EUR 850.00 For Business Accounts Only

Morningstar | Planned Redevelopments Continue to Drag on Empire State Realty Trust's Results

While Empire State Realty Trust's ongoing redevelopments slightly damped second-quarter results, we believe it is too early to assess whether the improvements will be successful, so we are keeping our $17 fair value estimate and no-moat rating intact. The company posted $0.24 per share in funds from operations, a penny less than we expected, and cash net operating income (excluding observatory NOI) grew 2.7%. The slight FFO miss is attributable to the firm receiving 3% less rental revenue than expected, resulting from continued worse-than-expected occupancy during portfoliowide renovations. This occupancy dip is partially offset by 17.9% leasing spreads that beat our expectations, but this was primarily because the previously escalated rent was below market. Although the renovations may boost rents somewhat, we believe the company faces structural headwinds for much of its non-Empire State Building portfolio; we are skeptical of the extent to which redone fractured floors on Class B property can attract top tenants, as evidenced by the generally lackluster occupancy and rent of the non-Empire State Building properties. We will be watching leasing spreads and occupancy after renovations are complete to see if the company can successfully market its non-Empire State Building portfolio.

As expected, the Empire State Building itself continues to be the company’s best asset thanks to strong rent and tourism. We estimate that the Empire State Building remains 5.5% more occupied and commands 3.8% higher annualized rent than the company’s average Manhattan office. We were also impressed by the building’s persistent ability to draw top tenants as seen last quarter, when the company closed a lease with LinkedIn, a subsidiary of deep-pocketed Microsoft. While tourists to the Empire State Building’s observatory were down 4.3% from the second quarter last year, we were happy to see that the planned price increases drove an estimated 3.6% in revenue growth from last year’s second quarter. After normalizing for the effects of the 2018 Easter holiday being split between the first and second quarters (2017's Easter was entirely in the second quarter), we estimate visitors were down a much more modest 1.1%, which supports our thesis that there is relatively inelastic tourist demand for this destination. We are looking forward to seeing if the new observatory entrance, which will open in the third quarter of this year, will drive more visitor traffic. Long term, we continue to believe that the company has a fantastic asset in the Empire State Building but faces headwinds in the rest of its portfolio.