Empire State Realty Trust, Inc. — 2017 Form 10-K
Business context and reporting period
Annual report for the fiscal year ended December 31, 2017. Empire State Realty Trust is a REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area, with the Empire State Building observatory as a separate business segment. At year-end, its 20-property portfolio contained approximately 10.1 million rentable square feet and was 89.6% occupied, or 92.2% leased including signed leases not yet commenced.
Financial and operating performance
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $712.5 million | $678.0 million | +5.1% |
| Operating income | $195.8 million | $184.5 million | +6.1% |
| Net income | $118.3 million | $107.3 million | +10.3% |
| Net income attributable to common stockholders | $62.6 million | $51.5 million | +21.7% |
| Diluted earnings per share | $0.39 | $0.38 | +$0.01 |
| Core FFO | $286.9 million | $269.0 million | +6.7% |
| Cash from operating activities | $191.5 million | $218.6 million | −12.4% |
| Cash used in investing activities | $224.6 million | $181.8 million | Use increased |
Operating and net margins were approximately 27.5% and 16.6%, respectively, based on reported GAAP results. Rental revenue increased 5.1%, largely from higher rents and occupancy. Observatory revenue rose 1.8% to $127.1 million, despite 4.05 million visitors versus 4.25 million in 2016; higher ticket prices and a better ticket mix offset more bad-weather days. The company reported $13.6 million of lease termination fee income, versus $7.7 million in 2016.
Year-end cash and cash equivalents were $464.3 million, down from $554.4 million. Total debt was approximately $1.7 billion, with a 4.05% weighted-average interest rate, 6.2-year weighted-average maturity and 100% fixed-rate indebtedness, including interest-rate swaps. The company reported $1.1 billion of available capacity under its revolving facility and compliance with its financial covenants. Debt maturities, excluding amortization, were approximately $262.2 million in 2018 and $250.0 million in 2019. Total assets were $3.93 billion and total equity was $1.98 billion.
Material changes versus prior year
- Revenue increased 5.1%, while operating expenses rose 4.7%; higher property operating expenses and real estate taxes partly offset revenue growth.
- Common-stockholder net income grew 21.7%. Interest expense declined 3.0%, primarily reflecting lower rates on refinanced mortgages; a $2.2 million debt-extinguishment loss related to the credit-facility amendment partly offset this benefit.
- Operating cash flow fell $27.1 million, primarily due to payment of a previously accrued obligation to the Helmsley estate. Investing cash use increased with higher building improvements and the Empire State Building observatory capital project.
- Capital expenditures, excluding tenant improvements and leasing commissions, increased to $126.6 million from $80.0 million. Office tenant improvements and leasing commissions totaled $105.9 million, up from $70.5 million.
- 2017 dividends were $0.42 per share, compared with $0.40 in 2016. The quarterly dividend was $0.105 throughout 2017.
Outlook, management commentary, risks and unusual items
Management expects continued growth from leasing and repositioning Manhattan office space, where 2017 new and renewed leases achieved a 35.6% mark-to-market rent increase. It cited 713,837 square feet of Manhattan office leases expiring in 2018, generally believed to be below market. The filing does not provide quantified earnings or revenue guidance. Metro Tower, an entitled Stamford development site planned for approximately 380,000 rentable square feet, is to proceed when management considers market conditions appropriate.
A multi-year Empire State Building project began in 2017, with approximately $50 million of expected annual investment over three years; $36.6 million was spent in 2017. Management expects no material disruption to observatory operations. The company also amended and extended its $1.1 billion revolving facility and $265 million term loan, and refinanced $336 million of 2017 mortgage maturities with $315 million of new long-term fixed-rate mortgages. Of $450 million in senior notes contracted for in December 2017, $115 million was issued in 2017 and $335 million was scheduled for March 2018, with proceeds intended in part to repay 2018 maturities.
Key risks include the portfolio’s geographic concentration, the Empire State Building’s large contribution to rental revenue and observatory income, leasing and renewal risk, redevelopment costs, interest rates and refinancing, and tenant credit. Six properties generated 71.7% of 2017 rental revenues; the Empire State Building alone generated 32.0%. The company disclosed ongoing arbitration brought by former Empire State Building investors, with hearings scheduled through July 2018; respondents consider the claims meritless. Soil contamination and use restrictions at two properties may constrain redevelopment or affect financing and resale. The company also identifies ground-lease, environmental, terrorism, cybersecurity, labor and REIT-qualification risks.
The Tax Cuts and Jobs Act prompted a $0.4 million deferred-tax-asset write-off in 2017. Goodwill was $491.5 million; management reported no impairment. Auditors issued an unqualified opinion on the financial statements and internal controls.
Important facts for investors to verify
- Whether reported occupancy and lease-up progress support management’s expected rent and cash-flow growth, particularly for 2018 expirations and signed leases not yet commenced.
- Execution, total cost and operating impact of the Empire State Building capital project, and whether observatory revenue growth continues amid visitor and weather variability.
- Refinancing and repayment of 2018–2019 maturities, completion of the remaining $335 million note issuance, and liquidity after committed tenant improvements and leasing costs.
- Cash-flow conversion and capital needs: operating cash flow declined while capital expenditures and distributions increased; FFO and Core FFO are non-GAAP measures, not cash available for distribution.
- Developments and potential costs in the investor arbitration, property environmental restrictions, ground leases, and the company’s ongoing REIT compliance.