If you have ever seen Storage Wars on A&E, then you understand hidden value. The premise is a group of investors are briefly shown the inside of abandoned storage locker, and then they bid on the unit. Similar to valuing a business, what you see goes into the price you pay. What is stuffed behind that dirty old mattress, however, is hidden value.
Take a quick glance at real estate investment trusts, or REITs, Vornado Realty Trust (NYSE: VNO) and Starwood Property Trust (NYSE: STWD) and there is plenty of obvious value. But there is also hidden gems that don’t get nearly enough attention.
Vornado Realty Trust
If you are unfamiliar with this $18 billion owner and developer of office towers in New York City and Washington D.C., it may surprise you to learn that in March 2005 the company paid $450 million to acquire a 32.6% interest in Toys “R” Us.
At the time, the global retailer of toys and baby products was struggling to compete with big box retailers, and the problems have only compounded with the continued emergence of e-commerce. Vornado Realty has felt the full force of the company fall from grace; taking $437 million worth of losses between 2013 and the end of 2014. Today, Vornado Realty holds their investment in Toys "R" Us at zero on their balance sheet.
However, according to the National Retail Federation, Toys "R" Us is the 56th largest retailer in the world. And the company still maintains recognition and brand equity along with FAO Swartz; which the company acquired in 2009. Moreover, Toys "R" Us in the midst of a transforming its e-commerce platform – which is now a $1.2 billion business – and attempting to improve its cost structure.
There is no guarantee that Toys "R" Us will regain some of its former glory, but if it does, Vornado Realty could be a chief beneficiary.
Starwood Property Trust
Following the financial crisis in 2008, Vornado Realty has been attempting to simplify its portfolio. Toys "R" Us is one of the few surviving segments that the company’s CEO, Steven Roth, would refer to as “off the fairway” investments. The U.S.’s largest special servicer of commercial mortgage loans, LNR, did not make the cut.
In April 2013, LNR was sold to Starwood Property Trust, which is currently the largest commercial mortgage REIT, and Starwood Capital for $1.053 billion.
The sale included a small equity interest in an online commercial and residential auction house, auction.com. The site was launched in 2008, and since then it has over 200,000 sales totaling more than $34 billion.
According to Starwood Property Trust's CEO, Barry Sternlicht, during their third quarter call in 2014, he views the investment as a "kind of a free option [and] value in our stock that probably nobody attributes to the stock." And this free option became considerably more interesting when Google Capital – Google’s new venture capital fund – invested $50 million and committee their support to the company in March 2014. At the time, the deal valued Auction.com at $1.2 billion.
As a financier of commercial loans, it will be interesting to see if Starwood Property Trust could benefit from a platform that pools together commercial investors. Or, perhaps, Starwood Property Trust eventually sells the position and pays a special dividend. But, either way, it’s an investment that isn’t really being accounted for, and could hold value in the future.
See the forest for the trees
As of today, Vornado Realty's investment in Toys “R” Us, and Starwood Property Trust’s position in auction.com shouldn’t be high on your list of reasons to invest in either of these companies. However, if you already own one or both of these companies, or you’re planning on investing, these potential hidden gems are certainly worth keeping an eye on as they hold serious upside, but are not getting factored into the price of the stock; which means you’re getting them for free. And who doesn’t love free?
