Empire State Realty OP, L.P. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. The partnership is the operating entity for Empire State Realty Trust, Inc. (ESRT), a REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area. Its portfolio comprised 10.1 million rentable square feet, including the Empire State Building and its observatory.
Financial and operating performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $192.9 million | $186.4 million | $536.4 million | $532.2 million |
| Operating income | $45.3 million | $48.5 million | $107.6 million | $132.4 million |
| Net income | $26.8 million | $29.2 million | $55.6 million | $77.5 million |
| Net income attributable to common unitholders | $26.6 million | $29.0 million | $54.9 million | $76.8 million |
| Core FFO, a non-GAAP measure | $71.8 million | $73.0 million | $193.0 million | $203.2 million |
| Operating margin, calculated as operating income divided by revenue | 23.5% | 26.0% | 20.1% | 24.9% |
Q3 revenue rose 3.5%, while operating income fell 6.7% and net income fell 8.4%. For the first nine months, revenue increased 0.8%, but operating income declined 18.7% and net income declined 28.3%. Basic and diluted earnings per unit were $0.09 for Q3 and $0.18 for the nine-month period, versus $0.10 and $0.26, respectively, in 2018. Distributions were $0.105 per unit in Q3 and $0.315 per unit year to date, unchanged from 2018.
Rental revenue increased to $150.2 million in Q3 and $434.7 million year to date. Comparisons require care: after adopting lease-accounting Topic 842 in 2019, tenant reimbursements were included in rental revenue; in 2018, they were presented separately. Observatory revenue declined 6.6% in Q3 and 5.8% year to date. Q3 observatory net operating income was $28.5 million, down 9.2% from $31.4 million.
Cash flow, debt and liquidity
- For the first nine months, operating cash flow was $198.4 million, compared with $187.4 million in 2018. Cash and restricted cash totaled $330.3 million at September 30, 2019, compared with $284.1 million a year earlier.
- Investing activities provided $210.3 million, primarily reflecting maturity of $400 million in short-term investments, partially offset by $189.7 million of building and improvement additions. Financing activities used $349.2 million, including repayment of $250 million of exchangeable notes and $96.4 million of distributions.
- Debt principal was approximately $1.677 billion; the balance-sheet carrying value, net of financing costs, was $1.669 billion. Management reported a 4.03% weighted-average interest rate, an 8.5-year weighted-average maturity, and no maturities before 2022 apart from scheduled amortization. The $250 million exchangeable notes were repaid in cash in August 2019.
- Cash and cash equivalents were $293.7 million, with $1.1 billion available under the undrawn revolving credit facility. Net debt to total market capitalization was approximately 24.1%. The company reported compliance with debt covenants; its fixed-charge coverage ratio was 4.1x against a 1.50x minimum.
- Management reported no variable-rate debt at quarter end because swaps fixed the $265 million term loan’s LIBOR rate. Swaps had $515 million aggregate notional value and a $28.9 million liability fair value.
Changes, outlook and notable items
- Revenue growth was more than offset by higher operating costs, including property expenses, general and administrative costs, taxes, and depreciation. Nine-month general and administrative expense rose 14%, partly because Topic 842 requires certain non-contingent leasing costs to be expensed as incurred; those costs were $3.7 million year to date.
- The 102nd-floor observatory was closed for about nine months during its upgrade and reopened October 12, 2019. Management anticipated opening the 80th-floor component in November 2019. Visitor count fell 10.7% in Q3 and 8.7% year to date; management cited the closure, lower visitation, and more bad-weather days, partly offset by improved pricing.
- Q3 leasing highlights included 25 leases covering 388,686 square feet and a 23.9% portfolio-wide increase in mark-to-market cash rent on new, renewal, and expansion leases. Total portfolio occupancy was 89.4%, or 91.7% including signed leases not yet commenced. Approximately 0.8 million square feet was available to lease; leases covering 7.7% of portfolio area expire in 2020.
- Management expected approximately $144.2 million of additional tenant improvements and leasing commissions under existing leases. It also described ongoing redevelopment and capital programs, including an approximately $165 million Empire State Building project over three years, with $137.8 million spent through September 30, 2019.
- No formal earnings guidance was provided. Management expected positive operating cash flow and anticipated funding near-term needs through operations, cash, debt issuance, and available revolver capacity. These expectations are subject to leasing, market, capital-market, and operating risks.
- A long-running arbitration brought by former Empire State Building investors alleges breach of fiduciary duty and related claims concerning the 2013 offering and formation transactions. Hearings concluded in August 2018; post-hearing briefing was scheduled to finish by March 2020. The company stated it considers the claims without merit and intends to defend them vigorously. Management said it could not reasonably estimate certain potential asbestos-removal obligations because settlement dates are indeterminable.
Important facts for investors to verify
- Assess whether rental growth and leasing spreads persist as leases roll, and monitor occupancy, expirations, and leasing costs.
- Track observatory visitation and revenue after the 102nd-floor reopening and the planned 80th-floor opening.
- Review debt maturities, interest-rate hedges and swap liabilities, refinancing access, covenant headroom, and the effect of future capital spending.
- Distinguish GAAP results from Core FFO and NOI, which are non-GAAP measures and do not represent cash available for distributions.
- Monitor the investor arbitration, the $144.2 million of estimated lease-related commitments, and any changes in environmental or other contingencies.
- Consider comparability limits from the Topic 842 adoption and the resulting presentation of tenant reimbursements and leasing costs.