2023-05-30 11:59:31 ET
Summary
- Vornado's common shares are down 37% year-to-date and 61% over the last 12 months due to various challenges, including a high Fed funds rate, a regional banking crisis, and reduced demand for office space.
- The REIT has suspended its dividends through the end of the year, saving at least $215 million.
- Vornado faces a wall of debt that will be difficult to refinance as the market values the REIT lower than during the 2008 financial crisis.
Vornado Realty ( VNO ) is experiencing the greatest challenge of its life as a public company with its common shares trading roughly where they were when the company went public in the 90s. They're down 37% year-to-date, 61% over the last 12 months, and the outlook for the rest of 2023 looks bad with the dividend suspended through to the end of the year. The Manhattan-focused office REIT is now besieged on all sides. From the north is a Fed funds rate that's been hiked to its highest level since 2008 at 5% to 5.25%, from the south is a regional banking crisis that sparked a selloff in the common shares and is set to discombobulate US commercial real estate funding. Then there's the stickiness of WFH in the post-pandemic world as fears about a possible hard landing continue to drive large corporate layoffs and reduce the broader demand for office space.
So what's the play here? For most investors, waiting for the normalization of current abnormal macroeconomic conditions would be the best way forward. The REIT's decision to suspend its pay-outs through to the end of the year was prudent and necessary and should help VNO save at least $215 million against the quarterly payout for the first quarter which at $0.375 per share was a 29% reduction from the prior payout. Vornado also announced it would be launching a $200 million stock buyback program as a consolation for the dividend suspension. This is against common shares currently changing hands at $13.33 per share, around a 41.5% discount to their tangible book value of $22.79 per share.
The Dividend Had To Go
Vornado is now trading in uncharted territory for the second time since 2008 with its market cap below its tangible book value. To be clear here, the market is currently valuing the company lower than the level it garnered at the bottom of the greatest financial crisis in a generation. So in many ways, this is it. Vornado's test of fire, a near existential crisis catalyzed by the aggregate of many factors all at once. The cruelty of Murphy's law here inflicts not just Vornado but a basket of office REITs who now all collectively seem like they're at different stages of the sinking of the Titanic.
Vornado's dividend had to be suspended with the REIT facing a wall of debt maturities that will be more difficult to refinance against the current macroeconomic backdrop. The REIT held total unsecured debt of $2.56 billion as of the end of its fiscal 2023 first quarter, broadly unchanged sequentially from the prior fourth quarter. Mortgages payable were $5.7 billion, down around $112 million from the fourth quarter. The larger debt balance came with a weighted average financing cost of 4.37%, but with the bulk of the variable portion of this subject to interest rate cap arrangements. These hedges have a weighted average strike rate of 3.98% and a weighted average remaining term of 11 months.
2023 Offers Uncertainty
The REIT saw first-quarter revenue come in at $445.92 million , a small 0.9% increase over its year-ago comp and a miss by $6.78 million on consensus estimates. Funds from operations were $116 million, around $0.60 per share, and that was down from $0.79 per share in the year-ago quarter with net interest expenses jumping 68.7% over its year-ago comp to $76.6 million. Hence, Vornado could have covered the reduced dividend payout, but using the funds to deleverage its balance sheet forms a more pressing need. The objective for Vornado is now to stabilize tangible book value and reduce the unsustainable year-over-year growth of its quarterly interest expenses.
I've taken the opportunity to add Vornado's 5.25% Series N Cumulative Preferred Shares ( VNO.PN ) to my income portfolio. They pay out a $1.3125 annual coupon for an 11.21% yield on cost and are currently changing hands for around 47 cents on the dollar. Whether the suspension of the common share dividends is a good thing for the preferreds depends on perspective. On one hand, it improves Vornado's ability to meet its preferred obligations, on the other it removes the first and only line of defense for the preferreds and could be the first step to a coupon suspension. However, it's important to note that these are cumulative and Vornado would accrue a liability to pay back any unpaid coupons at some point in the future first ahead of a resumption of dividend payments to common shareholders. I like the risk and reward profile of this with a double-digit yield backed up by strong FFO generation and a management that is moving to deleverage and fundamentally de-risk their balance sheet.
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Vornado Realty Is Besieged On All Sides