Vornado Realty Trust Wrongly Caught in Retail REIT Vortex

 | Jun 28, 2017 | 12:00 PM EDT
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Retail developers in the U.S. have been caught offsides, I believe. They have overbuilt retail space to the point where the U.S. has multiple times the retail space per person than does western Europe. At the same time, e-commerce has caught on in the U.S. and is taking larger and larger slices of the overall retail pie as habits change. As e-commerce continues to take share, bricks-and-mortar retailers will have an increasingly difficult time, which will continue to hurt retail REITs as a sector.

I'm a big believer in finding diamonds in the rough. Some retail REITs are going to be hurt than others, but most, if not all, are in the bargain bin right now. One of those is New York City-focused Vornado Realty Trust (VNO) . Indeed, it is an office REIT every bit as much as a retail one. (Vornado recently was downgraded to Hold from Buy by TheStreet's Quant Ratings; for a rundown on what it thinks of the company, click here.)

Vornado's focus is on real estate with office assets and publicly investable high-street retail, both of which are of unique quality and unique scale. Vornado's properties include office buildings on Madison Avenue, Park Avenue, Penn Plaza and several other prominent locations in New York City proper. Its retail properties include 1535 & 1540 Broadway, right along the "bowtie" of Times Square, and quite a bit on Madison Avenue and the high streets.

Although I'm not a huge fan of buying retail REITs at the moment, Vornado is more about office space, and the retail it does own is some of the dearest retail in the world. Furthermore, New York City consistently leads the country in employment growth and other important economic factors. This is one of those stocks you can buy if it's down. And these days it is down indeed.

For example, since reaching a recent high in mid-February, Vornado has tumbled more than 14% to $93.86 as of close of business on Tuesday, June 27. On a relative basis, valuation is also pretty good. Shares now trade at 14.8 times trailing funds from operations (FFO), and have averaged 16.8 times according to data from FAST Graphs. That's a discount of 12% to its average valuation, plus a 3% dividend.

Last year Vornado grew its dividend by 12%. It's difficult to chart Vornado's dividend growth, not least because the company doesn't give forward guidance. The lack of forward guidance might be one of the reasons Vornado is valued as low as it is. I don't blame management for not giving guidance; as a developer, Vornado's business can be a little blocky and unpredictable, and Vornado is working on several new development projects.

Vornado is working on re-developing Penn Plaza, the area around Penn Station. The total office leasing space comes out to 6.8 million square feet, including the re-development of Farley Post Office. Vornado is also re-developing four buildings in the former meatpacking district. All four of those are residential buildings and come out to about 1.4 million rentable square feet, cumulatively. Finally in New York, Vornado is building 220 Central South Park, a premier residential building right next to Central Park. This building topped out in last year's fourth quarter and everything will be completed in the third quarter of 2018.

New York City is thriving economically, and Vornado's limited retail coverage is mostly on high-street properties. For these reasons, I don't think the punishment of this stock is very fair. I think Vornado is an interesting, somewhat unique investment at a reasonable value. Dividend investors would be wise to consider this stock right now.

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