Empire State Realty Trust, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; compared with the three months ended March 31, 2018. ESRT is a REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area, with a separate Empire State Building observatory segment. Its portfolio comprised 10.1 million rentable square feet.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $167.3 million | $167.3 million | Essentially flat |
| Operating income | $26.1 million | $34.2 million | Down 23.7% |
| Net income | $9.9 million | $18.1 million | Down 45.4% |
| Net income attributable to common stockholders | $5.7 million | $9.8 million | Down 41.9% |
| Basic and diluted EPS | $0.03 | $0.06 | Down $0.03 |
| Operating cash flow | $77.9 million | $68.6 million | Up $9.3 million |
| NOI | $85.9 million | $86.2 million | Down 0.4% |
| Core FFO | $56.7 million | $59.3 million | Down 4.4% |
Operating margin was approximately 15.6%, compared with 20.4% in Q1 2018, based on reported operating income and revenue. Rental revenue rose 17.3% to $143.4 million; the comparison is affected by the 2019 adoption of lease accounting guidance, which combined tenant expense reimbursements with rental revenue. Observatory revenue declined 3.2% to $20.6 million. Interest expense increased 17.6% to $20.7 million, while depreciation and amortization rose 15.6% to $46.1 million.
At March 31, 2019, cash and cash equivalents were $242.9 million, short-term investments were $350.0 million, and restricted cash was $61.8 million. The company reported $592.9 million in cash and short-term investments and $1.1 billion available on its undrawn revolving credit facility. Debt principal was approximately $1.93 billion, with a 3.84% weighted-average interest rate and 7.8-year weighted-average maturity. ESRT reported net debt to total market capitalization of approximately 21.6% and compliance with debt covenants. Approximately $250 million of debt matures in 2019, including $250 million of exchangeable notes due August 15.
Q1 investing activities used $11.2 million; financing activities used $32.9 million, including $18.5 million of common dividends and $13.2 million of distributions to non-controlling interests. The declared dividend was $0.105 per share, unchanged from Q1 2018. The balance sheet included $29.5 million of right-of-use assets and corresponding ground-lease liabilities following adoption of the new lease standard.
Operating changes and management commentary
- Total portfolio occupancy was 88.8%, or 91.5% leased including signed leases not yet commenced. Manhattan office occupancy was 88.9%; the Empire State Building was 92.9% occupied.
- ESRT signed 34 leases covering 308,051 square feet and reported a 13.4% portfolio-wide increase in mark-to-market cash rent on new, renewal, and expansion leases. Manhattan office leases achieved a reported 21.1% increase.
- The FDIC renewed a 119,226-square-foot lease, addressing the company’s largest near-term lease expiration; it represented 1.3% of portfolio annualized rent.
- Management attributed the observatory revenue decline primarily to the Easter holiday falling entirely in Q2 2019, compared with a split between Q1 and Q2 in 2018. Visitor count declined 6.7%, to approximately 601,000. The 102nd-floor observatory closed in January for an upgrade and could remain closed for up to nine months.
- Management cited higher base rent as the main driver of rental growth. General and administrative expense increased partly because lease accounting adoption required certain leasing costs to be expensed as incurred. Higher depreciation, real estate taxes, and interest expense also weighed on earnings.
Outlook, commitments, risks, and unusual items
- Management expected positive operating cash flow and believed available liquidity would support near-term needs and refinancing of future maturities. No formal earnings or FFO guidance was provided in the filing text.
- Approximately $99.4 million of future tenant improvements and leasing commissions were expected under existing lease agreements. Management expected to fund these and other capital needs with operating cash flow, cash, borrowings, and property-level financing.
- The company expected approximately $160 million of investment over three years for the Empire State Building capital project; $105.1 million had been spent through March 31, 2019. It also anticipated approximately $40 million of upgrades to regional properties over 2018–2020; $17.7 million had been spent through quarter-end.
- Management identified risks including a soft Greater New York office market, leasing and vacancy pressures, redevelopment costs and timing, observatory tourism and competition, interest rates and debt refinancing, tenant defaults, and broader real-estate and capital-market conditions.
- A continuing arbitration brought by 12 former investors alleges claims relating to the company’s formation and offering. Hearings concluded in August 2018; post-hearing briefing was scheduled to finish by September 9, 2019. Respondents consider the claims without merit and intend to defend them. The filing states there was no other material litigation known to management.
- Adoption of lease accounting guidance on January 1, 2019 changed presentation and recognized approximately $29.5 million of operating-lease right-of-use assets and liabilities. The company also expensed $1.1 million of non-contingent leasing costs in Q1 under the new guidance; prior-year results were not restated.
Most important facts for investors to verify
- How the $250 million exchangeable-note maturity was refinanced or repaid after August 2019, and the resulting cost and capital structure.
- Whether leasing activity converts signed leases into occupancy and cash rent, and how upcoming 2019–2020 expirations affect portfolio occupancy and annualized rent.
- The duration and financial impact of the 102nd-floor observatory closure and the progress and cost of the Empire State Building upgrade.
- Whether operating cash flow and available liquidity cover the stated $99.4 million of lease-related capital commitments, redevelopment spending, and distributions.
- Trends in interest expense, capital spending, and Core FFO; FFO and NOI are non-GAAP measures and are not substitutes for GAAP earnings or cash flow.
- Developments in the former-investor arbitration and any potential financial exposure.