Business context and reporting period
Empire State Realty OP, L.P. is the operating partnership through which Empire State Realty Trust, Inc. conducts its business. It owns and operates office, retail and multifamily properties in Manhattan and the greater New York metropolitan area, as well as the Empire State Building Observatory. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2022; comparisons are to the corresponding 2021 periods. Financial amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Total revenue | $198.0 million | $153.4 million | $362.1 million | $298.7 million |
| Operating income | $46.5 million | $26.5 million | $52.5 million | $44.8 million |
| Net income | $48.7 million | $4.4 million | $31.5 million | $1.2 million |
| Net income (loss) attributable to common unitholders | $47.8 million | $3.4 million | $29.6 million | $(0.9) million |
| Basic and diluted earnings per unit | $0.17 | $0.01 | $0.11 | $0.00 |
| Operating cash flow | Not separately presented | $83.7 million | $83.7 million |
Q2 operating margin was approximately 23.5%, compared with 17.3% a year earlier. Q2 NOI, a non-GAAP measure, was $120.4 million versus $85.3 million; Core FFO, also non-GAAP, was $79.2 million versus $48.8 million. For the first half, NOI was $206.9 million versus $161.7 million and Core FFO was $128.3 million versus $89.8 million. These supplemental measures are not substitutes for GAAP results or cash flow.
- Revenue drivers: Q2 rental revenue increased 6.1% to $149.3 million, primarily reflecting recently acquired multifamily properties. Observatory revenue rose 227.4% to $27.4 million as visitation recovered; lease termination fees increased to $18.9 million from $3.3 million. Six-month revenue rose 21.2%.
- Cash and liquidity: June 30 cash and cash equivalents were $359.4 million, with $53.3 million of restricted cash. The company also had $850 million available under its revolving credit facility. Cash and restricted cash together fell to $412.8 million from $474.6 million at year-end 2021.
- Debt: Principal debt totaled $2.30 billion; balance-sheet debt, net of financing costs and discounts, was $2.28 billion. Weighted average interest rate was 3.9%, and weighted average maturity was 6.9 years. The revolver was undrawn. The filing says no debt maturity was due before November 2024, excluding scheduled amortization.
- Capital uses: First-half investing cash outflow was $56.6 million, including $56.6 million of additions to buildings and improvements. Financing cash outflow was $88.9 million, including $64.4 million of common-unit repurchases and $21.6 million of distributions. Expected capital expenditures, tenant improvements and leasing commissions under existing leases totaled approximately $105.3 million.
Material changes and unusual items
- Q2 results included a $27.2 million non-cash gain on the consensual foreclosure transfer of 383 Main Avenue, Norwalk, Connecticut, which had a $30 million mortgage. This transaction materially increased reported net income; it was not recurring operating revenue.
- Observatory revenue and attendance improved substantially: 573,000 visitors in Q2 2022 versus 162,000 in Q2 2021. Observatory revenue was $27.4 million and net operating income was $19.6 million in Q2.
- Lease termination fees were materially higher. Property operating costs, observatory expenses and depreciation and amortization also increased. Management attributed expense increases to higher operating costs, longer observatory hours, recently acquired multifamily properties and accelerated depreciation at one property.
- First-half repurchases were substantially higher than in 2021. ESRT repurchased $53.7 million of common stock in Q2 and through July 21, 2022; the filing reports approximately $256 million repurchased since the program began in March 2020.
Outlook, risks and contingencies
The filing provides no quantified earnings or revenue guidance. Management expects positive operating cash flow and intends to meet near-term needs through operating cash, cash on hand, debt issuance and available revolver capacity; longer-term needs may also be funded by mortgage financing, equity issuance and asset sales. Management expects to continue distributions as required for REIT purposes, subject to operating and debt obligations.
- Management reported the observatory reporting unit’s fair value exceeded its carrying value by less than 15% in its Q2 goodwill impairment test, leaving limited headroom if assumptions or conditions worsen. Goodwill assigned to the observatory segment was $227.5 million.
- Key stated risks include office-space demand and hybrid work, tenant defaults or non-renewals, tourism and observatory competition, interest rates and LIBOR transition, property valuations and impairment, refinancing and covenant capacity, development execution, inflation, recession and supply-chain disruption.
- At June 30, the company was in compliance with debt covenants. It reported a 31.6% maximum-total-leverage covenant measure against a limit below 60%, a 3.4x fixed-charge coverage ratio against a minimum of 1.50x, and compliance with its other listed financial covenants.
- A long-running dispute related to the company’s formation remains in litigation. A judgment of approximately $1.2 million was entered against respondents, who appealed; a motion to dismiss the appeal was pending. The company describes other routine litigation as not expected to materially affect its financial position, results or liquidity.
- The company disclosed asbestos-containing materials at certain properties but said it had no plans that would trigger removal requirements and could not reasonably estimate a conditional retirement obligation. It reported no expected material environmental remediation impact, while noting that not all potential liabilities can be ruled out.
- Management stated that disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter. No subsequent events were reported.
Important facts for investors to verify
- How much of the reported earnings improvement reflects recurring operations versus the $27.2 million foreclosure gain and higher lease termination fees.
- Whether observatory visitor recovery and the less-than-15% goodwill valuation cushion persist as tourism, competition and economic conditions change.
- The leasing outlook: portfolio occupancy was 87.8% leased and New York City office occupancy was 88.3%; approximately 1.2 million rentable square feet was available, while leases covering 3.4% and 6.2% of portfolio area expire in 2022 and 2023, respectively.
- Funding needs and refinancing exposure, including $105.3 million of expected tenant improvements and leasing commissions, scheduled debt maturities and interest-rate exposure. Management estimated a 1% increase in short-term rates would have added about $0.6 million to Q2 interest expense.
- Cash use from repurchases and distributions relative to operating cash flow, capital spending and remaining liquidity.