Description
Alexander’s (ALX) is a real estate investment trust focused on retail and commercial properties within the greater New York City metropolitan area. All of the company’s revenues come from retailers and financial service companies, and their properties are located within one of the most competitive real estate markets in the country. Rising capitalization rates, lower real estate prices, and Alexander’s dependence on retailers and financial services firms make this a compelling short idea.
Alexander’s traces its roots back to 1928, when it began as a discount clothing retailer. Alexander’s Inc., a publicly traded company, was established in 1968. The company evolved throughout the decades and later filed for bankruptcy in 1992 after several failed expansion and acquisitions. Vornado Realty Trust took over control of Alexander’s in 1995 and converted the company into a REIT structure in 1996. Steven Roth, Vornado’s CEO, had been an investor in the company since 1980.
Alexander’s currently owns and operates seven properties, five of which are fully developed, one which is under construction, and one which may be developed in the future. The portfolio is not well diversified across geographies or tenant type.
731 Lexington
This property is a 1,307,000 square foot mixed-use building with roughly 885,000 square feet of net rentable office space and 174,000 square feet of net rentable retail space. The office space is 100% rented primarily to two tenants: Bloomberg LP and Citibank N.A. at an average of $77/foot. The retail space is 100% rented primarily to The Home Depot, The Container Store, and Hennes & Mauritz (H&M clothing) at roughly $142/foot. The remainder of the space in the building is occupied by 105 condominium units which Alexander’s has already sold.
The property has mortgages of roughly $376,224,000 on the office space (Feb 2014 maturity) and $320,000,000 on the retail space (July 2015).
This is a high-end building with very expensive rents and a concentrated tenant base that may be able to use their leverage to lower rents in an economic downturn. Bloomberg’s 700,000 square foot lease accounts for roughly 33% of the company’s entire annual revenues.
King’s Plaza
King’s Plaza is a regional shopping center (two-level mall) with two anchor tenants, Macy’s and Sears. ALX owns and leases roughly 750,000 square feet, leased to Sears (289,000 sq feet) and roughly 120 different mall tenants. Alexander’s also leases 5.8 acres of adjacent land to Lowe’s Home Improvement Warehouse (20-year term). Macy’s owns the real estate for their own store.
Within the mall, 12 tenants have month-to-month leases (12.8% of gross annual rental revenues for this property), 11 leases will expire in 2009 (8.3% of revenues), 13 leases will expire in 2010 (7.5% of revenues), and 14 leases will expire in 2011 (10.5% of revenues). This means that, at a minimum, over 20% of gross annual rental revenue could expire or be renegotiated to lower rates during 2009. The 2010 lease expirations are at an average of $88.21/foot, by far the highest rental rates of any lease year. These leases will almost certainly be renegotiated lower toward the average rate of $38.83 for the entire property.
King’s Plaza has a mortgage of $200,565,000 maturing in June 2011.
Rego Park I
Rego Park I is a 351,000 sq foot retail building that is 100% leased to Sears, Circuit City, Bed, Bath & Beyond, and Marshalls. All of these retailers (with the possible exception of Marshalls) have publicly discussed their troubles, and Circuit City recently filed for bankruptcy and announced the closure of 155 stores. Althouhg the Rego park location is not on the initial schedule of stores to be closed, Circuit City is closing many locations in New York and may add mor elocations as it works through the bankruptcy process. Circuit City represents roughly 14% of the building’s leased square footage.
The Rego Park I property is secured by a $78,625,000 mortgage maturing in July 2009.
Paramus
Alexander’s owns 30 acres of land located at routes 4 and 17 in Paramus, NJ, which is leased to IKEA. The lease has a 40-year term expiring in 2041, with a purchase option in 2021 for $75,000,000. ALX has a $68,000,000 interest only mortgage on the property (maturing October 2011), and charges IKEA an annual triple-net rent of $700,000 plus the debt service on the loan.
Flushing
The Flushing property consists of a vacant four-floor building with 177,000 square feet and a parking garage located at Roosevelt Avenue and Main Street in Queens, NY. The company is currently trying to lease the building to retailers, which may prove difficult in this environment.
Rego Park II
Rego Park II consists of 6.6 acres of land adjacent to the Rego Park I property in Queens. The company is currently developing the property to include a 600,000 square foot shopping center on four levels and a parking deck with roughly 1,400 spaces. Construction is expected to be completed in 2009 at an estimated cost of $410,000,000, and the company has expended $263 million as of September 30, 2008. ALX obtained a $350,000,000 construction loan to finance the shopping center development which expires on December 20, 2010, with a one-year extension. As of September 30, 2008, $144 million had been drawn on this loan.
The shopping center is expected to be anchored by a Century 21 department store (134,000 square feet), a Home Depot (138,000 square feet), and Kohl’s (132,000 square feet). Per ALX’s 2008 Q3 10Q, “There can be no assurance that this project will be completed, completed on time, or completed for the budgeted amount.” That may certainly be true.
Rego Park III
Alexander’s also owns 3.4 acres of land adjacent to the Rego II property in Queens which is being used for public paid parking until the company finalizes a plan for its development.
Relationship with Vornado:
Alexander’s is controlled by Vornado, which owns 32.8% of Alexander’s outstanding common stock. Steven Roth is the Chief Executive Officer and the Chairman of the Board for both Alexander’s and Vornado. In addition, Interstate Properties, a NJ general partnership controlled by Roth, owns another 27.2% of Alexander’s common stock.
Alexander’s properties are managed, leased, and developed by Vornado pursuant to an automatically renewable annual agreement. Alexander’s pays Vornado tens of millions of dollars in fees each year from management fees, development fees, leasing agreements, and sales commissions. The company is operated like Vornado’s and Steve Roth’s personal piggybank.
At the current time, Alexander’s has 350,000 outstanding and exercisable Stock Appreciation Rights (“SARs”) amounting to a current expense of roughly $45,000,000. Compensation expense resulting from the SARs is calculated based on the difference between the market price of the stock on the day they are exercised and the stock price at the time of the original grant ($70.38 weighted-average price). The outstanding and exercisable SARs are cash settled and scheduled to expire on March 4, 2009, so it is almost certain that they will be exercised over the next few months.
In September and October 2008, Roth exercised over $60 million worth of SARs. In March 2007, Michael Fascitelli, the company’s president, exercised over $50 million worth of SARs. The company also has an additional 895,000 shares available for future grant under their stock plan.
ALX is clearly being run for the benefit of its affiliates and not the common shareholders.
Outlook for REITs:
The outlook for REITs is quite negative with general risk aversion increasing capitalization rates, forced selling of properties from other developers seeking liquidity, and significant refinancing risks. Alexander’s is likely to be impacted more seriously than the general industry due to their concentrated exposure to the worst areas of real estate – retail and financial services in the greater metropolitan NYC area.
Alexander’s could face significant headwinds from a retail slowdown and possible downsizing at Bloomberg and Citibank. While information on Bloomberg is closely guarded, it seems reasonable to assume that business could see a slowdown from the myriad of investment firms going out of business (and fewer Bloomberg terminals). The problems and layoffs at Citigroup are well-documented.
Beyond the financial services exposure at 731 Lexington, the company has significant exposure to discretionary home improvement spending through Sears, The Home Depot, The Container Store, Lowe’s, IKEA, Circuit City, and Bed, Bath & Beyond.
Store closings and bankruptcies are occurring at a rapid pace, and retailers are reluctant to commit to expensive, longer-term leases. Alexander’s derives revenue from “percentage rent” agreements with retail tenants. These agreements mean that if retailers achieve certain sales level thresholds, they begin to share a percentage of revenue above and beyond this threshold with Alexander’s. Declining sales will decrease this revenue for Alexander’s.
Analysis of a recent ChangeWave consumer spending survey concludes that recent spending “is down for all consumer categories this holiday season compared to the previous holiday season. Once again, it’s traditional retailers – Sears, Bed, Bath & Beyond, Macy’s, JC Penney, and Linens N Things – that are showing the greatest weakness going forward.”
Additional comments from retailers and industry observers show the potentially damaging impact on retail-focused REITs.
“We note that bankrupt retailers could account for as much as 4% - 5% of a company’s regional mall portfolio over the course of a prolonged downturn and highlight the risk of elevated store closings as a result…We could see a moderation in demand for space and more drawn-out lease renegotiations as dominant retailers attempt to scale back average store sizes.” – Goldman Sachs, Holiday Retail Update from the REIT perspective
From the Gap Inc. FQ308 conference call:
Q: “If you could talk briefly about the progress in negotiating with the mall developers on your store reduction plans?”
A: “…The natural laws of supply and demand have started to kick in over the last couple of months where a lot of people who were growing and adding square footage have now reconsidered that as a strategy…There have been some people that have vacated square footage already. They have declared they are going to be vacating square footage and I think there is a very large question mark in January and beyond how many of the retailers may be forced to make a lot of the same decisions in the spring as a lot of retailers did in the fall. I think that puts us actually in a good position for the re-negotiation…. I think that puts us in a good position to make sure our re-negotiating team uses that leverage as best as they can.
That kind of goes hand in glove with this parallel strategy that came up about 3 months ago which is the ability to reduce 10-15% of that square footage…I think people would rather keep us in their mall maybe in reducing 5,000 square feet and maybe us given an option that may not have existed three months ago to go across the street or somewhere else because of the supply and demand change that is currently going on in the marketplace.”
Occupancy rates at Alexander’s properties are already at very high levels, so there is little room for improvement and plenty of room for vacancies to rise. As of December 31, 2007, the leased rate was 100% at 731 Lexington (both retail and office), Rego Park I, and the Paramus ground lease. King’s Plaza was at 94%.
Tighter lending standards and falling underlying property values could also make it difficult for ALX to meet upcoming mortgage refinancing deadlines.
Valuation:
The real driver of REIT valuations are capitalization rates, which have increased fairly dramatically over the past several months. The cap rate is simply the value of a property’s net operating income divided by its purchase price. Higher cap rates indicate higher perceived risk and a higher required return on investment. Even small changes to cap rates can have dramatic effects on property valuations.
Historically, implied cap rates have tracked corporate borrowing rates. Current Baa rates are roughly 9%, and REIT cap rates have generally been 500 – 900 bps above these Baa rates. This would suggest current cap rates of at least 9.5%, and most REITS are priced with implied cap rates of 9.8% per Green Street Advisors.
ALX stock currently trades at $220 per share, and the company has an Enterprise Value of $1.65 billion. This equates to 8.3x price/book, and 13x EV/EBITDA. The stock also trades at over 18x trailing earnings.
To provide a base case estimate of the total value of ALX, we can take 2008 estimated revenues of $210 million and apply a 9.5% cap rate ($2.2 billion). Then, we add back the company’s cash and receivables (approx. $580 million) and deduct the outstanding mortgage debt and various liabilities (including dividends payable, the SARs liability, and amounts owed to Vornado), and you have an enterprise value estimate of $1.3 billion. This implies a stock price of $152, roughly 30% lower than current values.
Things get even more interesting if we assume some negative revenue impact going forward. There is certainly a risk of revenue decline from lower rents and higher vacancy rates. As discussed above, Alexander’s two most important properties (731 Lexington and King’s Plaza) could experience significant leasing trouble due to financial services and retail exposure. It is reasonable to expect lease renegotiations and possible insolvency of Circuit City to negatively impact 2009 and 2010 revenues.
The table below shows the valuation estimates for ALX based on various levels of revenue growth from 2008 levels and different cap rates. In almost all of these cases (with the exception of 5%+ revenue growth and lower cap rates) the company’s estimated valuation is significantly below current values. For the first 9 months of 2008, the company has grown revenues by 33 bps over 2007 levels. A scenario in which 2009 revenues grow by more than 5% and cap rates get materially lower seems highly unlikely.
Implied Valuation Net of Liabilities (Billions)
Cap Rates shown across the top, 2009 Revenue Growth Rates down the side (from 2008 estimated full-year revenue of $210 million)
8.5% 9.0% 9.5% 10.0%
-20% $1.05 $0.94 $0.84 $0.75
-15% $1.17 $1.05 $0.95 $0.85
-10% $1.29 $1.17 $1.06 $0.96
-5% $1.42 $1.29 $1.17 $1.07
0% $1.54 $1.40 $1.28 $1.17
5% $1.66 $1.52 $1.39 $1.28
10% $1.79 $1.64 $1.50 $1.38
Assuming a 5% revenue decline and a 9.5% cap rate (still below the current industry average), we arrive at an enterprise value of $1.17 billion and a stock price of $126. The company has 5.075 million shares outstanding.
A 15% decline in revenues and a 10% cap rate, a more pessimistic scenario, would result in an enterprise value of $850 million and a stock price of $45.
Catalysts:
- Significant exposure to financial services and retailers (and those stores within the discretionary home improvement and consumer electronics which have been hit especially hard) could mean lower leasing rates and higher vacancy levels
- Higher cap rates driven by higher return expectations for moderately risky assets
- Refinancing risk as large mortgages come due over the next several years and commercial lenders have tightened standards and reduced credit availability
- Highly competitive real estate environment and forced selling by struggling developers will increase supply of available property and cause lower values
- Bankruptcy or insolvency of a major tenant
- If Vornado sells their ALX shares to generate cash and support their own balance sheet, this would place significant downward pressure on the stock
Risks to thesis:
- Limited stock availability for shorting
- The possibility for Vornado to backstop any significant problems or acquire the rest of Alexander’s that it doesn’t already own Alexander’s maintains a reasonable amount of cash ($570 million), so there does not appear to be an immediate liquidity issue.
- Cap rates may go lower
- Retail sales at the highest-end locations may perform better than industry averages and leases may not be renegotiated lower
Catalyst
-Significant exposure to financial services and retailers (and those stores within the discretionary home improvement and consumer electronics which have been hit especially hard) could mean lower leasing rates and higher vacancy levels
-Higher cap rates driven by higher return expectations for moderately risky assets
-Refinancing risk as large mortgages come due over the next several years and commercial lenders have tightened standards and reduced credit availability
-Highly competitive real estate environment and forced selling by struggling developers will increase supply of available property and cause lower values
-Bankruptcy or insolvency of a major tenant
-If Vornado sells their ALX shares to generate cash and support their own balance sheet, this would place significant downward pressure on the stock