Empire State Realty Trust, Inc. annual report, FY2013

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Empire State Realty Trust, Inc. — FY 2013 Form 10-K

Reporting period: Fiscal year ended December 31, 2013. This is an annual filing, not a standalone fourth-quarter report. ESRT began operations as a public company after its IPO and formation transactions closed on October 7, 2013; consequently, annual comparisons combine successor and predecessor periods and are not fully like-for-like.

Business context and reporting period

ESRT is a self-managed REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area. At year-end, its portfolio comprised 8.35 million rentable square feet across 12 office properties and six standalone retail properties, plus retail space within office buildings. Occupancy was 86.1%; including signed leases not yet commenced, the portfolio was 87.7% leased. Annualized rent was approximately $345.7 million.

The IPO and formation transactions brought the portfolio and four previously non-controlled properties, including the Empire State Building observatory operations, into the company’s reporting structure. The company issued approximately 82.2 million Class A shares at $13 per share and received net IPO proceeds of approximately $884.1 million.

Revenue, profit, cash flow, margins, debt and liquidity

  • FY 2013 revenue: $333.7 million, up 28.2% from $260.3 million in 2012. The increase reflects, among other items, the consolidation of four properties and observatory operations after October 7.
  • Operating income: $75.7 million, down 14.6% from $88.7 million. Reported operating margin was approximately 22.7%, compared with 34.1% in 2012; the periods and entity scope are not fully comparable.
  • Net income: $156.2 million versus $48.6 million in 2012. FY 2013 included a $322.6 million gain on consolidation, $138.1 million of acquisition expenses and a $55.0 million settlement expense. These unusual items materially affect the comparison and reported profit.
  • Fourth-quarter figures: The unaudited quarterly table reports $149.4 million of revenue and $148.9 million of net income for the quarter ended December 31, 2013; $30.7 million was attributable to ESRT. The quarter includes the transaction-related accounting effects and should not be read as a run-rate result.
  • Operating performance measures: Company-period FFO was $220.8 million and Core FFO was $41.4 million for October 7–December 31. Predecessor-period FFO and Core FFO were $7.4 million and $62.4 million, respectively, for January 1–October 6. These measures use different periods and reporting bases; they are not a clean full-year comparison. FFO and Core FFO are non-GAAP measures and do not represent operating cash flow or cash available for distributions.
  • Observatory: Management reported 4.3 million visitors and $101.8 million of observatory revenue for 2013, up 2.7% and 10.8%, respectively, from 2012. The audited consolidated income statement includes $23.7 million of observatory revenue for the post-IPO period only.
  • Cash flow: Combining the reported successor and predecessor periods, operating cash flow was approximately negative $58.5 million, investing cash flow negative $676.8 million and financing cash flow positive $744.5 million. Cash and cash equivalents were $60.7 million at year-end; restricted cash was $55.6 million. Large acquisition and formation-related cash flows make these totals atypical.
  • Debt and liquidity: Total debt was $1.208 billion, with a 4.56% weighted-average interest rate and 3.1-year weighted-average maturity. Approximately 69.2% was fixed rate; floating-rate debt was $372.5 million. Debt principal maturities were approximately $197.5 million in 2014 and $90.5 million in 2015. The secured revolving and term facility had $325.0 million outstanding and approximately $441.8 million available under the revolving facility. The company reported compliance with its financial covenants at year-end.
  • Balance sheet: Total assets were $2.476 billion and total equity was $1.003 billion. Goodwill was $491.5 million, recorded in connection with acquisitions; management reported no impairment at year-end.
  • Distributions: The company declared a partial 2013 dividend of $0.0795 per share, classified as fully taxable ordinary dividends. A $0.085-per-share first-quarter 2014 dividend was declared after year-end.

Material changes versus prior comparable periods

  • Revenue rose, principally because the IPO and formation transactions added consolidated properties and observatory operations. The change in consolidation scope complicates comparison with 2012.
  • Operating expenses increased 50.3% to $257.9 million, including increases in property costs, real estate taxes, depreciation and amortization, and public-company and transaction-related expenses. Operating income consequently declined despite higher revenue.
  • The 2013 reported net income increase was driven by the consolidation gain; excluding transaction effects, the headline increase is not a straightforward indicator of recurring performance.
  • Manhattan office new and renewed leases covering approximately 948,320 square feet in 2013 had a reported average first-month contractual base rent of $44.54 per square foot, versus prior rents of $39.18 per square foot. The filing notes measurement changes and free-rent periods can affect comparisons.
  • Capital expenditures, excluding tenant improvements and leasing commissions, were $80.3 million in 2013, compared with $57.4 million in 2012.

Outlook, management commentary, risks and contingencies

  • Management estimated an additional $110–$150 million of capital would be needed after 2013 to substantially complete the Manhattan redevelopment program, expected by the end of 2016. This estimate excludes tenant improvements and leasing commissions and is subject to change. The company expects to use operating cash flow and borrowings.
  • Approximately $48.3 million of tenant improvements and leasing commissions were expected to be incurred during 2014 under signed leases. Metro Tower, an entitled Stamford development site supporting an approximately 380,000-square-foot office building and garage, would proceed when management considers market and other conditions appropriate; no development timetable or return guidance is provided.
  • The company was evaluating options to acquire 1400 Broadway and 112–122 West 34th Street, related-party properties totaling approximately 1.64 million rentable square feet. Independent valuations and approval by independent directors were part of the process; exercise and purchase prices were not assured.
  • Portfolio concentration is material: four properties represented approximately 62% of annualized rent, and the Empire State Building alone represented approximately 33%. The largest tenant, LF USA, represented approximately 10.4% of annualized rent; the filing describes marketing of portions of its space.
  • Key risks include the concentration of properties in the New York region, vacancies and lease renewals, tenant credit, redevelopment cost and timing, debt refinancing and floating-rate exposure, and competition for office tenants and observatory visitors. Management also cites potential competition from One World Trade Center’s planned observatory and broadcasting operations.
  • Litigation related to the formation transactions remained a contingency. An appeals court affirmed a key trial-court ruling in February 2014, but further appeal activity and separate class actions remained possible. The company stated that it could not predict outcomes and could incur defense costs or other liabilities; the $55.0 million settlement expense was recorded in 2013.
  • Environmental matters include restricted contaminated soil at a Westport retail property and land-use and development restrictions at 500 Mamaroneck Avenue. Management did not believe known environmental matters would materially affect operations, but disclosed potential effects on redevelopment, financing and resale.
  • REIT qualification is intended from the 2013 tax year. The filing describes risks if qualification requirements are not met, including potential corporate-level tax and reduced cash available for distributions. The company also disclosed related-party arrangements, tax-protection obligations and governance and voting-control considerations.

Most important facts for investors to verify

  • Reconcile successor and predecessor financial statements before using annual or quarterly growth, margin, FFO or cash-flow comparisons; distinguish recurring property results from acquisition and formation accounting effects.
  • Track leasing, occupancy, rent spreads, tenant improvements and leasing commissions—especially at Manhattan properties and for LF USA space—and assess whether reported rent growth converts to cash flow.
  • Review debt maturities, refinancing progress, facility availability, covenant headroom and sensitivity to interest rates, including the 2014 and 2015 maturities.
  • Monitor redevelopment spending against the $110–$150 million estimate and test whether expected occupancy and rent improvements justify the capital required.
  • Verify the outcome and terms of any option-property acquisitions, including valuation, funding mix, related-party safeguards and resulting leverage or dilution.
  • Follow litigation developments, environmental restrictions, goodwill impairment assessments and compliance with REIT distribution and qualification requirements.