Empire State Realty OP, L.P. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual report, not a standalone fourth-quarter filing. The partnership owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, with the Empire State Building Observatory as a separate business segment.
Business context and portfolio
- Portfolio comprised 14 office properties and six standalone retail properties, totaling approximately 10.1 million rentable square feet; occupancy was 88.8%, or 91.8% leased including signed leases not yet commenced.
- Annualized rent was $535.5 million. The portfolio is concentrated in the New York region; six properties generated 72.2% of rental revenue, with the Empire State Building alone contributing 31.9%.
- Management’s strategy centers on redeveloping and leasing Manhattan office space, raising below-market rents, improving occupancy, and selectively pursuing acquisitions or development. The entitled Metro Tower site in Stamford could support approximately 380,000 rentable square feet; development timing depends on market conditions.
Financial performance and liquidity
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total revenue | $731.5 million | $709.5 million | +3.1% |
| Operating income | $190.9 million | $192.9 million | -1.1% |
| Net income | $117.3 million | $118.3 million | -0.8% |
| Net income attributable to common unitholders | $116.3 million | $117.3 million | -0.9% |
| Net income per unit, basic and diluted | $0.39 | $0.39 | Flat |
| FFO | $282.6 million | $276.5 million | +2.2% |
| Core FFO | $290.4 million | $286.9 million | +1.2% |
| Cash from operating activities | $279.0 million | $194.2 million | +$84.8 million |
- Operating margin was approximately 26.1%, compared with 27.2% in 2017. Revenue increased, but operating expenses rose 4.7% to $540.7 million; interest expense increased 16.3% to $79.6 million.
- Revenue growth included higher rents, Observatory revenue, and lease termination fees. Lease termination fees were $20.8 million, up from $13.6 million; management also reported a $2.8 million settlement with a former broadcast tenant.
- Net cash used in investing was $643.0 million, including $400.0 million placed in short-term investments and $243.0 million of building improvements. Cash, cash equivalents and restricted cash totaled $270.8 million at year-end; separately, cash and cash equivalents plus short-term investments were $605.0 million.
- Debt was approximately $1.9 billion, with a 3.84% weighted-average interest rate and 8.1-year weighted-average maturity. The filing reports all debt as fixed-rate at year-end, including variable-rate facilities hedged by swaps. Net debt was 23.4% of enterprise value. Available revolver capacity was approximately $1.1 billion; the company reported compliance with debt covenants.
- Approximately $250.0 million of principal was due in 2019, including $250.0 million of exchangeable notes maturing August 15, 2019; no principal maturity was scheduled for 2020. The filing states management believed it could refinance future maturities.
- Quarterly distributions totaled $0.42 per unit in 2018, unchanged from 2017. A $500 million share and publicly traded OP-unit repurchase authorization runs through December 31, 2019; authorization does not require purchases.
Material changes and operating developments
- Manhattan office new and renewal leases generated a 24.5% increase in mark-to-market cash rent in 2018, versus 35.6% in 2017. Across the total portfolio, new, renewal and expansion leases achieved a 19.8% increase over prior fully escalated cash rents.
- Operating cash flow increased substantially, primarily because certain operating-liability payments made in 2017 did not recur in 2018. It should not be read as solely reflecting improved recurring operations.
- Interest income rose to $10.7 million from $2.9 million, primarily due to higher rates on cash and short-term investments. Real estate taxes, property operating costs, Observatory expenses, and depreciation also increased.
- The company issued $335 million of long-term senior unsecured notes in March 2018 and used proceeds in part to repay mortgages on 111 West 33rd Street and 1350 Broadway. It also refinanced and increased the mortgage on 1333 Broadway.
- Empire State Building Observatory revenue rose 3.2% to $131.2 million, while visitors declined 3.4% to approximately 3.805 million; Observatory net operating income increased 1.7%. Its 102nd-floor Observatory closed in January 2019 for upgrades, with closure expected to last as long as nine months.
Outlook, risks, contingencies and unusual items
- No formal earnings or operating guidance is provided. Management expects to continue redevelopment and leasing programs. Planned capital work includes approximately $163 million over three years for the Empire State Building project, of which $91.3 million had been spent by year-end 2018, and approximately $40 million through 2020 for greater New York suburban properties, of which $14.1 million had been spent.
- Management expects to re-lease approximately 464,792 square feet of Manhattan office space expiring in 2019; these leases had weighted-average base rent of $54.33 per square foot and were generally viewed by management as below market. Total portfolio vacancy was approximately 0.8 million square feet.
- Key risks include geographic and property concentration, lease expirations and tenant defaults, redevelopment costs and lease-up execution, competition in office and retail markets, interest rates and refinancing, and reliance on tourism and Observatory receipts. New competing New York observatories were expected to open in 2020.
- Three office properties are held under long-term ground leases expiring between 2050 and 2077. The company also disclosed environmental use restrictions at properties in Westport, Connecticut and Harrison, New York, which may limit redevelopment or affect financing or value.
- An arbitration brought by 12 former Empire State Building investors alleges breach of fiduciary duty and related claims concerning the IPO and formation transactions. Hearings concluded in August 2018; post-hearing briefing was scheduled through June 25, 2019. The company disputes the allegations. The filing does not provide a clear estimate of potential loss.
- Management reported no material off-balance-sheet arrangements and no goodwill impairment in 2018. The independent auditor issued an unqualified opinion on the financial statements and internal controls.
Important facts for investors to verify
- Whether 2019 debt maturities were refinanced or repaid, and the resulting borrowing cost and leverage.
- Actual occupancy, leasing spreads, tenant improvements and leasing commissions, particularly for 2019 expirations and vacant Manhattan space.
- The financial and visitor impact of the 102nd-floor Observatory closure, redevelopment spending, and new observatory competition.
- Recurring operating cash flow and earnings excluding termination fees, settlement income, and timing-related cash flow effects.
- Developments in the former-investor arbitration and any changes to disclosed environmental, ground-lease, or tax-protection exposures.