Empire State Realty Trust, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. ESRT is a self-managed 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 totaled 10.1 million rentable square feet.
Key financial results
| 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 stockholders | $16.3 million | $18.8 million | $42.8 million | $45.4 million |
| Diluted earnings per share | $0.10 | $0.12 | $0.26 | $0.29 |
| Core FFO, non-GAAP | $73.0 million | $77.5 million | $203.2 million | $212.0 million |
Q3 revenue was essentially flat, while operating income and common-stockholder earnings declined. For the nine months, revenue rose 0.9%, but operating income fell 7.2% and common-stockholder earnings fell 5.8%. Higher property operating costs, real estate taxes, depreciation and interest expense weighed on results. Q3 observatory revenue rose 2.4% to $40.2 million; higher ticket mix and average ticket price offset lower visitor counts.
Cash flow and investment: Nine-month operating cash flow was $187.4 million, compared with $174.8 million. Investing cash outflow was $569.6 million, including $400.0 million placed in short-term investments and $169.6 million of building additions. Financing cash inflow was $136.1 million. Cash, cash equivalents and restricted cash declined by $246.1 million to $284.1 million; cash plus short-term investments totaled $629.7 million at quarter-end.
Debt and liquidity: Total debt principal was approximately $1.93 billion, with a weighted average interest rate of 3.84% and average maturity of 8.3 years. Management reported 100% fixed-rate indebtedness and net debt to total market capitalization of approximately 20.4%. The $1.1 billion revolving credit facility was undrawn; the company reported covenant compliance. Approximately $250 million of debt, excluding amortization, matures in 2019. Balance-sheet debt is presented net of discounts and financing costs.
Quarterly dividends were $0.105 per share, unchanged from 2017. Nine-month dividends and distributions to securityholders totaled $96.0 million.
Business developments and material changes
- At September 30, portfolio occupancy was 88.4%, or 92.1% leased including signed leases not commenced. Manhattan office occupancy was 88.3%, or 93.0% leased including signed leases not commenced.
- During Q3, ESRT signed 43 leases covering 354,099 square feet, with a 24.1% portfolio-wide mark-to-market rent increase over previous fully escalated rents. Manhattan office leasing achieved a 27.3% increase.
- Nine-month rental revenue increased 2.7%, primarily due to higher rental rates. Lease termination fees fell to $2.2 million from $10.4 million in 2017. Other revenue included a $2.8 million settlement with a former broadcast tenant.
- Interest expense increased 12.8% for the nine-month period, primarily due to higher outstanding principal. The company issued $335 million of senior unsecured notes in March 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.
- ESRT authorized a $500 million share and publicly traded operating partnership unit repurchase program through December 31, 2019. The authorization does not require any purchases.
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 with operating cash flow, cash, debt issuance and available credit, subject to facility conditions.
- Management anticipates approximately $91.5 million of tenant improvements and leasing commissions under existing leases. It also expects approximately $160 million total investment over three years in the Empire State Building visitor-experience project; $78.5 million had been spent through September 30, 2018.
- The new observatory entrance opened August 22, 2018. Management expects to close the 102nd-floor observatory in early 2019 for up to nine months for additional work; the 102nd floor generated $11.4 million of revenue in 2017.
- Management cited a soft Greater New York office market and competition from redeveloped or planned properties. Key disclosed risks include vacancies, lease defaults or non-renewals, rental-rate pressure, rising operating costs, redevelopment delays or overruns, interest rates and refinancing, tourism and observatory competition, and environmental, weather and legal risks. Management reported no material changes to the prior annual report’s risk factors.
- A continuing arbitration by former Empire State Building Associates investors alleges fiduciary-duty and related claims concerning the company’s formation and offering. Hearings concluded in August 2018; post-hearing briefing was scheduled to conclude by January 17, 2019. The respondents consider the claims without merit and intend to defend them.
- Ground-lease payments totaled approximately $76.3 million over remaining contractual periods. Management said adoption of the new lease standard is expected to recognize a right-of-use asset and related liability for ground leases. No material environmental remediation liability was reported, though the company noted it cannot be certain all environmental liabilities have been identified.
Most important facts for investors to verify
- How the company will address the approximately $250 million 2019 debt maturity and sustain liquidity while funding capital needs and distributions.
- Whether leasing activity converts signed leases not commenced into occupied space, and whether reported rent increases translate into durable rental income.
- The operational and revenue effects of the planned 102nd-floor observatory closure and broader visitor-experience investment.
- Actual repurchases, if any, under the $500 million authorization, and the impact of competing capital-allocation needs.
- Developments in the investor arbitration and the timing and effect of forthcoming lease-accounting changes.
- Core FFO and NOI are non-GAAP measures; assess them alongside GAAP earnings, cash flows, capital expenditures and leasing costs.