Vornado Realty Trust Q2 2024 Earnings Call Transcript

Presentation

[Operator]

Good morning, and welcome to the Vornado Realty Trust Second Quarter 2024 Earnings Call. My name is Roth Helen [Phonetic], and I will be your operator for today's call. This call is being recorded for replay purposes. [Operator Instructions]

I will now turn the call over to Mr. Steve Borenstein, Executive Vice President and Corporate Counsel. Please go ahead.

[Steven Borenstein, Executive Vice President and Corporation Counsel at Vornado Realty Trust]

Welcome to Vornado Realty Trust's second-quarter earnings call. Yesterday afternoon, we issued our second-quarter earnings release and filed our quarterly report on Form 10-Q with the Securities and Exchange Commission. These documents, as well as our supplemental financial information packages, are available on our website, www.vno.com, under the Investor Relations section. In these documents and during today's call, we will discuss certain non-GAAP financial measures.

Reconciliations of these measures to the most directly comparable GAAP measures are included in our earnings release, Form 10-Q, and financial supplement. Please be aware that statements made during this call may be deemed forward-looking statements and actual results may differ materially from these statements due to a variety of risks, uncertainties, and other factors. Please refer to our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2023, for more information regarding these risks and uncertainties. The call may include time-sensitive information that may be accurate only as of today's date. The company does not undertake a duty to update any forward-looking statements.

On the call today from management for our opening comments are Steven Roth, Chairman and Chief Executive Officer; and Michael Franco, President and Chief Financial Officer. Our senior team is also present and available for questions.

I will now turn the call over to Steven Roth.

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

Thank you, Steve, and good morning, everyone. Our business is on plan and continuing to improve month-by-month. Our primary focus is always on leasing, and I can report that PENN 2 is extremely active and further, that in the overall portfolio, more than two-thirds of the recent vacancies have already been spoken for. Our focus continues to be on enhancing our liquidity, reducing leverage, and of course taking advantage of opportunities created by the current market dislocation. New York City is as crowded as ever and that's a good thing.

As I predicted over the past couple of years, working at the kitchen table wasn't an existential threat. We're now seeing building utilization percentages in the 70s and that's just about normal. Tenants are expanding and growing and actively searching for space. We actually compete in a market of over 200 million square feet and in many of the prime submarkets, good space is being eaten up and rents are rising. It may be that the most important dynamic in our market is that it is almost economically impossible to build new, thereby cutting off new supply. There hasn't been a new office building of size started in New York in the last five years. If history is a guide, when supply shuts down, it quickly leads to a landlord's market.

As Michael will cover in a moment, we are off to a very strong start in our leasing of this year. The Bloomberg renewal and extension of their 947,000 square feet at 731 Lexington Avenue, creating 16 years of a term is the highlight. And we have good activity at all of our assets. As I said, at PENN 2 with the lobbies, common spaces, amenities, and plazas now complete, we're seeing a significant uptick in tour activity and our pipeline at PENN is strong. Prospective tenants are really appreciating our transformation. And the PENN is really an extension of the New West Side from Hudson Yards to Manhattan West to PENN. The public space surrounding PENN 1 and PENN 2 is transformational and I encourage all of you to go out and check it out. The district is really bustling with our new food and beverage offerings. We are -- we could not be more optimistic.

I mentioned on the last call that we've been working on several large monetization transactions. We announced the first one yesterday, the sale of our portion of UNIQLO's Fifth Avenue flagship to UNIQLO for $350 million. This asset is in our retail joint venture, 52% of which is owned by us. UNIQLO is also acquiring the upper two floors of their store from the office owner. This transaction continues the theme of Fifth Avenue users purchasing their space. UNIQLO's lease was set to expire in April 2026, so protecting and perpetuating their control of this high-volume prominent Fifth Avenue store was paramount to the tenant. My bet is this won't be the last user purchase on Fifth Avenue.

As you will recall, we recapitalized this asset at a 4.5% cap rate as part of our street retail joint venture in 2019. The sale to UNIQLO is at a 4.2% cap rate on in-place NOI and the cap rate on the mark-to-market rent is in the mid-to-high 3% range. The sale is expected to close in the first quarter 2025. Importantly, all net proceeds will go towards repaying our preferred equity on this asset. There are a few other transactions in our pipeline to repatriate portions of the remaining $1.5 billion of preferred equity, all of which will substantially increase our liquidity. The second transaction I'll quickly comment on, which has been rumored in the market relates to 770 Broadway. We have reached a handshake deal with a user for a long-term master lease of the entire 1.1 million square foot office component.

We will retain the 92,000-square-foot market. After a difficult four or so years, market dynamics are now reversing and growing constructive. There is no new supply on the horizon, tenants are growing and expanding and searching for space, and New York continues to be the single best market in the nation. And importantly, our PENN district is finally showing brilliantly. We worry about the elephant in the room. The activity in the government bond and stock markets over the last three days is confirmation that the Federal Reserve's fight against inflation has succeeded and likely foretells a significant reversal of interest rates. All this will have a significant positive impact on our numbers and our values.

Now over to Michael to cover our financials and the market.

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

Thank you, Steve, and good morning, everyone. Our overall second-quarter FFO was $0.76 per share. This excludes $0.19 of non-comparable items, mostly our share of the gain from the discounted debt extinguishment related to the re-financing at 280 Park Avenue and gains from additional 220 Central Park South unit sales.

Second quarter comparable FFO as adjusted was $0.57 per share compared to $0.72 per share for last year's second quarter. This decrease was attributable to the known items we previously discussed and consisted of $0.07 of lower NOI from known move-outs, net of rent commencements, $0.07 of termination income in 2023 from a former tenant at 345 Montgomery Street in San Francisco, and $0.03 of higher net interest expense, partially offset by $0.02 of higher NOI from signage and the net impact of other items. We have provided a quarter-over-quarter bridge in our earnings release and in our financial supplement.

On our last earnings call, we stated that we expect our 2024 comparable FFO to be down from 2023 comparable FFO of $2.61 per share, primarily due to higher projected net interest expense of about $0.30 per share and the temporary impact of known vacancies at certain of our properties, primarily at 1290 Avenue of the Americas, 770 Broadway and 280 Park Avenue of roughly $0.25 to $0.30 per share. This is still a good assumption as these items are expected to have a larger impact during the second half of the year.

We already have commitments for about two-thirds of the aforementioned vacant space, assuming the 770 Broadway transaction is finalized, but the GAAP earnings from these leases won't begin until the latter part of 2025. Thereafter, we expect earnings to increase as income and the lease-up of PENN and other vacancies come online and as rates trend down, partially offset by the reduction of capitalized interest.

Now turning to the leasing markets. The overall trend of the New York office leasing market continues to be upbeat as we enter the second half of the year, particularly in Midtown. Private sector employment has reached a historic high, reinforcing that New York remains the leading magnet for talent in the US. Tenant demand for Class A properties is strong, outpacing 2023 and the mix of leasing is well-balanced between financial services, legal, and technology companies.

Given the lack of available quality blocks of space in Midtown Manhattan, a dearth of new supply for the foreseeable future, slowing sublease additions, and office conversions gaining momentum, many industry analysts are predicting a tightening of vacancy rates across the city in well-capitalized Class A properties as we head into the second half of 2024 and into 2025. A spike in rental rates, much like what we have seen on Park Avenue and the New West Side should naturally follow. All this bodes well for Vornado's best-in-class collection of high-quality repositioned assets within New York's most coveted submarkets on the New West Side, Park Avenue, and Sixth Avenue.

Our 2024 leasing activity reinforces that tenant demand for top-of-market properties near transit and which provide the type of space and amenities companies desire for employee retention, recruitment, and flexibility remained strong. During the first two quarters, we leased a total of 1.6 million square feet at market-leading average rents of $130 per square foot. This includes our second quarter lease renewal of Bloomberg for the global headquarters at 731 Lexington Avenue, where they will continue to occupy all 947,000 square feet of office space in the building. Excluding the Bloomberg renewal, our transaction volume for the first half of 2024 is 666,000 square feet at starting rents of $95 per square foot with a cash mark-to-market of 9.1%.

During the second quarter, we completed many important leases throughout the portfolio in addition to Bloomberg, including 11 leases at PENN 1 totaling 123,000 square feet at an average starting rent of $95 per square foot. The transformation of PENN 1 with its unmatched amenity program continues to attract tenants from all industry sectors who were previously occupying space in other city submarkets and at rents above our original underwriting. We continue to attract leading financial services companies to 280 Park, where this quarter we completed a long-term transaction with Elliott Management for 149,000 square feet in the base of the building. The addition of Elliot to our tenant roster, where they joined PJT Partners, GIC, Antares, and Invescorp, [Indecipherable] Park as one of Manhattan's premier financial services properties. Importantly, we have now leased 225,000 square feet of space at 280 during 2024 at an average starting rate of $124 per square foot.

Looking forward, our pipeline is roughly 2.6 million square feet, which consists of 1.6 million feet of leases in negotiation and well more than 1 million square feet in some stage of proposal negotiation. The pipeline consists of substantial activity at PENN 2, where we have seen a significant pickup in tenant tour activity and proposals during the second quarter following the recent completion of the project, the opening of our new pedestrian park at Plaza 33, and completion of our expansive district-wide new sidewalk program.

Our total pipeline of deals is a 50-50 mix of new tenant deals vying for our current vacancies and important renewals as we continue to work hand-in-hand with our tenants expiring during the next few years. In San Francisco at 555 California Street, we completed a 10-year lease renewal with Jones Day for 62,000 square feet and are currently finalizing a 46,000 square-foot renewal expansion with one of our leading financial services tenants in the building. Additionally, we are in late-stage letters of intent with several of our major tenants comprising a total of 250,000 square feet with upcoming lease expirations in 2025 and 2026. All these deals have positive mark-to-markets on the ranch, reflecting 555's trophy nature.

And finally, in Chicago [Indecipherable], we completed a long-term expansion and renewal lease in July with one of our major tenants, which tripled in size to 160,000 square feet. While the Chicago market is challenging, we are benefiting significantly from the quality of our assets with our market-leading work-life amenity program and rock-solid sponsorship and have a strong pipeline.

Turning to the capital markets now, while the financing markets remain challenging for offices and banks remain out of the market, we are beginning to see some early signs of improvement with the CMBS market open again for selective high-quality assets and even ones that are less straightforward. Rates are beginning to moderate and the SOFR forward curve is projected to come down meaningfully over the next year, which should help borrowing rates. We continue to be very active on the capital markets front.

In June, we refinanced the loan at 645th Avenue in our street retail JV, eliminating the $500 million recourse obligation to the company. While the rate is higher than we'd like, this financing demonstrates that the markets are open again for high-quality retail and office assets. At 731 Lexington Avenue, with the Bloomberg renewal now complete, we're in the process of refinancing this loan as well. We will have then taken care of all of our significant 2024 maturities and are in the process of addressing our 2025 maturities. Our balance sheet remains in very good shape with strong liquidity of $2.7 billion, including $1.1 billion of cash and restricted cash and $1.6 billion undrawn under our $2.17 billion revolving credit facilities.

With that, I'll turn it over to the operator for Q&A.

Questions and Answers

[Operator]

[Operator Instructions] Today's first question comes from Steve Sakwa with Evercore ISI. Please go ahead.

[Steve Sakwa, Analyst at Evercore ISI]

Yeah, thanks. Good morning. Steve, you certainly peaked my interest with your 770 Broadway comments. I'm just not sure I fully understand, I guess, kind of the transaction and discussion because I know that building is about 80% occupied today with a couple of different tenants. So I'm just not exactly sure if this new tenant subleases the space from the old tenant or just kind of how that -- I guess, I didn't really quite understand the whole transaction that's pending.

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

Steve, I wish I could help you, but I've said one that I'm going to say on that topic. It's an important transaction. We're under a confidentiality agreement and so that's all I'm going to say is that there's an [Indecipherable] transaction in process. Sorry.

[Steve Sakwa, Analyst at Evercore ISI]

Okay. Maybe switching gears to the 2 PENN and I guess, Michael, the pipeline you talked about sounds quite strong. Can you maybe just provide a little bit more color on the types of tenants that you're speaking to? And are these tenants that are, I guess, currently already in the marketplace and more at lease exploration driven or these kinds of new requirements in the market looking at -- looking at 2 PENN?

[Glen J. Weiss, Executive Vice President - Office Leasing and Co-Head of Real Estate at Vornado Realty Trust]

Hi, Steve, it's Glenn. How are you? And so it's a mix of both tenants expiring soon and some tenants expiring in the outer years. But I'll tell you at PENN 2, we have tenants buying for the same space right now both in the podium and in the tower. We have technology interests, fashion interests, financial interests, legal interests, academia interests, media, we have interests from all types of sectors on all the space. We're in different sorts of paper negotiations with all these tenants. So we're seeing very, very strong activity as we sit here.

Similarly, at PENN 1, we've leased about 155,000 feet at PENN1 this year at rents that are well above where we thought we wind up there and the types of tenants keep coming in. We release out right now with a major pharmaceutical company for two floors and we have other activity coming into PENN 1. And with that, we're also seeing great activity around the district at PENN 11 and some of the other properties. And so I would tell you, we're really on all cylinders now in PENN. When you walk the streets, it's really spectacular. Everything is looking great, the reception is better, better, and better as each day passes. So we're super-excited about what's to come.

[Steve Sakwa, Analyst at Evercore ISI]

Okay, thanks.

[Operator]

Thank you. And our next question today comes from John Kim at BMO Capital Markets. Please go ahead.

[John Kim, Analyst at BMO Capital Markets]

Thank you. On the UNIQLO sale, can you just talk about the earnings impact? I think you sold at a great price per square foot, but I think your preferred gets redeemed, so might be slightly dilutive in the near term. And also, you still own five assets on Fifth Avenue in that prime quarter between 51st and 55th Street. Is $20,000 per square foot the right way to value the remaining retail? And do you plan to monetize any further assets there?

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

Well, there's a lot in that, John. [Speech Overlap] And if I forget, remind me, but thank you. And I think you've been a steadfast believer in retail the whole time which we appreciate. Look, it's obviously a transaction we're quite pleased about. We think it's an outstanding execution. And I think if you look at the valuation and Steve talked about the cap rates and the value, the income is actually up a little bit from 2019 transaction. That would effectively tell you that the retail value that we sold in 2019 is sort of back to those levels.

So if you take the preferred and the -- just where the value of the equity was marked at the time, that's about $16 a share, which I don't think our stock price continues to reflect at all. So eventually people will appreciate the valuation of Fifth Avenue. But on the per square foot, 20,000 is -- that's the entire space. I think the most important thing to focus on when you're looking at Fifth Avenue retail is what's the amount of frontage, what's the amount of ground floor square footage. And when you take out a small allocation for the second floor given the rents are obviously quite a bit less, it's about $50,000 a square foot for grade square feet. So I think that's a more representative metric for Fifth Avenue retail in terms of the grade square feet. So you have to sort of look asset-by-asset.

With every user sale and we've now seen three major sales and I think we alluded over the last couple of calls, we expect that there would be some -- obviously, we knew this one was in the works, but I don't think you've seen the last, as Steve said. Yeah, each sale creates more scarcity in terms of what's remaining on Fifth, which should drive both rental rates as well as valuations for those that want to keep buying. So we're pleased that we own a significant portion of the frontage still. We still own north of 20% of the Prime Upper Fifth Avenue frontage and so that puts us in a good place.

Let's talk about the earnings impact, which I think was -- I think that was your first question. So all the proceeds will go to repay are preferred. We're only about four and three-quarters in that today. The entire amount, if you remember, we originally structured the transaction, the preferred was a proxy for first mortgage financing and it allowed us to defer any gain there. And when we refinance the preferred, that gain continues to get deferred when it gets actually paid off that triggers the gain. So the entire 340 will be gained, it likely will close next year. And depending on what other transactions we have in terms of losses and we already have some that have been monetized, we'll be able to keep some or all that cash. We think we'll be able to keep a significant portion of that cash if not all of it. And so I would tell you at a minimum, it will be a push in terms of earnings and hopefully, it will be accretive to the tune of a few million dollars. If you assume we redeploy that, if nothing else, just to pay off debt, let's call it 6.5% in terms of where it is today. So I think I covered everything you asked, but if not, tell me.

[John Kim, Analyst at BMO Capital Markets]

You covered it all. Thank you. And then my second question is on PENN 2 and the timing of MSG moving into that space as well as the capitalized interest. If you could just remind us of your capitalized interest policy, when do you start expensing the interest on that project?

[Thomas Sanelli, Executive Vice President - Finance and Chief Administrative Officer at Vornado Realty Trust]

Sure. John, it's Tom. MSG, we actually delivered some of their space, a portion of the space six months early. So in our second quarter results, you're seeing the impact of that. It gets fully delivered by the fourth quarter. So our fourth quarter will be a full quarter of MSG rent at the new rent. And then obviously, '25, it will be a full year of MSG on a GAAP basis. As it relates to capitalized interest, as we indicated in Michael's prepared remarks and on previous calls, capitalized interest will roll down in 2025, but most of that will be offset by additional GAAP revenue as it relates to some of the large leasing we did this past year with [Technical Issues].

[John Kim, Analyst at BMO Capital Markets]

And you do that floor by floor as it's delivered or the entire building at once?

[Thomas Sanelli, Executive Vice President - Finance and Chief Administrative Officer at Vornado Realty Trust]

It's going to be a portion of the building because as we had some open development going on, some of that interest will continue to capitalize in 2025.

[John Kim, Analyst at BMO Capital Markets]

Thank you.

[Operator]

Thank you. And our next question today comes from -- comes from Floris van Dijkum with Compass Point. Please go ahead.

[Floris van Dijkum, Analyst at Compass Point]

Hey, good morning, guys. Thanks for taking my question. Obviously, very interesting and bullish news on Fifth Avenue. I also noticed that your rent spreads on your retail portfolio were positive by the tune of around 13%. Maybe if you could talk a little bit more about some of the upside potential, is that a -- what you're seeing in terms of leasing activity? And also, obviously, now that UNIQLO owns its space, there's less space to lease in, particularly in the Upper Avenue quarter. What are your expectations for market rental growth and lease spreads that in your portfolio over the next year or so?

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

Good morning, Floris. On your first question, in terms of retail activity, I think we've talked about this on the last call, a couple of calls in terms of just the general market dynamics where the retailers are more active, and we're seeing continued recovery there, both in terms of rents improving and vacancy rates declining, and that certainly continues. I think if you look at our activity this quarter wasn't very meaningful, but it tends to be a little lumpy. But as I look forward at our pipeline, it's quite active. We probably have close to 160,000 feet in lease negotiations right now and probably another 150,000 feet of deals in various stages of letters of intent.

So a lot of activity, I would say that's principally focused in pen as well as in Times Square, where we have space that, obviously, we've redeveloped and PENN that we've delivered or delivered and then backfilling some of the spaces, particularly 1540 Broadway. So that's where the activity is. And I would say the rents are at pretty healthy levels relative to historical, particularly in Times Square. Fifth Avenue, we have one vacancy that comes up later this year. There is activity there. It's hard to extrapolate exactly just because there's not a tremendous amount of vacancy and every space is so particular in terms of where users want to be and how much space they want and whatnot. But rents are -- I think it recovered pretty significantly there.

So again, we see continued momentum. I think in terms of near term, we don't have a lot of roles coming up on fifth near term. So I don't know that really -- the near term is to mark that either way is really relevant. There's duration on most of those leases other than that one small lease that's coming up at the end of the year.

[Floris van Dijkum, Analyst at Compass Point]

Thanks, Michael. And maybe my follow-up is if you could talk a little bit about your plans for the $450 million of unsecured debt that matures, I think, in January of '25. You said you're in the market looking at some of those things. Is the idea to refinance that? Or will you pay that off with cash? Or if you can talk a little bit about your thinking about that?

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

Yeah. Look, as we sit here today, our plan is to pay it off. And we've got significant pressure on hand. Obviously, given the announcements in the last 24 hours, we've got more cash coming in. So that's the plan, like as you would expect, we are tuned to the markets and what's going on with rates trending down with spreads tightening and we obviously look at the Barrick financing markets to see where those are and that presents an alternative that's compelling. And we're pleased with the direction of that. But as we sit here today, plan is to pay it off.

[Floris van Dijkum, Analyst at Compass Point]

Thanks, Michael.

[Operator]

Thank you. And our next question today comes from Camille Bonell with Bank of America. Please go ahead.

[Camille Bonnel, Analyst at BofA Securities]

Good morning. Glenn, I wanted to follow up on the leasing side, given your comments around the improving outlook. Was the handshake deal on 770 Broadway included in the pipeline from last quarter? Or did it more recently emerge? And just outside of Broadway discussions. Curious to get your thoughts on what activity are you seeing specifically around the large office users.

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

Yeah, hi. The 770 transaction was included within Michael's remarks, in terms of the pipeline. In terms of overall activity, we're really seeing activity throughout the portfolio really everywhere right now. If I look at the list of the action, the leases out, and the proposals in, we're really seeing it very well spread out for all the buildings. And the one thing I would note is the bread-and-butter tenants, the 10,000, 20,000, 30,000-foot types are really coming into the market more so now than they have in a while. And we're seeing that a lot of the properties, particularly in PENN and in Midtown. So I'd tell you that the market is as well mixed as it's been in a long time, different sized tenants, different genres of tenants. So we're really seeing a very good consistent mix which is helping the market helping the volume. And as you can see in a lot of the reports, New York is clearly leading that charge by space throughout the country.

[Camille Bonnel, Analyst at BofA Securities]

And for my follow-up, I was wondering if we can get your latest thoughts on how taxable income is trending just following the pickup in dispositions this year. Are we likely to see more distributions paid out? Or is it still uncertain given the known move-outs? Thank you.

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

Still uncertain, Camille. As we get further on the year depending on what ultimately ends up closing, not closing, et cetera, then we'll have a -- we'll have a better sense. We have a decent sense and they can go in a number of different directions still.

[Operator]

Thank you. And our next question today comes from Michael Griffin with Citi. Please go ahead.

[Michael Griffin, Analyst at Smith Barney Citigroup]

Great. Thanks. Wondering if you can give us a sense of how concessions have been trending. I noticed it was, I think, notably lower this quarter, probably driven by the Bloomberg extension. But have you seen the concession environment improve at all, or is it pretty steady relative to recent quarters?

[Glen J. Weiss, Executive Vice President - Office Leasing and Co-Head of Real Estate at Vornado Realty Trust]

Hi, Michael. It's Glenn. So concessions have stabilized. They're stubbornly high, but they've stabilized. They have not gone up in some time. That's now being somewhat offset by higher rents in certain properties in certain subdistricts in our portfolio. So that we're seeing positive signs in terms of net effective rents in some of our properties. And so look, the hope is as the market tightens, we could bring the TIs and free rents down, but certainly, they've stabilized now for a bunch of quarters as we've been stating on these calls.

[Michael Griffin, Analyst at Smith Barney Citigroup]

Thanks for that, Glenn. Appreciate that. And then Steve, just on your kind of macro comments about the interest rate environment and the Fed's kind of fight against inflation. Obviously, I think lower interest rates are better for offices overall. But just given the chatter that we've heard recently around recessionary fears. I guess, how do you balance the more favorable outlook for interest rates mixed with what could be a recessionary scenario that would probably negatively impact the office sector?

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

The biggest driver and the biggest -- our biggest cost is the cost of capital. So the real estate industry has always thrived and increased in value as -- in the interest rate cycle as interest rates are trending down. The expectation of most market players is that we're in -- we're on the other side of the interest rate cycle and interest rates will be coming down. We are certainly not planning the business for interest rates to go down to the zero levels that they were, but hopefully, they will stabilize at a normalized level and we'll see how it works out.

[Michael Griffin, Analyst at Smith Barney Citigroup]

Great. That's it from me. Thanks for the time.

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

Thank you.

[Operator]

And our next question today comes from Dylan Burzinski with Green Street. Please go ahead.

[Dylan Burzinski, Analyst at Green Street Advisors]

Hi, guys. Thanks for taking the question. I appreciate the comments on street retail activity picking up. But I guess, as we look at the portfolio today, I think you ended the quarter, call it high 70s percent occupancy, which is still well below where it was pre-COVID. I guess, as you guys think about that business moving forward, I mean, is there a -- do you guys envision that eventually getting back to where it was pre-COVID or do you sort of envision an environment where things are improving, but you still don't necessarily see a recovery back to those pre-COVID levels?

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

Yeah, good morning. Look, I think the -- the number you referenced on the occupancy, I think we got to put a big asterisk next to that, which is it's really -- that lower number is driven by Manhattan. So JCPenney went bankrupt and vacated that store, and that caused about 10 points of occupancy decline there. Now, we've been given everything else we're doing in PENN evaluating what to do with that space and not necessarily wanting to lock it up long-term, certainly with a tenant that's not paying rent that we think is appropriate and recognizing that everything we're doing in the district is going to accrue to that asset over time.

So we've done a number of temp deals. In fact, we have one with Netflix that's opening right now and that's probably the plan. We don't actually -- when we do that, we don't take that into occupancy. In fact, maybe we should have taken that service because by and large, it's really not a focus of ours to lease a long-term unless we get a robust rent. So if you take Manhattan Mall out, that 77, if you will, goes to like 87 and we've got the other vacancy that we're working on. So the answer is the bottom line is yes. We think that number is going to get back up to levels we were at historically but keep in mind, there's 10 points that sort of frictional vacancy rate and our structural vacancy that is due to Manhattan Mall.

[Operator]

Thank you. And our next question today comes from Connor Mitchell with Piper Sandler. Please go ahead.

[Connor Mitchell, Analyst at Piper Sandler Companies]

Hey, good morning. Thanks for taking my question. So there's been a lot of talk about the high street retail and how the whole environment is rebounding in terms of that area. We've seen it from rents coming back, retailers acquiring the spaces are leasing but just thinking about one rent in particular, the -- there's been articles in I think it was June or July about Sephora recently negotiating their rents down by two-thirds on Madison. So I guess, I'm just wondering if you guys could help us think about the juxtaposition between some of the -- some of the metrics we've seen recently, your comments, and then some specific transactions such as the Sephora one.

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

On the Sephora deal, you mentioned at 520 Madison, I wouldn't call that a market transaction. It was a very short-term deal. I believe it was only for one or two years at the most. So I wouldn't take into account as it relates to the market of what's going on in that corridor.

[Glen J. Weiss, Executive Vice President - Office Leasing and Co-Head of Real Estate at Vornado Realty Trust]

I might add-on to that. I think when you define high street, I don't know that I would characterize 520 Madison as high street. Yes, it's Madison Avenue, but that's not the prime stretch of Madison Avenue. Prime stretch of Madison Avenue is 57th to probably 64th, which is where you see rents that are jumping north of $1,000 a square foot. So retail that is not prime prime is coming off older rents, that has not seen the same level of recovery. It's recovering, but it's not seen the same level of recovery as Prime Fit, Prime Times Square, and that Prime stretch in Madison. So both the short-term nature as well as, and we've always talked about this, the Prime High Street is really scarce and you have to focus on what that means different than any other set of blocks in the city. And I think the beauty of our retail is it is all Prime High Street.

[Connor Mitchell, Analyst at Piper Sandler Companies]

Very helpful. Appreciate the color. And then maybe just one more quick one. You guys had a lot of financing activity in the quarter, obviously. And then the 645 was refinanced at a fixed rate of $750 [Phonetic]. Just curious if that's a good rate that we should think about for some upcoming maturity such as 731 Lex or any others moving forward.

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

Yeah. That's probably -- as we sit here today, that's probably 50 basis points higher than it would be if we did it today, just given what's happened in the 10-year or in the future in the five years. So obviously, the base rate matters, spreads matter, et cetera. But 731, I think you'll see gets done much tighter than that, reflected the long-term lease that we executed last quarter. And I think it's asset-dependent. But I think in general, the markets continue to heal, I think you'll see those rates trend down to some extent just by the fact that base rates are down.

[Connor Mitchell, Analyst at Piper Sandler Companies]

Thank you.

[Operator]

And our next question today comes from Ronald Kamdem with Morgan Stanley. Please go ahead. Hello, Mr. Kamdem, your line is open. Perhaps you're muted.

[Ronald Kamdem, Analyst at Morgan Stanley]

Yeah, can you hear me now?

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

Yeah.

[Ronald Kamdem, Analyst at Morgan Stanley]

Okay, great. Just two quick ones from me. Going back to the 2.6 million square feet pipeline, can you break out how much of that relates to PENN 2? And the two floors that you mentioned on PENN 1 that's out for lease, is that on vacant space?

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

The PENN 1 deal-making is on vacant space. I really don't want to get into much more detail than I have already on PENN 2, but a good amount of the pipeline is PENN 2 with the plethora of deals brewing as we speak in different parts of negotiations, but rather not get into the very much detail of how many feet is what at this point.

[Ronald Kamdem, Analyst at Morgan Stanley]

Sure thing. If I could just sneak in a quick one. Can you just sort of comment on any updated plans for the former hotel PENN site given all the leasing activity you're seeing on PENN 1 and PENN 2?

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

It's -- look, I think as we've talked about in the past, the cost of construction financing, lack of availability makes it difficult to build right now. So like it's a prime site, arguably the best site left in the city, but its day has not come yet.

[Ronald Kamdem, Analyst at Morgan Stanley]

Thanks so much. That's it for me.

[Operator]

Thank you. And our next question today comes from Caitlin Burrows at Goldman Sachs. Please go ahead.

[Caitlin Burrows, Analyst at The Goldman Sachs Group]

Hi, good morning. Earlier, you mentioned how the leases you were doing at 555 California all had positive marks to market. So I guess, could you just talk about that a little bit more? How long do you think those positive spreads at 555 can last for? And I guess, given the occupancy there, how would you characterize market rents there? Like do you have the ability to push more or to what extent is vacancy in the market or sub-market limit the pricing side?

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

I think what we're seeing at 555 is that it is the best building in San Francisco. Our tenants have all remained. Our rents have held very strong and so this building is really insulated from the overall market and what you're seeing statistically in the city. Without getting into much detail on the negotiations we have going on with our tenants, we're seeing a lot of strength. We're even seeing growth in the deals expansion with these tenants. So what's going to happen in the future in terms of these rents, I mean, look, the rents at our building have historically kept going up. We feel very good about the rental rates we're achieving right now. We're ahead of the market. We expect to continue to be ahead of the market as we move more down.

[Caitlin Burrows, Analyst at The Goldman Sachs Group]

Okay, got it. And then back in the prepared remarks, you gave some color on the outlook to '25, I think, suggesting that with the leasing that's been completed and PENN 2 coming online that late '25 could see maybe an improvement in earnings. I guess, first, is that the right takeaway, but then b, when you think about all of the moving parts, are there additional 2025 large lease expirations we should be aware of and do you have any insight into those tenants' thoughts at this point?

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

We have a modest expiration schedule in '25. We're obviously speaking to all the tenants expiring during that period. But I think generally speaking, between 280, 770, and 1290, we've seen the real tide of expirations now. And as we go to '25 and forward, we're seeing a calming of those big expirations.

[Caitlin Burrows, Analyst at The Goldman Sachs Group]

Okay. Thanks.

[Operator]

Thank you. And our next question today comes from Anthony Paolone with JPMorgan. Please go ahead.

[Anthony Paolone, Analyst at JPMorgan Chase & Co.]

[Technical Issues]

[Operator]

Pardon the interruption here, Mr. Paolone, your line is coming in very poorly. I'm going to disconnect your line. I'm going to move on from you. If you can dial back in, we can get you right back into the queue.

Our next question today comes from Nick Yulico with Scotiabank. Please go ahead.

[Nick Yulico, Analyst at Scotiabank]

Thanks. Yeah, I know you talked about some of the leasing underway already for this year. I guess, can you give us a feel for how occupancy might trend for the back half of the year in the office portfolio?

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

Yeah. We're at about 893 today. We know that's going to trend down a bit next quarter. So just given that Meta is vacating 275,000 square feet at 770 Broadway. Obviously, if we complete the 770 deal as Steve alluded to, that's going to have a significant positive impact. But in terms of near term, certainly going to go next quarter, we have a bunch of things in the queue. I think we end up the year basically where we're at now, could it be 20 basis points, 30 basis points lower, higher, sure?

I mean, it all depends on timing, but I think just in terms of where we end this year, I think that's a decent number and there's some things in the work that could take that number up a couple of hundred basis points. But again, it's all timing. But I think just in terms of near term, next quarter or two, hopefully, that gives you what you wanted.

[Nick Yulico, Analyst at Scotiabank]

Yeah, that's helpful. Thanks. And then just going back to PENN 2. Can you give us a feel for maybe types of tenants looking at the space and from the standpoint of is it tenants that would be new to that submarket, anything else you could just talk about, about whether these are lease expiration driven where you're trying to sort of capture the market share there?

[Glen J. Weiss, Executive Vice President - Office Leasing and Co-Head of Real Estate at Vornado Realty Trust]

Hi, it's Glen. So as I said earlier, a very, very good mix of all different industry sector type tenants, technology, fashion legal, media, academia, it's a very good mix. And yes, there are new entrants to the district. And really, that's all due to the really great product that we're now delivering and even more so, the new streetscape, all the new reads that we've embedded on the street. So it's all positive in terms of new entrants, new types of sectors, et cetera, that's really the mix of the action.

[Nick Yulico, Analyst at Scotiabank]

All right. Thank you.

[Michael J. Franco, President and Chief Financial Officer at Vornado Realty Trust]

I think one thing I would just add, Nick. I think when we talk about this, I think it's important, right, the access to transit, which we sit on top of is just critical. And we are the most connected submarket. And when you look at some of the tenants and where they are attracting their employees from, that access is just critically important. So obviously, it's what PENN has been full historically, but now I don't know whether you've been over to the district and seem done. I really encourage everybody to do so. But it's a wow and when you combine that with the transit, I think it's now -- I think it's why you hear the excitement in Glenn's voice and it's why the pipeline is built so significantly.

[Nick Yulico, Analyst at Scotiabank]

Thanks.

[Operator]

Thank you. And our next question today is a follow-up from John Kim of BMO Capital Markets. Please go ahead.

[John Kim, Analyst at BMO Capital Markets]

Thank you. I just wanted to get back to 770 Broadway, I understand you're under a confidentiality agreement. But just to help us understand the market dynamics and demand a little bit better. Can you share what industry the tenant or users in, whether or not it's a tech user, and if this includes expansionary space in Manhattan?

[Glen J. Weiss, Executive Vice President - Office Leasing and Co-Head of Real Estate at Vornado Realty Trust]

I'm very sorry, but we can't say anything more than we've already said.

[John Kim, Analyst at BMO Capital Markets]

Okay. But it is a lease, right, not at a sale?

[Glen J. Weiss, Executive Vice President - Office Leasing and Co-Head of Real Estate at Vornado Realty Trust]

I'd reiterate with Steve I think, I've said -- that's all we're going to say, and I'll say that again. Thank you.

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

It gives you a reason to tune the for the next couple of calls, John.

[Operator]

Thank you. And our next question today comes from Dylan Burzinski with Green Street. Please go ahead.

[Dylan Burzinski, Analyst at Green Street Advisors]

Steve, I think in your prepared remarks, you mentioned potential or potential transactions to repatriate more portions of the preferred equity in the Time Square joint venture. Are you able to share any details as to what these potential sales, other recapitalizations?

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

So both of those are in play. So the answer is, first of all, that we'll end up with about $1.5 billion of preferred after the Uniqlo sale completes are -- is a -- first of all, the instrument is dollar good, supported by very valuable collateral. Secondly, that it is a source of liquidity for us either through sales or refinancing, both of which we are in the process of working on for portions of that $1.5 billion.

[Dylan Burzinski, Analyst at Green Street Advisors]

And then I don't think you guys touched on this yet, but curious appetite for share repurchases given where the shares are today.

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

So what was the question?

[Dylan Burzinski, Analyst at Green Street Advisors]

Share repurchases appetite.

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

So I was very excited in the teams there is incredible value still. But in the source with respect of our capital allocation at the price of the shares today, that's not our primary objective. We have sped handle, we have other capital allocation priorities. So right as of right now, the program is dormant.

[Operator]

Thank you. And our next question today comes from Brendan Lynch with Barclays. Please go ahead.

[Brendan Lynch, Analyst at Barclays]

Great. Thank you for taking my question. If I recall correctly, a few quarters ago, you engaged an expanded group of brokers to pull in demand to the Penn District from other markets around the country. Can you discuss how that initiative is contributing to leasing year-to-date and how it's impacting the pipeline now?

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

We brought in Cushman & Wakefield at the beginning of this year. They've been a very good add to our team. It certainly strengthens our outreach across the country is used to get and in the city. So we've been very pleased with them and their additive performance to our crew.

[Brendan Lynch, Analyst at Barclays]

Great. Thank you. That was my only question.

[Operator]

Thank you. And our next question comes from Steve Sakwa with Evercore ISI. Please go ahead.

[Steve Sakwa, Analyst at Evercore ISI]

Yeah, thanks. Just one follow-up. I think last quarter, you guys had talked about earnings probably bottoming in '24 and then moving higher in '25. I know there's a lot of moving pieces and interest rates will play a big factor. Is that still the case? Or is it possible that maybe with a timing of lease 2 PENN in capitalization burning off that earnings could still be down next year with more of an inflection point late in '25 into '26?

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

Yeah. Steve, it's -- honestly, it's early to give you much visibility there. I mean I think our comments still hold. But as you can tell from unit quote things, there's a lot of moving pieces going on right now. And that's -- and those are the only things we've talked about. So I just think it's too preliminary to give you that view because based on some of those things, it may impact whatever I tell you now. So I think that's a good working assumption, and we just have to wait as we get closer towards the end of the year.

[Operator]

Thank you. And this concludes our question-and-answer session. I'd like to turn the call-back over to Steven Roth for closing remarks.

[Steven Roth, Chairman of the Board and Chief Executive Officer at Vornado Realty Trust]

Thank you all for participating. I think you could tell from the call, the questions, and the numbers that we published, there's a large emphasis on leasing. Leasing is very, very, very healthy in New York. And we feel that we're on the foothills of a very, very good market and we're very excited. The PENN project especially is number one on our hit parade. And if you all haven't been down there recently, you should go down, take a walk around, see what's going on, what we've done and that will give you a reason for why tenant activity is excreting geometrically. Thanks very much.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Steven Borenstein, Executive Vice President and Corporation Counsel
• Steven Roth, Chairman of the Board and Chief Executive Officer
• Michael J. Franco, President and Chief Financial Officer
• Glen J. Weiss, Executive Vice President - Office Leasing and Co-Head of Real Estate
• Thomas Sanelli, Executive Vice President - Finance and Chief Administrative Officer

Analysts

• Steve Sakwa, Evercore ISI
• John Kim, BMO Capital Markets
• Floris van Dijkum, Compass Point
• Camille Bonnel, BofA Securities
• Michael Griffin, Smith Barney Citigroup
• Dylan Burzinski, Green Street Advisors
• Connor Mitchell, Piper Sandler Companies
• Ronald Kamdem, Morgan Stanley
• Caitlin Burrows, The Goldman Sachs Group, Inc.
• Anthony Paolone, JPMorgan Chase & Co.
• Nick Yulico, Scotiabank
• Brendan Lynch, Barclays PLC