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

Welcome to Citi's 2025 Global Property CEO Conference. I'm Michael Griffin with Citi Research, and we're pleased to have with us Empire State Realty and CEO, Tony Malkin. This session is for Citi clients only and disclosures have been made available at the corporate access desk. To ask a question, you can either raise your hand or go to liveqa.com and enter code GPC25 to submit questions. Tony, I'll turn it over to you to introduce Empire and the team, provide any opening remarks, tell the audience the top reasons investors should buy your stock today, and then we'll get into Q&A.

Terrific. Thank you very much, Griff and the Citi for the opportunity to present here this morning. Tony Malkin, Chairman and CEO of ESRT, and I'm joined today by our President, Christina Chiu. We are the pure-play New York City REIT with 4 diverse ways to play in New York City; Top of tier office portfolio that targets the deepest market segment, our top-ranked Observatory attraction and our growing Multifamily and street retail portfolios. Two weeks ago, we reported our strong fourth quarter and 2024 results. In 2024, ESRT continued to put points on the board in line with our priorities. Number one, lease space. Our Manhattan office portfolio is over 94% leased with over 1.3 million square feet leased in 2024, meaningful increases in occupancy and leased rates year-over-year and we expect further gains as outlined in our 2025 performance -- 2025 guidance, excuse me. Number two, sell tickets to our Observatory, named the #1 attraction in the world by TripAdvisor and achieved 6% year-over-year NOI growth. Number three, maintain a best-in-class balance sheet that provides ESRT tremendous flexibility to lease and transact opportunistically. Over the past 2 years, we proved our ability to recycle assets and shift towards growth with lower CapEx as shown by our move away from suburban office and towards New York Multifamily and the prime retail corridor of North 6th Street in Williamsburg. Number four, use our balance sheet to pursue additional growth opportunities. And those of you who have attended these sessions before know that #4 is new. Number 5 is achieve our sustainability goals. We're laser focused on these priorities. We continue to take advantage of the opportunities in the market and we're confident in our ability to move forward.

Tony, thank you for that opening. I guess we'll just start kind of as you alluded to, the relative strength of New York as an office market. So from a leasing perspective, last year was very strong. This year is off to a good start. What do you think kind of differentiates both New York and then your product offering in general? Is it greater return to office mandates as a company is finally looking to grow their real estate footprint again, what makes both New York and then Empire's portfolio that much more competitive relative to other office markets?

Griff, New York City is the -- the great benefit of New York City is that it's the place where tech companies have the shortest number of desks and the highest demand for new hires. It's the place where people wish to be. By evidence, it's the top destination and by an increased percentage of recent college grads. Those new entrants to New York. They want to live in New York, they want to be in New York, and they want to learn. And that helps drive people back to office because they don't want to take jobs and they won't take jobs and they've demonstrated they won't take jobs when managers are remote. So New York City, vibrant. We've got with that vibrance in the office sector, that means the Street life is back. And it means retail is strong in retail at a very strong 2024. Everyone talks about we're off the peak from the pre-COVID period as far as rents. The bottom line is at the pre-COVID peak during -- as far as rents were concerned. We didn't do -- the market didn't do a lot of leasing at that time period at those rents. So maybe 30% to 40% down in rental rates and at the same time, very active in leasing. And New York constantly reinvest itself. Our move to North 6th Street, driven by our desire to recycle our what we thought were lower growth opportunities in suburban office yielded our entrance into that marketplace initially with 1 transaction and then we added 2 more. And the fact of the matter is who thought North 6th Street in Williamsburg, you would have 10 years ago, a flagship Hermes store under construction. And when you look at Hermes, very smart, very logical, go to Williamsburg, second highest economic demographics for households next to West Village, New York City. One of two or -- I think it's three subways and stops the Bedford Street L Station Stop that has higher traffic on weekends than during the week days. So we think New York is terrific. We're very fortunate that we are there. And what does that yield? Greater demand, better net rents. Fourth quarter, we exceeded 2019 on our net rents, reduced concessions in the form of free rent, we hope in 2025 on TI and much higher face rents as well.

Maybe just touching on that face rent and the opportunity there for a bit. I know you've talked on past earnings calls about maybe those higher price points, triple-digit rent type tenants looking at some of your product offerings, whether it's the properties on Broadway or other ones within your portfolio, whether it's ESB, maybe talk about the opportunity set to capture some of those new tenants that might have looked at Park Avenue, but maybe the rents didn't make sense or it's too tight there. Where are you seeing in terms of that tenant demand?

We've got 2 interesting drivers here, one of which is that in 2024, by the end of the year, we had signed more than 3 million leases -- 3 million square feet of leases, excuse me, with existing tenants who have expanded since we went public. That number grew through 2024 to 3 million square feet. So the internal drive, we satisfy our tenants once they come and lease with us, they are happy, they stay, they extend and expand, number one. Number two, in the great game of musical chairs when you have 120 players and 118 seats, there's less urgency than when you have 20 players and 18 seats. And as Christina has said in our earnings calls, we have the haves and the have-nots, maybe Christina you touch on that for a quick second.

Yes. I think the central theme to your questions, Griff, is the market is bifurcated by haves and have-nots, haves are buildings that are modernized well amenitized, really well located, have landlords that are financially stable and ready to do business. And when you have that combination, you really are able to serve the market. Our product, in particular, is a great value proposition because we are very differentiated from the 200-plus per square foot price point, and we deliver to what is the deepest part of the New York City tenant market. So I think the combination of that is the value proposition differentiates us and allows for more growth as other parts of the market continue to increase in rents. .

So then I think it's also worth to take a look at exactly what that translates. We referenced in our last earnings call a financial services tenant at One Grand Central Place that expanded to over 200,000 square feet, has another commitment option for them at October of this year. We didn't disclose what that was, but the press figured out it's institutional capital networks and reported as such. That tenant has a block of space in the 20s, meaning the floor of One Grand Central Place in the 20s. That lease started at $72 a foot. So if anybody had said 12 months ago, we'd get $72 a square foot for spaces in the 20s, 26, 27, 28, 25 at One Grand Central Place, they would have thought that were incredible. And the fact of the matter is that's what we've gotten. So I think that means derivatively high 80s to 90 handle on tower floors in that building. And at Empire State Building, where we -- towards the end of the year, signing leases that began with high 7s and low 8s think we move well into the 9s. Now think about at 245 Park Avenue, SL Green and Mori, they'll probably finish up their leasing, they're hopeful we understand the market, going out to helping to get in the low 120s for those spaces. So we're at 3/4 of rent. So that speaks, I think, the general uplift at the haves and also the viability of our product type, where if people want to move, they have either got to accept a lot less in quality or spend a lot more. And this is a subject we've spoken about for some time that they want to move from us. It's either because you've closed your office or you have to pay a lot more or you have to accept a lot less.

Do you expect as kind of both occupancy and lease rate growth and you do have large signed lease not commence pipeline. But as we get toward that low to mid-90s kind of terminal occupancy over the next few years, would you expect the ability from a landlord perspective to be able to push base rents more and have greater pricing power. Is that the, I guess, longer-term expectation within the portfolio?

We are already moving our base rents. We're discussing at 1350 Broadway now rents starting in the 60s. And 2024, that was in the 50s. So we already see this 1359 Broadway, 60s. We were in the 60s at 1,400 are now in discussion of leases, they're high 60s to 70s, so the answer is unquestionably yes. We already see it. .

And in terms of what the leasing pipeline looks today, can you just kind of give us a sense either size of tenants, differentiation between new and renewal leasing and kind of the industries that you're seeing from a tenant demand perspective? .

As Tom Durels said very well in our earnings call and as demonstrated also in our investor deck, for anybody who'd like to that it's available at esrtreit.com. We see a very broad variety of tenants in our portfolio. It's a really great mix. There's not one concentration in any one area. Credit quality, quality tenants. That seems to be what we see more of, by the way, also because as people look for that value proposition, they look for that modernized and monetized well-located with a landlord who's got a good balance sheet and also the sustainability piece is a huge draw to the better quality tenants, where we provide them with a way to put points on the board in their own tallies for their own performance in their own activities. So when we look at our activity, first quarter is always historically sort of slower for us. We like the business we're seeing in the first quarter. We like the activity that we see, and it's a very good mix. We continue to look at expansion. We're looking at expansion lease with Burlington at 1400 Broadway right now. They've expanded several times in that building already fits in very well with the retail piece when you think about a recent statistic that said 10% of the population is responsible for 50% of the consumption in the United States. And then you also look at the fact that if you assume bottom 20% to 30% are responsible for sort of 10% to 15%, that leaves 40% to 35%, 40% for that middle sort of 60%. And so with our daily shop target, we have two of them, the activities we have at the base of our office buildings, which do better because we have better office occupancy. And then we've got Brooklyn, which really on Williamsburg that serves that higher economic demographic. So we like what we see throughout the portfolio as far as the ability to do rents across all the sectors and all the different product types we have.

Maybe we can turn now to the Observatory. Obviously, a very strong year last year. The forward guide, I imagine probably had a little bit of conservatism baked into it, just given impacts of a stronger dollar or where we might be headed from an immigration policy perspective. But just as you think about the year ahead and the opportunity set within the Observatory, what can we expect there? I would imagine still strong performance. It's the Empire State Building for a reason. So maybe just talk about the opportunity set a little bit.

Christina? .

Sure. Well, our Observatory is #1 ranked in the world by TripAdvisor, very proud of that. It's also a tremendous amount of work by the team. to ensure top experience and seamless execution throughout the business. What we learned from COVID was both the ability to better drive sales as well as drive top line as well as the ability to control expenses, and we'll look to carry that through going forward. So right now, we operate with above 2019 levels of net operating income. 2024 closed out at $99.5 million. The visitor level is at about 75% of head count as compared to 2019, where we see room is continued ability to drive revenues from admissions. The team has done a great job on revenue per cap. We continue to engage in different sales and marketing opportunities to further expand our channel for potential Observatory customers. So we're very excited about the overall business. . Your comment on the conservatism, there is some of that, but none of the factors that we bake in are unique to Empire State Building specifically. I think these are things that everyone in attractions and frankly, travel and hotel business are looking at stronger dollar, geopolitical tensions, when does international fully come back, in particular, China. So these are all things that we look out for. And as the year progresses and we have better visibility, we look forward to further tightening and hopefully expanding guidance. .

So let's take an example. 2019, 72 weekly flights from China to New York. 2024, 10. We saw when Trump won, an initial recoil from international tourist interest to the United States after some of the language and thoughts were expressed by his administration, by him. I expect we may see that this year as well. And then, of course, we have had the very strong dollar and anyone who's made a flight across the Atlantic knows or across specific knows, a lot of Americans on those flights, the vast majority. And you might say, well, of course, Americas is going to visit. But then, of course, it would also be Europeans or Asians who would be returning home from their visit to the United States. . So we will, of course, provide updates as we go forward. In the meantime, we're super confident about our team's execution and our ability to dominate more of the market share that does come in.

And just 1 follow-up that we got in here on Live QA. Can you give a breakdown? Or do you have a sense of the percentage of visitors that are international travelers versus domestic?

Yes. So on 2019, we had mentioned it's roughly 2/3 international and 1/3 domestic. I mentioned before, we're roughly 75% of 2019 levels, and the split is very roughly half-half right now. .

Maybe just shifting next toward the external growth opportunity set. Clearly, you did the retail acquisition in Williamsburg. It seems like that's a growing piece of the portfolio. Tony, I know you've talked about being an opportunistic omnivore in the past. But when you look at the kind of opportunity set ahead of you, whether it's acquisitions, maybe something on the debt side, maybe looking at joint venture structures. Again, I know currently you don't have any JVs, but where could we see Empire potentially pivot to offense, just given the opportunity set that we have in New York commercial real estate?

So a couple of things. Number one, you're exactly right on our viewpoint when people ask us, well, how much more will you purchase on North 6th Street recent transactions have been at much higher prices than we paid. And so we feel very good about where we are. And at the same time, we're the largest owner there on the street. So we feel at this point, there's no need for us to expand just for the sake of expansion. There's no manifest destiny, if you will, number one. Number two, when we look at the resi, it was the right time, right place, again, for those 1031 changes as we got out of the suburbs. On office, it's really very simple. There have simply not been enough transactions in order to set a clear picture of value. They are 60% in 2024, the dollar volume of transactions in office versus -- excuse me, 60% reduction office transactions versus 2019. End of 2024, we began to see transactions, and we see things now. So we're actively in underwriting. I think I'd like to just ask Christina to make a comment because we look at all of the different food groups as far as capital sources and maybe talk about uses of our capital and activities with others.

Sure. I think the transactions you mentioned, Griff, right, for Multifamily as well as Williamsburg, they were specifically tied to capital recycling. So we think of those much more from a pair trade concept. We exited suburban office, where we saw limited to negative NOI growth, coupled with high capital requirements even to lease and run in place and markets that had very high levels of vacancy. So really challenging. And when we think about capital allocation, even if they currently contribute positively to FFO does not make sense to continue to invest capital in. And so these assets that we acquired represented great assets at attractive valuations with NOI growth potential and lower CapEx requirements. So over 5, 10 years, better cash flow to the bottom line for the business. We differentiate that from balance sheet capital where we would look for more opportunistic situations. Tony mentioned pref equity on the call. There could -- we were also looking for basis reset deals, which, as Tony just mentioned, we haven't seen a lot coming to market. Sentiment in office has improved, but not all problems have solved. So it's still early to tell, but those are avenues we're interested in. We've also said that for office redevelopment type deals, we would welcome JV Capital, one, because they're capital-intensive and the trajectory, they're less cap rate deals, right? You're putting in capital and you're actually consuming cash and then generating cash flow later on and also the opportunity to earn fees and contribute our expertise and play the office cycle, I think those are good opportunities potentially to generate attractive multiple on invested capital if you can get in at the right basis. And then in Multifamily and retail, we have interest in those asset classes, but those continue to be very healthy, such that the trades that we did are attractive and unlikely to see them get to truly distressed for high-quality assets, but there could be situations to buy better. And I think the onus becomes on us to demonstrate the value proposition and how that contributes to cash flow to the bottom line over time. So those are the opportunities we look forward to. And we don't hold ourselves to just having the best balance sheet and the lowest leverage. It's great to do that and have full visibility on our operating runway and position us well. But for the right opportunity, we'd be okay with ticking up in leverage and utilizing our balance sheet to be opportunistic. .

And to be fair, we've said that in this room since we went public and now we're really in a position where we can -- we feel this is a cycle where we can play.

Maybe just expanding on kind of what your underwriting criteria are, whether it's in terms of yields or unlevered IRRs. Can you give us a sense of what you're targeting and how that compares to where you see your current cost of capital? .

Yes. I mean, it depends on the asset class, right? So in Multifamily, you'll often hear cap rates and in retail for high-quality assets, also in cap rate terms as well as per square foot. And I think on those metrics, it's obviously inside of where our implied cap rate is for the stock, but we look for situations where we can continue to add value over time and generate cash flows. In office, if we're looking at the opportunistic type, a lot of people will say, well, what are our cap rates now for those types of deals? They tend not to be cap rate deals because if they had income in place, either that income is leaving or they have a lot of vacancy, which makes it not a great metric. So more than likely, be on a per square foot basis, and that's where we've discussed getting a basis reset, so we can put in the capital required to make these competitive assets. And just like we did for our 8 million to 9 million square feet of office, we can improve these assets, institutionalize the floor plates, attract good quality tenants and increased rents. In terms of what that yields, it really depends. Probably they would most likely be multiple on invested capital-type deals. I caution against using straight IRR because that's highly skewed by your holding period. I guess there could be a scenario where it's a short-term hole. But if it's long term, who knows what cap rates are, and it really depends. But we would be looking for very attractive returns, and we would also bring in JV Capital as we mentioned. .

I think it's really important when you look at office situation. To the extent private equity and high leverage continues to focus on no investment and short-term hold it only furthers the gap between the haves and the have-nots. And so that will play into us as well because they're simply -- it's not enough just to do an elevator cab in a lot, people look deeper and people look for more.

In terms of debt capital availability, are you seeing greater lender interest for commercial real estate right now? Or is there still kind of a wait-and-see approach. I know it probably differs between property types, but any sense kind of you're seeing on that front would be great.

So overall, lender mood has improved significantly as compared to 12, 18 months ago when they were all concerned about how much commercial real estate exposure there was. That has since shifted. A couple of things. One is extend and pretend or kick the can down the road, whatever term people use. That has worked remarkably well in New York assets. In tougher markets, there's been greater propensity to force sales and get them off the books. But in New York, they see prospects and that has played out quite well as New York continues to strengthen. And so fast forward, lenders are now seeing payoffs of prior loans and alternatives. And as a result, they are now back into origination. It's not universal. It goes back to haves and have-nots for well-leased assets. CapEx already spent and good sponsors, they can see loans. CMBS market is also available now. Everyone saw the execution on Rock Center, on Spiral, very strong executions at debt yields that people didn't think were possible over a year ago. So that market has come back. But again, that's to well-leased assets where capital has been spent. So there's still a huge void for a lot of assets, and there could be a gap. But for stabilized assets, you're definitely seeing it come back. Multifamily, ample availability of agency financing and other lending and in retail for high quality, also very significant interest from lenders.

We had another question coming in here. I think it's probably pretty topical just given kind of how this has been in flux. But have you noticed any change in your office attendance or utilization as a result of the congestion pricing that was I guess, implemented in the beginning of the year, but now it seems to be kind of up in the air.

None. Office attendance, it continues to improve, it continues to increase. I think the congestion pricing question is a good one in relationship there, too. At the same time, I think we can put to bed this whole question of work for home versus office.

I know that ESG is a topical word that the people are placing a lot of emphasis on. And clearly, there are the kind of haves and the have-nots in the space. And it's clear that Empire is certainly a leader there. So Tony, maybe talk a little bit about your sustainability goals, kind of that and how it differentiates maybe from other players out there and how investors might reward that? .

So our focus has always been, when you talk about ESG on the E, the sustainable, which is environmental, the sustainability of the resiliency piece. And within that focus, it has always been based on return on investment. It is not based on do the right thing and don't have a result to show for it. And the #1 component to that, that we do is the energy efficiency piece which is a major cost savings for our tenants. It's a major cost savings for us. Portfolio-wide, since we began this work reduced the total energy consumption in our portfolio by 40%. I think it's important to note with regard to electricity costs particularly with the fact that the AI expansion and growth and the increase in use of American manufacturing chip fabs, two of them, Upstate New York, when they come online are projected to add to the total grid demand in New York State by 30%. That's from Doreen, who is the President of the New York State Energy Research Development Authority, Doreen Harris. So when we look at this, for us, it's really a matter of delivery to our tenants of a better, more efficient, less expensive option that they can also use to put points on their board on their own internal measures. That said, another component of what we do as we do our work is the internal air quality and we also work on diversion of waste, both water and solids. And all of those, again, our points on the board, all of them add to both return on investment and increase our rents and increase our demand and put us very squarely further in the haves. Last year, we earned for the second time the #1 rating on GRAS of all publicly listed companies in the Americas, not in our peer group. Everyone talk about they've got 5 stars. They had an A in disclosure. We're #1, 2 years in a row. So we continue our work. We continue to be an absolute thought leader. We continue to be involved in the policy side on this, both because we want to share our practices to improve policy and because we want to see where the ball is going before everyone else finds out about it.

And then another one just around kind of the pure-play New York focus, just given it's a mix of different property types. You've got the office, the Multifamily, the retail, the Observatory. Why does this diversified strategy work versus being more a pure play that some investors look at? .

Sure. Well, we've always mentioned we are focused. We're focused on New York City. And when you look at the fabric of tenant demand, right, work, live, play and shop, they all make logical sense. And so our entry into Multifamily and adding on to Retail, we feel are natural extensions. But overall, as a business, when you think about the mix, it really allows us to utilize our knowledge in New York City as an operator and play in these fields and add to the resiliency of the cash flows. You're not just relying on one single stream. Your sources of financing also broaden, your CapEx profiles are different from each of asset classes and your lease terms are different. And we think that, that adds to the overall resiliency of our cash flows and business creating a portfolio that is very strong, and it's unique because it's the only way to really get at New York City from all of these angles.

Maybe going back to the Williamsburg acquisition. I know a big chunk of it closed in '24 with the rest closing, I think, at the end of 2025. But can you talk maybe about the opportunity there in terms of mark-to-market, maybe when leases roll and how that's going to benefit the enterprise as a whole.

Sure. So we disclosed that we're buying in, in like the 4s cap rate and just from the completion of one development site, which is the Hermes store and lease-up of 1 piece of vacancy, we get to around 6% within 2 years. So that's the starting point. We also mentioned that the weighted average lease term is a bit over 6 years. So the mark-to-market rental potential is really high. However, we don't include that in our stated returns because it takes some time to get to it. But it is one of those interesting situations where if we have some movement in weaker performing tenants, that could actually be beneficial both to the place-making aspect of a retail portfolio as well as to the economics. So we look forward to those continued developments. . We think there's good upside. And I think this is a classic case where we may be buying in at what is core type valuations for a very good reason because it came out of suburban office as a paired trade, but instead of being fully baked you have good mark-to-market potential, and we've said that's above 20% and things can continue to improve in time as foot traffic continues to strengthen and sales continue to improve in that market. And we already see very strong sources of tenant demand across the board.

So we are very eager here. And frankly, there are -- there may be an opportunity to get our hands on some space from a very good credit tenant who, frankly, we think we can do better than they do and add to our mix. So just the same way we actively work our office portfolio. We actively work our retail portfolio and we feel very strong about that area. We like it.

And I know you have -- I know we're running up on time just one more question before the rapid fire. You have the one remaining suburban asset, I believe Metro Center. Would the plan for that be to kind of rotate capital out of there and reinvest back in New York? Or do you view that more as a longer-term .

That's already on the market. Teasers already been put out publicly. So we do look to ways in which we can exit that asset.

All right. If there's nothing else from the audience. I've only got 2 rapid fires to end the session. The first one, what is your expectation for net effective rent growth for the office sector overall, not Empire specifically in 2026 .

Market overall carried by the haves positive. .

Positive. Okay. And will there be more fewer or the same number of publicly traded office REITs a year from now?

Fewer.

Fewer. Great. Thank you so much.

Thanks so much.