Empire State Realty Trust, Inc. (NYSE:ESRT) Q1 2024 Earnings Call Transcript April 25, 2024

Empire State Realty Trust, Inc. isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to the Empire State Realty Trust First Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. The question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce Heather Houston, Senior Vice President, Chief Counsel, Corporate and Secretary. Thank you. You may begin.

Heather Houston: Good afternoon. Thank you for joining us today for Empire State Realty Trust first quarter 2024 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 are 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 property cash NOI, EBITDA and adjusted 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 and Chief Executive Officer.

Tony Malkin: Thanks, Heather, and good afternoon to everyone. Yesterday, ESRT reported strong first quarter results to start the year, with strong leasing progress, Observatory results and proactive balance sheet actions. Today, we will discuss them and our outlook for the rest of 2024. In the first quarter, FFO came in above expectations. Office, leasing, absorption and spreads, each showed consistently strong positive results. We delivered our ninth consecutive quarter of leased percentage growth and our 11th consecutive quarter of positive mark-to-market lease spreads. Our Observatory performance continues and we maintain a best-in-class balance sheet. Year-to-date, the company completed several capital markets actions to ensure the balance sheet strength and flexibility, which put us on our front foot and we are eager to create additional value for our shareholders in the current real estate cycle.

We leased about 250,000 square feet in our top of tier commercial portfolio to start the year. Our Manhattan office portfolio had 200 basis points of positive leased absorption year-over-year and is now nearly 93% leased. Tom will discuss our current activity. Our office leasing has outperformed the market, because one, we maintained balance sheet discipline during the financing and acquisition booms, did not lever up and did not pay top of market prices. Two, for a decade, we invested portfolio-wide and upgrades to modernize and monetize our portfolio. This included intentional vacates to consolidate floors, modernization through got renovation, addition of amenities and leadership in energy efficiency and indoor environmental quality. These efforts have resulted in top of tier, future ready product that attracts high quality tenants.

Three, our goal has always been to get the best deals in good times and get the deals in challenged times and draw consistent leasing volumes through cycles. Four, our price point and unique value proposition cater to the deepest segment of tenant demand in the New York City office market. Five, ESRT's commitment to service and tenant relationships drives strong tenant retention and expansion within our portfolio over time. Since our IPO, we have seen over 2.7 million square feet of tenant expansions in our portfolio. Six, tenants look to partner with a financially stable landlord, who will maintain high quality standards at their assets. We have the lowest leverage of any New York City reef and a strong liquidity position with no significant debt maturity until 2026 December.

Kristina will later discuss this. Seven and last, this is how we consistently put points on the board. The Observatory continues to perform in the face of an abundance of rainy low visibility days, first quarter NOI was up 13% year-over-year, driven by the continued improvement in revenue per caps and a 10% increase in visitation, which was partially helped by the shift of the Easter holiday into March of this year as compared to April in 2023 and generally based upon a gradual build back of international travel. Our NOI per cap towers above the competition. There is further upside to our Observatory’s performance as tourism continues to return. We have an exceptional global brand awareness. Our Observatory is iconic New York City and has been resilient through all economic cycles, new competition and the pandemic, all as shown on Slide 15 of our investor presentation.

Sustainability is a cornerstone of ESRT.'s business philosophy and we are the leader in environmental stewardship and healthy building performance. Our track record of successful partnerships with tenants and their employees and sustainability attracts tenants. We received the highest scores in this area. This quarter, we were pleased to receive the ENERGY STAR Partner of the Year Sustained Excellence Award for the second consecutive year and the WELL Equity Award and WELL Health-Safety Leadership Award. This makes ESRT the first commercial and multifamily reach to achieve WELL Health-Safety Certification four times, achieve WELL equity and have all buildings enrolled and WELL at scale. We are committed to deliver long-term value to our shareholders through continued excellence and sustainability.

I encourage you all to read our just released 2024 sustainability report that contains full details on our recent accomplishments and initiatives. ESRT's 2024 priorities include growth and a company-wide focus on cash generation from continuing operations. Of course, day-in and day-out, our focus is to lease space, sell tickets to the Observatory, manage the balance sheet and achieve our sustainability goals. These actions together enhance shareholder value. We have a future ready portfolio and an opportunity ready balance sheet, which gives us options today. We are in a position to take advantage of opportunities created through market disruptions and capital dislocations. Tom, Steve and Christina will provide more detail on our progress and how we plan to accomplish these goals in 2024.

Over to you, Tom.

Tom Durels: Hey, thanks Tony, and good afternoon, everyone. We just concluded our ninth consecutive quarter, in which we increased our leased percentage for our office and retail portfolio. That's nine consecutive quarters of positive absorption and an increase of 540 basis points in leased percentage since the fourth quarter of 2021. Fourth quarter of 2024 it was our 11th straight quarter with positive mark to market lease spreads in our Manhattan office portfolio. And we are off to a strong start in 2024 with 248,000 square feet of total leasing in the first quarter. New and renewal leases were signed at positive mark-to-market rent spreads of 4.8% and a weighted average lease duration of approximately 10 years. We increased our Manhattan office leased percentage to 92.7% in the first quarter, which increased 60 basis points compared to last quarter and is up 200 basis points compared to a year ago.

And Manhattan office occupancy increased by 160 basis points from last quarter to 88.9% and notable office leases signed in the first quarter include a 16 year 68,000 square foot expansion lease with Burlington at 1400 Broadway. Burlington has expanded with us three times with this latest expansion along with an extension of their current lease Burlington will occupy a total of 170,000 square feet for 16 year lease term, an 11 year 57000 square foot new lease with solid de Janeiro a lots of changes subsidiary at One Grand Central Place. And we signed leases for 14 prebuilt office suites that totaled 67,000 square feet. Additionally as shown on page 10 of our supplemental, we have $47 million in incremental cash revenue from signed leases not committed free rent burn-off.

Our nine consecutive quarters of strong leasing performance demonstrate that in today's market there is a flight to quality in product, service and balance sheets. ESRT continues to offer the top tier offering in our price bracket and our portfolio offers what tenants want. High quality product that is fully modernized. We've invested approximately $1 billion since our IPO to modernize our buildings. Amenities with a variety of fitness, food offerings, tenant lounges conferencing and abundant outdoor spaces. Energy efficiency, sustainability and indoor environmental quality, locations near mass transit and neighborhood amenities, quality service, turnkey built tenant spaces and accessible price points as tenants look for value and balance sheet strength.

Today in advance of every building tour the brokers' qualification list includes the capital stack of the building and the financial strength of the landlord. Tenants make long-term commitments with us based on our financial strength and confidence that we will deliver on our promises. We've seen strong tour volume year-to-date which will help drive new leasing activity later this year. In our Manhattan office portfolio, we have modest lease expirations for the balance of 2024 with 486,000 square feet set to expire of which 268,000 square feet is covered by expected renewals, relocations and new leases. Only 193,000 square feet are known vacates and 25,000 square feet remains undecided at this time. We have a healthy pipeline of over 200,000 square feet of leases in negotiation of which 140,000 square feet are new deals and the balance are renewals.

Our multifamily portfolio with occupancy of 97.1% at quarter end continues to perform exceptionally well and benefit from strong market fundamentals and recent property improvements. Once again we had a strong start to the year. And in the first quarter we signed over 248,000 square feet of commercial leases and increased our Manhattan office leased percentage by 200 basis points from a year ago to 92.7%. Our Manhattan office occupancy increased by 160 basis points compared to last quarter to 88.9%. We are well-positioned to lease space and achieve positive lease absorption with modest lease expirations for the year and a healthy pipeline of new leases to start the year and we continue to see strong demand for our multifamily portfolio. Thank you and I'll now turn the call over to Steve.

Steve Horn: Thanks, Tom. For the first quarter of 2024, we reported core FFO of $57 million or $0.21 per diluted share which increased 30% year-over-year. Same-store property cash NOI which now excludes first Stamford place increased 12.3% year-over-year primarily driven by higher revenues from cash rent commencements, which was partially offset by increases in property operating expenses. Excluding non-recurring items 1Q 2024 adjusted same-store NOI increased by approximately 8% year over year. As it relates to the onetime items in the current period we recognized approximately $1.5 million of revenue from various items including bad debt recovery and settlement of an insurance claim. The 1Q 2023 period was an easier comp as it had about $1 million less cash rents that resulted from adjustments recorded for a few delays in rent commencements.

While not material to their individual quarters, we call this out as it contributed to a roughly 4% pop in the comparable same-store cash NOI growth year over year. As Christina will discuss our outlook for same-store NOI growth for the year remains unchanged. We had a solid first quarter of growth driven by strong recurring rental revenues and free rent burn-off as well as the one-time items just discussed. That said, the remainder of the year will be a tougher year-over-year comp due to several non-recurring items discussed last quarter, which benefited 2023 results primarily in 2Q 2023 through 4Q 2023. Moving to our Observatory business. We generated net operating income of $16 million in the first quarter, an increase of 13% year-over-year.

Revenue per capita remains high and admissions continue to improve year-over-year. Observatory expense was $8.4 million in the first quarter. Christina will discuss the proactive measures we recently took to fortify our balance sheet and then discuss our outlook for the balance of the year. Christina?

Christina Chiu: Thanks, Steve. We had a busy start to the year from a balance sheet and transaction standpoint. Starting with the balance sheet. In March, we closed on a new $715 million credit facility, which consists of a $620 million revolving credit facility and a $95 million term loan. The new facility matures in March 2029 inclusive of extensions and replaces the prior facility that was due to mature in March 2025. After quarter end in April, we entered into a note purchase agreement to issue $225 million of green senior unsecured notes in a private placement transaction with three tranches, including $155 million that matures in 2029, $45 million that matures in 2031 and $25 million that matures in 2034 at an overall weighted average rate of 7.25%.

We received strong support from both new and existing high-quality institutional investors. This is scheduled to fund in mid-June, and we intend to use the proceeds to eventually pay down indebtedness, including the remaining $100 million maturity in 2025 and the $120 million drawn on our credit facility. With these financings, the company has successfully addressed the entire $315 million of debt that was due to mature in 2025 and extended the maturity of our revolving credit facility from 2025 to 2029 inclusive of extension. The next meaningful debt maturity is not until December 2026 when a $175 million term loan matures. On the transaction side, in March, we executed a buyout of the remaining 10% that we did not already own in two multifamily assets located at 561 10th Avenue and 345 East 10-port Street for approximately $14 million in cash and the assumption of $18 million of the in-place debt.

As a reminder, the debt on these two assets have a blended interest rate of 3.9% and mature in 2030 and 2033. As a result, ESRT now owns 100% of our portfolio. We have no JV ownership structure, and that allows for great opportunity and flexibility for future financing and capitalization. Subsequent to quarter end, in early April, we entered into an agreement for the strategic disposition of First Stamford Place via a cooperative consensual foreclosure with the lender, which is anticipated to close by the end of the second quarter. Pro forma for the completion of this disposition, 98% of net operating income will be from properties in our New York City focused portfolio. Further, upon completion, our debt maturity in 2027 is reduced to just $155 million, as shown in our pro forma debt maturity schedule on slide 9 of the investor presentation.

This transaction is consistent with our strategy to proactively manage our balance sheet and recycle capital. In our decision here, we considered after CapEx adjusted cash flows, submarket fundamentals in Stamford, Connecticut and our capital allocation objectives. This disposition avoids significant CapEx, reduces secured debt as a percentage of total debt and frees up $176 million of debt capacity from our balance sheet that we can recycle into stronger New York City focused assets that align better with our long-term business plan. Over the past two-plus years, we have disposed of five other noncore assets in Westchester and Connecticut and recycled into high-quality New York City multifamily and retail. MetroCenter will be our last remaining asset outside of New York City.

Its mortgage matures in November 2024, and we have had productive discussions with the lender and are close to finalization of the terms for its refinance at maturity. We continue to look for ways to reinvest capital in a tax-efficient manner and pursue investment opportunities that are additive to our New York City focused portfolio and enhance shareholder value. At quarter end, the company had net debt of $2.2 billion with a weighted average interest rate of 3.97% and a weighted average term to maturity of 5.4 years. We have strong liquidity, no floating rate debt exposure, a well laddered debt maturity schedule and the lowest leverage among all New York City focus reach at 5.3 times net debt to adjusted EBITDA. From an earnings perspective, the net impact from the balance sheet and transaction activity announced today, will be approximately $0.012 dilutive to our 2024 FFO.

This includes the repayment of the old $215 million term loan in March 2024, using proceeds from the new $95 million term loan and the $120 million revolver draw. The $215 million or so for swaps remains in place through March 2025. So the only impact is a modest change in spreads for the balance of 2024. It also includes funding of the new $225 million private placement notes in mid June. Prior to any repayment of debt, these proceeds will earn interest income around the current rate of approximately 5%. It also includes the buyout of our partner's 10% interest, in two multifamily assets at the end of the first quarter including, the assumption of their share of debt. And finally, it includes the disposition of First Stamford Place, which for the full year of 2023 generated approximately $10 million of cash NOI and incurred $7.5 million of interest expense.

We assume this transaction is completed by the end of the second quarter. Now on to our outlook for 2024, we continue to expect 2024 FFO to range between $0.90 and $0.94 per fully diluted share. As a reminder, our prior guidance range did not include the balance sheet activity and transactions announced to date. But as discussed, these items have only $0.012 impact on 2024 FFO and we therefore have room within our $0.04 range. Based on our performance to date and forward assumptions provided, we remain confident with this range. We continue to expect same-store cash net operating income for the commercial portfolio to be modestly positive at the midpoint, with a range of down 1% to up 2% relative to 2023 levels. Within this range, we expect positive revenue growth which assumes commercial occupancy of 87% to 89% by year end 2024, driven by a strong pipeline of signed leases not yet commenced and manageable lease expirations in 2024.

We expect an approximate 6% to 8% increase in forecasted property operating expenses and real estate taxes in 2024, which is partially offset by higher reimbursement. Lastly, we expect 2024 Observatory NOI to be approximately $94 million to $102 million and average Observatory expenses of approximately $9 million per quarter. In summary, ESRT had another productive quarter and executed well on our priorities. And with that, I will now turn the call back to the operator for a Q&A session. Operator?

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Steve Sakwa with Evercore ISI. Please proceed with your question.

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