Empire State Realty OP, L.P. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. The partnership owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, as well as the Empire State Building observatory. Its portfolio totaled 10.1 million rentable square feet. ESRT owned 57.9% of the partnership’s operating units.
Financial and operating performance
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Total revenue | $167.3 million | $167.3 million |
| Operating income | $26.1 million | $34.2 million |
| Net income | $9.9 million | $18.1 million |
| Net income attributable to common unitholders | $9.6 million | $17.8 million |
| Basic and diluted earnings per unit | $0.03 | $0.06 |
| Net operating income (NOI; non-GAAP) | $85.9 million | $86.2 million |
| Core FFO (non-GAAP) | $56.7 million | $59.3 million |
| Cash provided by operating activities | $77.9 million | $68.6 million |
Operating margin was approximately 15.6%, versus 20.4% a year earlier; net margin was approximately 5.9%, versus 10.8%. The filing reports a $0.105 per-unit distribution for both periods.
At March 31, 2019, cash and cash equivalents were $242.9 million, restricted cash $61.8 million, and short-term investments $350.0 million. Cash plus short-term investments totaled $592.9 million. Principal debt was approximately $1.929 billion (carrying value $1.919 billion); the revolver was undrawn, with $1.1 billion available. Management reported a 3.84% weighted-average debt rate, 7.8-year weighted-average maturity, and 21.6% consolidated net debt to total market capitalization. Debt covenants were met. The filing describes indebtedness as fixed-rate, including the term loan whose LIBOR exposure was swapped to fixed.
Material changes and business drivers
- Revenue was essentially unchanged. Rental revenue rose 17.3% to $143.4 million, partly reflecting higher rental rates; however, 2019 rental revenue includes tenant reimbursements that were shown separately in 2018 following adoption of lease accounting guidance, so the reported category is not directly comparable.
- Net income attributable to common unitholders fell 46.0%. Operating expenses increased 6.1%, led by depreciation and amortization, real estate taxes, and general and administrative costs. Interest expense rose 17.6% to $20.7 million, primarily due to higher outstanding principal balances.
- Observatory revenue declined 3.2% to $20.6 million and visitors fell 6.7% to approximately 601,000. Management attributed the quarterly comparison primarily to Easter falling in Q2 in 2019, rather than being split across Q1 and Q2 as in 2018. Observatory NOI declined 6.6% to $13.0 million.
- Portfolio occupancy was 88.8%, or 91.5% leased including signed leases not yet commenced. The company signed 34 leases covering 308,051 square feet and reported a 13.4% portfolio-wide cash rent increase on new, renewal, and expansion leases. Manhattan office cash rent mark-to-market was 21.1% on 21 new leases.
Outlook, risks, contingencies and unusual items
- Management expected positive operating cash flow and said available cash, operating cash flow, and borrowing capacity should support near-term needs. It anticipated refinancing future maturities, but reported approximately $250 million of debt due in 2019: the $250 million exchangeable notes mature August 15, 2019. The partnership stated its intent and ability to settle the notes’ principal in cash.
- Expected capital needs include approximately $99.4 million for tenant improvements and leasing commissions under existing leases. The company also anticipated approximately $160 million over three years for the Empire State Building project; $105.1 million had been spent through March 31, 2019. The 102nd-floor observatory closed in January for upgrades and could remain closed for up to nine months.
- Management cited a soft Greater New York metropolitan office market and competition from redeveloped properties. Lease expirations, vacancies, tenant defaults, leasing costs, construction overruns, tourism and weather variability, interest rates, access to financing, and leverage are among the disclosed risks.
- A previously disclosed arbitration by 12 former investors concerning the company’s formation and offering continued; hearings concluded in August 2018, with post-hearing briefs scheduled through September 9, 2019. The company and other respondents said they considered the claims without merit and intended to defend them. The filing stated other material litigation was not known.
- FASB lease accounting Topic 842 was adopted January 1, 2019, recognizing approximately $29.5 million of right-of-use assets and lease liabilities. The company also began expensing non-contingent leasing costs; $1.1 million was expensed in Q1. This changed presentation and expense timing versus the prior period.
- Interest-rate swaps had a net fair-value liability of approximately $10.3 million; the quarter included a $7.2 million unrealized hedge loss in other comprehensive income. Management estimated $2.0 million of accumulated hedge losses would be reclassified to interest expense within 12 months.
Key facts investors should verify
- How the August 2019 exchangeable-note maturity was ultimately funded or refinanced, and the resulting interest cost and liquidity position.
- Whether occupancy, signed leases, rent increases, and the scheduled 2019–2020 lease expirations translated into sustained rental growth and improved operating results.
- Effects of the 102nd-floor closure and broader observatory upgrades on attendance, revenue, and project costs.
- Progress and funding of the disclosed capital program, including the $99.4 million of lease-related commitments and the Empire State Building project.
- Whether the arbitration or environmental matters resulted in material costs or obligations; the filing said environmental remediation was not expected to have a material impact, while noting not all liabilities could be ruled out.
- Compare non-GAAP NOI and Core FFO with GAAP results and cash flow: the filing cautions that these measures exclude significant economic costs and do not represent cash available for distributions.