Empire State Realty OP, L.P. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; comparisons are with Q1 2014 unless otherwise noted. The partnership owns and operates office, retail and observatory properties, primarily in Manhattan and the greater New York metropolitan area. Its portfolio totaled 10.0 million rentable square feet.
Financial performance
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total revenue | $151.9 million | $140.3 million | +8.3% |
| Operating income | $23.8 million | $24.1 million | -1.4% |
| Operating margin | 15.6% | 17.2% | Lower |
| Net income | $7.9 million | $11.2 million | -29.8% |
| Net income attributable to common unitholders | $7.7 million | $11.2 million | -31.8% |
| Basic and diluted earnings per unit | $0.03 | $0.05 | Lower |
| Operating cash flow | $47.4 million | $23.9 million | Increased |
| Investing cash flow | $(28.0) million | $(15.0) million | Higher outflow |
| Financing cash flow | $(28.6) million | $(24.9) million | Higher outflow |
Core FFO was $52.7 million, or $0.20 per diluted unit, compared with $41.7 million, or $0.17 per unit. FFO and Core FFO are non-GAAP measures and are not substitutes for GAAP earnings or operating cash flow. The declared distribution was $0.085 per unit, unchanged from Q1 2014.
Revenue growth was led by rental revenue, up 22.0% to $110.1 million, primarily reflecting the July 2014 acquisitions of 112 West 34th Street and 1400 Broadway, as well as higher occupancy and rents. Observatory revenue rose 5.3% to $18.2 million as higher admission prices offset lower visitor numbers. Construction revenue fell 89.3% to $1.6 million amid lower project volume. Operating expenses increased 10.2% to $128.1 million; depreciation and amortization rose 37.5% and property operating expenses rose 18.4%. Interest expense increased 11.9% to $16.0 million. Net margin was approximately 5.2%, versus 8.0%.
Balance sheet, debt and liquidity
- At March 31, 2015, total assets were $3.273 billion and total liabilities were $1.905 billion. Cash and cash equivalents were $36.5 million; restricted cash was $61.0 million.
- Debt principal was approximately $1.600 billion; the balance sheet carrying amount was approximately $1.608 billion. Management reported a 4.1% weighted-average interest rate and 5.6-year weighted-average maturity, excluding premiums and discounts. Consolidated debt to total market capitalization was approximately 24%.
- Available capacity under the $800 million unsecured revolving credit facility was $635 million, with $165 million drawn at quarter-end. The facility matures in January 2019, with options for two six-month extensions. The company reported compliance with its covenants.
- In March, the partnership issued $350 million of senior unsecured notes: $100 million at 3.93% due 2025, $125 million at 4.09% due 2027, and $125 million at 4.18% due 2030. Proceeds were used to repay mortgage debt, reduce revolver borrowings and for general corporate purposes.
- The prior secured revolving and term facility was terminated in January and replaced with the unsecured facility, releasing its liens and collateral. The filing states there was no debt maturing in 2015 or 2016. Subsequent to quarter-end, the $91 million One Grand Central Place loan was repaid.
- Cash decreased by $9.3 million during the quarter, ending at $36.5 million. Operating cash flow increased mainly due to higher collections of tenant and other receivables and the acquired properties; investing outflow reflected higher building-improvement spending.
Operations and material changes
- Portfolio occupancy was 87.6%, or 90.0% including signed leases not yet commenced. Manhattan office occupancy was 86.1% (88.8% including signed leases); retail occupancy was 91.2% (92.7% including signed leases); Empire State Building occupancy was 84.2% (89.8% including signed leases).
- The partnership signed 60 leases covering 418,092 square feet and reported a 149.5% increase in mark-to-market rent over previously fully escalated rents on new, renewal and expansion leases. Manhattan office new leases reported a 67.8% increase over expired rents; five new retail leases reported an 861.0% increase. Management cautions that quarterly lease counts and mix can make these comparisons volatile.
- Observatory admissions were approximately 622,000, down from 664,000. Revenue nevertheless increased with higher admission prices; management cited more bad-weather days as a factor in lower attendance.
- The partnership stopped soliciting new construction-management business as of March 27, 2015 and planned to complete projects already in progress.
Outlook, risks and contingencies
- Management expected positive operating cash flow and anticipated funding short-term requirements from operations, debt issuance and available revolver capacity. It expected to fund longer-term acquisitions, redevelopment and capital needs through operating cash flow, borrowings, mortgage financing, debt or equity issuance, and asset sales. No formal earnings guidance was provided.
- Management estimated approximately $72.4 million of capital expenditures, including tenant improvements and leasing commissions, under existing leases, and $65 million to $105 million to substantially complete Manhattan redevelopment and repositioning beyond March 31, 2015. It expected the program to continue through the end of 2016; estimates are subject to change.
- Leases covering 7.6% of portfolio rentable area were due to expire in 2015 and 7.0% in 2016. Management noted that renewal outcomes, vacancy, leasing costs and renovation-related tenant relocation could affect revenue and occupancy.
- Key risks include real estate demand and rental rates, tenant defaults and lease expirations, interest rates and leverage, access to capital, development costs and delays, tourism and weather, competition for observatory visitors, ground-lease terms, environmental matters, and ongoing litigation.
- Litigation challenging the prior consolidation remains relevant: a separate appeal of the dismissal of the Second Class Actions was pending, and 12 investors who opted out of an earlier settlement pursued arbitration; related federal litigation was stayed. The partnership warned that an adverse outcome could have a material effect, including monetary damages or equitable relief. The earlier class-action settlement was described as final and non-appealable.
- The company reported no material environmental remediation obligations known to management, but noted uncertainty about identifying all environmental liabilities. It also disclosed asbestos-containing materials at certain properties; removal obligations could not be reasonably estimated because settlement timing was indeterminable.
Most important facts for investors to verify
- Whether rental growth and leasing spreads translate into sustained occupancy, cash rent growth and property-level profitability, given the quarter’s lower GAAP operating income and net income.
- The timing and full cost of the $72.4 million lease-related commitments and the estimated $65 million to $105 million redevelopment program, and their funding from cash flow versus borrowing.
- Debt maturities, floating-rate exposure and covenant headroom. The filing reports $256 million of floating-rate debt and estimates that a 1% increase in short-term rates would have increased period interest expense by approximately $2.6 million.
- Developments in the Second Class Actions appeal and investor arbitration, including potential indemnification or defense costs and any eventual financial or operational consequences.
- Observatory attendance and revenue trends, including weather, tourism, pricing and competition; Q1 attendance declined despite higher revenue.