Empire State Realty OP, L.P. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The Operating Partnership 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 comprised 10.1 million rentable square feet.
Financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $178.5 million | $176.3 million | $345.8 million | $340.7 million |
| Operating income | $49.7 million | $50.7 million | $83.8 million | $86.7 million |
| Net income | $30.2 million | $31.4 million | $48.2 million | $50.5 million |
| Net income attributable to common unitholders | $30.0 million | $31.1 million | $47.8 million | $50.0 million |
| Basic and diluted earnings per unit | $0.10 | $0.10 | $0.16 | $0.17 |
| Core FFO attributable to common holders | $71.0 million | $73.2 million | $130.2 million | $134.5 million |
| Net operating income (NOI) | $102.0 million | $103.4 million | $188.2 million | $191.0 million |
Q2 revenue rose 1.2%, while operating income declined 2.0% and net income declined 3.7%. For the first half, revenue increased 1.5%, but operating income fell 3.3% and net income fell 4.5%. Higher rents and Observatory revenue were outweighed by higher operating expenses and interest expense, and materially lower lease termination fees versus 2017. Q2 operating margin was approximately 27.8%, compared with 28.7% a year earlier.
For the first half, cash provided by operations was $109.7 million, versus $92.3 million. Investing activities used $498.6 million, largely reflecting $400 million placed in short-term investments and $98.6 million of building additions. Financing activities provided $169.2 million. Cash, cash equivalents and restricted cash totaled $310.5 million at June 30; cash and cash equivalents plus short-term investments were $651.8 million. Distributions were $63.9 million for the first half; the quarterly distribution was $0.105 per unit.
Debt and liquidity
- Principal debt outstanding was approximately $1.93 billion; carrying value, net of discounts and financing costs, was approximately $1.92 billion. Weighted-average interest rate was 3.84%, weighted-average maturity 8.6 years, and the filing described all debt as fixed-rate, with the $265 million term loan rate fixed by a swap.
- The $1.1 billion revolving credit facility was undrawn, leaving approximately $1.1 billion available. The company reported compliance with all debt covenants and net debt to total market capitalization of approximately 19.7%.
- Approximately $250 million of debt matures in 2019, principally exchangeable notes; the $265 million term loan matures in 2022. The filing states the company intends to settle the exchangeable notes’ principal in cash.
- During 2018, the company issued $335 million of senior notes and used proceeds in part to repay mortgages on 111 West 33rd Street and 1350 Broadway. It also increased the 1333 Broadway mortgage from $66.6 million to $160 million, fixed at 4.21% and due in 2033, and released a mortgage lien on 1400 Broadway.
Operations, changes and outlook
- At June 30, total portfolio occupancy was 88.4%, or 91.4% leased including signed leases not yet commenced. The Empire State Building was 92.9% occupied and 94.6% leased including such signed leases.
- In Q2, the company signed 37 leases covering 143,417 square feet; portfolio-wide mark-to-market rent on new, renewal and expansion leases was 17.9%. Manhattan office new leases covered 83,251 square feet and achieved 26.5% mark-to-market rent.
- Rental revenue increased 2.6% in Q2 and 3.5% in the first half, primarily from higher rental rates. Observatory revenue increased 3.6% in Q2 and 2.8% in the first half, with improved ticket mix and average ticket price partly offset by the 102nd-floor closure in Q1.
- Q2 Observatory attendance was about 1.078 million, down 4.3% year over year; first-half attendance was about 1.738 million, down 1.4%. Management cited holiday timing and weather comparisons as factors.
- First-half lease termination fees fell to $1.0 million from $9.2 million. Other revenue included a $2.8 million settlement with a former broadcast tenant.
- The company expects approximately $87.6 million of tenant improvements and leasing commissions under existing leases. It anticipates approximately $160 million over three years for the Empire State Building project to relocate the Observatory entrance and improve the visitor and office-tenant experience; $64 million had been spent through June 30, 2018. It also expects about $40 million in 2018–2020 for common-area and amenity upgrades at suburban properties.
- Management anticipated closing the 102nd-floor Observatory in early 2019 for up to nine months for further upgrades. It cited a soft Greater New York office market and competition from recently redeveloped or planned competing properties. No specific earnings guidance was provided.
Risks, contingencies and unusual items
Risks include office and retail demand, vacancies, lease expirations and tenant defaults; redevelopment costs and delays; interest rates and refinancing access; Observatory tourism, weather and competition; real estate taxes; and the ability to maintain distributions and REIT qualification. Leases covering 4.8% of portfolio area expire in 2018 and 7.2% in 2019, representing an estimated 4.8% and 7.3% of annualized rent, respectively. Approximately 0.9 million square feet was available to lease at quarter-end.
An arbitration brought by 12 former Empire State Building investors alleges fiduciary-duty and related claims concerning the 2013 offering and formation transactions. Hearings were scheduled through August 2018; respondents consider the claims without merit and intend to defend them. The company disclosed indemnification rights for certain named individuals. Management said routine litigation and identified environmental matters were not expected to materially affect financial condition, results or liquidity. Required ground-lease payments totaled $76.6 million; adoption of the forthcoming lease standard was expected to recognize a related right-of-use asset and liability.
Most important facts to verify
- Whether occupancy, leasing spreads and lease commencements progress as planned, especially for the 2018–2019 expirations.
- Funding and execution of the $87.6 million lease obligations and major capital projects, including the Observatory closure and its effect on attendance and revenue.
- Refinancing or cash repayment plans for the $250 million 2019 maturity, and continued covenant compliance and access to the undrawn revolver.
- Whether higher rents and Observatory pricing can offset expense growth, interest costs and reduced lease termination income.
- Developments in the former-investor arbitration and any changes to disclosed environmental or other contingencies.