Empire State Realty Trust, Inc. (NYSE:ESRT) Q1 2023 Earnings Call Transcript April 27, 2023
Operator: Greetings, and welcome to the Empire State Realty Trust First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief 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 and Secretary. Thank you. You may begin.
Heather Houston: Good afternoon. Thank you for joining us today for Empire State Realty Trust first quarter 2023 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. What a great day it is and how pleased we are to report solid first quarter results to start the year to provide updates on strong leasing, balance sheet recycling and observatory results, and discuss our positive outlook for the rest of 2023. Our more than a decade’s focus on modernization amenities, energy efficiency, indoor environmental quality and a strong balance sheet really puts us in a good place. We are in a great position with a differentiated balance sheet and multiple value drivers. We are able to act in and benefit from the current environment and in the first quarter of 2023, we did. We are New York City focused landlord with four diverse drivers of income: office, our observatory experience, retail and our growing multifamily portfolio, as shown on Slide 4 of our new investor presentation.
We are primed to take advantage of New York City’s recovery, resiliency and progress towards a new normal. According to the Department of Labor, New York City office use employment now exceeds pre-pandemic levels, and the narrative around in-office work has changed for the better. Yes, there is a cohort of employees cast adrift by the vanished troop bowls, pampering and compensation and retention, based on whether they return to the office or stay at home and complain. We focus more on the new narrative, about the importance for companies to gather in-person, to plan, mentor, learn, build and execute together and move forward towards and through uncertain times. This is a cycle. And it is a down cycle right now, one about which we spoke and for which we prepared for years, with a fortified balance sheet with low leverage.
ESRT’s modernized portfolio is well amenitized, leads in healthy buildings, energy efficiency and indoor environmental quality is 100% carbon neutral and renewable wind powered, is well located near mass transit and serves as a desirable place for employees to return. We see brokers and tenants who focus on landlord quality and balance sheets, lenders and investor who look at hard data, science-based targets and reporting on sustainability and challenges from floating rate borrowers, who have to go to lenders for TI accommodations and lease decisions. Our quality office portfolio is resilient and ESR benefits from the flight to quality trend. We had another solid quarter with over 200,000 square feet leased at positive leasing spreads, and made continued absorption progress with a 180 basis point increase in Manhattan office occupancy and a 110 basis point increase in Manhattan office leased percentage sequentially.
We have always said that, our goal is to get the best deals in good times and get the deals in challenged times and draw consistent leasing volumes through cycles. Tenants seek a compelling value proposition in well-located buildings, owned by landlords, who have planned for where the puck will be and gotten there with a solid balance sheet. We have added a great new slide on Page 5 of our new investor deck, that we introduced at the Citi REIT Conference to showcase how our portfolio benefits from the flight to quality and that this is not just ”new versus old” narrative. ESRT offers a high quality experience in trophy pre-war assets at our attractive price point. Importantly, we are also a landlord who has the balance sheet stand behind its commitments and obligations with an economically accessible winning portfolio.
This makes a big difference in today’s environment and helps to set us apart as a landlord. We know what we have to do and we are absolutely focused. Tom will cover the quarter in more detail, discuss our 2023 pipeline and speak to two great deals just signed yesterday. The Observatory is off to a strong start in 2023. In the first quarter of 2023, Observatory NOI reached 110% of pre-COVID 2019 levels. The Empire State Building is True Authentic New York City, and The True International brand. Prior to the pandemic, the Observatory contributed approximately 25% of total company NOI on a full year basis, and we are on-track to recapture that performance with tourism’s ongoing return. We own the number one position and our Observatory’s cash flows are reliable.
The resilience of our Observatory through cycles, new competition and a pandemic speaks for itself and is demonstrated on Slide 16 of our investor presentation. We have spoken about the strength of ESRT’s balance sheet for years. We have a clean balance sheet and simple capital structure. Our leverage is well below our peer average. We proactively manage our debts maturity schedule and rent roll and have neither near-term debt maturities, nor floating rate debt exposure. ESRT owns 100% of our office assets with no complex JV structures, and that allows for great optionality and flexibility for future financing and capitalization. Our balance sheet strength helps us to 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.
Our balance sheet allows us to indulge in prudent, omnivorous opportunism, be it share repurchases at the bottom of a cycle, new acquisitions or capital recycling. We will go where we see opportunity to enhance shareholder value. We remain resolutely focused on our sources of capital and seek attractive entry points on assets, which offer cash flow growth after CapEx. We have transitioned out of various suburban assets and reinvested tax efficiently into Manhattan multifamily. The addition of multifamily to our portfolio since December 2021 further diversifies our cash flow stream, and we are very pleased with the performance. According to the Census Bureau, New York City has more residents today than it did pre-COVID. And that drives strong leasing demand in our growing multifamily platform, now a true fourth leg of ESRT’s cash flow stream.
Our industry leadership and environmental stewardship and healthy building performance matters more and more each year to tenants, lenders and shareholders. We uphold our values and adhere to the highest standards in reporting. I encourage all of you to read our just released 2023 Sustainability Report available on our website, that contains full details on our recent accomplishments and new investment and return based goals. Just in this year, ESRT has received the 2023 Energy Star Sustained Excellence Award, was certified as a 2023 Great Place to Work in our first year of survey participation earned the International Well Buildings Award for Leadership and implementation was included in the 2023 Bloomberg Gender Equality Index for the second consecutive year and was recognized as a Platinum Green lease leader for the second consecutive year.
And we also won the 2023 Better Project and Better Practice Award from the Department of Energy’s Better Buildings Initiative. We are committed to the delivery of long-term value to our shareholders and our teammates through continued excellence in ESG. ESRT outperforms because of our people, because of our team who work together and each of whom understands his, her and their role towards our goals, our differentiated portfolio, strong balance sheet and leasing progress. We see disruptions in the market and we will manage through them. The current cycle poses its challenges and presents opportunities. Our priorities are unchanged, lease space, sell tickets to the observatory, manage the balance sheet, achieve sustainability goals, in short, put points on the board.
These actions together enhance shareholder value. We believe in New York City and we offer four ways to play it office, the Empire State Building Observatory, retail and multi-family. New York City is resilient and ESRT is future ready and well positioned to drive value for ESRT shareholders in 2023 and beyond. Tom and Christina will provide more detail on our progress and how we plan to accomplish these goals in the balance of the year. Let’s go over to Tom now.
Tom Durels: Thanks, and good afternoon, everyone. I want to emphasize what Tony just said. We invested nearly a billion dollars into our assets to create fully modernized buildings, build new amenities and new tennis spaces with our leading IEQ and healthy building standards, which we deliver at a compelling price point. What we know from past cycles is that those buildings, which capital has not been invested, are the ones that inevitably suffer the most. And owners with great balance sheets make a difference to brokers and tenants. We’ve done the work, invested the capital, and had the balance sheet to put us in a position to compete and win deals. As a result, we have continued to increase our Manhattan office portfolio occupancy and lease percentages.
Occupancy in our Manhattan office portfolio increased by 180 basis points over the last quarter and increased 390 basis points over the past 12 months. The least percentage in our Manhattan office portfolio increased by 110 basis points compared to last quarter and was up 210 basis points compared to a year ago. We delivered positive market to market spreads for the seventh quarter in a row, and most of the 202,000 square feet to of total leasing volume this quarter was for new leases in our Manhattan office portfolio, where we are now 90.7% leased. The narrative that only new development can compete and attract tenants is wrong, as demonstrated by our results, we are a destination in the flight to quality and tenants have decided that our differentiated product, central locations, near mass transit, fully modernized buildings, quality service in building and neighborhood amenities and value proposition is what they choose to lease.
I encourage you to see page five of our latest investor presentation. In times like this, tenant and brokers become hyper-focused on the financial strength of landlords with whom they depend. This too represents a flight to quality trait that ESRT possesses to give tennis confidence that we can and will deliver on our commitment to build turnkey quality office space on time and deliver superb services without interruption. In the first quarter 90% of our approximately 202,000 square feet of total leasing volume was for new leases. We signed 19 new and renewal leases, which include 183,000 square feet in our Manhattan office properties, 18,000 square feet in our greater New York metropolitan office properties and about a 1000 square feet in our retail portfolio.
Notable lease is signed in the first quarter include a new 16 year lease with STV, a multinational engineering firm for 65,000 square feet at the Empire State Building, an 11 year lease with a non-profit organization claims conference for 34,000 square feet at 1359 Broadway. And we signed leases for 11 pre-built office suites. And after quarter-end just this week, we signed a long-term full floor30 year lease for the 29,000 square feet with rising ground at 1333 Broadway, and just yesterday afternoon signed a 25,000 square feet lease with Skanska who has committed to stay at the Empire State Building for another 11 years. We have active deals in our pipeline throughout the portfolio, including pre-built suites and full floors. And we have $61 million in incremental initial cash revenue from sign leases not commenced and free rent burn-off.
As reported by the FDIC, the Flagstar subsidiary of New York community bankcorp bought substantially all customer deposits and retail branches of Signature Bank whose lease with us covered 326,000 square feet of office space. Our understanding of the terms of the agreement with the FDIC is that Flagstar has the right to assume signatures leased by May 19th. If Flagstar does not assume the lease, the FDIC controlled Bridge Bank has until July 10th to reject the lease, while there has been no official announcement, Flagstar remains current on its rent obligations. From a leasing perspective, Flagstar occupies desirable base and tower floors with four usable terraces at 1400 Broadway, where the office space is currently 100% leased to an excellent tenant roster, with 1,400 hundreds new tenant lounge and town hall amenity due to open this summer.
Along with access to campus amenities should Flagstar terminate its lease, we are prepared and confident in our ability to lease the space. If Flagstar assumes the signature lease, we are well positioned to increase our leased percentage by year-end, since we managed our rent roll and executed earlier renewals such that in 2023, we expect only about 223,000 square feet of tennis to vacate, which will be offset by additional new lease signed. We have invested nearly a billion dollars into our assets to create fully healthy, fully modernized buildings. Our tenant spaces are newly built with our leading standards for IEQ and sustainability. We are adding to our robust in building and campus amenities, all our assets are centrally located near mass transit, our strong balance sheet allows us to compete in today’s environment and give tenants and brokers confidence that we will deliver on our promises and we have an exceptional, dedicated team that executes daily on behalf of our tenants and demonstrated our ability to lease space through all cycles.
While Christina will provide details on our financial results in a moment, same-store property operating expenses remain below pre-pandemic levels through disciplined cost control and despite the effects of inflation and union contract rate increases. We expect 2023 same-store property operating expenses will be below our 2019 levels. I’m extremely proud of our team, who delivered outstanding results and accomplished the successful sale of assets amidst a challenging environment, 500 Mamaroneck Avenue, 10 Bank Street and our Westport retail all closed during the past five months. We effectively executed our business plans harvested value created for our shareholders, and reinvested proceeds into our latest acquisition 298 Mulberry Street. We are encouraged by our early success at 298 Mulberry, where demand exceeds our initial projections and we see opportunity for future growth.
Across our entire multifamily portfolio, we are experiencing strong demand with an average occupancy rate of 97.2%, positive mark-to-market increases and solid market fundamentals. All our multifamily properties are strategically located and we are proactively making property improvements to enhance future performance. In summary, we had another solid quarter with 202,000 square feet of total office and retail leasing and signed a long-term full floor lease for 29,000 square feet after the quarter end, including and another 25,000 square feet, as just announced at the Empire State building. We increased our Manhattan office portfolio lease percentage by 110 basis points over the prior quarter and by 210 basis points from a year ago to reach 90.7% leased.
We are well-positioned to further increase our lease percentage in 2023, and we continue to see strong fundamentals and performance in our growing multifamily portfolio. And now, I’ll turn the call over to Christina. Christina?
Christina Chiu: Thanks, Tom. For the first quarter of 2023, we reported core FFO of $43 million or $0.16 per diluted share, which compares to core FFO of $49 million or $0.18 per diluted share for the first quarter of 2022. Notably, in the first quarter, we have decided to record a $0.024 reserve on the straight line rent receivable of our tenant Signature Bank that I will discuss in more detail. Same-store property cash NOI excluding lease termination fees declined 11.4% year-over-year, primarily due to low operating expenses in 1Q ’22 amid lower building utilization, coupled with a number of one-time cash revenue items in 1Q ’22. On the expense side, 1Q ’22 expenses were still coming off of lower levels from the meaningful and proactive expenses cuts implemented by our team amid lower building utilization during the pandemic, which contributed to positive year-over-year same-store NOI growth throughout 2020 and into early 2021.
The largest year-over-year operating expense increases in 1Q ’23 or R&M and payroll and in particular cleaning, real estate taxes were also higher in 1Q ’23, and this was partially offset by higher tenant reimbursement income. On the revenue side, as noted in our earnings call last year, 1Q ’22 results included a number of one-time cash revenue items that aggregated approximately $3.3 million inclusive of lease modification payments received. Excluding these onetime items in 1Q ’22, the same store property cash NOI decline would be 7%. The Observatory generated NOI of $14.3 million in the first quarter up significantly from NOI of $7 million in the first quarter of ’22. Notably, first quarter NOI was 110% of 2019. Observatory expense was $7.9 million in the first quarter.
The Observatory’s NOI recovery has outpaced visitation. As a reminder, the observatory historically contributed roughly a quarter of the Company’s NOI and stands at approximately 23% on a trailing 12 month basis through the first quarter. Our balance sheet as of March 31, 2023 had total liquidity of $1.1 billion, which was comprised of $273 million of cash and $850 million of undrawn capacity on our revolving credit facility. At quarter 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 6.2 years. Our ratio of net debt to adjusted EBITDA was well below PR averages at 5.7 times. We have no floating rate debt exposure, and we have a well laddered maturity schedule with no debt maturity until November 2024 when a $78 million mortgage matures.
We have the balance sheet flexibility that these uncertain times demand to generate shareholder value. We can repurchase our shares, pursue investment opportunities that are additive to our New York City focused portfolio and recycle our balance sheet. In short, while we have a solid defense, our thoughts and focus are new points on the board. In the first quarter and through April 25, 2023, the Company repurchased 11.6 million of its common stock at a weighted average price of $6.11 per share. This brings the cumulative amount repurchase to 292.2 million at a weighted average price of $8.20 per share, which represents approximately 12% of total shares outstanding as of March 5, 2020, the date our share buyback program began. In our focus on capital recycling, we look hard at each and every one of our assets and pursued 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.
As mentioned in the first quarter, we completed the disposition of our retail assets in Westport, Connecticut for our purchase price of 40 million, and subsequent to quarter end, we closed on our previously announced disposition of 500 Mamaroneck Avenue in Harrison, New York for a purchase price of 53 million. The acquisition of 298 Mulberry Street in December 2022 was funded by proceeds from these dispositions. We would note, our cash balance as of quarter end does not yet reflect net proceeds from these sales. Now, I’d like to take a moment to add additional details on Signature Bank. Our balance sheet is among the most well positioned in the sector, and we operate a well diversified business with four income streams from office, multi-family, retail, and the observatory, along with a well diversified tenant roster.
Signature represents only 2.5% of total company revenues and that percentage will be further diluted when one factors in the ongoing recovery of the observatory. As Tom said, Signature is located in a very desirable asset and our highest leased office building with many contiguous floor plates that will be attractive to market should we ultimately get the space back. At this point, there is no definitive decision yet on Signature Bank’s office lease. Flagstar Bank and FDIC are still within their 60 day and 120 day periods respectively to accept or reject the lease. And as of April, the tenant is current on its rent obligation. Importantly, while we do not yet know the outcome of receivership, we proactively prepare for all outcomes. Given the uncertainty of the outcome for the entirety of the remaining lease term, the appropriate accounting policy was to reserve the straight-line rent receivable balance, which is reflected in our first quarter results, and we will account for rent collected on a cash basis going forward.
We have adjusted our 2023 guidance to account for this decision. As a result, our 2023 FFO guidance range is reduced by $0.02 due to the 1x straight line rent receivable reserve taken in 1Q ’23 for signature. We assume continued rent — cash rent collection in the balance of the year. Our updated full year FFO guidance range is now $0.80 to $0.84 per fully diluted share. Our same store commercial occupancy guidance is unchanged at $0.85 to $0.87. As we stated last quarter, this factor is in some conservatism on the revenue side, particularly in terms of leasing assumptions and timing of lease commencements. Our cash same store NOI guidance is also unchanged at a range of a 4% to 6% year-over-year decline. We expect the decline in same store NOI will be more pronounced in the first half of the year down roughly 10%, primarily due to low operating expenses in 1Q ’22 amid lower building utilization, coupled with a number of 1x cash revenue items in 1Q ’22 as discussed earlier.
We expect same store NOI growth in the second half of the year will be closer to flat on average. This range still assumes an approximate 8% increase in forecasted property operating expenses and real estate taxes, which is partially offset by higher tenant reimbursement income. The increase in operating expenses is largely tied to assumptions for increased building utilization in 2023. We would note that even with this increase full year property operating expenses are expected to be approximately 3% below 2019 levels, which reflect some permanent cost savings and efficiencies we achieve from pre COVID levels. To summarize, the only impact to our guidance from signature at this time is the $0.02 straight line rent receivable reserve tied to accounting treatment and our assumption for signature cash rent collection, occupancy, and same store NOI contribution for 2023 are unchanged at this time.
As mentioned, Flagstar Bank and FDIC are within their 60 and 120 day periods respectively, to accept or reject the lease, and we will revisit our guidance when we report 2Q results as relevant. That said, we want to provide full transparency in the meantime on the additional potential impacts to guidance should the outcome be a full reduction of the lease. In such an event, and assuming no additional cash rent is collected in the second half of the year, the impact on year-end commercial occupancy would be negative 320 basis points. It would have an additional approximate 2% adverse impact on our full year same store NOI growth production. It would have an additional approximate $0.02 adverse impact on our FFO guidance range in the balance of the year, which could still come within our guidance range, albeit at the lower end subject to the performance of our other underlying guidance assumptions.
Our other underlying operating assumptions are unchanged. The leasing pipeline remains on track, expenses are in line with our prior expectations, and our observatory has performed well. For the observatory, we continue to expect 2023 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. Our NOI guidance assumes Observatory expenses at approximately $9 million per quarter on average 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 potentially unfavorable timing in terms of leasing assumptions and lease commencement.
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 made further progress in our capital recycling strategy in 2023, with completed dispositions of two suburban retail assets and one additional suburban office. We remained active on share buybacks, which aggregated $282 million or 12% of total shares outstanding, since the inception of the buyback program. We prudently and strategically manage our balance sheet and have strong liquidity, which enables the Company to take advantage of attractive investment opportunities that may emerge in this period of uncertainty and capital dislocation.
Our capital structure is clean with 100% owned office assets and no complex JVs, which also allows for optionality and flexibility for future financing and capitalization. Our commercial portfolio is now 86.7% occupied and 89.4% leased and we continue to benefit from tenant demand for our high-quality assets, a strong value proposition and landlords with strong balance sheets, who can deliver on their commitments. Our Observatory recovery continues with good momentum to start the year. And the fourth leg of growth, multifamily, continues to perform well and contribute to the resiliency of ESRT’s cash flow. I started my work at ESRT as CFO just three years ago in April 2020. My time here from COVID to recovery has been one of accomplishment for the entire ESRT team and our stakeholders, as we maintain our acute focus on execution and results.
And all the ways in which we deliver stakeholder value with our well-positioned and flexible balance sheet, a focus on disciplined capital allocation and continued commitment to ESG. This is a fantastic journey with a great team and I thank all my colleagues at ESRT, our Board, investor and analyst community, lenders and advisors for their partnership, which have been key to the successes ESRT has had to date. And I look forward to the benefits to all of us through hard and intelligent work and preparedness in the years ahead. And with that, I’ll turn the call back to the operator for Q&A. Operator?
Q&A Session
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Operator: Thank you. Our first question is from Steve Sakwa with Evercore ISI. Please proceed with your question.
Steve Sakwa: Yes, great. Thanks. Look, I understand the Signature Bank is a very fluid situation and hard to kind of pinpoint. My understanding is that the Flagstar was acquired by NYCB, and they have got a suburban footprint and headquarters. I guess I’m just trying to really understand the operational aspect of what takes place in New York and how to think about, maybe what pieces of that 300,000 feet could stay and how much might be duplicative with what NYCB has maybe out in the suburbs?
Tony Malkin: I will just tell you that our view is pretty straightforward. We know the build out that there that they have there and they have underway, and we’re really just going to let them tell their story. It’s not up for us to speculate. We feel actually pretty good about it. At the same time, it was prudent for us to take the mark that we did and that’s why we did what we did and we look forward to be able to update based on their decisions when they have the opportunity to tell us their final outcome.
Tom Durels: Steve, I would just add that — look, as I mentioned before, they occupy really desirable five base floors of 1,400 Broadway and six tower floors. All the floors are consolidated. Most of them have been recently built. 1,400 Broadway is fully modernized. We’re adding to the amenities there. And as I said, they’re current on their rent, and beyond that, I think that we’ve given the dates before.
Steve Sakwa: Just to make sure I heard you correctly. So they have kind of a decision May 15, and if they not to, I guess accept the lease, then it goes to July and then that July is kind of the drop dead date with the FDIC. Is that — am I reading that or hearing that correctly?
Christina Chiu: Yes, Steve, there’s two operative dates that Tom outlined. So the first is flag stars and the second is FDIC. So you have that correct. And we await to response and are very much prepared either way.
Steve Sakwa: And then I guess second question, just in terms of the investment landscape, obviously, things have changed a lot in the last, I don’t know, 30 to 45 days. So either Tony, Tom or the rest of the team, how are you sort of thinking about new incremental investments? And have you changed your investment hurdle for where or how you would deploy capital? Meaning are you — I guess forcing yourself to get a higher IRR in today’s environment given where the stock trades as an, as an alternative?
Tony Malkin: I think that what we are doing right now is what we have done when we do go into a 10 31 situation, we operate in really compressed timeframes and we have to put that money to work, identify within 45 days, execute within 180. And that’s a slightly different drill. And it’s really based on, we look at side by side cash flows and we look to recycle the balance sheet in that situation and go to where we can go cash flow accretion and growth. When it comes to deploy new capital, where we have no real time bind, that’s a different story and we continue to look frankly, we’re in the best position out of all the cycles in which I and Tom and I have worked together for 30 years plus on this. We’re the best position for any cycle we’ve ever had.
And we’ve got a very clear view of our balance sheet and how we can put it to work. And we’ve got very good conversations about how to look at other sources of capital in order to be able to execute deals when we see them. So right now, we’re super pleased the way the team is executed on these 10 31 s and as we go forward and we look to the future, we’ll react as price discovery and that more, more decisions driven by lenders occur.
Christina Chiu: And Steve, just as we’ve discussed, we’re fortunate to have a balance sheet that’s positioned where we can do all of those things and we’re not forced to pick one or the other. The shares are attractive, buybacks are a strategic part, and we will continue — we will continue to recycle the balance sheet in a way that aligns with our long-term objectives and we maintain the capacity to be opportunistic. So we feel very fortunate we have all those options and the team is very active and engaged in pursuing all those opportunities.
Steve Sakwa: Okay. And just one last one for Tom. Just in terms of the pipeline, industries that are maybe most active that you’re sort of talking to in your portfolio today would be what?
Tom Durels: It’s a diversified set of industries, Steve. It’s anywhere from professional services, non-profit, consumer brands, some far, some tech, but those first three I mentioned are probably the dominant activity. And of course, like we just signed a non-profit and then Skanska at Empire State Building that gives you — we’ve always attracted a wide diverse set of industry types. Let’s just be clear, we cater to the deepest pool of office space users in New York City with tremendously priced very competitive property offerings, amenities, modernization, energy efficiency, indoor environmental quality, and brokers and tenants really differentiate now based on sponsorship and based on where they know commissions will be paid, tenant installations will be funded, and they’ll be able to enjoy quiet enjoyment with the landlord with whom they signed their deals in the first place.
Operator: Thank you. Our next question is from John Kim with BMO Capital Markets. Please proceed with your question.
John Kim: Just on that Flagstar space, was wondering if you can give any color on how utilized it was physically? And what the mark-to-market is of their space versus where it leased today?
Tom Durels: Well, they’re in place fully escalated rent is about $58 a square foot. So, I put that maybe just below market, and as I said, they have11 floors of 1400 Broadway, both base floors and tower floors all are very desirable, all have been fully consolidated. We’ve turned over all of the space to signature pre-Flagstar, except for one floor of about 24,000 square feet. And they’re in in use of the space.
John Kim: And Tom, I don’t know if you mentioned the pipeline that you have today as far as where it is today versus last quarter and also on that Skanska space that you signed yesterday. Did that represent an expansion or same amount of space or contraction?
Tom Durels: Skanska will occupy about the same footprint that they have now. They’re relocating and taking a full floor in the building that was occupied by one of our last I’ll call it legacy tenants, will achieve about a 60% plus mark-to-market spread on the lease of that space. And so it’s a ladder movement as far as our pipeline. I feel good about it. We’ve got activity, quite a bit of pre-built activity, a few full floors. I mean, this is in addition to the — again, the two leases that we just signed this week that exceeds 50,000 square feet in total. And I feel good about the pipeline. It’s — we have three full floor pre-built that’s seen a lot of activity and interest. Got a lot of showings there for a full floor that’s built at Empire State Building, 1 at 1350 Broadway, and 1 at 250 West 57th Street.
So, and as I mentioned before, it’s we’re getting activity from professional services, non-profits, consumer products, a variety of industry types. And as Tony said, look tenants are — they are looking for landlords that can deliver. They’re looking for modernized buildings, newly built office space, healthy buildings that are modernized, energy efficient space, amenities, they want convenient access to mass transit, they want central location, they want access to neighborhood amenities. We deliver all of this at an attractive price point and that’s why we attract the wide variety of tenants that we do as well as tenants from a variety of submarkets.
John Kim: Okay. My final question is on multifamily. When you look at acquisition opportunities today, where is pricing in your markets? And if there is any difference between Manhattan, Brooklyn, Jersey City, Long Island City, some of the other submarkets outside of Manhattan?
Tom Durels: I think, if the best thing to do would be to consult that John, we are guessing to — sorry. My glasses aren’t and I’ve got a cold. The best thing it would be to consult with the brokerage community on this. Everything we’ve done is off market. We haven’t done anything that’s broadly market. And so we haven’t been involved in any of those processes, and if you really want that kind of an overview, there are probably better people to go to than to us.
Operator: Thank you. Our next question is from Michael Griffin with Citi. Please proceed with your question.
Michael Griffin: Great. Thanks. Toni, I’m not a hockey fan, but I appreciated the pop category in your opening remarks. Maybe next quarter, we do something around football. But I just want to touch on the leasing and oxide side for a bit. It looks like those numbers came up sequentially. Maybe that’s for Durels, how should we think about a cadence of that sort of throughout the year? I think you talked about the 200,000 square feet of leasing in the quarter. A new deal signed, I think Toni said yesterday. Is there any kind of color around how that will trend for the rest of the year would be great?
Tom Durels: Well, as I’ve stated before, we have modest move outs in 2023 in our Manhattan portfolio. We have only about 176,000 square feet of known move outs. In the total portfolio, it’s about 223,000 square feet of move outs. And so it’s I think, spread somewhat evenly throughout the quarter. Look, we just came off about 390 basis points positive absorption in occupancy year-over-year, and 180 basis points increase in lease percentage in our Manhattan portfolio. And look, we are — combined with our modest move outs for the year and the leasing that we are doing, I think you are going to see a pretty smooth cadence for the balance of the year.
Michael Griffin: Got you. Thanks for that, Tom. And maybe just turning to capital allocation, I think one of the earlier questions is maybe around buybacks, potential acquisitions. I mean, I think with the distressed we might be seeing in the market coming due to go on the private side, maybe it might make a sense to public reach that leverage their balance sheets to be opportunistic. I know you are omnivorous, I think I got that wrong. But any one property type maybe pick out or take advantage, could it be office, apartments? Any color on that would be helpful.
Christina Chiu: Yes. So we have been very clear. Our opportunity set continues to be New York City, office, retail and multifamily, and we look for opportunity. Because the biggest issue is, there is not a ton for sale. There is a lot of behind the doors, workouts and processes going on. So we are still watching things reveal itself and unfold and the team is very active in evaluating any potential opportunities and we are interested into stress. It just has to make sense for the portfolio. On your comment on leveraging balance sheet. So, we are fortunate we have the capacity to do so, which was our point lower leverage versus peers, have a net debt-to-EBITDA at 5.7 and has some ability to trend down just from continued recovery and observatory business. And we have the ability to JV if we wanted. So there are a lot levers that are available to us, should we choose to go down that path without putting ourselves in an unhealthy or stressed situation.
Michael Griffin: And then maybe just one on the financing side of things. Do you have a sense maybe for buildings that aren’t necessarily that trophy product, if there is financing that has to get done, do you think this is feasible — large? Or we might see it more in kind of a one-off context? Every office building is unique so to say.
Christina Chiu: Yes, every office building is unique. I think every relationship is unique as well. So as the data points unfold, keep an eye out for sponsorship and the type of debt that they’re obtaining, right? You may not be able to get long term. Maybe you get something shorter term or they’re guarantees. So I think it really runs the gamut. The short answer is probably there’s money out there for sure, and people are looking for these higher rates of return on debt, but they will be selective in their opportunity.
Operator: Thank you. Our next question is from Blaine Heck with Wells Fargo. Please proceed with your question.
Blaine Heck: Tony, you touched on this a little bit already in the call, but there’s obviously been a lot of discussion around debt maturities in the office sector and the wave of maturities we’re facing over the next few years. So just really wanted to get your view on how this all plays out. Do you expect a significant amount of forest or distress transactions to emerge or not? And what’s that mean for asset pricing in the office sector? And again, potential opportunities for you guys to invest?
Tony Malkin: So, it’s interesting. Look, first of all, we’re very early. There are a few major forces out there. We’ve got fiscal contraction to correct unparalleled peace, time, fiscal and monetary stimulus. That goes against an ordinary credit cycle. The business cycle there is secular over building and there is selective obsolescence. Look at all these buildings out of which we work, and these tech tenants will be rolling out those. A lot of the places where those leased, those are non-functional buildings in the first place. So when we look at this along with post COVID adaption and adjustment, gosh, there’s so many things out there, they’re moving around. That said, I think the biggest impact, we think the biggest impact is low negative interest rates and greater availability of credit enhanced returns and allow a lot of people to borrow a lot of money.
My grandfather always said, low interest rate environments, borrow as little as you need. High interest rate environments, borrow as much as you can afford. And I think a lot of people borrowed as much as they could afford in a low interest rate environment, and they’re over their skis, and the market doesn’t have a really good clearing mechanism. And certainly, the feds and the regulators are not speaking to each other. The treasury and the regulators are not speaking each other. It was just down at the real estate round table at the board meeting a couple of days ago, early this week. And this is the topic that the — it’s quite amazing. Washington DC Treasury and the Fed, they’re not even in the office, they just were instructed to develop plans to return to the office.
So from our view, we are very happy with what we’ve got as far as our balance sheet. Very happy with our recycling, and we really do expect to see problems and we expect to benefit from them. And in the meantime, we think it’s early days, we’ve got low levels of debt. It’s all fixed rate, long, average term of debt outstanding. So from our perspective, we’re well positioned to execute and we’ll focus on the opportunities that we see when we see them arise. I think realistically though, we’re talking about an interesting time over the next 6 to 18 months.
Blaine Heck: Great. Very helpful color there. Switching gears to leasing tenant improvement costs and leasing costs per square foot rose to one of the highest levels we’ve seen since the pandemic began. Can you just talk about whether mix this quarter had anything to do with that, or whether you expect those costs to continue to rise this year? And also, whether you’re seeing any noticeable trends in free rent?
Tony Malkin: Yes. By not — you got this quarter, you got to look at the fact that 90% of our leasing was for new leases and we signed long-term leases with STV and claims conference. And those leasing costs are advertised over the long term. As far as trend look the lease cost in our Manhattan portfolio was about just under $11 square foot, which is in line with the past four-year range that goes anywhere from $8 to $14 per square per square foot. So we really look at our leasing costs as the function of the overall net effect of rent. And it’s, we’re pretty much in line with the past four years.
Operator: Thank you. Now our next question is from Camille Bonnel with Bank of America.
Camille Bonnel: Just to follow up on the previous question around tenant improvement costs. So for the remaining 430,000 square feet expiring this year, do you expect to continue to offer similar packages to get these deals signed?
Tony Malkin: Yes. It’s consistent with the market, but of course not all of this square footage that’s expiring this year will vacate, as I’ve mentioned before only about 220,000 square feet is what we expect to vacate. And of course, we benefit on the significant investment we’ve made into tennis spaces in the past, particularly with our pre-built and what’s coming back is a mix of some pre-built space, some built space, some space that we will have to rebuild. So, it really depends space by space. And as I said before, our leasing costs have generally been within that range of $8 to $14 per square feet each year. And that’s been the range over the last four or five years.
Camille Bonnel: Okay. And I think you mentioned in your observatory guidance that the second half of the year does factor in a slowdown from the momentum we’ve seen in first quarter. More broadly, just given the seasonality and sensitivity to the consumer side and some of your income streams, are you baking in any recessionary risk into the low end of your guidance?
Christina Chiu: I’m sorry, Camille, to clarify, we did not mention that on observatory and actually back half of the year, you get more favorable factors in terms of seasonality. So our guidance holds, as we’ve mentioned, trending back to pre-pandemic levels. In terms of whether our guidance has other assumptions, we do incorporate buffers for the fact that timing can fluctuate some of our leasing assumptions. But that also is offset by sign leases not commence that are scheduled to come in and are contractual. On operating expenses, we do factor in inflationary factors, so there’s elements of what’s going on in the market that don’t require sort of a full-on downside assessment.
Tony Malkin: Yes, I want to be very clear. We are — we’re very happy with the observatory. We’re very happy with its performance. We’re very happy with its recovery. We’re very happy with our revenue per visitor. So, if anyone who might have heard us say, something about we’re not sure in seasonality again, that investor presentation, there’s a slide in there that points out during wars, recessions, new competition we’ve always performed, and we continue to do so and we will.
Operator: Thank you. Our next question is from Dylan Burzinski with Green Street. Please proceed with your question.
Dylan Burzinski: Just curious on the capital recycling front, if you guys have anything in the market today? And if so, what are some of the types of buyers that you’re seeing out in the market?
Christina Chiu: So, I can only comment on what we have already transacted on. As I mentioned, we take a hard look at everything. So we keep our options open. In terms of the buyers for the other two, they were more local based in nature, had others within their buyer group were interested in the entry cap rate and the potential financing that they could obtain to possibly get to positive financing spreads. And that was really the nature of the buyer. So there is demand out there. I think the biggest question mark in the marketplace today, even for non-core suburban assets, what have you, is the ability to line up financing because that’s not just up to the buyer. It’s up to the banks cooperating and the data that we are in within the capital markets.
Dylan Burzinski: That’s helpful. Thank you. And then just going back to the Observatory, obviously, a good first quarter, guidance is unchanged for the year. But curious how the first quarter results compared to sort of your internal underwriting and where we are trending throughout April so far?
Tony Malkin: Let me clear that, we have — not that we give guidance to the Observatory. It’s obviously in our guidance. I will just tell you that, it’s vibrant. It is active. We see a return of international visitors, which continues to grow. People are extremely happy. The reviews we get online are extremely positive. The transition that we did to the all reserved program during COVID is a huge success. And really we are very pleased with not only the Observatory, also, with how we perform compared to the other attractions which are out there. So beside the Observatory, we feel good about where it’s come in compared to our history, and just while we don’t break it out, let’s say, we are quite pleased with the evolution that it made during the quarter made us quite happy.
Christina Chiu: Yes. And as we progress through the year, because we provide the range $88 million to $96 million, we will provide commentary if things are off track. So you should assume it’s in line if we are reaffirming guidance and expenses are on track.
Operator: Thank you. There are no further questions at this time. I’d like to hand the floor back over to Tony Malkin, Chairman, President and CEO for some closing remarks.
Tony Malkin: Thanks so much everybody. Great work team. ESRT is a great way to play New York City. Our portfolio is stronger and more diversified than it was a year ago. We are well-positioned to perform and build on our well-diversified income stream. Our strong and flexible balance sheet empowers us to take advantage of investment opportunities. We are future ready to drive value for our stakeholders and we see opportunity ahead. Remember, I encourage everyone to read through our latest investor presentation and our new Sustainability Report. They both include many great improvements and videos, including some great tenant testimonials that speak to the flight to quality that our portfolio offers. Many thanks to our great team, we are working incredibly hard and I have confidence we will continue to do a great job on behalf of our stakeholders’ special call out to Christina on her third anniversary from Tom and Me and the entire team.
And special words to our entire team and all of you out there, who like us have a lot of children in your office today. Take your daughters and sons to workday is on right now and we hope our future leaders have enjoyed their first earnings call. So thank you for your participation on today’s call. We look forward to the chance to meet with many of it non-deal road shows, conferences, and property tours in the month ahead, till then, thank you for your interest and onward and upward.
Operator: This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.