Empire State Realty OP, L.P. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. The partnership owns and operates office and retail properties in Manhattan and the greater New York metropolitan area, including the Empire State Building and its observatory. Its portfolio totaled 10.1 million rentable square feet.
Financial performance
Amounts in $ millions except per-unit data. Comparisons are with the corresponding 2015 period.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | 175.8 | 175.8 | 498.7 | 492.4 |
| Operating income | 53.6 | 45.3 | 131.9 | 114.1 |
| Net income | 32.9 | 26.1 | 74.2 | 60.6 |
| Net income attributable to common unitholders | 32.7 | 25.9 | 73.5 | 59.9 |
| Basic and diluted earnings per unit | $0.12 | $0.10 | $0.27 | $0.22 |
| Operating margin | 30.5% | 25.8% | 26.4% | 23.2% |
| Net operating income (NOI) | 102.6 | 97.8 | 281.6 | 266.0 |
| Core FFO | 71.9 | 70.6 | 194.8 | 191.5 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | 162.1 | 159.6 |
Q3 revenue was essentially flat: rental revenue rose 4.3% and observatory revenue rose 6.7%, offset by lower tenant reimbursements and other revenue. For the nine-month period, revenue increased 1.3%; operating income rose 15.6% and common-unitholder net income rose 22.9%. Expense reductions, including lower property operating costs and depreciation and amortization, supported operating income growth. Interest expense increased 6.0% over nine months, and general and administrative expense increased 25.5%, including higher compensation and legal costs.
Cash, debt and capital
- Cash and cash equivalents were $594.3 million at September 30, 2016, versus $46.7 million at year-end 2015. The increase largely reflects the August equity investment; it is not solely internally generated cash.
- Nine-month cash flows: $162.1 million provided by operations, $120.3 million used in investing, and $505.8 million provided by financing. Building and improvement additions were $120.4 million; reported portfolio capital expenditures were $55.0 million, excluding tenant improvements and leasing commissions.
- Qatar Investment Authority acquired newly issued ESRT shares for $621.8 million gross proceeds, contributed to the partnership in exchange for 29.6 million Series PR units. The company reported $611.3 million net proceeds from unit issuance and used $45 million to repay revolving-credit borrowings.
- Total debt principal was approximately $1.621 billion; balance-sheet debt, net of premiums and financing costs, was $1.616 billion. Weighted-average interest rate was 4.15% and weighted-average maturity 4.9 years. The company reported net debt to total market capitalization of approximately 14.0%.
- The $1.1 billion unsecured revolving facility had no borrowings outstanding at quarter-end. Management reported $594.3 million cash and $1.1 billion available on the facility; debt covenants were met. Approximately $336.0 million of debt maturities were due in 2017, excluding amortization.
- Three interest-rate swaps had $465 million aggregate notional and a $31.2 million fair-value liability. A 1 percentage-point increase in short-term rates was estimated to raise interest expense by approximately $2.6 million. A forward swap fixes LIBOR on the $265 million term loan from August 2017 through maturity.
- Declared distributions of $0.105 per unit for Q3; distributions were $0.295 per unit for the first nine months, versus $0.255 in 2015.
Operations, outlook and risks
- At quarter-end, the total portfolio was 87.9% occupied and 90.3% leased including signed leases not yet commenced. The Manhattan office portfolio was 86.6% occupied and 89.5% leased including signed leases not commenced.
- During Q3, the company signed 51 leases covering 348,770 square feet, reporting a 30.2% mark-to-market rent increase over previous fully escalated rents. New Manhattan office leases signed during the quarter had a reported 59.3% increase.
- Observatory revenue increased with more visitors and a more favorable ticket mix; the observatory remains exposed to tourism, weather, seasonality and competition. Management reported 1.34 million Q3 visitors, compared with 1.327 million a year earlier.
- Broadcasting revenue faces uncertainty: CBS, NBC Universal and WNET planned to leave at lease expirations in 2017–2018; their leases generated approximately $6.3 million of combined 2015 revenue including reimbursements. The company said preliminary renewal proposals could mean lower revenue and higher capital spending. Univision and Emmis renewed on terms with lower initial annual revenue than before.
- Management expects positive operating cash flow and plans to fund operating needs, distributions and capital requirements through cash, operations, debt facilities and financing. No quantified earnings or revenue guidance was provided. Approximately $57.1 million of tenant improvements, other lease improvements and leasing commissions remained expected under signed leases.
- One arbitration brought by 12 investors who opted out of an earlier class-action settlement remained pending; hearings were scheduled to resume December 19, 2016. The company said it intended to defend the claims and considered them without merit. It also has indemnification obligations that could result in defense costs.
- QIA’s investment includes a tax indemnity arrangement that may constrain property sales or strategic transactions. Other disclosed risks include REIT qualification, ownership and voting concentration, possible resale of QIA shares, tenant defaults or vacancies, interest rates, refinancing and redevelopment costs, and environmental uncertainties. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Investor verification priorities
- Reconcile the MD&A highlight of $16.0 million net income attributable to the “Company” with the financial statements’ $32.9 million consolidated net income and $32.7 million attributable to common unitholders; confirm the differing attribution basis.
- Assess the 2017 maturity schedule, refinancing plans and the ability to fund lease-up costs and capital commitments without materially increasing leverage.
- Evaluate occupancy and signed leases not yet commenced, including whether reported mark-to-market rent gains translate into collected rent after tenant improvements and leasing commissions.
- Track broadcaster departures, renewal negotiations and related revenue and capital expenditure effects, as well as observatory dependence on tourism and weather.
- Monitor the pending investor arbitration, potential indemnification exposure, and the restrictions or costs associated with QIA’s tax-protection and registration-rights arrangements.
NOI, FFO and Core FFO are non-GAAP measures; the filing cautions that they are not substitutes for GAAP earnings or operating cash flow and may not be comparable across companies.