2023-07-11 06:48:27 ET
Summary
- Vornado Realty Trust, a New York City-focused office REIT, is a good investment option for income investors looking for reliable high dividend income, despite the current challenges in the office sector.
- The company's preferred shares, particularly Series M, offer dividend safety due to an extra layer of protection compared to common equity.
- Despite a heavily leveraged balance sheet, Vornado's high-quality A Class space, strong leasing, shareholder-friendly management, and low risk of bankruptcy make the preferred shares a worthwhile investment.
Dear readers/followers,
I've written a number of articles on office REITs, focusing on the ones that own young, high quality A Class buildings located in the best locations of major US cities. Examples of these include Boston Properties ( BXP ), Kilroy Realty Corp ( KRC ) and Highwoods Properties ( HIW ).
I'm quite bullish on all of these from the current levels, but it's important to recognize that the office sector has a lot of problems at the moment and is likely to continue facing significant headwinds going forward. This can make investing in the common equity quite risky and although the upside is there, the above mentioned REITs may not be ideal for income oriented investors that are looking for stable high dividends.
Luckily, there is another option, which in addition to very high potential upside also provides investors with an extra layer of safety. Of course, I'm talking about preferred equity, in particular Vornado Realty Trust ( VNO ) and their Series M ( VNO.PM ).
Vornado Overview
Vornado is a New York City focused office REIT which owns over 60 properties in Manhattan. The company also owns multiple development sites, most notably the PENN District which will grow into a major campus surrounding the Pennsylvania Station in Central Manhattan.
In addition, the REIT also owns a minority stake in another NYC REIT - Alexander's, Inc. ( ALX ), the MART in Chicago and a majority interest in 555 California Street in San Francisco.
Since I'm mostly interested in the preferred shares, my main focus is on determining whether there is any risk of Vornado going out of business. Overall I believe that the chance is very low, because of four reasons.
1. High quality space
What's important is that Vornado owns predominantly high quality A Class space which is very well located near some of the largest transit hubs, not only in NYC, but in the whole country.
This will be especially important in light of work from home which continues to threaten occupancy in the office sector. WFH is likely to cause many firms to downsize their office space as their leases expire.
As they downsize, they may want to move to nicer higher quality buildings with more amenities. This is why many analysts, me included, expect B and C Class office space to struggle while A Class could benefit. This is also why the only office space I would even consider to invest in at the moment is A Class and the newer the better.
2. Strong leasing
So far, on the leasing front, the company has been doing quite well, despite the negative headlines surrounding NYC commercial real estate. During the first quarter of the year Vornado leased a total 777,000 sqm and managed to increase rents on new leases by 8.5% (1.7% on a cash basis).
That's a great result in the current economic environment and with only about 700,000 sqm of lease expiries in the remaining three quarters of this year, the REIT is well on its way to maintain or even improve its occupancy this year.
But despite solid leasing, the share price has continued to fall, on fears of WFH, a recession, high interest rates, inability to refinance debt and more. Office REITs are currently facing the perfect storm and Vornado is not immune to this.
3. Shareholder friendly and good management
As a result, management has decided to eliminate the dividend from Q2 onwards so that they can preserve liquidity and use it for debt management and/or stock buybacks. They have already paid a $0.375 first quarter dividend and only plan to pay what they must, based on taxable income, in Q4 2023.
Although the REIT has resisted buy-backs for a long time, management has recognized that at current levels, it makes sense to authorize a $200 Million share buyback program, which isn't insignificant given the roughly $3.5 Billion market cap. I see this as the right step, given the circumstances, and a confirmation of good management which is trying to maximize shareholder value by doing the right thing (even though unpopular).
4 - Leveraged, but reasonable balance sheet
One of the main reasons why the stock has sold off so much is its heavily leveraged balance sheet. With roughly $10 Billion in debt, the net debt to EBITDA stands at almost 9x.
This is simply too high in the current interest rate environment. It doesn't mean that the REIT is going bankrupt, but increased interest expense has become as issue as it has eaten away a large part of earnings.
Consider this, last year taxable income totalled $2.08 per share. This year, it's only projected at $1.05 (net of disposals), largely due to increased interest expense.
Still, the balance sheet is not all bad as it maintains a BBB- rating, has about three quarters of debt fixed and debt maturities are low until 2025. This means that while the bottom line is likely going to suffer from high debt load, there are no major catalysts that could push the company to bankruptcy.
The theme I'm trying to get across is that while there are a lot of problems, the company is nowhere near bankruptcy. I'm not advocating for buying the common shares here, because I view those as quite risky, but given that I don't expect the company to go out of business, I'm quite interested in their preferred shares for reliable high dividend income.
Preferred shares
In particular, Series M shares, which currently trade at $14.70 per share seems interesting. The shares pay a $1.31 per share dividend which translates to a yield of about 9%.
The best part is that the series is cumulative , which means that even if the dividend is paused, it has to be paid eventually, unless of course the company goes bankrupt. This, in addition to a more senior ranking in the balance sheet, makes the preferred shares much safer that common equity.
Moreover, the shares currently trade at only a fraction of par value ($25) which leaves plenty of upside in case the tied turns and commercial real estate rebounds. In the meantime, investors get to collect a 9% dividend which frankly is already in line with the long term market level return.
I think Vornado Series M is a good choice for income investors who want dependable dividend income and don't mind the volatility of the underlying position too much. For this reason I rate VNO.PM as a BUY here at $14.70.
For further details see:
Vornado Preferred Shares Offer Dependable Dividend And Upside