Empire State Realty Trust - Q2 2024

Transcript

Operator (participant)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Heather Houston, Senior Vice President, Chief Counsel, Corporate, and Secretary. Thank you. You may begin.

Heather Houston (SVP, Chief Counsel, Corporate, and Secretary)

Good afternoon. Thank you for joining us today for Empire State Realty Trust second quarter 2024 earnings conference call. In addition to the press release distributed yesterday, a quarterly supplemental package with further detail on our results and our latest investor presentations 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 property cash NOI, EBITDA, and adjusted EBITDA, which we believe are meaningful in evaluating the company's performance. The definitions and reconciliations of these measures to the most directly comparable GAAP measures are included in the earnings release and supplemental package, each available on the company's website. Now, I will turn the call over to Tony Malkin, our Chairman and Chief Executive Officer.

Tony Malkin (Chairman and CEO)

Thanks, Heather, and good afternoon to everyone. Yesterday, we reported ESRT's strong second quarter and year-to-date results. We are happy to report continued strong leasing momentum, observatory growth, and capital recycling progress. So let's dive into our discussion of our results for 2Q and our outlook for the rest of 2024. In the second quarter, we delivered once again on office leasing absorption and positive rent spreads. Here's the big leasing story for New York City office. Team ESRT put points on the board again with our 10th consecutive quarter of leased percentage growth. That's 10 quarters in a row and our 12th consecutive quarter of positive New York City mark-to-market lease spreads. Positive lease absorption, positive lease spreads. New York City is strong, and our modernized, amenitized, energy-efficient properties with indoor environmental quality are in demand.

Our observatory performance continues very nicely and was named number one destination attraction in the United States for the third consecutive year, and number one destination attraction in the world for the first time in Tripadvisor's Best of the Best. We have contracted to expand the retail component of our NOI with additional retail on the prime North 6th submarket of the remarkable Williamsburg submarket of Brooklyn, and we maintain a best-in-class balance sheet. In 2024, ESRT is on our front foot, and we are eager to create additional value for our shareholders in the current real estate cycle. Year to date, we have leased 640,000 sq ft, of which 270,000 sq ft were leased in the second quarter.

Our Manhattan office portfolio had 170 basis points of positive leased absorption year-over-year and is now 93.3% leased. Our redevelopment work over the past decade has produced a unique, top-of-tier product that tenants want to lease. Please see a new slide on page nine of our investor deck that features great before and after pictures. ESRT's commitment to service and tenant relationships continue to drive strong tenant retention and expansion within our portfolio over time. Since our IPO, and this is a new number, that just continues to grow, we have seen 2.8 million sq ft of new leases comprised of tenant expansions. Tenants appreciate that we have the lowest leverage of any New York City REIT, a strong liquidity position, and have addressed all meaningful debt maturities until December 2026. Our balance sheet delivers leases.

Year to date, observatory NOI is up 6% year-over-year, driven by continued improvement in revenue per caps and increase in visitation. Our NOI per cap towers above the competition. Our global brand awareness has no equal, and as noted, in June, the Empire State Building observatory deck was named the number one attraction in the world in Tripadvisor's 2024 Travelers' Choice Awards, Best of the Best Things to Do, and the number one attraction in the United States for the third consecutive year. I promised our observatory team I would take a pie in the face if we achieved this great result, and watch our social channels for that very occurrence soon. See slide 17 of our investor presentation for more on the observatory performance story.

Sustainability continues to be a cornerstone of ESRT's business philosophy, and we are the leader in environmental stewardship and healthy building performance. Just last week, the Empire State Building earned the Building Owners and Managers Association, BOMA, 2024 International Earth Award. That is a big deal, and we are so happy for the recognition of our team. Please read our 2023 sustainability report to see what leadership looks like. Our track record of successful sustainability partnerships with companies and their employees attracts tenants and contributes to our leasing success. Tom, Christina, and Steve will provide more detail on our progress and how we plan to accomplish these goals in the balance of 2024. Now I'd like to hand it over to Tom.

Thomas Durels (President and COO)

Hey, thanks, Tony, and good afternoon, everyone. In the second quarter, our office and retail portfolio continued its steady trajectory of positive absorption. This was the 10th consecutive quarter in which our team increased our leased percentage. That's an increase of 690 basis points since the fourth quarter of 2021. Today, our Manhattan office portfolio stands at 93.3% leased, an increase of 60 basis points compared to last quarter, and is up 170 basis points compared to a year ago. In the second quarter, our Manhattan office occupancy increased by 120 basis points year over year to 88.8%. The second quarter was also our 12th straight quarter with positive mark-to-market lease spreads in our Manhattan office portfolio. New and renewal leases were signed with positive mark-to-market rent spreads of 2%.

Leasing volumes continue to be strong, with 272,000 sq ft of total leasing in the second quarter, inclusive of 55,000 sq ft of early renewals. This increases the total leases signed year to date to 642,000 sq ft. We have added new disclosure in our supplemental on pages 11 to 12 to include early renewals, defined as leases that are renewed two or more years ahead of lease expiration. Nearly all the early renewals signed year to date were done in connection with expansions. While it has always been our practice to seek opportunity to extend the lease term of existing tenants, we did not previously include these numbers in our reported renewal statistics.

Notable office leases signed during the second quarter include an 11-year, 41,000 sq ft expansion lease with Pantheon, who will relocate to the Empire State Building from their current 11,000 sq ft space at 111 West 33rd Street. An 11-year, 28,000 sq ft new lease on the two highest- ... fully modernize and amenitize our portfolio. Please make sure to check out our new slide on page 9 in the investor presentation, with before and after pictures that help visualize just how meaningful our portfolio transformation has been. It is because of this redevelopment work over the past decade, carried out by our exceptional leaders, Ryan Kass in leasing, Michael Ponte in property management, Dana Schneider in sustainability, and Peter Sjolund in construction, that we have top-of-tier assets today that attract leasing demand and win in the flight to quality.

In addition to the previously mentioned 24,000 sq ft lease that was signed today, we have a healthy pipeline of another 150,000 sq ft of leases in negotiation, of which 70,000 sq ft are new deals and the balance are renewals. In our Manhattan office portfolio, we have modest lease expirations for the balance of 2024, with 190,000 sq ft of known vacates and 12,000 sq ft is undecided at this time. Looking forward to 2025, we have only 162,000 sq ft of known vacates and 114,000 sq ft of tenants who are undecided. This is against the backdrop of an average 827,000 sq ft of annual leasing for the past three years in our Manhattan office portfolio.

Our multifamily portfolio, with occupancy of 97.9% at quarter end, continues to perform exceptionally well and benefit from strong market fundamentals and recent property improvements. In summary, in the second quarter, we signed over 272,000 sq ft of commercial leases. We increased our Manhattan office leased percentage by 170 basis points from a year ago to 93.3%. We have our 10th consecutive quarter of increased leased percentage. Our Manhattan office occupancy increased by 120 basis points compared to last year, to 88.8%. We have a healthy pipeline of activity, and we continue to have strong performance in our multifamily portfolio. With that, thank you. I will now turn the call over to Christina.

Christina Chiu (EVP and CFO)

Thanks, Tom. We continue to make progress with our capital recycling initiative. As disclosed in our earnings release, subsequent to quarter end, we entered into two agreements to acquire prime retail assets in Williamsburg, Brooklyn, for $195 million in aggregate, with anticipated closing dates in 3Q. The first portfolio is for $103 million of assets located on North 6th Street between Wythe and Berry Street. These assets span approximately 40,000 sq ft across five retail storefronts that include high-quality tenants such as Nike and Ermenegildo Zegna. These assets are 86% leased, with near-term upside from signed leases that have not yet commenced, in addition to vacancy lease-up. The in-place retailers have a weighted average lease term of 7.5 years, and we estimate significant mark-to-market upside as leases roll.

The second portfolio is for $92 million of prime retail assets, also on North 6th Street. Due to confidentiality requirements, more details on this additional portfolio will be disclosed upon closing. We are very pleased to increase our scale in this prime retail corridor of Williamsburg, following our prior acquisition of a retail asset on North 6th Street in September 2023, that continues to benefit from increasing population density, strong household income, and new multifamily and hospitality development recently completed and underway. We see the Williamsburg story to be a decade ahead of value creation. Please see Slides 19 to 20 for more color on these transactions and the strength of this retail submarket. These all-cash acquisitions are consistent with our strategy over the past couple of years to recycle capital and balance sheet capacity from noncore suburban assets into strong New York City assets.

As shown in a new Slide 10 in our investor deck, we have disposed of five noncore assets in Westchester and Connecticut since 2022, and recycled into nearly $650 million of high-quality New York City multifamily and retail assets that have great growth prospects and less capital expenditure requirements over time. As a result of this capital recycling, we have improved our sector diversification. Pro forma for the latest retail acquisition and the previously announced disposition of suburban office, our NOI composition is approximately 58% office, 12% retail, 5% multifamily, and 25% observatory. Importantly, we strategically executed on these capital recycling transactions while maintaining our pure leading balance sheet strength and below-average leverage. Going forward, we will continue to focus on investment opportunities with attractive upside potential, in addition to distressed transactions that we expect to arrive in this cycle.

In July, we executed an agreement to refinance the mortgage on our Metro Center property that was due to mature in November 2024. Beginning November 2024, the new loan balance of $72 million will be interest only at the same interest rate of 3.6%, with a maturity of November 2029, inclusive of a 1-year extension option. As previously mentioned, we intend to use a portion of the proceeds from our recent unsecured notes issuance to pay down the $100 million maturity in March 2025. As a result, we have no meaningful uncovered debt maturity to address until December 2026, when a $175 million term loan matures.

At quarter-end, the company had $2.3 billion of total debt outstanding, with a weighted average interest rate of 4.27% and a weighted average term to maturity of 5.8 years, pro forma for the recent Metro Center refinancing and the planned paydown of our March 2025 debt maturity. We have strong liquidity, no floating rate debt exposure, a well-laddered debt maturity schedule, and the lowest leverage among all New York City-focused REITs at 5.1x net debt to EBITDA. Please note that we do expect leverage to tick up from this level once the Williamsburg acquisitions are closed and after we utilize cash from the recent unsecured notes offering to pay down maturing debt in March 2025.

As we have said for many years, we are prepared to increase leverage to take advantage of value opportunities to grow our business. We view approximately 6x net debt to EBITDA as a more stabilized leverage level to think about going forward. And now, I will turn the call over to Steve to discuss our results and outlook for the remainder of 2024. Steve?

Stephen Horn (EVP and Chief Accounting Officer)

Thanks, Christina. For the second quarter of 2024, we reported Core FFO of $66 million, or 24 cents per diluted share. Same-store property cash NOI increased 7.4% year-over-year, primarily driven by higher revenues from cash rent commencement, which was partially offset by increases in property operating expenses, which we anticipated in our guidance, albeit the increase was less than initially guided, partially due to lighter utility expenses than expected. Note that the second quarter also included approximately $2 million of positive one-time revenue items. Excluding these non-recurring items from the current period and prior year period, second quarter adjusted same-store cash NOI increased by approximately 6% year-over-year. Moving to our observatory business, we generated net operating income of $25 million in the second quarter, approximately 2% higher than the prior year period.

Observatory expense was $8.9 million in the second quarter. Keep in mind that the shift of the Easter holiday into the first quarter of this year versus the second quarter of last year impacts comparability. Year to date, net operating income for the observatory was $41 million, an increase of approximately 6% year-over-year. Revenue per capita remains high, and year-to-date admissions continue to improve year-over-year. Now on to our outlook for 2024. We continue to expect 2024 FFO to range between $0.90 and $0.94 per fully diluted share. Within this range, our key assumptions are as follows. Same-store cash net operating income for the commercial portfolio to range from 0%-3% relative to 2023 levels. This represents a 100 basis point increase from our original expected range.

The increase is largely driven by our expectation for property operating expenses and real estate taxes to come in towards the lower end of our previous range of a 6%-8% increase over the prior year. We now expect an approximate 6%-7% increase year-over-year. The improvement is primarily due to lighter than expected utility and payroll expenses. Within this range, we continue to expect positive revenue growth, which assumes commercial occupancy of 87%-89% by year-end 2024, driven by a strong pipeline of signed leases not yet commenced and manageable lease expirations in 2024. We continue to expect 2024 Observatory NOI to be approximately $94 million-$102 million, and average Observatory expenses of approximately $9 million per quarter.

Our guidance range takes into account variability in our Observatory results due to tourism fluctuations and bad weather in any given quarter, and the recent capital markets and transaction activity announced year to date. Also included within our FFO guidance range, we expect a larger than usual increase in 2024 G&A to approximately $68 million for the full year to reflect the recent NEO promotions and accelerated recognition of certain non-cash stock-based compensation expense as a result of executives approaching retirement eligibility. While we do not provide our formal outlook for 2025 yet, we do believe it's important to share a few items that could impact next year. Those include, 1, the full year run rate of higher G&A, as just discussed, and 2, the 9-month impact of the higher interest rate on our recent unsecured notes issuance.

With that, I will now turn the call back to the operator for the Q&A session. Operator?

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Thank you. Our first question comes from the line of Steve Sakwa with Evercore. Please proceed with your question.

Stephen Sakwa (Senior Managing Director and Senior Equity Research Analyst)

Yes, thanks. Good afternoon. I mean, maybe starting on the just the pipeline, Tom, and sort of the leasing activity that you're seeing. You know, just any additional thoughts and color that you can provide around kind of expansion opportunities and, you know, just kind of the discussions that you're having with tenants. And you know, I noticed that you had that new disclosure about early renewals. You know, is that something that you're hearing and seeing more of today, and tenants are willing to come to you early, maybe sooner than they have to, to kind of lock in space today?

Thomas Durels (President and COO)

I'll take the second part of your question first, Steve. We have always executed on early renewals, and certainly we make that part of our discussion with existing tenants. Often it comes in connection with an expansion of an existing tenant, where we look to use that opportunity to extend their existing lease on the back of their current term. And so that's always been kind of our part of our diet. And so that we see that really more the case. As far as pipeline, we've got... Look, as I mentioned before, we just received a signed lease for a full floor of 24,000 sq ft at 1350 Broadway.

Between that and the deal we signed with Carter's, it's gonna bring that building into the mid-90s% leased. We've got another called 160,000 sq ft of leases in negotiation. 150 of that is in Manhattan for our office portfolio. And look, we've been approached by a tenant at the Empire State Building for an expansion. We haven't yet issued paper on that, but they're talking to us about taking an additional full floor. So what we're seeing more often is that more and more tenants have moved beyond this whole you know issue of work from home. They're committing to their space in New York City. They want desks for their employees.

Their employees want to be in the office, and you're seeing more and more of that decisiveness by, by tenants, and that's reflected in, look, the fantastic leasing results we've had to date and the good pipeline we're seeing now.

Tony Malkin (Chairman and CEO)

And the only thing I'd add to that, Steve, Tony Malkin here, is that people come to us, brokers come to us. We are on the list because we're, I'm not just pushing our own book here. They come for the modernization, the amenitization, the energy efficiency, the IEQ. They look at that and say these are key attractants for their, their, their employees. But the brokers come to us because of our balance sheet, and they know that there's no issue of speaking with us and a lender, that we can do the whole transaction ourselves and take care of everything based on our reputation. And the existing tenants are huge advocates for us. We see now a lot of new tenants come to us on the basis of recommendation of current tenants. So we are in a different zone.

New York City, in general, is recovering. We are not recovering. We're forward.

Stephen Sakwa (Senior Managing Director and Senior Equity Research Analyst)

Okay, great. And then second question, Christina, I know you can't provide maybe tons of detail on the, on the retail transactions, but maybe on the bigger one, can you kind of provide anything about going in yields and maybe where you think that portfolio might stabilize, you know, a couple of years out? You know, how do you think about the NOI growth on that portfolio over the next maybe two, three, four years?

Christina Chiu (EVP and CFO)

Sure. So we will definitely provide more details at closing. Just given confidentiality agreements, we're not closed yet. We can't provide that much more at this time.

... What I can say as a reference point, which should be helpful, is our acquisition last year of Prime Retail in Williamsburg was just under 6% for a stabilized asset with no near-term CapEx and strong upside over time. As we alluded to, both in my remarks and in our investor deck for these acquisitions, these are prime retail assets with some near-term ramp up from signed leases not yet commenced and vacancy lease up, plus have characteristics of long-term upside that we believe will create a lot of value over time. So hopefully, that's helpful in the landscape.

Tony Malkin (Chairman and CEO)

I would add to that, Tony, again, if you look at this, this won't repeat SoHo Meatpacking, but it's gonna rhyme with SoHo Meatpacking. And we think there's a solid ten-year run of growth in what will happen here in this remarkable submarket. So we're really pleased to have been able to transact, and we're giving you more detail than we gave on the residential acquisitions, and hopefully, that is better for you guys.

Stephen Sakwa (Senior Managing Director and Senior Equity Research Analyst)

Great, thanks. That's it for me.

Operator (participant)

Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.

John Kim (Managing Director)

Thank you. Just to follow up on the retail acquisition, I was wondering if you could provide where you think market rents are for Williamsburg, on that corridor, and where you think it could go to. I mean, if we're looking at CoStar data, it would suggest a cap rate or initial cap rate around 2%, which seems pretty low. I don't know if that, if that data is accurate, but just wanted some color on market rents.

Thomas Durels (President and COO)

Look, as Christina said, right, we're bound by confidentiality. In general, the location is fantastic. Two prime blocks on North 6th Street is where these properties are located. You can look at various market data out there, where deals are getting done, you know, well below north of $300 a sq ft. And I think at this point, that's... We'll have more to disclose after closing, specific to our transaction. Combined with the-

John Kim (Managing Director)

I guess-

Thomas Durels (President and COO)

The combined with the characteristics here, that these are this property type is one with which we've had a lot of familiarity, particularly going into developing neighborhoods historically. 10 Union Square as a prime example of that. And the fact is that these will produce a heck of a lot of cash flow out of their NOI, and that's what attracts us to this asset category, and we again see tremendous growth here in this market area.

John Kim (Managing Director)

Okay. My second question is on the new disclosure you had on early renewals. So it looks like because of the early renewal disclosure, your first quarter leasing activity picked up as you include the 122,000 sq ft of early renewals. My question is: Where did you disclose that before? Was that as the leases commenced, that number was in, so you're just basically pulling forward that leasing activity, or was it just not previously disclosed?

Thomas Durels (President and COO)

Sorry. John, John, yeah, so first of all, it was excluded from our reported leasing statistics on transactions. However, where it would appear is simply in the annual lease expirations. So as leases get pushed out, that would simply show up in the rollover schedule that appears in our supplemental. But we thought it was helpful to give the additional color on these early renewals, defined as lease extensions done where there's more than two years of remaining lease term left.

John Kim (Managing Director)

Okay. I mean, I'm just. When I look at the first quarter, this disclosure this quarter and last quarter, activity picked up, and then the lease spreads also moved a little bit. So again, I was. I'm a little bit confused as to whether or not you're just pulling this up, and previously, it was disclosed when those leases commenced. But I'm happy to take this offline.

Thomas Durels (President and COO)

Sure. I'm not sure. Yeah, happy to, happy to spend more time with you afterwards, but I think the disclosure on the leasing on the early renewals is pretty, really straightforward.

John Kim (Managing Director)

Great. Thank you.

Operator (participant)

Our next question comes from the line of Michael Griffin with Citi. Please proceed with your question.

Michael Griffin (VP)

Great, thanks. You know, maybe just getting back to kind of the forward outlook and leasing pipeline. Tom, I think in your prepared remarks, you mentioned, I think, free rent starting to stabilize and go down. But have you seen really a change on other concessions, whether it's tenant improvements or, or other things? And then can you give us a sense of kind of how net effective rents have been trending?

Thomas Durels (President and COO)

So I'm glad you asked that question because I was expecting some questions on our leasing costs, which, one might read into that, that they went up slightly this quarter. But on a year-to-date average, they're really very much in line with 2023. But if you look at our net effective rents over the last three years, two and a half to three years, we're up about 10% from 2021 on an average for year to date. And so I think that's a pretty healthy indicator. Look, we focus on net effective rent because it factors in all of the lease economics, not just the leasing costs, but certainly the top-line rent.

The deals that we did with Kearney and Pantera, they're gonna average over $80 a sq ft during the term of their lease. And so, generally, you know, we're—Look, we're moving in the right direction. I'm heartened by the fact that we're tightening up on our free rent offering. We still deliver turnkey built space. We have a lot of pre-built product that's already built in second generation, keeping our leasing costs down. And on full floor deals, we'll deliver turnkey space for tenants because they look to us to design and build a space for them, 'cause so that they can focus on their business, and we execute on what we do best.

Tony Malkin (Chairman and CEO)

And I would add to that, where we do see movement right now is in our rents and in our free rent. And you'll see the effects of that as we report in the future with greater definition, number one. Number two, what really helps distinguish us among other landlords is we have an integrated team of architecture, completely qualified construction team, led by Peter Sjolund, and the sustainability piece, and our ability to turnkey for people, high-performing spaces with indoor environmental quality is a huge attractant. So the fact that people of all tenants of all sizes, very few tenants who come to us build out their own space. It's an added feature and benefit to a transaction with ESRT.

Michael Griffin (VP)

Great. Appreciate the, the additional color there, Tony. And then just on sort of distressed opportunities that you're seeing out in the market. I mean, it seems like the Williamsburg acquisition might have been more stabilized, maybe not as much hair on that. But for other things that you're seeing out there, I mean, are we seeing the distress more in one property type? Is it, you know, office that is providing maybe more attractive returns, or do you still see opportunities within retail and multifamily in order to benefit from some of the distress out there?

Tony Malkin (Chairman and CEO)

So I would tell you that in multifamily, because of the GSEs, the Freddie, Fannie, and the popularity there, the real issue there is that if you have a low interest rate, your equity is significantly hit or could evaporate, due to a refi. We don't really qualify that as distressed because we see a lot of attention there. We did do a very good purchase at 298 Mulberry. I don't think that anybody thought that was distressed. We just got in there, and we found ways to create a lot of value. We do see opportunities developing in that area based on property handovers. We see a lot of attention from buyers. With regard to the retail we purchased, you're correct.

We look at that and say, we think we paid a fair price to a willing seller. And just over time, with our duration, we see a great opportunity for synergy of what we've already bought, and we really understand, feet on the ground, how to work on that. We do see the biggest distress in office. There's no question. And a lot of the office distress out there, you know, it's all a matter of basis, and we've got to get to the right basis where we can attract capital to partner with us to acquire property.

And we really think that the pricing needs to be able to deliver a 3x multiple of invested capital over a 7-10 year timeframe in order to attract capital to partner with our balance sheet to do those transactions. We do not see either the property types by location, floor plate. We've seen one office property on which we bid, and JPMorgan Chase has contracted to acquire it because it's next to their new headquarters. And outside of that, we're biding our time. We're waiting for the right pricing. With that in mind, I think on the overall perspective, you have to focus on the number of transactions, and dollar volume of transactions are tremendously down and remain tremendously down. We do see more properties coming to the market.

And the other area where I think we might see distress coming in the future also, though it's a sub-market, is this medical research biotech purpose-built lab space, where there's just not as much demand, and there's been a lot of product put out there. But I don't think that's something we will pursue. Tom or Christine, anything you want to add to that color on the market?

Thomas Durels (President and COO)

No, you said it well.

Tony Malkin (Chairman and CEO)

Thanks.

Operator (participant)

I'm sorry. Please proceed with your question. Mr. Griffin?

Michael Griffin (VP)

Yeah, I had just finished my questions. Thank you.

Operator (participant)

Thank you. Our next question comes from the line from Blaine Heck with Wells Fargo. Please proceed with your question.

Blaine Heck (Managing Director and Senior Equity Research Analyst)

Great, thanks. Good afternoon. Just following up on the acquisitions, can you talk a little bit more about how the transactions were sourced? Were they off market or marketed deals? And also, whether you think the NOI mix that Christina went over is optimal for your portfolio, or should we expect the non-office exposure to kind of continue to grow?

Tony Malkin (Chairman and CEO)

So there's a universal shaking our heads of no around the table. We really don't want to comment on the sourcing. We'll just say that we work hard on this stuff, and we want to respect our partners and, you know, on the other side of this transaction, so we really don't have anything to say there. And as far as the mix, look, we remain, as we've said over time, we're omnivorous opportunivores. And we really like how our NOI mix is, it will develop. We think that this initial acquisition has a starting point, but then we'll have greater value over time as a component of our NOI mix.

In the meantime, though, we've got other things which are also developing very well as far as NOI on the, on the resi and on the office side. So I do think a thing that is of interest to us is when we come to NOI and FFO, what's really hitting the bottom line in the form of cash? And we've mentioned this in a prior earnings call, and that's really our focus. Everything we do, lease space, sell tickets, deliver on our sustainability objectives, manage the balance sheet, flow cash to the bottom line so that we have greater flexibility as we go forward. So we really will remain opportunistic. We've got a lot of areas where we can deploy capital with confidence when we see the right opportunity.

Blaine Heck (Managing Director and Senior Equity Research Analyst)

Great. Thanks, Tony. And just following up on that, I guess, how did you guys weigh this purchase of retail assets versus investing more in your own stock through repurchases at, you know, potentially higher returns at this point?

Tony Malkin (Chairman and CEO)

We definitely look at this as something with duration, will deliver a very high return to us relative to where we think a purchase of our, of our stock. We think it will greatly help our stock as we go forward. And we just think there's tremendous upside if you have duration here. And so we do have duration, and we can live through a couple of lease cycles on this. I don't know, Christina, Tom? Christina, comment.

Christina Chiu (EVP and CFO)

I would just say we have buybacks on the agenda. We've done it in size. It remains a strategic part of capital allocation, and as we mentioned earlier, unique opportunity to create scale on a very prime retail corridor in a great location, high foot traffic, proximity to Manhattan, great demographics. We've mentioned this market also has more opportunity for retail, more opportunity for residential, create long-term upside over time, and in an asset class that has a different CapEx profile versus office. So for a lot of reasons, this just made a lot of sense. So fortunately, we have a great balance sheet. Nothing is off the table. We'll evaluate everything, but this was a really unique and great opportunity for the company.

Blaine Heck (Managing Director and Senior Equity Research Analyst)

Great. That's, that's very helpful. And then it seems as though you're, as though optimism around the return to office for tech companies has been building. You know, layoffs has come through, and some of the companies are mandating more in-person office time. Tom, great to hear about the lease this morning, and you guys have additional tech exposure in your portfolio. So can you just talk about expectations with respect to leasing activity amongst tech tenants, and whether you're seeing kind of any shift in their preference to be in New York versus their more traditional footprint on the West Coast?

Thomas Durels (President and COO)

Well, I'll give you two examples. The lease that we just signed at 1350 Broadway for a full floor of 24,000 sq ft, that's a tech firm. That represents growth by them, expansion by them. The other tenant I mentioned that's looking to expand at Empire State Building, during COVID, they had given up, shed some space elsewhere, outside of our building. Now looking back and saying, "Gee, we want our employees in the office, and they want to be in the office, and they all deserve to have desks, and they want to have desks." And so they're looking at an expansion with us by a fairly significant amount, you know, more than doubling their size.

So those are two very good examples of what we're seeing in the tech space. And look, as you know, our rent roll is very diversified. We're not focused on one single industry. We attract tenants from all industry, and the examples I gave and the commentary I just gave about that potential expansion tenant at Empire State, but we're hearing that more and more from other tenants. The fog or the indecisiveness around the work from home, they've moved beyond that. They're making clear plans, definitive plans, to place their office and have their employees in the office in New York City.

Tony Malkin (Chairman and CEO)

I'll also add two things. I want to be careful on this use of the term tech firm. Both of these companies, of which Tom just spoke, are highly profitable. You know, they are not startups. They've got very good business models, and so we do, as you know, a real underwriting of these businesses and their viability, before we sign a tenant. Our largest tenant, LinkedIn, started as a single floor at the Empire State Building. That was a time when everyone thought they were just another tech startup, and we did the research. We said, "No, this is a real business with real business growth prospects." So let's be careful. We have not changed our underwriting standards one bit.

Number two, New York City is absolutely, positively the preferred destination for new tech jobs. It's because that's where the employees, the colleagues, the team members want to be. That is a statistic. And New York City is alive. It is vigorous. I was in San Francisco on Tuesday and Wednesday, excuse me, of last week. There is simply no comparison between the two markets. New York City is popping, and the energy is tremendously attractive, not just to recent college grads, but also to people whom want to move and locate where there is going to be activity and there's going to be life. As our lead director says, "It's where people want to create their lives, meet their future life partners, and enjoy life."...

The last thing that I'll say is, with regard to this, we see tremendous interest in us by virtue of tenants' responses to their employees' and colleagues' attendance in the office in our buildings. And the tenant who looks to expand at the Empire State Building, they have looked to shed other office spaces. At the same time, they saw the number one location for employee in-office participation out of their locations was the Empire State Building. And they said, "Okay, we want more space there because that's where people show up." So, I think that just to round it out, I want to make sure from a balance sheet perspective, understand we're not taking additional risk.

New York City is definitely the desired location, and our portfolio particularly is attractive on the basis of existing tenants' experiences with our own employees and colleagues.

Blaine Heck (Managing Director and Senior Equity Research Analyst)

Very helpful. Thanks, everyone.

Operator (participant)

Our next question comes from the line of Camille Bonnel with Bank of America. Please proceed with your question.

Camille Bonnel (REIT Analyst)

Hi, Tom. I wanted to follow up on your comments around leasing costs being lower because of the strategy you've implemented this year. So looking forward, as you work through leasing these turnkey spaces, I wanted to get a better sense of what's going on in the general market, given there are reports that tenant improvements are increasing in Manhattan. Are you seeing these trends, too, in the portion of the market that you operate in? Or is this less of a concern because there's enough demand to continue implementing that turnkey solution?

Thomas Durels (President and COO)

Camille, I would say this. As I mentioned earlier, our average net effective rent has increased by 10% over the past 3 years, and that factors in the top line, you know, gross rents as well as the leasing costs, and that's the number to really keep an eye on. As I mentioned earlier, we're—and as Tony mentioned, we're moving our rents. We're tightening up on free rent, and that's having an impact on improving our net effective rents. We benefit from having built space throughout our portfolio. As I mentioned earlier, we have an inventory of second-generation pre-built space that is less expensive to turn it back into service for a new tenant, and that helps lower our TI costs, having previously already invested the capital in those spaces.

And then, generally, nothing has changed over the last 5 or 6 years in terms of what we deliver to tenants by way of full turnkey service. It's always been part of our offering. We deliver pre-built space ready for move-in, and we deliver turnkey spaces when we're talking to a tenant for technically a large full floor, space for a long term. We would just custom design and build that space for that tenant. So what we're offering on TI is, has, has been pretty, has been pretty consistent. We're benefiting from, again, having invested capital previously. But all, all in all, our net effective rent has improved 10% over the past 3 years. So hopefully, that gives better perspective, and answer to your question.

Camille Bonnel (REIT Analyst)

Got it. And shifting to your observatory business, it continues to show good growth. So what do you attribute to the lower visitor count versus last year, despite having less bad weather days?

Tony Malkin (Chairman and CEO)

Tony here. First of all, we did have a shift of Easter into the first quarter of this year, and that always produces a shift. So and, and last year's comp, Easter was in the second quarter, number one. Number two, you know, we're managing the demand in order to maximize the benefit to the visitor, and we do see that we have from time to time, we cap our attendance. But the biggest shift is from Easter. That's the first piece. I will say there's one other piece, and that is that there's unquestionably a much lower international traveler presence in New York City this summer. Full stop.

You can get it from the airlines, even the New York City official travel bureau will grudgingly acknowledge this. When you look at established venues from the 9/11 Museum on across New York, Statue of Liberty, you name it, everyone has recognized and commented on this. And so what we see is big domestic demand, which comes with domestic travel pieces. The international demand is not as robust. It is still gathering back strength. And yet, what I would draw attention to is we've continued to grow the top line, we've continued to grow the bottom line, and our NOI per cap continues to tower above any other competitor.

So, we feel very good about where we are and about what we're doing with our business there.

Camille Bonnel (REIT Analyst)

That color is very helpful. Just finally, despite perceptions on how to define quality, your leasing teams continue to define the norm. I'm curious to get your views on where you see structural vacancy for your office portfolio. Do you expect to be able to grow your lease percent much further above the 92%-93% levels today?

Thomas Durels (President and COO)

Camille, we're really well positioned based on all the work that we've done. For the balance of the year, we have about 190,000 sq ft of tenant vacates, and the space that we're getting back are full floors that are consolidated. They're very marketable. Some come with outdoor terrace space, so we're confident that we will be able to lease those spaces. And so that's a modest amount of lease expirations that and tenant vacates, and offset by the leasing activity in the pipeline that I mentioned earlier. And then in 2025, because, again, we've done a great job of proactively managing our rent roll, we only have about 162,000 sq ft of vacates and 113,000 sq ft of undecideds.

And that's, you know, again, that's against the backdrop of over 820,000 sq ft of leasing that we typically have done in the past three years in our Manhattan office portfolio. So, you know, it may fluctuate quarter to quarter, but you see the trend that we've been on for the last two and a half years. We're well positioned, going from now and into 2025, to continue to make progress on our lease percentage. And as our lease percentage climbs, our occupancy percentage will follow.

Tony Malkin (Chairman and CEO)

I'd add, there'll always be variations, but when you look at our forward numbers, as Tom described, you know, we do manage, and early renewals are a part of this. As tenants expand, we renew and extend their existing leases. So we're super active on these activities. And recognize something else, we don't wait for tenants' leases to expire to be active. So we do a lot of leasing of tenants who say, "I've got excess space." So before they ever get to the point where they want to vacate, we work with them to lease their space while they're still in occupancy, directly to a new tenant.

So a lot of work in this regard, and a lot of opportunity for us. We're just very, very happy with how the market receives our product and where we go with this.

Operator (participant)

Our next question comes from the line of Dylan Burzinski with Green Street. Please proceed with your question.

Dylan Burzinski (Senior Associate of Equity Research)

Hi, all. Thanks for taking the question. Just wanted to touch on the reaffirmation of 2024 FFO guidance. I mean, you guys are doing this acquisition that's expected to close in Q3. You guys raised same property cash NOI growth guidance. So just curious, sort of, on the decision on deciding to reaffirm guidance, given some of those positive characteristics that I just mentioned. I mean, what are some of the offsets to that? I know you guys mentioned G&A possibly being higher. So sort of just curious, you know, anything else that we might be missing.

Stephen Horn (EVP and Chief Accounting Officer)

Sure. This is Steve here. So, yeah, our 4-cent FFO guidance range is meant to capture a variety of scenarios. And some of those live within the observatory. You know, we have tourism fluctuations and bad weather days to deal with. And our revenue, our NOI, sorry, is split typically 40% in the first half of the year, 60% in the second half of the year. So even though we're halfway through the year, the observatory's performance there will have an outsized impact in the second half of the year. As far as the transactions and capital markets activity, if you recall, in the first quarter's call, we did note that with the new term loan and the facility, Fetner buyout, and the FSP sale, it had about a $0.01 dilutive impact on FFO.

And there was also about 3.5 cents, sorry, $3.5 million of one-time items that benefit revenues within the first half of the year that we don't expect to recur in the second. So with all that in mind, we still feel good about our FFO guidance not changing and sticking to that $0.90-$0.94 share. As far as G&A, we already had that modeled in our FFO guidance for the year. Just calling it out as a benefit for models for 2025.

Dylan Burzinski (Senior Associate of Equity Research)

Great. Appreciate the detail.

Operator (participant)

We will now turn the call back to Tony Malkin, Chairman and CEO, for some closing remarks.

Tony Malkin (Chairman and CEO)

Okay. As we move forward, ESRT's priorities are to lease space, sell tickets to the observatory, manage the balance sheet, and achieve our sustainability goals. These actions together enhance shareholder value. We are pure play New York City, more so now that we have honed our portfolio. Four diverse ways to play it: our office portfolio, top of tier in the deepest market segment, our number one ranked observatory, our growing everyday street retail, and our multifamily platform. We are a future-ready portfolio and opportunity-ready balance sheet. We have options today. We're in a position to take advantage of opportunities created through market disruptions and capital dislocation. We're confident in our team's ability to execute on our goals and drive further goals for our shareholders. I want to thank the team on the call today and people who work every single day, incredibly hard.

We have confidence in you, and we'll continue to do a great job on behalf of our shareholders. I want to take a moment and do a special call-out to board member Grant Hill. The entire company and the board are in support of our fellow board member, Grant Hill, who's managing director of the United States men's basketball team in the Paris Summer Olympics. Grant, we wish you all the best. We'll be cheering for you. Finally, I'd like to thank everybody for the participation in today's call. We look forward to the chance to meet with many of you at non-deal roadshows. We'll be going to Europe in the fall, conferences, property tours in the months ahead. Until then, thank you very much for your interest, and onward and upward.

Operator (participant)

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.