Empire State Realty OP, L.P. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; compared with the corresponding 2016 periods. The partnership owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, including the Empire State Building and its observatory. Its portfolio totaled 10.1 million rentable square feet.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $187.3 million | $175.8 million | $529.4 million | $498.7 million |
| Operating income | $56.8 million | $53.6 million | $144.9 million | $131.9 million |
| Net income | $35.5 million | $32.9 million | $86.0 million | $74.2 million |
| Net income attributable to common unitholders | $35.3 million | $32.7 million | $85.3 million | $73.5 million |
| Diluted earnings per unit | $0.12 | $0.12 | $0.28 | $0.27 |
| Core FFO attributable to common holders | $77.5 million | $71.9 million | $212.0 million | $194.8 million |
- Q3 revenue rose 6.5% and net income 7.9% year over year; nine-month revenue rose 6.1% and net income 15.8%. Q3 operating margin was approximately 30.3%, versus 30.5% in Q3 2016.
- Rental revenue increased 5.8% in Q3 and 5.0% for the nine months, primarily from higher rental rates and occupancy. Observatory revenue increased 3.2% and 3.4%, respectively. Nine-month tenant expense reimbursements declined 4.4%.
- Other revenue and fees rose substantially, mainly reflecting lease cancellation income ($9.9 million for the nine months), interest income, and a real estate tax refund. These items contributed to reported growth.
- Operating cash flow was $173.9 million for the nine months, compared with $162.1 million. Investing used $159.2 million, primarily for building and tenant improvements; financing used $137.0 million. Cash and cash equivalents were $432.1 million at September 30, down from $554.4 million at December 31, 2016.
- Total debt was approximately $1.6 billion, with a weighted-average rate of 4.05% and weighted-average maturity of 6.2 years. Net debt to total market capitalization was approximately 15.7%. The $1.1 billion revolving facility was undrawn; management reported covenant compliance.
- Approximately $262.2 million of debt maturities fall in 2018, excluding amortization. Management said it believed refinancing was feasible given liquidity and preliminary lender discussions.
- Declared distributions of $0.105 per unit for Q3, unchanged year over year. Nine-month distributions paid were $95.2 million.
Material changes and management commentary
- Portfolio occupancy was 89.8% and leased occupancy, including signed leases not commenced, was 91.7%. The Manhattan office portfolio was 89.1% occupied and 91.5% leased; the Empire State Building was 93.3% occupied and 93.5% leased.
- During Q3, the partnership signed 34 leases covering 487,854 square feet, reporting a 27.7% mark-to-market rent increase over prior fully escalated rents. New Manhattan office leases covered 276,964 square feet and had a 46.1% increase on that basis.
- The observatory generated $39.3 million in Q3 revenue, up 3.1%, despite visitors declining 4.8% to approximately 1.276 million. Management cited improved ticket mix and higher average ticket price; bad-weather days increased to 14 from 10.
- In August, the partnership amended and restated its revolving credit and term loan facility. The transaction extended the revolver maturity to August 2021, lowered borrowing costs and added covenant flexibility; it recorded a $2.2 million debt-extinguishment loss. The term loan matures in August 2022.
- Management continued a multi-year Empire State Building entrance and visitor-access project, expecting to invest approximately $40–$50 million annually over three years. Spending was $20.3 million during the first nine months of 2017. Separately, estimated future capital expenditures under existing leases were approximately $78.2 million.
- Broadcasting operations face industry pressure. Four radio broadcasters renewed long-term leases and licenses; Ion Television and Fox Television said they would leave at year-end 2017. Management was negotiating with other broadcast tenants and said preliminary renewal proposals could mean lower revenue and higher capital spending.
Risks, contingencies and unusual items
- Former Empire State Building investors are pursuing arbitration alleging fiduciary-duty and related claims concerning the IPO and formation transactions; hearings were scheduled to resume in November and December 2017. The partnership said respondents considered the claims without merit and intended to defend them. Related defense and indemnity rights exist for named individuals.
- Management cited risks including leasing demand and tenant defaults, vacancy and rental rates, tourism and weather, interest rates and access to capital, redevelopment costs and delays, real estate valuations, ground leases, environmental matters, and REIT qualification and distributions.
- Interest-rate swaps had a net liability fair value of $13.4 million and an aggregate $790 million notional amount. Nine-month other comprehensive loss included $14.3 million from swap valuation changes; these changes are not equivalent to current-period operating cash flow.
- Management disclosed asbestos-containing materials at certain properties but no plans that would trigger removal requirements; environmental remediation previously identified at certain sites was reported completed. Management cautioned it cannot ensure all environmental liabilities have been identified.
- No formal earnings guidance was provided. Management expected positive operating cash flows and planned to fund operations, distributions and capital needs from operating cash, cash on hand and borrowing capacity, while noting these expectations are subject to risks.
Important facts for investors to verify
- Whether rental growth and leasing gains persist, and how the 89.8% occupied portfolio and 2017–2018 lease expirations affect cash rents.
- Whether the 2018 maturities can be refinanced on acceptable terms and whether liquidity remains adequate after planned capital spending and distributions.
- The recurring contribution of lease cancellation income and other items to revenue and reported earnings; assess Core FFO alongside GAAP results and cash flow.
- Observatory attendance, ticket pricing, weather effects, and the financial impact of broadcaster departures and renewals.
- Progress, total cost and expected returns of the Empire State Building project, plus tenant improvement and leasing commission requirements.
- Developments in the investor arbitration and any resulting indemnification or financial exposure.