Empire State Realty Trust, Inc. annual report, FY2015

Empire State Realty Trust, Inc. — 2015 Form 10-K

Reporting period: Fiscal year ended December 31, 2015. The filing is an annual report, not a standalone fourth-quarter filing; quarterly figures are noted below. The company is a REIT focused on office and retail properties in Manhattan and the greater New York metropolitan area, including the Empire State Building.

Business and portfolio

• Owned 14 office properties and six standalone retail properties, totaling approximately 10.1 million rentable square feet; portfolio occupancy was 87.3%, or 89.1% including signed leases not yet commenced.
• Portfolio annualized rent was $453.3 million. Manhattan office occupancy was 84.9%; greater New York metropolitan office occupancy was 93.9%; retail occupancy was 94.3%.
• The Empire State Building observatory is a separately reported business. The company also licenses broadcasting space and operates a 380,000-square-foot entitled development site, Metro Tower, in Stamford, Connecticut.

Financial results and liquidity

Metric	FY 2015	FY 2014	Change
Total revenue	$657.6 million	$635.3 million	+3.5%
Operating income	$151.4 million	$141.3 million	+7.1%
Net income	$79.9 million	$70.2 million	+13.8%
Net income attributable to common stockholders	$33.7 million	$26.7 million	+26.5%
Diluted earnings per share	$0.29	$0.27	Up from $0.27
FFO per diluted share/OP unit	$0.94	$0.84	+11.9%
Core FFO per diluted share/OP unit	$0.97	$0.89	+9.0%

• Revenue growth reflected primarily a full year of contribution from two properties acquired in July 2014 and higher rents. Construction revenue fell sharply as that business wound down.
• Operating cash flow was $203.2 million, versus $138.6 million in 2014. Investing cash flow was negative $142.3 million and financing cash flow was negative $59.9 million. Year-end cash and cash equivalents were $46.7 million; restricted cash was $65.9 million.
• At year-end, debt was approximately $1.6 billion on a reported carrying basis, with $1.640 billion principal outstanding, a 4.12% weighted-average interest rate and 5.4-year weighted-average maturity. Approximately 81.4% of debt was fixed rate. Debt was 25.3% of enterprise value; net debt to EBITDA was 4.9x.
• The company reported $760 million of available borrowing capacity under its $800 million unsecured revolving facility. It reported compliance with its debt covenants.
• Principal maturities were approximately $355.8 million in 2017, $262.2 million in 2018 and $290 million in 2019; no 2016 maturity was reported, excluding amortization. Dividends were $0.34 per share for 2015, classified as entirely taxable ordinary dividends.

Fourth-quarter snapshot

For the quarter ended December 31, 2015, revenue was $165.2 million, operating income was $37.2 million, net income was $19.4 million, net income attributable to common stockholders was $8.3 million, and basic and diluted EPS was $0.07.

Changes, outlook, and material items

• Leasing activity was strong: the company signed 245 leases covering 1.21 million square feet across its portfolio. Management reported a 73.7% increase in mark-to-market rent on new, renewal and expansion leases; for Manhattan office space, it reported a 43.3% increase. These comparisons use prior fully escalated rents and should not be read as net effective rent growth.
• Observatory revenue increased 0.6% to $112.2 million, despite visitor count declining to 4.1 million from 4.3 million. Broadcasting license and related lease revenue was $20.9 million. Several broadcasters, including CBS, NBC and WNET, planned to leave at the end of their lease terms; management cited industry changes and a new competitor at One World Trade Center.
• Management expected positive operating cash flow and planned to substantially complete Manhattan office repositioning by the end of 2016. It estimated $30–$50 million of remaining redevelopment capital, primarily in 2016, excluding tenant improvements and leasing commissions. Existing signed lease obligations were expected to require approximately $51.2 million for tenant improvements and leasing commissions during 2016. No specific earnings or FFO guidance was provided.
• In 2015, the company replaced its secured revolving facility with an unsecured $800 million facility, issued $350 million of senior unsecured notes, and obtained a $265 million unsecured term loan. It also repaid mortgages on 1359 Broadway and One Grand Central Place.
• The construction management business stopped soliciting new work in March 2015 and completed projects in progress. Construction revenue declined to $2.0 million from $38.6 million.
• Unusual accounting items include a $1.7 million write-off of deferred financing costs and prepayment-related costs associated with facility recasting and mortgage repayments. Goodwill was $491.5 million; management reported no impairment in 2015.
• Litigation connected with the earlier consolidation remained relevant: a separate arbitration brought by 12 investors who opted out of a prior class settlement had hearings scheduled to begin in May 2016. The company said it could not reasonably estimate the timing, outcome or any related loss. The earlier class settlement was final, and the company stated it would not bear that settlement payment.

Key risks and contingencies

• Geographic and asset concentration: all properties are in the New York metropolitan area, and five properties generated 66.2% of portfolio rental revenue; the Empire State Building alone represented 31.4%.
• Leasing and tenant risks: approximately 1.1 million square feet was vacant, while leases covering 7.7% and 7.3% of portfolio square footage expired in 2016 and 2017, respectively. The five largest tenants represented 15.6% of annualized rent.
• Redevelopment, leasing costs and capital needs could exceed budgets or fail to produce expected rents or occupancy. Management disclosed that redevelopment estimates exclude tenant improvement costs and leasing commissions.
• Three office properties are held through long-term ground leases. Environmental restrictions affect 69–97 Main Street in Westport and 500 Mamaroneck Avenue; the filing notes potential constraints on redevelopment, resale or financing.
• The observatory is exposed to tourism, weather, currency and competing attractions; broadcasting operations face tenant departures, technology changes and regulatory uncertainty. The company also disclosed insurance, cybersecurity, labor, interest-rate, REIT-qualification and tax-protection agreement risks.

Investor verification priorities

1. Review audited statements and supplemental reconciliations for FFO, Core FFO, cash flow and debt, including their non-GAAP limitations and per-share/unit denominators.
2. Check subsequent leasing results, occupancy and actual rent spreads, particularly for 2016–2017 expirations and the reported vacant space.
3. Confirm completion costs and leasing commitments for the Manhattan redevelopment program and the timing and funding of 2016 capital needs.
4. Track refinancing or repayment plans for 2017–2019 maturities, revolver availability, covenant headroom, and exposure to floating rates.
5. Monitor broadcaster departures and replacement leasing, observatory visitation and revenue, and the status and potential financial effects of the investor arbitration.