The Sky-High Stakes in Vornado's Twin Towers Deal


By David Shook Move over Donald Trump. The famously press-shy Steve Roth is on the verge of the biggest Manhattan office property deal in Big Apple history. On Feb. 22, his company, Vornado Realty Trust (VNO), announced a $3.25 billion, 99-year lease of the World Trade Center -- one of the world's most recognized symbols of capitalism. Not even the $1.6 billion sale of Rockefeller Center in December came with a price tag this big.

But being the biggest doesn't necessarily translate into being the best. Vornado has never been an easy company for the average investor to understand. That's because Vornado and Roth are about as close-mouthed as a public company and its CEO can get. Roth considers mandatory federal filings his way of communicating with investors. Beyond the 10-Ks and 10-Qs, Vornado is utterly mute -- at least to the public.

NO TELLING. Given Roth's silence, the final terms of the World Trade Center deal are not expected until Mar. 14, presenting real estate analysts with the difficult task of determining whether Vornado and those 110-story twin towers at the southern tip of Manhattan can pay off in an uncertain economic environment.

This deal certainly bears tremendous risk, with questions about its terms weighing on Vornado's stock. So while negotiations with the Trade Center's owner, The Port Authority of New York & New Jersey proceed, here's something to consider: Vornado derives about half its operating income from New York office properties. With Roth's insatiable appetite for Big Apple real estate, that proportion can only be expected to rise. So, for investors who believe New York will forever remain the center of world commerce, this might be a good time to jump into Vornado -- while the many uncertainties of this deal keep the stock from moving.

Once the deal is signed, Vornado shares may soar past their two-year high of $40. Right now, they trade at around $38 -- hung up on the news of the Trade Center deal and trading without much volatility at roughly the same price as on Jan. 1. In the meantime, analysts are getting headaches trying to calculate all the possibilities that could make the deal a boon -- or a bust -- for investors.

DIVERSE PORTFOLIO. "The risk is that Vornado is paying a bull-market price while we're entering a bear market," says Lehman Bros. analyst David Shulman, who has a strong buy rating on Vornado. "The question is whether we're entering a short-term, cyclical bear market or a structural bear market. If this is a structural bear market, then the company could have a problem."

Vornado isn't the typical real estate investment trust. It doesn't focus solely in offices, retail, or apartments. It owns and manages a diverse portfolio of strip malls, cold-storage warehouses, and much of the office space surrounding Madison Square Garden in Manhattan. But those office floors are clearly the centerpiece of Vornado's fortunes. Founded 35 years ago, Vornado got it start in retailing until Roth transformed it into a real estate developer in 1981. Since then, Vornado has emerged as an industry leader -- as well as one of New York's biggest landlords.

Roth also is widely known for making huge sums on the properties in which he invests -- in both good times and bad. If there's one investment that hasn't prospered, it's the 88 cold-storage warehouses Roth acquired with partner Crescent Real Estate Equities (CEI). The joint venture has been forced to defer some rent payments to Vornado because of sagging business at the warehouses.

ALL OVER TOWN. Many more deals, however, have gone Roth's way. When Vornado became a major investor in the former Alexander's department-store properties, for example, he acquired several chunks of prime retail space. Today, on the site of the old Alexander's store in Manhattan -- an entire block near Bloomingdale's flagship emporium on the East Side -- Vornado is said to be building the future headquarters for Bloomberg, the financial news and information company.

Roth is also masterminding the redevelopment of New York's Penn Station and Madison Square Garden neighborhood -- having taken control of 1, 2, and 11 Penn Plaza, the Hotel Pennsylvania, and several other properties near Macy's signature department store at 34th Street and Seventh Avenue. Not bad for a little-known Bergen County (N.J.) company that grew out of now-defunct retail chains.

Still, questions abound concerning the Trade Center deal. Analysts are wondering, for example, about the sort of taxes Vornado will have to pay New York City. Currently, the Port Authority hands over about $25 million a year to City Hall in lieu of property taxes. But some analysts say the city's deal with the Port Authority might not apply to Vornado and that New York could charge as much as $100 million a year. The city is involved in the negotiations, but with a new mayor expected next year, terms could change if a multiyear agreement isn't reached.

TOWERING QUESTIONS. And what about the financing rates Vornado would pay for the lease, as well as the capital spending that'll be required to upgrade and maintain the skyscrapers? Then there's the tortured history of the Trade Center itself. During the other bear markets that have come and gone in the 30 years since the twin towers began to rise over New York Harbor, the Port Authority has at times had trouble filling vacancies. For many years, the building was home to government agencies paying below-market rents. And with 10 million square feet of space, the Trade Center isn't much smaller than Vornado's entire office portfolio. (The company now has 14.4 million square feet of commercial office space.)

As if these questions don't add enough risk, the deal arrives at a jittery time for Manhattan real estate -- especially properties near Wall Street. Since the city's financial district tends to move in step with the stock market, the slowing economy and beaten-down market make Vornado's ability to maintain high occupancy rates far from assured, as well as its ability to impose rent increases. "There are a number of big swing factors in this deal," notes Morgan Stanley Dean Witter's Greg Whyte, who has an accumulate rating on Vornado.

A signed deal on Mar. 14 won't answer all those questions. But if the terms prove sweet enough, a slowing economy might not matter all that much to Vornado. There's a good chance the company could be required to pony up as little as $350 million in cash because initial indications are that the Port Authority will ask for a down payment of roughly 20% of the $3.25 billion. While that comes to about $700 million, analysts believe half of that sum could be financed at market rates, with the balance of the lease -- perhaps $2.5 billion -- financed separately at a lower rate by the Port Authority. If the interest on the lease is substantially less than the rents Vornado charges, the company would make a sizeable profit on the spread.

GOLD RECORD. Oh, what some investors would give if Vornado's CEO would say a little more about his company. But with the tersely worded, two-paragraph statement on Feb. 22 about the megadeal, Roth made it clear he wasn't about to change his tight-lipped style. "Steve Roth is not the most communicative person, and that frustrates some people," says Barry Vinocur, editor of Realty Stock Review. "But at the end of day, he's without question one of the shrewdest real estate operators in the business -- and he has consistently made a lot of money for his investors."

With Roth's track record, analysts say he wouldn't bother with the deal unless he felt it would make a killing for shareholders -- and himself. After all, Vornado hasn't been shy about backing out of Manhattan bidding wars when the price went too high, as Roth did a few years ago when the Chrysler Building went on the auction block. This time, Vornado outbid several other heavyweights, striking a deal at a price well above the figure at which analysts initially valued the property. Somewhere in his silence, Roth must feel he has plenty of room to work his magic. Shook covers financial markets for BW Online in New York


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