Empire State Realty Trust, Inc. quarterly report, Q3 FY2016

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Business context and reporting period

Empire State Realty Trust, Inc. (ESRT), a self-managed REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area, filed this unaudited Form 10-Q for the quarter ended September 30, 2016. Its portfolio comprised 10.1 million rentable square feet, including 14 office properties and six standalone retail properties. The Empire State Building observatory is reported as a separate segment.

Financial performance and liquidity

MetricQ3 2016Q3 2015Nine months 2016Nine months 2015
Total revenue$175.8 million$175.8 million$498.7 million$492.4 million
Operating income$53.6 million$45.3 million$131.9 million$114.1 million
Net income$32.9 million$26.1 million$74.2 million$60.6 million
Net income attributable to common stockholders$16.0 million$11.2 million$34.5 million$25.5 million
Diluted EPS$0.12$0.10$0.27$0.22
Core FFO attributable to common stockholders and non-controlled interests$71.9 million$70.6 million$194.8 million$191.5 million

Q3 operating margin was approximately 30.5%, versus 25.8% a year earlier; the nine-month margin was approximately 26.4%, versus 23.2%. These are calculated as GAAP operating income divided by total revenue. Dividends were $0.105 per share in Q3 2016, compared with $0.085 in Q3 2015.

  • Revenue and profit drivers: Q3 rental revenue grew 4.3% and observatory revenue grew 6.7%, while total revenue was essentially flat. Nine-month revenue rose 1.3%; common-stockholder income increased 35.4%.
  • Cash flow: Nine-month operating cash flow was $162.1 million, compared with $159.6 million. Investing activities used $120.3 million, primarily for building improvements. Financing activities provided $505.8 million, including net proceeds from the QIA share issuance. Cash and cash equivalents were $594.3 million at September 30, 2016.
  • Debt and liquidity: Total debt principal was approximately $1.621 billion, with a 4.15% weighted-average interest rate and 4.9-year weighted-average maturity. Net debt to total market capitalization was approximately 14.0%. The company reported $1.1 billion of revolving-credit capacity available and no revolver borrowings at quarter-end. Approximately $336 million of debt matures in 2017, excluding amortization; no debt matures in 2016.
  • Capital needs: The company estimated $57.1 million of future tenant improvements and leasing commissions under existing leases. Nine-month capital expenditures, excluding tenant improvements and leasing commissions, were $55.0 million, versus $36.7 million.

Material changes versus the prior comparable period

  • Q3 operating income rose 18.2%, while common-stockholder income rose 42.4%; nine-month operating income increased 15.6% and common-stockholder income increased 35.4%.
  • Lower property operating expenses and depreciation and amortization helped operating income. Interest expense increased 7.5% in Q3 and 6.0% for the first nine months, reflecting higher rates and, for the year-to-date period, higher debt balances.
  • General and administrative expense increased 15.9% in Q3 and 25.5% year to date, including higher compensation and equity compensation; year-to-date expense also included incremental legal costs related to formation-transaction litigation.
  • Observatory revenue increased with higher visitor activity and improved ticket mix. Year-to-date observatory revenue rose 7.8%.
  • On August 23, 2016, QIA bought 29.6 million newly issued Class A shares at $21 per share, generating approximately $621.8 million gross proceeds. The transaction materially increased cash and equity; proceeds included repayment of a $45 million revolver balance, with remaining funds designated for general corporate purposes, redevelopment and future investments.

Outlook, commentary, risks and unusual items

  • No quantified earnings or FFO guidance is provided. Management expects positive operating cash flows and says redevelopment and repositioning should support higher occupancy and rents over the long term, while acknowledging possible near-term occupancy pressure during renovation and tenant relocation.
  • At September 30, the total portfolio was 87.9% occupied and 90.3% leased including signed leases not yet commenced. Management reported 51 Q3 leases covering 348,770 square feet, with a 30.2% mark-to-market rent increase over previous fully escalated rents; Manhattan office new leases had a 59.3% increase.
  • Broadcasting presents a risk: CBS, NBC Universal and WNET notified ESRT they will leave at the end of their current lease terms in 2017 or 2018. Those leases generated approximately $6.3 million of combined 2015 revenue, including expense reimbursements. Management noted industry pressure, a new One World Trade Center competitor and potential lower renewal revenue and higher capital expenditures.
  • Interest-rate sensitivity: management estimated that a 1% increase in short-term rates would increase interest expense by approximately $2.6 million, based on variable-rate debt balances. Interest-rate swaps had a $31.2 million liability at quarter-end; a default under debt arrangements could trigger settlement obligations under derivative agreements.
  • Formation-related investor arbitration remained pending; hearings were scheduled to resume December 19, 2016. ESRT provides defense and indemnity rights to certain executives and affiliates, creating potential costs. Other related class-action matters described in the filing had been dismissed or settled.
  • The QIA investment includes a conditional tax indemnity related to certain dividends attributable to gains on U.S. real property interests, which could constrain property sales or strategic transactions. The filing also identifies ownership concentration, potential resale of QIA shares, REIT qualification and domestically controlled REIT status as risks.
  • Management reported compliance with debt covenants, effective disclosure controls and no material change in internal control over financial reporting. No subsequent events were reported.

Important facts for investors to verify

  1. Whether 2017 debt maturities of approximately $336 million are refinanced or repaid on acceptable terms.
  2. Leasing progress, occupancy and rent mark-to-market realization, together with the funding and returns on remaining redevelopment and tenant-improvement costs.
  3. Revenue replacement, capital requirements and tenant outcomes as CBS, NBC Universal and WNET vacate their broadcast space.
  4. How the QIA share issuance, registration rights, top-up right and tax indemnity affect dilution, governance and strategic flexibility.
  5. Potential costs or outcomes of the pending arbitration and related indemnification obligations.
  6. Core FFO and NOI are non-GAAP measures and do not equal cash available for distributions; compare them with GAAP results, capital expenditures and leasing costs.