This year has been a brutal one for New York City real estate. The COVID-19 outbreak ravaged the city earlier this year, causing the government to shut down most retailers while requiring employers to shift their employees to remote work. Those issues led many to flee the city.
This trend is causing some concern about the long-term impact on occupancy and rental rates for properties in the city. These worries have weighed heavily on the market values of real estate investment trusts (REITs) focused on the city, including Vornado Realty Trust (NYSE: VNO) and Empire State Realty Trust (NYSE: ESRT), which are down about 48% and 55%, respectively, this year.
However, the city has endured setbacks before and always found a way to bounce back. Because of that, this year's sell-off in REITs focused on the region might be a great long-term buying opportunity. Here's a look at which one of these two REITs looks the most compelling right now.
The case for and against Vornado Realty Trust
Vornado Realty Trust is a diversified REIT that focuses on New York City, though it owns some assets in Chicago and San Francisco. In its core market, it owns office, retail, and residential properties, a hotel, and an interest in Alexander's (NYSE: ALX), a diversified REIT that owns seven properties in the city. The company also owns theMART in Chicago and 555 California Street in San Francisco, which are iconic office buildings in those cities. These high-quality assets tend to be in high demand, which enables Vornado to benefit from high occupancy and rental rates.
However, the company's focus on New York and its diversification hasn't paid dividends during this year's real estate downturn. Nearly all its retail tenants closed their doors in March and didn't reopen until late June. Because of that, many couldn't afford to pay their rent (it only collected 72% of the retail rent it billed during the second quarter). The company also closed its hotel. Because of those and other issues, FFO tumbled from $0.91 per share in 2019's second quarter to $0.55 per share this year, or down 39.6%. As a result of those weaker results, and "in recognition of the uncertain and rapidly changing environment caused by the COVID-19 pandemic," the REIT cut its dividend by 20% to $0.53 per share.
Meanwhile, there's some long-term concern about whether its retail tenants will survive. On top of that, many residents are leaving the city because of the impact of COVID-19. That caused residential rental rates to drop by 10% in July, and vacancy climbed to its highest point in 14 years. These headwinds could impact Vornado's retail and residential properties in the coming quarters.
On a more positive note, the company has a strong balance sheet and lots of liquidity. Because of that, it has the funding flexibility to weather this storm while continuing to invest in expanding its diversified portfolio. That puts it in a strong position to capture future opportunities as the New York City market bounces back.
The case for and against Empire State Realty Trust
Empire State Realty is an office REIT focused on the New York City region. The company owns nine office properties in Manhattan -- including the iconic Empire State Building -- three in Connecticut, and two more just outside of New York City. These buildings contain 9.4 million square feet of office space and another 700,000 square feet of retail space. The company also generates ticket sales revenue from the Empire State Building's Observatory.
The REIT's more concentrated portfolio has weathered the COVID-19 outbreak a bit better than Vornado's diversified real estate operations. Empire State's properties generated $0.14 per share of FFO during the turbulent second quarter. While down from $0.22 per share (or 36.4%) in the year-ago period, due in part because it had to keep the Observatory closed (which is now open), it was still more than enough to cover its $0.105 per share quarterly dividend.
Empire State Realty also has a strong balance sheet. Its leverage ratio, which stood at 5.2 times net debt to EBITDA at the end of the second quarter, is well below its peer group average of 7.6 times. It also has lots of cash ($873 million at the end of the second quarter), which gave it the flexibility to maintain its dividend during this year's downturn and allowed the office REIT to buy back some of its beaten-down shares.
Sometimes diversification doesn't pay dividends
Both Vornado and Empire State own high-quality real estate portfolios focused on New York City. However, Vornado's diversification exposes it to harder-hit property groups like retail, residential, and hospitality. Because of that, it cut its dividend.
On the other hand, Empire State's focus on top-notch office buildings has helped insulate it a bit more during these turbulent times. Add that to its stronger cash-rich balance sheet, and the fact that it's returning more cash to shareholders and not less, and it looks like a better buy these days.