Empire State Realty Trust, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. ESRT is a REIT owning office and retail properties in Manhattan and the greater New York metropolitan area, as well as the Empire State Building observatory. Its portfolio comprised 10.1 million rentable square feet.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $176.2 million | $178.5 million | $343.5 million | $345.8 million |
| Operating income | $36.2 million | $49.7 million | $62.3 million | $83.8 million |
| Net income | $18.9 million | $30.2 million | $28.8 million | $48.2 million |
| Net income attributable to common stockholders | $11.1 million | $16.7 million | $16.8 million | $26.4 million |
| Diluted EPS | $0.06 | $0.10 | $0.09 | $0.16 |
| Core FFO, including non-controlling interests | $64.5 million | $71.0 million | $121.1 million | $130.2 million |
Operating margin was approximately 20.6% in Q2 2019 versus 27.8% in Q2 2018, and 18.1% for the first half versus 24.2% a year earlier. These are calculated as operating income divided by reported revenue.
- Revenue comparability: ESRT adopted lease accounting Topic 842 on January 1, 2019. Tenant expense reimbursements are included in 2019 rental revenue, while 2018 presented them separately. Rental revenue rose 13.7% in Q2 and 15.5% in the first half, but this reported increase is not directly comparable; rental revenue plus tenant reimbursements was $141.1 million in Q2 2019 versus $140.2 million in Q2 2018, and $284.5 million versus $280.3 million for the first half.
- Observatory revenue declined 6.6% in Q2 to $32.9 million and 5.3% in the first half to $53.5 million. Reported observatory operating income was $3.0 million in Q2, down from $5.5 million.
- Operating expenses rose 8.6% in Q2 and 7.3% in the first half. Higher depreciation, real estate taxes, G&A and observatory costs contributed; G&A also reflected leasing costs expensed under Topic 842 that previously could be capitalized.
Cash flow, debt and liquidity
- First-half operating cash flow was $89.3 million, down from $109.7 million. Investing activities provided $119.4 million, primarily due to maturities of short-term investments, while financing activities used $66.1 million.
- At June 30, cash and cash equivalents were $375.3 million, short-term investments $150.0 million, and restricted cash $38.0 million. Cash plus short-term investments totaled $525.3 million. ESRT also reported $1.1 billion available under its revolving credit facility.
- Total debt principal was approximately $1.93 billion; weighted-average interest rate was 3.84% and weighted-average maturity 7.6 years. ESRT reported no variable-rate debt outstanding, with its term loan rate fixed through a swap. Net debt to total market capitalization was approximately 23.6%; all stated facility covenants were met.
- A $250 million exchangeable note matured August 15, 2019; ESRT said it had elected to settle principal in cash. The filing reported $250 million of 2019 maturities excluding amortization.
- First-half capital expenditures, excluding tenant improvements and leasing commissions, were $64.4 million. Estimated remaining commitments under existing leases for tenant improvements and leasing commissions were $93.9 million. The quarterly dividend was $0.105 per share.
Operating trends, outlook and risks
- At June 30, total portfolio occupancy was 90.2%, or 92.2% including signed leases not yet commenced. ESRT signed 55 leases totaling 261,052 square feet in Q2 and reported a 12.2% increase in mark-to-market cash rent on new, renewal and expansion leases.
- Management described the Greater New York office market as soft and cited competition from recently redeveloped or planned properties. It expects ongoing repositioning to support occupancy and rents over the long term, while renovations and lease transitions may weigh on occupancy in the near term. No specific earnings or FFO guidance was provided.
- The Empire State Building’s 102nd-floor observatory closed in January for upgrades and was expected to remain closed through September 2019. Q2 visitation fell 7.7% year over year, affected by the closure and more bad-weather days; the observatory also has seasonal tourism exposure.
- ESRT anticipated approximately $165 million of investment over three years for the Empire State Building capital project; $119.6 million had been spent through June 30, 2019. It also expected approximately $40 million of improvements across certain properties over 2018–2020, with $22.2 million spent through June 30, 2019.
- A previously disclosed arbitration by former Empire State Building investors alleging fiduciary-duty and related claims remained pending; post-hearing briefing was scheduled to conclude by January 2020. The company said it considers the claims without merit and intends to defend them. The filing reported no other material litigation, but noted environmental and asbestos-related uncertainties for which obligations could not be reasonably estimated.
- Other stated risks include leasing demand and vacancy, tenant defaults or non-renewals, redevelopment costs and delays, observatory tourism and weather, interest rates and refinancing, access to capital, and maintaining REIT qualification.
Important facts for investors to verify
- Cash funding and refinancing execution for the $250 million August 2019 note maturity, and subsequent debt developments.
- Whether observatory visitation and revenue recover after the 102nd-floor reopening, and whether renovation spending remains within expected cost and timing.
- Lease commencements, occupancy, renewal spreads, tenant-improvement commitments and near-term expirations, including 2019 and 2020 lease exposure.
- Underlying revenue and expense trends after adjusting comparisons for Topic 842’s reclassification and immediate expensing of certain leasing costs.
- Progress and potential exposure from the investor arbitration and any environmental or other contingencies.