Vornado Realty Trust

Good morning and welcome to the Vornado Realty Trust second quarter 2023 earnings call. My name is Gary and I will be your operator for today's call. This call is being recorded for replay purposes. All lines are in a listen only mode. 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 touch tone phone. I will now turn the call over to Mr. Steve Borenstein Senior Vice President and Corporation Counsel. Please go ahead.

Welcome to Vernado Realty Trust's second quarter earnings call. Yesterday afternoon, we issued our second quarter earnings relief and filed our quarterly report on Form 10-Q with the Securities and Exchange Commission. These documents, as well as our supplemental financial information packages, are available on our website, www.dno.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 supplements. 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, 2022, 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 opening comments are Steven Ross, 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 the call over to Steven Ross.

Thank you, Steve, and good morning, everyone. It seems to me there's a very close parallel between what happened to malls and what is now happening to office. Five years or so ago, there was universal certainty that malls and brick-and-mortar retail were dead forever, the victim of ubiquitous and explosively growing e-commerce. Capital markets shut down. No-no malls were built. But behold, today, five years later, malls are booming. Sound familiar? It seems to me that CBD office in all our cities, New York included, has fallen victim to the same emotional and short-sighted view in the investment community. Work from home is to office what the internet was to retail. We believe in-office work is the better bet and a little time, frozen capital markets, and no new supply will restore value and glory to office. Walls in office and the center cities of America are not going away. Our business is continuing to perform well and on plan in this environment. Michael will cover the math and give color in a moment. The principal difference in our numbers this year to last year is the rise in interest rates. Overall, the economy has been more resilient than we expected in the face of the Fed's historic interest rate hikes. Real estate capital markets remain challenged, even for us. Highlights of our immediate business plan are to conserve cash and protect our balance sheet, and even to raise cash by accretively selling select assets. To reduce debt and buy back stock, And for us, the Penn District continues to be the main event. As Farley, Penn 1, and Penn 2 come online, they will create significant growth and shareholder value with much more to come. Over the last few months, we've brought back 2,025,000 shares for $29 million at an average price of $1,440. Sam Zell passed away on May 18th. There was a memorial service in his honor in Chicago three weeks ago. Over a thousand people attended. I gave a eulogy. It could be said that Sam was the father of the publicly traded beef market. He called it liquid real estate. I wish us all to be as smart and accomplished and live life as large as Sam did. I apologize in advance, but Glenn and I must leave at 1115 for a tenant meeting. Now over to Michael to cover our financials and the market.

Thank you, Steve, and good morning, everyone. So down from last year, we had a solid quarter as it relates to our core business. Second quarter comparable FFO as adjusted was $0.72 per share compared to $0.83 for last year's second quarter, a decrease of $0.11 or 13.3%, driven primarily by expected higher net interest expense from increased rates. In addition, there were several non-recurring items in the quarter that essentially offset each other. Those items include $0.07 of termination income from a former tenant at 345 Montgomery Street in San Francisco, offset by $0.02 of additional interest expense related to the restructuring of the St. Regis retail loan, which is forgiven by the lenders but is required to be recognized by GAAP, and $0.04 of additional stock compensation expense related to the new compensation plan we implemented in June. We have provided a quarter-over-quarter bridge in our earnings release and in our financial supplement. Notwithstanding the headwinds from higher interest rates and the impact from non-recurring items, our core office and retail businesses remain resilient with long-term credit leases. Our New York cash same-store office business was up 3%, and our New York business overall was up 2.7%. With respect to the remainder of 2023, You'll recall that we previously said that we expect 2023 comparable FFO to be down from 2022 and provided the known impact of certain items totaling a $0.55 reduction, primarily from the effect of rising interest rates. Our outlook hasn't changed since the beginning of the year, though with the additional recurring expense related to the new share-based awards granted in June, you can expect an additional G&A expense of approximately five cents in total for the rest of the year. For 2024, the incremental impact of the plan versus our prior year run rate is two to three cents overall. Of course, our expectation of FFO is absent the impact of any potential additional asset sales. Now turning to the leasing markets. Against the backdrop of the Fed's sharp interest rate increases, we continue to be encouraged by the level of activity year to date. Leasing activity has been led by strong demand from traditional industries, financial services, and law firms in particular, with many financial firms growing their footprint and accounting for almost 40% of the 5.2 million square feet leased in the quarter. Overall, tenants in the market continue to be focused on the highest quality, new or redeveloped Class A buildings that are well amenitized, have strong sponsorship, and are near transportation in Midtown and the Westside. which is resulting in rents moving up in these buildings. Our office portfolio is filled with these types of buildings. Midtown accounted for 70% of this quarter's leasing activity, with 75% of Midtown leasing occurring in Class A properties, reinforcing the Flight to Quality theme. For companies, it's all about tenant attraction and retention and creating culture, and they are willing to pay more for the right work environment that will help accomplish these objectives. Taking rents in top-tier buildings are at peak levels, and the delta between Class A and Class B properties continues to widen. While there is solid activity in the market, large requirement deal flow is lagging, and concessions remain stubbornly high. Focusing on our portfolio, during the second quarter, we completed 19 leases totaling 279,000 square feet with very healthy metrics. including starting rents at $91.57 per square foot and a positive mark-to-market of 5.7% cash and 9.9% gap. Overall, for the first six months of the year, we have signed 1 million square feet of leases at a market-leading $99 per square foot. Our average starting rents continue to trend up, evidencing the quality of our portfolio and the continued flight to quality we've discussed. At PEN1, we continue to execute a steady stream of leases with new top-tier tenants at attractive rents, reflecting tenants' attraction to the unique amenity offering we have in the most successful location in the city. Last quarter, we signed a lease with Samsung at the building. This quarter, we signed a 72,000-square-foot lease with Canaccord Genuity, a leading financial services firm. Tour activity is picking up at PEN2 as well, now that the project is nearing completion. and tenants can better appreciate the redeveloped product. PEN1 and PEN2 now compete in the very top tier of the marketplace, in most cases versus new construction to the west of us in Manhattan West and Hudson Yards. This is a testament to the marketplace's reception to these two market-leading projects, as well as confidence in the future of Penn District as the new epicenter of New York. Overall, we have very good activity in many of our assets, including strong deal volume at 1296th Avenue and 280 Park, and at higher rents than we previously forecast. Here's the headline. Industry insiders understand there's a shortage of good space on Park Avenue and 6th Avenue. Actual vacancy is below 10%, and rents are moving up nicely. There are certain competitive pockets in the market, such as these, where there is a healthy tenant-landlord equilibrium, allowing us to push rental rates higher in our best-in-class buildings. Our leasing pipeline in New York is strong and not reflective of the media's negative office narrative. We have 580,000 square feet of leases in negotiation, plus an additional 1.2 million square feet in our pipeline. This activity is well-balanced in buildings where we have current vacancy and known vacancy where space is coming back to us over the next 18 months, and is a good mix of new deals, renewals, and expansions. The financial sector in particular continues to be the most active. Much of our retail leasing this quarter occurred in the Penn District, primarily a mix of food and fitness activations, as we continue to curate the district like no other neighborhood in the city. We are excited about the best-in-class operators we are bringing to the district, and more importantly, both our current and prospective office tenants are really enjoying everything we have done and have recently announced. We have much more in the works here. Turning to the capital markets now. The financing markets remain highly constrained, particularly for office, driven by the volatility from the Fed's sharp rate increases. There's more appetite for retail as this asset class is perceived to have bottomed. Banks are dealing with an increase in problem loans, regulator scrutiny, and lack of loan attrition, and thus they remain cautious and constrained in lending. The tone of the CMBS market has improved modestly in the past quarter, but is still largely closed. High-quality sponsorship is more important than ever. We are in good shape, though. We have no material maturities until mid-2024. During the quarter, we completed the restructuring of the St. Regis retail loan, adding five years of term and also extended a couple of smaller loans that had near-term maturities. We are actively working with our lenders to push out the maturities on our loans which mature in 2024 and beyond. Our mantra remains consistent as we continue to review the portfolio. If an asset is overleveraged or not refinanceable, we will support the asset only if we have sufficient term for the asset or markets to recover. We're able to do this because the loans are secured by individual assets and are generally non-recourse. We have found the banks to be cooperative in working through these situations thus far. Servicers, TBD. You will see in our financials that we continue to push out our interest rate hedge. giving us good protection over the next few years from future increases. Finally, we continue to be active in selling assets and recently announced the sale of four small retail assets in Manhattan, which don't produce much FFO, closing in the third quarter, and the Armory Show, which closed in July. We are hard at work on others as well. In these volatile times, we remain focused on maintaining balance sheet strength. Our current liquidity is a strong $3.2 billion, including $1.3 billion of cash and restricted cash and $1.9 billion undrawn under our $2.5 billion revolving credit facilities. With that, I'll turn it over to the operator for Q&A.

Thank you. We will now begin the question and answer session. If you have a question, please press star then 1 on your touchtone phone. If you wish to be removed from the queue, please press star then 2. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then 1 on your touchtone phone. Each caller will be allowed to ask one question and a follow-up question before we move on to the next caller. The first question comes from Steve Sokwa with Evercore ISI. Please go ahead.

Thanks. Good morning. Michael, I was wondering if you could maybe just comment or elaborate a little bit more on the leasing pipeline that you talked about and how much of that relates to kind of the lease up of 2 Penn and then also just on the New York leasing, you know, the spreads were reasonably good. I'm just wondering how much of the leasing in the quarter was at Penn 1 where I know you're achieving very strong uplift.

Morning, Steve. I'm going to turn it over to Glenn to tackle it. I'll follow up if necessary.

Hi, Steve. It's Glenn. How are you? So in terms of the quarter, about 40% of the activity was at PEN1, including the headline Canon Core deal. As it relates to the pipeline, you know, very strong pipeline, almost 600,000 feet of leases out, another 1.2 million in the works. You know, I sketched out this morning my calendar for the week. We got a final LOI in the final innings for a 320,000 foot tenant. We're getting a lease out for another 240,000 foot tenant. We responded to an LOI for 275,000 feet, and we're deep in term sheets with another firm for 175,000 feet. So we're busier than we've been, feeling much better as we go, which we predicted. We do have very good action also at PEN2 at this point, lots of tours. We have some proposals in the house. Project is showing very well, and we feel great about PEN2 coming out of the chute later this year.

Okay, and maybe a question for Steve or Michael. Just as you think about the dividend, I know you sort of put the dividend at least on the back burner as you sort of contemplated asset sales, and you've got a few that you talked about, some of these retail assets in the armory. I guess, are there other larger assets that you're contemplating bringing to market between now and the end of the year? And I guess just sort of what's the updated thought on the dividend and then the pace of buybacks? Thank you.

Good morning, Steve. So the answer is, I think we talked in the last call, you know, we're going to be opportunistic about looking to sell assets. We obviously announced a few small ones last week. We're working on some others. There could be a couple larger ones. I can't tell you the tax impact that, you know, I think in total, by the way, on the ones we just sold, there'll be a tax loss on those. So that'll reduce taxable income. And, you know, as we've said, historically, you know, our policy is to pay out taxable income. We'll evaluate where we end up at the end of the year in terms of cash versus stock mix. You know, our objective, I think, has been to retain cash, utilize it for buyback, utilize it to pay down debt. But we'll see where we end of the year. And will other things get done before the end of the year? Possibly, but, you know, it's, you know, all these things have a pace. of when they can get done, and so I can't tell you anything else. Large is going to get done definitely by year end, but, you know, we're working on some things.

The next question is from Camille Bunnell with Bank of America. Please go ahead.

Michael, you provided commentary around the mark to market opportunity for 1290 Avenue of Americas. Are you able to quantify this for the rest of your expiries through 2024? Are the market opportunities there positive or are there any meaningful unique leases that are above market rents?

Hi, this is Glenn Weiss. As usual, it's hard to predict the markets quarter to quarter because that will depend on our activity. As Michael said, we're really, right now, really pleased with the rent levels we're seeing you know, at the buildings where we have major experts coming, whether it's 1290, 770, 280, or otherwise. But, you know, it's hard to predict where they're going to lay out, but we feel good about the rents. And our starting rents have been extremely strong and consistent for the last, I think, two years. In the 80s, even 90s, you know, this year, of the million feet we've leased, our starting rents are $99 a foot. So it shows just the quality of our buildings, The pace of our leasing is picking up. So on the mark-to-market, I can't really predict exactly what's going to happen here, but we feel our rents are top tier throughout, and we're making matches everywhere right now.

I would just add that, you know, I think it's hard to predict. And even as we sit here, it's August, right? And so as we look at the activity, we talk about the sub-markets like Park Avenue, 6th Avenue for the Class A buildings. you know, rents are up double digits from six, nine months ago, right? And so if you'd asked us six, nine months ago, you know, would the mark to markets be on some of those leases, you know, they wouldn't have been as strong as they're turning out to be or what's in the pipeline. So, you know, to sit here and tell you what they may be in 2024, we can't predict, but I think what you're hearing from us is that, and I think it's a really important point, right? One of them is we spent a lot of time with counterparties talking about is sort of separating fact from fiction, right? The negative narrative that, you know, it's on the front pages every day versus what's actually going on in the field. And in these key submarkets and the better buildings, you're at an equilibrium level, right? You're sub 10% vacancy. And so it's allowing us to really push rents, you know, in those buildings, in those submarkets. And that is where a lot of our expiries are occurring this year, next year, And so we feel good about it. So where it'll end up, I can't tell you, but I think there's positive momentum there.

That's very helpful. And I assume those comments around market rents being up over the last six months are on a gross basis. So any update on how that's trended on the TI and rent-free side?

The concessions are still stubbornly high, too high. So the rents have continued to inch up on the best of our buildings. Concessions have remained where they've been.

The next question is from Alexander Goldfarb with Piper Sandler. Please go ahead.

Hey, good morning. And Steve, quite the honor for you to give the eulogy for Sam. So I have two questions. The first question is the new comp plan that you guys rolled out, One, are you terminating the old comp plan? And two, just the thought process, you put it out, you know, like 4.30 ahead of July 4th weekend, and just curious why it wasn't done as, you know, part of the annual proxy. Normally companies will update comp plans at the start of the year. You guys did it mid-year. So just want to get some thinking about how you're looking at that, the decision that went into making it in the mid-year, and then are you terminating the old plans?

Alex, good morning. I want to handle your comment about we snuck it out on a Friday. The fact of the matter is that the SEC regulations say when you do something like that, you have to file an 8 within 48 hours. So that turned out to be on that particular Friday. So we had to get it out. The second thing is our teams that handle this are used to a 4 o'clock closing. So they put it out after what they thought would be the 4 o'clock closing without really realizing that because it was pre-holiday, the markets would close at 1 o'clock. So we're not in a sneaky business, and we did what we had to do. The rest of your question, Michael can handle.

Good morning, Alex. Let me take them in pieces. Are we turning the old comp plan? The answer is no. You know, that plan will expire, I think, in 2025. As we sit here today, you know, it doesn't look like it will earn, but we'll see. And it's not a big number, you know, either way. You know, in terms of the comp plan now, you know, why do it now? Look, I think our view was we felt it was – we're in a challenging period. And we lost a few key people over the last few years, or a few people, I should say. And we felt it was an important message to send to our team to put in place a plan that both incentivizes retention as well as rewards for performance during this period and coming out of this period. And so we put a plan in place. We think it's a great plan for shareholders, by the way. It requires sustained performance over a meaningful period of time. And so as the stock price goes up, obviously the plan is more valuable and pieces of it don't even vest in until performance is achieved much higher than the price at which it was awarded. So it's very aligned with performance. We think it's great for shareholders and we think it's great for the team. So the reaction from the team has been extraordinary. It was allocated to a broad group of people. We think we've ensured stability of the team for the next several years, which is important, important for shareholders. And frankly, our shareholders have been, I think, very helpful both in constructing the plan on the front end and in follow-up after. So until January, we wanted to put it in place now, send a very strong message to our team about the importance of, you know, if we drive value over time, what is there for everybody to receive and to get people excited, and that's been the exact reaction, and I'm confident that we have a broad group of people that are even more laser-focused on how we're going to drive the stock price.

It's important to note that Michael and others on our team communicated broadly with our largest shareholders in constructing this plan and got universal support from our shareholders, and so that's a very, very good thing. We have gotten also universal positive commentary from our peers in the industry about what we did, why we did it, and gee, what a good idea that was.

Okay, and then the second, the follow-up question, Steve. The studio deal on Pier 94, just curious more details, is Hudson... going to be the main operator? You know, what are the economics? What is your role? I mean, obviously, you have a deep, you know, theatrical background in your family. So just more details in the economics and how the operations will run between you guys, Victor, and Blackstone.

You know, we're not 100% finished with all the details on this deal, so we're not going to get into that. So what it is, basically, it will be the only studios on the island of Manhattan, so we're extremely enthusiastic about it. We have half the deal. We came in with the land, and Hudson Pacific is the operator, and Blackstone is Hudson Pacific's partner and now our partner. So there will be more about that as we consummate this.

The next question is from Julian Blown with Goldman Sachs. Please go ahead.

Yeah, hi, thank you for taking my question. I guess just at a high level, I was wondering if you could give us any insight into leasing activity in San Francisco and Chicago, maybe how you would compare those two markets, which of them is in better shape right now?

Hi, it's Glenn. San Francisco, You know, we've been fortunate enough and very successful, you know, at 555 Cal, even given, you know, the markets, which are quiet. There's very little new tenant demand in San Francisco, but we've been very insulated in a very successful way at 555. Chicago, I would say, is a different story, that there is a lack of tenant demand, particularly big tenants. The action we have at the Mart, you know, is 100,000 feet and less tenant variety. On the market there, you know, I'd say it's more quiet. But I think both cities generally, there's a lack of demand. There's uncertainty as it relates to the cities and the government. So I would say the kind of equal as it relates to the action. For us specifically at Vernado, we're in great shape in San Francisco. Chicago, we've got a lot of state police. We've got explorations that we're grappling with right now. We're feeling better. We just completed our work-life program. We just had a huge broker event last Wednesday night, which was a huge success. So we're now on our way, but we got a lot of wood to chop.

I would add a couple of comments. In San Francisco, we own the premier financial services building. So we are sort of different than all of the supply companies of technology buildings. And so all of the important financial services tenants and clients are in our building and have been there for 25 years at Walker. So the building is sort of unique. It's the highest quality, and it's by far the most important financial services building. So it's a great piece of real estate. In Chicago, similarly, The building is a great piece of real estate. The market is a little bit soft, and we're navigating that now.

That's very helpful. Thank you. And maybe as a quick follow-up, I may have missed it in the answer to Steve Sackler's question, but what were the New York office leasing spreads in the quarter excluding PEN1?

Yeah, I don't know that we have that offhand. We'll have to come back to you on that, Julian.

We don't have that at our fingertips. We'll get back.

The next question is from Anthony Pailone with JP Morgan. Please go ahead.

Thanks. You talked earlier about maybe selling some more stuff over the rest of the year, but if we look out the next two or three years, is there a part of the portfolio that you'd really like to get rid of if you can, or should we think about just any part of the business shrinking, whether it's retail or a certain sub-market?

There is no target on a particular type of our assets. I mean, we're fairly concentrated in New York in office, and our retail is extremely unique. So we don't have a target on any particular division of our business. We don't have very many divisions. We're an office company headquartered in New York. We have a great building in San Francisco, another great building in Chicago, and a retail presence on the most important streets in New York City. So we don't have a target. On the other hand, if we can sell assets for prices which are accretive to our stock and create shareholder value, that's something that we are looking at very intensely.

Okay. And then second one, just on NOI, as we think about the second half of the year, in retail, the first couple quarters were very consistent and you did a lot of leasing. So Just what should we expect in the second half there? And then in office, it seemed like there was a big bounce in the gap, NOI 1Q to 2Q. And same question, just kind of how to think about the second half.

Are we predicting the second half? I don't think so. So we're not forecasting or guiding for the second half. So that's a premature question. Sorry.

The next question is from Nick Ulico with Scotiabank. Please go ahead.

Thanks. I just wanted to go back to the asset sales. I want to ask specifically about the Farley building and whether you're contemplating any plan there to sell a joint venture stake in the asset. It seems like the type of asset would gather good investor demand, long-term lease with a strong credit tenant, tie a lot of success there. So any thoughts on that you can provide?

We like the asset just as much as you do. and we're not going to comment on in the future.

Okay, I guess secondly on Forley as well is I don't know if, you know, there's no mortgage there, so I don't know if that's also an asset that you're considering, you know, putting a mortgage on if you've had any conversation with banks, be sort of an interesting, you know, test case for, you know, strong office building and the ability to finance it. Any thoughts you could share there?

I mean, but we agree with you. It's a very strong asset with a very strong long-term lease on it. It's arguably one of the best buildings of its type and kind in the city. It has no mortgage. It has high basis. It has no financing on it. So obviously, it's a great asset and could be an important source of liquidity.

The next question is from Ronald Candom with Morgan Stanley. Please go ahead.

Hey, just two quick ones. So on the $0.72 of FFO on the quarter, can you just remind us what is one-timer that we need to adjust for? What is recurring? So both, is there any sort of lease termination or anything like that so we can get the right sort of run rate?

Yeah, look, Ronald, I think there's a lot that goes in there every quarter, right? timers up down this small. I think this quarter probably a little more significant one-timer from the tenant termination at 345 Montgomery, which we said was 7 cents. At the same time, you know, we had a couple cents that was related to the St. Regis loan restructuring where the interest that was accrued during that default period was forgiven, and we were required to recognize that by GAAP, right? So that nets down to to $0.05, and then, you know, on the stock comp, you know, that'll continue, as we said, for the rest of the year, but be probably a lesser incremental amount for next year. So, you know, net-net, probably let's call it $0.05 this quarter that's true, non-recurring, and the stock comp will, you know, decline a little bit as we get into next year.

Great. Okay. So, got it. So, $0.72 down to $0.05, $0.67. Got it. So just on the last one, just on the leasing, you talked about, I think, 580 in negotiation, 1-2 in the pipeline. Can we put that all in the blender? So how should we think about occupancy going from here, right? Is it flat? What are sort of the puts and takes when you're thinking about the occupancy for the rest of the year and into next? Thanks.

I'd say occupancy for the rest of the year. We'll hover around the range we're at now. It depends when these deals happen, when they close, and how everything goes here. I think we'll hold pretty much at these levels over the next couple quarters. I'm hoping to see more absorption as we go based on getting these deals done over the next three, six months or whatever it will be.

I think Glenn and his team are doing a great job on some of the expiries that are coming up. Some of this will be timing, whether those deals are, you know, I mean, we have some known move-outs, for example, at 1290 and 280. And the extent we backfill those, then, you know, occupancy won't dip. To the extent that there's a timing gap in terms of when it's backfilled, you know, it will dip. So, you know, I agree with Glenn's comments around here, where it'll stabilize. But, you know, could it go down a little bit at the beginning of next year, depending on timing of whether we have the space backfilled? You know, it could. So, I wouldn't hold your breath saying it's going to stay exactly at 91% change from here on out. It may go down a little bit, but we're confident that with time, that space will get backfilled and the occupancy will get rebuilt.

There are no further questions at this time, so this concludes our question and answer session. I would like to turn the conference back over to Stephen Roth for any closing remarks.

Thanks, everybody, for attending. This is a record. I mean, we've never done a call that was 35 or 40 minutes before. So in any event, it's a record that is kind of surprising. We'll see you in three months at the next call. Have a great day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect.