The Real Deal

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'Vornado Tornado' gets ready to land

Steven Roth

"Stupid, stupid, stupid cheap." That's how low prices have to fall before the commercial real estate market hits bottom, Steven Roth, the chairman of Vornado Realty Trust, predicted earlier this year.

In a letter to shareholders in April, the square-jawed mogul confided, "I think we are now at the third and last stupid."

Not that he's buying yet. But in recent months, the 67-year-old real estate titan, along with CEO Michael Fascitelli, the other half of the so-called "Vornado Tornado," has been building a war chest to go shopping.

And when Vornado gets ready to shop, there's good reason to pay attention.

Long before this down cycle, and before the real estate investment trust had become the largest single owner of office property in Washington, D.C., and among the largest in New York City, Roth was building his fortune by identifying the value in distressed assets.

The Dartmouth grad hit his first grand slam in New Jersey when he won control of a near-bankrupt discount retail company named after a fan manufacturer called Vornado. Then he built it with savvy -- and what the New York Times once called a "bare-knuckled negotiating style that leaves his opponents gasping"-- into a publicly traded national real estate empire.

Those same skills will come in handy in the months ahead. Not since the great bottom-fishing extravaganza of the early 1990s, when the savings-and-loan crisis flooded the market with distressed real estate, has cash been so hard to come by.

Then, like now, credit was frozen and those with access to capital had their pick of assets at fire-sale prices. Those who succeeded, like Sam Zell, built fortunes and helped fuel a boom in IPOs for REITs in the years that followed. Now those REITs have matured, and in recent months, many have been busy raising funds.

Vornado has been one of the most aggressive among them.

Indeed, in recent months, Vornado has been building up a formidable amount of money. And unlike some REITs, which have been stockpiling cash to stave off calamity, some believe Vornado may be getting ready to go on a spending spree.

"A lot of very smart people out there basically think this is a once-in-a-lifetime opportunity," says Barry Vincour, editor of REIT Zone Publications, which tracks the industry. "The bottom line is that Steve and Mike are widely considered among the savviest of the savvy in REIT land. … And most people would tell you that they expect them to be in the thick of the hunt for opportunities arising out of the financial meltdown."

Earlier this year, Vornado began paying its dividends in 60 percent stock and 40 percent cash, allowing it to stockpile about $400 million a year.

The move -- which is being replicated by a number of smaller REITs -- is controversial. Some prominent investors in the REIT industry have complained it will drive capital away by deterring people from buying stock and say it will create additional drag on already anemic share prices. (Vornado's share price declined 28.4 percent in 2008, but is up 15 percent so far this year.)

However, Robert Freedman, executive chairman of FirstService Williams, which does business with Vornado, believes Roth's gambit to raise cash "should position them exquisitely." He notes that it will create a $1.6 billion war chest over the next four years.

Vornado has also been seeking new investors. Early last spring, the company offered 12.5 million additional shares to the public, raising $710 million. Then in June, Vornado announced that it was seeking to raise an additional $1 billion for a private-equity fund to invest in distressed properties.

Roth and Fascitelli will oversee the proposed fund, Vornado Capital Partners LP, aiming to generate returns of more than 20 percent in office and retail locations in New York and Washington.

"This will be an equity-driven recovery," Roth said at an industry forum at the Hotel Pierre last April. (He rarely talks to the media and declined an interview request for this article.) "If you don't have equity, you're dead."

Of course, it is possible Vornado could use those funds to stave off calamity. Indeed, the bursting real estate bubble has been punishing for Vornado. The company's first-quarter profits have slid nearly 70 percent compared to the same period last year, while net income fell to $125.8 million, down from $389.6 million in the first quarter of 2008.

In a letter to investors earlier this year, Roth acknowledged that poor performance -- "If we were still school-age, we'd be off to detention" -- but he emphasized that "our income stream, which comes from 300 buildings and 5,600 tenants, is quite stable."

Just last month, Standard & Poor's Ratings Services lowered its outlook on Vornado from "stable" to "negative" (though at BBB+, the rating is still considered investment grade).

Analyst James Fielding cited concerns about Vornado's low-yield cash holdings and sizable joint venture investments. But he acknowledged that the company has ''one of the highest cash balances among related real estate investment trusts,'' and that its portfolio will provide stable cash flow relative to its peers.

And Vornado's fund-raising activities, while not quite unique, stack up well against their peers.

All told, REITs have issued $16.2 billion in new equity and $2.6 billion in debt this year. Mort Zuckerman's Boston Properties -- another blue-chip REIT -- has raised $840 million.

Roth, who handed over the CEO mantle to Fascitelli this spring, is likely to be in the thick of the big deals. And for the hard-charging deal maker, who remains Vornado's chairman, the market of the next several years should play into the very strengths that helped fuel his success.

Fanning out

Nowadays, the name Roth is firmly linked to New York's most glamorous social circles.

In addition to heading the city's first and largest REIT (according to a Crain's ranking last month, Vornado edged out SL Green in total square footage), his family has strong ties to the artistic heart of the city: Broadway.

Roth's wife, Daryl, has produced 50 Broadway and Off-Broadway plays since 1988. Roth's son, Jordan, 33, is a producer in his own right. He recently finalized a deal to buy an ownership stake in and to lead Jujamcyn Theaters, which owns and operates five theaters and is the third-largest landlord on Broadway.

But it wasn't always that way.

Born in the Bronx to a children's clothing manufacturer, Roth graduated from Dartmouth in 1962, and from business school there one year later. Two years after that, he convinced a wealthy New Jersey real estate investor named David Mandelbaum to invest $250,000 to form a partnership called Interstate Properties.

Roth started buying shopping centers, and repaid Mandelbaum within just about a year.

Then, in 1979, Roth engineered the coup that gave Interstate its stake in the company they would eventually take public. Two Guys, a modest national discount retail chain, had acquired the shell company of defunct fan maker Vornado for tax purposes in 1959.

The stock had a book value of $26, although one analyst estimated the liquidation value of the company at $35 to $45 a share. The draw was the land on which the company had built its stores and parking lots, land located in prime high-traffic areas of Northeastern suburbia.

Roth and his partners, Russell Wight Jr. and Mandelbaum, began snapping up Vornado stock.

When they had enough, they waged an ugly proxy fight. After gaining control of the company through the board, Roth shuttered the stores and began developing strip malls (Vornado fans were later revived under different ownership). Within a little more than a decade, he'd grown his stable of strip malls to more than 50, in addition to regional malls.

By 1992, Vornado's earnings had risen sixfold, from $4.3 million in 1981 to $26 million.

But not everyone approved of the human cost. Prizewinning Newsday columnist Allan Sloan wrote that Roth "put employees on the street, leased the vacant stores to able operators such as Bradlees and Wal-Mart, and watched the money roll in."

Roth's negotiating style helped burnish his reputation as an often ruthless operator.

In a 1993 article headlined "No Mr. Nice Guy," Forbes related a tale typical of the lore surrounding the brash and savvy New Yorker, quoting one "sophisticated" commercial real estate broker twisted in knots by Roth in negotiations over a shopping center.

"I had already convinced the client to ask 35 percent less than he wanted before my first meeting with Roth," the broker said. "Roth was cordial, but that number that came out of that meeting was down another 20 percent -- 80 cents. I had to go back to my client. He wasn't happy, but he wanted to sell. So I met with Roth again. Now he wouldn't go higher than 50 cents. So, no deal.

"You don't mess with Steve Roth. He wants properties for nothing."

Battling Trump

Roth's second big confrontation was with an even bigger fish. This time it was the department store Alexander's, which was also sitting on the equivalent of real estate gold. With 11 prime locations, including a 39-acre site at Routes 4 and 17 in Paramus, and a one-square-block property at 59th Street and Lexington Avenue in Manhattan, the struggling behemoth had also drawn the attention of other shrewd investors, including Zell and Sol Goldman.

Roth started his play by acquiring 9 percent of the company's stock in the early 1980s. By the end of the decade, he'd grown that to a 29 percent stake.

But he wasn't the only one with the idea to grow shares in the company. By the late 1980s, Donald Trump had obtained 27 percent of Alexander's, and won himself a seat on the board across from Roth. The pair fought each other to a standstill about what to do with the real estate, until finally, in 1992, Trump's fortunes were snared in the real estate bust, and he turned his stake over to Citicorp to settle an outstanding debt.

Shortly after that, Alexander's declared bankruptcy. Sloan, the Newsday columnist, labeled it "one of the odder bankruptcies around," noting that the company had an asset value that greatly exceeded its debt.

"So why file? That way, no one can blame Alexander's board of directors for closing the stores and putting 5,000 employees on the street," Sloan wrote.

"No blame attaches to Alexander's dominant shareholder, a low-profile real estate developer named Steven Roth."

But if Roth could be ruthless, he also demonstrated a disarming quality not shared by some of his fellow real estate moguls: modesty.

He was willing to admit when he needed help to fill his knowledge gaps, and he was willing to pay for it.

"Not all stupendously gifted people retain the best and the brightest," Freedman says. "Roth has surrounded himself with the smartest people."

He noted that Roth's colleagues "are guys with big egos and formidable skills themselves, mini-Roths, if you will, which is a credit to Roth."

Sandy Lindenbaum, counsel at Kramer Levin Naftalis & Frankel, and one of the city's most high-profile land-use attorneys, recalls Roth following him out to the elevator after a meeting for a deal they were both involved in.

Roth asked Lindenbaum to represent him. When Lindenbaum said he would have to get permission from the client he had represented in the meeting, Roth promised to take care of it.

"That afternoon, I got a check for $25,000 on my desk with a note saying, 'Okay, now you are representing me,'" Lindenbaum recalls. "He said to me, 'I'm coming to New York. I know how to build with toothpicks. I want to learn how to build with steel.'"

It was Roth's decision to convert Vornado into a REIT that gave him the capital he needed to buy that steel and learn how to build with it.

He took Vornado public in May 1993. By 1995, he had purchased the controlling shares of Alexander's from Citicorp for $55 million. And by the fall of 1996, Vornado owned 56 shopping centers and industrial and office sites totaling 12 million square feet of developed property on the East Coast.

But Roth's biggest post-REIT investment was in human capital. In December 1996, he lured Fascitelli away from Goldman Sachs, where he headed the firm's real estate practice. Fascitelli, a former McKinsey & Co. consultant, was reportedly earning about $5 million a year as a partner at Goldman. Roth made him an offer he couldn't refuse: a five-year, $50 million employment contract that contained a $25 million signing bonus (along with 1.75 million shares of Vornado stock, additional options for 350,000 shares of Alexander's common stock, and a $600,000 annual salary).

It was Michael Jordan-like money, almost unheard of: At the time, the average pay package, including stock options, for CEOs at Fortune 200 companies was $4.9 million.

However, the hire would prove a savvy move. In Fascitelli, Roth snagged an industry insider with a fat Rolodex of contacts and the ability to raise capital.

Vornado tapped that Rolodex immediately. In March 1997, just four months after Fascitelli signed on, Vornado shelled out $656 million to buy seven Midtown office buildings (for a total of 4 million square feet), owned by former Fascitelli client Bernard Mendik.

In a letter to shareholders written shortly after the deal, Roth noted that he had previously contacted Mendik to try to get him to sell his portfolio. Mendik never returned Roth's calls. However, "the day after it was announced that Mike was joining us, Bernie called Mike."

The Mendik deal was just the beginning. Over the course of the next year and a half, Roth and Fascitelli shelled out $1.7 billion to buy or invest in 20 buildings in the city.

Among the acquisitions was One Penn Plaza, a building occupying the block between 33rd and 34th streets and Seventh and Eighth avenues. With many other buildings in the area, Vornado is now the largest holder of real estate in the neighborhood around Penn Station.

On top of the old Alexander's site, Roth and Fascitelli built a 55-story, 1.4 million-square-foot office tower and inked Bloomberg L.P. as an anchor tenant.

Vornado now owns more than 100 million square feet of real estate, including 28 office properties with 16.1 million square feet in New York City alone, mostly in Midtown.

Rethinking dreams

For a while, the company had ambitious plans for a massive redevelopment of the Penn Plaza district, which would have included moving Madison Square Garden and developing its 5 million square feet of airspace.

The company also planned to demolish the Hotel Pennsylvania, build a new tower for Merrill Lynch and expand Penn Station into a nearby post office. But those plans -- in partnership with the Related Companies -- were scrapped last year, in favor of a more modest renovation that would add three floors of retail to the hotel and scrap the MSG move.

According to the New York Observer, the firm took a $23 million writeoff in connection with "abandoning" that project. The abandonment of that project, along with a project in Boston, and write-downs or impairments on eight others, "is a performance that we cannot be proud of," Roth wrote in his letter to shareholders.

He continued, "But ours is a large business and we pursue moneymaking through multiple acquisitions, transactions, developments, etc., predictably some of which will be unsuccessful. As my 92-year-old father taught me 40 years ago, when he was working and I was just starting: '… if you don't have any bad debts, you are not doing enough business.'"

Before the new buying begins, "first we must batten down the hatches and make sure our house is in order and is strong -- we've already done that," Roth told shareholders last April. "Then we must determine when systematic risk has passed -- not quite yet."

In recent months, the company's stock has begun to rebound. Year-to-date, it's now up 15 percent, compared to 12 percent in the REIT industry as a whole. Now the question is, when will the fire-sale purchases start? No way to know. However, when Vornado makes its first move, it may be as good an indication as any that the market has reached bottom.