Empire State Realty Trust, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. ESRT is a REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area, with the Empire State Building Observatory as a separate operating segment. Its portfolio comprised 10.1 million rentable square feet.
Financial performance and liquidity
| Metric | Q3 2020 | Nine months 2020 |
|---|---|---|
| Total revenue | $146.6 million, down 24.0% | $457.8 million, down 14.6% |
| Net income (loss) | $(12.3) million | $(23.6) million |
| Net income (loss) attributable to common stockholders | $(8.2) million; $(0.05) per share | $(16.5) million; $(0.09) per share |
| Operating income | $11.9 million, down 73.7% | $39.2 million, down 63.5% |
| Operating cash flow | Not provided for the quarter | $163.6 million, versus $198.4 million |
| Core FFO | $34.9 million, versus $71.8 million | $128.1 million, versus $193.0 million |
Cash and cash equivalents were $373.1 million; cash plus restricted cash was $428.0 million. ESRT reported $1.1 billion of undrawn revolving credit availability and described total liquidity as approximately $1.5 billion. Total debt was approximately $2.0 billion, with a 4.0% weighted-average interest rate and 8.3-year weighted-average maturity. Debt was 93.7% fixed-rate and 6.3% variable-rate; net debt to total market capitalization was 46.3%. No debt maturity was scheduled before 2024, excluding amortization. The company was in compliance with debt covenants.
Common dividends were suspended for Q3 and Q4 2020. The company said it expected no taxable income for 2020 and that a dividend was not then the highest and best use of its balance sheet. It paid $65.4 million in total dividends and distributions during the first nine months of 2020.
Material changes versus the prior comparable period
- Q3 rental revenue declined 6.9% to $139.9 million; nine-month rental revenue declined 2.0% to $426.0 million. Management cited straight-line and uncollectible receivable write-offs and lower tenant expense reimbursements.
- Observatory revenue fell 88.2% in Q3 to $4.4 million and 73.6% for the nine months to $24.0 million. The Observatory closed March 16 and reopened its 86th-floor deck July 20 and 102nd-floor deck August 24. Q3 attendance was approximately 30,000, down 97.1% from 1.042 million.
- Property operating expenses declined 29.4% in Q3 and 19.9% for the nine-month period, reflecting lower utilization and cost reductions. Year-to-date operating expenses were $26 million below the prior year.
- Interest expense rose 20.3% in Q3 and 10.2% for the nine months, largely due to 2020 financings and temporary revolver borrowings. The $550 million revolver draw was repaid September 1.
- The company recorded $6.2 million of impairment charges year to date: $4.1 million for an energy-efficiency project deemed uneconomic and $2.1 million for a halted build-to-suit project.
- Operating cash flow declined by $34.8 million year over year. Cash and restricted cash increased, primarily reflecting debt issuance, partly offset by share repurchases.
Management commentary, risks and unusual items
- Q3 Same-Store Property Cash NOI, excluding lease termination fees, increased 9.3%, primarily from lower property costs and free-rent burn-off, partly offset by lower revenue. This is a non-GAAP measure.
- ESRT collected 94% of Q3 billings (96% office; 84% retail). By October 31, it had collected 93% of October billings (94% office; 86% retail). Management noted particular pressure on smaller food and service retailers and was considering percentage-rent arrangements with repayment terms.
- The portfolio was 89.7% leased at September 30, including leases scheduled to expire covering 2.6% of space in 2020 and 6.2% in 2021. Management expected near-term leasing activity to remain slower and discussed possible longer vacancy periods and lower rents.
- Management continued to believe in long-term office demand but said the pandemic could change space use, including less densification and more distancing. It expected international Observatory visitors to take time to recover; a typical visitor mix, approximately two-thirds international, was not expected until broad international air travel resumed, potentially in 2022.
- Management reported approximately $130.1 million of expected capital expenditures, tenant improvements and leasing commissions under existing leases. It reduced planned 2020 building-improvement spending by $24 million versus 2019.
- Observatory goodwill was $227.5 million. Its estimated fair value exceeded carrying value by less than 5%, leaving limited valuation headroom; further impairment testing may be required as assumptions change.
- An arbitration panel awarded former investors approximately $1.2 million, including interest, on one claim and denied the remaining claims. ESRT said it considered the award without merit and was evaluating next steps; the filing records an estimated IPO-litigation expense of $1.2 million.
- Key uncertainties include COVID-19 effects on tenant rent payments, leasing demand, tourism, capital access and property values; possible tenant defaults or bankruptcies; refinancing and interest-rate risk, including LIBOR transition; and execution and cost risks for redevelopment and capital projects. ESRT disclosed no material changes to its other previously reported risk factors.
Investor verification priorities
- Track rent collections, deferrals, tenant credit quality, lease expirations and leasing activity, especially for retail and near-term expiries.
- Monitor Observatory visitation, revenue, operating costs and goodwill impairment headroom as travel restrictions and tourism evolve.
- Review the suspended-dividend policy, REIT taxable-income expectations and cash needs against the $130.1 million of anticipated lease-related spending.
- Verify debt covenant headroom, floating-rate exposure, revolver maturity and extension options, and refinancing plans for maturities beginning in 2024.
- Assess whether cost savings and higher reported same-store cash NOI persist as buildings repopulate and tenant expense recoveries change.
- Follow the IPO-related arbitration award and any further litigation expense or resolution.