The WSJ reports that Vornado Realty Trust is seeking to raise a $1bn distressed real estate fund to use as its "exclusive vehicle for real-estate and real-estate-related investments."
The article wonders why a publicly-traded REIT like Vornado would choose to raise money from private investors rather than in the public market. To do the former, the article argues, "risks dismaying shareholders who hoped Vornado would use its investing expertise to do deals on its own balance sheet," and quotes Mike Kirby of Green Street Advisors as follows:
I guess the real question is: cheapest capital for whom? For companies themselves--ie existing investors--or for new investors?
As a publicly traded entity, Vornado's management has a duty to its existing shareholders, which includes the duty not to dilute them. As a REIT, even in good times it is capital-constrained, because by law it must distribute at least 90% of its taxable income as dividends. To do deals and grow it must constantly raise money, both debt and equity, and if you read Vornado's annual letter, chairman Steven Roth often praises Wendy Silverstein (Executive VP-Capital Markets) for her ability to do that. If a company has a duty not to dilute existing shareholders, yet must also constantly raise new money, with every new capital raise it must ask itself "Does this new capital create value for existing shareholders?" In its long history, Vornado has shown that its answer to this question has mostly been "yes."
Seen in its proper light, a REIT like Vornado already contains aspects of a PE fund--call it a "public equity fund." Existing shareholders, most notably management, are constantly raising outside money to do deals with positive expected values. If the deals work out, some of that value goes to the new outside money, but a lot also goes to existing shareholders. That's why the value per share of Vornado has historically increased at such a high rate, and the further you go back the better their record is. Because the new capital they constantly raise has been invested in good deals, some of whose value has flowed to existing shareholders.
In times of distress/opportunity a company like Vornado is even more capital-constrained. It sees many more deals it wants to do than it has capital to do them with. The "traditional" solution, to just raise new equity, is unattractive because Vornado's stock is down. My strong guess is that Vornado has concluded that any equity raise at current prices would be too dilutive to current shareholders--it would allow new shareholders to buy into Vornado's existing portfolio of assets at a bargain price, and at the expense of existing shareholders. So it has opted for an untraditional solution, raising private money in a PE fund structure, maybe even at 2 and 20, to give it the capital it needs to do all the deals it will want to do.
How can raising money in the private market at 2 and 20--where investors literally pay up front for the privilege of being able to invest alongside Vornado's management team--be more expensive than raising new public equity, with the stock down over 50% from its highs and where Vornado would itself have to pay almost 9% in dividends as an inducement?
I think Vornado is simply doing its job here, and doing it well. If I were a Vornado shareholder I would not be "dismayed," I would be happy. If I were an institutional investor being pitched Vornado's new PE fund, the smart thing to do might be to say no to the fund and simply invest in the stock. Most institutional investors are not set up this way though--they decide in advance "We're going to allocate X to 'distressed real estate opportunity funds'" and don't have the flexibility to invest in a potentially superior mousetrap that targets the identical asset class. You might say Vornado is making an institutional rigidity arbitrage bet here.
Disclosure: No Position (yet)