Empire State Realty Trust Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 26, 2023

There are 10 speakers on the call.

Operator

Greetings, and welcome to the Empire State Realty Trust Third Quarter 2023 Earnings Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce Katie Malinowski, Vice President of Investor Relations.

Operator

Thank you. You may begin.

Speaker 1

Good afternoon. Thank you for joining us today for Empire State Realty Trust's 3rd quarter 2023 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 presentation 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 law, including those related to market conditions, property operations, capital expenditures, 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.

Speaker 1

Empire State Realty Trust assumes no obligation related to those 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. And now, I will turn the call over Tony Malkin, our Chairman, President and Chief Executive Officer.

Speaker 2

Thanks, Katie, and good afternoon to everyone. We continue our efforts to educate the market that ESRT is a top our tier destination For Tenet's flight to quality today, we are not B properties. We are top of our tier in our accessible price range, and we continue to capture market share. We can think of no better way to inform than to continue to put points on the Board. So we are pleased to report a 3rd quarter of strong performance in 2023.

Speaker 2

We did not predict the weather. We built an arc for the storms that were certain to come. We positioned ESRT to perform in all cycles. We built a brand around modernized, amenitized, well located, energy efficient buildings with indoor environmental quality And a team of union and non union colleagues distinguished by service and collaborative work. And we report our earnings from a position to take advantage of the opportunities ahead while we perform in today's market.

Speaker 2

Your ESRT team is more focused than ever on points on the board. In the 3rd quarter, FFO came in above expectations. We leased another quarter of a 1000000 Square Feet that is 787,000 positive leasing spreads. That is 9 consecutive quarters of positive leasing spreads and our Observatory continues to perform. We completed a 100% recycle of sales proceeds from prior dispositions through 10/31 transactions With no tax leakage, our balance sheet remains best in class.

Speaker 2

ESRT is a New York City focused company and we have 4 diverse drivers of value that complement each other well. Our office portfolio that is The top of our tier and targets the deepest market segment, our Observatory that is the number one ranked attraction in the United States According to TripAdvisor, for the 2nd consecutive year, our high foot traffic everyday Retail that serves as a great amenity to our office tenants and a growing multifamily platform. We continue to deliver consistent leasing volumes. We leased a250,000 square feet in the 3rd quarter. Tenants choose ESRT's constructive partnership on energy efficiency and indoor environmental quality, where we add value to their installation and occupancy with our top tier modernized assets, our amenities, our locations and the certainty delivered by our great balance sheet.

Speaker 2

Those relationships have driven more than 2,600,000 square feet of tenant Expansion in our portfolio since IPO. Put this in perspective, our entire portfolio today Totals just over 9,300,000 square feet. We are happy to announce that in the Q3, we grew our partnership with Starbucks grown from our original retail store in the lobby of a building we no longer own in the early 1990s, All the way to the remarkable 23,000 Square Feet 3 Level Starbucks Reserve that opened in late 2022 To this new full floor office lease. Tom Durels will discuss another expansion, this one with LinkedIn, which brings their total footprint in the Empire State Building to over 500,000 square feet. And our partnership with LinkedIn started with a few 1000 square In 2010, as of quarter end, our Manhattan office portfolio is nearly 92% Leased and this reflects an increase of 250 basis points over the past 12 months.

Speaker 2

Our leasing success Meets the performance of newly built Class A office properties, improves we are a destination for the market's flight to quality. ESRT's successes are built upon the investments we have already made. We are future ready, And we service the deepest segment of tenant demand in the New York City office market at our accessible price points. Our balance sheet makes a big difference to tenants in today's environment. We have always said that our goal is to get the best deals in good times, Get the deals in challenged times and draw consistent leasing volumes through cycles.

Speaker 2

We know what we have to do and we are absolutely focused. The Observatory continues to perform well. Year to date, Observatory NOI Exceeded comparable 2019 levels by 2% with 71% of the admissions relative to 2019 levels. Candidly, we could have done without 4 consecutive rainy weekends in September, and we look forward to this weekend where the sun is meant to shine. That said, we continue to manage expenses, drive top line growth and provide visitors with unmatched customer experience.

Speaker 2

The Empire State Building Observatory is the authentic New York City experience and is the number one ranked attraction in the United by TripAdvisor for the 2nd year in a row. Our Observatory's cash flows are reliable as demonstrated on Slide 14 of our investor presentation. ESRT's balance sheet is the strongest amongst all New York City office REITs, And the capital structure is simple. There's no doubt that our balance sheet is a competitive advantage. Tenants look to partner with a financially stable landlord who will maintain high quality standards at their assets.

Speaker 2

We can allocate capital as we think best, be it capital recycling, new acquisitions or share repurchases. Just in the last Years of criticism for the fact that we bought nothing during the frothing decade that led to the current credit crunch. ESRT has been the quantitative sustainability leader for more than a decade, and sustainability is integrated within every decision we make. Our industry leadership and sustainability and healthy building performance matters more and more each year to tenants, lenders And shareholders, and this is a cornerstone when we say we are future ready. There can be only one number one.

Speaker 2

ESRT's overall GRESD score ranked 1st, number 1 amongst All 115 listed companies in the Americas as well as the 1st and the most competitive peer group within the United States. We achieved the highest possible GRESB 5 star rating for the 4th consecutive year. The Empire State Building was just awarded the 2023 BOMA New York Earth Building of the Year Award And the Boma Grand Pinnacle Award, tremendous accomplishments for our entire company. Our data based sustainability work delivers economic returns and provides us with a competitive advantage over our peers. ESRT priorities are unchanged.

Speaker 2

Lease space, sell tickets to the Observatory, manage the balance sheet and achieve our sustainability goals. This quarter, we demonstrated our commitment with more points on the Board. These actions together enhance shareholder value. While we work through challenges, we are in a position to take advantage of opportunities Created through market disruptions and capital dislocations, ESRT is prepared to act. We believe in New York City, And we offer 4 ways to play it: office, the Empire Stapleton Observatory, retail and multifamily.

Speaker 2

New York City is resilient and ESRT is future ready and well positioned to drive value for shareholders. Tom and Christina will provide more detail And how we plan to accomplish these goals in

Speaker 3

the balance of the year. Tom? Thanks, Tony, and good afternoon, everyone. We had another strong quarter with 248,000 square feet of total leasing at 10% positive mark to market rent spreads for our office And retail portfolio. This represents our 7th consecutive quarter in which we achieved positive absorption Based on leased percentage for our commercial portfolio and our 9th straight quarter with positive mark to market lease spreads In our Manhattan office portfolio, we continue to attract new and renew existing tenants who look for high quality product that is modernized, Amenitized well located near mass transit and neighborhood amenities and has best in class sustainability and indoor environmental quality at an accessible price point.

Speaker 3

We increased our Manhattan office leased percentage to 91.9% in the 3rd quarter, which increased 30 basis points compared to last quarter is up 250 basis points compared to a year ago and has increased 4.90 basis points since the end of 2021. In the Q3, we signed 2 148,000 square feet of leases, which include a 235,000 square feet of leases in our Manhattan office properties. And in our retail portfolio, we signed a new lease with an exciting sushi restaurant at 1359 Broadway, which be a great amenity For office tenants in the Broadway portfolio, where we continue to bring in food and services to support the growing demand from office users. Notable leases signed in the Q3 include a 10 year 144,000 Square Foot lease with LinkedIn at the Empire State Building. LinkedIn acted upon its existing rights to relocate 119,000 square feet from tower floors to base floors And also expanded by 25,000 square feet, which brings Lincoln's total lease square footage at the Empire State Building to 527,000 Square Feet.

Speaker 3

Our track record of tenant retention and expansions, including this most recent expansion by LinkedIn It's the result of excellent work by our entire team to provide exceptional service to our tenants. And this is not just effort, It is results. We signed a full floor 11 year office lease with Starbucks for 25,000 Square Feet at the Empire State Building. The company where we locate its only New York City office to the Empire State Building, where it currently operates a 3 storey Starbucks Reserve. As Tony mentioned, our long standing partnership with Starbucks continues to add value to both Starbucks and to our portfolio.

Speaker 3

And we signed leases for 14 pre built office suites that total 66,000 square feet across the portfolio. Our reported weighted average TI costs, tenant installation costs vary by quarter depending on the variety of space types leased. Long term full floor leases typically include turnkey installation or equivalent tenant installation contribution. And for most prebuilt spaces, we have already incurred the prior cost to build. Our TI costs in the 3rd quarter were Higher than the prior quarter, mostly due to the LinkedIn and Starbucks deals, which represent about 2 thirds of our total lease volume this quarter.

Speaker 3

Both are long term leases for full floors and the TI costs are consistent with full floor leases that we have signed over the past Several years. One thing to note about the LinkedIn transaction is that it includes an as of right relocation within the Empire State Building. The TI allowance for the floors they will vacate has not been contributed and will now be used for the new space they will occupy. Against that background, for our Q3 Manhattan office leasing, the average starting rent was $67.73 per square foot With an average lease term of 8.6 years, 10.9 months of free rent and tenant improvement allowance of $93 per square foot. That is consistent with our historic free rent and tenant improvement allowance for the last several quarters and represents no increase in our general market terms.

Speaker 3

Following the close of the Q3, we signed an 11 year 9,500 Square Foot new lease with Elymas, a subsidiary of La Citeigne at 111 West 33rd Street and extended La Citeigne's existing 21,000 Square Foot lease for an additional 5 years. Year to date through the Q3, we have leased 787,000 square feet throughout our Higher commercial portfolio and as shown on Page 10 of our supplemental, we have $50,000,000 in incremental cash revenue From signed leases not commenced and free rent burn off. Looking ahead to the Q4 of 2023, We expect approximately 136,000 square feet will be vacated by year end, which will be partially offset by new leases that we expect to be signed We have manageable lease expirations in 2024 with only 496,000 square feet set to expire, Of which about 207,000 square feet are known vacates. Based on our annual average of 680,000 square feet of new leases signed in the past 3 years, we are well positioned Amenitized and energy efficient with superior indoor environmental quality and our product is top in our tier, Competitive and attractive to tenants as demonstrated by our leasing results. Within our multifamily portfolio, the average occupancy 97.1 percent reflects strong market fundamentals and we are underway with property improvements that will enhance future performance.

Speaker 3

So once again, we had another solid quarter with 248,000 square feet of total office and retail leasing at strong positive mark to market spreads. We increased our Manhattan office portfolio leased percentage by 30 basis points over the prior quarter And by 250 basis points from a year ago to reach 91.9%. We are well positioned to further increase our lease percentage in 2024 and we continue to see strong performance in our multifamily portfolio. With that, I'll turn the call over to Kristina. Kristina?

Speaker 4

Thanks, Tom. For the Q3 of 2023, we've reported core FFO of $66,000,000 or $0.25 per diluted share, which is up 17% year over year, excluding lease termination fee income. Same store property cash NOI excluding lease termination fees increased 8.8% year over year, primarily driven by cash rent commencement and increased tenant expense reimbursement. In the Q3, the Observatory generated NOI of $28,000,000 an increase of 14% year over year. Revenue per capita remains high and admissions continue to improve.

Speaker 4

Observatory expense was $9,500,000 in the 3rd quarter. Year to date, the Observatory generated NOI of $7,000,000 which represents NOI recapture of 102% as compared to the same period in 2019. As of September 30, 2023, the company had total liquidity of $1,200,000,000 which was comprised of $354,000,000 of cash And $850,000,000 of undrawn capacity on our revolving credit facility. At quarter end, the company had net debt of $2,200,000,000 With a weighted average interest rate of 3.9% and a weighted average term to maturity of 5.7 years. We have the lowest leverage among all New York City office REITs at 5.5 times net debt to adjusted EBITDA.

Speaker 4

We have strong liquidity, no floating rate debt exposure and no meaningful debt maturity until early 2025. ESRT owns 100 percent of our commercial assets with no complex JV structures and that allows for great opportunity and flexibility With this balance sheet flexibility, we have recycled capital, Pursuit investment opportunities that are additive to our New York City focused portfolio and repurchased our shares and we'll continue to allocate capital to generate shareholder value. Our off market acquisition of Prime Retail in Williamsburg during the Q3 completes the redeployment of our 10/31 proceeds and is consistent with our strategy to recycle capital into high quality, well located, high foot traffic New York City assets with strong demographic trends. Share buybacks remain on the agenda as a strategic part of our capital allocation. While we do not repurchase shares this quarter, From March 2020 to date, we have repurchased $294,000,000 at a weighted average price of $8.18 per share, which represents approximately 12% of total shares outstanding since our share buyback program began.

Speaker 4

And now on to our outlook for the balance of the year. We have adjusted our 2023 guidance as follows. Our 2023 FFO guidance is increased to a tightened range of $0.85 to $0.87 per fully diluted share. This is driven by an improvement in our same store cash NOI outlook by 100 basis points, that were not realized year to date. Within our updated FFO guidance range, we do expect a sequential decline in the 4th quarter, which factors in an increase in operating expenses largely tied to the expected timing of major R and M projects underway.

Speaker 4

Our expense expectations for the full year are unchanged and continue to reflect some permanent property operating cost savings and efficiencies that we achieved from pre COVID levels. Additionally, there is typical seasonality in the Observatory business. While we feel good about the Observatory's performance to date, we continue to leave room within our updated FFO guidance range for uncertainty around tourism We maintained our expected Observatory NOI range of $88,000,000 to $96,000,000 for 2023, up from $75,000,000 in 2022. Our NOI guidance assumes Observatory expenses average approximately $9,000,000 per quarter in 2023. Our same store commercial occupancy guidance is unchanged at 85% to 87%.

Speaker 4

In summary, The company continues to manage our best in class balance sheet prudently and strategically with strong liquidity to take advantage of attractive investment Our commercial portfolio is now 87% occupied In 90.5 percent leased, we continue to benefit from tenants demand for our high quality assets and the unique value proposition At the best in class base in our rental price range and balance sheet strength that we offer as a landlord. Our Observatory recovery continues with good momentum year to date And our 4th leg of growth multifamily has performed well and adds to the resiliency of ESRT's cash flows. And with that, I'll turn the call back to the operator for a Q and A session.

Operator

Thank you. We will now be conducting a question and answer session. Our first questions come from the line of Steve Sakwa with Evercore, please proceed with your questions.

Speaker 5

Thanks. Good afternoon. Maybe Tom, starting on the leasing, If you could just maybe give us a little bit more specificity on kind of the current pipeline. And are you seeing more demand today in kind of the Penn Station maybe garment area or are you seeing kind of more strength over in the Grand Central submarket?

Speaker 3

Yes, Steve. We've got a good pipeline Of activity, we've got activity and interest from tenants and that's both proposals and leases and negotiation At 1 Grand Central Place where we're trading paper on prebuilt and full floor, 250 West 50 Summit Street, where we have A full floor that's been pre built. We have activity on that. At Empire State Building, we're optimistic I'm getting another significant lease done there as well as some smaller pre builts and at 1400 Broadway Where we have some leases that expiring next year as part of our known tenant vacates, we're already in active discussions For tenants to backfill that space, so it's really across the portfolio in terms of the pipeline, generally, I'd say Roughly somewhere around 200,000 square feet of leases in negotiation. Timing will dictate as to whether those leases get signed in the Q4 or Q1, but we feel Pretty good about our overall pipeline of activity and it's really continues to be from a broad variety of industry types That includes technology, fire sector, not for profit, professional services and consumer goods.

Speaker 3

And so look, we're on a pretty good run here, right? We've had 7 consecutive quarters of positive lease percentage absorption and 9 quarters of positive mark to market lease spreads. So I think we're incredibly well positioned.

Speaker 5

Good. Thanks for that color. Maybe, Christina, you had a good Q3 here at $0.25 I think The full year guidance implies kind of a $0.20 run rate for the Q4 at the midpoint. So can you maybe just walk us through what some of the, I guess downward pointing arrows would be for the transition from Q3 to Q4?

Speaker 4

Sure. So as I mentioned in my remarks, within 4Q, we expect the sequential decline driven by an increase Operating expenses and some of that, in large part is due to some major R and M projects that are underway. So this is just timing and where the expenses fall out. For the full year though, we would note that OpEx change is as we guided, which is about an 8% Increase, so that is consistent. And the other piece is the typical seasonality in the Observatory business.

Speaker 4

So if you look back, there traditionally has been some seasonality factor between 3Q and 4Q. And as we mentioned, we do factor A little bit of uncertainty around tourism fluctuations and bad weather. So that would be the primary driver of that sequential decline.

Speaker 5

Okay. And then just last question. I know you've got a mortgage coming due up in I think it's kind of late in 2024. That asset is around 80% occupied. I'm just curious kind of the discussions with the lenders Today, how you're thinking about that asset and is that something that's kind of long term for the portfolio?

Speaker 4

Yes, we continue to have active discussion with our lenders, on that piece of property and mortgage as well as other maturities and we'll keep the market Apprised, but we run the portfolio and these are discussions that we always have and continue to discuss what makes the most sense with our lending partners.

Speaker 5

Thank you.

Speaker 4

Sure. Thanks, Steve.

Operator

Thank you. Our next questions comes from the line of Michael Griffin with Citi. Please proceed with your questions.

Speaker 6

Great, thanks. Maybe just going to Tom on the leasing. I'm curious if you've noticed Any time for space takers that they're delaying decision making in terms of taking space? And then can you provide some more color on concession package? Appreciate what you provided kind of in the prepared remarks, but your kind of expectations for that on a go forward basis would be helpful.

Speaker 3

Sure. I believe your first question was that the timing of tenants in terms of deciding on their leasing And it really is tenant by tenant. It will range from very quick decisions and particularly for those that want built space that Where our prebuilt suites and even full floor prebuilt will attract those tenants. We're working on a deal right now. We're actually a tenant It has a pretty quick timeline of whether they want to get into the space.

Speaker 3

And then there's others That can enter the market as much as 18 months or more before their lease current lease And there'll be shopping the market for an extended period of time. So I can't say there's a trend as much as it just really runs A wide gamut depending upon the particular tenant's needs and what's going on with their business as well as the space type that they're pursuing. And your next question was on leasing costs. Well, I made the comments earlier in my prepared remarks about What drove our leasing costs this quarter, we're really not seeing a significant change in the market. Generally, most of the leasing we do involves a fully prebuilt space that's been built on spec for which we already have a Significant amount of built inventory and we've already incurred that cost, 2 turnkey installations.

Speaker 3

And that's generally what we continue to see in the marketplace and that was what we experienced on both the LinkedIn and the Starbucks transactions, which has And consistent with the market over the last and consistent with the leasing we've done over the last several years.

Speaker 6

Great, thanks. And then just on the retail acquisition Williamsburg, should we read into this as these kind of acquisitions appear more attractive relative to other And is there anything you can kind of quantify in terms of cap rate or on a IRR basis that would be helpful?

Speaker 2

Hi, Graf. We were very happy to be able to complete 100% recycling of the sales proceeds From prior sales and it's really a matter of just as I've said before, we're omnivorous opportunivores. We go for where we think there is the best combination of value and growth potential when we do either acquire or recycle capital. And I think what you should read into it is that given the nature of a 1031 exchange, Which operates in a compressed timeframe, you have to operate on the best, execute on the best opportunities presented to you at that time. At the right price, the right basis, we'll definitely do office.

Speaker 2

We know how to build out, renovate, modernize, amenitize with energy efficiency and indoor environmental Quality assets in the right locations with the right size floor plate to perform. We've demonstrated that. The fact is that we have to operate in the compressed timeframe and that's what presented its best opportunity when we

Operator

Thank you. Our next questions come from the line of John Kim with BMO Capital Markets. Please proceed with your questions.

Speaker 7

Thank you. I had a follow-up on the LinkedIn decision to move from the tower floors to the base floors. Can you comment on the new rent that they leased versus what they vacated? And also what the mark to market is of the vacated space?

Speaker 3

Yes, John, I don't want to get into the specific details of the lease transaction, but I would just generally say we've been signing leases in the 70s per square foot. In the last quarter, we signed Leasing the tower floor in the 80s. And so the deals that we signed this quarter were Fairly consistent with what we've been seeing over the last couple of quarters. Does that answer your question?

Speaker 7

The move to the base floor, is that because of the floor plate size or?

Speaker 3

Yes, it was contiguous with other space that they occupy. So they're moving out of 3 Tower floors, which are highly desirable and marketable. They will move to base floors and expand by 25,000 square feet, puts them contiguous To other spaces they have as well as closer to some built out amenity space with food hall on the 3rd floor, It was part of a prior agreement that we had in connection with the earlier lease that was signed. And as a reminder, we did not spend or provide the allowance on those 3 tower floors that they're vacating and we'll be contributing that allowance money to the base floors that they will build out. But they have they are in occupancy Currently of those tower floors, we have an opportunity to market those in advance of them moving out in 2026.

Speaker 3

So all in all, it's a really favorable deal. It works very well for LinkedIn and it works very well for us as well. And it's the type of thing we do to accommodate tenants that have expanded and grown

Speaker 7

within our portfolio. At the Empire State Building with Starbucks moving in, was that a consolidation of existing space within New York or And expansion in the market.

Speaker 3

It is a relocation of their New York City offices of their only New York City offices From the Penn District in Tampa State Building.

Speaker 7

Okay. And then Christina, You mentioned R and M expenses dragging down 4th quarter earnings. Any further color you could provide on that? And also on the Observatory, it looks like You're guiding to 12% reduction quarter on quarter in the Observatory versus a 3% Quarter reduction last year. Is there anything you're seeing as far as leads or website traffic that would lead you to think that There'd be a bigger seasonality impact this year?

Speaker 4

For the Observatory, a lot of that is Seasonality, so that we'll continue to provide more information as that goes along. And for the major R and M, nothing in particular to call out. We have regularly Planned projects and it happens to just be timing, if it comes into 4Q or if it bleeds into 2020 So not much notable on either item. These are both routine.

Speaker 7

The seasonality impact last year was pretty minimal though, 3%.

Speaker 4

Seasonality last year, but last year we were still in the midst of ramping up. When you look overall in

Operator

Thank you. Our next questions come from the line of Camille Bonnell with Bank of America. Please proceed with your questions.

Speaker 8

Hello. Can you talk to the renewal activity your teams are executing on? It seems like quite a step up compared to the recent years. How far in advance are tenants coming to you?

Speaker 3

Sure. We proactively Speak to all of our tenants on a regular basis and we certainly ramp up those conversations starting 24 months out before lease expiration. And generally what we find is that the smaller tenants, 10,000 square feet in that are really postponed their decision Until the year of their lease expiration and some don't even get to about 6 months prior to their expiration. And that's why you see the as we update the Page 14 in our supplemental, you'll continue to see certain amount of tenancy that remains in an unknown category until those tenants get closer To those expiration dates, generally we've been averaging around a little over 60% on renewal rate when you factor in early renewals. And I think that look, it's a reflection of the fact that we've completed our redevelopment work.

Speaker 3

We've spent $1,000,000,000 to redevelop our Portfolio, we've scraped and redeveloped 95% of our tenant spaces. We've added we've built amenities and we're adding to our amenities and we're Definitely benefiting from a flight to quality as we deliver the best product and location in our price tier.

Speaker 8

Occupancy over the past few quarters and appreciate your comments on the lease percent outlook. But on the occupancy side, do Do you think you can also continue to maintain or grow that further from here?

Speaker 3

Well, occupancy has increased 4.60 basis points Since the end of 2021. So again, it's an increase of 4 60 basis points since the end of 2021. We've had 7 consecutive quarters of positive least percentage absorption. Look, we're confident we'll achieve our guidance That we provided for the year end and we're very well positioned for 2024. We feel really good about our ability to increase Occupancy next year based upon a modest amount of known move outs.

Speaker 3

And look, Convent, we have about 207,000 square feet of known vacates in 2024 and that's against the backdrop of roughly 250,000 square feet of leases on vacant space that should Commence by next year and generally we're averaging over 600,000 square feet of new leasing per year. So I think we're Well positioned to improve both leased percentage and occupancy percentage next year.

Speaker 8

Appreciate the clarification there. And finally, just your comments around looking at office as potential investments. Can you expand a bit more on the opportunity you look at? Would it be more value add or potentially Looking at assets to further improve the quality of your overall portfolio. Thank you.

Speaker 2

Our skill set It's Tony here. Our skill set is redevelopment and our unique intellectual property, our IP advantage is We actually don't have to do this conceptually. We know the costs and we know the demand and we know the time it takes Because we've done it throughout our entire portfolio. At the same time, we'll always react opportunistically 2 things which develop. What I would say at this point is there has been very little market clearing in the office environment and if we had seen opportunity that was better than what we chose to Invest in proceeds from our sales, we would have acted.

Speaker 2

We didn't. And as soon as we see opportunity, we'll let you know.

Speaker 8

Thank you for taking my questions.

Operator

Thank you. Our next questions come from the line of Blaine Heck With Wells Fargo, please proceed with your questions.

Speaker 9

Great, thanks. Just want to follow-up on that last question. Just hoping you could talk a little bit more about your appetite For additional new investments and I guess what level of returns you might be targeting given the increase in rates and again Where do those returns need to be on a property acquisition to make them compelling relative to repurchases?

Speaker 4

Yes. So, look, the returns sought and required have obviously gone up because cost of capital has gone up, because Traditional lenders, have created a void and that has led to higher, debt cost of capital in this period to make, any deals work. I think take that as a given across the board. As we look at the landscape, as Tony mentioned, we believe there will be distressed opportunities And it all comes from buying in at the right basis, so that we can do our work, which does require capital and understanding the rental price points, which Will allow us to get leasing velocity the way we have in our own portfolio. And that's the way the returns pencil out.

Speaker 4

So clearly it's higher than before, but in the Actual investment transactions in the market, don't want to get ahead and quote what the returns are. Everyone knows that the bar It's higher and it's higher for us as well. As for share buybacks, we do think it's a very attractive opportunity. Even currently, when we look at our implied Price per square foot implied cap rate, even if there's a question mark on private market valuation, these are very attractive values, Especially considering we've already spent the CapEx. So when you buy into ESRT stock, our implied value per square foot is CapEx already spent, Right.

Speaker 4

And that makes it a tremendous value. That said, when we think about share buyback, it's not just about the value opportunity. That is Huge component. It's also about continued operating runway for the company, continued access to capital. And we all know we're in a peak period of capital dislocation.

Speaker 4

So we need to be prudent about how much we do at a given time. And clearly, we've done a lot in size.

Speaker 9

That's very helpful, Christina. And then probably for Tom, I guess, can you talk a little bit more about demand for your prebuilt suites? Clearly, some of the largest operators of co working and flexible space are having trouble and Tony has been vocal about leasing to them in the past. But Are you guys seeing this as an opportunity to expand that offering and how has that demand kind of trended for that type of kind of turnkey space?

Speaker 3

Well, we've always had consistent demand and good leasing activity For our pre built suites, fortunately for us, we have about a little over 200,000 square feet of vacant pre built suites where we've already incurred the costs And don't have to incur that cost on a go forward basis. We lease those spaces and they're ready to go, ready for immediate move in. Really, I can't say that we see a big trend of movement from Tremendous that come out of co working type spaces into our prebuilts. I think that generally those that want their own office space, their own Shepherd Environment have opted to lease with someone like us in built space. And a lot of those prebuilt tenants that we leased to have gone on to grow within our portfolio to Subsequently lease full floors with us.

Speaker 3

And look, a lot of those tenants also want the direct relationship with the landlord And don't really want to be in, I'll call it a shared or co working environment. But we signed 14 leases for prepost this quarter. It's pretty consistent with our pace over the last couple of years.

Speaker 2

And just not to overstate the obvious, If there were a great deal of demand within those co working spaces, those companies would not go out of business. So it's a question of what those tenants have been, what those users have been and are they suitable for us in the first place.

Speaker 9

Yes, fair enough. Thank you all.

Operator

Thank you. Our next questions come from the line of

Speaker 7

Just sort of going back to capital allocation and appreciate the comments on how you guys evaluate underwriting new acquisition opportunities versus repurchasing your stock. But I guess just when you guys are underwriting new acquisitions just from a property type perspective, Are you guys requiring a larger rate of return when you guys are underwriting office opportunities? Or I guess just can you give us a sense for how you guys think about that internally when evaluating Opportunities across property types.

Speaker 4

Yes. So our interest continues to be, as we've mentioned, New York City office, retail and multifamily. The return requirements have gone up across the board and we've discussed a bit on how we underwrite and think about all of this and It's usually predicated on basis and making sure we get high quality space that we can do our work on. Within our interest in multifamily, I think we do have a recognition But that asset class is being valued differently, even access to financing is different. So that will come into Consideration as we look at it, that asset class has access to agency financing.

Speaker 4

You are able to buy down on the rate and that cost of debt Capital will impact the returns that buyers will expect and it's also a very healthy asset class, with high occupancy levels and continued rental strength. We have to keep that in mind as we look at opportunities. That said, we'll still look at individual opportunities that come along And make sure that that asset is additive to our portfolio and there is upside to our entire portfolio and shareholder base.

Speaker 7

Appreciate that commentary. And then I guess just one on occupancy. I think you ended the quarter at 87% occupancy. You didn't change guidance. So you guys are ending the quarter at the high end.

Speaker 7

Just curious sort of the moving As you look towards Q4.

Speaker 3

Yes. Well, first we're confident that we will achieve our guidance. That's 85%, 87% for the portfolio and about 100 basis points higher for Manhattan office. As I stated earlier, we do expect about 136,000 square feet of tenants to vacate in the Q4 and that will be partially offset By signed leases that commence in the Q4 and anything new that we signed that will also commence in the Q4. In 2024, as I commented, I feel really good about our ability to increase both occupancy And least percentage based upon the modest amount of known move outs.

Speaker 3

We've proactively managed our rent roll. We have built space. We have modernized buildings. We have robust amenities. We're adding to those amenities that open up next year.

Speaker 3

So I think we're very well positioned to improve upon our performance and our percentages for next year.

Operator

Thank you. We will now turn the call back over to Tony Malkin, Chairman, President and CEO for closing remarks.

Speaker 2

Thank you very much, everybody. A few final notes. This month, We celebrated ESRT's 1st decade as a public company listed on the New York Stock Exchange. Since our IPO in October 2013, We really have not followed the crowd as we have made and executed our plans to be the New York City focused REIT with 4 diverse verticals, Office, the iconic Empire State Building Observatory, retail and multifamily and a best in class balance sheet. Our leadership and sustainability in our carbon neutral commercial real estate portfolio continues to put points on the Board Leasing and the development of practices to inform policy, the biggest call out goes to our dedicated employees, directors, tenants, stakeholders Partners who drive our success and position ESRT for future growth.

Speaker 2

Thank you all for your participation in today's call. We look forward to chance to meet with many of you at non deal roadshows, conferences and property tours in the months ahead. Until then, thank you for your interest and onward and upward.

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Earnings Conference Call
Empire State Realty Trust Q3 2023
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