Empire State Realty OP, L.P. — Q1 2018 Form 10-Q
Unaudited results for the three months ended March 31, 2018, compared with Q1 2017. The partnership owns and operates office, retail, and Empire State Building observatory assets in Manhattan and the greater New York metropolitan area; its portfolio totaled 10.1 million rentable square feet.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $168.5 million | $165.0 million | +2.1% |
| Operating income | $35.4 million | $36.7 million | -3.5% |
| Net income | $18.1 million | $19.1 million | -5.7% |
| Net income attributable to common unitholders | $17.8 million | $18.9 million | -5.7% |
| Operating cash flow | $68.6 million | $60.9 million | +$7.7 million |
| Cash used in investing activities | $44.1 million | $47.1 million | $3.0 million less used |
| Core FFO attributable to common stockholders | $59.3 million | $61.3 million | -$2.0 million |
- Rental revenue increased 4.4% to $122.3 million; tenant reimbursements rose 11.4% to $17.8 million. Observatory revenue increased 1.5% to $21.2 million.
- Operating expenses grew 3.8% to $133.1 million, including higher property costs, general and administrative expenses, and real estate taxes. Operating margin was approximately 21.0%, versus 22.2% a year earlier.
- Cash and cash equivalents were $690.5 million at quarter-end; cash plus restricted cash totaled $752.2 million. The $222.0 million increase in cash and restricted cash during the quarter primarily reflected debt issuance proceeds.
- Principal debt totaled $1.93 billion; carrying value, net of discounts and financing costs, was $1.92 billion. Weighted-average interest rate was 3.84%, weighted-average maturity 8.8 years, and management reported all outstanding debt as fixed-rate, including the term loan fixed through a swap. Net debt to total market capitalization was approximately 19.5%.
- The $1.1 billion revolving facility was undrawn, leaving approximately $1.1 billion available. The partnership reported compliance with debt covenants. Approximately $250 million of debt matures in 2019, excluding amortization.
- Distributions were $0.105 per unit; total distributions and dividends paid were $31.8 million.
Material changes and operating performance
- Total revenue growth was partly offset by lower lease termination fees: $0.6 million versus $7.9 million in Q1 2017, which included two significant termination fees totaling $7.5 million. Other revenue increased to $6.1 million, including a $2.8 million settlement with a former broadcast tenant.
- Management attributed rental growth primarily to higher rental rates. New, renewal, and expansion leases achieved a portfolio-wide 11.4% increase in mark-to-market rent; Manhattan office leases achieved a 23.8% increase.
- At March 31, total portfolio occupancy was 88.1%, or 91.5% leased including signed leases not yet commenced. Manhattan office occupancy was 87.3%; Empire State Building occupancy was 92.8%.
- The observatory’s 102nd-floor level was closed during Q1 for elevator replacement. Observatory revenue rose despite the closure, aided by ticket mix and average ticket price; excluding the prior-year 102nd-floor revenue, management reported comparable revenue growth of 11.4%.
- Financing activity included issuance of $335 million of senior unsecured notes in March, with proceeds used partly to repay mortgages on 111 West 33rd Street and 1350 Broadway and partly to increase cash. The 1333 Broadway mortgage was increased from $66.6 million to $160 million and extended to 2033 at a fixed 4.21% rate.
Outlook, risks, and contingencies
- No specific earnings or revenue guidance was provided. Management expects positive operating cash flow and anticipates funding distributions, operating needs, debt service, and capital spending through operating cash flow, cash on hand, debt issuance, and available credit.
- Management expects approximately $88 million of capital spending under existing lease commitments, including tenant improvements and leasing commissions. It also expects to invest approximately $50 million annually over three years in the Empire State Building visitor and entrance project; spending through March 31, 2018 was $48.2 million. An additional approximately $40 million is expected for common areas and amenities at other properties during 2018–2020.
- The 102nd-floor observatory is expected to close again in early 2019 for up to nine months. Observatory performance is exposed to tourism, seasonality, weather, competition, and ticket pricing. Office and retail operations face leasing, occupancy, rent, tenant credit, and capital-project execution risks; management characterized the Greater New York office market as soft.
- Leases covering 6.1% of portfolio rentable area expire in 2018 and 7.3% in 2019. Approximately 0.9 million square feet was available to lease at quarter-end. Existing lease commitments included approximately $60.9 million of remaining ground-lease payments.
- An arbitration brought by 12 former Empire State Building investors alleges fiduciary-duty and related claims concerning the offering and formation transactions. Hearings were scheduled through August 2018; respondents considered the claims without merit and intended to defend them. The partnership provides indemnification rights to certain respondents.
- Management reported no other material litigation, no material changes to previously disclosed risk factors, and no material subsequent events. It noted environmental uncertainty, including asbestos-containing materials at certain properties, but said it could not reasonably estimate a related retirement obligation because settlement timing is indeterminable.
Investor verification points
- Confirm the debt maturity schedule, refinancing plans for the $250 million 2019 maturity, and continued compliance with credit-facility covenants.
- Assess whether occupancy and leasing gains translate into commenced leases, sustained rent growth, and cash flow after tenant improvements and leasing commissions.
- Evaluate the effects of the 2019 observatory closure and ongoing Empire State Building capital program on observatory revenue, property access, and spending.
- Separate recurring operating performance from Q1’s $2.8 million broadcast-tenant settlement and the prior-year lease termination fees when comparing periods.
- Track the investor arbitration, capital expenditure commitments, and adoption of lease-accounting rules, which management expected to result in recognition of ground-lease right-of-use assets and liabilities.