Earnings Call Transcript - VNO Q4 2021

Operator, Operator

Good morning. And welcome to the Vornado Realty Trust Fourth Quarter 2021 Earnings Call. My name is Richard, and I will be your operator for today’s call. This call is being recorded for replay purposes. All lines are in a listen-only mode. 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 Mr. Steve Borenstein, Senior Vice President and Corporation Counsel. Please go ahead.

Steve Borenstein, Senior Vice President and Corporation Counsel

Welcome to Vornado Realty Trust fourth quarter earnings call. Yesterday afternoon, we issued our fourth quarter earnings release and filed our quarterly report on Form 10-K 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-K and financial supplements. 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, 2021, 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 are Steven Roth, Chairman and Chief Executive Officer; and Michael Franco, President and Chief Financial Officer.

Steven Roth, Chairman and Chief Executive Officer

Thanks, Steve, and good morning, everyone. By any measure, Vornado just reported an outstanding industry-leading quarter at the head of the class of our industry peers. Comparable FFO for the fourth quarter increased 19.1% from last year’s fourth quarter. Company-wide same-store cash NOI for the fourth quarter increased 10.1% from last year’s fourth quarter. Same-store cash NOI from our New York business for the fourth quarter increased 11.3% from last year’s fourth quarter. Company-wide, we leased 2.9 million square feet for the year, of which 2.5 million square feet was in New York, where our leasing teams secured the second and third largest office leases, and the second largest retail lease. For the quarter, we leased 1,036,000 square feet company-wide, of which 1,008,000 square feet was in New York. You will hear more about our leasing activity in Michael Franco’s comments shortly. New York office cash starting rents were $83 for the year and $88 for the quarter. New York office cash mark-to-markets were positive 10.8% for the year and a positive 29.1% for the quarter. Importantly, our triple-digit Madison Square Garden anchor lease at PENN 2 and our current leasing successes at PENN 1 validate our Penn District program. Here’s a short update on the Penn District. The acclaimed Moynihan Train Hall is open to the public. Our retail leasing in the Train Hall is nearly complete with 26 leases executed. The doubling in width and the doubling in height of the Long Island Rail Road concourse is scheduled to be completed by year end. We own the retail on both sides of the LIRR concourse, all of which space was vacated to accommodate the construction. We are now finalizing with over 30 retailers for that space, many of them food-oriented at terms that are better than pre-COVID levels. Finally, we have turned over all of Facebook’s 730,000 square feet to them for tenant fit-out. At PENN 1, our grand new lobby and multi-floor amenity offerings are largely completed and open. Our amenities here are extensive. We believe them to be the largest amenity package in the city by far and unique, tailored to the demographic of our workforce and are receiving rave reviews from tenants and brokers. After all, we are in the hospitality business and that means pleasing our tenants and pleasing their employees. On the seventh floor of PENN 1, our experience leasing center is open and busy. This 14,000-square-foot facility, complete with multiple scale models and floor-to-ceiling wall-to-wall videos vividly illustrates and brings to life our vision and plans for the buildings, restaurants, retail, amenities, lifestyle and work style that the Penn District will become. At PENN 2, we have about 25% of the construction completed. Our construction operations in the Penn District span three to four blocks, from 31st Street to 34th Street, along the West side of Seventh Avenue. In a few short months, everything in our Penn District will come to life, as the shiny modern curtain wall continues to be erected on the PENN 2 building. As the steel framework is erected, it is giving shape to the massive two-block wall and architectural statement that will announce the entrance to Pennsylvania Station, Madison Square Garden and our office building. I believe that a winning strategy allows investors to choose between the high growth development-oriented Penn District or our other terrific Class A traditional core assets or both. However, we have decided to pause the execution of a separation by tracker. This is a purely internal transaction with no counterparty or deadline and I believe a delay until COVID is resolved and New Yorkers return unmasked to the office is appropriate and warranted. A word about our retail business. The Manhattan retail market has definitely bottomed, and activity is accelerating. For 2021, our retail cash NOI was $160.8 million, surpassing our guidance of $135 million. Furthermore, we are increasing our 2022 retail cash NOI guidance by $15 million from $160 million to $175 million. While we own very large and important trophy-quality assets in regions outside Manhattan, Vornado is primarily a Manhattan-centric company. As we interact with our tenants, other occupiers and market participants, our conviction about Manhattan’s future performance, importance and even dominance is stronger than ever. Case in point, Manhattan has become the second home to all of the tech giants, specifically on the New West side, and they continue to grow here. With inflation, I should point out that the replacement cost for New York office buildings is rising aggressively. I submit that replacement cost has always been a leading indicator foretelling that our existing stock of office buildings will be increasing in value. In the same vein, the Manhattan residential market is also a leading indicator, having gone from 100% occupancy pre-COVID down to 70% at the height of COVID, and is now back to 100% at rents higher than pre-COVID levels, as New Yorkers have returned. The city is full, but office buildings are not yet. The last domino will fall when employers and employees resolve hybrid work schedules, and the office districts are teeming with activity again, and I believe that will come sooner than you think. That concludes my remarks, now to Michael.

Michael Franco, President and Chief Financial Officer

Thank you, Steve, and good morning, everyone. As Steve mentioned, we had an outstanding quarter and a strong year. Fourth-quarter comparable FFO as adjusted was $0.81 per share, compared to $0.68 per share for last year’s fourth quarter, an increase of $0.13 per share or 19%. For the year, comparable FFO was $2.86 per share, up $0.24 or 9% from the previous year. We have provided a quarter-over-quarter bridge in our earnings release on page four and in our financial supplement on page eight. We had several non-comparable items in the quarter, primarily 1290 Avenue of the Americas defeasance costs and a TRS non-cash deferred tax liability, partially offset by a 220 Central Park South gain, which total reduced FFO by $0.08 per share. Looking ahead, we are expecting another strong year in 2022 with double-digit percentage FFO per share growth, driven primarily by previously signed leases in both office and retail, particularly Facebook at Farley and the continued recovery of our variable businesses. Regarding our variable businesses, we continue to see a recovery in the fourth quarter. Our dominant signs in Times Square in the Penn District continue to attract disproportionate demand and maintain healthy signage bookings. BMS continues to perform near pre-pandemic levels. A number of trade shows successfully took place, albeit with lower attendance primarily due to travel restrictions. Finally, we still expect our garages to be fully back in 2022. Other than Hotel Penn’s income, we still expect to recover most of the income from our variable businesses in 2022, with full recovery anticipated for 2023. Company-wide same-store cash NOI for the fourth quarter increased by a strong 10.1% over the prior year’s fourth quarter. Our core New York office business was up 8.5% and our retail same-store cash NOI was up 32.3%, primarily due to rent commencement on new leases at 595 Madison Avenue, 4 Union Square South, 770 Broadway and 689 Fifth Avenue. Our New York occupancies also continue to recover nicely. Our office occupancy ended the quarter at 92.2%, up 60 basis points from the third quarter and 110 basis points from the trough state in the second quarter. Retail occupancy ended the quarter at 80.7%, up 350 basis points in the third quarter. We expect further improvement in both occupancies by year-end 2022 based on our deal pipeline and modest 2022 office exploration schedule. Turning to the leasing markets, the New York office leasing market continues to strengthen and show resilience in this period of change, supported by strong economic and private sector job growth. Quarter-over-quarter sustained leasing momentum has led to a total volume in 2021 of 25 million square feet, by far the highest level since the start of the pandemic. Tenant demand continues to surge, especially from technology and financial services users. These companies are committing to long-term leases as they map out their futures. Tour activity has returned to pre-pandemic levels, with many deals in the works. Most industry experts are forecasting market rent and occupancy improvement in 2022, with pent-up demand building as more employers get off the sidelines and into the market. The recent performance in the office market is centered on flight to quality, as the highest quality properties are clearly winning. Tenants are strongly attracted to transit-oriented properties with state-of-the-art systems, amenity-rich programming, outdoor space, and health and wellness features, along with food and beverage offerings. Notably, they are willing to pay for quality and value, as it is increasingly important for CEOs to provide appealing and engaging workspaces to attract and retain their employees. JLL reports that in 2021, an all-time high of 164 leases comprised of 3.4 million square feet were signed at starting rents of $100 or more. Our leasing team led the market here with 831,000 square feet or 25% of these deals, including the largest deal in this class for the second year in a row. Our lease with MSG at PENN 2 follows on the heels of 2020’s largest trophy transaction with Facebook at Farley. We expect this trend to continue, which bodes well for rental growth of our high-quality assets. Overall, we continue to outperform the market, as is evident from our statistics, and it is worth underscoring our leasing accomplishments during the pandemic. Over the past 24 months, we have leased 4.48 million square feet, achieved starting rents of $85 per square foot, marked-to-markets of 8.6% cash and 14.1% GAAP, and an average lease term of nearly 13 years. In 2021, our office leasing performance comprised of 98 transactions for over 2.2 million square feet in total, with initial starting rents of $83 per square foot and an average lease term of 11 years. Moreover, cash and GAAP mark-to-markets were strong at 10.8% and 15.9%, respectively. 38% of this activity involved trophy transactions at triple-digit rents. During the fourth quarter, we completed 23 leases totaling 954,000 square feet. Our average starting rent during the quarter was $88 per square foot, with cash mark-to-market at 29%. GAAP mark-to-market was 39% and average lease term was 14 years, all very strong figures. The Madison Square Garden lease represents another major milestone for us in the Penn District and validates our program to increase rents significantly.

Operator, Operator

Yes. If you could unmute the backup line.

Michael Franco, President and Chief Financial Officer

For the year, we executed 36 leases for 229,000 square feet at positive GAAP and cash mark-to-markets of 37% and 13%, respectively. We have an active pipeline with over 170,000 square feet in the works. Interest in the Penn District in particular is strong, and we expect it to grow with the commencement of leasing in Long Island Railroad Concourse. Now turning to Chicago and San Francisco. While the Chicago market continues to be challenged by high vacancy, negative absorption, and elevated tenant concessions, there are signs suggesting a growing confidence by tenants entering the market, as leasing activity continues to increase quarter-over-quarter. We have recently embarked on bringing our New York work-life amenity ecosystem from PENN 1 to the MART and plan to spend approximately $40 million to create a new tenant booking focused on the first and second floors. This program will further differentiate the MART, include top-notch fitness and conference facilities, a new outdoor plaza main entrance fronting the River North neighborhood, and new outdoor spaces and landscaping along the Chicago River, building on what we first accomplished in 2016 with our Grand Stair restaurant and new food hall. We anticipate starting construction in the second half of this year, with completion expected in 2023. We have begun to introduce this project to the marketplace and are experiencing a meaningful uptick in tour volume and proposals. We have a lease out for 80,000 square feet with a fintech company and are in advanced dialogue regarding an additional 50,000 square feet with potential new tenants. In San Francisco, the city’s office leasing market is beginning to thaw, and recovery seems to be underway. Office leasing volume averaged 2.1 million square feet over the last two quarters. We renewed 446,000 square feet in total here during 2020 and 2021, putting the campus in great long-term shape. We have zero lease expirations in 2022 and a modest 203,000 square feet expiring in 2023 and 2024, where we finalized the renewal with one tenant for 50,000 square feet just last week at a significant positive mark-to-market, and are in discussions with our remaining tenants to renew. You will see that our occupancy in the campus declined from 98% to 94% this quarter, which is solely due to bringing the 78,000 square foot cube, which is vacant, back into service. The balance of the campus is full. Lastly, turning to the capital markets. The investment sales markets continue to pick up with the return of large office deals at strong pricing, such as 4419 for $1 billion, 452 Fifth Avenue for $855 million, and 1 Manhattan West for $2.85 billion. Investor interest in New York is clearly rebounding, as they see that the city has bottomed out and find the relative value compelling. On the debt side, despite the rise in rates, spreads remain tight and all-in coupons are attractive. We refinanced over $4 billion of debt in 2021, taking advantage of the very favorable financing markets to secure low rates, including our early refinancing in November of the $950 million loan on 1290 Avenue of the Americas. We have modest debt maturities in 2022, the largest of which we are currently in the process of refinancing, and essentially no maturities in 2023. Finally, our current liquidity stands at $4.105 billion, including $1.93 billion of cash and restricted cash, and $2.175 billion undrawn under our $2.75 billion revolving credit facilities. With that, I’ll turn it over to the Operator for Q&A.

Operator, Operator

Thank you. Our first question online comes from Mr. Emmanuel Korchman from Citi. Please go ahead. Your line is open.

Micheal Bilerman, Analyst

Good morning. It’s Micheal Bilerman here with Manny. Steve, I want to go to your comments around the tracker and putting it on pause. And maybe you can just walk us through your and the Board’s decision to put that on pause. Obviously, you made the announcement last April when we were in the throes of COVID. It had been multiple years that you’ve been thinking along those lines. And so why would you put it on pause now, when there is a lot of vibrancy in the city, a lot of excitement, and obviously, the office stocks have rebounded? It would seem to be an appropriate time to initiate something. So maybe just walk us through the decision to put it on pause and whether you would look at other transaction alternatives to the tracker, or if it’s still 100% on that path?

Steven Roth, Chairman and Chief Executive Officer

Good morning, Michael. How are you? So, look, I mean, I think my remarks speak for themselves. We think COVID is not resolved yet. Our tenants’ customers and the CEOs that we talk with, who are in our portfolio and in the city, note that they have not resolved yet to come back to work and are finalizing employee schedules. So, we’re still in an uncertain period. Our thinking is that we want to have put our best foot forward. There is still uncertainty, and we don’t think the timing is right. That’s our judgment, and I stand by it. With respect to your initial question, I still have conviction about the concept of having our investors be able to invest in either the Penn District or our other terrific assets. There are no other transactions being contemplated at the moment, although we do have a responsibility to cover all the bases.

Micheal Bilerman, Analyst

I’m just really trying to understand what really changed in your thinking because this wasn’t a financially-driven transaction. You didn’t have a counterparty to weigh in on it. This was really...

Steven Roth, Chairman and Chief Executive Officer

Michael, I couldn’t be clearer. This was still not done with COVID; buildings are still 30% occupied. This is not the right time to launch something like we contemplated for success. I couldn’t be clearer.

Micheal Bilerman, Analyst

I know you’re clear. But this is not something you announced during COVID, right? You’ve been progressing along this path for a number of years. So it’s just surprising to now put it on pause when we’ve had all this information, and you’ve been doing this during COVID. That’s the thing...

Steven Roth, Chairman and Chief Executive Officer

I’m not happy that you’re surprised. I have nothing further to say.

Micheal Bilerman, Analyst

Okay. Thank you.

Operator, Operator

Thank you. Our next question online comes from Mr. Steve Sakwa from Evercore ISI.

Steve Sakwa, Analyst

Yeah. Thanks. Good morning. Michael, unfortunately, the line cut out for maybe a minute or two. I think we lost a little bit of information, at least I did. And I don’t know if you could talk a little bit about the pipeline. But maybe you could just talk a little bit about the leasing pipeline, and perhaps how the MSG lease directly impacted the leasing statistics in the fourth quarter. I realize there was a very big mark-to-market on that lease, which probably helped get you up towards that 29% figure. So, I was just wondering if you could unpack maybe MSG from everything else in the quarter and then talk about the pipeline in general?

Michael Franco, President and Chief Financial Officer

Steve, I did make a comment on the MSG lease. If you take MSG out of the mark-to-markets— I guess, that’s where I cut out. But MSG was a tremendous deal. That being said, the balance of the quarter was similarly outstanding. If you take the MSG lease out, the mark-to-markets for the quarter were 9.2% cash and 12.9% GAAP. So outstanding starting rents and mark-to-markets really across the board, which I think is reflective of our portfolio.

Steven Roth, Chairman and Chief Executive Officer

Steve, let me give you a little color, the way I look at it. There were three components in the leasing this quarter. One was the MSG lease, the second was a 136,000 square foot lease in a building we own in Long Island City. The market there is in the mid-30s for rents, so that was part of the averaging, and then there’s the balance of the portfolio. The number that I think is most relevant is the starting rents because that speaks to the quality of the assets. So the rent in Long Island City was in the mid-30s. The Madison Square Garden lease, we know about. By subtraction, the remainder of our portfolio, excluding Long Island City and MSG, the starting rents were $94 a foot. I think focusing on that is an important measure. This is idiosyncratic; it depends quarter-by-quarter on the mix of buildings and tenants; nevertheless, the fact that the balance of our portfolio, ex Long Island City and ex Madison Square Garden, commanded $94 starting rent, is extraordinarily telling of the quality of our assets and how they are received in the marketplace.

Steve Sakwa, Analyst

Okay. And on the pipeline...

Glen Weiss, Analyst

Hey. Steve, it’s Glen. On the pipeline in Michael’s remarks, we stated two things. We have leases out for final negotiations of more than 400,000 square feet, notably about 80% of those deals with new and expanding tenants. Furthermore, we’re in very good negotiations on another, call it, more than a million square feet, which consists of a real balance of new expansion renewals throughout the portfolio across all of our buildings, with strong activity throughout the portfolio. As we sit here today, straight out of that 440, again, maybe I cut out here, 160,000 square feet is at PENN 1 at over $90 per square foot starting rents.

Steven Roth, Chairman and Chief Executive Officer

To continue down this line on this question, which is important along with the statistics. What is happening in the Penn District is what we initially announced; we stated that we were going to take the two existing buildings, which are the better part of 5 million square feet combined, significant assets, and we are going to spend to upgrade and take the rents from an average of $55 a foot up into the $90s and triple digits. We believe our performance this quarter validates that program. The MSG lease is not a one-timer. It’s not an anomaly. We expect to continue leasing in the Penn District, not only with existing buildings, but with new buildings that will be developed. So we will be announcing roughly 100,000 square feet a quarter or whatever the number may be at $90 rents, perhaps triple-digit rents, looking into the future. What I’m happiest about is the balance of our portfolio that commanded $94 this quarter. This is an extraordinary number, and we are very proud of it, and the result of years spent improving, redeveloping, and nurturing those assets.

Steve Sakwa, Analyst

Great. Thanks for that commentary. I guess, Steve, just as a follow-up, with new government officials at both the governor and mayor levels, I’m curious...

Steven Roth, Chairman and Chief Executive Officer

That’s not a follow-up; that’s a whole new topic.

Steve Sakwa, Analyst

Just briefly, can you talk about the priorities of the mayor and how they fit into the Penn Station considerations, especially regarding issues like homelessness and crime? What are you thinking about that and the key focal points over the next six to 12 months?

Steven Roth, Chairman and Chief Executive Officer

The densely populated urban centers across the northern belt of the country, from Washington, D.C. to New York and Chicago, to San Francisco, are all experiencing similar challenges, namely increases in crime and homelessness. This situation is distressing and disturbing. However, we believe that the political climate in New York is improving. If you read the headlines regarding what the mayors in Chicago, San Francisco, and New York have said, they are all resonating the same sentiment—that the situation must improve and that it is their responsibility to improve it. Therefore, we remain optimistic about the political climate in New York at both the governor and mayor levels, and we are very supportive of these improvements.

Operator, Operator

Thank you. Our next question online comes from Mr. John Kim from BMO Capital Markets.

John Kim, Analyst

Thank you. I had a couple of questions about guidance. You mentioned increasing your 2022 retail guidance to $175 million. Can you talk about some of the factors influencing that, considering you’ve sold some assets since the original tenant was put out? How does this impact your 2023 guidance, which was initially at the $175 million level?

Steven Roth, Chairman and Chief Executive Officer

We don’t give guidance, but we did provide retail guidance due to the significant changes in market dynamics. As such, we made this adjustment to assist you with your modeling and valuations for our retail assets. I don’t think it's productive for me to delve into 2023, even though we are optimistic and believe 2023 will be better than 2021. We are on a recovery trajectory.

Michael Franco, President and Chief Financial Officer

I would just say, John, if you think about where we were a year or two ago when we first laid this out, there was some skepticism. We’ve consistently mentioned that we own the best retail assets in the city. At the outset of COVID, the market took a hit due to no tourism or workers in the city. However, things are beginning to change with a significant uptick in tourism in the fall, which has led to retailers being more active. We’re seeing this continuing trend, and I think the increase in the 2022 retail guidance reflects the leases signed at multiple of our assets coming online.

Steven Roth, Chairman and Chief Executive Officer

From a technical standpoint, we guided and predicted what 2021 would be, and we exceeded that by $25 million. So, that number is now known. It is therefore responsible for us to update our expectations for 2022, as we’ve articulated in my remarks. This is an evolving dialogue as we think through these figures.

John Kim, Analyst

Got it. I just want to clarify that the Moynihan retail units; is that delivery being expedited to 2022, or is that still expected to be a 2023 delivery?

Steven Roth, Chairman and Chief Executive Officer

The latter.

John Kim, Analyst

Okay. My follow-up question is on variable income. Your indication is that it will be fully returned in 2023. However, if I look at your fourth-quarter gain on the variable income of $12.5 million versus the loss recorded in the prior-year's fourth quarter 2020, which was $24 million, deducting Hotel Penn’s income of about $14 million. It seems you’ve already reclaimed all the variable income lost in the fourth quarter of 2020. So, I’m curious if components of this variable income have changed?

Steven Roth, Chairman and Chief Executive Officer

I can’t answer that detail on this call. Would you prefer us to handle it supplementally off the call?

Glen Weiss, Analyst

Either way. I mean, it’s primarily garages and trade shows that are going to come back, along with the signage which is largely back to where it was pre-pandemic.

Michael Franco, President and Chief Financial Officer

On the signage side, we’ve seen significant growth. While we are back to pre-pandemic levels on the signage, it’s not entirely same-store; once we fully recover those signage positions, we believe that number will also increase considerably.

Steven Roth, Chairman and Chief Executive Officer

Our BMS business and signage operations, by the way, are both growing. In a normal scenario, we are recovering from the hit of COVID. Under typical conditions, we expect continued growth in those sectors. I hope this clarification helps you, John.

Steve Borenstein, Senior Vice President and Corporation Counsel

Next question, please.

Operator, Operator

Thank you. Our next question online comes from Jamie Feldman from Bank of America. Please go ahead.

Jamie Feldman, Analyst

Great. Thank you. Good morning. I wanted to get your thoughts on exposure to floating rate debt. You look at the balance sheet, you do have a decent amount of it. Clearly, we’re in a rising rate environment. If you could step back and tell us your philosophy and what we should expect going forward in terms of either earnings risk from floating rate debt or just how you expect to manage the balance sheet in terms of percentage floating versus fixed?

Michael Franco, President and Chief Financial Officer

Jamie, good morning. A few comments: we do run our balance sheet with a mix. Nobody can accurately predict exactly where rates are going in any environment. But if you borrowed fixed for the last several years, you would have generally been mistaken regarding where rates would go. Currently, our balance sheet is roughly 50% fixed and floating. When you account for approximately $1.5 billion in cash, which serves as a natural hedge against floating rate debt, our fixed percentage becomes about two-thirds, with one-third floating. This proportion does not significantly differ from our peers, with one company being entirely fixed. We opt for floating debt where it aligns with our business plan. As we execute redevelopments, borrowing fixed may not be beneficial, as the buyer generally does not want a setup that accommodates all fixed debt. We understand rates may rise now, but we believe, ultimately, they will stabilize at levels still deemed low. So that's the general commentary. I will allow Steve to add anything further.

Steven Roth, Chairman and Chief Executive Officer

The common misbelief is that fixed-rate debt is safe and floating rate debt is risky, which is misleading. If you're a fixed-rate borrower for the past 15 years, you've been incorrect, and that has incurred huge costs. There is inherent risk with fixed rate debt that many don’t recognize. If your income is down and you attempt to refinance or sell the asset, you will face high defeasance penalties. While floating rates have risks, they offer a premium for borrowers. For many borrowers, locking into fixed rates has often been a costly mistake. For context, we executed a floating rate loan recently at 555 California last year at very favorable rates and we bought a swap at an incredibly low fixed rate. So we hedged our bets smartly. If you reconsider the last 15 years, fixed debt has generally been detrimental. Let’s also ensure that we maintain liquidity with our current cash balance along with our debt. As Michael elaborated, our balance sheet is very manageable with a careful approach to debt acquisition.

Jamie Feldman, Analyst

Hi. Thank you. I appreciate the detailed and thoughtful response. You’ve provided insight into the state of office tenants right now in terms of their return to work. How would you characterize the thought process of retail tenants as we view their location preferences and types of spaces they’re looking for? What insights should we consider at this point in the cycle?

Haim Chera, Analyst

So the first signs of resiliency in New York City are evident in the neighborhoods and in the basic needs retail, such as Union Square and 770 Broadway—these have returned robustly. However, the high streets like Fifth Avenue and Times Square will take a little longer to recover. We need our international tourists back, as well as workers in the city to fill these streets, and that’s lagging a bit behind. I predict these areas will also return strongly.

Steven Roth, Chairman and Chief Executive Officer

There has been and probably continues to be negativity surrounding brick-and-mortar retail. Yet, surprising recovery is happening across the country. Open-air shopping centers and freestanding brick-and-mortar retailers are performing well. Take, for example, Target's recent stock performance, which is quite remarkable. They operate a combination of brick-and-mortar and e-commerce, as do other brands. Luxury brands are thriving, primarily in brick-and-mortar setups. While large cities in America are lagging, New York is trailing behind. However, we believe the dynamics will change over time, and New York's high street retail will recover; we do not expect it to hit peaks from four or five years ago, yet hopefully rebound significantly from current levels.

Jamie Feldman, Analyst

Is there anything you see in the market that will alter your interest in certain types of assets or your positioning within retail?

Steven Roth, Chairman and Chief Executive Officer

Well, let's consider this: we have offloaded several assets. Our opinions on areas like Madison Avenue are less favorable for a variety of reasons I have previously described. We’ve identified other minor assets downtown to sell. Otherwise, regarding the rest of our holdings, we are satisfied and confident. Owning two major mega blocks in Times Square constitutes irreplaceable assets. Though Fifth Avenue is struggling, the traffic will recover, so our commitment to our portfolio's quality remains strong.

Operator, Operator

Thank you. Our next question comes from Alex Goldfarb from Piper Sandler. Please go ahead.

Alex Goldfarb, Analyst

Hey. Good morning, Steve. Hopefully, your bankers and lawyers have paused their billables for the tracking stock as well. I have a question about the tenant improvements reflected in the reported quarter, and presumably, there’s a large impact from Madison Square Garden and other tenants. Also, I’ve been hearing from brokers that many tenants are shortening their lease terms. How have the economics changed in leasing, considering the escalated TIs? Is it purely to offer higher rents due to inflation, or do you expect some of this to decrease?

Michael Franco, President and Chief Financial Officer

As a starting point, TIs have deflated somewhat. They escalated after COVID, but we’ve recently seen stabilization. Rents are strengthening in many of our buildings. This quarter was weighted to the MSG deal, which had a market TI. The numbers should give you insight. In San Francisco, much of our deal-making over the last two years involved renewals with shorter lease terms, averaging five to six years. However, the overall commitment to longer-term leasing across our portfolio is apparent with average lease terms of 13 to 14 years, signaling confidence from CEOs.

Steven Roth, Chairman and Chief Executive Officer

The inducement package for TIs is elevated, which we do not favor. However, it’s market-driven and we respond accordingly. The standard formula is realistically one month free rent for every year of lease term. Concurrently, some in the market will boost the TI package, aiming to raise rent, but we prefer to follow calculated approaches to leasing to avoid unnecessary complications.

Alex Goldfarb, Analyst

Okay. Thank you for that detailed response. Regarding your prior remarks about uncertainty in the market, I noted a headline stating Mayor Adams may not pursue bail reform with Albany, suggesting it might have gotten dropped. This is concerning since we need this change.

Steven Roth, Chairman and Chief Executive Officer

Speculating on political outcomes is complex. Just because the newspaper indicates such does not guarantee that will be the outcome.

Alex Goldfarb, Analyst

I get that. My question is related to your earlier comment about COVID uncertainties. It appears many companies, especially major banks, are moving past the pandemic and pushing to return employees to the office. Even Governor Hochul acknowledges this. If you comment on the uncertainty you perceive, is it rather a concern that until labor pressures settle, companies may need to adopt cautious stances, or is there genuine fear from leasing managers that another COVID wave will redirect employees back home? It just feels like many in the market are eager to resume normal operations.

Steven Roth, Chairman and Chief Executive Officer

I didn’t express that it was a risk. I simply stated that COVID isn't resolved. All CEOs we've spoken to want their teams back in the office. Businesses function effectively from the office—not from home. While different health concerns may have affected perceptions and strategies, it seems rather silly to speculate when things will shift back to normal. However, they will. It’s just a matter of time.

Alex Goldfarb, Analyst

Understood. Thank you.

Ronald Camden, Analyst

Hey. Two quick ones for me. Going back on variable income, you provided insights on that. Is there a way to quantify what’s left as it relates to pre-COVID? On a broader context, in 2021, you did one acquisition, and bought a partner out. Are there more similar opportunities anticipated in 2022 and 2023 as you consider your portfolio and joint ventures?

Michael Franco, President and Chief Financial Officer

I don’t want to give you a cutoff number here, Ronald. We can definitely follow up offline for a clearer breakdown by component.

Steven Roth, Chairman and Chief Executive Officer

We will see...

Michael Franco, President and Chief Financial Officer

In reference to joint ventures, the opportunity we pursued with our partner initiated from them, and we happily responded. Our current partners appear content, and further opportunities are less likely at the moment.

Ronald Camden, Analyst

Got it. Thank you.

Operator, Operator

We have no further questions at this time.

Steven Roth, Chairman and Chief Executive Officer

Thank you very much. We appreciate your participation. From the results published last evening and our dialogue today, we're very proud of the quarter. We believe it’s a remarkable achievement. I am very proud of our teams for their hard work to deliver these results, which reaffirms the quality of our portfolio. We assert that we are bouncing from the bottom aggressively in retail and are incredibly excited about the Penn District. Thank you all again for joining us, and we look forward to our next call.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for your participation. You may now disconnect.

Steven Roth, Chairman and Chief Executive Officer

Thank you, Richard.