Business context and reporting period
Empire State Realty Trust, Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2015. The REIT owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, as well as the Empire State Building observatory. Its portfolio included 10.1 million rentable square feet. The company reports real estate and observatory segments; it stopped seeking new construction-management business in March 2015.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $175.8 million | $169.4 million | $492.4 million | $464.9 million |
| Operating income | $45.3 million | $43.4 million | $114.1 million | $110.0 million |
| Net income | $26.1 million | $22.7 million | $60.6 million | $59.2 million |
| Net income attributable to common stockholders | $11.2 million | $8.3 million | $25.5 million | $22.5 million |
| Basic / diluted EPS | $0.10 / $0.10 | $0.09 / $0.09 | $0.23 / $0.22 | $0.23 / $0.23 |
| Operating margin | 25.8% | 25.6% | 23.2% | 23.7% |
| Core FFO per diluted share | $0.27 | $0.25 | $0.72 | $0.65 |
For the nine months, cash from operating activities was $159.6 million, versus $101.6 million a year earlier; investing used $105.0 million, versus $264.6 million; financing used $54.0 million, compared with $155.2 million provided in 2014. Cash and cash equivalents were $46.4 million at September 30, 2015; restricted cash was a further $64.9 million. The company had $780.0 million available on its $800 million unsecured revolver.
Total debt principal was $1.623 billion ($1.629 billion carrying amount including unamortized premiums and discounts). Management reported a 4.11% weighted-average interest rate, 5.7-year weighted-average maturity, and debt equal to approximately 26% of total market capitalization. No debt matured in 2015 or 2016. Fixed-rate mortgage debt was $738.2 million; floating-rate borrowings under the revolver and term loan totaled $285.0 million. A 1 percentage-point increase in short-term rates would have increased interest expense by an estimated $2.9 million, based on balances at quarter-end. Debt covenants were reported in compliance.
The common dividend was $0.085 per share for the quarter, unchanged from 2014. Nine-month capital expenditures excluding tenant improvements and leasing commissions were $36.7 million, compared with $48.9 million. The company estimated $65.7 million of capital commitments under signed leases over the following 12 months.
Material changes versus prior comparable periods
- Q3 revenue rose 3.7%; common-stockholder net income rose 34.8%. Nine-month revenue increased 5.9%, while net income increased 2.2% and common-stockholder net income increased 13.1%.
- Rental revenue increased 4.5% in Q3 and 15.7% for nine months. Management attributed much of the year-to-date increase to the July 2014 acquisitions of 112 West 34th Street and 1400 Broadway, with the balance mainly reflecting higher rents.
- Q3 operating income grew 4.4%; nine-month operating income grew 3.7%. Depreciation and amortization rose 19.2% in Q3 and 30.6% year to date, including a $5.7 million write-off of acquired lease intangibles after a tenant reduced its space.
- Construction revenue fell to zero in Q3 and to $2.0 million year to date as the business wound down. Q3 other revenue included a $2.5 million acquisition break-up fee; this is non-recurring and excluded from the company’s NOI reconciliation.
- Q3 observatory revenue was essentially unchanged at $35.7 million. Nine-month observatory revenue increased 1.4% to $84.5 million despite lower admissions; management cited higher admission prices and more adverse-weather days.
- Debt refinancing changed the funding mix: the company issued $350 million of senior unsecured notes and borrowed $265 million under a new unsecured term loan, while repaying mortgage and prior credit-facility borrowings. The prior secured credit facility was replaced by an unsecured revolver.
Outlook, commentary, risks and unusual items
No specific earnings or revenue guidance was provided. Management expected positive operating cash flow and planned to fund near-term needs through operations, cash, debt issuance and available revolver capacity. It estimated $45 million to $75 million of remaining capital needs to substantially complete its Manhattan redevelopment and repositioning program, expected by the end of 2016; work at the Empire State Building was expected to continue through 2016. Management cautioned that budgets and timelines may change and that renovation activity may temporarily reduce occupancy.
At quarter-end, the portfolio was 87.4% occupied and 90.0% leased including signed leases not yet commenced. Manhattan office occupancy was 85.4% (88.4% leased including signed leases); the Empire State Building was 83.7% occupied (91.2% leased including signed leases). The company signed 67 leases covering 338,477 square feet in Q3, with a reported 34.5% mark-to-market rent increase over prior fully escalated rents; new Manhattan office leases had a reported 41.0% increase. About 10.0% of portfolio area was available to lease, and leases covering 3.9% and 7.2% of portfolio area were due to expire in 2015 and 2016, respectively.
Key risks include leasing and tenant credit, real estate and tourism conditions, interest rates and access to financing, redevelopment costs and execution, and ground-lease expirations. The company identified ongoing litigation and arbitration related to its formation/consolidation transactions; it could not reasonably estimate potential loss or timing for certain matters and noted that an adverse outcome could materially affect it. It also disclosed indemnification obligations for certain executives. Environmental assessments found asbestos-containing materials at some properties, but management said it had no removal plans that would trigger applicable removal requirements and could not reasonably estimate a related retirement obligation. Three interest-rate swaps had a $4.4 million fair-value liability and generated an unrealized loss recorded in other comprehensive income. Broadcasting licenses generally expire between 2016 and 2023; management cited industry deterioration, a spectrum auction and new competition, and said preliminary renewal proposals could mean lower revenue, higher operating costs or capital needs.
Important facts for investors to verify
- Whether leasing gains, occupancy and rent mark-to-market improvements persist as redevelopment progresses and upcoming leases expire.
- Whether the $65.7 million of signed-lease commitments and the remaining $45 million to $75 million redevelopment budget are funded and delivered on schedule and within budget.
- Debt maturities, floating-rate exposure, swap effectiveness and continued compliance with financing covenants.
- Potential outcomes and financial exposure from the consolidation-related litigation, appeal and arbitration, including the company’s indemnification obligations.
- Whether observatory admissions and broadcasting revenue remain resilient amid tourism, weather, competition and broadcast-market changes.
- How much of reported earnings and Core FFO reflects recurring operations versus items such as the acquisition break-up fee and lease-intangible write-off; FFO and Core FFO are non-GAAP measures and are not cash flow.