Morningstar Magazine - December 2017/January 2018 - 57

Vornado Takes Manhattan
This office REIT looks to streamline its portfolio and
become a premier NYC landlord.
BEST IDEAS: EQUITY

Brad Schwer

Vornado Realty Trust VNO

This article is adapted from a Morningstar equity research report dated
Oct. 31, 2017.

Stats 10/31/2017

Vornado Realty Trust VNO continues to divest assets as it looks to become a
pure-play New York office and retail owner and operator. The primary
moat source for REITs is efficient scale, where the firm operates in a market of
limited size that is effectively and efficiently served by one firm or a small
number of firms, and we do not see any indicators of competitive advantages
for Vornado: Manhattan contains about 400 million square feet of office
space, and Vornado makes up only about 5% of the market.

Morningstar Rating
QQQQ

Sector
u Real Estate

Industry
REIT-Diversified

Price
$74.86

Fair Value Estimate
$92.00

Uncertainty
Medium

Economic Moat
None

Stewardship Rating
Standard

Market Cap
$14.1 Billion

Price/Fair Value 10/31/2017

$120

That said, Vornado is poised to take advantage of Manhattan's newest growth
area, with 6.5 million square feet of office space located just east of the
upcoming Hudson Yards project. This project should bring added foot traffic to
Vornado's retail locations and increase asking rents for its office buildings.

Price

100
92.00
Fair Value Estimate

Vornado is now focused on a historically profitable region that continues
to attract top tenants willing to pay top dollar for the best in Class A office and
retail property. After the spin-off of its Washington, D.C., assets in July,
Vornado will achieve almost 90% of its EBITDA from New York, an area where it
maintains office space occupancy of more than 95% with properties in
densely populated areas near key transportation and other highly desirable
features. While the company does have investments elsewhere in the
country, specifically San Francisco and Chicago, they are performing well and
are in well-located central business districts. Vornado's exposure to these
areas is promising, as we view this as a main growth area that is lacking in
portfolios focused on suburban properties.
Vornado's tenants are some of the best names in finance, consulting,
and technology, and represent the ideal for Class A office space. Such large
and financially sound companies typically have an established presence
in Manhattan. While the West Coast continues to produce technology jobs, we
believe that Manhattan will maintain its status as America's business hub
and remain confident that its expansion will have positive impacts on
Vornado's existing portfolio.
The stock, along with office REITs in general, has been beaten down in recent
months despite an improving jobs market. Vornado has been hit twice as
hard as of some its peers, which we believe is unwarranted. We are pleased

80
74.86
60

10/2012

10/2013

10/2014

10/2015

10/2016

with rental rates surrounding Penn Plaza, which climbed into the upper-$60s
per square foot in 2016 and the first half of 2017. We see this trend continuing.
Half of Vornado's lease expirations for 2018 are concentrated in One Penn
and Two Penn Plaza, and next year will provide an opportunity to renew these
leases at higher rates given the greater appeal for that submarket.
Vornado put together strong third-quarter results, its first report since shedding
the Washington, D.C., portfolio through its tax-free spin to JBG Smith. Funds
from operations adjusted for comparability was $0.99 per share compared with
$0.93 per share last year. This 6.5% growth is an early sign that the company is
off to a fast start with its streamlined portfolio despite a tough high-street retail
environment. We believe the stock remains undervalued despite rallying
after the earnings release. Unlocking the value in Vornado's portfolio may take
some time given that the Hudson Yards project is in its infancy, but this
quarter reaffirmed our long-term view of the company. We plan to maintain our
$92 per share fair value estimate and no-moat rating. K
Brad Schwer is an equity analyst with Morningstar Research Services.

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Table of Contents for the Digital Edition of Morningstar Magazine - December 2017/January 2018
