Good morning, and welcome to the Vornado Realty Trust Second Quarter 2019 Earnings Call. My name is Michelle, and I will be your operator for today's conference. This call is being recorded for playback purposes. All lines are in listen only mode, and our speakers will address your questions at the end of the presentation during the question and answer session. I will now turn the call over to Ms.
Kathy Creswell, Director of Investor Relations. Please go ahead, Kathy.
Thank you. Welcome to Vornado Realty Trust's 2nd quarter earnings call. Yesterday afternoon, we issued our 2nd 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 package 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 Form 10 ks 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 is Michael Franco, President. In addition, Stephen Ross and our senior team are present and available for questions. I will now turn the call over to Michael Franco.
Thank you, Kathy, and good morning, everyone. Let me start with a few comments on our Q2 financial results before giving some thoughts on the markets in our portfolio and the important new disclosure we provided on our Penn District redevelopments in our earnings release and supplement. While FFO as adjusted on a GAAP basis for the Q2 was $0.91 per share, dollars 0.07 lower than last year's Q2. Cash basis FFO was up 2.1%, reflecting the underlying strength of our core business with strong same store results, which I will review shortly. Let me explain the GAAP numbers as they contain a little noise.
1st, this year so far, we have sold assets aggregated almost $3,000,000,000 notably the 45.4% stake in our Upper Fifth Avenue and Times Square assets and our stock interest in Lexington Realty Trust and Urban Edge Properties. Even though these sales were applauded by all and they were done at NAV and should have accretive to our share price. Earnings go down as a result. As an aside, we were surprised and disappointed by the stock market's ho reaction. FFO decreased by $10,000,000 or $0.05 per share in the 2nd quarter due to these sales, partially offset by $5,000,000 or $0.02 per share of interest savings from the retirement of the 5 percent, dollars 400,000,000 unsecured notes.
So that accounts for a $0.03 per share net decrease. Next, FFO was reduced by almost $0.02 per share from the non cash impact of one time equity awards issued to the new leadership group, net of the savings from the accelerated vesting of restricted stock awards in the Q1. We also had a couple of retail tenant issues impact our 2nd quarter results. At the end of June, Topshop closed all its U. S.
Stores, including our 2 locations at 608 5th Avenue and 478 Broadway, following the Topshop U. S. Retail operating entity being placed in U. K. Administration in the commencement by the U.
K. Administrators of a Chapter 15 case in New York. While we were paid rent through the end of June, we wrote off the straight line rent balances associated with this tenant. The increase in the straight line write offs in this year's Q2 over last year's Q2 amounted to $9,900,000 or $0.05 per share, which is included in both same store NOI and comparable FFO results, primarily attributable to Topshop at Broadway. We treated as non comparable the write off at 608 5th Avenue of the straight line rent and the right of use asset at this location.
Under the new lease accounting standard, on January 1st this year, we recorded as an asset the present value of the rents we pay under this 14 year non recourse building ground lease. We have the right to cancel this non recourse ground lease. In terms of the bottom line impact of Topshop, upon such a cancellation of the ground lease at 608 5th Avenue, we will no longer have the asset and in such event FFO will be permanently reduced by $10,000,000 per year, which will make our NAV by roughly $1 per share. At 478 Broadway, FFO will be temporarily reduced by $8,000,000 per year from the vacancy. This is great space, which we will release in the ordinary course.
We may convert some of the upper floors to office given the attractiveness of this bull's eye location in SoHo to creative types. So to summarize, the aggregate of all these items that affected 2nd quarter comparable results was a $0.10 per share decrease. This was partially offset by $0.03 growth from the core business, which I will cover in a minute. In our July 12 press release, we covered the details of the non comparable items in the quarter, which includes a $2,559,000,000 net gain on the retail joint venture, the previously discussed non cash charge on 608 5th Avenue, which was $77,200,000 and an $88,900,000 after tax net gain on unit closings at 220 Central Park South. Speaking of 220 Central Park South, sales continue apace.
To date, we have closed on 38 units for net proceeds of $1,030,000,000 and earlier this month paid off the remainder of the $950,000,000 loan. The property is now debt free. Closings will continue throughout 2019 2020 and importantly from here, we will retain all future net proceeds, which will be redeployed primarily into the Penn District redevelopments, turning this capital into highly accretive earnings. On July 11, just after the close of the second quarter, we sold our interest our 25 percent interest in 330 Madison Avenue to our partner at a $900,000,000 valuation, netting us approximately $100,000,000 after our share of the mortgage. This asset was the subject of a buy sell and the pricing offered, which included it was a better sale than a buy.
Over our 20 year hold period, we made 8 times our investment. And by the way, we have quite a few like this. The taxable gain related to this sale coming on top of the big retail deal will increase the special dividend requirement at year end, which as of now looks like it will be approximately $1.75 per share. To give you some visibility into comparable FFO for the second half of the year, the aforementioned asset sales after the unsecured note repayment will reduce FFO by approximately $21,000,000 or $0.10 per share $10 per share and the loss rent from Topshop will reduce FFO by approximately $13,000,000 or 0 point 0 $6 per share. We expect 2019 will represent a trough year for comparable FFO per share.
As we continually say, cash NOI is the most important metric in our business. That's how real estate is traditionally valued. Companywide, our 2nd quarter cash basis same store NOI increased by a healthy 4.3% broken down as follows. New York office was up 3.3%, street retail was up 4.2%, The Mart was up 15.5% and 555 California Street was up 12.9%. Let me now turn to the New York market.
New York's deep pool of talent and the fact that they want to live and work here coupled with record venture capital investment has led to enormous technology sector employment growth of 80% since 2009. This has played an important role in attracting large tech tenants to the city and continues to feed their insatiable appetite to grow their footprints in Manhattan. These tenants not only want to be in New York, they need to be in New York. Just think of the names in the last 90 days who have either committed or are actively looking for space. It's a who's who.
In fact, almost all the well managed companies in every other industry are copying this template in their efforts to attract the best talent. As a result, the New York City economy continues to enjoy sustained job growth, driving strong tenant demand for office space. Private sector jobs increased 54 as compared to 76,000 for all of 2018 with 6 month office sector jobs increasing 12,000 as compared to 20,000 again for all of 2018. Overall, our office portfolio is in great shape and continues to perform well. Occupancy stands at 96.7 percent with only 132,000 square feet of remaining expirations in 2019.
Our Midtown portfolio, which has been completely modernized and redeveloped for the long term, remains very resilient and highly sought after by tenants. In the Q2, our leasing team completed 221,000 square feet of office leases and 29 separate transactions in New York at a very healthy average starting rent of $83.54 per square foot.
Our mark
to market rents were positive 3.3 percent cash and 5.9 percent GAAP. While the first half leasing activity of 617,000 square feet is on the lighter side for us historically, realistically our portfolio is substantially full. But there is more to the story. We have a robust leasing pipeline with more than 2,000,000 square feet of deals in various stages of negotiation. We are experiencing strong leasing activity across all submarkets from tenants in all industry sectors.
We have our first leases out at the recently delivered 512 West 22nd Street, including one with a leading media company, all at triple digit rents. Now turning to the next major driver of growth and value creation in our business, the Penn District. First and most importantly, yesterday we published on Page 8 of our earnings release and Page 30 of our supplement the projected costs and returns for the Farley Building, PENN1 and PENN2 redevelopments. In total, these three projects comprise 5,200,000 square feet consisting of an 845,000 square foot new build at Farley and 4,300,000 square feet of renovated and new space at Penn Wine PENN2. The redevelopments will be transformative for these buildings and for the district overall.
Please see our latest renderings and videos of these projects on our website. We are projecting to spend 2,200,000,000 to redevelop these assets along with other district wide improvements, of which we have spent $514,000,000 to date. We project these redevelopments will generate $183,000,000 of incremental cash NOI upon stabilization, a very strong 8.3 percent initial stabilized yield on cost. This is before ground lease rent reset on PENN1 in 2023, which will be comfortably absorbed by that asset's increased NOI. Overall, we expect to replace $60 plus per square foot office rents at PENN1 and PENN2 with $90 plus per square foot rents and expect to achieve triple digit rents at Farley.
These redevelopments will begin to contribute to earnings in 2022 and accelerate over time as the projects are finished and leased up. As we have mentioned previously, the capital for these projects will be funded from the net proceeds of 220 Central Park South without the need for any new debt, which will be very accretive to earnings. We expect that this will put our earnings growth at the head of the pack. Notably, the projected returns from these projects do not include the knock on effects on all of our other existing assets in the Penn District and the multiple additional development opportunities we control. All will clearly benefit enormously.
As the Penn District transformation takes hold, we believe that the Hotel Pennsylvania will be one of the best development sites in the city. Once redeveloped, we are confident the Penn District, which is located directly on top of all major transportation serving the city and region, will become the heart of the new west side, where companies will plant their flag order to attract and retain talent by creating new workplace environments in our buildings. Looking towards 2020, our lease expirations stand at 1,100,000 square feet with $560,000 of this amount coming at PENN2, primarily McGraw Hill, which will be taken out of service as this redevelopment kicks into high gear. It is here at PENN1 and PENN2 where we are creating a unique campus and we'll be providing today's workforce with the office of tomorrow. The scale of our 4,300,000 square foot campus at these buildings enables us to provide our tenants with an unrivaled amenity package.
These buildings will operate and feel much like a full service hotel with fitness and wellness centers, abundant conferencing facilities, large town hall spaces, food and beverage facilities, as well as many communal spaces to work alongside to work alongside colleagues. Anticipating our redevelopment program, during the Q2, we signed a 38,000 square foot lease at Penn 1 with a Fortune 200 company at a starting rent of $93 per square foot, a sign of things to come. This is a 1st generation lease. If this lease would have been included in our mark to markets, the mark to market for New York office would have been approximately 20% on a cash basis. In addition, both at Farley and PENN2, we are deep in negotiations with multiple large users for anchor spaces, all in the triple digits.
All of this validates the unique nature of what we're delivering here in our underwritten pricing for space in the new Penn District. In addition to the capital we are spending in the Penn District, the government is also investing an estimated $3,000,000,000 on various infrastructure improvements, including the Moynihan Train Hall, the West End Concourse, 34th Street Subway Station Improvements and the new 33rd Street Train Station entrance. In addition, we have entered into a memorandum of understanding with New York State to redevelop the Long Island Railroad Concourse under Pen 1. This redevelopment will tie together 7th and 8th Avenues underground, dramatically widen the corridor and raise the ceiling height, allow natural light into the concourse and substantially improve the user experience. Overall, we couldn't be more excited about what we're doing here.
At the Mart in Chicago, occupancy was 94.8% at quarter end. We have strong leasing activity with term sheets in negotiation for much of the 125,000 square feet of vacant space on floors 45, in addition to discussions with 2 large tenants regarding early renewals fueled by their expansion needs. During the quarter, we completed 30,000 square feet of showroom leases at an average starting rent of $63.83 per square foot. Our mark to market rents were positive 6% cash and 14.9 percent GAAP. At our 555 California Street Complex in San Francisco, we are 100% leased.
During the quarter, we completed a 30,000 square foot renewal with 1 of our blue chip financial services tenants at an initial starting rent of $86 per square foot. Our mark to market rents were positive 12.8 percent cash and 32.2 percent GAAP. As an aside, we believe rents at 555 California are under market by say 25%, which will result in continued strong growth over the next few years as leases roll. Finally, turning now to our New York Street retail business. Overall, the retail market continues to be challenging with leasing velocity slow and assets prone to negative surprises, a la Topshop.
I will also point out Forever 21 has hired restructuring advisors and is working with the mall owners to provide rent relief to help stabilize the company. They are a continuing tenant of ours at 1540 Broadway and 4 35 7th Avenue. Their lease at 4 Union Square expires this November and we chose not to renew them. We have re leased a portion to Whole Foods for an expansion of its store and are actively negotiating to release the balance of their space at higher rents. 435 7th Avenue is a new 5 year lease where they recently opened.
At 1540 Broadway, we will likely participate with the mall owners for rent relief in some small measure. Retail occupancy was 94.7 percent at quarter and down from 97.1% last quarter, all due to Topshop and the Four Seasons restaurant. In the Q2, we leased a total of 70,000 square feet of retail space, achieving mark to markets of 18.7% cash and 44.4 percent GAAP. The highlight was a significant 20 year 61,000 square foot renewal and expansion with Whole Foods at 4 Union Square South, the premier asset in that submarket. They are enlarging and remodeling this high volume store.
To conclude, we continue to maintain a fortress balance sheet with reasonable leverage and an abundance of liquidity today and growing over the next few years. Our current liquidity is $3,770,000,000 comprised of $1,100,000,000 in cash, restricted cash and securities and $2,600,000,000 undrawn on our revolving credit facilities. With that, I'll turn it over to the operator for Q and A.
Thank you, sir. We will now begin the question and answer session. The first caller in the queue is from Manny Korchman with Citi. Please proceed with your question.
Hey, good morning, everyone. Michael, I think you mentioned that 2019 would be a trough year for FFO. Just given the bigger move outs like McGraw Hill and some of the retail vacancies that are going to come into the year, can you walk us through why 2020 wouldn't dip versus 2019?
Joe? Manny, it's Joe. Our forecast shows a substantial recruitment of this year's diminution next year. So when you did that pencil to paper and took Michael's one timers that affect the rest of this year, comparable FFO in the 140s somewhere I'm sorry, 340s somewhere around there. Our projections are next year, not with saying that a bigger piece of 2 Penn will be out of service is greater than that.
Don't forget, we have 2 of the other Westside assets coming back into service. We have growth in the core business. We have steps. We have many pluses offsetting those minuses.
Thanks, Joe. And then on Farley, it looks like the costs sort of on a pro form a basis ticked up versus where you had them the last time you talked about costs. Can you just tell us what's going into that project that's maybe taking a little bit more money to get done?
So, Manny, we probably could have done a little better given the road map here, but I think the short answer is that the cost we publish now include the initial land contribution of $230,000,000 plus the amount we paid related, which was I think $41,500,000 So when you take the previous costs, which when you grossed up was $800,000,000 plus the $230,000,000 plus related etcetera, you essentially get back to the number we published now. There's some minor scope changes, but net net you're pretty close with all those additions.
Thanks, Michael.
Thank you. The next question is from Steve Sakwa with Evercore ISI. Please proceed with your question.
Thanks. I guess I wanted to first touch on kind of the ground lease at One Penn. I know you probably can't get into a lot of detail. But could you just whatever you can sort of tell us about maybe what you're paying today and maybe how we think about the fair market value reset? And then are there any other ground leases in the next, say, 10 or 15 years that have any kind of renewals or resets that we should be aware of?
The current rent at One Penn is $2,500,000 The reset is in 23. The term of that lease goes all the way out to 2,098. So it is a truly a long term control over the land. It's a fairly standard fair market value reset and we don't really have very much else to say about the where we'll end up. One thing is that if you look at 1 Penn as an asset, the income is in round numbers, the better part of $100,000,000 today.
We project that that income is going to go up by another $40,000,000 $50,000,000 odd as a result of the redevelopment and neighborhood improvements. So somewhere around the reset date, the income will be on that building somewhere around $140,000,000 150 $1,000,000 maybe a pinch less, maybe a pinch more, so that, that asset can easily and comfortably withstand an increase in the land value. We have 3 other ground leases that I can recall. We have one at 330 West 34th Street, which has a reset coming up in 2020 in 2020, which will be it's a small asset, so whatever the rent reset might be is going to be immaterial. We have another one at 888 Seventh Avenue, which comes out for reset at the end of the decade of late 2020s.
And we have a 3rd ground lease at 909 Third Avenue, which has an expiry of when, David? 2,063. 2,063 and is flat from now. There are no resets whatever. And the rent is an extraordinarily low and favorable number to us.
One comment about the ground lease reset process. There are plenty of these kicking around and the recent resets over the last year or 2 have been in my mind pretty stupid. I mean, you just take the Barney's reset and take a look at that, that has basically the numbers have no reality and basically will bankrupt Mr. Barney's. So we believe that there will be more reality in the reset process going forward.
The issue that really caused the issue, the problem is that retail rents went crazy and therefore land for retail became extremely inflated, hyper inflated a bubble. And similarly, the condo market went crazy and that was a bubble. We expect those 2 bubbles are coming out of the market. So the answer is that we believe that the resets will be more realistic whatever they happen to be, we can handle economically easily. And I think that's a pretty fulsome explanation, Steve.
Okay. Thank you. And then I guess the second question, just to kind of circle back on kind of McGraw Hill and some of the move outs. As we think about 2 Penn going into kind of redevelopment, you're showing about 1 point 3,000,000 square feet in service of the kind of 1.6. Outside of the McGraw Hill space coming offline, is there really any other space in that building that needs to come offline for you to effectuate this redevelopment?
Joe, you have an answer for that one?
So Steve, you were on Without getting too specific. We did disclose almost 300,000 square feet out of service today. We project that will go up to about a 500,000 feet at the end of this year. It will go up in 2020 as more of the building is taken out of service. Approximately 2 thirds of the building will be taken out of service at peak.
And then of course, start to come back in as the hospital is built as the top 2 floors are rented, etcetera, etcetera.
So, but look, Steve, I know you can't do this because I know modeling is the essence of what you do. But I would ask you to look at the real estate business that we're in from a different point of view. We will be taking this building and we will be transforming the building from $60 rents to $90 $100 rents, okay? We will be taking a building which has as long of tooth and bringing it into the modern age and making it be one of the most competitive buildings in terms of a work environment for our tenants, okay? So we believe that this will be extremely profitable activity.
I'm not even getting into how it will help to transform the entire neighborhood. It's an enormous undertaking. The building has 400 odd feet of frontage on Seventh Avenue from 31st Street to 33rd Street, all of which will look totally different when we completed. You've seen the pictures. I'm sure you've seen the pictures.
So this will be in the interim, while we do our work, it will have a slight dilution. But the objective is to convert $60 space to $90 space, which will be extremely accretive to earnings and NAV when we complete this in just a few years. So I know that you have to be extremely interested in model what happens month by month and quarter by quarter. Our perspective is on the end game as to what the product will look like when we're done and how it will increase our earnings and our NAV. Furthermore, the market is has been the market tenants and brokers community have been extensively exposed to the product and they love it.
And the example of which is that we are going to lease now with the first very large anchor tenant at a triple digit number. So the building will be a success. It is a success. And just while you have to model, take a look at the long view. Okay.
Thank
you.
Okay. The next question in the queue comes from Jamie Feldman with Bank of America Merrill Lynch. Please proceed with your question.
Great. Thank you and good morning. I was just hoping to dig a little deeper into your yield assumptions. Can you just talk about kind of what gives you comfort on those rents and what the leasing pipeline looks like in detail for these projects?
We have Michael, you did a great job, Michael. Thank you. I thank you for multiple reasons, okay. First, you did a great job and second of all, I didn't do it. So Michael said in his remarks that we have executed a lease with a Fortune 200 company, so a large important company at PENN2 at $93 a
foot. PENN1.
I'm sorry, at PENN1, PENN1 for $93 a foot. Now obviously that's a significant gap from the market value or the perceived market value of the building today. The reason for that is, is that this tenant and the community believe in what we're doing and is willing to pay the fair price. So we believe in the market price where the building went as we lease it up now and as we complete our redevelopment is well into the 90s, okay? Think about where it is, okay?
We are in the west side of New York, which is the hottest area in New York and we're directly on top of the transportation network. So we have that as a 2, we have as validation that we are going to lease with an anchor tenant at a triple digit number. With respect to Farley, we are in the market. I think one of the analysts wrote in a report that I read overnight that his while we haven't announced any leasing at Farley, his broker checks indicate that there is intense activity on the building. That is correct.
The activity is at triple digits and that's all I think that's all we have to say about these important negotiations going on at Farley. So we have our view, we have the market's view, we have lead tenants executing leases at our underwritten numbers. By the way, there's nothing that says that we won't exceed our underwriting.
Okay. Thank you. Can you talk about operating expenses in those buildings and whether they'll change post renovation?
Somebody is going to have to do that other than they.
I think Jamie, our general view is that not meaningfully, right? There's we're obviously expanding and dramatically enhancing the plazas, etcetera. So at PENN1, there's probably a little bit additional increase from an OpEx standpoint. Obviously, taxes go up proportionate with rents. But from an OpEx standpoint, I think the answer is not meaningfully other than maybe a little bit on PENN1.
Let me handle the question slightly differently. The increase in space rent that we are underwriting, almost all of it will drop to the bottom. The what will not drop is a marginal increase in taxes and the maintenance expense of the building will remain basically the same. The building is the building, the cleaning is the cleaning, the common areas are the common areas. So we believe that almost all of call it 90% or whatever of the increase in face rent will go to will drop the FFO.
By the way, that's an important comment. I say drop the FFO because there will be no extraordinary thing. With no new debt, which we think is an extraordinary thing.
Okay. Thank you. Do I get another or that counted as my second?
What's that?
Do I get another question or that counted as my second?
Yes, sir.
So can you just talk about, I mean with Topshop bankruptcy, just some thoughts on credit risk in the retail portfolio going forward?
Well, the first thing is that somebody asked the question about what who's on our watch list and the answer is everybody is on our watch list. So that's the way we run the business. The second thing is by and large, almost all of the retailers that we do business with
are large and important credit worthy companies.
The issue is credit worthy companies. The issue is not their credit worthiness, although Topshop was obviously an issue. And Forever With 'twenty one by the way is a little shaky. But the issue really is that what happens when the leases expire. So the answer is that we have a few weak tenants of course as everybody does, but by and large the credit of the portfolio is pretty cool.
Okay. All right. Thank you.
Thank you. The next question in the queue comes from John Kim with BMO. Please proceed.
Thank you. On the incremental cash yield of 8.3% at Penn, can you clarify what how you calculate that number? Is it new rent over incremental cost or is it the incremental rent over the incremental cost?
It's basically the Farley is a new build, right? So that's NOI over the budget. And then for the balance, it's the incremental NOI over the cost to be spent.
Okay. So the numerator would be the $30 difference in rents between $60.90 that NOI over That's
right. That's right. Essentially as Steve said, right? It's the incremental rents, multiplied by the square footage. Obviously, we're adding some square footage at PENN2 with the addition of the bustle and then converting some of the top two floors from mechanical to office.
But accepting that, it's the incremental rent with a slight leakage for taxes and OpEx.
Okay, great. Thank you. And can you also describe what is in the $100,000,000 of district wide improvements? Are those investments in your assets or is that infrastructure costs basically?
Principally common area in between the buildings, the putting plazas and plinths in the common areas and not inside the building. So it's principally exterior work. It includes safety ballads, it includes some other miscellaneous improvements connecting the business.
Has that increased more than you expected or was that within budget?
This is the first time that we have published anything about this. And it was we thought it was appropriate to list it in the budgeting that we released, but we can't allocate it and we didn't allocate it to any specific building. We didn't allocate a return on it either. So we just put it in together as part of the neighborhood.
Of course, John, it's Joe. We gave you the yield on the total cost inclusive of that.
Very helpful. Thank you.
Yes, sir.
Thank you. The next question in the queue comes from Vikram Malhotra with Morgan Stanley. Your line is open. Please proceed.
Thanks for taking the question. So just around Street Retail, you had cash NOI of about 66,000,000 dollars this quarter. And if I just for the full quarterly impact of the JV, it's probably closer to $60,000,000 maybe low $60,000,000 Given sort of all the move outs you mentioned and the potential moving pieces including Forever 2021, How should we think about a run rate heading into 2020? I know you've given some you had given disclosure earlier. But now post the JV in the numbers, how should we think about the run rate even if there's a range you can provide that will be helpful going into 2020?
Vikram, give me the question again please.
Your street retail cash NOI was $66,000,000 this quarter. But if I adjust for the full quarter because the JV occurred in April, mid April. So if I adjust for that, I think your cash NOI should be closer to the low 60% range. But if we look forward, you talked about Topshop, Forever 21 potentially just looking at
I got it. Thank you. So let me give you some numbers which may which I think is a direct a very direct answer to your question. Last year, we gave guidance on the retail income. We started out with a $304,000,000 number.
We then raised it to $309,000,000 as a result of some space at 770 3 So we then got up to $309,000,000 Mid year, we is it the other way around?
Yes, it's the other way around. Gosh. 309 went to 3 0.
So we started out with 309, we reduced it to 304 because we took space out of the retail segment into the office segment. We then raised it to $315,000,000 on performance during the year and we ended up the year at $324,000,000 on performance. So that's the starting point, okay? The retail JV, which we believe was a monumental deal, a superb execution and very important, okay, will reduce the running rate NOI of the retail segment by $84,000,000 okay? And that basically is simplistically taking the income that was included in that venture and saying we lose 45% of it.
Now that's not an economically good number because that is offset by the proceeds, the cash that we got and the huge preferred dividend that we're getting, etcetera. But that is just if you just look at the retail segment, that's a number. The Topshop, so that's an $84,000,000 deduct. The Topshop, the 2 stores in Topshop that lift will
nip the income stream
by an annual running rate of $17,000,000 So if you take those $324,000,000 which was the actual less $84,000,000 which is the loss of the 45% of the JV retail less $17,000,000 for the 2 top shops, you get to a $223,000,000 number, okay? I'm not comfortable with that number, but I am comfortable with something in the low 200s. So that's where we think that that will go. Now understand, this is only the retail segment. It doesn't account for several ins and outs on the financial side of our balance sheet, etcetera, so that the economic number is actually much higher.
But anyway, that's the way that's where we see it. Okay. Hang on, Vikram, Joe is going to approve my answer.
2 things. When you look at Steve's Chairman's letter as it was amended, he talked about $109,000,000 His $84,000,000 is the retail piece of that.
Yes, the retail. Got it. And then the $223,000,000 that may be adjusted. I mean, I'm assuming there's no assumption there for potential lease up of the Massimo space or any other of the like the Madison Avenue assets. This $223,000,000 just as the math that you gave, there's no other assumption behind those 2?
Vikram, when I went to $223,000,000 I said I'm not comfortable with that number yet, but I'm comfortable in the low $200,000,000 s.
That was
in my mind for move ins, move outs and other things that may happen, which will affect it, but not in a significant amount.
Got it. Okay. And then just a bigger picture question. Okay. Okay.
Yes, sir. Just a bigger picture question. You sort of mentioned or I think maybe Michael mentioned you were disappointed with sort of the ho sort of reaction to the retail JV, which was indeed very good execution. I'm just sort of thinking bigger picture, either similar are you thinking about similar structures on the office side or tactically, strategically anything else just to kind of start to close this NAV gap? I know you have a lot operationally going on, but just more strategically, anything else you can sort of offer in terms of thoughts around closing the NAV gap?
Obviously, we were extremely with the reaction to the retail deal, which we thought was a spectacular deal and a spectacular execution in a challenging market. And obviously, we continue to work away at all many different alternatives to create value. Nothing that we are prepared to discuss today or hint at or get into.
Okay. And no changes on the buyback from your perspective on a buyback?
Since you mentioned it, let's spend a second on buyback. So I wrote extensively about it in my shareholders letter 18 months ago. And there's a paragraph in there on Page 23 of that letter that if you have a mind go back and reread it. But basically what it says is that buybacks are very useful if you have if they are funded out of a recurring stream of earnings so that you can continuously do it. And there's lots of Fortune 500 companies that are in continuous buyback mode, but they are doing it out of retained earnings, recurring to retained earnings.
We don't have that. So we have to do it out of basically off our balance sheet by selling assets or whatever. So and I think I said in my letter that if we did $1,000,000,000 buyback, it would increase our NAV by maybe for the remaining shareholders by maybe $1.5 or some such number. And then our management and our board would rather have the $1,000,000,000 than the $1.5 NAV increase when we're already selling at some huge number below NAV. But now there's a better way to look at it, okay?
So what I've said, if we used if we took cash off our balance sheet or we sold an asset or whatever it is and we bought back our shares, my math is that for every $1,000,000,000 that we would do it, we would increase NAV to the remaining shareholders by 1.5 dollars But we're not doing that. We may do it, but we're not doing that. What we are doing is we're going to spend $1,000,000,000 at an 8.3% return on our own assets and that doesn't take the knock on effect of the value we will create on the buildings that surround the buildings that we are redeveloping at Penn Plaza. Now if you take that math, if you can invest $1,000,000,000 at 8%, that generates $80,000,000 of income at a 4.5% cap rate, that's a $1,700,000,000 of value creation. That $1,700,000,000 divided by 200 odd 1000000 shares is rounded $9 a share.
So would you rather invest $1,000,000,000 in buying back your stock where by the way the $1,000,000,000 goes away, you lose the liquidity $500,000 or would you rather invest it in the buildings where you will be creating $9 a share for the remaining shareholders of NAV? Of NAV, I don't think that's a difficult question. Now what's more, when we get done with this, we will have Farley with no debt whatsoever. We will have 1 pen with no debt whatsoever and 2 pens with debt of about $500,000,000 which is debt that is on there now and we're not going to increase. So with those three buildings alone, there are multiple 1,000,000,000 of dollars of additional liquidity available to the company for whatever corporate purpose we have.
So we think that our we're on the right track here. We're not inflexible.
Fair enough.
That's fair.
Hang on. I'm not done yet. Okay. Sorry. We're not inflexible and we think we try to learn.
1 of our pals is doing a buyback, okay, very committed to it, okay? It hasn't worked yet, but if it if as and when it does work, we will learn from that, okay? But as of right now, we would rather invest a couple of $1,000,000,000 on our own assets and create $150 odd,000,000 of new earnings rather than buying back our stock. That's where we are.
Great. Thank you very much.
Thank you. The next question in the queue comes from John Guinee with Stifel. Please proceed.
Well, thank you for all the information on Penn Station Penn District Campus. I'm convinced it's going to be a spectacular product. Steve, why would anybody want to be in Hudson Yards or Manhattan West if they can be at Penn Station?
Welcome to the team, John.
Hey, John, that's not John, John, John, John, that's not a serious question. But the answer to that is, first of all, look, my pal, Stevie Ross, did a great job, and Jeff and the boys, they did a great job at Hudson Yards. I mean, all of our friends that are developing in our neighborhood, we're all friends. It all plays off each other. It all makes the entire district of the West Side of Manhattan better, okay?
So I'm not sure that we would be able to no, I am sure. I am sure that we would not be able to create the value that we are going to create in our Penn Plaza assets has not Hudson Yards preceded us. So that's step 1. By the way, John, since I got you wrote something on June 12, and normally I'm not nuts about what you're right, okay? But this one I'm going to read out now because I love you, okay?
We said on June 12, expect Phase 1 of Penn Plaza to be extremely well done, sparing no expense to create a transformative environment and landmark on the Westside. We expect the finished product to be completely different than the current landscape. The cost and return on costs are as of now unknown, but now you know them, by the way. So anyway, thank you for that. We appreciate your support.
Thank you. Can I ask one more question?
No. I want to stop while I'm ahead. Go ahead.
Okay. So Farley, dollars 12.20 a square foot. If you take out the land and the payment to related about $900 a foot. Manhattan, what I understand, ex the land, new builds about $1200 to $1300 a foot. But your budget for PENN2 is only $416 a foot.
And it seems to me kind of difficult to demo down to the frame, beef up the steel, all new skin, couple of 100,000 square feet of new space, elevators, MEP, TIs, lease and commission soft costs for $416,000,000 a foot seems like a really low number. Is that fair?
No, it's not a low number. It's an accurate number. So let me give you Barry Wishup. So here's our budget, okay? So the $750,000,000 now remember that doesn't include carry because we're basically funding it with cash, okay?
So our budget in round numbers is that we're going to be creating 90,000 square feet, call it 100,000 square feet of new space in the bustle and at the top of the building where we're converting mechanical space into highly leasable and triple digit rent space. And that in round, round numbers is a couple of $100,000,000 okay? We are going to skim the building. We're not taking it down to the frame. We're going to take portions of frame off and reimage it.
We're going to skim the building and put a new beautiful glass front on it. And that in round numbers is $200,000,000 in our budget. That budget also includes the heating and convectors at the grass at the perimeter of the building, okay. So there's $200,000,000 to create new space, which is income producing and return space and there's a good return on that. $200,000,000 to do the basic curtain wall project.
And then the balance of the $350,000,000 is for lobbies, elevators, new bathrooms, new corridors, etcetera, and the new amenity space. So we you've been yelling at me
for quarter
after quarter after quarter for not having made our cost projections and our budgets public. And the reason for that is, is that it's a big project we've been working on and we're trying to get them accurate. And this is our best guess as to what the numbers are, okay? By the way, a significant portion of this job is already in construction drawings and already bought, okay? And when you drive by it, you'll see that the first mock up of what this enormous bustle, which projects 45 feet off the plaza and 75 feet off the ground, which includes the better part of a couple of 100,000 square feet of new space is already mocked up.
So we can get a feel for it. So this is our budget. We're happy with our budget. Great.
All right. Thank you. And good luck. Great job.
Thanks, John. One last thing. To be totally clear, the budget includes TIs and leasing commissions for the new bustle created space, okay? It does not include TI and leasing commissions in the normal course for re renting all of the other space in the building, which we think is an appropriate way to do the cost accounting.
Great. Okay. Thank you.
Thanks. I love what you wrote on June 12, John. Thanks.
And the next question comes from Nick Yulico with Scotiabank. Please proceed with your question.
Thanks. Just wanted to go back to Farley. We have heard that there's good interest in the building's high floors. And even if we look at your website right now, the 5th floor is not showing as being available. And earlier this month, the 4th floor wasn't shown as being available, although it is now.
I mean, is it fair to say that these two floors are spoken
for? We have nothing more to say about Farley other than what we've already said, okay. We have activity. It does us no good to speculate on what these important negotiations are that are ongoing now. It does us no good to speculate on that in this venue.
Okay. And then going back to 110, I think you gave the annual rent on the ground lease being $2,500,000 Can you give us a formula about how that works? Is it a percentage of the value of the land on a fair market value reset? I mean, for some other companies we've seen it or buildings that could be 4% to 5% of land value. What's the formula calculation here?
I think we've disclosed what we're prepared to disclose at the present time. The current rent is $2,500,000 It's a normal fair market value reset. It happens in 2023.
Yes. I guess, I mean, the reason I ask is, if you do assume it's 4.5% of land value, then it looks like the land value is about less than $50 a foot, which seems pretty low and would require you could be facing a as you even mentioned in your supplemental, a material reset on the ground lease. So I think it would be pretty helpful for us to understand how that could work, so we can think about the ultimate yield on the project.
Well, the answer is it will be material and but we're not prepared to speculate. This is a reset which is subject to arbitration 4 years from now. It's impossible to predict what the land values will be 4 years from now. I have already said in my comments 10, 15 minutes ago, we strongly believe that the land value is coming in and coming our way. And I really don't want to say anything more about it.
Thanks.
I will say one last thing. In the last comments I made about that, I said that the income of this building is going to go up to the sunny side of 100 and $50,000,000 a year. Whatever the land resets to will be it will be a material number, but it will not be significant in the scheme of the huge income coming in from this great building.
Okay. The next question in the queue comes from Alexander Goldfarb with Sandler O'Neill. Your line is open. Please proceed.
Good morning over there. So two questions. First, Steve, sort of a 2 part on Penn. You talked about the $100,000,000 of, I'll just say, yes, sort of catchall development. So sort of curious, 1, I don't know who the landowner is.
I don't know if it's the MTA. But I'm assuming that, that $100,000,000 captures whatever public mandated improvements, whether it's subway or train or whatever. I'm assuming that, that $100,000,000 includes that in that budget. And then 2, I still maybe I missed it earlier, but I don't think that you guys have quantified the NOI that's going to come offline when you start work on PENN1 and PENN2, just as we think about our 2020 earnings?
The first is that the $100,000,000 of neighborhood improvements really is improvements. It does include improving the street bed that we have closed in between the two buildings. But the rest of it basically is capital that we're spending on behalf of our building, okay? There's another project that's in the works, which will enhance our situation the underground in Penn Station, which is not yet ready for disclosure and that will probably come out next quarter or the quarter after. It's not a big deal, but it's incrementally better and better and better.
With respect to what comes offline, comes online, etcetera, and the timing of it quarter by quarter, we do not give guidance. And we have not basically said other than some brief remarks that Joe made about what is going to happen in terms of the details of that. I did make what I consider to be an important comment half an hour ago that says, I know that you have to model and I know it's important. But the big picture here is that over a short period of development time, we're going to transform a neighborhood. We are going to add all the surrounding land that we have and assets that we own and we are going to take a $60 building and take it into the 90s.
That's the big picture, okay. We have not given guidance about quarter by quarter results, okay, quarter by quarter, in service, out of service, etcetera.
Okay. And then the second question is on the Topshop on Fifth Avenue, you guys wrote off the value of your improvements for that ground lease position, just based on sort of the market value being equivalent to what the ground rent is, which I believe you guys said is 5,500,000 dollars So just sort of curious, just given that that rent seems really low, especially given what your neighbors signed with Puma across the street, Just sort of curious more about how you made the determination that the ground rent effectively represents market value. I don't know, maybe it's counting all the fit out that you'd have to do or maybe it's the length of time left on that ground lease that drives it just more than the actual what the actual street retail rents would be there?
Alex, it's all of the above. First of all, we have not said that we are abandoning the ground lease. That may cut it. It's an option that we have in the future. That's that one.
The accounting is that there is a liability and an asset for this right to use. Is that the terminology? Right of use. Right of use. And so we wrote off the asset right of use.
We retained the liability if as and when we cancel the non recourse lease, that will be that liability will be taken into income and extinguished. So that's the accounting. In terms of the business side of it, the way we do the math, if you take the ground rent payments and the expenses of operating the building and you take the expected income that comes from the small office portion and what we might get from the market visavis retail, the building is pushed to slightly underwater. If you then take the fact that there's a 14 year ground lease and you would have to amortize the tenant improvements, it becomes water more. And if you take the fact that the ground lease goes up by its terms, I know the $2,000,000 or $3,000,000 a year shortly, then the bill is on the whole, when you get done with the math, there's either negative economics or no economics.
And the likelihood is, this is not something that we want to spend our energy and time on.
Okay. No, you with the 14 years left, you answered the question. Thank you, Steve.
Thanks, Alex. See you.
The next question in the queue comes from Daniel Ismail with Green Street Advisors. Your line is open. Please proceed.
Thanks and good morning. Just two quick ones on Penn Plaza. I appreciate all the new disclosure, but can you give an update and a refresher on the air rights that you own in Penn Plaza and the usability and perhaps the ability to monetize those air rights in the future?
There's plenty of air rights. We own lots of them. There's air rights that are on top of Madison Square Garden that we own a share of. There's air rights on top of the landmark Farley building that we have are we contracted to move those that we have access to, we don't have legal access, we have access to. So there's plenty of air rights, okay?
And then now where do you put them? And so we have multiple sites that are in the future. The most interesting one of which is obviously the Hotel Pennsylvania, which has a current EULA approval for a 2 point 8,000,000 square foot. 2.8 rentable. 2.8 rentable.
Okay. For 2,800,000 square feet, which would be a tear down and a rebuild, etcetera. And then we have multiple other sites in the neighborhood. So there is not a shortage of air rights. We own plenty of them and there are plenty of them available to be purchased and moved from different government sources and private owners.
And can you remind us about how many air rights you directly own currently?
I don't think so. I don't have that in my head. So we would have to get that to you. But I don't think it's a material calculation.
Okay. And just one on the redevelopment of Penn Plaza. With the new Green New York building standards, did that cause any material uplift in total costs? And will the new redevelopments be in compliance with the new standards?
Barry? Not a material increase
in cost today. And yes, the new developments will be in compliance with those standards.
Well, the answer is there is not a compliance. There is a goal of the emission standard. And if you do not meet the goal, there are penalties. So actually, if there's not a binary comply or don't comply, What there is, is that the assets will be measured for their ambition. And based upon that result, there will be a penalty tax, if you will.
The interesting thing about it, and we said this, I think, on the last call, and that is that we believe that we are already in substantial compliance with the 2024 requirements. The ones that come at the end of the decade are more strenuous. We but if we maintain our current position, the tax would be de minimis for non compliance, okay? Now there's 2 things that are going on with respect to the regulation. By the way, this is in New York, but it's going to go universal across the whole country and probably the world as The first is that 80% or 85% of the energy usage on our buildings is under the control of our tenants, not under the control of the landlord.
So therefore, and we've been talking to the government authorities about this, the law needs to be modified so that it gives incentives to the tenants to comply. And that will happen over time. The second is even more important. To the extent that alternative sources of energy are going to go into the creation of electricity and transmission of it from where it's created down into New York City and other major cities, that will cause the carbon footprint to decrease substantially, okay? So there's all of that kind of stuff that's going on.
That's helpful. Thanks.
The next question in the queue comes from Manny Korchman with Citi. Your line is open. Please proceed.
I'm in with Manny. Michael or Joe, just to think about sources and uses from a just timing perspective, you think about you got $1,000,000,000 today, another $1,000,000,000 coming in from 2 20, the $100,000,000 that closed post quarter from 3 30 Madison and then the eventual $1,800,000,000 redemption of the preferred a couple of years out. You've outlined the $1,700,000,000 dollars which is quite helpful to have the costs and the returns, that incremental $1,700,000,000 that needs to go out the door plus another $360,000,000 dollars for the dividend towards the end of the year. How should we think about the timing of that $2,000,000,000 going out and then the drawdown of cash and the influx of cash, just as we think about the ins and outs going on?
Michael, it's Joe. That's a pretty complicated question to do by phone. But I at least want to clarify one thing. You said $1,000,000,000 on coming in from $220,000,000 That's $2,000,000,000 not $1,000,000,000 $2,000,000,000
Well, of net of the debt that you're going to repay, dollars 1,000,000,000 of net cash.
No, there's no that whole $950,000,000 is 0 today. And from that point forward, we get $2,000,000,000 a $1,000,000,000 of profit, $1,000,000,000 of our cost that we put into the project recouped through the sales process. The right number for you to think of is 2,000,000,000 dollars Now our NAV shows it properly, but the incremental cash coming to the company is $2,000,000,000 against the $1,700,000,000 that you accurately portray needs in the 3 projects in the Penn District area we outlined. Of course, the capital needs if we were to do the Hotel Penn would be much, much larger or any of the other add ons that we haven't talked about that the question on the air rights is helpful.
I don't know if you were I mean, we can come back to you with a little more specificity on timing of the outflows. Obviously, Farley is well underway. PENN2 will be generally from let's call it 2020 through 2 and PENN1 over a couple of year period beginning next year. But I think the most what I think you're trying to get, I think the most important point is the cash will be in the door before that money has to be spent, right? So $220,000,000 I think we sit on today, Joe, correct me if I'm wrong, dollars 1,000,000,000 of liquidity as of quarter end, right?
That number will go well north of $2,000,000,000 by year end, Michael. And so when you look at the post the special dividend, that's exactly right. So net of the special dividend, that will still be well north of $2,000,000,000 right? So that gives you a sense of the amount of money that's going to flow out of $220,000,000 the balance of this year. And so as we look at the ins and outs, right, all the money will be in the door in advance of needing to spend the $1,700,000,000 that's laid out in the supplement, right?
And that's without needing to touch on retail preferred ever, etcetera, the money will be in the door.
Right,
which gives you even more liquidity as you start thinking about the $1,800,000,000 preferred, but then also the refinancings that occur in 2020. And I don't know if you want to talk about 11.10 and 8.8 87, whether as you think about upsizing those mortgages or you're thinking about using cash to repay and just reduce leverage further, How should we start thinking about the incremental cash that potentially could come from that or use of cash?
Michael,
the answer is, first of all, with respect to 220, the sell out, published sell out is 3 maybe $3,250,000,000 okay? We've sold $1,000,000,000 so far. That means there's $2 odd 1,000,000,000 coming out of that with no debt requirements that all comes into our treasury, okay. That's step 1. Step 2 is our internal budgets show that our kit that we are able to spend as it comes to over the next number of years, the $1,700,000,000 incremental that's going into PENN1, PENN2 and Farley.
And at the same time, our cash balances will funded out of off our balance sheet with no new debt and our cash balances will grow, okay? With respect to our balance sheet, we have been showing pro formas to you all that shows that our debt ratios are actually, if you pro form a for what's happening with certainty, our debt ratios are low and going lower and we're very comfortable with that. We have enormous liquidity on our balance sheet, and we have an enormous queue of unfinanced assets and even under financed assets that we can increase our liquidity for. So for example, I mean the right strategy, we are principally a secured lender, okay. We do that for lots of reasons that I have written about, which has to do with non recourse debt and safety and whatever.
And we have in fact, we're actually engaged in an internal conversation about this now. We have rather than encumber a new asset, which is currently unencumbered and we have $10,000,000,000 or $15,000,000,000 of those, we would rather increase the debt on an under levered asset, which is encumbered. So all of that is what to consider. But right now, we have we're in a spectacular financial condition and we're very happy with where we stand. And we are delighted to be able to deliver PENN1, PENN2 and Farley off our balance sheet with no debt.
Yes. Last question, Michael, in your prepared remarks, I think you made the comment, it's better to be a seller than a buyer. Is there anything else that's left in the disposition program today, any other cleanup and anything else that you're contemplating from that perspective?
The answer is yes, Michael. We've got there's still a few cleanup items from the original $1,000,000,000 Steve referenced, I don't know, 18 months ago or whatnot. Small one of which we just put under contract, but $70,000,000 We've got 2, 3 others in the works as well. So we're finishing that original $1,000,000,000 of non core assets. Team is hard to work on those.
It's interesting. First of all, the community has been suggesting that we sell our non New York City assets out there in what I call the suburbs of New York, mainly the Martin Chicago at 555 South California Street in San Francisco for years now. The fact of the matter is that those 2 are 2 of our best assets with the highest growth trajectory. And when we have sold 555 California 3, 4 years ago when there was a big drumbeat to do it, we would have undervalued the asset by $500,000,000 $700,000,000 at least. I think Michael said in his remarks that, that asset is under rented by, pick a number, 25%.
And so whatever. So those two assets are not on the for sale list today. The other thing is that, I think one of the analysts wrote when you sell assets, you dilute your earnings. And so if you take our retail sale, we sold it at NAV, we sold it at a number which we thought and the market I think thought was a very strong execution. But nonetheless, you are selling the income to the buyer and you are losing that income, so it's dilutive income.
So there is a tension between selling assets when you decrease your income and your analysts want to take your stock down for that. So it's a complicated thing.
I appreciate the color. And one
last little tag on to that, Michael, and that is that it's good to have cash, but cash doesn't appreciate, okay? Assets appreciate. So if you have well chosen assets that have a great future, they can appreciate. So I mean that's just sort of a little bit about that. But you can be sure we look at every asset and every asset and every piece of debt in the company at least once a month.
Yes. And it was helpful to get your thoughts regarding using cash on a buyback versus investing it in new as well as redeveloped assets and harvesting that value. It definitely sounds as though there's additional cash coming in and we'll continue to look for ways that the balance sheet and that cash can be used to drive value for existing and new shareholders?
Yes. And we look, the investing the money and creating $9 of value versus $1.5 per $1,000,000,000 is a no brainer, right? The point that you're making is that that's not our only cash. We've got more assets. We've got more financial flexibility.
We couldn't be more well aware of that. Thank you for pointing it out.
All right, guys. Have a great rest of the summer.
Thanks. You too.
And gentlemen, there are no further questions at this time.
Great. Thank you everybody for listening, participating on our call today. We look forward to your participation in our Q3 earnings call, which will be on Tuesday, October 29. Enjoy the rest of the summer as well. Thank you.
Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation. You may now disconnect.