Empire State Realty Trust, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; balance-sheet figures are as of June 30, 2018. ESRT 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. Its portfolio totaled 10.1 million rentable square feet.
Financial and operating 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 stockholders | $16.7 million | $16.6 million | $26.4 million | $26.6 million |
| Basic and diluted EPS | $0.10 | $0.10 | $0.16 | $0.17 |
| Core FFO attributable to common stockholders and non-controlled interests | $71.0 million | $73.2 million | $130.2 million | $134.5 million |
| Operating margin | 27.8% | 28.7% | 24.2% | 25.4% |
Q2 rental revenue rose 2.6% and observatory revenue rose 3.6% year over year. For the first half, rental revenue increased 3.5% and observatory revenue increased 2.8%. Operating income and net income declined despite revenue growth, as operating expenses and interest expense increased. Core FFO is a non-GAAP measure and is not cash flow or a measure of cash available for distributions.
- Cash flow: First-half operating cash flow was $109.7 million, versus $92.3 million in 2017. Investing cash outflow was $498.6 million, including $400.0 million placed in short-term investments and $98.6 million of building additions. Financing provided $169.2 million.
- Liquidity: Cash and cash equivalents were $251.8 million; restricted cash was $58.7 million; short-term investments were $400.0 million. Cash, cash equivalents and short-term investments totaled $651.8 million. The $1.1 billion revolving credit facility was undrawn.
- Debt: Total debt principal was approximately $1.93 billion, with a weighted-average rate of 3.84%, weighted-average maturity of 8.6 years, and all debt fixed-rate or hedged to fixed-rate. Approximately $250 million matures in 2019, excluding amortization. Net debt to total market capitalization was 19.7%. The company reported compliance with debt covenants.
- Distribution: Quarterly dividend was $0.105 per share, unchanged from 2017. Distributions and dividends to securityholders totaled $63.9 million in the first half.
Material changes and management commentary
- Total revenue rose 1.2% in Q2 and 1.5% in the first half. Higher rental rates and observatory ticket mix/pricing supported growth; lower lease termination fees weighed on first-half comparison, with $8.5 million of significant fees in the 2017 period versus minimal fees in 2018.
- First-half other revenue and fees included a $2.8 million settlement with a former broadcast tenant. Higher repairs, labor, observatory marketing/payroll, real estate taxes and equity compensation contributed to higher expenses. Interest expense increased with higher outstanding debt balances.
- At June 30, portfolio occupancy was 88.4% and leased occupancy, including signed leases not commenced, was 91.4%. ESB was 92.9% occupied and 94.6% leased. In Q2, 37 leases covering 143,417 square feet were signed; portfolio mark-to-market rent on new, renewal and expansion leases increased 17.9% over prior fully escalated rents.
- Management described the greater New York office market as soft and cited competition from recently redeveloped or planned properties. It expects to spend about $40 million during 2018–2020 on common areas and amenities across certain properties.
- The multi-year Empire State Building project is expected to cost about $160 million over three years; $64.0 million had been spent through June 30, 2018. Management anticipated closing the 102nd-floor observatory in early 2019 for up to nine months for planned work. The 102nd-floor observatory generated $11.4 million in 2017 revenue.
- Management expects positive operating cash flows and plans to fund near-term needs with operating cash, available liquidity and borrowings. No specific earnings or FFO guidance was provided.
Risks, contingencies and unusual items
- A dispute brought by 12 former investors relating to the company’s formation and IPO remained in arbitration, with hearings scheduled through August 2018. The company and other respondents say the claims are without merit and intend to defend them; the filing does not quantify a potential loss.
- Estimated capital expenditures, tenant improvements and leasing commissions under existing leases were approximately $87.6 million at quarter-end. Ground-lease contractual payments totaled $76.6 million.
- Risks identified include office and retail demand, vacancies and lease expirations, tenant defaults, redevelopment costs and delays, real estate taxes and operating costs, tourism and observatory attendance, interest rates, refinancing and access to capital, leverage, environmental matters, and the ability to maintain REIT status.
- Environmental reviews identified asbestos-containing materials at certain properties; management had no plans to trigger removal obligations and could not reasonably estimate a conditional retirement obligation. Management did not expect identified environmental matters to materially affect results, but noted liabilities may not all have been identified.
- The company reported no material changes to its previously disclosed risk factors, no off-balance-sheet arrangements, and no material changes in internal control over financial reporting. Disclosure controls were concluded effective.
Important facts for investors to verify
- How occupancy, leasing activity and rent mark-to-market translate into recurring cash rent, considering available space and lease expirations.
- Liquidity and refinancing plans for the $250 million 2019 maturity, including the role of cash, investments and the undrawn revolver.
- Actual costs, timing and expected returns from the ESB project and other planned capital spending, including the anticipated 102nd-floor closure.
- Observatory attendance, ticket pricing and revenue trends, and expiring broadcasting licenses and related leases.
- Progress and potential financial exposure from the former-investor arbitration, along with the company’s ability to meet planned capital needs while sustaining distributions.