Option pricing is a hot topic - just read the financial press day after day after day. We knew that our option pricing policies and procedures were absolutely by the book, in a word, Hoyle. Joe Macnow, Chief Financial Officer, and Alan Rice, Corporation Counsel, ahead of the curve, initiated an internal review to document our Hoyle. The review was conducted by Alan, reviewed by Joe, Sullivan & Cromwell, our general counsel, and ultimately by the Audit Committee and our Board of Trustees. The records for each option grant for the last ten years were reviewed, involving 1,350 individual grants. The conclusion of this review was that options were granted in compliance with Company plans and good practices.
A lesson from Toys "R" Us - in an era when decent real assets trade for 20 to 30 times, it makes good sense to look at companies that trade at 8 to 10 times, especially where those company values are underpinned by hard
real estate assets. This is not a game for everyone (mining the stock market for real estate), but it is a most profitable game that we have been playing and winning for our
entire career.
Over the long term, replacement cost is, to me, the single most important metric for real estate investing. Of course, replacement cost only works where there is sufficient demand to support new-builds. In this period of rapidly rising asset values, replacement cost has risen as much,
(10) Theoretically speaking, since no such sites are available. That is why we are buying on Park Avenue and Sixth Avenue.
(11) The math works - if market rents are, say, $100 a square foot in New York (and they are almost there), nets will be about $70 per square foot, which surely does support $1,000 per foot asset values, or more.
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not only in New York, but in each of the coastal cities. Replacement cost is now over $1,000 a square foot for a Class A New York office building on a "normal" site - much more on a Park Avenue or Sixth Avenue block-front site.(10) There is historical precedent for asset values to reach 125% or so of replacement cost and I believe this cycle, with its unbelievable head of steam, will be no different. Think about it, with Vornado's stock now in the low $120's, I believe the market is pricing our New York assets at, say, $600 per square foot and our Washington assets in the high $300's per square foot - a steal in the private market place.
The cycle is now long of tooth, or is it? Trees surely don't grow to the sky, or do they? Wise men, fund guys and OPM guys are both buying and selling, in equal measure. Confusing. Here's what I think - interest rates are benign and unless something comes along to quench the liquidity binge, asset values will not be threatened. True, asset prices over the last years got way ahead of rents, anticipating the increases that were to come. There may be
a pause while rents catch up (and they are doing so
as we speak)(11) and then the game will likely continue.
The surprise in this cycle may very well be how fast and how high rents rise. And if I'm wrong, believe you me,
in a downturn our fortress balance sheet will be a monster offensive weapon.
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