Empire State Realty Trust, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2018; results are unaudited and compared with Q1 2017. ESRT is a REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area, with the Empire State Building observatory as a separate business segment. Its portfolio comprised 10.1 million rentable square feet.
Financial and operating performance
- Total revenue was $168.5 million, up 2.1%. Rental revenue rose 4.4% to $122.3 million; observatory revenue increased 1.5% to $21.2 million.
- Operating income was $35.4 million, down 3.5%; operating margin was approximately 21.0%, versus 22.2% in Q1 2017. Net income was $18.1 million, down 5.7%; net income attributable to common stockholders was $9.8 million, down 2.2%. Basic and diluted EPS remained $0.06.
- Core FFO was $59.3 million, compared with $61.3 million, a decrease of about 3.3%. NOI was $87.4 million versus $88.2 million. Both are non-GAAP measures and are not substitutes for GAAP net income or operating cash flow.
- Net cash provided by operating activities was $68.6 million, up from $60.9 million. Investing activities used $44.1 million; financing activities provided $197.5 million, primarily reflecting debt issuance. Cash and cash equivalents were $690.5 million at quarter-end, with restricted cash of $61.7 million.
- Quarter-end debt principal was approximately $1.93 billion; weighted-average interest rate was 3.84% and weighted-average maturity was 8.8 years. The company reported all outstanding debt as fixed-rate, including the $265 million term loan hedged with an interest-rate swap. Consolidated net debt to total market capitalization was approximately 19.5%.
- Available liquidity included $690.5 million of cash and $1.1 billion of capacity under the revolving credit facility. The company reported compliance with its debt covenants. Approximately $250 million of debt principal, excluding amortization, matures in 2019.
- At March 31, the portfolio was 88.1% occupied and 91.5% leased including signed leases not yet commenced. ESB observatory revenue was $21.2 million; approximately 660,000 visitors attended, up 3.8%.
Material changes and unusual items
- Revenue growth was offset by operating expenses rising 3.8%; real estate taxes increased 8.9%, property operating expenses 4.7%, and general and administrative expenses 13.9%.
- Lease termination fees fell to $0.6 million from $7.9 million, including two significant fees totaling $7.5 million in Q1 2017. Other revenue and fees increased, including a $2.8 million settlement with a former broadcast tenant and higher interest income.
- The 102nd-floor observatory was closed during Q1 for elevator replacement. Management said observatory revenue would have increased 11.4% excluding the prior-year 102nd-floor revenue; the company anticipates another closure in early 2019 for up to nine months.
- In March, ESRT issued $335 million of senior unsecured notes, with maturities in 2030 and 2033 and fixed rates of 4.26% and 4.44%. Proceeds helped repay mortgages on 111 West 33rd Street and 1350 Broadway and were also added to cash. The company also increased and refinanced the 1333 Broadway mortgage to $160 million at 4.21%, due 2033.
- Occupancy and leasing: management reported 41 leases signed for 259,530 square feet and an 11.4% portfolio-wide mark-to-market rent increase on new, renewal, and expansion leases. Manhattan office new leases covered 158,932 square feet, with a reported 23.8% mark-to-market increase.
Outlook, risks, and contingencies
- No specific earnings or FFO guidance was provided. Management expects positive operating cash flow and plans to fund near-term needs from operations, cash, debt issuance, and available revolver capacity.
- Management anticipates approximately $50 million annually over three years for the Empire State Building multi-year project; spending through March 31, 2018 was $48.2 million. It also expects approximately $40 million over 2018–2020 for common-area and amenity improvements at other properties.
- Approximately $88.0 million of capital expenditures, including tenant improvements and leasing commissions, was estimated under existing lease commitments. Management identified a soft Greater New York office market, competition from redeveloped properties, lease expirations, and near-term occupancy pressure during repositioning as relevant risks.
- Other disclosed risks include tenant defaults or nonrenewals, real estate market and valuation changes, interest rates and access to financing, observatory tourism and weather, ground leases, environmental matters, and maintaining REIT qualification. Management stated that risk factors had not materially changed from its 2017 Form 10-K.
- A continuing arbitration by former Empire State Building investors alleges fiduciary-duty and related claims concerning the IPO and formation transactions; respondents dispute the claims and intend to defend them. Hearings were scheduled through August 2018. Management reported no other material litigation and no material expected environmental remediation impact.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. No subsequent events were reported.
Important facts for investors to verify
- Whether leasing, rent growth, occupancy, and signed-but-not-commenced leases translate into realized revenue and sustained cash flow.
- The timing, costs, and operational effects of ESB capital projects and the planned 102nd-floor observatory closure in 2019.
- Debt refinancing plans for the 2019 maturity and the company’s liquidity and covenant headroom as capital spending proceeds.
- The quality and comparability of reported Core FFO and NOI, alongside GAAP earnings, operating cash flow, and required property reinvestment.
- Developments in the investor arbitration and any changes to the company’s stated litigation, environmental, or market risks.