Q2 2019 Earnings Call
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I would now like to turn the conference over to your host Mr., Greg <unk> director of Investor Relations for Empire State Realty Trust.
Thank you you may begin.
Good morning, Thank you for joining us today for Empire State Realty Trust second quarter 2019 earnings Conference call.
In addition to the press release distributed last evening, a quarterly supplemental package with further detail on our results and our latest investor presentation have been posted in the investors section of the company's website at Empire State Realty Trust Dot com.
On today's call management's prepared remarks and answers to your questions may contain forward looking statements as defined in applicable security laws, including those related to market conditions property operations capital expenditures income and expense.
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 Companys filings with the SEC.
Finally during today's call, we will discuss certain non-GAAP financial measures, such as AFFO modified and core FFO and 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 John Kessler, President and Chief operating Officer.
Good morning, and thank you Greg welcome to our second quarter 2019 earnings Conference call.
At Empire State Realty Trust.
No. It is not that popular these days, we are in New York City focused office and retail read with fully modernized assets central locations and easy access to mass transit.
Our four drivers of growth deliver embedded upside and peer leading cash leasing spreads.
Our portfolio is well positioned price between trophy class, a and class B properties.
To outperform in any market.
We have a fortress balance sheet with significant cash undrawn line of credit and low leverage.
And we are an industry leader in sustainability and energy efficiency.
Today, Tom Durels will speak about the second quarters, approximately 261000 square feet of leases.
Market demand for our properties and our market leading leasing spreads.
For our discussion of financial performance and our balance sheet, we will hear from Greg for Jay.
As we all know from our prior filing our CFO , David Carbs last day is a week from today.
And David is here with us and a signed off on all our numbers for the quarter.
As part of our transition plan going forward, Greg will be our lead with investors and analysts and he will report to me.
And today he assumes David's prepared remarks role for the call.
Then David will say a few words.
And finally, Tony Malkin, our chair and CEO will provide some comments on David and our CFO transition.
As always we also have with us in the room to press, our Chief Accounting Officer, and Treasurer, who will shortly as per our filings be our acting CFO .
And John Hog, who many of you know.
Our head of financial planning and analysis.
I'll now turn the call over to Tom Durels Tom.
Thanks, John and good morning, everyone.
In our second quarter numbers, we made more progress on our four drivers of topline de risked and embedded growth.
The breakdown of these top line revenue growth drivers were as of June Thirtyth 2019.
Over the next five years, we estimated to be $96 million can be found on page seven of our investor presentation.
For reference this compares to $543 million in trailing 12 month cash rental revenue and $386 million in trailing 12 months cash NOI as of June Thirtyth 2019.
In the second quarter, we signed 55, new and renewal leases totaling approximately 261000 square feet.
This included approximately 175000 square feet in our Manhattan office properties.
53000 square feet in our Greater New York Metropolitan Office properties and.
33000 square feet in our retail portfolio, which included 27000 square feet of parking garage space.
Significant new office leases signed during the quarter include a 26000 square foot new lease at 111, West 30, Threerd Street with the Interpublic group.
And a 21000 square foot full floor, new lease with lots attain.
Also at 111, West 30 Threerd Street.
In addition, we released 14, new Prebuilts for 81000 square feet predominantly at one Grand Central place.
13, 50, Broadway and 111 West 30 Threerd Street.
As a reminder, on page nine of our supplemental.
We maintain updated disclosure on potential vacates.
And renewals for leases that expire for the remaining two quarters of 2019 and full year 2020.
This chart shows tends to be relocated within our portfolio and vacates to be replaced by new tenants with whom leases have been signed.
We have continued with our proven strategy to vacate and consolidate spaces.
Redevelop them and release those spaces at higher rents to better quality tenants.
There was a delay between the move out of the existing tenants and the commencement of replacement leases.
And a further delay between lease commencement and GAAP revenue recognition, so our occupancy varies quarter by quarter and delays impact our near term reported revenue.
During the second quarter rental rates on new and renewal leases across our entire portfolio were 12.2% higher on a cash basis compared to prior cash escalated rents and at our Manhattan Office properties, we signed new leases at a positive cash rent spread of 22.2%.
Our vacant redevelop office space had prior cash fully escalated rent a $53 per square foot, which is well below current market.
On page 28 of our Investor presentation, we estimate our future cash leasing spreads on Manhattan office leases will vary between 12 and 24%.
Based on the assumption that current market rents without any increase.
We have raised our weighted average asking rents in our Manhattan office buildings by over 4%.
On a trailing 12 months basis following increases throughout 2018.
And demand for our product locations and price points.
As we show on page 12 of our Investor presentation, our trailing 12 month net effective rent growth on a year over year basis for new Manhattan office.
Increased by 6.2%.
The third straight quarter in which we have experienced net effective rent growth in excess of 5%.
We have a healthy pipeline of leases in negotiation across the portfolio for both full floors and pre builts.
We remain focused on our strategy to vacate.
And redevelop space that we will bring to market for future lease up.
Now I will turn the call over to Greg for say Greg.
Thanks, Tom.
For the second quarter, we reported core FFO of $65 million or 22 cents per diluted share cash NOI was $94 million down approximately 3% from the prior year period.
Excluding the observatory results on which I will comment momentarily cash NOI was flat.
On page six of the supplemental we have added a new disclosure in response to helpful comments from the investors and analysts.
This new quarterly schedule of commenced leases and their free rent period provides visibility to when the cash contribution to NOI is realized.
Also for your models note our property operating expenses will be impacted in the next two quarters by onetime RM expense associated with our Quint Quint Glendale, local 11 and tower work at the Empire State building.
These expenses are expected to total approximately $5 million in the second half.
Page 16 of our supplemental highlights our observatory operations revenue for the second quarter of 2019 decreased to $32.9 million or 6.6% from the prior year period.
Four factors combined for this result, $3 million of reduced revenue related to the closure of the 102nd floor observation deck and bad weather offset by improved pricing and the shift of Easter to the second quarter.
Net operating income for the observatory was $24.5 million or 10.9% lower than the second quarter of 2018 due to the aforementioned revenue drivers and higher expenses related to the observatory redevelopment.
Our present schedule is to open new galleries on the second floor on a 20 month of July .
The new 102nd floor in September and the new 80 for the final phase in November .
Excluding the second quarter, 2000, 1800 second quarter revenue, but including the benefit of the entire Easter holiday during the second quarter of 2019 revenue increased 2.3% year over year and NOI was flat over the same period.
As reported on page 16 of the supplemental the observatory hosted approximately 968000 visitors in the second quarter 2019.
A decrease of 81000 visitors compared to the second quarter of 2018.
Of this 81000 decline we estimate the bad weather days resulted in approximately 67000 fewer visitors in the prior year period.
In addition, we estimate that the shift in the Easter holiday, which fell entirely within the second quarter of this year.
And in the prior year was split between the first and second quarters results in a benefit of approximately 20000 visitors that leaves 34000 fewer visitors attributable the other factors.
For the six months ended June Thirtyth, 2019 observatory revenue decreased to $53.4 million or 5.3% from the prior year period due to a similar mix of factors I just mentioned.
Net operating income was $37.5 million, 9.4% lower than the prior period.
Excluding the 102nd floor revenue in 2018 Observatory revenue was roughly flat and then why was down 2.5% over the same period.
The Observatory hosted 1.57 million visitors in the first half of 2019 down 7.3% compared to the $1.69 million in the prior year period.
Moving to our balance sheet as of June Thirtyth 2019, we had total debt outstanding of approximately $1.9 billion and no borrowing under our 1.1 billion dollar unsecured line of credit the debt has a weighted average interest rate of 3.84% and a weighted average term to maturity of 7.6 years, none of our outstanding debt has variable rates, our debt maturities are well laddered and our $250 million exchangeable bond matures. This August 15th.
We plan to retire the debt utilizing some of our existing cash on our balance sheet and we continue to consider our options to replenish the cash balance in the fourth quarter of 2019 with long term fixed rate financing.
For many of the following options bank term loan private placement public bond offering or secured mortgage financing.
As of June Thirtyth 2019, our consolidated net debt to total market capitalization was 23.6% and consolidated net debt to EBITDA was 3.9 times and we held cash cash equivalents and short term investments of $525 million.
I would now like to turn the Mike over to David.
David.
As per our press release it said.
Next week I will step down from my responsibilities as CFO and return to the West Coast.
I joined SRT back in November 2011, and I take pride in the role I played in our company's IPO the creation of our extraordinary balance sheet.
And the accounting financial planning and analysis and Investor teams have built here.
To our investors lenders and sell side analysts.
I have enjoyed our collaboration and the time, we spent together.
I am, particularly proud just knowing that some of you can now tell the difference between an IP and a farmhouse AOL.
So with that I will say, thank you and I look forward to when our pads next cross.
Now I will turn the call over to Tony for some remarks before we open the call for your questions Tony.
First of all.
On behalf of our board and leadership team.
We all want to thank David for his service to SRT.
You all know and we hear all recognize that a company is run by a team and SRT is no different.
Our great team here has worked together and we will continue to work together to maintain our low leverage liquid and flexible balance sheet.
We look forward to continue our excellent relationships with our investors lenders and analysts.
The accounting team led by our soon to be acting Chief Financial Officer Drew Prentice.
The financial planning and analysis team led by our two and a half decade veteran John Hog.
And Investor Relations team led by Greg Vishay.
We'll all be guided by John Kessler, as we move through our transition to a new CFO .
We have engaged Korn ferry international in a search for our next CFO .
And we have tremendous inbound interest and the position from outside the company.
And interest from within.
We thank David for his leadership and contribution.
And wish him the best of luck out there in California and Oregon.
Now.
Let's turn the call over to the operator for Q a day.
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Our first question comes from the line of Jason Green with Evercore ISI. Please proceed with your question.
Good morning.
And any ability to find an acquisition in the marketplace that make sense.
Change in thinking surrounding buybacks.
Hi, Good morning, Jason It's John No I think our view on buybacks continues to be where it was in the past as you know we're focused on trying to grow the business rather than shrink it.
And deploying capital into a buyback reduces our share count et cetera, we'd rather.
We have the balance sheet that weve constructed the cash and liquidity.
For a purpose, which is to create optionality for the future and for growth and that continues to be where our mind is that.
Okay, and then I guess beyond bad weather days, what are you guys seeing in the general tourism market that potentially might be driving visitation down to the observatory.
Well I would say Tony here of the competitive landscape.
For destination attractions has been very challenging in general.
The performance has been.
For across the board.
Quite sketchy when I look at everything from one World Trade Center, which is down 33% from last year.
Through our vendors.
Who we share and which is our only source of input vendors, meaning folks who.
Sell our tickets.
And.
And.
In common with other venues.
We know we're outperforming on top of the rock.
Though we don't have a full picture of their performance the way, we do from one world trade.
We know that circle line and some other attractions.
Our or down public.
Announced numbers for the first six months of.
2019 show the Metropolitan Museum in some other museums down.
And at the same time.
That is opened which initially a report spoke to tracking cell data.
Upwards of 70000 people a day on weekends now that same cell data reports.
Less than half that number per day.
I think we should anticipate that the noise from competing.
Transactions, including one Vanderbilt in the press and advertising around them.
And tourist trends will continue for some time.
We did see this with the opening of the 911 Memorial Museum and one World Trade Center.
And even the reopening of the top of the rock that said, we've always grown revenue.
I think it's a moment just to say.
Couple of words about.
The redo of the observatory and to set the table as to where we are.
And to give you guys an expectation of.
What we are going to be doing.
Phase one of that which was the new observatory entrance opened in August 2018.
And has already increased the desirability of our 34th Street retail space abilities, and cleaned up our fifth Avenue lobby in fifth Avenue experienced for tourists and office users alike.
Phase two which are new galleries on the second floor.
We'll open on the 29 this Monday 29th of July .
And I have to say that you will have to see it to believe it but.
It is extraordinary.
Phase three which is our complete redo of the 102nd floor will open by the end of September .
Phase four which is our complete redo of the floor well open by the end of November .
So.
There is nothing like the Empire State building and there is nothing like we will deliver here in the world.
Period full stop no exceptions.
We've all done this work.
While operating the observatory.
This is truly impressive.
By our MSR, t. professionals and outside creative and execution team.
If you add to that the fact that we have had scaffolding up for our Quinn Kenny old local law 11 work.
It has not been simple to move millions of tourists. In addition.
To all of the contractors and labors and trades and creative folks that we've had in and out of the observatory. So just to shine a little light on the Observatory I think it's just worthwhile to note.
There are there is there is going to be noise out there number one and number two.
We full well recognize that.
We're executing at a very high level on the office.
We are delivering Tom Durels will be able to go into it.
Great trailing 12 month net rent growth.
We are delivering fantastic credits on long term leases to our buildings very busy.
But we've had a significant.
Hurdle to overcome which we have which was the reduction in our broadcast income.
And we know that if the.
Observatory.
Doesn't deliver that a lot of that.
Great result on the office leasing isn't going to show.
So.
The Observatory, we're excited for the opening.
The competitive landscape is all over the place.
Don't forget we had as you know we had heinous whether the worst in years for the first half of this year.
If we adjust for the closure of 102nd observation deck second quarter revenue was up 2.3% last year in first half revenue was flat.
And our our per caps.
On trailing 12 months with a 6% increase versus last year that said will there'll be a lot of noise coming for the upcoming period and if I am sorry, if I've gone on too long, but I figured I'd answer a lot of questions about this all at once.
Thank you.
Thank you. Our next question comes from the line of Craig Mailman with Keybanc capital markets. Please proceed with your question.
Hey, guys, let's start say David Congrats.
Best of luck with the next phase and thanks for your help over the years.
Just wanted to hit on.
The cash NOI growth so in the quarter.
I guess.
Maybe Greg or David could you guys. Just walk me through I would have thought given kind of the conversation last quarter about the 3 million that would kind of flow through more so in Q Q, then a little bit more on top of that that we may have had kind of a bigger pickup this quarter.
Sure. This is Greg care.
If you look on a sequential basis, we did show some property cash NOI growth of about 3% and if you look more closely at the cash rental revenues. They increased about 1.3 million on a sequential basis from first quarter to second quarter. This increase consisted of two parts really at the we had approximately $3 million or free rent burn off and that was partially offset here by tenant vacates about 700000, and holdover rent that occurred Q1 in the first quarter of about 600000, and a few other small miscellaneous items.
Okay. So.
Yes, I think if you look at the new schedule that you saw there on page six that gives you a little more clarity in terms of the timing as it comes in quarterly we've built that in there specifically to help people model it better and then you've got the vacate schedule on page nine that I would also you have to look at that in terms of the offset that you'll see over the course of 19 and an early 20.
And the only thing I'd add to that is look we're always opportunistic to generate additional revenue, where we can from existing tendencies.
And so.
If you look at the underlying recurring business.
It's actually.
Doing very well.
We had.
Other income from other.
Tenant related transactions.
And we will always do that to the extent that we really prefer to do direct leases with new tenants that will then enable subleasing.
In our spaces, we like to get tenants to buy their way out of leases, which produces extra revenue.
And covers our cost of retenanting, rather than let the market pickup this great but the discount.
And so that can distort the excellent performance, we're achieving on a recurring basis.
That's helpful.
And maybe Tony just just thoughts here I mean, you kind of.
The commentary today has been good the results have been good in the net effective rent growth side on the occupancy side.
But yet the stock still trades at a pretty wide discount hearing.
New York last summer check still pretty good global market. So I'm just curious your thoughts.
Overall kind of it.
What do you think you guys need to do or.
The market needs to understand on the disconnect here between public and private values and fundamentals versus sentiment.
But first of all I very much appreciate your question because it.
Gives me a chance to explain to Jamie Feldman that I do more than just the observatory.
Second of all.
I think there are a few things, which really stand out.
Number one.
There's a reason we went public.
And the reason we went public was to resolve.
A series of antiquated.
Partnerships and limited liability companies bring in modern governance structure in a unified balance sheet.
And make things more efficient.
And.
That process was difficult we're glad we did it.
If I sit down with other.
Rather in the right business right now public public companies.
Brother, and sister and I would say.
I would say that there is a.
The common refrain that I hear is the reason that your public as to be able to access capital markets and the discounts at which where we're trading we can't access capital market. So why should we be.
Should we be public I think that speaks to two things one.
We don't need to access capital markets right now to grow externally.
I've got a great balance sheet liquidity.
Great access to additional cash through our line and we have low leverage.
So I'm very mindful of the general schedule, but that you hear from the CEO side.
And how our differentiated there.
I'd also say I had to.
Certainly put together for me by Greg Vishay, which takes a look at the different retail sectors and their premium or discount to any vs determined by Green Street, whether that's accurate or not it's a consistent measure.
In July 2017, compared to July 2019.
And we had the lowest discount in our peer group in July 2017, and we were trading at a slight discount.
Single digit discount.
Chart today to that July 2019.
Office reads are down there with malls, but if you blow opened that office Secretary you will see the bottom for properties are all in New York City based reads SL Green.
Tornado Paramount and ourselves and we still have the lowest discount to that end Avi.
That being said.
It's still a difficult spot in which to be.
And there is no question that while we're focused on external growth we have to look at that massive disconnect between what the private equity flows are and how thats driving values in the market.
And where we are as a public company.
So.
First of all while we're not exercising it now everybody knows that we've got a buyback privilege, we have that right and we actually made that capacity bigger the last time, we reviewed it.
Number two we've got to balance sheet, which would allow that to occur or should that something we want to pursue.
When we look at it a bigger picture.
And the things that we have to do we have to continue to execute as an office and retail primarily New York focused.
Right.
We have to continue to execute at a high level, we have to address the observatory, which we're doing which we saw three years ago, three and half years ago, and all that work is coming to fruition now.
And then I think you are right we have to have existential conversation amongst the executive team and with our board.
On a regular and recurring basis, which is what we do.
Which is how should we be positioning ourselves as a public company.
What's the best way to deliver long term value for the shareholders. How do we drive the bottom line and in that I would just tell you that we always look at every option.
And we try not to do it daily because it gets in the way of executing our regular tasks, but we look at every option. It's a robust conversation and that the question you're having is something that we answer with a variety of options, which we weigh every time, we get together with our board.
Hey, Tony its Jordan Sadler here with Craig I had just one follow up on sort of the buyback.
Yes, John in response to the initial questions that you guys want to grow the company not shrink the capital base, which is understood.
But your cost of capital is quite high as implied by the market.
Would you guys invest.
Opportunistically in assets today at returns that are lower than those that could be garnered by just buying your stock.
I think that.
If you were to look at it at a current return.
With the prospect of improvement over time.
The answer to that would be yes, I think if you were to look at.
Buying 540 Madison Avenue at a four and a half unlevered IR at least how we underwrite it or for 77 Madison at a similar number for a lesser asset.
Or.
I can run down a list of other transactions, which have taken place in New York City, Yeah, Theres no way.
It's absolutely better to have the flexibility or to increase our return per share.
But don't forget we still have.
At 96.
Or so million dollars of of of topline growth, which we're driving our from our embedded growth drivers.
We still believe that.
Look when you start to see the articles out there explaining why this economic cycle justifying and rationalizing by this economic cycle as virtuous and will never end.
Every time those articles have popped up its a sign that the things pretty close to ending on those.
Those articles are popping up we've got tremendous deficits in the government, we have tremendous unfunded state.
The liabilities we have a.
A trade war.
With China, which is impacting tourist visits along with flows of capital sales of homes you name it.
We have a a world in which.
Yes, the Europeans are talking about lowering their interest rates again.
Now we've got negative spreads in Europe .
And in.
But negative to zero and bonds Europe and Japan.
At some point at some price.
I would imagine given the alternatives, we could find ourselves in a position, where we would say it makes more sense to buy our stock than to do anything else.
But right now I think John very.
Correctly and succinctly expressed our view.
Okay.
Thank you.
Thank you. Our next question comes from the line of Blaine Heck with Wells Fargo. Please proceed with your question.
Thanks, Good morning, Tony or John just to expand on the investment picture can you give any color on whether you guys are pursuing anything right now and whether there are specific opportunities.
For the kind of challenged assets are unique situations that you've talked about before.
Yes, Hey, Blaine its John here, we I mean, we are we do look at.
Actively what is out there in the market and I think what just and maybe going back to the prior question I think.
About would we.
How would we deploy capital and as you can see that we havent alright, we haven't made any investments in the current environment because of the.
Super low returns that were seeing.
That investors are getting in the private market because there's so much capital there.
I think what we've continued to see is whether it is a.
Income in place sort of core deal or a.
A redevelopment or value add situation that the market continues to price it aggressively and today, we haven't found anything that's attractive to us and I think we havent seen that change.
We've also seen.
It seems like certainly the smaller transaction sizes also there's there's even more liquidity and they are more aggressively priced.
Okay. That's helpful and you guys, obviously have a relationship with Q.
They have a right of first refusal on any JV you guys might like to do.
So I am assuming you guys have regular discussions with them can you give us any sense of their appetite for investing in New York office at this point.
Good.
First of all we are fortunate to maintain a very good and close relationship with our country partners and.
These are excellent people with a with a long term view.
They've been terrific partners.
Second of all I think it's no secret to know that date.
They still have capital to invest they played a large role in the four NATO joint venture providing half of the new equity that went into the new capitalization of of there the retail on which they did transact.
He wrote a big check they have the ability to write big checks.
I think that it's also very clear.
These are smart.
Long term thinkers.
And they are.
Willing ready and able to participate in anything where we present a compelling case.
And we talk about this often.
The reality. However is we have an add anything where we've been able to present to them a compelling case.
And.
Yes, we're not a private equity operation, where we're seeking to aggregate capital collect fees and.
And get up.
Hope certificate for Optionality for upside in the future.
So.
We take our our partnership with them.
Very seriously we treat it with the highest respect and regard and we know that if we discuss things with them we have there at year.
And if there are things, which we advocate we have a very high level of confidence that they will they will participate as far as their interest generically.
And what they might do.
I am not in a position to comment on that it's best to ask them, but just they remain very engaged with us and.
When we discuss ideas with them, which we have where we are trying to rub two sticks together and create value for our investors they've been very supportive.
Okay. That's helpful. And then lastly, Tom we noticed you guys added to 28000 square foot intentional vacate in 2022, the retail portfolio.
Yes, small in size, but for the retail it's kind of big can you just give some color on that decision and where that spaces.
Well the the Vacates in 2022, primarily relate to.
Our Heartland brewery, whose lease expires in early 2020.
As a reminder, as they occupied about 17000 square feet occupied the corner has started for the good base. The Empire State building. We view this is.
A great opportunity for us to.
Enhance the experience and the reach or the retail at the base.
Our state and we are actively marketing that space and then we added some size Street retail.
At five one seventh Avenue is occupied by some legacy environment tenants. We've just like when you bring in a better type of tenancy to provide amenity and services to our office tenants. So those are the primary drivers of the vacate in 2024 retail.
But while we're on the topic of just the the.
The planned and known Vacates and intentional vacates on the office side.
Whether it be the tenant vacate intentional vacates some of the unknowns, we have space that represents a great upside opportunity for us.
There are floors that we will be getting back or potentially getting back that include tower floors at Empire State building were fully escalated rent on an average of $39 a square foot.
We have full floors at 1400 Broadway and fiber one seventh Avenue also with in place fully escalated rents of $39 a square foot. These are well below market, we're anxious to have the opportunity to.
Release, those spaces at significantly higher rents.
Okay, Great. That's helpful. David Thanks for your help over the years and enjoy that west coast beer.
Thanks, Glen I appreciate that.
Thank you. Our next question comes from the line of Emmanuel Korchman with Citi. Please proceed with your question.
Hey, its Michael Bilerman here with Manny.
Tony I want to come back to the buyback program, just understand sort of the board's perspective in authorizing the buyback last October .
Which was 500 million you know the stock.
Time, let's call it 16 to $17.
Over the course.
The last nine months.
You know its been anywhere down from 10% to 15% from those levels.
So I have to imagine that when you put it in place there was some expectation that the stock represents a decent value at that point.
And I understand that you want to have liquidity and you want to keep the balance sheet.
Fresh.
But why put one in place.
And then not even.
Any of it even modestly.
At values that I would imagine you and the board.
Fuel felt very comfortable when you put it in place as a tool.
And probably feel even more compelled now that it's 10% to 15% lower than that value.
Sure. Thanks, Thanks, Michael.
I look at this in two ways first just by way of background.
If you recall at the time, we put this into place.
We did announce that we had already had a buyback authorized.
And what we did with this authorization.
Is recognized that we were going into.
New territory.
Not just for us as a public company, but for the.
The New York City office sector in general.
And we decided that we wanted to make that authorization.
Two things, one bigger and number two public.
And the reason we wanted to make a bigger was to make sure that we could take advantage of opportunities should things really fall out of bed all together.
And number two.
We wanted to make it public because our plan.
Is.
If we were to execute not too.
Do it and drips and drabs.
To support the stock price.
But to do it.
Frankly quietly and stealthily too.
Acquire an aggregate value for.
Ongoing investors as opposed to selling investors with that in mind.
What we've discovered through advice from council as if we didnt make that.
Fact that we had a buyback program in place public we could be exposed to litigation.
Should we execute in that quiet and stealthy fashion.
And having spent.
Decades in litigation with various parties I really have no interest in entering into that again in my lifetime. So it was a prophylactic measure the second thing I would say is.
We look at ourselves not just in relationship to our value relative to.
Our stock price.
But we look at our stock price in relationship to peers, with whom we might like to conduct M&A activity in New York City.
And they are all trading at bigger discounts than we are.
And the fact is.
That.
We look at that relative value merger opportunity as a meaningful.
Outlet for us, which we have.
Regular discussions internally in which which weve again trying to rub two sticks together, we want to leave the option open for that.
So instead of just looking at our balance sheet.
And our stock price and our net asset value.
I look at our balance sheet, our stock price, our net asset value and the surrounding environment.
And that's where I say, what's the major distinguishing factor between us and the rest.
As we have.
A lot of cash and a lot of leverage ability within our balance sheet.
Both to transact and to assist others with problems that might develop with liquidity on their their watches in case of further dis orientation. So when we have these discussions at the board level and the board is.
100% aligned with management management is 100% aligned with the board.
We look at that second factor.
Very carefully.
And and again, we on the first part of the response.
We made that change as far as size and going public.
Just to protect ourselves increase our flexibility.
And then when you think about M&A, putting aside public to public I think one of the big things you've always talked about since the IPO process was the relationship that you and your family had.
With a lot of private owners that.
Asset.
Not just office assets, but other property types within the New York.
In the Metro area and that the ability to provide units to those holders that can buy into.
The Empire State Realty Trust was an advantage and given where your stock is can you talk a little bit about how those negotiations are those discussions.
Have been going.
Like one would assume that it's a little bit more challenging given where the current stock prices relative to what you perceive as has any value.
You're a master of understatement there are many.
With when Michael.
Well its Michael Okay, sorry, I Didnt, well, well then Manny your silent Michael your master of Understatement.
I would say that when when you look at 477 Madison.
Which is a slump b.
Low ceiling clear height.
Half block frontage.
On a on a with best up retail because the.
Madison Avenue goes downhill there so it's not even even retail front injured. Your next to St packs Cathedral and that the the palace hotel. So when you win when you look at these things and you say that building.
Functionally when you look at the purchase price and what they have to spend on it is easily a thousand dollars a foot.
And when you look at that and the rents that can be achieved there and the operating costs and real estate taxes.
You say to yourself well.
Every single private owner of office in New York City.
Assumes her or his value or her his asset.
On a transaction is worth between 850, and 1200 Bucks a square foot.
And if there is a slight difference between the public.
Value and the private value.
It's a much easier bridged.
You have to take to get over that gap of value.
That being said.
We still firmly believe in the conversations we have we'd like to highlight that if theres a next gen, which is not capable.
If theres a next gen, which has such diffuse interests as far as continuing to receive distributions.
Wanting to increase distributions are wanting to cash out.
If there is a nexgen.
Which has disputes as to who's in charge.
We are a terrific sols.
I would make one other comment it's not just the prices at which these properties are trading.
But it's the availability of debt.
We know of one family that has a property, which is going to go 100% vacant within over market or nearly at market lease.
It has debt maturing at the same time as the vacate.
It has no depth.
To execute.
On an improvement program.
Confronting that New York City 80 by 50.
Laws with regard to energy consumption and greenhouse gas coefficient carbon output.
They've got proposals.
To take out there.
Expiring retiring maturing loan.
And fund.
All of their improvements based on speculation.
And no new tenant.
And so the availability in debt.
Markets the availability in capital markets.
No question it makes our task Carter.
Doesn't Don to us.
Non stop us.
But it definitely makes it harder.
Okay. Just last thing the buyback does expire at the end of this year at one point.
Your reauthorize that.
And is the intention to let the 500 million flow for another year or what.
Process in discussion going on at the board level for that.
Well, let's put it this way I can't talk about the future, but I can talk about the current in the past and our view is in our view has been when I say, our that means management and the board.
That having.
Stock buyback.
Authorization.
Authorizations, I should say because let's not forget there are a couple of different ways, and one which under which one can buyback stock.
We we believe is very important to have this in place.
And it's an option narrow in our quiver and we want to make sure it's in there.
Right, just narrow, but you haven't been able to take it doesn't sound like any intent to take it at any time in the future.
Well anytime in the future is a long way in the distance.
I would say that.
We havent seen a reason to do it yet.
I would say that standing here today or sitting here as we are.
We absolutely have a specific price at which we would act. There is no question that the same time, if we were to get that and find out that every other New York City based right.
Scott moved in concert with ours, we would look at that along with.
Our own stock price.
And coming to a decision, but but right now I can tell you for sure that there is a number at which the board and we have agreed we would act.
Right I think if you look at it flow, bringing I think from that perspective, they are selling assets and the navy and buying their stock back at a discount inherently they're creating any value in real estate value.
Arguably what's going on in the macro environment, New York is clearly affecting all of your stock prices, but just purely from a capital allocation perspective.
Using that capacity selling assets selling interest in assets at market value, which there is a large and liquid market that you've just talked about.
And then buying back stock at some level of a discount creates value right and it's just math you can't argue with it.
So it would seem as though that strategy.
It would be a good one.
No.
SL green spend a lot of money.
And their average buyback prices materially in excess of where their stock trades today.
But I would I wouldn't look I wouldn't look at the stock price is being the measure of success I would look at the value creation in terms of selling assets, and then avi and buying back stock below it where where their stock to be if they hadn't gotten that where were there any the b if they didnt do it right is pure capital allocation.
You can right.
In hindsight hindsight, yes, one would like to stock could be higher but selling assets add any value in buying stock back at a discount to that value created value.
Doing nothing.
So I'll I'll, let the call go on thank you.
Thanks.
Thank you. Our next question comes from the line of Jamie Feldman.
With Bank of America Merrill Lynch. Please proceed with your question.
Great. Thank you.
I guess, just a follow up I mean do you guys think at all about asset sales.
Hey, especially in your core kind of New York Manhattan assets.
Yes, we've looked at this.
Jamie from that perspective that.
If we sell assets.
Particularly.
In our.
In our core.
Locations.
In New York City in Manhattan.
We have to look at what are we going to do with that money.
And B, we have to look at it and say we're already a smallish company.
And if we liquidate further.
We will be.
Hey, definitively smaller company.
And I think it's.
At that point and there's not a lot that we can do which which wouldn't really just say.
Either we should liquidate the whole company.
Or we shouldn't sell anything.
And when we look at selling assets.
Or portions of assets not only does that shrink the business, but when you are selling partial interest in taking in JV partners.
We as you know we don't have any of that right now.
And that gives us absolute flexibility to do whatever we want whenever we want.
So.
Again, we look at everything we discuss everything but what we're doing right now is where we've come out.
After the robust.
Discussions we've had to date.
Okay.
Alright shifting gears.
You guys had talked about that.
Debt maturity coming up in the back half of the year can you talk about I know you talked about several different options to refinance how should we think about the potential accretion or dilution from those different options.
What do you think it's more of a neutral for earnings.
Yes, Jamie it's David.
So if you take a look at the existing exchangeable on a cash coupon basis, we pay about 2.625%.
And for GAAP purposes, which incorporates the non cash portion of the equity option and the amortization of the deferred financing costs, it's around 3.9%.
We have a swap in place we put to put in place a seven year forward, starting interest rate swap, which has a strike price of 2.958%.
If you look at current spreads, let's just say on a seven year term loan that's running about 150 basis points.
And that would put us in an all in coupon of about 4.5%.
Just want to cash basis, our interest cost would be about 190 basis points higher.
Which assuming a 250 million notional amount would translate into.
$4.7 million annually on a GAAP basis, our incremental interest costs would be roughly 60 basis points higher which equates to roughly one and a half million annually on again on that same notional $250 million.
Okay, because I think you guys listed several different options. It sounds like Thats. Your most likely option is to roll in and so I am just here and yes, I'm just giving you that is one example.
Yes, we do have a number of options. We can do a seven year term loan we can do a private placement we could enter the public markets and we could do a secured mortgage financing. So there are a lot of options.
To look at I just gave you the term loan is one example.
Okay. So I guess, if you were to think about the best case scenario would there which of those would actually be accretive or would they all be kind of at least the neutral if not dilutive.
There they are all roughly in the same ballpark.
And I think.
Given that we have to swap in place of roughly 3% that's going to be the driver. The spreads are going to be somewhat comparable across executions. So I think that's that's really the difference.
Okay.
And then Greg you talked about this on an expense in the back half of the year can you talk more about that and then.
If you look at your year over year expenses on the Observatory.
They are up meaningfully and in fact, the you compare the revenue.
The revenue decline year over year to the Eni decline year over year, and it's a much bigger hit.
Can you just talk about the expenses in the quarter and then what to expect going forward.
Yeah, Jamie this is Greg I'll touch on the RM and then I'll switch back to David to talk about the observatory.
The RM work is at work related to local all 11, which is an annual five your exercise every five years you have to do that work and Thats primarily done at Empire State building also known as Quinn Kendall.
As well as some work at the top of the tower. There, we expect about 5 million of expense in the second half relating to this these two combined.
And on the observatory expense year over year increase was really attributable to.
The higher expenses, both maintenance and consulting which was associated with our new ticket kiosks.
And the entrance hardware and software we had higher R&D expenses, we had higher marketing expenses. This was partially offset by lower payroll and benefits, but what I will point out is that we still anticipate the run rate on expenses to approximate what we experienced in the fourth quarter of 2018.
Yeah as I said before this anticipation is based upon early experience with the technology and has the new systems and technology are stabilized.
We're going to have a better sense of what the run rate will be as the year progresses and we'll communicate.
To you if we feel they are going to be any differences from that run rate.
Lastly, just on the labor savings that we realized.
From the reduction in the cash cash shares is being somewhat offset by the higher technology costs.
Okay that sounds good comes down from the Twoq run rate and we should look at Fourq you as an example.
I would yes, yes, I mean quarter over quarter.
There was a there was an increase as well on that was associated with.
Some higher marketing, which is timing related and higher security and credit card fees, which is seasonality. So we're always going to see some movement.
Around the expenses for seasonality, we had introduced introduction of the new.
Software, but.
When we look at our expectations I think a good run rate is what we saw in the fourth quarter of 2018.
Okay.
And then Tony commented about some of the sign he seeing that given a little bit of concern that were late in the cycle.
In one of his responses to one of the questions before I'm. Just curious are you guys seeing any kind of shift in tenant behavior, whether it's the types of tenants, you're seeing leasing space or their willingness to go long or short or anything that's kind of telling you based on prior cycles that something's changing as well.
Yeah.
Yes, good [laughter].
Oh, just far on the leasing front.
I would.
At this time by the way on the leasing front, we're not seeing any any change in the market that would indicate that were.
They were late in the cycle I would say that we feel great about the pipeline of active we have an office space. We've got leases and also negotiation or partial floors that were 11, 1400, 13, 33 and 250, we're seeing demand for across all of our properties for both Prebuilts and fourth floors from a variety of tenant types that includes tech.
Tammy.
Consumer products.
Professional services and other and as you know as I pointed out my earlier comments look at the net effective rent growth that we've posted our actual trailing 12 month net effective rent growth on a year over year basis.
For New Manhattan office leases increased by 6.2% this quarter, that's a third straight quarter in which we have experienced net effective rent growth in excess of 5% for new leases in our Manhattan office properties and that again has reminded us on page 12 of our Investor presentation, and we're seeing a lot of the leasing that we're doing is about a dozen vault employment costs are all of these are good signs, we're not seeing any change at least out on the street on the Frontlines, where we're we're doing leasing.
Okay. That's helpful.
Hi, David Good luck in the next chapter it's been a pleasure working with you.
Thanks, Jamie as with you.
All right take care.
Thank you. Our next question comes from the line of John Guinee with Stifel. Please proceed with your question.
Great. Thank you.
Well I'm worn out from that theoretical a share buyback conversation.
David we are going to Miss you you do know that in California, They only drink wine they don't drink beer.
Well, that's why it's good it's been busier in Bend, Oregon.
So.
Dealing with the more mundane day to day stuff here.
Your page six page nine analysis.
Or comparison is.
Incredibly helpful.
And if I look at the.
Cash gains for.
Commenced leases in free ran I come up what you come up with about $29 million.
And then if I look at the rest of this year and next year and I look at the tenant vacates and the intentional vacate.
Vacations.
I get about 570000 square feet and at your in place rent.
That equates to about $30 million. So is this just kind of a Yang Yang layer.
All the.
Leases about to commence are offset by the Rollouts in the next 18 months or is there a chance that we see some.
And a lot of growth.
Yes.
John This is Greg care, yes, we do give these schedules here to help you out and as you noted we give the new schedule on page six that gives you a little more clarity into the timing there and I think it's important to look at that as well as the Vacates, we give on page nine.
And just from a growth perspective, we do have the 102nd for observation for that's currently out of service and we'll come back online at the end of September and few other factors that have sort of create these headwinds here in 2018 that we discussed previously in terms of leasing costs that are previously capitalized are now being expensed and so as we look forwards we expect to see some growth.
And the other thing Thats important and why we went to the quarterly representation is that the timing both vacates and the burn off of the free rent are important when it occurs if you just took a convention mid mid quarter mid year or whatever it might distort what is really really expected to happen. So I take a close look at the quarterly breakdown and that might help you fine tune your model.
John This is going.
Just one additional comment I'd like to make on that is as a reminder, we are intentionally but getting space to unlock the.
Value creation through Mark to market, an increase in rents I pointed out earlier, we have a number of spaces that either.
We're intentionally basin or that if the tenants through the rate case, we will release those spaces at significantly higher rents.
Because the in place rents are significantly below market. So we view this as upside opportunity.
Okay.
Tom a great segue.
Everything I read about Stamford, Connecticut, and the new York's suburban markets in that facility is.
Pretty scary.
Can you talk about the suburban market and the ability to release this product.
Given your $40 million capital spend.
And then also a curiosity question Heartland brewery 17000 square feet.
Will that be a roll up or roll down in rent and what kind of capital do you think you'd have to expand there.
So let me first hit upon the greater New York much quality of portfolio. As a reminder, we're just about 89% leased and we did do 53000 square feet of leasing this quarter as as you mentioned as previously announced we're underway with an upgrade of the common areas and amenities.
Improvements to our gym's dining coffee, including new coffee lounges.
Conference centers lobbies and outdoor areas and.
The work that we've completed so far looks great. We've received very favorable feedback from brokers and tenants were early in the marketing of some of the space that we know that we've been getting back as a reminder, we got the best locations when each within each of our Submarkets and work conveniently located near mass transit stations and intersections of major thoroughfares look we're confident in our offerings.
And based upon the work that Weve completed that in the face of feedback that weve gotten we're quite confident.
We'd like a locations and we like our product moving on to the.
The retail its I will simply say that corner space at Empire State building is incredibly.
Unique we are focused on bringing in the right use for the space that will enhance the experience for both our office tenants and Observatory, Yes, we're working on with some prospects right now some very interesting and exciting.
Concepts, so whether ends up being.
No.
An increase in rats.
Or not I think we're looking at more holistically as to what it does for the Empire State building and the observatory and for office tenants in the overall.
Experience.
And we just don't think that these are the kind of dose does much for us right now.
Holistic leasing okay, great. Thank you.
You bet.
Thank you. Our next question comes from the line of John Kim with BMO Capital markets. Please proceed with your question.
Thank you congratulations to David Good luck.
My first question is on occupancy.
The highest occupancy you've had as a public company.
But at 90%, there's still room for upside.
Do you see occupancy growing from here or is this just a blip and.
With the tenant move outs and so forth it kind of.
Days or hovers around nine year below.
Just this is Tom look we've given a lot of information in on page nine.
Of the supplemental.
The.
Which details you know, obviously, our or future Rollouts, you know the amount of leasing that weve.
Done to date look last year, we did about three quarters a million square feet of new leasing in our Manhattan office portfolio.
We had a very good quarter with 260000 square feet of leasing as we move into 2020, you can see just the the.
The amount of unknowns.
Our shrinking and the amount of space that is targeted for redevelopment, where we've completed about 7.6 million square feet only have roughly 600000 square feet left within the entire portfolio speaks to as we go forward less what's move outs. So look we.
We give a lot of detail on page nine.
We're confident in our ability to lease space. We're active right now we've got active proposals and leases in negotiation.
Across the portfolio as a reminder, publicly occupancy is going to bump around from quarter to quarter, but on an overall trend we feel confident where we're headed.
Yes, I am just wondering I mean, some of your peers are right.
Let's say, 5% to 6% vacancy I think the market overall is probably around eight or nine.
And your.
Consistently above that amount of vacancy rate when do you get back to market or closer to your peers.
Look as I said before we're going to continue to execute on our program.
To vacate spaces and consolidate smaller spaces in the larger offerings. So that we can.
Released those space to better tenants at higher rents the purpose of providing you the detail on page nine gives you our best look as to what we expect will happen through the end of 2020 as we.
It worked our way through the balance of the undeveloped space will will be much more towards the stabilized portfolio.
If I could ask the cash NOI contribution.
Question in a different way.
And I. Appreciate the addition of disclosure you have on page six.
But at the beginning of the year, you had 23 and a half million dollars of leases that will we're going to begin to contribute.
Cash NOI this year.
And I realize you're not going to get all of that this year because of the timing of when those leases.
Start.
So.
For lack of a better word that's a balance number but on a cash flow basis, how much of that 23 and a half million.
Will you see.
Contributing to cash flow.
In 2018.
I think if you look at the schedule on page John This is Greg if you look at the schedule on page six there. It is as you pointed out the balance number right. So they have to look as it gets realized over the course of a year. So if you are using the December 31 number we should realize 21 million.
Over the course of the year and then the additional schedule that Weve now added in on page six will give you some better insight into the timing going forwards and this clarity will help you.
For 2019 or 2020.
You had 19.
And then final question, maybe for Tony on the on the Observatory all the.
Additional exhibits in the bells and whistles on the second many of you have the floor.
How do you think this will impact revenue will it justify higher ticket prices or is it just really to make the experience better.
Well first of all yes, absolutely.
I think important to differentiate ourselves from all the other burst khalif as that are being put up in the marketplace.
Second of all.
We have a.
The uniqueness to us.
Which is instilled in everybody's mind hard.
You name it.
Around the world.
But finally I think most importantly, well every single thing that has to do with offense is good for defense. This is all offense.
And we're definitely looking at a much better offering.
Let's think of US as the only museum, which is open from ATM to Lam seven days, a week in New York City or in the World.
It's a museum level installation.
Again, seeing it will be believing it.
And.
We believe this will help us not only maintain but also our goal is to increase revenue and by the way the increase reasons to come to the building on bad weather days as well.
But it won't be a separate ticket price. Maybe this was just an all in one price to see the observatory not exhibit.
That is correct.
Although of course as you know we do offer several different levels of experiences in our ticket pricing.
And they'll still be the express opportunity to bypass everything.
And be the quickest visit.
This is part of the of quote the ticket price unquote.
You don't do one or the other.
Got it thank you.
Thank you, ladies and gentlemen that concludes our question and answer session I'll turn the floor back to Mr. Malkin for any final comments.
So first of all I want to say.
The team has been executing at an extraordinarily high level.
Continued great leasing terrific execution.
On not only the redevelopment of our properties, but the redevelopment of the observatory well, all thats up and running.
Just really pleased with what we're doing there and a hats off to the whole team.
Great leasing spreads net effective rent growth and momentum, which we have seen continue into the third quarter.
So we are delivering on our goals and we look forward to the next time, we report to you on our next quarterly earnings.
I very much want to give a last hats off to David.
We've taken our hats off so many times no one has a hat left.
We look forward to seeing you all in the in the months ahead Congresses NDR as property tours Calendared for the second half of the year.
All the best everybody. Thank you sorry for the long haul.
Thank you.
Today's teleconference. You may disconnect your lines at this time, thank you for your participation.