Business context and reporting period
Empire State Realty OP, L.P. is the operating partnership through which Empire State Realty Trust, Inc. conducts its business. It owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, including the Empire State Building and its observatories. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019; amounts below are in millions unless stated otherwise.
The portfolio comprised 10.1 million rentable square feet. At quarter-end, it was 90.2% occupied and 92.2% leased including signed leases not yet commenced. Management reported signing 55 leases covering 261,052 square feet during Q2, with a 12.2% portfolio-wide increase in mark-to-market cash rent on new, renewal, and expansion leases.
Financial performance and condition
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $176.2 | $178.5 | $343.5 | $345.8 |
| Operating income | $36.2 | $49.7 | $62.3 | $83.8 |
| Net income | $18.9 | $30.2 | $28.8 | $48.2 |
| Net income attributable to common unitholders | $18.7 | $30.0 | $28.3 | $47.8 |
| Basic and diluted earnings per unit | $0.06 | $0.10 | $0.09 | $0.16 |
| Core FFO attributable to common stockholders (non-GAAP) | $64.5 | $71.0 | $121.1 | $130.2 |
| Net operating income (non-GAAP) | $96.7 | $102.0 | $182.6 | $188.2 |
Operating margin was approximately 20.6% in Q2 versus 27.8% a year earlier, and 18.1% for the first half versus 24.2%. Net margin was approximately 10.7% versus 16.9% in Q2 and 8.4% versus 13.9% for the first half. Dividends per unit were $0.105 for Q2 and $0.210 for the first half, unchanged from the comparable 2018 periods.
- Cash flow: First-half operating cash flow was $89.3, down from $109.7. Investing activities provided $119.4, mainly reflecting $250.0 of maturities of short-term investments, partly offset by $130.6 of building and improvement additions. Financing activities used $66.1, primarily distributions of $64.2. Cash and restricted cash totaled $413.4 at June 30.
- Liquidity and debt: Cash and cash equivalents plus short-term investments were $525.3; $1.1 billion was available under the revolving facility. Principal debt was approximately $1.928 billion, with a 3.84% weighted average interest rate and 7.6-year weighted average maturity. Management reported all outstanding debt as fixed-rate, including variable-rate term debt fixed through swaps. Net debt to total market capitalization was 23.6%. All reported facility covenants were met.
- Balance sheet: Total assets were $4.156 billion and total liabilities $2.208 billion at June 30. The revolving facility had no borrowings. Topic 842 adoption added approximately $29.5 of ground-lease right-of-use assets and liabilities.
Material changes versus the prior comparable period
- Q2 total revenue declined 1.3%; first-half revenue declined 0.7%. Rental revenue rose 13.7% in Q2 and 15.5% for the first half, but 2019 presentation combines tenant reimbursements with rental revenue following adoption of lease accounting. The 2018 statements reported tenant reimbursements separately, so category-level comparisons are not directly comparable.
- Net income fell 37.3% in Q2 and 40.3% for the first half. Operating income declined 27.0% and 25.7%, respectively, while operating expenses increased 8.6% and 7.3%. Depreciation and amortization and general and administrative costs increased; first-half interest expense also rose 8.3%.
- Observatory revenue declined 6.6% in Q2 and 5.3% for the first half. First-half visitors fell 7.3%, to approximately 1.569 million. Management attributed the decline to closure of the 102nd-floor deck, lower visitation and unfavorable weather, partly offset by improved pricing.
- First-half comprehensive income fell to $9.4 from $55.3, including a $19.4 net unrealized loss on interest-rate swaps in other comprehensive income, compared with a $7.1 gain in 2018.
Outlook, commentary, risks and unusual items
- No formal earnings or FFO guidance was provided. Management expects positive operating cash flows and believes current liquidity supports debt refinancing, but results and funding needs remain subject to market and operating conditions.
- The 102nd-floor observatory, closed in January for upgrades, was expected to remain closed through September 2019. The broader Empire State Building project was expected to cost approximately $165 million over three years; $119.6 million had been spent through June 30. Management also expected approximately $40 million of improvements to other regional properties over 2018–2020; $22.2 million had been spent through June 30.
- Approximately $93.9 million of tenant improvements and leasing commissions were estimated for existing lease commitments. Management expected to fund these with operating cash flow, cash, mortgage financing and available credit.
- A $250 million 2.625% exchangeable note matured August 15, 2019; the partnership stated it had elected to settle principal in cash. This was a significant near-term funding requirement at the reporting date.
- Lease-accounting adoption required non-contingent leasing costs to be expensed as incurred; these costs totaled $2.2 million for the first half. Management cited this, higher equity compensation and increased depreciation as contributors to expense growth.
- Risks include office and retail market softness, vacancies and lease rollover, redevelopment execution and cost risks, tourism and weather sensitivity, interest rates and refinancing, and environmental matters. A 2014 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 partnership said it believed the claims were without merit and intended to defend them vigorously. It reported no other material litigation and no material risk-factor changes.
Important facts for investors to verify
- Confirm how the August 2019 $250 million note maturity was funded and its effect on liquidity and debt costs.
- Review comparable rental and reimbursement trends with the 2019 Topic 842 presentation change in mind.
- Track leasing, occupancy, upcoming 2019–2020 lease expirations, and the stated $93.9 million of committed tenant improvements and leasing commissions.
- Assess observatory recovery after the 102nd-floor reopening and the impact of visitation, weather, tourism and competition.
- Monitor swap valuations and the reported $22.9 million derivative liability, as well as future reclassification of accumulated hedge losses to interest expense.
- Follow the pending arbitration, redevelopment spending and whether management’s liquidity and refinancing expectations are realized.