Business context and reporting period
Empire State Realty OP, L.P. is the operating partnership through which Empire State Realty Trust, Inc. (ESRT), a REIT, conducts its business. This Form 10-K covers the fiscal year ended December 31, 2016; the filing also reports fourth-quarter results. The company owns and operates office and retail properties, principally in Manhattan and the greater New York metropolitan area, and operates the Empire State Building observatories.
At year-end, the portfolio comprised 10.1 million rentable square feet across 14 office properties and six standalone retail properties, plus retail space within office buildings. Occupancy was 88.1% and leased occupancy, including signed leases not yet commenced, was 90.2%. The business reports Real Estate and Observatory segments.
Financial and operating performance
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total revenue | $678.0 million | $657.6 million | +3.1% |
| Operating income | $184.5 million | $151.4 million | +21.9% |
| Net income | $107.3 million | $79.9 million | +34.2% |
| Net income attributable to common unitholders | $106.3 million; $0.38 per unit | $79.0 million; $0.29 per unit | +34.6% net income |
| Net cash from operating activities | $218.6 million | $203.2 million | +$15.4 million |
| Core FFO | $269.0 million | $257.7 million | +4.4% |
Operating margin increased to approximately 27.2% from 23.0%. FFO and Core FFO are non-GAAP measures; the filing cautions that neither represents operating cash flow or cash available for distributions. The 2016 highlights separately report $51.5 million of net income attributable to the Company; consolidated net income was $107.3 million.
Revenue growth reflected higher rents and an 11.3% increase in observatory revenue to $124.8 million. Property operating expenses declined 3.0%, while general and administrative expense rose 28.9% to $49.1 million, including higher incentive compensation, equity compensation and legal costs. Interest expense increased 5.4% to $71.1 million, primarily reflecting higher interest rates. Other revenue included $7.7 million of lease cancellation fees, compared with $2.0 million in 2015.
Cash and cash equivalents were $554.4 million at year-end, up from $46.7 million, primarily due to the QIA equity investment. Investing cash outflow was $181.8 million, mainly for building and tenant improvements; financing cash inflow was $470.9 million. Capital expenditures, excluding tenant improvements and leasing commissions, were $80.0 million. The company also estimated $57.3 million of future tenant improvement and leasing commission commitments under signed leases.
Total debt was approximately $1.6 billion, with a 4.19% weighted-average interest rate and 4.7-year weighted-average maturity; 83.6% was fixed-rate. Net debt was 14.9% of enterprise value. The $1.1 billion unsecured revolving facility was undrawn at year-end. Scheduled debt principal maturities, excluding amortization, included $336.0 million in 2017 and $262.2 million in 2018. Management reported compliance with applicable credit covenants.
For the fourth quarter, revenue was $179.3 million versus $165.2 million in the fourth quarter of 2015; net income was $33.0 million versus $19.4 million. Distributions were $0.40 per unit for 2016, up from $0.34 in 2015. The fourth-quarter distribution was $0.105 per unit.
Material changes versus the prior period
- Total revenue grew 3.1%; rental revenue increased 2.9% to $460.7 million and observatory revenue increased 11.3%.
- Manhattan office leasing activity generated a reported 42.2% increase in mark-to-market rent on 724,417 square feet of new and renewed leases. The total portfolio was 88.1% occupied.
- Property operating expenses fell, but G&A, real estate taxes and interest expense increased. Depreciation and amortization declined 9.5%.
- In August 2016, QIA purchased 29.6 million newly issued ESRT Class A shares for $621.8 million gross proceeds, contributed to the partnership in exchange for Series PR units; QIA received a 9.9% economic interest and top-up rights.
- The revolving credit commitment increased from $800 million to $1.1 billion. The company refinanced the 10 Union Square mortgage with a $50 million fixed-rate loan at 3.7%.
- The construction management business, which had stopped soliciting new work in 2015, completed its remaining projects and ceased operations.
Outlook, commentary, risks and contingencies
No formal numerical earnings or occupancy guidance is provided. Management expects positive operating cash flow and believes available liquidity supports refinancing near-term maturities. It intends to finish its Manhattan office redevelopment and repositioning program, described as substantially complete as originally contemplated. Metro Tower, an entitled Stamford development site planned for approximately 380,000 rentable square feet plus a garage, has no announced start date; development is contingent on market and other conditions.
Key risks include the portfolio’s geographic concentration, leasing and tenant credit risk, redevelopment costs and execution, competition, interest rates and refinancing, and reliance on the Empire State Building. Six properties generated approximately 71.4% of 2016 rental revenue; the Empire State Building alone represented 32.6%. Approximately 1.0 million square feet was vacant at year-end, and leases covering 7.0% of portfolio area expire in 2017.
The observatory depends on tourism, weather and pricing. Three broadcasters—CBS, NBC Universal and WNET—had notified the company they would leave at lease expiry in 2018; their leases generated approximately $5.9 million of 2016 revenue including reimbursements. Environmental restrictions at properties in Westport and Harrison may limit redevelopment or affect financing and resale. The company disclosed an ongoing arbitration and related stayed lawsuit by former Empire State Building investors concerning the offering and formation transactions; respondents deny the allegations and intend to defend them. The filing states there were no other material litigation matters, apart from ordinary-course disputes.
Other material considerations include ground leases on three properties, tax protection and indemnity agreements, potential uninsured losses, REIT qualification requirements, and a $491.5 million goodwill balance subject to impairment testing. Management reported no goodwill impairment in 2016. The company also disclosed that its collective bargaining agreements cover 599 employees and that the relevant multiemployer pension plan is in critical status.
Important facts for investors to verify
- Reconcile the reported $51.5 million attributable-to-Company highlight with consolidated net income of $107.3 million and common-unitholder net income of $106.3 million.
- Track occupancy, the conversion of signed leases to commenced leases, 2017 expirations and realized leasing spreads against the reported mark-to-market gains.
- Assess refinancing plans and terms for 2017–2018 maturities, debt costs, interest-rate hedges and continued covenant compliance.
- Monitor the QIA investment terms, including top-up rights, resale registration, tax indemnity and potential dilution or share-sale effects.
- Follow broadcaster departures and renewals, observatory visitor and revenue trends, and the outcome and costs of the investor arbitration.
- Evaluate redevelopment and leasing commitments, environmental restrictions, ground-lease obligations and the sustainability of distributions relative to cash flow and capital needs.