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 substantially all of its business. It owns and operates office and retail properties concentrated in Manhattan and the greater New York metropolitan area, as well as the Empire State Building observatory. This Form 10-K reports the fiscal year ended December 31, 2017; comparisons below are principally with 2016.
At year-end, the portfolio comprised 14 office properties and six standalone retail properties, with approximately 10.1 million rentable square feet. Occupancy was 89.6%, or 92.2% leased including signed leases not yet commenced. ESRT owned approximately 53.8% of the partnership units.
Financial and operating highlights
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Total revenue | $712.5 million | $678.0 million | +5.1% |
| Operating income | $195.8 million | $184.5 million | +6.1% |
| Net income | $118.3 million | $107.3 million | +10.3% |
| Net income attributable to common unitholders | $117.3 million | $106.3 million | +10.3% |
| Diluted net income per unit | $0.39 | $0.38 | +$0.01 |
| Core FFO (non-GAAP) | $286.9 million | $269.0 million | +6.7% |
| Cash provided by operating activities | $191.5 million | $218.6 million | −$27.1 million |
Rental revenue increased 5.1% to $483.9 million, primarily from higher rents and occupancy. Observatory revenue rose 1.8% to $127.1 million, despite fewer visitors (4.05 million versus 4.25 million in 2016), reflecting improved ticket mix and higher average ticket prices; bad-weather days increased. Total annualized portfolio rent was $518.6 million. The filing does not present a single headline operating-margin measure; operating income was approximately 27.5% of revenue.
Operating cash flow declined mainly because the partnership paid $18.4 million to the Helmsley estate for transfer taxes previously accrued. Investing cash use was $224.6 million, including higher building and observatory project spending. Capital expenditures, excluding tenant improvements and leasing commissions, were $126.6 million, compared with $80.0 million in 2016. Distributions paid to equity holders totaled $127.0 million; declared distributions were $0.42 per unit for 2017.
At December 31, cash and cash equivalents were $464.3 million, down from $554.4 million. Debt was approximately $1.7 billion, with a 4.05% weighted-average interest rate and 6.2-year weighted-average maturity; all debt was fixed-rate or hedged at year-end. Consolidated net debt was 16.6% of enterprise value. The $1.1 billion revolving facility was undrawn. Contractual principal maturities, excluding amortization, included $262.2 million in 2018 and $250.0 million in 2019; covenant tests were met.
Material changes versus 2016
- Revenue, operating income, net income, and Core FFO increased. Rental revenue growth was supported by leasing and occupancy; Manhattan office leases signed in 2017 achieved a reported 35.6% increase over prior fully escalated rents on the space renewed or re-leased.
- Other revenue and fees rose to $26.3 million, including $13.6 million of lease-termination fees versus $7.7 million in 2016. These fees are not necessarily recurring.
- Operating expenses increased 4.7%, including higher property costs and real estate taxes. Interest expense fell 3.0%, while the reported loss on early debt extinguishment rose to $2.2 million.
- Cash declined as capital spending increased. Financing cash flow also shifted from a $470.9 million source in 2016, which included QIA equity proceeds, to a $56.9 million use in 2017.
- In August 2017, the partnership amended its revolving credit and term loan facility, extending the revolver’s initial maturity to August 2021 and lowering borrowing costs. It refinanced 2017 mortgage maturities with $315 million of new mortgages. A $450 million private placement of senior notes was agreed: $115 million was issued in December 2017 and the remaining $335 million was scheduled for March 2018.
Outlook, risks, contingencies, and unusual items
No specific earnings or FFO guidance is provided. Management expects to continue leasing and repositioning the portfolio, with near-term vacancy possible as space is renovated. It expects to fund capital requirements through operating cash flow, cash on hand, borrowing capacity, debt or equity financing, and asset sales. The company reported approximately 0.8 million rentable square feet of vacant space at year-end and leases representing 9.1% of portfolio square footage expiring in 2018. Management characterized much of the Manhattan office space expiring in 2018 as below market.
A multi-year Empire State Building project began in 2017 to relocate and enlarge the observatory entrance and improve tenant, retail, and visitor circulation. Management expects to invest about $50 million annually over three years; 2017 expenditures were $36.6 million. It does not expect material disruption to observatory operations. The entitled Metro Tower site in Stamford could support approximately 380,000 rentable square feet, but development timing depends on market and other conditions.
- Concentration and leasing: Six properties generated 71.7% of rental revenue; the Empire State Building alone contributed 32.0%. Global Brands Group represented 6.3% of portfolio annualized rent. Tenant defaults, nonrenewals, leasing costs, or weaker New York-area demand could pressure cash flow.
- Observatory and broadcasting: Observatory operations generated $127.1 million in 2017, and broadcasting licenses and related leases generated $19.5 million excluding reimbursements. Tourism, weather, competition, technology, and broadcast regulation create additional exposure.
- Debt and capital needs: Refinancing 2018–2019 maturities, maintaining covenant compliance, and funding lease costs and redevelopment remain key. Existing lease commitments included about $78.2 million of tenant improvements and leasing commissions. The filing reports no off-balance-sheet arrangements.
- Tax and unusual items: The 2017 Tax Cuts and Jobs Act reduced the corporate tax rate; remeasurement of deferred tax assets increased tax expense by $0.4 million. A $2.2 million debt-extinguishment loss and $0.3 million derivative loss were recorded. The filing also reports $10.5 million of other comprehensive loss, primarily related to interest-rate hedges.
- Contingencies and property matters: Arbitration brought by former Empire State Building investors remained pending, with hearings scheduled through July 2018; respondents dispute the allegations. Soil contamination and land-use restrictions affect the Westport property at 69-97 Main Street, and restrictive environmental covenants apply at 500 Mamaroneck Avenue. Management did not expect known environmental matters to have a material effect, but remediation and redevelopment constraints remain risks.
- Other risks: The portfolio’s geographic concentration, three ground leases, rising property taxes or interest rates, insurance adequacy, cybersecurity, labor relations, and continued REIT qualification are material considerations. The 32BJ pension plan was reported in critical status; the applicable collective bargaining agreement runs through 2019.
Management reported effective disclosure controls and internal control over financial reporting. Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether 2018–2019 debt maturities were refinanced as planned, including completion of the $335 million note issuance scheduled for March 2018 and the January 2018 1333 Broadway refinancing.
- Subsequent occupancy, leasing spreads, tenant improvement and commission costs, and lease commencements—especially for 2018 expirations and the largest tenants.
- Whether the Empire State Building project stays within its expected three-year schedule and approximate annual spending, and whether it improves observatory and retail economics as management expects.
- Recurring operating performance apart from lease-termination fees and other nonrecurring items; assess GAAP net income alongside FFO, Core FFO, and cash flow rather than treating non-GAAP measures as cash available for distributions.
- Developments in the investor arbitration, environmental restrictions, the multiemployer pension plan, and any changes affecting ESRT’s REIT status or tax obligations.