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On Sep 12, 2013, we reiterated our long-term Neutral recommendation on Vornado Realty Trust (VNO - Analyst Report), a N.Y.-based real estate investment trust (REIT). Though we commend the company’s strong second-quarter results, ongoing successful portfolio repositioning measures and its financial flexibility, we believe that the continued volatility in the office sector, rising interest rates and stiff competition from commercial property developers will remain overhangs.

Why Neutral?

Driven by the successful execution of strategic initiatives, Vornado’s second-quarter 2013 adjusted funds from operations (FFO) per share of $1.30 exceeded the year-ago figure by 22.6%. Moreover, including the non-recurring items, FFO came in at $1.25 per share, substantially higher than 89 cents recorded in the year-ago quarter. Aided by leasing and occupancy gains, the results also exceeded the Zacks Consensus Estimate of 24 cents.

Vornado’s Class A office properties are concentrated in select high-rent, high barrier-to-entry geographic markets that usually fare better in challenging economic conditions. Moreover, the company is focused on improving its core business and is making strategic acquisitions and divestitures. The recent deal to buy a retail and office property on 655 Fifth Avenue Manhattan was noteworthy in this respect.

Moreover, Vornado has a strong balance sheet and adequate liquidity, which help it to take advantage of distressed selling. Furthermore, with the FFO payout ratio (based on FFO as adjusted for comparability) of 56.2% in second-quarter 2013, Vornado has considerable scope to increase shareholders’ return.

However, the demand for office space remains moderate with unemployment levels still high. New supply as well as increased utilization of office space continue to be headwinds for the demand of Vornado’s properties. Moreover, the rise in interest rates increases the company’s investment-related expenses, and thus poses a threat to its profitability.

Over the last 30 days, the Zacks Consensus Estimate for 2013 FFO per share moved down a cent to $4.74 while for 2014, it moved up a cent to $4.96 per share. The stock currently has a Zacks Rank #3 (Hold).

Other REITs to Consider

Some better-performing REITs that are worth a look include Highwoods Properties Inc. (HIW - Analyst Report), Sovran Self Storage Inc. (SSS - Snapshot Report) and SL Green Realty Corp. (SLG - Snapshot Report). All these stocks carry a Zacks Rank #2 (Buy).

Note: Funds from operations, a widely used metric to gauge the performance of REITs, are obtained after adding depreciation and amortization and other non-cash expenses to net income.

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