Business context and reporting period
Empire State Realty Trust, Inc. (ESRT) filed this Form 10-Q for the quarter ended June 30, 2014. The REIT owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, along with the Empire State Building observatory. At quarter-end, its portfolio comprised 8.4 million rentable square feet and was 88.6% occupied, or 89.6% leased including signed leases not yet commenced.
Comparisons with 2013 require caution: ESRT began operations after its October 2013 IPO and formation transactions. The 2013 figures are those of its predecessor, which did not include the four non-controlled properties and observatory operations that were consolidated into ESRT in 2013.
Financial results and key metrics
| Metric | Q2 2014 | Six months 2014 | Comparable 2013 |
|---|---|---|---|
| Total revenue | $155.2 million | $295.5 million | $59.6 million / $122.0 million |
| Operating income | $40.6 million | $66.2 million | $11.7 million / $26.0 million |
| Net income | $25.3 million | $36.5 million | $3.1 million / $5.0 million |
| Net income attributable to ESRT; diluted EPS | $9.8 million; $0.10 | $14.2 million; $0.15 | Not directly comparable; predecessor period |
| Operating margin, calculated | 26.2% | 22.4% | 19.7% / 21.3% |
| NOI, non-GAAP | $79.6 million | $142.6 million | $40.7 million / $77.2 million |
| FFO, non-GAAP | $53.8 million; $0.22 per share/unit | $95.1 million; $0.39 per share/unit | $18.0 million / $33.8 million |
Rental revenue was $92.2 million for Q2 and $182.4 million for the six months; observatory revenue was $30.4 million and $47.7 million, respectively. Q2 observatory revenue increased 11.4% year over year, while six-month revenue increased 8.4%; six-month visitor count was unchanged at 1.886 million. Growth in reported revenue and expenses was substantially driven by the post-IPO consolidation of properties and observatory operations, rather than solely by comparable-property performance.
Six-month cash from operations was $46.1 million, investing cash outflow was $45.3 million, and financing cash outflow was $19.8 million. Cash and cash equivalents fell by $19.0 million to $41.8 million; restricted cash was $55.5 million. The company paid $0.085 per share and OP unit for each of the first two quarters, or $0.17 for the six months.
At June 30, total debt was approximately $1.229 billion: $873.9 million of mortgage debt and $355.0 million under the secured term and revolving credit facility. Management reported a 4.47% weighted-average interest rate, 2.6-year weighted-average maturity, and 67.2% fixed-rate debt. Debt fair value was $1.243 billion versus carrying value of $1.229 billion. The company reported $445 million available under its credit facility, subject to a $27.3 million availability reduction pending specified Empire State Building capital expenditures.
Material changes and significant transactions
- Year-over-year increases in revenue, operating expenses, depreciation and amortization largely reflect consolidation of the four non-controlled properties and the observatory after the October 2013 formation transactions. Prior-period equity income from non-controlled entities ceased after consolidation.
- ESRT acquired the ground and operating leases at 112 West 34th Street and the ground lease at 1400 Broadway on July 15, 2014, for total consideration of approximately $733.6 million, including cash, assumed debt, common shares and Series PR OP units. The acquisitions were not included in June 30 results; the company subsequently borrowed an additional $190 million under its credit facility in connection with them.
- Three loans totaling $89.8 million were extended after quarter-end from August 1, 2014 to February 1, 2015. Management also cited approximately $200.9 million of 2014 and $98.5 million of 2015 debt maturities at quarter-end and believed they could be refinanced.
Outlook, risks and unusual items
Management reported 403,000 rentable square feet of new leases, expansions and renewals signed during the first half. Approximately 3.4% of portfolio area was due to expire in the second half of 2014 and 8.5% in 2015. Management expects repositioning and redevelopment to support occupancy and rents over time, while noting that renovations and tenant relocations can weigh on occupancy in the near term. It estimated $80 million to $120 million of additional capital to substantially complete the Manhattan office redevelopment program, targeted by the end of 2016, and $60.8 million of tenant improvement and leasing commission commitments under existing leases.
Key risks include refinancing and interest-rate exposure, tenant defaults or non-renewals, leasing and redevelopment costs, property-market conditions, and observatory tourism, weather and competition. A 1 percentage-point increase in short-term rates was estimated to increase interest expense by approximately $4.0 million for the period analyzed. The company was in compliance with its credit facility covenants at June 30; those covenants include leverage and fixed-charge tests and can restrict distributions.
Pending appeals related to litigation over the original consolidation could result in monetary damages or equitable relief if successful; management said it could not predict their timing or outcome. A separate set of class actions was dismissed by the court in July 2014, subject to plaintiffs’ right to appeal. The company may incur defense and indemnification costs. Other items affecting results included $0.735 million of acquisition expense, $0.950 million of preferred exchange offering costs, and approximately $1.0 million of observatory lawsuit-settlement income. Management identified no property impairment for the six-month period. It also disclosed asbestos-containing materials at certain properties, with removal obligations not reasonably estimable because settlement timing is indeterminable.
Ground-lease properties carry additional risk: ESRT’s interests in 1350 Broadway, 112 West 34th Street and 1400 Broadway depend on long-term leases, and the company may lose operating rights or face materially reduced profitability upon breach or lease expiration. The REIT’s distribution requirements and debt obligations may also constrain cash available for investment or distributions.
Investor facts to verify
- Separate acquisition-driven growth from comparable-property operating performance; the 2013 predecessor comparison is not like-for-like.
- Confirm post-quarter acquisition financing, updated debt balances, facility availability and refinancing of near-term maturities.
- Track occupancy, signed leases, expirations, tenant improvement commitments and the cost and timing of the redevelopment program.
- Review the status and potential financial consequences of consolidation-related litigation appeals and indemnification obligations.
- Assess observatory attendance, seasonality, pricing and competitive conditions, and monitor compliance with REIT and credit-facility distribution requirements.