Empire State Realty Trust, Inc. (ESRT) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Empire State Realty Trust presentation at NAREIT REITweek 2020 Virtual Conference. My name is Rick Skidmore from the Goldman Sachs equity research team. And I'm joined here today by members of Empire State Management team: Tony Malkin, Chairman and Chief Executive Officer; John Kessler, President and Chief Operating Officer; Christina Chiu, Executive Vice President and Chief Financial Officer; and Tom Durels, Executive Vice President of Real Estate. ESRT is a pure-play Manhattan and greater New York metro area office REIT, with over 10 million square feet of office and retail space. Tony Malkin will start off today's presentation with a few prepared remarks on the current state of the business at ESRT before our Q&A session. With that, I'll pass it over to Tony. Tony?

Thank you very much, Rick. And welcome sports fans. Please, if you can, go to the Investors section of empirestaterealtytrust.com. That's empirestaterealtytrust.com. Go to the Investors section, and you'll see the latest presentation, investor presentation and we will refer to that in this session. So I'm happy to be joined today by Christina Chiu, our new EVP and CFO. Although only her fifth week here, Christina's already put in about 2 months of time between the office and at home. We're very happy to have her on board. I'd like to just focus first on our strong and flexible balance sheet, lowest leverage amongst our public office, New York City peers. As of March 31, we had $1 billion-plus capacity in our -- in cash plus our $550 million letter of credit capacity. Additionally, we have no debt maturity until August 2021. That is our line. And we have 2 6-month extensions available to us. We are a fully modernized for the 21st century, well-located portfolio of properties. According to Morgan Stanley, we have the lowest carbon footprint per square foot of publicly traded New York REITs, where all our assets are located approximate to or next to public transit. We rent at a substantially lower price compared to our new construction Class A competitors, and we offer much more than the Class B assets. That's our niche. We have $50 million of contracted revenue growth in place and the track record of superior cash leasing spreads in our Manhattan office portfolio. Our observatory, that in Q4 2019, completed its top-to-bottom $165 million renovation, delivered fantastic results in January and February 2020 when we were open and offer significant upside when we reopen. I'd like to just touch on our story in brief. When we went public, we said we would redevelop our portfolio. Subsequently, we raised $622 million at $21 a share and borrowed additionally to do that work. We've nearly completed that work. We were criticized for the fact we haven't done any new acquisitions other than our option properties shortly after our IPO. And we said at first that we were focused on our redevelopment and in recent years, that we viewed the market to be too choppy. I'd just like to reemphasize that last week, we announced our new Senior Vice President and Chief Investment Officer, Aaron Ratner, who will build out a team to apply our strong and flexible balance sheet, external growth. And we were criticized for years for the fact we did not buy back our stock. At the end of Q1, we announced that we had done, at nearly 50% the levels where those criticisms began, a significant buyback. I have no other comment on the buyback today. We are the leaders in energy efficiency in the build environment. Maybe we haven't communicated that well enough about our sustainability, but Dana Schneider, our new SVP of Sustainability and Energy, who's worked with Empire State Realty Trust, was just last week featured in a very large interactive story in the Washington Post. And our appointment of our new Director of ESG are already serving, Senior Vice President Justine Urbaites from our legal team are going to make our disclosures better. I think that we get a AAA for our work, and we've gotten a D for our disclosure. Other people are AAA for their presentation, and I'll let you grade their own work once we put ours out there. So finally, I'll just say, this is my sixth crisis since my career began in the real estate business in 1989 after a few years in the private equity business. We're nearly there with our reposition for ESRT version 2.0, and our stock is silly cheap. So with that, Rick, we're ready to take a few of your questions.

Great. Recently, Tony, you -- just to remind viewers with questions today for ESRT's management team, utilize the Q&A function of the platform, and we'll try to get to as many questions as possible during our allotted time. To start the Q&A session, Tony, you recently were interviewed by commercial observer in which you discussed very positive sort of outlook for New York City longer term, but some challenges in the short term. Can you perhaps elaborate on your comments, both short term and long term, and how you square the circle between the short term and the long term?

Sure. I'd like to maybe, if I could, Rick, take that on along with work-from-home because I think they're related. I think that it's important to note that New York City, it's the only capital of the world that isn't actually a capital of a government body of any kind. So we are the attractor of talent. Talent wants to be here. And the people who come here are motivated to be here. We have an intern program this summer, lots of people are doing virtual intern programs. Our interns want to be in our offices. They want to be here. They want to work with us. So that said, I think that what we need to do is look at the attributes of New York City within the context of the 3 phases of the COVID-19 pandemic. One, you've got the lockdown and the concomitant issues related there too. Two, you've got the post lockdown, pre-herd immunity vaccine [Audio Gap] that means something in the hospital, a Tanna flu-type treatment. And then three, you've got the post herd immunity lockdown, the post-treatment -- post vaccine. And that we're all going to be in an interesting period of time during this Phase 2. I feel very confident that when Phase 3 happens, New York City is going to roar back. It's going to come back with retail which is far less expensive, so we're going to have a lot more interesting restaurants, a lot more interesting bars, much more approachable from a cost perspective. We're going to come back with a tremendous amount of housing, which is still being developed and will be available for people to live in. And we're going to come back with the lure to New York City, which has always been the best, the brightest, the smartest, most motivated, want to be here and do their work. We've got to address certain issues along the way, and we will, and we do. And I look at how our own teams, as I toured all our properties yesterday morning after the looting of the prior evening, and just saw such an incredible group of amazingly motivated, functional, on top of it people, from union folks to nonunion folks, many of whom worked overnight in the buildings, protecting our buildings, standing guard, standing watch while this went on. Last night was much better, by the way, on the street. The police did a much better job. And I think we'll continue to see that trend down. And by the way, the protesters are fine. It's the organized looters who need to be defeated. And then we'll move forward, and we'll move forward from solid ground. And the work-from-home and densification and all this other stuff, I think it's really important to note, many pundits have mistaken survival -- work-from-home for progress. Work-from-home is a bright, shiny and distracting penny that has already begun to tarnish for most. People want to be connected to their organizations, culture and their peers. Data shows that you cannot build teams in isolation. Video is very disadvantageous to workers, particularly younger workers and workers from economically disadvantaged backgrounds, women with children. Anybody who wants to be judged by their peers and their supervisors and want to be parts of teams, it doesn't work. Young, talented, educated people want to be in the office. Maybe if the world revolves around you, you can take time out of the office. But if you want to be part of the company's culture, learn, get ahead and compete, you cannot do most things from your card table at home. And so I think it's very important. We recognize that for New York City and for work-from-home in general, that talent and competition will drive this. And I'd like to also talk just a moment about this concept of work-from-home and flextime. We're going to come out of this COVID experience in an economic downturn. I really do believe that it's going to be very difficult for people to pose the thought that they want more work-from-home for convenience. The option, I think, will be -- will, in that case, will bring people who want to work in the office for your job. And I think the people might also have to get used to dropping off and picking up their own dry cleaning. I think the world will be different, and so I think that will make a change. All this talk about gig working, what people want. I think if people want jobs, they'll need to get involved and participate and get in on the ground. And then the final thing is we do see already planners and consultants. They're no longer looking at hiring Adam Neumann and his group to see how many bodies they can wedge into a space and what desk utilization is and how to hot desk. People don't want to show at in a workspace with a bunch of wipes and have to clean something down every time they come into the office. Who was at this workstation the day before? We're going to see less density, greater focus on healthy workplaces, which fit right in with our indoor environmental quality focus, which we've had at Empire State Realty Trust. We're going to see these co-working groups either go bust or have their influence greatly diminished. And don't forget that when they do that, it will be very interesting to see how the landlords who have their space deal with the cost of new capital outlays for a complete redevelopment of those spaces commissioned, the lack of economic performance of these spaces. It'll be very interesting to see how these landlords get -- are impacted. We think that's a great opportunity actually for us as we go forward. So we believe in the resilience of New York City and the demand for employers and employees to be here. We've recovered from past economic cycles and external shocks and come out stronger, more diversified and vibrant each time. I was just on the phone before this with the building committee of the Metropolitan Museum, a Board on which I sit. We learn from these experiences and we move forward.

Great. Thanks for that, Tony. Just to respond to one of the questions that come in based on a little bit of your comment around social distancing and densification in the office. What's the Observatory going to look like with social distancing as you go forward? Can you maybe elaborate about the Observatory and how you see that restarting?

So it's really interesting. We already operate the Observatory right up until the last possible day, which we could when we looked at the pre-COVID lockdown. And we had people down to 500 visitors at any one time in the building. And I think it's important to note that during that period, when we have 70,000 square feet over 5 floors, which equates to social distancing for typical group size of 2.6 visitors per group, more than 18 feet between visitors, right? We have MERV 13 filters in the observatory. We have AtmosAir. But we have ventilation, which is the introduction of outside air. This is a $165 million redo we did for the observatory. One of the key features, we have a separate entrance for the observatory from the rest of the building. So the entrants to the observatory do not enter with tenants. They're segregated. They're separate. So we put all of this together. We have ventilation in place for healthy indoor environmental quality for up to 26,000 people a day, 1,500 to 1,600 people an hour. We feel very confident we'll be able to operate. Not one of our employees during the extended period that we continue to operate with every other attraction in New York closed, contracted COVID-19 on the job. I'm convinced it has to do with our ventilation, with our air purification systems, with the distancing that we have in our exhibits, which are museum quality and cause people not to rush to the elevators to run in. It actually causes people to take their time. We will see some of our interactive exhibits run by themselves. We have certain high-touch exhibits, which we will allow people in the initial period to -- will allow them to engage with them. And at the same time, we feel very confident, very comfortable. We've got our deck together. We'll have it in front of the governor by the end of this week, beginning of next week, about our plans to reopen. We've got time ticketing, which we will roll out by the 13th of June, where our new CTO, Suresh Rangarajan, one of our -- part of our ESRT 2.0 team has gotten done. Or will get done in 2 weeks, something that our outside consultant wanted to charge us $4.5 million to do. So we feel really good about the reopen of the observatory and believe it offers a lot of upside. I will point out and remind people that on the 22nd of April, we said that we thought the earliest we would open, and we just put it out there as a straw horse, was the 1st of July, and we thought we would reopen at 20%, at a very slow ramp-up to 2022. So I think that we've got a view, and we look to execute. We've got the team and the tools, people want to come back to work and want to go to work and get it done.

Maybe just taking a couple other questions that have come in together and going back to the discussion around New York City, resilience in New York City. Are you seeing any shift in your tenant demand for, say, New York -- for Manhattan to some of your suburban properties? And as you work with tenants on renewals, are there any changes to the terms -- in terms of moving more short term versus long term?

I might hand this over to Tom Durels for a quick comment. I look to my left to see Tom Durels, but evidently, Tom is not in the room with us. Tom?

But I am on the call. Rick, regarding the move from Manhattan to suburban properties, I would just say that we have received some recent inquiries from New York City-based tenants that seek a location within our greater New York metropolitan portfolio. We have some well-located properties right next to mass transit and with excellent access to major thoroughfares. We're in an excellent position to take advantage of any tenants that are seeking to either relocate or have a second office outside of New York City, and we've seen some tenants express a desire to have a touchdown out in the suburbs. Our existing suburban assets are, as I mentioned, are conveniently located next to mass transit and intersections of major thoroughfares. And we're well underway with an upgrade to all the common areas and amenities and nearly complete. With regard to renewals, we have been executing renewals, and we've seen -- as I mentioned, in the earnings call for the first quarter, we continue to work on deals that were in negotiation pre-COVID. We've executed on a number of renewals and new deals. As it relates to a move toward shorter-term renewals, I would simply say this, that there were a number of tenants that were thinking of relocations, including relocations within our portfolio or outside, and instead opted to renew and stay in place. So that's been a positive bit of news. I think that tenants just simply opted to say, we're going to stay in place, stay within our offices, and it's resulted in some renewals that we did not anticipate.

Great. And maybe...

I'd take that one step further, if I may. What we have done is we have mobilized during this period of time. We have to understand that most tenants are, unless they have to make a decision, don't want to make a decision right now. We've mobilized with the brokerage community. We've actually tried to help educate the brokerage community and stay, and we've definitely stayed in touch with them through virtual happy hours. We've done digital outreach. We've got video tours that we posted on key spaces. We have spaces that are prebuilt with furniture in place which are absolutely workable into which people can move in our greater New York metropolitan area. And I'd say one other thing. One of the other comments that has been made of young people with families moving out of New York, and is that a big crisis for New York City. I think that it is logical to consider that as part of the moves that have occurred over the last 15 years, women have moved to have children at a later age. And that dictates, by the way, when families are formed, and as women do have something to do with that, and when people need schools, playgrounds, et cetera. So you've had people stay in the workforce for much longer, and you have had them stay in New York City for much longer. As people get older and as they move forward, they traditionally -- with children, they traditionally by the age of 3 or 4 for kids, many of them have moved to the suburbs. Once they get to be 6 or 7, they've got to do soccer and things of that sort. It's a tougher thing to do in New York City, and not everybody can handle that. That said, I think it's careful though -- you got to be careful and understand that this may cause people to reflect over time, is this the time to move? And I think that also means that we may say, is this the time - excuse me, tenant say, is this the time we want to open a location in the suburbs, for these people who have chosen to move, which is something they would do anyway. Don't confuse that with the next generation of people who want to come to New York City and fill up those spots and take advantage of what New York City has to offer because they don't have kids. Consider one factor. Figure the number of public companies whose health care programs paid for the freezing of eggs, 15 years, 10 years ago versus today. This whole concept of a delay by almost a decade of child bearing has changed the complexion of New York City. It will remain changed as new people come in and take their place.

Maybe, Tom, going back to the lease activity, a couple of questions around what's happening with regards to lease economics on any recent deals? And are you seeing any downward pressure on rents?

Yes. Rick, I will say that for deals we had in negotiation prior to COVID, some deals have proceeded without any change in terms. I think that's a very positive sign. And we've renegotiated some very modest change on terms on a few others. So that's what we're seeing real-time, is either modest to no change on deal economics, lease economics for deals that were -- began negotiation pre-COVID. Since COVID and the shutdown, obviously, we have been unable to do physical showings. As Tony mentioned, we are doing virtual showings. But new leasing activity is somewhat on pause right now until we're able to get prospects back into the buildings to begin the process of showing space and negotiating on new deals. But on a very positive light, I would just reemphasize that on those deals that we have in negotiations, very -- either no to modest change on lease economics.

And there's a question that came in with regards, maybe coming back to tenants and expirations. A question around a California build that's circulating in their state senate. Is there anything with regards to New York, on the legislative front, that would allow tenants to avoid leasing contracts?

So -- go ahead, Tony.

Yes. The answer to that is no. There are some efforts with regard to small local tenants who are disadvantaged in this situation with regard to eviction actions. And those are both -- and those are on retail, and they are also primarily the focus -- they are applicable to retail, and there are some things with regard to residential. However, avoiding legal contracts raises all kinds of constitutional aspects. The New York -- you have to understand, the New York City Council, 2/3 of it is lame duck due to term limits. They are looking to do -- they wish to do whatever they can do to pad their nest as they look to move into the private sector. Our mayor is in a lame duck position, so they're -- you'll hear all sorts of things go on there. At the same time, I think that it's important to note what's different here. What's different here is it has been a focus on ability to pay rent. And we've taken a very proactive effort with regard to our small tenants, our small retail tenants, our local retail tenants. We've given them immediate relief from the obligation to pay rent. These are folks who don't have a balance sheet other than their checkbook. We've told them when they reopened, they'll got to percentage rent. Then after a period of time, when things normalize, we'll go back to regular rent then we'll talk about the deferral from there. But the important thing is to note that we are for our local tenants. We are for our local businesses. And we have made a very early move. We just -- we mentioned this on April 22. We're going to move constructively with them so they can stay in business.

And Tony, you meant on the rent deferrals, in your presentation, you provided an update on rent collection. Can you just give a quick update on rent collection and maybe on a relative basis, what you might see is the difference between the ESRT's rent collection versus maybe some of your peers?

Yes. I don't think we're putting ourselves to talk about ourselves and our peers. We've made tremendous progress on rent collection. I'll let Tom cover it, but the important thing to note is it is an ongoing process for us, and Tom's got some great updates, which demonstrate great progress even from April, and we will continue to see more progress as we go forward. Tom?

Sure. I would first encourage everyone to refer to our new investor deck, that Tony mentioned is available at empirestaterealtytrust.com, and see Page 10 for a full presentation and update on where we are today. And compared to the numbers that we gave out on our first quarter earnings call, which reflects very solid progress. In short, for April, we have collected an additional 11% of total charges for a total of 80% before any consideration of security deposits since that date for the month of April. And our May collections are ahead of where we were at this time last month in our April collections. And when you apply security deposits, that number for April goes to 93% collection. For May, we have collected to date 75% of total charges before any consideration of security deposits. And as I said, our May collections are ahead of where we were at this time last month in our April collections. And once again, once you apply security deposits, that number goes to 90%. We have an update on our request for deferrals on Pages 10 and 11 of the investor report, and there are some tenants with strong balance sheets who have taken an opportunistic approach to pay rent. And after conversation with some of those, they've begun to pay rent. And as Tony mentioned, we are working with those smaller tenants, particularly the food and service and retail tenants that have been hit particularly hard. And we'll work with those to ensure that they reopen. In general, we've seen and expect to see collections improve for April, and we expect the same for May, and we'll have updates on each new month and prior months as we go forward in the near term.

Great. Thanks, Tom. Maybe Tony, circling back, a question from an investor with regards to your ESG reporting. And the question being, does that -- will you begin to start reporting to the GRESB or CDP or setting science-based targets or net 0 commitments as part of your ESG path?

Sure. Thanks, Rick. To Samuel Adams, which makes me think either we have someone that's related to or actually is one of our presidents and former brewers, the -- look, Sam, we have absolutely got scientific targets. We're, in fact, the leaders of setting forth objectives with accountability and monitoring and verification. We are finally fed up with the fact that people who put together really great-looking presentations but are not really science-based, win awards and get credit for same. So we will definitely begin to weigh in Dana Schneider and Justine Urbaites have their goals and targets. We gave some disclosure of this in our proxy where we foreshadowed what we would do additionally going forward in the year ahead. We will make good on that. We have continued -- we lead the New York State Energy Research Development Authority's project, which we actually conceived with them for them, and we led and engaged other landlords in this to look at how they might be able to spend their money and identify what services and products are worthwhile and have a worthwhile result and deserve support from NYSERDA on the go-forward. We have -- we are in the midst of ESRT energy efficiency retrofits version 2.0. We have the lowest carbon footprint per square foot of any publicly traded New York City-based REIT according to Morgan Stanley's report. They don't even cover us, and that's the conclusion to which they came after looking at publicly filed information. I have a fundamental issue that goes back ages to when [indiscernible] founded GRESB. I've got a fundamental issue with regard to the greenwashing from the U.S. Green Building Council. That said, Dana is on board, and we will begin to participate more of these, and we're going to show our [Audio Gap] better than everybody else's stuff.

Great. Tony, we have about 90 seconds or so left. Just one quick question, follow-up on the balance sheet. You mentioned the strength of the balance sheet and opportunities. Maybe a quick comment on where you might be looking in terms of opportunities to deploy the balance sheet? And then any closing remarks?

We've got -- we're [ omnivorous opportunivores ] with regard to what we do going forward. Aaron Ratner came from 9 years at TPG. Before that, he spent 2 years at Eastdil Secured. We feel very comfortable with Aaron on board and the team that he will build, where we already have that underway. And the fact of the matter is that we will look at all aspects. We will consider going outside of our region, but our focus is going to be on our region, but look at all property types, all different ways to invest and get involved, from joint ventures to preferred equity to mezz to restructuring existing deals. So it could be residential, it could be retail, it could be office, and we expect to say more about that in the quarters ahead. But we look at this as a -- as not as a here and now, but as an 18- to 36-month window of unique opportunity before we start to see an upswing again, and we look forward to that. And in general, other than that, I would just like to say that I'm really happy to have the opportunity to present to you all. We really appreciate it. We believe that we're in a great position. We understand that the market may have different views with regard to New York City. We understand that the market may have different views with regard to Empire State Realty Trust. That makes a market. We've got a great balance sheet. It gives us a lot of runway, a lot of strength to make a lot of choices, which a lot of people have to -- don't have that flexibility. Our capacity to execute relative to our size is excellent. We look forward to [ yielding ].

Great. Thank you, Tony, for those comments, and thanks, everybody, for joining today, and this concludes the Empire State Realty Trust presentation. Thank you.

Thanks, Rick.