Empire State Realty Trust, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. ESRT is a REIT owning and operating office and retail properties in Manhattan and the greater New York metropolitan area, plus the Empire State Building observatory. Its portfolio comprised 10.1 million rentable square feet. The 2019 adoption of lease accounting standard Topic 842 combined rental income and tenant expense reimbursements into one line; prior periods were not restated, limiting direct line-item comparisons.
Key financial results
| 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 attributable to common stockholders | $15.9 million | $16.3 million | $32.6 million | $42.8 million |
| Basic and diluted EPS | $0.09 | $0.10 | $0.18 | $0.26 |
| Core FFO | $71.8 million | $73.0 million | $193.0 million | $203.2 million |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $198.4 million | $187.4 million |
Q3 operating margin was approximately 23.5%, compared with 26.0% a year earlier; nine-month operating margin was approximately 20.1%, versus 24.9%. The company declared dividends of $0.105 per share for the quarter, unchanged year over year.
- Revenue and operations: Q3 revenue increased 3.5%; nine-month revenue increased 0.8%. Reported rental revenue rose 21.5% for Q3 and 17.5% for nine months, but the comparison is affected by the Topic 842 presentation change. Observatory revenue fell 6.6% in Q3 and 5.8% for nine months.
- Profit and expenses: Q3 common-stockholder net income decreased 2.8%; nine-month net income decreased 23.7%. Nine-month operating expenses rose 7.2%, including higher depreciation, general and administrative costs, property operating costs and real estate taxes. Nine-month interest expense increased 3.3%.
- Cash flow and investment: Nine-month operating cash flow was $198.4 million. Capital expenditures excluding tenant improvements and leasing commissions were $99.3 million. Cash and cash equivalents were $293.7 million at quarter-end; restricted cash was $36.6 million. Cash, cash equivalents and restricted cash totaled $330.3 million.
- Debt and liquidity: Total debt principal was approximately $1.677 billion; weighted-average rate was 4.03%, weighted-average maturity 8.5 years, and management reported all indebtedness as fixed-rate. Net debt to total market capitalization was approximately 24.1%. The company had $1.1 billion available on its revolving credit facility and reported covenant compliance. The $250 million exchangeable notes were repaid in cash in August; excluding scheduled amortization, no debt was due before 2022.
Material changes and operating developments
- Q3 portfolio occupancy was 89.4%, or 91.7% including signed leases not yet commenced. Manhattan office occupancy was 89.6%; Empire State Building occupancy was 93.4%.
- ESRT signed 25 leases totaling 388,686 square feet in Q3, with a 23.9% increase in mark-to-market cash rent over prior fully escalated cash rents. Manhattan office new leases totaled 266,769 square feet and achieved a 32.6% increase on the same basis.
- The 102nd-floor observatory was closed for about nine months during 2019 and reopened October 12, 2019. Q3 observatory revenue was $37.6 million, down 6.6%; visitors declined 10.7% to approximately 1.042 million. Management cited the closure and lower visitation, partly offset by higher pricing. The 80th-floor upgrade was expected to open in November 2019.
- Management reported approximately $144.2 million of expected capital expenditures, including tenant improvements and leasing commissions, under existing leases. It planned to fund these with operating cash flow, cash, property-level mortgage financing and borrowings.
- ESRT adopted Topic 842 on January 1, 2019, recording approximately $29.5 million of ground-lease right-of-use assets and liabilities. It also began expensing non-contingent leasing costs; these costs were $3.7 million for the first nine months.
Outlook, risks and contingencies
No specific earnings or financial guidance was provided. Management expected positive operating cash flows and anticipated funding short- and long-term needs through operating cash, cash on hand, debt and available credit. It continued a Manhattan redevelopment and repositioning program, describing potential long-term benefits to occupancy, rents, operating margins and cash flows, while acknowledging that renovations may temporarily reduce occupancy. It cited a soft Greater New York metropolitan office market and competition from recently redeveloped or planned properties.
- Key disclosed risks include weaker office or retail demand, lower rents or higher vacancies, tenant defaults or nonrenewals, real estate market changes, redevelopment delays and cost overruns, interest-rate and capital-market volatility, leverage and refinancing, observatory attendance and tourism trends, and environmental, regulatory and climate-related risks.
- A long-running arbitration by 12 former investors related to the company’s formation and IPO remained pending; post-hearing briefing was scheduled to conclude by March 2020. The company and other respondents considered the claims without merit and intended to defend them. The company had indemnification obligations to certain respondents.
- Management estimated $144.2 million of future lease-related capital costs. It also disclosed asbestos-containing materials at certain properties; no removal obligation could be reasonably estimated because settlement timing was indeterminable. Management did not expect known environmental matters to have a material impact but noted it could not be certain all liabilities had been identified.
Most important facts for investors to verify
- How much of reported rental-revenue growth reflects underlying rent growth versus Topic 842’s reclassification of tenant reimbursements.
- Whether occupancy, signed leases and mark-to-market leasing gains translate into commenced leases and recurring cash rent, alongside the cost of tenant improvements and commissions.
- Whether observatory attendance and revenue recover following the 102nd-floor reopening and planned 80th-floor work.
- Funding and timing for the $144.2 million of lease commitments, ongoing redevelopment spending and future debt maturities; confirm covenant headroom and liquidity remain adequate.
- Developments in the former-investor arbitration and any material changes to environmental or other contingencies.