Empire State Realty Trust, Inc. (NYSE:ESRT) Q4 2022 Earnings Call Transcript

Empire State Realty Trust, Inc. (NYSE:ESRT) Q4 2022 Earnings Call Transcript February 16, 2023

Operator: Greetings, and welcome to the Empire State Realty Trust Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. . As a reminder, this conference is being recorded. It is now my pleasure to introduce Heather Houston, Senior Vice President, Chief Counsel, Corporate & Secretary. Thank you. You may begin.

Heather Houston: Good afternoon. Thank you for joining us today for Empire State Realty Trust fourth quarter 2022 earnings conference call. In addition to the press release distributed yesterday, a quarterly supplemental package with further detail on our results and our latest investor presentation were posted in the Investors section of the company's website at esrtreit.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements as defined in applicable securities laws, including those related to market conditions, property operations, capital expenditures, income, expense, financial results and proposed transactions and events. As a reminder, forward-looking statements represent management's current estimates.

They are subject to risks and uncertainties, which may cause actual results to differ from those discussed today. Empire State Realty Trust assumes no obligation to update any forward-looking statement in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements in the company's filings with the SEC. During today's call, we will discuss certain non-GAAP financial measures, such as FFO, modified and core FFO, NOI, same-store NOI, cash NOI, and EBITDA, which we believe are meaningful in evaluating the company's performance. The definitions and reconciliations of these measures to the most directly comparable GAAP measures are included in the earnings release and supplemental package, each available on the company's website.

Now, I will turn the call over to Tony Malkin, our Chairman, President and Chief Executive Officer.

Tony Malkin: Thanks, Heather, and good afternoon to everyone. This is Heather's firsthand on the wheel on our earnings call since the retirement of Tom Keltner. We are delighted to have her here with us and we will always be grateful and appreciative of Tom Keltner's more than 40 years of commitment and contribution to ESRT and its predecessor entities. ESRT is pleased to report strong fourth quarter results to close out the year, provide updates on our capital recycling activities and leasing, and our outlook for 2023. Our ESRT team accomplished a lot this year. ESRT's top priorities are to lease space, sell tickets to the Empire State Building Observatory, make good use of our balance sheet, achieve our sustainability goals, and do all of this with an unrelenting focus on shareholder value.

We had a very solid leasing year. We leased over 1 million square feet at consistently positive leasing spreads and made meaningful absorption progress with a 210 basis points increase in Manhattan office occupancy and a 260 basis points increase in Manhattan office leased percentage throughout the year. Our buildings represent affordable options in the flight to quality, the character, full modernization, great locations near mass transit, great amenities in place with more to come and industry leadership in energy efficiency and indoor environmental quality. Our goal is to get the best deal in good times and get the deals in challenged times and draw consistent leasing volumes through cycles. Existing tenants who know and love our product grow in our portfolio.

We have completed 258 expansions, which total 2.5 million square feet since the company went public. We continue to build our leased percentage and that will drive higher occupancy and earnings in the future. Tom will cover 2022 in more detail, announce a great lease just completed and discuss our 2023 pipeline. Our quality portfolio is resilient and ESRT benefits from the flight to quality trend. Our entirely re-imagined Empire State Building Observatory is the beneficiary of a $165 million renovation and new exhibits completed just prior to the pandemic and our introduction of our timed ticketing operation. The customer experience has been improved by the exhibits and by reduced crowds with generally no lines. Now that we know when customers will be there, we plan better our staffing and control expenses.

We now reap the rewards of these efforts. Tripadvisor's number one attraction in the United States, number three in the world is the authentic experience that benefits by comparison to all the other new entrants in the market. We hit our observatory NOI expectations in 2022, largely driven by growth and revenue per capita, prudent expense management, exceptional brand awareness, and a shared commitment to excellence by the entire leadership team. In December 2022, observatory NOI reached 99% of pre-COVID 2019 levels and visitation reached 88% of pre-COVID 2019 levels. We are an international brand. We have spoken about the strength of ESRT's balance sheet for years. It helps us win new tenants who look to partner with a financially stable landlord who will maintain high quality standards at their assets and deliver on their commitments to tenants.

Tenants seek a compelling value proposition and ESRT offers a high quality experience and trophy assets at our attractive price point. Our balance sheet allows us to be nimble and engage in share repurchases new acquisitions and capital recycling. We derive our income from diverse sources, office rentals, Observatory income, retail rentals, and residential rentals. The addition of multi-family to our portfolio since December 2021 further diversified our cash flow stream. We have recycled our balance sheet tax efficiently through the sale of various suburban assets and reinvestment into Manhattan multi-family. We have broadened our industry leadership in environmental sustainability and healthy building performance over the past year. ESRT achieved carbon neutrality in 2022 and we continue to make progress towards a goal of zero net -- net zero emissions by 2035.

We published the Empire Building Playbook for decarbonization of existing buildings in partnership with the New York State Energy Research Development Authority, a guide for others on how to achieve sustainability goals. We received target validation approval from the science-based targets initiative with their most advanced 1.5 degree target. Platinum recognition with Green Lease Leaders maintained the highest possible GRESB ratings and global sector leadership distinction and achieved re-certifications for WELL Health-Safety fit well and Energy Star. We are the only New York City commercial landlord on the Local Law 97 implementation Advisory Board, and we are the only New York City commercial landlord on the New York City Sustainability Advisory Board.

We have been included in the Bloomberg Gender-Equality Index for two consecutive years. These ESG accomplishments and initiatives are increasingly important both tenants and their employees as well as investors, and remain a top priority for ESRT. Our stock outperformed CBD office peers from 2020 to 2022 and year-to-date for many of these reasons, even though we think it is obvious that it still trades at a crazy discount. Lastly, we introduced guidance for the first time in 2022 to give the Street more clarity on the earnings trajectory and outlook for our company and actual results, which exceeded our initial expectations. This is the work of a great team that is navigated through challenges and rises to the occasion with incredible focus on our company's four priorities and demonstrated progress.

We move forward into 2023 with the same goals, lease space, sell tickets to the observatory, proactively manage our portfolio, achieve our sustainability goals, manage our balance sheet, and drive shareholder value. Tom and Christina will provide more detail on our progress and how we plan to accomplish these goals in 2023. Before I turn it over to Tom, I also want to congratulate Christina on her promotion to Chief Operating Officer in addition to Chief Financial Officer this quarter. Christina is a great partner to all of us, a great leader and has tremendous value. Her new title reflects the role into which she has grown as a great fellow executive officer to Tom and me, and she's involved in every strategic decision. Tom?

Tom Durels: Hey, thanks, Tony, and good afternoon, everyone. We had a very solid year in 2022 and 2023 shows real promise. During the year, we signed over 1.1 million square feet of leases, which is consistent with our pre-COVID three-year average lease volume for 2017 to 2019. In our Manhattan office portfolio, we achieved positive mark-to-market lease spreads in each of the last four quarters, experienced steady net effective rent growth throughout the year, and signed major new and expansion leases with quality tenants, including iCapital, Signature Bank, Progyny, Crown Castle, and others, and leased to just shy of 300,000 square feet of pre-built during the year nearly matching our total volume of pre-built leased in 2019.

While Manhattan's market wide office availability rate increased in 2022, ESRT's Manhattan office leased percentage rate improved by 260 basis points and occupancy increased by 210 basis points for the year. We benefit from the flight to quality trend and our outperformance demonstrates tenants' desire for our fully modernized, energy efficient and healthy buildings, which are conveniently located in your mass transit with in-building amenities, access to neighborhood amenities and exceptional tenant services, and an attractive price point. In the fourth quarter, office leasing spreads remained positive with new and renewal lease spreads signed at our Manhattan office properties up 5% on a cash basis compared to the prior escalated rents. We signed 29 new and renewal leases totaling approximately 144,000 square feet, which includes 93,000 square feet under our Manhattan office properties dominated by healthy activity in our smaller pre-built suites, 50,000 square feet in our Greater New York Metropolitan office properties and over 1,000 square feet of retail.

After year-end, we signed a 16-year 65,000 square foot lease with an engineering firm at the Empire State Building. Combined with fourth quarter leases, we have signed nearly a 100,000 square feet of new leases at the Empire State Building, where we have significantly increased our leased percentage. We have active deals in our pipeline throughout the portfolio, including pre-built suites and several full floor leases that should drive portfolio leased percentage higher. We're well-positioned and confident in our ability to drive our leased rate higher in 2023. We invested approximately $1 billion into our assets since our IPO to create healthy buildings that are fully modernized. We are adding to our robust in-building amenities at the Empire State Building and shared campus amenities in our Times Square South portfolio.

Our tenants' spaces are newly built with the best in indoor environmental quality and energy efficiency, which lowers tenants' occupancy costs while increasing employee health and productivity. Our assets are well located near neighborhood amenities and mass transit hubs. The recent opening of the East Side Access to Grand Central Station will greatly benefit us at One Grand Central Place. After years of consolidating smaller spaces to create move-in ready pre-built suites and full floor turnkey spaces, our hard work is done with over 95% of our tenant spaces now redeveloped, and our vacant space is ready for immediate lease up. We proactively managed our rent roll such that only 5.1% or 494,000 square feet of leases are set to expire in 2023.

Building, Real Estate, Investment

Photo by Frans Ruiter on Unsplash

And we have $54 million of contracted incremental rent from signed leases not yet commenced and free rent burn-off. Our strong balance sheet affords the ability to compete in today's environment and gives our tenants and brokers confidence that we will deliver on our promises. We have an exceptional dedicated team that executes daily on behalf of our tenants and their brokers. And although, New York City office using employment has recovered and now exceeds pre-pandemic levels as close to 200,000 office using jobs have been added since the second quarter of 2020. We have demonstrated our ability to lease space through all cycles. We've done the hard work to position ourselves to increase our lease percentage and achieve positive absorption in 2023.

Same-store property operating expenses and real estate taxes were up this year as contemplated in our guidance, but were approximately 7% below pre-pandemic levels in 2022 due to a combination of permanent cost saving measures by the excellent work of our operations team and gradual return to office throughout the year. Property operating expenses alone were 13% below pre-pandemic levels and through continued discipline cost control; we forecast 2023 property operating expenses will be approximately 3% below our 2019 actuals. Christina will provide more detail in a moment. Turning to our multi-family assets. As previously announced, we close on the off market acquisition of 298 Mulberry Street in late December and are thrilled to add this property to our growing multi-family portfolio.

298 Mulberry is a 96 unit fully occupied multi-family asset located in a highly desirable neighborhood at the confluence of the NoHo, Nolita and East Village submarkets, which have a limited supply of market rate, full service product and is in walking distance to NYU. Importantly, this asset is 100% free-market and we see upside opportunity through mark-to-market on in-place rents and future rent growth. Total multi-family occupancy, which now includes the newly acquired 298 Mulberry, remains strong at 96.3%, and we continue to see good mark-to-market increases as steady demand across the Board, which validates our investment decision. In summary, as I said at the start, we had a very solid year. We've done the hard work, invested in our assets over many years, and are exceptionally well-positioned to lease space and achieve positive absorption again in 2023 We signed office and retail leases of 144,000 square feet in the fourth quarter and over 1.1 million square feet during the full year.

We increased our Manhattan office portfolio leased percentage by 260 basis points and achieved positive absorption of 210 basis points in occupancy over the prior year. We signed a new lease for 65,000 square feet at the Empire State Building after year-end, and we have grown our multi-family portfolio where we continue to see strong fundamentals and performance. And now I'll call -- turn the call over to Christina. Christina?

Christina Chiu: Thanks, Tom. Let's start out with an overview of results for the year. We reported core FFO of $244 million or $0.90 per diluted share, which compares to core FFO of $195 million or $0.70 per diluted share for 2021. 2022 core FFO exceeded our most recent guidance range of $0.83 to $0.85, largely driven by stronger performance at the observatory towards year-end and lower than expected year-over-year decline in full-year same-store NOI of 4.1%, driven by modest same-store revenue growth offset by an approximate 9% higher property expenses as expected. For the fourth quarter of 2022, we reported core FFO of $59 million or $0.22 per diluted share, which compares to core FFO of $50 million or $0.18 per diluted share for the fourth quarter of 2021.

Same-store property cash NOI excluding lease termination fees was down 3.3% year-over-year, largely driven by higher property operating expenses and real estate taxes partially offset by higher revenues from cash rent commencements. The observatory hosted 660,000 visitors and generated NOI of $23.8 million in the fourth quarter, up significantly from 360,000 visitors and NOI of $10.7 million in the fourth quarter of 2021. Observatory visitation recapture in the fourth quarter was 74% of comparable 2019 visitation, which exceeded our revised hypothetical forecast of 66% of comparable 2019 visitation largely driven by strong December demand when visitation exceeded 88% of comparable 2019 levels. Notably, fourth quarter NOI recapture as a percentage of 2019 was 82% and the testament to our team's execution.

For the full-year, observatory NOI totaled $74.9 million, which represented NOI recapture as a percentage of 2019 of 79%. We continue to tightly manage expenses at the observatory and generate strong revenue per capita, which were up 18% in 2022 versus comparable 2019 level. As a result, the NOI recovery has outpaced visitation relative to pre-pandemic levels. We will be focused on the NOI outlook going forward as we provide guidance to the Street on the observatory's performance from here. As a reminder, the observatory historically contributed roughly a quarter of the company's NOI and stands at approximately 21% on a trailing 12-month basis through the fourth quarter. Our balance sheet as of December 31, 2022, had total liquidity of $1.1 billion, which was comprised of $264 million of cash and $850 million of undrawn capacity on our revolving credit facility.

At year-end, the company had net debt at share of $2.3 billion with a weighted average interest rate of 3.9% and a weighted average term to maturity of 6.4 years. Our ratio of net debt to adjusted EBITDA was 5.7x well below peer averages. Notably, we have no floating rate debt exposure and a well laddered maturity schedule with no debt maturity until November 2024, when a $78 million mortgage matures. Our balance sheet affords us flexibility to engage in activities that generate shareholder value. This includes the repurchase of our shares, the pursuit of investment opportunities that are additive to our New York City focused portfolio and capital recycling. For the full-year 2022, the company repurchased a total of $88.9 million of its common stock at a weighted average price of $7.78.

In the fourth quarter, and through February 13, 2023, the company repurchased $8.2 million of its common stock at a weighted average price of $6.70 per share. This brings the cumulative amount repurchased to $281.2 million at a weighted average price of $8.31 per share, which represent approximately 11% of total shares outstanding as of March 5, 2020, the date our share buyback program began. As previously mentioned, we focus on capital recycling and we take a hard look at each and every one of our assets and pursue dispositions where we have executed on the business plan and/or can recycle the proceeds into assets that align with our long-term portfolio cash flow growth objectives. We are pleased that during this period of significant market uncertainty, the company successfully executed on its capital recycling strategy.

In terms of dispositions, in the fourth quarter, the company closed on the sale of an office asset located at 10 Bank Street in White Plains, New York, at a gross asset valuation of $42 million. 500 Mamaroneck Avenue in Harrison New York remains under contract for sale for $53 million with an expected closing in the first quarter subject to customary closing condition. Subsequent to year-end in February, the company closed on the disposition of its retail assets located at 69-97 and 103-107 Main Street in Westport, Connecticut, at a gross asset valuation of $40 million. The Westport sale was a related party transaction approved in accordance with the company's protocols. The proceeds from these suburban office and retail dispositions were redeployed in a tax efficient manner into the $115 million acquisition of 298 Mulberry Street that we announced in our December 2022 Business Update.

In a market with limited investment opportunities given dislocation in the capital markets, particularly those of high quality, we are pleased that our investment team was able to source this off-market transaction. Importantly, this acquisition enabled the company to redeploy its disposition proceeds in a tax efficient manner into an asset with a more favorable CapEx profile. Further, given ESRT's flexible balance sheet with strong liquidity, we were able to acquire the asset on an unlevered basis and contribute this to our unencumbered pool. This represents ESRT's third multi-family acquisition as we continue to strengthen our position as a New York City focused company with a strong balance sheet and portfolio with multiple sources of upside that include fully modernized office buildings that benefit from tenants in search of quality and a strong value proposition, everyday retail in high foot traffic locations near mass transit, the Empire State Building Observatory, a high margin business, which continues to experience a strong recovery with even stronger brand recognition compared to pre-COVID and our multi-family portfolio of well amenitized well located assets.

Turning to guidance. We expect 2023 core FFO to range between $0.82 to $0.86 per fully diluted share. This compares to 2022 core FFO of $0.83, excluding lease termination fee income. As a reminder, our guidance range does not include any meaningful future lease termination fees, which totaled $0.07 in 2022. Let me spend a moment to discuss the assumptions used in our guidance. In 2023, we expect same-store cash NOI, excluding lease termination income to be down in the 4% to 6% range from 2022 levels. The change is primarily due to an approximate 8% forecasted increase in property operating expenses and real estate taxes, which is partially offset by higher reimbursement income. The increase in OpEx is largely tied to assumptions for increased building utilization in 2023.

For reference, even with this increase, property operating expenses will be approximately 3% below 2019 levels, which reflect some permanent cost savings and efficiencies we achieve from pre-COVID levels. The increased property operating expenses are partially offset by modest revenue growth anticipated, which assumes same-store occupancy of 85% to 87% by year-end. Similar to 2022 guidance, we have factored in some conservatism on the revenue side, particularly in terms of leasing assumptions and timing of lease commencements. Turning to the observatory. We expect 2023 observatory NOI to be approximately $88 million to $96 million, up from $75 million in 2022. As a reminder, pre-pandemic, the observatory generated $95 million in NOI. This NOI guidance assumes observatory expenses of approximately $9 million per quarter for 2023.

The low end of our guidance range reflects the potential for a slower than expected observatory ramp up due to uncontrollable factors that could impact travel and tourism and conservatism around property revenues, particularly in terms of leasing assumptions and timing of lease commencements. The high end of our range reflects a ramp up in observatory performance that marginally exceeds pre-pandemic levels. Please note that the guidance estimates and assumptions just described do not include the impact of any meaningful future lease termination fee income, or any unannounced future property acquisitions, dispositions or capital markets activity. In summary, the company has executed well on its priorities. We executed on our capital recycling strategy with completed dispositions of two suburban office assets, two suburban retail assets, and one additional suburban office asset pending closing.

In each instance, the transactions were structured to enable the company to redeploy the proceeds in a tax efficient manner. We source through off-market transactions three attractive Manhattan multi-family assets, which now comprise approximately 5% of ESRT's NOI and contributes approximately $0.04 to 2023 FFO. We remained active and executed on approximately $90 million in share buybacks in 2022, which brings our cumulative buyback total to $281 million or 11% of total shares outstanding since the buyback program began in March 2020. We did all of this while prudently and strategically managing our balance sheet to have no floating rate debt exposure, no debt maturity until late 2024, a revolving credit facility that remains undrawn and matures in 2025, plus has two six-month extensions, a strengthened unencumbered pool that now includes multi-family and continued strong liquidity to enable the company to take advantage of attractive investment opportunities that may emerge in this period of uncertainty and capital dislocation.

Our commercial portfolio is now over 85% occupied and over 88% leased, and we continue to benefit from tenants demand for high quality assets, a strong value proposition, and landlords with strong balance sheets who can deliver on their commitments. As we look ahead, ESRT advances into 2023 with a well-positioned and flexible balance sheet, a focus on disciplined capital allocation, and continued commitment to ESG, which we believe will allow us to continue to perform despite the economic headwinds and uncertainties in the market. And with that, I'll now turn to the operator for Q&A. Operator?

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