utilization will be from now, you know, it's anybody's guess, higher. You know, we continue to see a trend higher, and, you know, there's a fairly consistent pattern of Monday through Thursday higher, Tuesday through Thursday the highest, and Friday no one feels like commuting in the city. So, you know, absent their bosses telling them to get in the city, Friday will probably continue to be the low mark. But that number continues to trend up, and I think it'll – It will continue to do so. I'm not going to certainly make a prediction on the plan will in terms of what the number is. I think Steve's comments on the type of space people want, companies want, you know, that trend started pre-pandemic. It's accelerated post-pandemic. I think what we're doing in Penn is exactly what companies want. I think that's why we're seeing the reception we're seeing with Penn 1 and now Penn 2 and even Penn 15 as they've seen the plans, although that's still a bit off. So, but it doesn't just go for Westside, right? We're seeing demand at the 770s and the 8510s and the 350 parks and so on. So, but that being said, and we talked about, at least in my comments, you know, selling assets. You know, Long Island City, yeah, that was an asset that clearly doesn't fall in that category. You know, a 40 Fulton, which we're going to brand new market shortly. It's a fine building, but that's not an asset that we think is – It's consistent where we want to own in five, ten years. We're going to prune the portfolio. We're going to continue to upgrade, make sure we own assets that we do believe are going to reflect what tenants want, or we can push rents most importantly. We want to have assets where we're going to see rental growth over time. If assets we believe are not going to fall into that category, then I think you'll see us actively prune those over time. What would you add to those?

I think Michael covered it, Jamie. And, you know, it's not a one-size-fits-all answer. It's very tenant-specific. It's very industry sector-specific in terms of the tenant and what their business is. But I will tell you, we see positive momentum. So, number one, people are coming back more and more week to week. Leasing velocity is much higher this year than this time last year. There's a lot of large deals out there, a lot of large deals which have been signed and other global banks on the New Deal yesterday on the west side. So there continues to be momentum. And I think more and more people are coming back into the office market, wanting new space. That's definitely a theme. Recreating their culture in terms of talent, recruiting people, improving their brand, et cetera. But I think you're seeing now what we had predicted last year. It will be an unwinding back to the office. People are now starting to come back, getting more comfortable, and I think month to month it's continuing to improve out there in terms of the environment.

Jamie, I think in your question there was implied the culture of work and what the design of space that the employers and the employees want. This is something that our company and our teams have been focused on for a long while. So we believe that the tie and suspenders and striped suit are a thing of the past in the business community today, whether you're in the finance industry, on Park Avenue or whether you're in the tech industry on the west side. So what we have done, we think very successfully and tried very hard at, is to focus on the hospitality aspect of our buildings and our space. So if you go through the amenity package in one pen, which is 160 odd thousand square feet, so it's enormous. And one of the strategies that we have is that if you have a cluster of buildings in a campus, you can afford to have a much larger amenity offering than if you have a single building. And so if you go through there, we have food offerings, we have places to hang, we have places to chat, we have gyms, we have health facilities. We have all manners of things. We also have a conference center so that a tenant can take 60,000 square feet and not have to devote 4,000 of those square feet to conference rooms. We have it. We also have co-working space in the building. So we think that that's the future. The other part of it is that we want the staff in the building to treat our tenants as if they were guests at a hotel. Know their names, welcome them, greet them, and treat them as they want to be greeted. So there's an entire cultural thing the way work will be done in the future. And this is pretty universal, by the way, not only in New York, but that better owners are sort of doing what we're doing. We think we're in the front of it, but we're not unique.

All right. Thank you for everyone's thoughts on that. So I guess just, you know, following up on two pens, can you talk more about just the leasing demand? I know you signed the big MSG lease, but how do you think that stack works out based on, you know, the discussions you're having, or do you feel like it's still just kind of early to have a view on that? And then similarly, you know, just, there's just so much buzz around crime and safety and around the Penn district, you know, how would you gauge it today versus maybe where it was a year ago and maybe some of the initiatives that could improve it further.

In terms of leasing at Penn too, the building is at the very top of the list for any user coming into the market, looking for other new construction or the very best of the redevelopment in the market. So we're in continuous meetings with tenants, brokers, presenting the asset, but we are in no rush. The bustle structure has just gone up. As each month goes on this year, Jamie, it's going to just get better, better, and better physically. We'll then start bringing people into the project to get a feel of just how unique and spectacular this space will be. So we're seeing everybody, we're showing everybody the reception's been A+. We're on every tour of every important client who's walking around New York for space. As it relates to the district, I think we're, you know, the streets are noticeably improved from this time last year. We're, of course, working daily with all the jurisdictions, both between NYPD, the mayor's office, the business improvement districts, our colleagues in the district, other owners, our major tenants, et cetera, and really focused, of course, on safety in the neighborhood. And I do think it has improved year over year. We still got work to do, and we're, of course, on it every day in terms of admission. But the reception at Pen 2 has been excellent. And at Pen 1, as we've said in the remarks, the action is enormous. The rents continue to rise, and we're seeing tenants coming into the building for tours. They're coming from every sub-market in the city, from Park Avenue, 6th Avenue, downtown, all over the place, honing in on the district and into this campus amenity program that we're offering.

I would just say, Glenn talked about year over year. I think quarter over quarter, the streets are better. The activity level in the streets is has increased more traffic through the station. That has made the streets feel safer. It's made it feel better, right? Push some of the other elements to the side, maybe out to other areas. So I think when you're, I don't know when the last time you've been to the district, I know you're going to be walking the area soon, but I think you'll see a noticeable improvement. Still work to be done, though.

Thank you. We have our next question from Steve Sokla with Evercore ISI.

Thanks. Good morning. Steve, I was wondering if you could just comment a little bit more about your appetite and desire to still be part of a casino project or licensing agreement if New York City were able to get one. I'm just curious if you're looking to be part of the operations or you're looking to more be of a landlord and If it's on the landlord side, how big of an integrated resort do you ultimately think the winning bid needs to be? Does it need to be hotel rooms and convention space, or do you think it can just be a standalone casino kind of in the heart of Manhattan?

Well, some of the answers to your questions are, at the current time, unknowable. This is going to be a political process. and there are going to be government officials who are gonna make these decisions. With respect to the idea of a casino, we are aggressively pursuing it, as we should and as we must. And I've said in the last two letters I've written, that we believe that there are going to be three downstate licenses. We believe that the best place for the third license, one goes to Yonkers, one goes to Aqueduct probably, although that might be contested as well, but we believe that the third license would be best served to go into Manhattan. When you think about it, Manhattan is the center of everything. It's the center of the hotel industry, the entertainment industry, the restaurant industry, the business industry, the theater industry, et cetera. And one of the anomalies is, while it's the economic engine of New York by far, the voting population, who is of interest to the political leadership, of course, is not necessarily in Manhattan. So that's an interesting thing. We are in the process of talking to multiple people, and the casino industry operators are talking to multiple landowners. We are in the process of debating whether we would be just a landlord, and the word just is an understatement, being a landlord, or being part of the operation, or being a hybrid, which is a landlord with a kicker or whatever. We're in the throes of thinking about and talking about and debating the financial arrangements. With respect to whether the winning bid, so to speak, would be a small, isolated casino or an entire Las Vegas-style complex with hotel rooms, entertainment, food, et cetera, offerings, I don't know which is the right one, okay? we believe that we can pursue both of them. We have multiple sites that we intend to bid with. And, for example, if you just take the Penn District, what's in the middle of the Penn District? Madison Square Garden. Madison Square Garden is the biggest and most important entertainment complex, you know, and certainly in the New York area and maybe, you know, far and wide. The interesting thing about Madison Square Garden is, in addition to the teams, it has 220 dates a year of concerts. So it's the center of the music industry as well. And it sits on top of, so our land is adjacent to Madison Square Garden and sits on top of the transportation network, which is interesting. There's been some talk about Times Square, which is also interesting. And we have sites there. So, you know, this is early days, and we are exploring. We're working very hard exploring all of the different options, and we expect to try to – we will probably get a resolution as to what direction we are going to go in sometime, you know, way well before the end of the year. We – I think I read one transcript somewhere that somebody thinks that this process is going to be over in the first quarter of next year. I don't think it's going to be anywhere near over. That's going to take a lot longer than that, as it should. It's a deliberative process, and it's important. So we believe that Manhattan is the right venue to get the third license. We intend to compete aggressively for it. And one last thing. We think speed to market or speed of opening is going to be a very important determinant of the economics of the bidders. So if you have to build a new complex, that could take three, five years. or if you're retrofitting a building that could take one to one and a half years, there are billions of dollars difference in that calculation. That's it for me on this topic.

Great. Thank you for that. I guess second question, you know, Michael, could you maybe just speak a little bit more to the financing market? It sounds like, you know, 770 Broadway is in for refinancing. Can you just Maybe give us a sense of kind of where the market is today for kind of mortgage debt and just give us an update on kind of size and pricing and how that market's changed.

Yeah, look, anytime you get into periods of volatility, which we're clearly in right now, you get hesitancy on the part of, I would say in particular bond buyers and to some extent the banks, although I think it's really much more so in the CMBS market. So I think you started the year with a heavy supply of CMBS volume and then you had rates gap out, war, economic uncertainty that caused the spreads to gap out. So you had a bit of a double whammy both on spreads and rates. CMBS market's open, but if you don't have to issue in that market in size, you know, it's probably a market you'd prefer not to go into right now, and we don't need to go into that. So, you know, 770 will end up getting done in the bank market. You know, it's an asset that's, you know, it's a high-quality asset with a great tenant, and so, you know, well-received in the bank market, and, you know, we'll roll that over at a spread. I think pretty comparable to where we're at today, you know, on that building. So, You know, spreads aren't what they were, you know, six, 12 months ago, but, you know, still attractive for high-quality assets. And as I said, I think the bank market, you know, much more liquid than the CMBS market, but that can only handle, you know, so much. So, again, our assets on a one-off basis, you know, there's good demand in both markets, but for 770, you'll go in the bank market, which I think has more stability right now.

Fixed or floating? So, you know, given the bank market is... Hey, Steve, I'm going to ask a few questions now. Kicks or floaters?

Well, given it's the bank market, it'll be a floater, but, you know, we'll likely, as we've done a number of other situations, you know, swap that out for, you know, a portion of all the terms.

And thank you.

I don't have anything else in the financing market. Hopefully that answers your question. I mean, beyond 770, you know, we don't really have any other material finance. We've got a couple of small things we'll get done, but no other material financings for 2022 and 2023. So that's, you know, we did a lot of that opportunity last year. We obviously had a number of maturities last year. So, you know, even in outstanding markets, we really didn't anticipate being very active in 2022. Got it. Okay, thanks.

And thank you. Our next question is from John Kim with BMO Capital Markets.

I think you just answered my question, but Steve, in your opening remarks, you did mention that having a high floating rate strategy works nine and 10 years and rates will come back down again. So I just wanted to confirm that you're comfortable maintaining a high floating rate strategy in the near term.

Yeah, we think we spend a great deal of time on our balance sheet is very important liquidity. and safety and the ability to be defensive, but even more the ability to be offensive is extremely important to us and in running this business. So every time that you look at a financing opportunity, if you compare a floating rate debt to a 10 year fixed rate debt, the spread is enormous. It goes to, what was it, two and a half percent, two and a half points, 250 basis points most of the time. So what happens if you elect to go 10-year fixed, you are for certain costing yourself 250 basis points more. And during the life of, you know, over the last 30 years, I think one of the firms that we use as an advisor on financing is said every single month for the last 30 years, the right decision was to go floating rather than fixed. So the answer is, is that do you pay 250 basis points more or do you go floating? Now, there's other parts of it, too. If you are in a fixed rate loan, you are locked in. And if you decide you want to sell the building or refinance the building or whatever before the end of the term, you have to defuse that. which is normally a very, very expensive proposition. So it takes away all of your flexibility if you are going to sell or improve or whatever the asset. And that's an extremely important thing. Now, while we have floating rates on our books now, and our interest expense is increasing, if we would have had all of that debt at fixed, it would have been substantially more in interest expense than we are currently paying or we expect to be paying. So we think that the fixed rate strategy, while it seems safer, it's for certain much more expensive and for certain much less flexibility, which is why in the meat industry, most folks seem to like the unsecured debt route where you are not encumbering the asset with a mortgage or what have you, and you can get that flexibility. But we still believe, I still believe in the floating rate strategy as being a superior strategy.

I'm just wondering with inflation at four-year highs, if there's a risk that rates could remain higher for longer. And with 770 Broadway in particular, is it contemplated at all to to have that as a fixed-rate mortgage? Or fixed-rate things? I couldn't understand your question, John. What did you say, 770? With 770, have you decided to definitively have that floating and hedge it near term?

Yeah. The base loan will be a floater because it's going to be in the bank market, but our intent is to swap that at the corporate level for a period of time.

Okay. And then one final question. With the ground lease reset, you know, addressed and the retail guidance already provided, why not provide FFL guidance going forward, just given the amount of uncertainty there is in the markets and with your company in particular?

um you know the answer is uh like real estate's a long-term business there's a lot of ins and outs we're in a heavy development phase generally and it's difficult to do you know we gave you we gave you some a preview at the beginning of the year and uh uh you know and now we're now we're walking that back a little bit given rate so it's a difficult thing to do we've given you i think reasonable sense for 2022 mid to high single digits um so that's you know i think that's Pretty good guidance for this year. That's our best guess. Things change. It's a fluid business, but that's our best guess for this year.

And thank you. Our next question is from Alexander Goldfarb with Piper Sandler.

Hey, good morning. Good morning, Steve. So a few questions here. The first is you guys had the billion seven of cash. You bought some T-bills. But why not use a portion of that cash to pay down some of the floating rate debt as opposed to just buying the T-bills?

Alex, good morning. Good morning, Michael. The answer is we did deploy some of that cash in T-bills in order to get some of the benefit of earning more than what's in the banks. A lot of that capital that's still left, we intend to deploy into our development activities in Penn. Since the quarter end, by the way, we've put a little bit more in T-bills. By the way, those are staggered maturities, 3, 6, 9, 12 months. A lot of that capital is going to go into Penn too. and to finish up what's left at Farley and Penn One. So that's the rationale in terms of why it wasn't all deployed, why it wasn't all paid on debt. In New York, you have the additional issue on the mortgage debt. You do have mortgage recording tax, which costs you 3%. If our intent is to have financing on those assets over the longer term, that would be wasted money that we've paid once before that we would never have to pay again. So we don't want to do that likely.

Alex, in this market where the financing markets are extremely choppy and hostile, if we pay down short-term debt, replacing it if we need the capital later on is going to be more difficult. The other strategy is you can hedge it, and if we take the cash, which we need and we have places for and it's all allocated in our capital plan and our budgets, And so if we take cash and hedge it by buying treasuries, so let's say we can arbitrage it so the interest expense on that particular slug of capital is 100 basis points less than we would earn on the treasuries. So 100 basis points, let's say, on a billion dollars is $10 million. That's a lot of money, but it doesn't move the needle. So I'd rather have the liquidity. rather than pay down the debt and not be able to replace it easily and quickly when we need it. Steve, that's helpful.

Yeah, that's helpful. And as we look, Michael, as we look at the, I know that you're not giving distinct guidance, but from the 81 cent run rate that you gave in fourth quarter, you're now having an extra 750 million of dispos, higher interest rates. There's the ground lease reset. So just sort of ballpark, Are we talking an extra 5 cents lower from that number, an extra 10 cents lower than that number? It sounds like the number is lower given all these moving pieces, but you guys did bake in a fair amount into your guidance when you did say 81 despite Facebook coming online. So just trying to get a gauge for collectively how much off of that 81 cent run rate we're looking at.

Yeah, I don't want to be that precise, Alex, just because, again, you know, we're in a fluid environment. I mean, we did assume originally at the beginning of the year the LIBOR was going to go up. You know, the curve is steeper today. So, you know, it's up. Look, we don't know where it will end up, but it's certainly steeper than what we originally projected. You know, the 750 of sales, you know, there's not tremendous earnings that are coming off a lot of that. So I don't think that's going to have a huge impact. There are a lot of smaller assets that are not producing a lot of capital. There's a lot of earnings, so I don't think that's material. I think we gave you a range, mid to high single digits, and you can sort of deduce the run rate depending on what you plug in for that coming off of the 286 for last year.

Alex, I'm going to go out on a limb and my financial guys are going to whip me.

They would never whip you, Steve. The whipping goes the other way. The whipping goes the other way, Steve.

No, no, no. Let's get serious. Our internal budgets, which are highly detailed and revised frequently, show that with interest rates rising, even rising at a faster rate than we had expected as recently as three or four or five months ago, by the way, I believe that I said in my remarks that the economy is now in the hands of the Federal Reserve, as it should be. The Federal Reserve means business. They always win, and they will handle inflation, and this too will pass. But anyway, so our internal budgets, which are extensive, show that even with the one-pen ground lease reset and even with a reasonable reasonably predicted rise in interest rates taken off the yield curve. And by the way, 95% of the time the yield curve exaggerates the actual fact. So that's another statistic. We believe that our earnings will grow through and we will have maybe one ding a couple of years out, but otherwise our earnings are going to grow right through it. Now I'm going to give you something that I know they're going to whip me for. Our budgets show well in excess of $300 million a year of NOI coming in from Farley, OnePen, and TwoPen above our current numbers over the next period of time. Your job is to predict what the period of time is, okay? My job is to get those earnings. It will not come in a quarter or even a year, but as we complete this program, without touching another piece of land in the Penn District, our earnings will increase by well over $300 million just from those three projects.

That's annually or aggregate?

Annually. $300 million. I said that. Now that I said that, I've got a lot of people throwing knives at me in here. That's the math, okay?

Okay. Steve, if I can end on a high note, the studio business that you're contemplating with an operator, would you be just a landlord or would you be active in the participation of those studios?

Well, the answer is that it's going to be a development deal in New York. That's what we do. We do better than anybody. So we're a full partner. We're a full decision maker. There's a skill to designing these things so that the customers and the tenants, they work for the customers and the tenants. So we've hooked up with a very talented, experienced operator, and he's going to do his part, we're going to do our part, And we think it will have a very fine result. We believe that studios in Manhattan are a unique asset, as opposed to studios in the boroughs or across the river or somewhere else.

And we have our next question from Daniel Ismail with Green Street.

Great, thank you. I'm just curious, given the discussion of interest rates and the plan to dispose of $750 million through the course of the year, how do you think that's impacting cap rates, both overall and on the assets you're looking to dispose of?

Daniel, in terms of what's the impact, I think it's too early to tell. Like if financing rates are higher, is it going to impact cap rates? Certainly. But it depends on where rates settle out and so forth. So I think it's too early to tell, but it will have some impact, sure. Will it affect the 750? The answer is a lot of those are small assets. Some are value-add in nature. I don't think it's dependent on the last basis point is where somebody borrows. I think we have a pretty good sense as to where we can execute that, but we didn't necessarily say it was going to happen all this year, so I want to just clarify that as you said it. It's certainly planned to go into the market this year, but when it'll close, TBD. I think, Daniel, we've got to wait and see. If you're financing literally in this market right now, I think you're paying more than you probably will. If you look at the financing markets historically, as rates rise, spreads do tend to compress somewhat. so that, you know, the all-in rate doesn't go up, you know, basis point for basis point. We're in an environment right now, you know, given the uncertainty that's existing with, you know, what exactly is the Fed going to do, what's going to happen with the economy, et cetera, where, you know, spreads have gapped out, rates, rate expectations have risen. So, you know, it's not a great market to be borrowing in. I think that'll change as we get, as it settles down here. And so, you know, what the impact on cap rates will be TBD. But look, if borrowing rates are up, you know, it'll have some impact.

Daniel, I would much rather have put these assets on the market two years ago when interest rates were lower. But it is what it is. It's the right strategy for our company to sell these assets. If we get 3% more higher price or 4% lower price at the margin, it just doesn't matter. These assets are for sale and we will execute.

Got it. That makes sense. And thanks for the clarification on the timing, Michael. And just a last question for me on Penn District and rezoning. You know, there's been a variety of news articles going back and forth about the potential additional density there and the state versus the city's plans. I'm just curious, can you give us an overall update as to what's going on with any potential rezoning and any potential timeline on that as well?

You're talking about the GPP in Penn District?

I am, yes.

Yeah. I think we'll stand pat on that. I mean, this is basically the city of New York and the state of New York are partners in government. The MTA and the transit is basically a state asset. The capital plan that will be expended in Penn Station is basically state capital. So it makes lots of sense, and there's multiple, multiple historic precedents for this, for the state to be in, I'm going to use the word in charge, that's really not an accurate word, of the zoning and the development process. The city and the state are cooperating on that. There's been extensive public hearings on the plan and the proposal. The political leadership in terms of the governor and the mayor have both endorsed the plan. And I think that's about all that I have to say about it. Obviously, we support it.

Got it. Appreciate the cover.

Thank you. Our next question is from Ron Camden with Morgan Stanley.

A couple quick ones for me. One is just on sort of the CapEx. I think you'd mentioned in the K that you were looking for about $235 million this year. OneQ was sort of in $36 million range. I know you talked about the leasing pipeline and that potentially accelerating, but just how are you thinking about CapEx for the rest of the year?

I would say on the 235, I like to comment on the CapEx for the rest of the year. It depends on whether it's a new lease, renewal lease. The 235, that's our best estimate at the beginning of the year based on both what's in process and what we expect to come down the pike. It's obviously dependent on actual transaction volume. While this quarter was lower, obviously our leasing volume was lower as well. We talked about it. being significant. That number will normalize. I wouldn't vary from the 235 today. I think we've commented on the tenant improvements generally having stabilized. They've stabilized higher than we'd like, but they've stabilized. They're not going up any further. What else would you add to that?

The leasing quarter-to-quarter, it's always very fluid. We're always looking ahead, blocking and tackling way ahead of our expirations. creating opportunities in the buildings on core value with all releases coming up, whether it's this year, next year, two years, or even further away. So it's really not a completely predictable quarter-to-quarter number, but certainly the TIs we definitely believe have stabilized, and that's always due to the mixed quarter-to-quarter of the new deals and expansion deals weighted against renewals.

Got it. Okay. All my questions have already been asked. Thank you. Thanks, Raj.

We have our next question from Caitlin Burrows with Goldman Sachs.

Hi there. Earlier you mentioned a lease at PEN1. I was just wondering, was that included in the reported 1Q leasing spreads? And if so, could you share what New York office spreads would have been excluding it?

The answer was, I'm sorry, Ken, you're saying on the, you're talking about the stats for first quarter?

Yeah.

Yeah, if you exclude the PEN1 deal, because not all the leasing activity in PEN1 had a mark-to-market to it, the high single digits would be low single digits. So it's still positive. It was in that 3% to 4% range.

Okay, got it.

And then...

And then just regarding the ground lease at 330 West 34th and the increase there, I was wondering if you could go through how much of a catch-up of retroactive payments does this represent versus the amount you had been accruing while it was in arbitration and whether this will impact financials going forward.

That's all been recognized and trued up already.

Okay. Okay. Thank you. That happened last quarter, I think.

Yeah. Thank you.

And thank you. We have our next question from Vikram Malhotra with Mizuho.

Thanks so much for taking the question. Just maybe first to clarify, can you confirm was the Farley and Facebook specifically, was that recognized gap revenue? Was that recognized in OneQ? And if not, when will gap and cash be recognized?

Yeah, Bikram, that was recognized first quarter. Gap cash will be at some point second quarter.

Okay, great. And then just more broadly on street retail, can you help us just understand where you think we are in this rent correction cycle now, specifically on Fifth Avenue and Madison in terms of occupancy costs and what you're hearing in terms of specific demand for some of your vacancies on Fisk?

Vikram, we're just coming off the bottom. And so I think I alluded to this in my recent letter. If you go back 18 months ago, there was no demand, no tours, no interest whatsoever in prime, prime, even in prime, prime, prime retail on Fisk Avenue. That's changed. There is now a fair amount of demand, but it is still at what I call, characterize as bottom fishing pricing. What we expect is, and this is the way markets generally work, the vacancies will be absorbed at low rents. The markets will get tighter. Business, and this happens over some period of years, business will improve. demand will accelerate and the rents will go up. We are right now at the point in the beginning of that market cycle where we're just coming off the mark.

Okay, great. Thanks so much. And then just last question, you know, your abated thoughts on co-working and WeWork specifically in your tenant roster, you know, how are you thinking in this, I would say, not new, but maybe evolving environment, what's the room for co-working in your portfolio? Either your own or partners.

Hi, it's Glenn. So we certainly think there's a long-term role for co-working flex space in our portfolio. And we're seeing great success early already at N1 with the 80,000-foot co-working operation we've opened up there earlier this year. We expect to roll more of that in the portfolio as we go building to building. So I think certainly there's a role. There's certainly a need out there for more short-term flexible space opportunities. One thing we're seeing at PennOne specifically is that our existing tenants in the district are utilizing the facility to their benefit as it relates to folks coming in for short-term projects from out of town. or if they're reconstructing their space in one of the buildings or coming into our co-working facility to park themselves there to operate their business while they're rebuilding. We're even seeing cases where new leases we're assigning where tenants want a home now while they're waiting for their space to be built, they're coming into PEN1 operating there with us as they wait for their space to be built. So I certainly think there's a role And I certainly think what we create at PennOne is by far the best operation in Manhattan, and we expect to roll that out more and more in the portfolio as we see those opportunities arise.

Kudos to Barry and Glenn for creating our amenity package in OnePenn and the co-working space. We believe that co-working as an asset class is here to stay. The interesting thing is the strategy of how you use coworking. So we put, was it 80,000 feet of coworking space into one pen. And you gotta remember that's in a four and a half million square foot complex. We believe that for our clients, whether they be an existing tenant in pen one or pen two, or a entrepreneur that is looking for space or in the neighborhood, that the advantage of having that co-working facility inside our complex where they have a huge amenity package that they could use, they have gyms, they have food, they have other offerings, they have conference centers, they have everything that they could possibly want is an enormous advantage. So our strategy is in a 4.5 million square foot complex to put the better part of it in round numbers, 100,000 square feet of co-working, which is available to our tenants and to the neighborhood as well, and they can use all of the facilities that are in this massive complex. So we think that that's a competitive advantage than going into a co-working space that's seven blocks away and has 80,000 square feet of couches and nothing else. That's our thinking.

And this concludes our question and answer session. I will now turn the call over to Stephen Roth for closing remarks.

Thank you all very much for participating. We look forward to the next call, and we will see you then. Thank you, and have a great day.

And thank you. Ladies and gentlemen, this concludes our conference. We thank you for participating. You may now disconnect.