Vornado Realty Trust Q1 FY2020 Earnings Call

Good morning, and welcome to the Vornado Realty Trust First Quarter 2020 Earnings Call. My name is Sidney, and I will be your operator for today's call. This call is being recorded for replay purposes. I will now turn the call over to Ms. Cathy Creswell, Director of Investor Relations. Please go ahead.

Thank you. Welcome to Vornado Realty Trust's first quarter earnings call. Yesterday afternoon, we issued our first 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 annual report on Form 10-K for the year ended December 31, 2019 and our quarterly report on Form 10-Q for the quarter ended March 31, 2020 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 intend to update any forward-looking statements. On the call today from management for our opening comments are Steven Roth, Chairman and Chief Executive Officer; and Michael Franco, President. And our senior team is on the call and available for questions. I will now turn the call over to Steven Roth.

Thank you, Cathy, and good morning, everyone. Before we begin, I ask for a moment of silence in honor of the lives that have been lost during this COVID-19 pandemic, including Haim's beloved father and my dear friend, Stanley Chera. We now find ourselves in almost total shutdown, a never-before situation. Life as we know it is upside down, people are hurting, businesses are hurting, and the future is uncertain. At Vornado, as our first priority, we are following strict protocols and taking all measures to protect our employees, our tenants and our communities. We pray for the health and safety of all, and we commend and admire the talent and courage of our health care providers. In their honor, the Crown of 731 Lexington Avenue, our Bloomberg Tower, is now flying scrubs blue, as is our block-long Times Square sign and also the light projection on theMART. Our entire organization is working remotely and doing a remarkable job keeping the trains running and on time. They have our thanks. Our office buildings remain open, safe and sanitized with a rightsized operating staff. Building census is currently less than 5%. All but essential retail is closed, giving a lethal blow to some in an already challenged industry. We have taken the following operating steps to reduce expenses and preserve cash. We have placed 1,800 employees on temporary furlough, including 1,300 employees of BMS, our wholly owned subsidiary, which provides cleaning, security and engineering services to our properties; 400 employees at the Hotel Pennsylvania and 100 of our corporate staff. We have deferred certain capital projects to the tune of $125 million. We have closed the Hotel Pennsylvania temporarily. Effective April 1, 2020, for the remainder of the year, our executive officers waive portions of their annual base salary, beginning with my 50% reduction and scaling down from there, and each member of our Board of Trustees will forgo their annual cash retainers. Now let's talk a little about the math of this COVID-19 situation as it affects our business. I see it in three parts. First, we expect a $9 million average monthly income reduction from: one, the Hotel Pennsylvania being closed; two, theMART's canceled trade shows; three, reduced revenue from BMS cleaning services; four, reduced income from our garages; and five, reduced third-party spot signage rentals. All of these businesses are variable depending upon economic activity as opposed to fixed price leases. They represent only 6% of our overall revenue, and all of these businesses will rebound to prior levels when life returns to normal. Second, our rental revenue stream is supported by over 1,000 office leases with an average lease term of 8 years and over 300 retail leases with an average lease term of 6.5 years. This year, total annual rent due from all tenants is over $1.7 billion or $142 million per month. As is normal, we have collected virtually all rent due from January through March. For April, we collected 90% of office rents and 53% of retail rents, or a combined 83%. Interestingly, of the unpaid office rents and coincidentally of the unpaid retail rents, almost two-thirds is due from creditworthy tenants. So in April, we have uncollected rents of almost $24 million, and that's calculated at 17% times $142 million, which will become a receivable on our balance sheet, in effect, a loan to our tenants. We have $302 million of tenant security deposits protecting bad debts, of which $51 million is from tenants who have not yet paid April's rent. As you would imagine, we are in discussion with almost every one of our tenants. We are confident that we will ultimately collect most of this receivable. By way of further information for the first four days of May, we have collected 53% of office and retail rents, which is very slightly ahead of the first four days of April. Here's the punchline of my first two points as they affect valuation. If April's run rate were to continue for, say, an entire 12-month year, and we surely hope it will be shorter than that, the cost or earnings loss from the variable businesses I mentioned plus from our educated guesses to what bad debts might be is a one-time cost of around $1 per share, and that would be for a total 12 months. This does not give any credit for security deposits. And my third point is the larger issue affecting valuation. What will our world be like when COVID-19 passes? We each estimate or guesstimate what will be tenant demand, rents and building values. How many tenants will not survive and how many retail tenants will seek bankruptcy. The stock market has voted by taking the price of our stock down $25 or $5 billion. I think this is a gross exaggeration. Our current liquidity is $3.4 billion, including $1.7 billion of cash and restricted cash and almost $1.7 billion undrawn under our $2.75 billion revolving credit facilities. In addition, we are scheduled to receive $750 million from 220 Central Park South closings from May through the balance of this year. So you might say our liquidity is really over $4 billion. Interestingly, since the heat of the crisis in mid-March and through April, we closed as scheduled five units for net proceeds of $210 million. We remain committed to our redevelopment and capital plans for the Penn District, Farley, PENN1 and PENN2. These projects are the center point of our Penn District vision, the new epicenter of New York, where we will be delivering for tenants cutting-edge, next-generation amenities and services unmatched anywhere. Each project is progressing, albeit at a somewhat slower pace due to government-mandated construction restrictions. As we have said before, these three large Penn District projects are debt-free and are being funded off our balance sheet and from the aforementioned proceeds from 220 Central Park South closings. No debt, no joint ventures, and Vornado shareholders keep 100% of the upside. We have built Vornado to weather the storm and importantly to flourish as it passes. We have a cycle-tested management team. We are always laser-focused on our balance sheet and liquidity and in recent years have been aggressively selling and spending assets, aggregating over $19 billion, pushing away from top tech acquisitions and pushing away from stock buybacks. As cycles go, all of a sudden, it is now surely a better time to buy than to sell. The next few years should be great advantages for investors. So you might say I am ringing the bell. Here is a thought for you. We invest not for quarterly returns, but for two, three and even five years, and we hope you do too. Buying right and the passage of time and patience, we get outsized rewards. I'll now turn it over to Michael Franco for our first quarter financial results.

Thank you, Steve, and good morning, everyone. I hope you're all safe and healthy. As we expected, our first quarter FFO, as adjusted, was $0.72 per share compared to $0.79 for last year's first quarter. First quarter cash basis same-store NOI performance was as follows: New York office was up 2.1%, street retail was down 1.9%. theMART was down 11.8% resulting from the cancellation and postponement of trade shows due to the pandemic, but positive 2% excluding trade shows, and 555 California Street was up 3.7%. New York office occupancy stood at 96.9% at quarter end. In the quarter, we leased 311,000 square feet of office space at a very healthy initial rent of $90.47 per square foot. The GAAP and cash mark-to-markets on second-generation space were negative 3.3% and positive 0.8%, respectively, negatively affected by a short-term renewal and expansion with Citadel at 350 Park Avenue as we line up that building for a potential ground-up development to start in three years. Without this one lease, the GAAP and cash mark-to-markets would have been positive 5.2% and 10.7%, respectively. New York Retail occupancy stood at 94.9% at quarter end. In the quarter, we leased 15,000 square feet of retail space and an initial rent of $416.36 per square foot. The GAAP and cash mark-to-markets were positive 126.6% and 104.6%, respectively, driven by our lease with Sephora Union Square. At theMART, occupancy was 91.9% at quarter end. In the quarter, we leased 231,000 square feet at an initial rent of $47.31 per square foot, including an important long-term renewal with PayPal for 148,000 square feet. The GAAP and cash mark-to-markets were positive 2.6% and negative 1.2%, respectively. At 555 California Street, we are full at 99.8% occupancy at quarter end. In the quarter, we leased a small 6,000 square foot unit at an initial rent of $117 per square foot with GAAP and cash mark-to-markets of 44.5% and 29.7%, respectively. As to our New York office pipeline, leases that were already in progress pre COVID-19 are moving forward. They amount to 1.7 million square feet. Our first quarter noncomparable items consisted primarily of a $59.9 million after-tax net gain on unit closings at 220 Central Park South, partially offset by $56.2 million at share of write-downs from our real estate fund and $7.3 million of credit losses on loans receivable resulting from the adoption of the new CECL GAAP accounting standard. We have three loans receivable totaling $52 million, consisting of two partnership loans and a purchase money mezz loan provided to facilitate a sale in 2014. We have no loan book. Now back to Steve to wrap up our opening remarks.

Thanks, Michael. New leasing activity in New York and just about everywhere has slowed to a trickle. Next year or so will be very challenging, a lost year, a tragic period for this industry. But we must look to the other side. COVID-19 will have an end date. When we get there, I am actually quite optimistic. Farley will be generating income and PENN1 and PENN2 will be coming to life. These will generate large accretive earnings for us. Further, our New York office expiries for the next three years will trend well for both stability and growth. Amounting to only 1.9 million square feet for the three years or 12% of our portfolio, an average of only 4% per year at a weighted average expiring rent of only $74. Now a word about our common dividend. We pay out at least 100% of our taxable income. A few days ago, our Board declared a regular quarterly dividend of $0.60 per share payable on May 22. So far this year, we have paid two quarterly dividends amounting to $252 million. We do expect our dividend to be sustained this year. Without telegraphing any intention, we will, as we must, reevaluate our third and fourth quarter dividend based upon financial and economic conditions at that time and our then estimate of taxable income. Here are some final thoughts for you, actually a plug for New York. We continue to believe in New York, and all it has to offer. Its large and highly educated workforce, eight professional sports teams, concerts, Lincoln Center, Carnegie Hall, Broadway, great museums, great restaurants and nightlife, the best hospitals and universities, and of course, the largest concentration of Fortune 500 headquarters, the world's banking center, the world's media center and now a growing tech center. You get the message. New York's human infrastructure is unparalleled, and New York is the business capital of the world, and New York has always come back bigger and better from every crisis. While we are now working from home, we do not believe working from home will become a trend that will impair office demand and property values. The socialization and collaboration of the traditional office is the winning ticket. Also I believe the densification trend has bottomed, the victim of lots of things and now including social distancing. In sum, we are respectful of the severity of the current situation and cautious for the next couple of years. We are actually optimistic after that and excited about Vornado's business prospects. Lastly, we look forward to welcoming our tenants as they return to our buildings. Our operations teams are hard at work preparing protocols to ensure the health and safety of our tenants, their visitors as well as our staff. Gaston Silva and Lisa Vogel are our team leaders here. With that, operator, we're happy to take questions.

Our first question comes from Jamie Feldman with Bank of America.

Steve, I want to go back to your comment that you're ringing the bell, finally it might be a good time to start buying. Can you talk through your thoughts on what you might expect to see, what the landscape looks like in terms of troubled balance sheets and competitors? And also how you think about capital availability to fund big acquisitions?

I didn't understand what you meant about competitors and competitiveness. What do you mean by that?

Well, where you just might see some distress in types of opportunities.

Look, obviously there has been a sea change. Actually, it's a global sea change in the economies of the world, and we do expect, and we can already see, that there is a fair amount of disruption and distress out there. I'd say before we push away from uptick prices, this cycle may very well give us the opportunity to buy at fair prices and maybe even good prices, okay? So our antenna is very alert. We are actually very enthusiastic about the prospects of growing and expanding externally, and it's very high on our radar screen. We feel that we have the financial capacity to partake. I can't predict where it's going to go or what we're going to invest in, but I can say that we are anxious about the potential opportunities going forward. By the way, this is a totally different environment than we have perceived as a management team for the last three to four years.

Okay. And then just when you think about your liquidity and balance sheet, I mean, how do you think about how much you'd want to keep for the long-term funding, the Penn Plaza redevelopment? It just seems like there's a lot of different needs over the next several years, and if there's big opportunities out there, how do you think about what you would use to fund?

The answer is, we think our balance sheet is in very good shape. We have access to all different phases of the capital markets. And we think that our internal capital requirements for the next number of years are fully funded already, and we think we have capacity.

Jamie, I would just add that, look, we have significant capital, as Steve said, for the opportunities we've already identified internally. But we also constantly have capital partners seeking to do things with us, and many reached out as soon as this crisis hit. So if there are large opportunities, we want to avail ourselves of capital beyond our own balance sheet. We're confident we will have the capital to do so.

And then would you only consider New York City office? Would you look at retail or things outside of the metro region?

We're going to look for value. We're going to look for opportunities that are squarely within our skill set. We know our strengths, and we're not going to invest in Argentina or in a steel company. We'll focus on what we know how to do, and it doesn't necessarily have to be limited to the four corners of Manhattan.

And our next question comes from the line of Manny Korchman with Citi.

It's Michael Bilerman. And my condolences to Haim and his family. Steve, as you think about the investing of capital and you talk about the stock market being a gross exaggeration in terms of the stock being driven down $25, $5 billion, how do you line up the external growth in terms of putting new capital to new deals versus your own company, either in the stock or buying out venture partners' interest in some of your assets?

How are you? Where are you, by the way?

We are Upstate New York.

Stay safe. This is the old buyback question. I've been clear and transparent: since we don't have recurring earnings to continuously repurchase shares, buybacks would sap our capital. We believe the wealth creation and NAV accretion from repurchasing a chunk of stock is insignificant compared with what we can do by investing the same capital in other opportunities. For example, the returns we expect on One Penn or Two Penn based on the capital required exceed, by a multiple, the accretion to NAV we might generate through buybacks. We're not mindless of our stock; we review it continuously and discuss it at every quarterly board meeting. Right now, it's not our top priority. By the way, we're actually not pleased that we moved away from the recommendations of many people that we buy back our stock when it was $30 higher.

Going to the external growth in terms of where you may invest. And I remember it was I don't know if it was last year's letter, or maybe it was a year before, maybe a year before that, you talked about diversification from the perspective of the company in sort of addressing the New York centric. And you basically said, investors can make their own diversification choices by buying different companies, where we don't think being a New York centric company that's what we are. And so I guess from your perspective of looking for value and you wouldn't be confined to the four corners of New York, I guess, why not -- why go and further be present elsewhere.

We are a New York company. We are a tried-and-true New York company. There is no doubt about that. We think we have the best skill set of any New York operator, and there are plenty of opportunities in New York. One would even say, enormous opportunity in New York. So our first, second and third priority will be to invest in what we know and where we know and where we have a powerful franchise. Having said that, we will not preclude other things. So if you go back a long time ago, we were a New Jersey-centric company in strip shopping centers, and we made the better part of $10 billion by sailing across the river and doing something that's different. So we are absolutely a New York-centric company. Our number one, two and three priorities is New York. The prospects that we will invest outside of New York are low, and it would only be for an absolutely extraordinary breathtaking opportunity, and there may be one.

And our following question comes from the line of John Kim with BMO Capital Markets.

I think, Steve, you mentioned that leasing has slowed to a trickle. And I'm wondering if that includes any leasing activity at Penn Plaza and Farley?

So as you would expect, this is an extremely disruptive, confusing, and paralyzing time for everyone, including our tenants and customers. Our tenants and customers fall into two broad categories: those that are essentially shut down with no revenue and no visibility into how long it will last or what the financial ramifications will be, and others who are thriving during this period, including the FAANG companies. Regarding Penn Plaza, we've talked about two big leases in that area. One is a large block of space at Two Penn with an incumbent tenant who is devoted to that building and has been for a long time; they are currently in pause while they wait for their business to reopen, which is understandable and something David, Glenn and I are sympathetic to. They are not going away, just paused. The other is a large tenant that has been the subject of rumors; we have been in active dialogue with them, the conversation is moving forward aggressively, and it may be nearly complete.

Are either of those tenants co-working? What are your views on co-working?

No, no, no. For sure, no.

Can I just ask one more. Of the 6% of nonoffice and retail revenue that has been impacted, how much of this do you expect to recover in the second half of the year? It sounds like trade shows are off the table. But I'm just wondering about hotels, parking and cleaning services.

With a census below 5%, you can't staff a full cleaning crew in the buildings. That makes no sense. Cleaning crews and the revenue they generate will return as tenants come back. The garages are the same. We'll probably miss trade shows this year and pick them up next year. But basically all of that, what I call variable business, will rebound to where it was shortly after things reopen. There will be a ramp-up period, but all of those businesses will definitely rebound.

Our next question will come from the line of Alexander Goldfarb with Piper Sandler O'Neill.

Echoing Michael Bilerman's comments. Condolences to Haim and his family. And then, Steve, thank you for addressing the dividend upfront. Appreciate it. So two questions for you. The first, happy to hear about 350 Park...

Alex, I hope you think I was clear on the dividend.

Yes. Yes. You were unambiguous. You were clear. So one, obviously, good to hear about 350 Park, that you guys are considering it. On the capital side, which has been one of the hallmarks of you guys with the balance sheet, your comments in the press release about 220 Central Park South, potential for delays that could disrupt closings. And then also thinking broadly about the $2 billion street retail preferred. So one, risk on 220; and second, on the $2 billion preferred for the street retail, is there a risk that that is somehow impaired? Or that's not the $2 billion of liquidity that we originally thought it was last year, but it could be something less than, which means as you guys think about funding these projects, that may not be the source of liquidity that we thought it was.

Thanks, Alex. First on 220, I was pretty careful to communicate to you all that notwithstanding the pandemic, since the middle of March, we closed actually five units on schedule for $200 million. So we do not expect, in fact, we are even more certain than that, that the scheduled closings for the remainder of the year, somewhere in the neighborhood of $750 million, will come off on schedule. The only little wrinkle in that is that we, from a construction point of view, have to finish punch list and minor work in those apartments, maybe 30 days per apartment. And so right now, we don't have access to those apartments because of governmental-mandated work stoppages, but that's going to come back pretty soon. So we are very confident that all of those closings will occur approximately on schedule and will give us the better part of $700-odd million this year. With respect to the retail preferred, which I think is $1.8 billion, we have never used that in public or in private as a source of capital for any of our investment opportunities or our ambitions or whatever. So we have looked upon that as just an asset on our books, which will generate, now you remember that this was a highly structured tax-driven deal that we did probably, I don't think quite a year ago. And that $1.8 billion of preferred, if we were to sell it, triggers a 100% tax. So basically it's an asset on our books. It's a liquid asset on our books. We have never in our plans, we have never had in our plans to sell it or to use it to augment our capital.

And then, second question, Steve. From your initial conversations with tenants, what are they saying is the crucial thing for them to reopen their offices? Is it solving mass transit? Is it providing PPE for their employees? Given that New York is harder hit, what are the key items tenants are telling you need to be solved before they can start to reopen buildings and get employees back into New York?

That's a good question, Alex. And that sounds like something for Glenn and David.

Alex, good morning, it's David. I think everybody recognizes this is both a physical and a psychological issue. As you and we have continued to speak to our major tenants during the building shutdown process, I think as the world begins to reopen it will be very gradual. Tenants expect an initial return in the 10% to 20% range, ramping up over time. I think you talked about, and we talked earlier, about garages. We're going to see fewer people using mass transit; more people will drive in. Initially, when we open up, most people will be walking, bicycling, or driving to work. So it will be a process that takes time. As this unfolds, we are hopeful it will be gradual as people acclimate to coming back to work. I don't know about everyone else on the phone, but we are all anxious to get going.

Alex, look, this will have an end date. The COVID pandemic crisis will have an end date. That end date will be when there is a therapeutic and maybe even a vaccine. As I understand it, a therapeutic treats you if you get infected, and a vaccine prevents you from getting it at all. Every medical scientist in the world is working 24 hours a day on this problem, and hopefully there will be a medical solution in a finite period. In between, while there is still a risk of infection, we will just crawl back to regular behavior. Regular behavior will be disrupted. The subways are going to be disrupted. Baseball is going to be disrupted. I can't predict exactly what will happen, but I do know that in some finite period of time we will very quickly snap back to normal like a rubber band.

Well, not having to take the 5:30 a.m. train is certainly a help. So there is, at least there's something there. Anyway, listen.

So by that, I take it, you're going to continue to work from home.

It will be me and David on the same town, but yes, it's much more efficient. It is much more efficient.

And our next question comes from the line of John Guinee with Stifel.

First, very sad to hear about the furlough of over 1,800 people. And I want to congratulate you on a brilliant execution of selling 50% of your retail about a year ago. Thinking about Hotel Pennsylvania and the Manhattan Mall, I know those have been on the redevelopment page for a long time. Is there any thought to just using this opportunity to decommission both of them and demolish them sooner or later?

First, thank you for your comments about the furloughs. Under the new unemployment insurance, supplemented by the PPP federal program, almost everyone on the furlough list is receiving the same or even more in wages than before. We implemented this with a great deal of sensitivity and care for our employees; it was not done to hurt anyone. We cut the furlough list where we believed people would not be able to receive compensation from government programs. I appreciate your sympathies, but we handled this very carefully and thoughtfully for our staff. The Hotel Pennsylvania has been a puzzle for a long time. It is effectively a parking lot for a potential development site. We closed it during the pandemic because occupancy fell into the low teens and single digits, making it uneconomic. We have considered repurposing it and never reopening, which could happen, but I doubt it. That is the first step. The Manhattan Mall is a single building with two distinct components: a large office building above that is fully leased and performing well, and mediocre retail space in the few floors below. You could close the retail, but you cannot demolish it because of the office structure above. In our development plans, the Hotel Pennsylvania would be addressed first at some future date, and the Manhattan Mall is far, far in the future.

Second question: I think everybody is a big believer in the resiliency of New York. But lately, given the number of issues New York has had and the fact that you previously had mayors like Giuliani and Bloomberg, you now have an incredibly different political environment. Can you talk about that current political environment, how it has changed, and how that helps or hurts the resiliency of New York?

John, that's a good question. We think about this a lot. Despite all the problems New York faces—its very liberal, left-leaning politics, homelessness and other issues—the best real estate city in the country right now is San Francisco. In many respects San Francisco is worse than New York: it's further left-leaning and has a worse homelessness situation. Politics are important, but they're not decisive. We believe New York's resilience will continue. Its human, cultural, business and financial infrastructure is extraordinary, the best in the world, and we have confidence in its resilience. I would love to get Mr. Bloomberg back; I'm his landlord and we know each other well, but that's not going to happen.

And our next question comes from the line of Vikram Malhotra.

My condolences to Haim's family as well. I hope everyone else is well and safe. Steve, maybe just a higher-level question. I know you've addressed this in prior questions. But you said many years ago that New York was sort of moving to South and West, given sort of Hudson Yards and other developments. If you were to just sort of have a high-level view of what work from home could do to the office market, maybe New York or more broadly, what would that be?

We think about that all the time. It's a very important question. In fact, I gave that question a couple of sentences at the end of my prepared remarks. So here's the way I see it. At the margin, there will be, I mean now that we've experienced this, by the way, we talked to all of our tenants, we even talked to all of our employees, there's a very small majority, which I guess includes Alex, that prefer to be working at home. Most people are dying to get out of home into the office. So the difference is that working from home, you're in isolation. And the only benefit that I can see of working from home is you save the commute. And I guess, depending upon who you are and where you live, that could be an important thing. But in all other regards, in terms of the socialization, the collegiality, the interaction, the creativity, the office wins. If you are ambitious and want to get ahead and you work from home, you're not getting ahead. If you're in the office and you are performing with all of your colleagues, then you can get ahead. If you are a leader of a team of people, and they all work from home, and you can't be in contact with them, it's an almost impossible job. So we find, in terms of controlling your employees, we find there's an enormous number of benefits to the traditional office. I mean it's lasted for a thousand years, it will continue. At the margin, there will be a little bit of an incremental nick. This is kind of like a trend. There are trends. They happen all the time in relation to crisis, and then they go back. The reaction to 9/11 was nobody wanted to rent space in the upper reaches of buildings because it was dangerous. And now the space that's the most valuable is the upper reaches of the buildings. So this will pass. At the margin, there are some people who want to work from home, continue to spend the day in their pajamas and continue to have their kids running around, but I don't think that's a trend that is going to impair the macro demand for office buildings nor impair values. I mean, for example, let's think about the densification. The densification in REIT went to a certain level and it went from whatever to, I don't know, now maybe the average densification is 160 feet or 170 feet, something like that. WeWork, again, trying to take it down to 60 feet. And that was the justification for their pricing. That didn't work. So anyway, that's where I am. I think the office is the right ticket.

That makes sense. And then just on street retail, given sort of, again, sort of the social distancing, maybe higher e-commerce penetration as a result of this. Can you give us your thoughts on sort of pricing power, meaning kind of rents holding up over the long-term on sort of your core upper fifth markets, Madison, et cetera, and for Haim, specifically, any thoughts on sort of what re-taking rents could shake out over the very near-term in these core markets?

Vikram, that's another good question. Look, I'll give you a perverse thing, which is a secret. I don't want this to get out. I have said and I have written, and you got to remember, we made the early call on the secular decline of retail five years ago or six years ago, and everybody laughed at us. And here we are. I have written that there are two huge problems with retail. The most important is that there are maybe two to three times as many square feet of retail space in the country as there should be. So I think, as I do the math, there's 50 square feet per capita, or I think the number should be like less than 20. And then I said that it would take, I don't know, 15 years for that excess space to work off and evaporate. So in a perverse way, maybe this pandemic is going to get us into alignment much more quickly. So we'll see. I don't think that the physical retail store is dead, but I do think it's certainly injured. I can't really give you math as to what's going to happen in the very short term to rents. I can only tell you that they are down, and I have a negative outlook for rents over the short term. Over the medium term, I think there will be some adjustment for great property. I think great property will always be in demand. And I think Haim will tell you. Haim, will we ever get to the peak pricing that there was three years ago on Fifth Avenue?

I don't believe so.

And that is our firm view.

Okay. Just last clarification. The 53% rent collection seems pretty strong given where we are in May. Can you clarify, is that 53% on average across office, retail, parking, et cetera? Or could you just break that up between office and retail?

It is 53% on average. It's obviously much higher for office and lower for retail.

Steve, let's just clarify, that for the 53%, what is retail? It's just retail.

No, no, no. I think Vikram, I think your question was for May collection, not the April.

For May, yes. For May, specifically.

Okay. So the math is it's in the 20s for retail right now, which is tracking exactly what happened in April, and it's in the 60s for office with a weighted average of 53%. And I think that the exact math is, I think David told me this, this morning, that our collections in May are running $1 million, which is significantly better in May than in April.

And our next question comes from the line of Manny Korchman with Citi.

Maybe one for Glen. Glen, with the path to coming back into the office and companies targeting about 50% occupancy for the near term, how do they think about leasing or renewal decisions in that context? If you are planning for half your workforce to be in the office and you do not know how long that will last, how do you make any leasing decision in that environment?

Look, I think the answer is for the first, call it, six months, plus or minus, the market's going to be quiet as it relates to new leasing decisions, meaning people moving out of their existing building, expanding into new space. Renewals keep going because we have expiring leases and people need their leases. So we are in discussions on a lot of renewals. And with that being said, there is some action. We've been receiving some proposals during this shutdown for people looking to change their life and move to another building within our portfolio. But generally, I would tell you, during the ramp-up of getting back in, you're going to see slow demand for new deals and expansions.

And I guess, more so from the question of those decisions more sort of from a focus level, how are they going to think about the number of square feet per person when the person counts are just so drastically off? I guess it's a question of how do they even think about how much space they need?

I think it's too soon to say. No one knows. I mean, we're going to get back into the buildings between the summer and the winter. I think things have to settle back in. We get back to normal, so to speak, and then people see how their table is set. I think right now, it'll not be fair to project how people are going to look at how much space they need, how many chairs they're going to fit per foot, et cetera. I just think nobody knows until we get back and people get settled back into their offices during the year.

Manny, the large tenants I speak to, and I try to speak to as many as I can frequently, are looking past this period. They are not focusing on thinking, "Oh my God, what a great thing, I can save 7,000 square feet of office space." That's not top of mind. What they're trying to do is get their businesses back. The ones I speak to basically want all their employees back. They want all the desks full, and they want to return to where they were six months ago. With respect to deals, Glen and David will tell you this: this is not a good time for a tenant to make a deal other than a renewal or an important space need, and it's not a good time for us to be bargaining with the tenant. Everything will come back to normal at some point, hopefully within a year, and then we'll get back to business.

And then maybe flipping to street retail in a similar context. A lot of the larger deals we saw were probably more showroom in nature than a productive retail environment, and a lot of that was based on tourism and the like. I guess, do you guys think about a sentiment shift or a psychological shift among shoppers, where they're not going to go shopping as a pastime and so that showroom or flagship concept becomes harder to pitch to a retail tenant?

So I actually think the street retail format will prove to be more resilient and more important to the ecosystem of connecting with the consumer. I think e-commerce will continue to grow and gain market share. But I also think that street retail will prove more resilient than other physical retail formats, like the mall.

I think there could, counterintuitively, be the opposite. My wife is a shopper and she is very frustrated. She can't wait to get out and walk up and down Madison Avenue and Fifth Avenue. I think that when this opens up, the population that has been shut down will want to go out, they want to shop, they want to go to restaurants, they want to have their life back. So I think this is not as dire as some of the commentaries I've read.

I think they all just really want haircuts, but Michael has a couple of follow-ups.

I had just two follow-ups.

And Manny, when you get your haircut, take one from me, please.

Sure. I had two follow-ups. One was just on the density question, which I think part of the move to having much more dense populations was the cost of things. It allowed the tenants to be able to afford the rents paid because they were able to jam more people into more seats. How does that equation change in terms of you as a landlord being able to get the returns that you need and the tenant's affordability to act as they now have to take more space to fit the same number of people?

David, do you want to try that?

Again, I think we're focused, as it relates to that question, on a period of time which is today. So today, people are talking about social distancing. Today, people are not talking about it, it's been mandated by the public authorities. So obviously, today, in an office you couldn't bring back 100% of your workers, you couldn't fit them within the office and properly socially distanced. But as people are looking at long-term decisions for themselves, I think they are recognizing that ultimately it may take six months, 12 months or two years — we don't really know, as Steve said. Ultimately, we're going to have to find an antidote to the virus. When that happens, I think what we're going to be seeing substantially is effectively going back to much like we were. People are going to want to come to offices, as Steve said. And as it relates to some of the density that we've seen, nobody ever believed that we were going to get to 60 feet a person as some of the co-working companies had aspirations to densify. But in terms of what today is in our portfolio, the way we've seen financial services, technology and other service companies changing the use of their space, do we expect that to radically, radically change long term? I think our view is we don't think so today.

And then just a follow-up on the retail joint venture. Given that only 50% of tenants have paid rent, how do the cash flow distributions work within the venture so it can afford paying the 4.5% on your preferred security in that venture? What's the cash flow waterfall today with only 50% of rent-paying tenants?

Michael?

Yes. The way the preferred is structured is that, as you know, we have two third-party pieces of debt on the portfolio as well as on the venture. All the cash is effectively aggregated for purposes of paying the preferred. At the current time, there's sufficient cash to pay the preferred. If cash collections fall off at some point, that will not be the case, and it will never accrue. But as of today, the preferred is being paid, and we think it will continue to be paid for the near term. If there's a deficit in one and excess in the other, that cash is aggregated across the different instruments.

I mean, the answer is that the preferred gets first call on the income. But the percentage of rent collection in the JV assets was approximately 60%, and that swung negatively by one big very creditworthy tenant who decided not to pay, which we will undoubtedly collect. So it's not as bad as you think the numbers are.

Right. So there's more cash coming into the venture than it would be for the portfolio overall?

Let's hope.

And our next question comes from Steve Sakwa from Evercore ISI.

Most of my questions have been asked. But I guess I had one question just on some of the newer developments, like Farley and the work you're doing at Two Penn. What sort of changes do you need to make in order to deal with sort of the issues at hand today? And how costly might those changes be and kind of the design for the base building, maybe thinking about the elevators and some of the stuff that might take place on the floor, the air handlers and all that kind of stuff?

Who wants to handle that?

I could take a shot. So Steve, thanks for the question. First, I would tell you is we've designed these buildings as what I will call forward, forward-thinking buildings. In terms of the air handling systems, in terms of the filtration systems, all of this pre-COVID was being engineered state-of-the-art in terms of having the ability to use the highest-rated MERV filters. There are other technologies that potentially are available. Some of them have not even yet been tested in the United States. There is an ionization type of technology as it relates to having the air flow through tubes. It's not enormously costly. In fact, it is relatively efficient. It's something that we're currently looking at. But first, we're working with, obviously, our engineering experts, thinking about the potential technologies like that. In terms of touchless entry systems, we have facial recognition systems in the portfolio. We have the ability to walk in the portfolio with your iPhone to get access through turnstiles, similar for visitors. So again, the types of systems that people are thinking about, in fact, our systems that pre-COVID, we have thought about and the buildings themselves are being designed realistically for the next generation. And then the nature of the spaces, the communal spaces that we have designed in the building, obviously today, would not comply with social distancing. But again, we are designing these buildings not for the next 6, 12 or 18 months, we're designing these buildings for the long-term, and there is really no change that we would make to any of the communal spaces from a long-term perspective, whether it's the auditorium space, that's great space in PENN2, the Grand Stair in PENN1. These are spaces that we think tenants long-term will continue to want in the buildings. We think that the buildings have been designed right spot-on for the future.

And just a follow-up, Dave. Would that include things like large conference rooms? Or I know there was a point in time you were looking at large gym for kind of the Two Penn buildings. Do things like that still work in your mind today longer term? I know they don't short-term, but...

Yes and yes.

And our next question comes from Jamie Feldman with Bank of America.

So I'd like to get your latest thoughts on long-term tenant credit quality, especially in retail coming out of this. We've seen headlines of several bankruptcies in the last week or so. I know we'll get through this and things will return to normal, but how do you now feel about tenant credit default risk? And have you made any changes to your reserve balance? I know you don't give guidance, but to the extent that that's changed at all.

The question is as to our thinking about retail credit, Jamie? Well, the answer is that I think I've read most of the transcripts of all of the gang that have had the conference call so far. I think we're the only one that raised the point of a bad debt reserve in our remarks. So periodically we will see; this is a new thing for us and everybody. This is the first time we have ever had accounts receivable of any moment. So when you have accounts receivable, you have to go down into the weeds and figure out what our debt reserve will be, which I think I gave an inkling of in my prepared remarks when I got to the $1 a share for 12 months might be the cost of COVID so far. So we don't have anything to say about a debt reserve yet. When we publish our financial statements, we will, of course.

But I guess, taking a step back, just kind of your view of whether it's your retail tenant base or even some of your office tenant base that may not make it through this downturn. How have your views changed from, say, a quarter ago?

Well, the history is that tenants drop out during every severe economic contraction. This may be the poster child, because not only is there an economic contraction but there's a total shutdown. We are expecting some of our customers to fail, and that's part of the business. I can't quantify it. We have a watch list, as you would imagine. That will all come out in the wash over the coming months and year.

And our next question comes from the line of John Guinee with Stifel.

Just a follow-up. I know, Steve, Michael, you guys have been pretty negative on co-working. If you look at WeWork in particular, how long do you see them in business? Indefinitely or is there an end in sight?

I was going to say as long as SoftBank funds them.

I don't think that's a bad thing to say. The co-working business would have been just an evolutionary sort of nonevent were it not for the huge loaded market value that WeWork seemed to develop. So if WeWork had a market value of $500 million, nobody would have paid attention. The fact that they ended up with some crazy number got everybody's attention. So WeWork model contributed a couple of things, which I think might be here to stay. The first is their short-term lease or no lease, which gives total flexibility to a user. So that's a very interesting thing, and we've talked about that a lot. And that will be important to some people. The second thing is they developed a culture of informality, beer kegs and ping-pong tables and what have you. And if you look at the interior design industry for the conventional office space, a lot of their innovations have been adopted by conventional tenants because that's the way young people sort of want to work. So those two things, the culture of work and the tenure of the financial commitment are two things that I think are going to play. The third thing is that when you used WeWork space, you walked into existing desks and you took them as is. You didn't have to go through a six-month period of hiring an architect and building out space. I think that's also a very attractive thing. The rest of it, I think, is all a load of hogwash.

Good. Okay. Second question, maybe I haven't been in tune. But this is the first I've heard about a ground-up redevelopment of 350 Park. Can you talk about the size and the scope and the timing of that?

I'm happy to do it, Steve. John, I think we've referenced it once or twice previously. We have an existing 570,000-foot office building. And with the Midtown East rezoning district, we have the ability to tear that building down and with the acquisition of air rights that are available to build a brand-new 1 million square foot building. We also have the option to combine with our neighbor to the west and build a combined 1.7 million, 1.8 million square foot building, which again has expanded from the combined existing buildings. So there's the ability, and those air rights are available and cost-effective. And so we have a location that is preeminent and arguably the best in the city. We've had tenant inquiry previously, looking for headquarters locations and danced with the tenant probably about 18 months ago. We continue to have interest in the site from others as Glen and team have spent time educating the brokers on the possibilities there. And we have the ability to build what we think is one of the best office buildings in the world in one of the preeminent locations. So it's a building that has garnered interest. And given the ability to upsize it, it is potentially economic if the market is there. And from a timing standpoint, one of the things we've done over the last several years is line up the leases, so that we have that option, knowing that the Midtown East district was being finalized. So Glen and all his leases has put in place demo clauses, including in the most recent one with Citadel, so that we have the option that all the leases are lined up to tear the building down. And so that's the effect, it's that we have an opportunity in the next three years or so to create what is a first-class building in a preeminent location.

John, we're in a very interesting position in that situation. Number one, as Michael said, I think we have the single best location in West. Number two is we have the flexibility to either, a, stay where we are, which is a 40-year-old office building, which is perfectly serviceable and has a value of X; or we can tear it down and build a brand new soup to nuts building that Michael said, one million feet, or we can combine with our neighbor, Michael said to the west, I would say, to the rear because I am always a little bit more difficult than Michael and build a much bigger building. So the marketplace will tell us what to do based upon tenancies and inquiries and what have you. And I want to emphasize one other thing that Michael said. He said that we danced with a very major financial services company to do, he said, the entire block and build a headquarters for them, which merely far down the line, but never materialized.

Do you have a no-observatory pledge on that development?

I give you my word, there will be no observatory. Unless you think we should have an observatory.

No comment.

And our next question comes from the line of Anthony Paolone.

I was wondering if we can go back. I may have missed this. But in the first quarter, you had $284 million of cash NOI. Can you maybe put some brackets around just what the drawdown to that could look like in the next few quarters from parking, signage, hotel, shows at theMART or move-outs, not so much the deferrals, but just the other things and where that goes?

Anthony. Yes, Steve did in his prepared remarks say that those elements of our business, which are variable, the Hotel Penn, the trade shows, the parking, signage are a run rate of $9 million a month.

And so do you think those basically go away in the next few quarters? Or...

They're closed today. The Hotel Penn is closed. The trade shows for the remainder of this year are not going to happen. Signage is at a standstill. So for sure, as long as COVID goes on, they're going to have that effect.

Tony, it's important to make this distinction. The $9 million a month Joe mentioned we view as a one-time hit because it will rebound when the economy and businesses reopen and COVID begins to recede. This is not like having empty space that represents a permanent, long-term reduction in our values. Based on our estimate of potential bad debts over the next 12 months, if it lasts that long and we hope it does not, together with the reduction for these variable businesses, it could amount to about $1 per share, or roughly $200 million, as a one-time hit.

Okay. I understand. And then, sorry, I have to repeat this, but I don't know if I was just clear as maybe others on the dividend. But what is the plan for the rest of this year on the dividend?

Tony, I think I said in my remarks pretty clearly that we paid the first two quarterly dividends. We declared the second quarter dividend a few days ago. So that's about $250 million of dividends for the first half. With respect to the third quarter and fourth quarter, we will look at them in light of the economy, market conditions, the world, our expectations of the future, and most importantly, our taxable income.

So that means you may have not paid them in normal course as you have been?

No, no. Tony, you're putting words in my mouth. I said very clearly, I think at least I tried to be clear, without giving any indication as to where we might go, these are the parameters of the decision. It's all I said.

Okay. So there was no clear decision. It's just brackets around how you think about it?

This is a Board decision that has to be made at the time, okay? So we can't possibly forecast that now. We have the financial capacity to do basically anything we want, and we will do a combination of that and whatever is financially prudent for the business.

Okay. And then just last question. Just the idea of opportunities arising on the investment front. What would constitute an interesting opportunity in terms of the economics? I noticed in the Q, you changed IRRs and cap rates that you estimate value to fund with, and I think you moved cap rates up by 200 basis points and IRRs by 450 basis points. Is that kind of the order of magnitude or was that just accounting matter? Just trying to get color on what would put something in the strike zone for you.

Yes. Tony, on the latter point, I think that was primarily accounting driven. Keep in mind the largest asset in the fund is a hotel, so that's the most stressed category. Cap rates and discount rates have risen there. In terms of opportunities, it's still early days. The public markets react the quickest and some CMBS bonds have traded off. The Fed stepping in has helped stabilize bond markets and stocks have come back somewhat. Private markets take longer. Many lenders are forbearing now and working with borrowers to let them stabilize. When you get to the other side, you may see projects that were being developed where the developer was out of balance on capital ratios or had aggressive lease-up assumptions. We're looking for value and where we can buy high-quality assets at discounts to replacement cost, apply our skills, and generate strong returns. You generally know it when you see it. We're looking at both debt and assets, but I would characterize it as still early days.

That's correct. It's absolutely early days in terms of this acquisition cycle to the extent that there is an acquisition cycle. But clearly the playing field is much more attractive for acquisitions today than it was three months ago.

Our last question comes from the line of Daniel Ismail.

Just a big picture question here. New York City's budget is clearly on your under-stream, like many others across the nation, which might have several ramifications for landlords in the market. Are there any near and long-term opportunities or threats emerging as cities look to fix their fiscal situation?

Well, Danny, that's the question. The next thing that's going to rear its ugly head is the fiscal condition of every single one of the 50 states and every one of the 100 largest cities in the United States. Every one of those governmental entities is in a disastrous fiscal situation. In New York state, the governor has announced that there's a $15 billion hole this year and over three years it will be $61 billion by projection. All the other big states are in similar condition. New York City and New York state are not isolated. The only places they can plug that hole are either by cutting expenses radically or by going to the federal government for help. The federal government is the only government in the country that can run a deficit; the others have to balance their budgets somehow. I think the Senate majority leader made a statement two or three weeks ago that got national attention, saying, let them go bankrupt, and I was appalled at that. What he was saying, if you give him his due, was that there has to be something to push these governments to get their budgets under control. There has to be some pressure. I don't know what's going to happen. I believe the biggest single fight in the upcoming presidential election will be whether the federal government is going to spend $2 trillion to fix this. We'll see. But clearly, I don't believe they're going to go crazy and raise taxes, and I don't believe they're going to do nothing. The only way out is for the federal government to come to the rescue. God only knows what conditions the federal government will put on that rescue money, and that will depend a lot on the outcome of the election.

Okay. So you're not anticipating any, say, rezoning of areas in New York, additional air rights, speeding up permitting processes, anything like that, at least in the near term?

I think that will happen, but that will take five years to make anything happen.

Sure. And then just lastly for me. The projected cash yield on the in-process development pipeline didn't change quarter-over-quarter. Is it still your anticipation that for the redevelopments and developments in your pipeline still hitting those pre-COVID development targets?

The answer is yes, with two caveats. Number one, we believe that leases in process will conclude, which was the basis for those projections when we put them out last year. Now there are two variables to those. The first is if Barry does a superman job and gets the advice better so that we build for less, which is absolutely a possibility in this environment, and that's a plug I'm giving to Barry. The second is what the rents will be. We just don't know yet, okay? So we will adjust them when we get visibility, but we're not going to react precipitously to a change in a newspaper article this next week or the week after.

And our last question comes from Steve Sakwa.

Just one follow-up. I know you don't have that much debt coming due this year, but you are, I think, north of $2 billion of mortgage debt coming due next year. And I'm just curious if there are things you can do kind of this year to take advantage of the low rates and perhaps credit spreads narrowing over the next six months? And how early can you get to some of that debt and kind of lock it away?

Steve, we always get out ahead in refinancing our debt. We're already working on refinancing and extending some loans so we're ahead. With LIBOR and the 10-year Treasury down significantly, and even if spreads have widened, all-in borrowing costs are attractive. For example, at 555 California we are paying north of 5% and we plan to bring that down. So yes, we're on it and comfortable. Also, the loans maturing next year are on our premium office assets, with low loan-to-values and the highest debt yields, so we're confident in those refinancing executions.

And I'm not showing any further questions at this time. I would like to turn the call back to your speakers.

Thank you. Thank you, everybody. We're grateful for everybody joining us this morning. Please don't get too comfortable working from home, Alex, that's not you. We need you back in the office and paying rent in our buildings. Please stay healthy and safe. Our second quarter earnings call will be on Tuesday, August 4, and we look forward to your participation again. Take care. Stay healthy.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.