Empire State Realty Trust, Inc. (ESRT) Q3 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the Empire State Realty Trust third quarter 2016 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Thomas Keltner, Executive Vice President and General Counsel at Empire State Realty Trust. Thank you, you may begin.

Good morning. Thank you for joining us today for Empire State Realty Trust's third quarter 2016 earnings conference call. In addition to the press release distributed last evening, a quarterly supplemental package with further detail on our results has been posted in the investor section of the Company's website at empirestaterealtytrust.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements as defined in applicable securities laws including those related to market conditions, property operations, income and expense. As a reminder, forward-looking statements represent management's current estimates. They are subject to risks and uncertainties which may cause actual results to differ from those discussed today. Empire State Realty Trust assumes no obligation to update any forward-looking statement in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements in the Company's filings with the SEC. Finally, during today's call we will discuss certain non-GAAP financial measures such as FFO, modified and core FFO, NOI, and EBITDA which we believe are meaningful in evaluating the Company's performance. The definitions and reconciliations of these measures to the most directly comparable GAAP measures are included in the earnings release and supplemental package, each available on the Company's website. Now I will turn the call over to John Kessler, President and Chief Operating Officer.

Good morning. We are delighted to welcome you to our third quarter 2016 earnings conference call. Empire State Realty Trust is a pure play Manhattan and greater New York metro area office and retail portfolio that offers a unique opportunity to grow income as we continue to redevelop and lease our properties at market rents and bring occupancies to market levels. Since inception, we have delivered and we expect to continue to deliver embedded de-risked growth. During the third quarter, we continued to execute on our strategy and again delivered strong results. Last night, we reported core FFO of $0.26 per share. We continue to see strong tenant demand for our value price point and well-located quality buildings. During the quarter, we completed approximately 349,000 square feet of total leasing. We continue to capture significant upside in rents achieving average leasing spreads of 59.3% on our new Manhattan office leases and 30.2% on all new and renewal leases across our entire portfolio. Additionally, our Observatory continues to produce strong results and achieved a 6.7% year-over-year increase in revenue in the third quarter and 7.8% year-over-year increase in revenue through the third quarter on a year-to-date basis. Turning to our broadcast operations, we recently signed a long-term lease and license renewal with ABC for their television station at Empire State Building. We remain in ongoing negotiations with our other broadcast tenants. I would remind you that neither the extension nor non-renewal of broadcast leases and licenses has or is expected to have a material impact on our financial results. As we reported in August, we expanded our line from $800 million to $1.1 billion and an affiliate of the Qatar Investment Authority is now a major shareholder of ours. David Karp will repeat the details on that in his report. These moves add more liquidity, strength, and flexibility to our clean, transparent, joint venture free, and already low levered balance sheet. We completed a move to our new headquarters space at 111 West 33rd Street during August. Our move accomplishes multiple purposes. Our office-free environment on one floor is much more efficient and productive for us. We have a great show floor to show prospects for our available space at 111 West 33rd Street and we vacated two full floors and a prebuilt unit at One Grand Central Place for rent at higher rates, which is a net positive for investors. Our prepared comments this morning will be fairly brief. Tom Durels, our Executive Vice President and Director of Leasing and Operations will provide an update on our portfolio and David Karp, our Executive Vice President and Chief Financial Officer will then review financial results in more detail and discuss our balance sheet. After that, our team including our Chairman and CEO, Tony Malkin are here to answer your questions. I'll now turn the call over to Tom Durels, Tom?

Thanks, John and good morning everyone. On today's call, I will review our overall leasing activity in the third quarter. I'll provide a summary of our current and future space availabilities and discuss the timing of new lease commencements. Our third quarter results reflect our continued progress on our four key growth drivers, which are one, upside from signed leases not commenced of $14 million. Two, the mark-to-market on our expiring Manhattan office leases of $18 million. Three, lease up of developed vacant office space of $33 million and four, the mark-to-market and lease up of available retail space of $17 million. In total, we estimate these drivers will contribute approximately $82 million of NOI growth as of September 30, 2016 relative to our trailing 12 months cash NOI of $343 million. As a reminder, we had both the Macy's office lease and the Sephora retail lease at 111 West 33rd Street commence in the third quarter representing annualized revenue of $15 million exclusive of free rent. In the third quarter, we signed 51 new and renewal leases totaling approximately 349,000 square feet. This included approximately 264,000 square feet in our Manhattan office properties and 60,000 square feet in our greater New York metropolitan properties. I would like to mention three significant leases. At 111 West 33rd Street, we signed a three-floor 86,500 square foot lease with the Michael J. Fox Foundation for Parkinson's Research. And at the Empire State Building, we signed a two-floor 46,500 square foot lease with JCDecaux, the worldwide leader in outdoor advertising. And at 1359 Broadway, we signed a full floor 24,200 square foot lease with Sisense, a leader in data analytics. At quarter-end, our total portfolio was 87.9% occupied, which is up 130 basis points from the second quarter and including signed leases that have not yet commenced, the total portfolio leased percentage was up 90 basis points from the second quarter at 90.3% leased. And at our flagship property, the Empire State Building, we were up 140 basis points from the second quarter 2016 to 90.1% occupied and including our signed leases not yet commenced, our leased percentage was 91.5%, up 80 basis points from last quarter. Now as we discuss every quarter, we expect that our occupancy will fluctuate from quarter to quarter as we vacate and consolidate spaces in order to redevelop and re-lease those spaces at higher rents to better tenants. There is also a timing lag between the move-outs of existing tenants and when we complete our work and before new leases commence. As we execute our strategy, we unlock the embedded growth within our portfolio and drive significant increases in rental rates and future cash flows. As a result of our redevelopment strategy, we continue to capture strong rental growth spreads. During the third quarter, rental rates on new and renewal leases across our portfolio were 30.2% higher on a cash basis compared to prior escalated rents and at our Manhattan office properties, we signed new leases at rent spreads of 59.3%. In our total portfolio as of September 30, we have 1.229 million square feet of vacancy against which we have 244,000 square feet of signed leases not commenced for a net total of 985,000 square feet of unleased space, which is comprised of Manhattan office vacancy of 794,000 square feet, retail vacancy of 83,000 square feet, and greater New York metropolitan office vacancy of 108,000 square feet. Of the 794,000 square feet of unleased Manhattan office space, approximately 549,000 square feet is consolidated and redeveloped space that includes prebuilts and white-boxed space. Approximately 72,000 square feet is being held off market until it can be consolidated for future redevelopment, and the balance of our vacant space is being planned for redevelopment. We expect to vacate 159,000 square feet in our Manhattan office portfolio by year-end. The in-place fully escalated rent on this space is just $47.90 per square foot. These anticipated move-outs include 92,000 square feet that will be vacated by Aeropostale, who recently rejected their lease at 111 West 33rd Street as part of their bankruptcy process. Aero's six floors had been leased at an average fully escalated rent of only $45.70 per square foot. Now Aeropostale occupies desirable full tower floors at 111 West 33rd Street where ESRT recently relocated its headquarters and where we are underway with a lobby renovation by, a design by STUDIOS Architecture. One of Aero's floors of 10,500 square feet was already leased to Michael J. Fox Foundation as part of an earlier negotiation at higher rents. We will gut the remaining floors immediately to prepare them for new tenants. We look forward to bringing them to market in early 2017 and expect to achieve rents well above what Aeropostale has been paying. As a reminder, as of September 30, we have signed leases that have not yet commenced of 244,000 square feet, all of which are expected to commence by the end of early 2018 and will add nearly $14 million in NOI growth. Returning to our office availabilities, we have available nine full floors totaling 211,000 square feet throughout our Manhattan portfolio including one floor at the Empire State Building, three floors at 250 West 57th Street where we are underway with a new building lobby, storefronts, and elevator cabs. You can already see part of the new storefronts at 250 and they look great. Two floors at 111 West 33rd Street where we are also underway with a new lobby, new 33rd Street entrance, and new elevator cabs and two floors at 1400 Broadway and one at One Grand Central Place. Turning to our retail business, we signed six leases in the quarter for 24,400 square feet in total. Rental rates on both new and renewal leases were 19% lower than prior fully escalated rents. Two comments to make on this number. First, one of the spaces was a 14,000 square foot space at 1359 Broadway leased to Wolfgang's Steakhouse at a lower rent with the intention of bringing a needed amenity in the form of a quality restaurant to our office properties in Times Square South. Second, since nearly two-thirds of the retail space leased during the quarter was vacant, we will have $460,000 in NOI growth after free rent from the retail leases signed during the third quarter. In addition to Wolfgang's, we signed Chopt at Empire State Building and Sweetcatch Poke Bar at 501 Seventh Avenue. We believe that the addition of these quality food concepts is a long term investment that supports the growth in office employees and helps attract new office tenants to our properties. Further, following the close of the third quarter, we signed a 2,600 square foot retail lease with the food purveyor [Making Kaiser] on which we achieved a mark-to-market spread of 87.2% over the prior fully escalated rent and we signed a 3,200 square foot retail renewal lease with Sprint at a mark-to-market spread of 25%. These two retail leases alone will add another $1.1 million in NOI growth after free rent. Within our larger retail portfolio, we are currently marketing at 112 West 34th Street, approximately 40,000 square feet including 8,000 square feet at street level and directly opposite Macy's flagship store. We had our first broker event just last week to show the newly white-boxed space, which looks fantastic with 20-foot high ceilings and great 34th Street frontage looking directly at Macy's entrance and we will also be showing the space to retail brokers during the upcoming New York ICSC in December, but realistically, we don't expect to see attention by retailers sooner than early 2017 following the 2016 holiday selling season. We feel very good about our leasing pipeline and I am very confident in our team's ability to execute and deliver on our four key growth drivers. Overall, we continue to see steady demand for our properties, which offer prospective tenants an attractive combination of location and amenities at a value price point. We continue to lease up our vacant space and execute on our proven strategy to consolidate, vacate, and deliver redeveloped space in order to lease to new better credit tenants at higher rents, increase NOI, and improve shareholder value. Now I'm going to turn the call over to David Karp. David?

Thanks, Tom and good morning everyone. I'll start with a review of our financial performance and follow with an update on our balance sheet. For the third quarter, we reported core FFO of $71.9 million or $0.26 per diluted share. Modified FFO, which is defined as FFO plus adjustments for any above or below market ground lease amortization was also $71.9 million or $0.26 per fully diluted share. Cash NOI was $93.7 million, up 4.7% from the prior year period. For the nine months ended September 30, 2016 core FFO was $194.8 million or $0.72 per fully diluted share. Modified FFO was $194.2 million or $0.72 per fully diluted share. Cash NOI was $259.7 million, up 7.3% from the prior year period. While Aeropostale moved out of 111 West 33rd Street shortly after quarter-end, the Company had remained current on its lease obligations until it vacated its space minimizing the impact on the third quarter results. The fully escalated rent on the space was $4.2 million on an annual basis representing less than 1% of our total annual rental revenue. The impact of the lease cancellation on fourth quarter revenue will be a reduction of approximately $700,000. As Tom has said, the space needs to be demolished and prepped for marketing. Turning to our Observatory operations, revenue for the third quarter 2016 grew 6.7% to $38.1 million from $35.7 million in the third quarter 2015. The Observatory hosted approximately 1.34 million visitors in the third quarter 2016 compared to 1.33 million visitors in the third quarter 2015, an increase of 1%. The increase in revenue is attributable primarily to an improvement in our ticket mix. In the third quarter 2016, there were 10 bad weather days, four of which fell on weekend days compared to six bad weather days, zero of which fell on weekend days in the third quarter 2015. For the nine months ended September 30, 2016, the Observatory hosted approximately 3.18 million visitors, up 2.2% compared to 3.11 million visitors in the prior year period and Observatory revenue was $91.1 million, up 7.8% compared to $84.5 million in the prior year period. Turning to our balance sheet, our transparent, joint venture free, strong and flexible balance sheet with significant cash on hand remains a competitive advantage for us in any market environment. We are focused on increasing financial flexibility and capacity, lengthening our maturities, and lowering our cost of capital. During the quarter, an affiliate of Qatar Investment Authority purchased 29.6 million newly issued Class A common shares at $21 per share, which represents a 2.1% premium to the closing stock price on the day prior to issuance. The investment is equivalent to a 9.9% economic and voting interest in the Company on a fully diluted basis and importantly QIA has a top-up right to maintain their ownership stake at 9.9% over time. We received $621.8 million in gross proceeds from the issuance and applied $45 million to repay the then outstanding balance on our credit facility. We invested the remaining cash in liquid short-term investments. The investment adds more liquidity, strength, and flexibility to our already low levered balance sheet. In the quarter and as previously reported, we increased our borrowing capacity by $300 million to a total committed borrowing capacity of $1.1 billion and can further increase our capacity to an additional exercise of the accordion feature $1.25 billion. At September 30, 2016, there was no outstanding balance on our revolver. At September 30, 2016, we had total debt outstanding of approximately $1.6 billion. Approximately $1.36 billion of this debt is fixed rate with a weighted average interest rate of 4.55% and a weighted average term to maturity of 4.8 years. The remaining $265 million of debt is variable rate with a weighted average interest rate of 2.13% and a weighted average term to maturity of 5.9 years. At the end of the third quarter, we had $594.3 million in cash and cash equivalents. Our leverage ratio reflected by consolidated net debt to total market capitalization was 14% and our consolidated net debt to EBITDA was 3.1 times. I'll now update you on our redemption requests. For operating partnership units, our lockup period expired one year after issuance, which was October 7, 2014 for units issued in the IPO and July 15, 2015 for units issued on the acquisition of 112 West 34th Street and 1400 Broadway. Upon such expiration, holders of such operating partnership units could have their holdings redeemed for Class A shares which are listed and traded on the NYSE. As of September 30, 2016, we have had conversions from operating partnership units and Class B common shares to Class A common shares totaling 27.1 million shares or approximately $568 million at the closing share price of $20.95 on September 30, 2016. This represents a 33% increase in the number of Class A shares since our IPO. Finally, our Board of Directors approved a quarterly dividend of $0.105 per share for the third quarter of 2016. This dividend was paid on September 30th to shareholders of record on September 19th. With that, I would like to open up the call for your questions. Operator?

Thank you. The floor is now open for questions. [Operator Instructions] Our first question is coming from Craig Mailman of KeyBanc Capital Markets. Please proceed with your question.

Maybe just start with the leasing environment. John, I know you said it was still strong and Tom, your comments were helpful there. I'm just curious, are you guys seeing any early signs of any kind of slowdown of sub-markets from tenants pushing back, taking longer to get deals done, anything on that front?

I would point to the fact that we had a very strong third quarter with over 349,000 square feet of leases completed and 270,000 square feet of that was new leasing with 223,000 square feet new Manhattan office leasing. The major leases that we did in Manhattan with Michael J. Fox Foundation for 86,000 square feet, JCDecaux for 46,000 square feet at Empire State Building I think are a sign of the market that we are seeing in our buildings in our sub-markets. So I can point to just the most recent activity and the recent quarter as an indication of the market that we're experiencing. Now I will say that our properties show well, you've seen them. As we've said before, we offer centrally located properties with great access to mass transit, newly built modern office space, and we offer an excellent value and so we are unique and we continue to see steady demand. I would remind you that the timing of when leases are done and our leasing volume in any given quarter is going to be impacted by our ongoing effort to vacate and redevelop space and time when we bring those spaces to market. So you're not going to expect an immediate or linear increase in occupancy.

And you guys have been pretty successful at kind of pushing, asking [rentiers] since the IPO. Given the activity that you're seeing in the pipeline, is that trend kind of continuing here into 2017?

Well, we constantly revisit our asking rents on all of our properties and all of our individual spaces. We've increased our asking rents on certain spaces such as full floors at 250 West 57th Street where we're renovating the lobby and installing new storefronts and new elevator cabs. We're holding our asking rents on certain other spaces after very significant increase in those asking rents, but as a reminder, based upon the current market and our current fully escalated rents that are well below market, we're going to achieve superior mark-to-market rents. As we've said in the past, regardless of whether the market improves, remains constant or declines, we're going to outperform and I think you saw that this past quarter with 59% mark-to-market spreads on all new Manhattan office leasing.

Great, that's helpful. Then maybe just turning to the acquisition market, you guys are sitting on a pretty nice cushion of cash here. Just some thoughts on what you're seeing in the market, if you guys have any deals maybe you're closer to at this point than you have been in the past and just thoughts generally around how you view the timing on that capital deployment?

Good morning, Craig. This is John. We've no comment about future plans. When we do have something to say, we're certainly going to let you know. Until then, we certainly like the strong balance sheet that we have and our low leverage and really significant liquidity position. We're going to continue to focus on off-market opportunities that we think provide shareholders with long-term value and our low levered balance sheet and cash position give us a lot of flexibility to take advantage of opportunities when we see them. Importantly for the next couple of years, our business does not need to make acquisitions to grow given the NOI and significant embedded growth that we have there from the redevelopment of our space. As Tom mentioned, we have $82 million in growth in NOI from this embedded growth strategy relative to our $343 million in trailing 12 NOI today and we're getting really good returns on that redevelopment spend, which we estimate at 8% to 22%. So, when we can invest at prices that compete with that, then we'll pursue it.

I appreciate the commentary and kind of the hesitancy to discuss kind of opportunities here, but I guess could you guys just then give a little bit more detail on the decision to take that much cash, lower leverage just aggressively? I mean is it that you guys are concerned about the macro? Like you could have -- I guess why the timing now to take that much of an equity infusion if you don't feel like there may not be near-term need for it or uses?

Well, I think it's very simple. We think the investment really strengthens our balance sheet and give us flexibility and positions us for whatever opportunities may lie ahead. We're thinking very long-term and probably was the right thing to do.

I might just add Craig that we see this as a unique opportunity to bring on one of the leading global real estate investors with a demonstrated track record of being an authentic partner over a long period of time. We took a deliberate and systematic approach to this and we didn't do this from the perspective that we needed it to do a deal. We did it from a perspective we thought it was best for the long-term prospects of the business.

Thank you. Our next question is coming from Jamie Feldman of Bank of America. Please proceed with your question.

I guess starting with the Observatory, can you just give us some color, maybe composition of attendees this quarter and just kind of trends you're seeing, maybe we can think about as we're, thinking about the potential going forward into 2017.

Well, I think we've made disclosures on this in the past, Jamie and the only thing I would say is that, we really have no change to report. In the past, we have indicated in our presentation materials that approximately two-thirds of our visitors are international. Approximately two-thirds of our visitors are between the ages of 18 and 35. We saw nothing really to express any change about when we do since we begin from that information before, we'll certainly add it.

Okay and then, you had a nice increase on NOI in the Observatory. Looked like you had about 1% increase in visitation. Can you talk about some of the expense savings and operating improvements still to come or do you feel like the margins you're seeing now are probably about as good as it's going to get?

Well, don't forget that as we see more visitors, we have the benefit of lower fixed operating costs against our revenue, number one. Number two, same comment can be made about our ticket mix and mix of our revenue sources, but number three, I would just emphasize that we continue to work very hard at maintaining the quality of the experience for our visitor, the quality of the execution at the Observatory and appropriate balance with expense and revenue. And I would just say that as we've process scientifically over time, we have developed better understanding with exactly what is needed when and that flows to the bottom line.

Okay. That's helpful. And then the Aero space, I just want to confirm. So, the lease you signed with Michael J. Fox, that's for a different space, right? So, the Aero, the 92,000 square feet is going to be completely available?

One floor of the Michael J. Fox lease was a floor that had been occupied by Aeropostale. That one floor was 10,500 square feet out of a total lease space of Aeropostale of 92,000 square feet. So as part of an earlier negotiation, we took back one floor of 10,500 square feet from Aeropostale out of their total 92,000 square feet, leaving roughly 82,000 square feet remaining that we will redevelop that space, white-box it, and bring it to market.

Okay, so that space has not been redeveloped yet?

Not yet.

That is an absolute scrape and clean. The space is disgusting.

Okay and then as you think about, just the leasing pipeline, you kind of answered the question before, but just maybe heading into year-end, heading into election, maybe just a little bit more color on how you think tenants are thinking about making decisions here? And then as you look at the pipeline of the potential leases like how does that compare to this time last quarter?

We're busy. We're busy with showings, we're busy trading paper, we're busy with lease negotiations, but I would caution, it's going to be lumpy quarter-to-quarter. As you've seen that in the past and I think you will see that going forward. I can just point to coming off of a very strong quarter of 349,000 square feet of leasing and the majority of the leasing that we did for Manhattan office space was for new leases. I think we feel very good. I would say that we're seeing steady demand. So there is -- not really seeing anything to change going into the fourth quarter and I'm feeling pretty good about where we're at and where we're headed into the end of the year, but again I remind you that our leasing volume quarter-to-quarter is going to be lumpy.

And then just I guess a follow-up for David on the back to Aero. So you said a $700,000 reduction in NOI in the fourth quarter, I assume there's no termination fee. Is that on the 82,000 or that's on the 92,000, the $700,000?

The $700,000 was just on the portion that was not expected to expire in November. So that would be on the lower amount.

But for modeling purposes, we just take $700,000 of NOI out for the fourth quarter until you get it released?

Yes, if you want to do that, sure.

Thank you. Our next question is coming from Blaine Heck of Wells Fargo Securities. Please proceed with your question.

Just following up on Jamie's question on the Observatory. So expenses have been down pretty substantially year-over-year for the past two to three quarters, which I think has provided a little bit of a tailwind for your NOI growth. Do you think there is more room to decrease expenses at this point or I guess should we expect them to flatten out a little bit in 2017 and maybe dampen that NOI growth for that business as we go forward?

Let me just identify the route of that reduction in Observatory expenses year-over-year. Remember, we discontinued the audio tour, which was one contributor to the reduction of expenses; the other is the elimination of Skyride as a tenant, which reduced some of our security costs. So those are, I'll say, baked in ongoing in terms of how we look at the future.

Well, I would just add that, what we did is we discontinued the handing out of free card devices for the audio tour. The audio tour is still available. It's on app, which is free to download which -- that works out very well really to what people are accustomed to at this juncture. The second thing is we just continued to keep looking at how we operate and I would expect as we do with all of our business lines that you guys should think or we're looking at ways to innovate, we're looking at ways to adapt, and there are a lot of opportunities be it from technology or just how we station our people to impact the way our expenses work. I will say that the real driver here is -- revenue increased 7.8% and we've had a strong performance through the year on that and we're just very effectively working on our ticket mix, understanding how we price to the different components of our incoming tourists and it does reflect the fact that we feel very secure that the iconic status of the Empire State Building makes it a must see visit for visitors to New York City. We're definitely seeing less competition as One World Trade Center is now in year two of operation. The initial novelty has worn off and frankly people aren't all that impressed with it. We continue to drive demand by continually enhancing Observatory experiences. We have our new elevator cabs with the show on the ride up and the ride down, which by the way we had planned long before the One World Trade Center opening, but we had to wait until elevators which served the Observatory were being replaced as part of our extensive program of replacement. We have our premium experience, which is $175 a head sort of back of the house special tour and we've now opened up our Sunrise experience, which is $100 a person, limited time, only 100 people a day, which has gotten fantastic reviews. People get to see the sunrise over New York City and it's a remarkable unique prospect from which to do that. There's also the fact that John Guinee is paying a very big registration fee for the Empire State Building run up this year and that should move the numbers considerably.

Great. Thanks, Tony. So David, you guys have reasonably high yielding debt maturing next year. Obviously, as Craig alluded to, you guys have a lot of cash on the balance sheet. So just wondering if you had any preliminary thoughts on how you guys are going to address some of those maturities and whether prepayment was an option?

We have been looking -- we continually review our mortgage debt maturities and we look at the economics of any prepayments. Currently, we had only paid down the $45 million balance under the revolver. At this time, we do not plan to repay any of the mortgages that mature in 2017 with the capital that we raised from the QIA transaction since we really believe it's valuable to our shareholders to maintain significant liquidity on our balance sheet. We've already begun work to address those 2017 maturities and if you'll recall, we put in place $200 million worth of forward-starting interest rate swaps to hedge against the cost on the refinance of those mortgages.

Thank you, our next question is coming from John Kim of BMO Capital Markets. Please proceed with your question.

Just a follow-up on the QIA capital raise. So you did raise above where your stock was trading at the time, but slightly below consensus NAV. Presumably, NAVs would be going up if we're in a benign interest rate environment. So how did you think about raising so much equity at a slight discount?

Well, it's Tony here, I'd just tell you that the investment was the outcome of a deliberate and systematic approach that we undertook. Ever since going public, we sought to develop a long-term relationship as part of our overall program to make sure we've got long-term relationships in general with strategic investors and with key sources of debt capital. So we had a number of conversations over a prolonged period of time with various sources in conjunction with this investment and I would point out that if we had not found the right investor on the right terms, we would not have closed on a transaction. As the largest shareholder, I can just tell you that I viewed this as a tremendous plus for us and as far as the pricing and the valuation of it, that was just where we felt it was right and comfortable to do. That price was locked in frankly at a time that our stock was trading at a much lower number and we feel good about it. As far as relative to NAV, we don't tell you what our view of NAV is, but we've got a lot of confidence in the business and certainly wasn't, I [wouldn't] like to think we were giving out a signal that this was a market top or a demonstration of where we thought value was. We think the value was in the relationship and the number was worthwhile given all factors considered.

Thanks for that. And you've been very I would say conservative on your acquisitions. Has your underwriting criteria changed at all with this equity raise or are you going to continue to be prudent?

John, its John here. We haven't changed our underwriting criteria at all. Again, I think we continue to be very cognizant of this really strong internal growth that we're generating and the track of returns we're getting and I think anything that we look at externally regardless of what our capital position is has to measure up and be attractive relative to continuing to invest in the redevelopment of our own portfolio. So, no change there.

Okay. Tenant incentives have risen for the last couple of quarters on a per year basis and also as a percentage of rent. Is this just the price of doing leasing today and is there, are there certain tenants that are requiring higher incentives today?

This is Tom. I'm glad you asked that question because I would point out that number one, our leasing costs are going to vary depending on whether we do a new lease or renew a lease and the percentage of new versus renewal leases in any given quarter. Certainly, the overall economics of a deal, the length of term and the amount of redeveloped first generation space that we lease in a given quarter. This quarter, we had a higher percentage of new leases in our Manhattan office portfolio compared to prior quarters and that includes first generation prebuilt which have long-term retention value and will require little TI costs for future renewals or re-leasing. Because we lease so much new space and first generation space, we achieved a 59% mark-to-market on our new Manhattan office leasing. Keep in mind, we said previously that we would vacate and consolidate much space in 2016 and in 2017. That's fueled our pipeline of redeveloped vacant space. We said we were going to do this. This is intentional to unlock the embedded growth and enable us to re-lease spaces at higher rents to better tenants.

Okay, so some of the major redevelopments that you've been doing. That CapEx is captured in the TIs this period. Is that what you're saying?

When we execute a lease, the leasing costs are recorded in the report that you see. When we refer to consolidated and redeveloped space, the timing of delivering that is really just the mere consolidation taking that space back and demolishing it. At that point, we treat it as available developed space. From that point forward, we still need to execute a lease that's going to require a TI concession or the prebuilt cost.

Okay and then finally the [Benson market reports] that Midtown South office rents are now the highest price point in the city. Do you think those levels of rents are sustainable and are many tenants getting pushed out into other sub-markets?

Well, I can only point to the fact that we have drawn tenants from all sub-markets, all parts of Midtown and Midtown South. I think certainly to the extent that rents are at the level they are at in Midtown South makes our portfolio and our properties look much more attractive and exatuates the value and the convenient location and the quality of the product that we deliver. So, I won't project where Midtown South rents are headed, but I will simply say that the spread or the differentiation between the two sub-markets and our convenient location or quality product like the differentiated areas is helpful to us and we will continue to draw tenants from all parts of Midtown and Midtown South.

Thank you. Our next question is coming from Tom Lesnick of Capital One Securities. Please proceed with your question.

I guess first, I know you talked about the leasing environment a little bit, but if you break out the market between large spaces and small spaces, are you seeing any bifurcation in the market? Are you seeing fewer large users out there looking for space; I'm just wondering if you could talk about that a little bit?

We're not seeing a difference between what we consider a large user. Bear in mind a large user for us is generally a full-floor that can be 20,000 square feet to 40,000 square feet or the multi-floor deals that we did. We're not out there really marketing very significant large blocks of space. So at 111 West 33rd Street where we can assemble on non-contiguous floor in excess of 200,000 square feet. We do expect that those floors will lease to more than one tenant. To that extent, when we look at the small suites for our prebuilts that range from say 2,500 square feet to 6,000 square feet to the full-floor deals, we're really not seeing a difference in demand. Certainly, because of the amount of inventory, the smaller suites that we have, we're generally going to do more individual transactions that are of the smaller size, but we like the mix, we like the mix of the small prebuilts and the full floors and the ability to deliver a multi-floor availability, but to answer your question specifically, can't really make a distinction between a one side of that market being slower or more active than the other. We're trading paper candidly with both full-floor tenants and prebuilts throughout the portfolio.

I'd add one thing to be clear. When you talk about large tenants, I think a lot of the market thinks 250,000 square feet and up and there are certainly peers in our office universe publicly and privately held who have 200,000, 300,000, 500,000, 600,000, 1 million square feet opportunities. We don't have those. So a large tenant for us really is 25,000 square feet and up, 35,000 square feet and up, that's a large tenant to us. So when we talk about large and small, that's what we talk about and I just think it's important to distinguish that from the way the market looks at this and the way some of our peers talk about it based on the needs they have to fill.

And then, I guess my second question, I know it's a minority piece of your -- minority is probably the wrong word, but relatively a small share of your portfolio in the greater New York City portfolio, but just wondering if you could provide an update on kind of what you're seeing out in Stamford right now and maybe for context, talk a little bit about the vacancies of UBS and RBS.

Sure, well first starting off, we're 94.2% leased. So our job and our focus has been working on early renewals and retention of our existing tenants. By the way, we have a great tenant roster, terrific tenants out there and we're actively speaking with them and negotiating with the tenants to extend term. So we're happy with the status of our portfolio. We're happy with our level of leasing. We executed on some early renewals this past quarter and year. We have a very modest role in the balance of the year for 2016, only about 17,000 square feet. In 2017, only about 139,000 square feet. I think with regard to UBS and RBS, they are unique assets. UBS was built for a single tenant. It's yet to be seen what's going to happen with that. Right now, it's really not directly competitive with us. Keep in mind that we have truly Class A multi-tenanted office properties that are fully amentized, great access to mass transit and right now, the UBS space is really not having any impact on us. RBS has leased space to other tenants and it's pretty well leased. There are some more availability there, but generally tenants that are taking space there are taking large blocks and complete wings of the RBS building and there again, I think with exception of maybe a rare occasion, we have maybe competed with them on only a handful of deals at most. We have the ability to subdivide down to small suites of a few thousand square feet to full-floors. So we like our position, we like our competitive position, we think we've got great product and the [bidding show fantastic].

Thank you, our next question is coming from John Guinee of Stifel. Please proceed with your question.

Great, I'm in the stairwell right now training. Well, congratulations on top taking the equity raise with Qatar, brilliant timing. A quick cleanup, just refresh my memory, David, you did these exchangeable senior unsecured notes a couple years ago. Are they in the money, is there any unusual accounting for them et cetera?

There will be an addition to the share count for a portion of those securities that are in the money. I think we had roughly number of shares would be 700,000 shares get added to the share count in connection with those exchangeable that are in the money.

Got you, okay. Second mark-to-market continued to be really healthy. Do you provide GAAP mark-to-market anywhere? What we're learning is pretty easy to manipulate the wrong word, but manage the cash mark-to-markets. Do you do GAAP anywhere? Do you disclose GAAP mark-to-markets?

John, we don't, but let me just point out, generally GAAP mark-to-market is greater than cash leasing spreads since GAAP rents will factor in the rental increases that occur during the lease term term. However, for the leases associated with acquired buildings, the cash mark-to-market will be greater than GAAP mark-to-market and a number of our buildings are considered acquired buildings. So just keep that in mind as you think about that.

Could you repeat that again for the acquired building?

So when we acquire a building, we end up marking those for acquisition accounting, we end up having to mark those leases to market and therefore, the cash mark-to-market on a lease that expires in an acquired building will be greater than a GAAP mark-to-market whereas in most buildings, it's the other way around, the GAAP mark-to-markets will be higher.

This is, are you referring FAS 141 accounting.

Correct.

Okay, got it. And then lastly, G&A looked a little higher this quarter, anything going on unusual there?

Well as we look at our G&A as a percentage of revenue, we feel comfortable where we are in relation to our peers. I think overall when you look at the G&A year-over-year, remember that the equity compensation grants and the layer of the amortization expense increased approximately $1.2 million from Q3 2015. This is going to reflect the vesting of IPO performance grants.

And as we said in the past, over time, remember we are still, we've just completed our third year as a public company and our equity grants have a full year vesting horizon. So each year we're layering on an additional layer. Once we get to four full years of operating as a public company, that stabilizes and you won't see that addition each year as we layer on that additional year of equity compensation.

Thank you. Our next question is coming from Brad Burke of Goldman Sachs. Please proceed with your question.

I'll just ask one to try to keep this to an hour. John you talking about always looking at off-market opportunities, so I'm just hoping that you could characterize the current opportunities set whether there is more to look at now versus a year ago? How pricing has trended over the last year or so?

Well, we're going to look to take advantage of opportunities that make sense for us. We're not going to make any general statement about whether the market is topped or not. I think we're focused as we've said repeatedly on relationship oriented opportunities that we can source off-market and we're continuing to work on those and when we have something to report on, we're going to share it with you. Until then, that's all we have on that.

Thank you. Our next question is coming from Tom Catherwood of BTIG. Please proceed with your question.

Quick one, I appreciated the color on the Wolfgang lease. When we look at the rest of the 83,000 square feet of retail that you have available, are there any other spaces that you've prioritized as a retail amenity for tenants where we might see similar roll downs to this quarter?

Well, the most significant retail availability that we have is the 40,000 square feet of 112 West 34th Street that I commented on in my opening remarks. The prior fully escalated rent on that space was approximately $27 per square foot. So that alone is going to result no matter where we end up doing a lease, it's going to result in a very, very significant mark-to-market. The Wolfgang's and the other food uses that we brought in were specific, they were intentional; they were to bring in important amenities and food choices to our growing office population. I think that that was a unique occurrence and so I don't think we're going to see that level again of a negative mark-to-market, certainly not on the 40,000 square feet of space that we have at 112 West 34th Street, which is really a very meaningful part of our focus right now. We just white-boxed that space; it looks fantastic; its 20 foot ceiling height, its great exposure looking directly at the frontage to Macy's. We just had our first broker function there last week. 200 brokers showed up. The reaction that we got from folks who was wow, space is phenomenal. So we're excited about it.

Thank you. At this time, I'd like to turn the floor over to Mr. Malkin for closing comments.

Thank you all for attending and we appreciate the questions and the commentary. I just like to wrap with a thought. I think it helps to think of us, we think, as a very strategic set of managers and to keep track of our prior experiences as they impact on what we do today. Before we went public, our slogan used to be performance for today, perspective for tomorrow. We eschew short-termism. When it comes to balance sheet deployment, our view is very long-term. We believe that to be right in the real estate business, you need to be right for a very long time, not just for today or the next week or even for the next two years but for the next decade. We didn't make the moves we made on our balance sheet to play the market. We made them to be prepared and we are always working on new opportunities. We see ourselves as true problem solvers. We look at authentic opportunities in which we can use our capital to unlock opportunity for us, but also for the people with whom we do business. Whatever we do, it's much more likely to be complicated and off market and innovative than broadly marketed. At this time, in our present business, we are fortunate to have a few more years of outsized derisk internal growth. Our balance sheet is liquid, low leverage, and very straightforward. No joint ventures, no complicating factors, no debt programs, very flexible and ready for anything and I hope that this is helpful for you guys to position what we did in light of our view and the way we look at things. That being said, we thank you very much. We are very much looking forward to reporting next quarter's results and until then, all the best.

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