Vornado Earnings: Manhattan Office Market Still Challenging, but Recent Transactions Offer Respite

No-moat-rated Vornado Realty’s VNO second-quarter results were largely in line with our expectations as the firm reported funds from operations, or FFO, of $140.7 million, or $0.72 per share, in the second quarter, which was around 12% lower than the $160.1 million, or $0.83 per share, reported in the second quarter of the previous year. The demand for Manhattan office real estate remains muted because of macroeconomic factors and a slower recovery in physical office utilization rates. The FFO decreased by about $20 million year over year, mostly because of higher interest expenses. As we have highlighted earlier, the company will continue to feel a disproportionate impact of higher interest rates due to its significantly leveraged capital structure. This structure also makes the equity valuation highly sensitive to movements in interest rates and cap rates. We are maintaining our $29 per share fair value estimate for Vornado Realty after incorporating second-quarter results into our model.

The shares of the company have rallied around 80% since mid-May, buoyed by some encouraging office building transactions in Manhattan. The recent deals are a vote of confidence for the valuation of high-quality office assets in Manhattan. The market has been trying to price Manhattan office REITs in an environment where high-value transactions of trophy assets have almost dried up. The recent transactions have helped create a valuation benchmark for high-quality office buildings in Manhattan. The shares of the company are currently trading at around a 20% discount to our fair value estimate.

For investors considering office REITs, we continue to believe that Kilroy Realty offers a better risk/return profile than Vornado Realty given its high-quality portfolio, low leverage, and appealing valuation.