Empire State Realty OP, L.P. — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. The partnership began meaningful operations on October 7, 2013, when its IPO and formation transactions closed. Accordingly, full-year 2013 combines predecessor results through October 6 with successor results thereafter; the portfolio and accounting basis changed materially at closing, limiting comparisons with 2012. The filing also presents unaudited fourth-quarter results.
Business context and portfolio
The operating partnership owns and operates office and retail properties, primarily in Manhattan and the greater New York metropolitan area, and conducts the business of Empire State Realty Trust, Inc. (ESRT), its sole general partner. At year-end, the portfolio comprised 8.35 million rentable square feet, was 86.1% occupied and 87.7% leased including signed leases not yet commenced, and generated $345.7 million of annualized rent. The Empire State Building observatory is a significant additional business.
Financial performance and liquidity
| Metric | 2013 | 2012 |
|---|---|---|
| Total revenue | $333.7 million | $260.3 million |
| Operating income | $75.7 million | $88.7 million |
| Net income | $156.2 million | $48.6 million |
| Interest expense | $63.8 million | $54.4 million |
Revenue rose 28.2%, largely reflecting the October acquisition and consolidation of four previously non-controlled properties; observatory operations were also included in consolidated results after closing. Operating income fell 14.6% as expenses increased. Net income was substantially affected by a $322.6 million gain on consolidation, $138.1 million of acquisition expenses, and a $55.0 million settlement expense recorded in predecessor results. The filing explains that the settlement was to be funded by certain former owners and investors, not by the partnership. Thus, reported net income is not a clean measure of recurring performance.
The filing reports fourth-quarter 2013 revenue of $149.4 million and net income of $148.9 million; the quarter includes the effects of the formation transactions and consolidation gain. For the successor period from October 7 through December 31, revenue was $127.6 million and net income was $193.4 million. These periods are not directly comparable with a normal standalone quarter.
Cash flow: For the combined 2013 periods, operating activities used approximately $58.5 million, investing activities used approximately $676.8 million, and financing activities provided approximately $744.5 million. The cash outflow reflected, among other items, acquisition and formation costs and the cash paid to acquire non-controlled properties. Year-end cash and cash equivalents were $60.7 million, with $55.6 million of restricted cash.
Debt and liquidity: Year-end consolidated debt was $1.208 billion, with a 4.56% weighted-average interest rate, 3.1-year weighted-average maturity, and 69.2% fixed-rate. Debt represented 24.3% of enterprise value. The filing reports $441.8 million available under the secured revolving credit facility; it separately cites approximately $452.4 million of available borrowing capacity under loans and credit facilities. Debt maturities were approximately $197.5 million in 2014 and $90.5 million in 2015. Floating-rate debt was $372.5 million; management estimated a 1-percentage-point rate increase would have added about $3.7 million to 2013 interest expense.
Material changes and operating trends
- Rental revenue increased 16.6% to $228.7 million, while tenant expense reimbursements rose 25.9% to $37.1 million. Acquired properties drove much of the increase; lower Empire State Building overage rent partly offset it.
- Observatory revenue was $101.8 million for full-year 2013, up 10.8% from 2012, with 4.3 million visitors, up 2.7%. Fourth-quarter revenue rose 10.4% to $25.4 million, with visitors up 8.5% to about 980,000.
- Management reported $948,320 square feet of new and renewed Manhattan office leases in 2013. First monthly base rent after free-rent periods averaged $44.54 per square foot, versus $39.18 for the prior leases.
- Year-end office occupancy was 85.6%; Manhattan office occupancy was 84.4%, and retail occupancy was 91.9%. About 1.0 million square feet was vacant, excluding signed leases not yet commenced.
- Capital expenditures were $80.3 million in 2013, excluding tenant improvements and leasing commissions. The company estimated a further $110 million–$150 million of capital was needed beyond 2013 to substantially complete its Manhattan redevelopment program, targeted by the end of 2016.
Outlook, risks, contingencies and unusual items
- Management expects to fund redevelopment, lease-up costs and other capital needs through operating cash flow and borrowings. It described financing and refinancing alternatives as viable, but made no numerical earnings or revenue guidance.
- The company plans to continue repositioning Manhattan offices, leasing aggregated and pre-built space, and pursuing acquisitions selectively. It also owns entitled Stamford land for a potential approximately 380,000-square-foot office tower and garage; development timing depends on market and other conditions.
- Tenant rollover and execution are central risks: 5.1% of portfolio area was scheduled to expire in 2014 and 8.6% in 2015. The company cited LF USA as its largest tenant, representing about 10.4% of annualized rent, and disclosed marketing arrangements for portions of its leased space.
- Revenue is geographically concentrated, and four properties accounted for about 62% of annualized rent; the Empire State Building alone accounted for about 33%. Observatory income is exposed to tourism, weather, seasonality, and competition, including the planned One World Trade Center observatory.
- Four putative class actions filed in late 2013 concerning the formation transactions were consolidated; the amended complaint did not name the partnership or ESRT, and defendants moved to dismiss in March 2014. Appeals and possible further litigation related to earlier consolidation litigation remained matters to monitor. The filing states that the company may incur defense costs and cannot predict outcomes.
- Other risks include floating-rate debt and near-term maturities, redevelopment cost and leasing uncertainty, environmental restrictions at properties in Westport and Harrison, potential insurance shortfalls, tax-protection obligations, related-party conflicts, and ESRT’s need to maintain REIT qualification. Goodwill was $491.5 million; management reported no impairment in 2013.
- ESRT’s disclosure controls were deemed effective at year-end. The filing did not include management’s assessment or auditor attestation of internal control over financial reporting because of the transition period for newly public companies.
Important facts for investors to verify
- Reconcile full-year, predecessor, successor and fourth-quarter results; specifically, identify the recurring earnings contribution apart from the consolidation gain, acquisition costs and settlement accounting.
- Track leasing, tenant retention and occupancy, especially LF USA’s space, near-term expirations, and whether signed leases commence as expected.
- Confirm refinancing or repayment plans for 2014–2015 maturities, actual revolver availability, covenant headroom, and exposure to floating rates.
- Monitor redevelopment spending against the $110 million–$150 million estimate, committed lease costs, and the timing and economics of lease-up.
- Verify the outcome and financial implications of the formation-related litigation and any option-property decisions, including appraised purchase prices and related-party safeguards.
- Assess the sustainability of distributions against cash flow, debt service, capital requirements and ESRT’s REIT distribution obligations; the filing cautions that FFO and Core FFO are non-GAAP measures and do not equal cash available for distributions.