Empire State Realty Trust, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also presents unaudited fourth-quarter results. ESRT is a self-managed REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area, with the Empire State Building observatory as a significant operating business.
Business and portfolio
- Portfolio totaled 10.1 million rentable square feet across 14 office properties and six standalone retail properties; occupancy was 88.8%, or 91.8% leased including signed leases not yet commenced.
- Manhattan office occupancy was 88.8% (92.7% leased including signed leases not yet commenced). Retail occupancy was 90.8%.
- Annualized portfolio rent was $535.5 million. The Empire State Building represented 31.9% of portfolio rental revenue; six properties together represented 72.2%.
- Management operates two reportable segments: real estate and observatory.
Financial performance and liquidity
| Metric | FY 2018 | FY 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 stockholders | $65.6 million | $62.6 million | +4.7% |
| Diluted EPS | $0.39 | $0.39 | Flat |
| FFO attributable to common stockholders and non-controlling interests | $282.6 million | $276.5 million | +2.2% |
| Core FFO | $290.4 million | $286.9 million | +1.2% |
| Cash provided by operating activities | $279.0 million | $194.2 million | +$84.8 million |
Operating margin was approximately 26.1%, versus 27.2% in 2017, calculated as operating income divided by revenue. Interest expense rose 16.3% to $79.6 million, chiefly reflecting higher outstanding principal; real estate taxes rose 7.4% to $110.0 million.
- Revenue drivers: Rental revenue increased 1.9% to $493.2 million; observatory revenue increased 3.2% to $131.2 million; lease termination fees increased to $20.8 million from $13.6 million. Other revenue included a $2.8 million settlement with a former broadcast tenant.
- Cash flow and investment: Investing cash outflow was $643.0 million, including $400.0 million placed in short-term investments and $243.0 million of building additions. Financing cash inflow was $104.6 million. Total cash and restricted cash ended the year at $270.8 million; short-term investments were $400.0 million.
- Debt and liquidity: Total debt principal was $1.930 billion, with a 3.84% weighted-average interest rate and 8.1-year weighted-average maturity. All debt was fixed-rate at year-end, including variable-rate borrowings hedged with swaps. The company reported $1.1 billion of available revolving capacity and $605.0 million of cash, cash equivalents and short-term investments. Net debt was reported at 23.4% of total market capitalization. Debt covenants were met.
- Distributions: Dividends were $0.42 per share for 2018, unchanged from 2017; aggregate common dividends and distributions were $126.5 million. The company authorized a $500 million share and publicly traded OP-unit repurchase program through December 31, 2019; authorization does not obligate repurchases.
Material changes and fourth-quarter results
- Revenue growth did not translate into higher operating income or net income, as operating expenses increased 4.7% to $540.7 million and interest expense increased.
- Operating cash flow improved substantially versus 2017, partly because 2017 included payment of an accrued formation-related New York City transfer-tax amount.
- ESRT issued $335 million of long-term senior unsecured notes in March 2018, helping fund repayment of mortgages on 111 West 33rd Street and 1350 Broadway. It also refinanced and increased debt on 1333 Broadway to $160 million, due 2033 at a fixed 4.21% rate.
- Unaudited Q4 2018 revenue was $199.3 million, operating income $58.5 million, net income attributable to common stockholders $22.8 million, and diluted EPS $0.13. Q4 2017 comparables were $182.3 million, $50.2 million, $17.3 million and $0.11, respectively.
Outlook, management commentary and risks
- Management expects to continue repositioning and leasing Manhattan office space, stating that 2019 expirations of 464,792 square feet (6.1% of Manhattan office area) are generally below market. New and renewal Manhattan office leases signed in 2018 achieved a reported 24.5% increase in mark-to-market cash rent.
- The Empire State Building redevelopment was expected to cost approximately $163 million over three years; $91.3 million had been spent through year-end 2018. A separate approximately $40 million program for common areas and amenities at suburban properties was expected through 2020; $14.1 million had been spent by year-end.
- The 102nd-floor observatory closed in January 2019 for upgrades and could remain closed for up to nine months. The observatory generated $131.2 million of 2018 revenue despite visitor counts declining 3.4% to 3.805 million. New York observatory competition was expected to increase, with Hudson Yards and One Vanderbilt attractions anticipated in 2020.
- Approximately $250 million of debt principal was scheduled to mature in 2019, principally the 2.625% exchangeable senior notes; no principal maturities were scheduled for 2020. The filing states management believed available liquidity supported refinancing, but provides no formal earnings or FFO guidance.
- Key exposures include geographic concentration in the New York area, significant revenue contribution from the Empire State Building and other large properties, tenant and lease rollover risk, redevelopment costs and temporary vacancy, retail-market weakness, interest rates and refinancing, and the ground leases underlying three office properties.
- An arbitration brought by former Empire State Building investors alleges 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 respondents dispute the allegations. The filing text does not provide a clear estimate of any potential loss.
- Environmental restrictions affect properties at 69-97 Main Street in Westport and 500 Mamaroneck Avenue in Harrison, potentially limiting redevelopment or affecting financing and resale. Management reported no known environmental liability expected to materially affect operations.
- The 32BJ pension plan covering unionized employees was reported in critical status; ESRT reported $13.5 million of total multiemployer plan contributions in 2018. The applicable Local 32BJ collective bargaining agreement ran through December 31, 2019.
Most important facts for investors to verify
- Whether office and retail occupancy, lease commencements and achieved rents support continued rent growth, especially as 2019–2020 leases expire.
- Refinancing or repayment of the approximately $250 million 2019 maturity, and the cost and terms of any replacement financing.
- Actual capital spending and returns from the Empire State Building and suburban-property improvement programs, including impacts of the 102nd-floor closure.
- How much recurring earnings and cash flow depend on lease termination fees, settlement proceeds and observatory revenue, and the comparability of reported FFO and Core FFO.
- Developments in the investor arbitration, environmental restrictions, labor negotiations and any related financial exposure.
- Distribution coverage and cash available after debt service, leasing costs, tenant improvements and redevelopment spending.