Empire State Realty OP, L.P. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. The partnership owns and operates ESRT’s real estate business, including office and retail properties in Manhattan and the greater New York metropolitan area, and the Empire State Building observatory. Its portfolio comprised 10.1 million rentable square feet.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $186.4 million | $186.5 million | $532.2 million | $527.2 million |
| Operating income | $48.5 million | $56.0 million | $132.4 million | $142.7 million |
| Net income | $29.2 million | $35.5 million | $77.5 million | $86.0 million |
| Net income attributable to common unitholders | $29.0 million | $35.3 million | $76.8 million | $85.3 million |
| Basic earnings per unit | $0.10 | $0.12 | $0.26 | $0.29 |
| Core FFO attributable to common holders | $73.0 million | $77.5 million | $203.2 million | $212.0 million |
Q3 operating margin was approximately 26.0%, down from 30.0%; nine-month operating margin was approximately 24.9%, versus 27.1%. Rental revenue grew 1.0% in Q3 and 2.7% year to date, while observatory revenue increased 2.4% and 2.6%, respectively. Total revenue was nearly flat in Q3 and rose 0.9% for nine months.
For nine months, net cash from operations was $187.4 million, compared with $174.8 million. Investing activities used $569.6 million, including $400.0 million placed in short-term investments and $169.6 million of building additions. Financing activities provided $136.1 million, compared with $137.0 million used in the prior-year period. Cash, cash equivalents and restricted cash ended at $284.1 million; cash and short-term investments available for liquidity were reported at $629.7 million.
Debt, liquidity and capital
- Total debt principal was approximately $1.93 billion, with a weighted-average interest rate of 3.84% and weighted-average maturity of 8.3 years. Management reported all debt as fixed-rate, including floating-rate exposure hedged through swaps; the revolving credit facility was undrawn.
- Approximately $250 million of debt matures in 2019, principally the exchangeable senior notes. A further $265 million term loan matures in 2022. The partnership reported compliance with all debt covenants.
- Available liquidity included $1.1 billion under the unsecured revolving facility. Net debt to total market capitalization was approximately 20.4%.
- Quarterly distributions were $0.105 per unit; distributions to securityholders totaled $96.0 million for the nine months.
Material changes and operating developments
- Net income attributable to common unitholders declined 17.8% in Q3 and 10.0% for the nine-month period. Operating expenses rose 5.6% in Q3 and 4.0% year to date, outpacing revenue. Higher property costs, taxes, depreciation and interest contributed to the decline.
- Nine-month lease termination fees fell to $2.2 million from $10.4 million. A $2.8 million settlement with a former broadcast tenant contributed to higher other revenue and fees.
- During March, the partnership issued $335 million of Series E and F senior notes and used proceeds in part to repay mortgages on 111 West 33rd Street and 1350 Broadway. It also refinanced and increased the 1333 Broadway mortgage to $160 million.
- At quarter-end, the total portfolio was 88.4% occupied and 92.1% leased including signed leases not commenced. Q3 leasing included 43 leases covering 354,099 square feet, with a 24.1% portfolio-wide mark-to-market rent increase over previous fully escalated rents.
- Q3 observatory revenue rose despite visitors declining 5.6% to approximately 1.168 million; improved ticket mix and average ticket price were cited. The new observatory entrance opened August 22.
Outlook, risks and unusual items
Management expects positive operating cash flow and plans to fund near-term needs with operating cash flow, cash, debt issuance and available credit. No numerical earnings or revenue guidance was provided. Planned investment includes approximately $160 million over three years for the Empire State Building project, with $78.5 million spent through September 30, 2018, and approximately $40 million on suburban property common areas and amenities through 2020, with $6.1 million spent to date. The 102nd-floor observatory was expected to close in early 2019 for up to nine months. The partnership estimated approximately $91.5 million of tenant improvements and leasing commissions under existing leases.
Key risks include a soft greater New York office market, vacancies and lease expirations, leasing and redevelopment costs, interest rates and refinancing, observatory tourism and weather, and property tax increases. A 2014 arbitration brought by former Empire State Building investors alleges fiduciary-duty and related claims concerning the offering and formation transactions. Hearings concluded in August 2018; post-hearing briefing was scheduled through January 17, 2019. The partnership says it considers the claims without merit and intends to defend them. Management disclosed no material environmental remediation obligation, but noted it cannot be certain all environmental liabilities have been identified.
ESRT authorized a $500 million stock and publicly traded OP unit repurchase program through December 31, 2019; the authorization does not require purchases and may be suspended or discontinued. The filing reported no material changes to previously disclosed risk factors, no off-balance-sheet arrangements, and no subsequent events.
Important facts for investors to verify
- Whether leasing activity, occupancy and rent mark-to-market gains translate into higher recurring rental income and improved margins.
- Refinancing or repayment plans for the approximately $250 million 2019 maturity, and the terms and availability of credit as capital needs evolve.
- Actual costs and timing of the Empire State Building and suburban improvement projects, plus the $91.5 million of existing lease-related commitments.
- Observatory performance during the planned 102nd-floor closure and whether ticket pricing offsets visitor fluctuations.
- Developments and potential exposure in the investor arbitration, and whether the repurchase program is used and at what price.