Empire State Realty Trust Builds On IPO With NYC Icon

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The 83-year-old Art Deco-style Empire State Building is an iconic part of Manhattan's skyline, a major tourist attraction immortalized in films and, for a fledgling New York-based public real estate investment trust, the centerpiece of a growing commercial-property portfolio that generates millions of dollars in revenue.

More than 200 tenants occupy 83% of the storied skyscraper's 2.8 million square feet of office space. It's the flagship property forEmpire State Realty Trust ( ESRT ), a REIT that went public in October on the New York Stock Exchange at an initial public offering price of 13 a share.

The company sold 82.2 million shares in its IPO. Including an underwriters' overallotment option, ESRT raised about $884.1 million net of offering costs, it said in a quarterly report. The stock now trades near 17, up 29% from the IPO price.

ESRT's portfolio includes 8.4 million square feet of office and retail space, mostly in Manhattan, the New York metro area, nearby Fairfield County, Conn., and Westchester County, N.Y.

A record 4.3 million visitors spent $101.8 million last year taking in panoramic views of New York's boroughs and five states from the Empire State Building's observatory. A decade ago, the annual revenue was $40 million.

The observatory is a "cash cow," said Michael Knott, managing director for real estate research firm Green Street Advisors, but a new observatory being built at One World Trade Center could siphon as much as 20% of that revenue, beginning in 2016.

Towers And Turnarounds

Analysts and ESRT senior managers say competition is among the challenges ahead for ESRT, which is redeveloping and repositioning office and retail properties to attract better credit-quality tenants so as to lower vacancy rates and boost rents.

Four office properties -- the Empire State Building, One Grand Central Place, First Stamford Place and 250 W. 57th St. -- accounted for 62% of the REIT's annualized rent last year. The Empire State Building accounted for a third of it.

"The Empire State Building used to be our poorest-performing asset," said ESRT CEO Anthony Malkin.

Now the landmark property is experiencing a major turnaround.

ESRT has moved out hundreds of small tenants and consolidated the space to attract larger tenants with better credit for longer terms. It has improved the building's energy efficiency, elevators and lobby, provided access to fiber-based broadband and added amenities.

The building is evolving into the "ultimate urban campus," Malkin said, a small neighborhood of sorts with tenants-only fitness and conference centers, five different dining concepts, banking, a cellular-phone store and more.

"You name it, it's here," he said.

Among the many tenants is professional-networking website operatorLinkedIn ( LNKD ), which recently added 43,401 square feet of space.

The Empire State Building benefits from four income streams: office, retail, broadcasting and the observatory, providing diversity and resilience, Malkin says.

Tenants are grabbing up renovated floors, rent per square foot has jumped 20%, and revenue has more than doubled, analysts say. At the end of 2013, tenants occupied 86% of ESRT's total portfolio space, generating $345.7 million a year in rent.

"We still have approximately 1.7 million square feet of space left to redevelop within the Manhattan portfolio," Malkin said.

"We vacate and consolidate spaces, scrape them to the bone and re-tenant them with better-quality tenants at what to date has been positive rental-rate spreads," he added. "We also have earlier leases done at the earlier stage of overall portfolio turnaround, so we think we have built in another level of rental increases which are unique to our portfolio."

REITs Perform

ESRT is among many REITs that have fared well over the past year, said Brad Case, senior vice president of research and industry information for the National Association of Real Estate Investment Trusts (NAREIT).

During the first four months of 2014, all sectors of the U.S. REIT market delivered double-digit returns, including office, at 13.6%, and retail, at 12.6%, Case said. That marks a switch from last year, when REIT returns were weak.

With a market cap near $1.6 billion, ESRT amounts to one of the smaller companies in IBD's Finance-Property REIT industry group, dominated in size by mall ownerSimon Property Group ( SPG ), which has a $51.8 billion market cap.

Big office REITs in the group includeBoston Properties ( BXP ), with a market cap around $18.4 billion, as well asBrookfield Office Properties ( BPO ) andSL Green Realty (SLG), each of which weighs in with a market cap over $10 billion. The group currently ranks No. 35 in performance among 197 that IBD tracks.

In May, ESRT paid $734 million to acquire the ground and operating leases at 112 W. 34th Street in Manhattan and the ground lease at 1400 Broadway, both sizable Times Square South office buildings. The acquisitions expand ESRT's portfolio by about 15%.

Malkin said that ESRT tends to focus on attracting more mature businesses with steady profits, strong credit profiles, proven business models and long-term prospects for success.

The IPO gave ESRT a "strong balance sheet" to fund its capital program and future investments, Malkin said, giving ESRT one of the lowest leverage ratios in the office sector relative to publicly traded peer REITs, with total outstanding debt of $1.2 billion. He says running this business became much simpler when ESRT went public.

"We had 23 individual reporting entities, including three public registrants, with no central balance sheet," he said. "Now we are centrally managed with one unified, modestly levered balance sheet, which gives us the ability to compete when we see opportunity."

Since the IPO was completed on Oct. 7, and for the period through Dec. 31, core funds from operations (core FFO) reached $41.4 million, or 0.17 per fully diluted share, ESRT reported. Core FFO excludes the impact of acquisition costs, severance costs, retirement-equity compensation costs and gains on the consolidation of non-controlled entities.

FFO, which includes those factors, was $220.8 million, or $0.90 per fully diluted share. Net income was $75.2 million, or $0.79 per fully diluted share. In May, the ESRT board of directors declared a Q2 dividend of $0.085 per share.

In the first quarter, on a fully diluted basis, FFO totaled 17 cents per share and net income 5 cents per share.

Improvements are helping to bring the Empire State Building full circle, analysts say.

What's A View Worth?

For its first year, after opening in 1931 during the Depression, the observation deck took in about $2 million, as much as owners earned in rent. A dearth of renters led some New Yorkers to dub it the "Empty State Building," and the property didn't turn a profit until 1950.

The Empire State Building's most recent repositioning really began in 2006, Knott said, when ESRT's management finally gained operating control and "had a massive mess to clean up from the prior managers," from personnel and operations to leasing strategy.

"The building had become unleasable in the minds of many tenants and brokers," he said. "That mindset is gone, and the $550 million repositioning appears to be working. There is plenty of upside left."



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: ESRT , LNKD , SPG , BXP , BPO

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