Empire State Realty Trust, Inc. (ESRT) Q2 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Empire State Realty Trust Second Quarter 2017 Conference 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, Thomas Keltner, Empire State's General Counsel. Please go ahead, sir.

Good morning. Thank you for joining us today for Empire State Realty Trust Second Quarter 2017 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, capital expenditures, 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, cash 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 second quarter 2017 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, our embedded de-risked growth. During the second quarter, we continued to execute on our focus strategy and delivered strong results. We saw significant tenant demand for our value price point and well-located, quality buildings as we signed over 329,000 square feet of leases during the quarter. This activity includes a two full floor office lease with the Gap at 111 West 33rd Street for 81,000 feet, our largest transaction in the quarter. We continued to capture significant upside in rents, achieving average leasing spreads of 49.9% on our new Manhattan office leases and 31% on all new and renewal leases across our entire portfolio. Additionally, our Observatory continues to be resilient and achieved a 6.9% year-over-year increase in revenue in the second quarter, and a 3.6% year-over-year increase in revenue through the second quarter on a year-to-date basis. We continue to introduce new visitor options, such as the AM/PM Combo Pass and improve the overall experience. In our Broadcast operations, in the second quarter, we signed long-term lease and license renewals with two of our radio broadcasters, iHeart and CBS Radio for a total of 9 radio stations at Empire State Building. We previously disclosed that we had successfully renewed lease and license agreements with TV broadcasters, Univision, ABC and WPIX, and radio broadcasters, Emmis Spanish Broadcast Systems and New York Public Radio. We remain in ongoing negotiations with our other broadcast tenants. And I would remind you that neither the extension or nor non-renewal of broadcast leases and licenses has, or is expected to have, a material impact on our financial results. We will continue to drive growth and unlock value as we redevelop and re-lease our space at attractive spreads. We believe our portfolio and strategy can outperform, regardless of market conditions. During the quarter, we refinanced all of our 2017 mortgages at attractive rates, and extended our maturities. With our highly liquid and low levered balance sheet, we are well positioned for additional opportunities in 2017 and beyond. 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; David Karp, our Executive Vice President and Chief Financial Officer, will then review financial results in more detail and discuss our balance sheet. And 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. On today's call, I will provide you with an update on our four key growth drivers, review our leasing activity in the second quarter, give an overview of our current and future space availabilities, discuss the timing of new lease commencements and discuss new redevelopment work. As you know from our Investor Day in March 2015, we set forth our four key growth drivers from our existing portfolio. At that time, we presented revenue growth of $90 million to $100 million from these four growth drivers over the next 5 to 6 years. Since January 2015, when we exclude the contribution to NOI growth from the Observatory, and adjust it for the mid-2014 acquisitions of 1400 Broadway and 111 West 33rd Street, we have delivered $62 million in cash NOI growth in just 2.5 years. This is net of the loss of income from the vacancies we create through our redevelopment and releasing program. Our second quarter numbers reflect further progress on our four growth drivers, which are: one, upside from signed leases not commenced of $12 million and burn-off of free rent to $24 million, which together total approximately $36 million in growth; two, lease-up of developed vacant office space of $31 million; three, the mark-to-market on our expiring Manhattan office leases of $19 million; and four, the mark-to-market and lease-up of available retail space of $8 million. Based on these updated numbers, we estimate these drivers will contribute approximately $94 million of growth over the next 5 to 6 years as of June 30, 2017, relative to our trailing 12 months cash NOI of $370 million. Now remember, we calculate these numbers based on our view of the current market for starting rents without consideration for potential increases in future starting rents. And 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 release 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 before lease-up and when new leases commence. For pre-builts and full floors, overall down time is generally 9 to 24 months, following the last date of occupancy by a prior tenant, to allow time for redevelopment and lease-up, though it can be less or more depending on the space and our overall inventory. And as we execute our strategy, we unlock the embedded growth within our portfolio and drive significant increases in rental rates and future cash flows. In the second quarter, we signed 51 new and renewal leases totaling approximately 330,000 square feet. This included approximately 251,000 square feet in our Manhattan office properties, 49,000 square feet in our Greater New York Metropolitan properties and almost 30,000 square feet of retail. Significant leases signed during the quarter include office leases with Gap's Intermix brand for nearly 81,000 square feet at 111 West 33rd Street; Renfro for approximately 30,000 square feet at 1400 Broadway; and iCapital Network for 17,500 square feet at One Grand Central Place. At quarter-end, our total portfolio was 89.2% occupied, which is up 40 basis points from the first quarter. And including signed leases that have not yet commenced the total portfolio leased percentage was up 180 basis points from the first quarter at 91.3% leased. At our flagship property, the Empire State Building, we were up 60 basis points from the first quarter 2017 to 92.1% occupied. And including our signed leases not yet commenced, our leased percentage was 92.4%, up 70 basis points from last quarter. As a result of our redevelopment strategy, we continued to capture healthy rental growth spreads. During the second quarter, rental rates on new and renewal leases across our entire portfolio were 31% higher on a cash basis compared to prior escalated rents. And at our Manhattan office properties, we signed new leases at rent spreads of 49.9%. That's nearly 50% positive mark-to-market spread. Remember, leasing spreads will vary by quarter, depending on the prior fully escalated rents. Our average tenant installation cost for the quarter was $68.24 per square foot for the total portfolio. This number will also vary by quarter depending upon the mix of spaces leased, including white-boxed, pre-built, first generation and second generation, and the ratio of new versus renewal leases. Throughout the total portfolio as of June 30, we had 1,094,000 square feet of vacancy against which we have 209,000 square feet of signed leases not commenced for a net total of 885,000 square feet of unleased space, which is comprised of Manhattan office vacancy of 704,000 square feet, retail vacancy of 28,000 square feet and Greater New York Metropolitan office vacancy of 153,000 square feet. Of the 704,000 square feet of unleased Manhattan office space, approximately 519,000 square feet is consolidated and redeveloped pre-builts and white-boxed space ready for lease-up. Approximately 102,000 square feet is being held off market until it can be consolidated. And the balance of our vacant space is either planned for redevelopment or storage. We expect to vacate 167,000 square feet in our Manhattan office portfolio by year-end. With in-place fully escalated rents of $45.43 per square foot, we expect to release this space at much higher rents. As a reminder, as of June 30, we have signed leases that have not yet commenced in free-rent burn-off, which will add $36 million in cash NOI growth by the end of 2018. Within our Manhattan office portfolio, we currently have available 11 full floors totaling 200,000 square feet, including 3 floors at 250 West 57th Street, 4 floors at 111 West 33rd Street, 2 floors at the Empire State Building, and 1 floor each at 1350 Broadway and One Grand Central Place. The redevelopment work that we're doing at 111 West 33rd Street and 250 West 57th Street, which includes new lobbies, elevator cams, and street front is well underway, and should be completed by Labor Day. The work done to date looks fantastic, and reaction from tenant prospects and brokers has been excellent, and has no doubt materially contributed to our leasing successes to date at 111 and 250. In the second quarter, we commenced a long-term capital project at the Empire State Building that will greatly improve the experience for our office tenants and their visitors and Observatory visitors, and the value of our 34th Street retail. In the first phase, we will relocate the present Observatory entrance now located on Fifth Avenue, to a new larger designated entrance at the western side of the Empire State Building on 34th Street. This new Observatory entrance will provide a separate, dedicated entrance for Observatory visitors; eliminate Observatory visitors from entering the Fifth Avenue lobby, thereby reducing Observatory traffic in the Fifth Avenue lobby by more than 50%; and restore better access to the Fifth Avenue lobby to our office tenants and their visitors; enhance the value of all of our 34th Street-facing retail space; enhance the Observatory visitor experience; and increase Observatory revenue per capita. We currently anticipate that we will invest approximately $40 million to $50 million annually over the next three years to complete this project. As we disclosed in the supplement, we spent $6.9 million in the second quarter related to this first phase. There will be no disruption to Observatory operations or the visitor experience during the project. While plans are set, for competitive reasons, we will only provide details of the project as each phase is implemented. Our objective is to create long-term value for shareholders, and this investment is an outcome of continually looking at ways to innovate and enhance the office and retail and visitor experience at the Empire State Building. Turning to our retail business, we signed five leases in the quarter for 29,600 square feet in total. The majority of the activity, approximately 27,000 square feet, was related to the renewal of two parking garages, which are reported within our retail numbers. These garages consist of below-grade space for which market rents per square foot is considerably lower than our street retail, and contributed to the reported negative rent spread for the quarter. But putting this into context, the total aggregate rent spread between starting rents and prior fully escalated rents, is only about $220,000. More importantly, our street retail portfolio is 95.9% occupied and 96% leased, and is located in high-traffic areas with excellent submarkets. The strong execution and leasing results delivered by our team has positioned us well. We have leased all our retail space on 57th Street, Broadway and the entire 89,000 square feet at 112 West 34th Street, where we previously reported a mark-to-market aggregate rent spread of nearly $19 million. And we have less than 6% of our retail spaces expiring in the next two years. Overall, I feel very good about our leasing pipeline. I remain very confident in our team's ability to execute and deliver on our four key growth drivers. 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, revisit Tom's discussion of our four drivers, and follow with an update on our Observatory operations and balance sheet. For the second quarter, we reported core FFO of $73.2 million or $0.25 per diluted share. Cash NOI was $97.3 million, up 8.6% from the prior year period. For the six months ended June 30, 2017, core FFO was $134.5 million or $0.45 per diluted share. Cash NOI was $180.1 million, up 8.5% from the prior year period. Since January 1, 2015, we have delivered approximately $62 million in cash NOI growth from our office and retail leasing performance. In addition, we have delivered approximately $17 million in NOI growth from our Observatory performance. Finally, we estimate our updated four key growth drivers will deliver approximately $94 million of revenue growth over the next 5 to 6 years relative to our trailing 12 months cash NOI of $370 million. As you will recall, last quarter we disclosed that we adopted a change in our revenue recognition practices. As of January 1, 2017, for our leases where the tenant constructs tenant improvements in which we share the funding obligation, we began to recognize rental revenue at the earlier of cash rent commencement, or completion of tenant improvements. Previously, we started rental revenue recognition when the lease commenced. This change is consistent with the practice of our peers that have made similar modifications over the past years. This new accounting practice resulted in approximately $1.8 million less revenue for the second quarter 2017, compared to the practice in place for the prior year period. Turning to our Observatory operations, revenue for the second quarter 2017 grew 6.9% to $34 million from $31.8 million in the prior year period. The calendar shift of the Easter weekend to the second quarter in 2017 increased the number of visitors, but was partially offset by unfavorable weather conditions. Our continued revenue improvement grew NOI 7.4% to $26.8 million from $24.9 million in the second quarter of 2016. The Observatory hosted approximately 1.13 million visitors in the second quarter 2017, an increase of 0.2% compared to the second quarter 2016. In the second quarter of 2017, there were 15 bad weather days, compared to 13 bad weather days in the second quarter 2016. We no longer are breaking bad weather days into week and weekend days. Instead, we are now providing an estimate of the impact of bad weather days on overall attendance based on compiled Observatory historical data. For the second quarter, we estimate that bad weather resulted in approximately 60,000 to 70,000 net fewer visitors than in the prior year period. We're happy to discuss our methodology for this new calculation in greater detail at a later time. Keep in mind that we define a bad weather day as one in which the top of the Empire State Building is obscured more than 50% of the day. We take into account the entire first half results of the Observatory when we measure our performance, as it accounts for the Easter weekend calendar shift. For the six months ended June 30, 2017, the Observatory hosted approximately 1.76 million visitors, down 4.4% compared to 1.84 million in the prior year period. Observatory revenue was $54.9 million, up 3.6% compared to $53 million in the prior year period, while net operating income grew 5.5% to $40.4 million in the prior year period. For the six months ended June 30, 2017, there were 37 bad weather days, compared to 21 bad weather days in the prior year period. As a reminder, we always look at the Observatory's results on a holistic annual basis. Turning to our balance sheet, our strong joint-venture-free and flexible balance sheet, including significant cash on hand, remains a competitive advantage for us in any market environment. During the quarter, we successfully refinanced all of our 2017 maturities, replacing $336 million in maturing mortgages with new mortgages totaling $315 million, a reduction of $21 million in debt balances. We accomplished several objectives during the refinancing process, including first, we lowered our weighted average coupon by 123 basis points from a weighted average coupon of 5.67% to an effective weighted average coupon of 4.44% after adjusting for the settlement of a $200 million forward-starting interest rate swap. This translates into a net reduction in annual interest expense of $5.1 million or $0.017 in FFO per fully diluted share. Second, we lengthened the weighted average maturity of our total debt balance to 6.5 years as of June 30, 2017, from 4.5 years a quarter ago. Third, we continued to diversify our capital sources by accessing both a life insurance company and securitized mortgage markets at very attractive rates. And we established relationships with two new life insurance company lenders. At June 30, 2017, we had total debt outstanding of approximately $1.6 billion. Approximately $1.33 billion of this debt is fixed rate with a weighted average interest rate of 4.19% and a weighted average term to maturity of 6.7 years. The remaining $265 million of debt is variable rate with a weighted average interest rate of 2.82% and a weighted average term to maturity of 5.2 years. At the end of the second quarter, we had no outstanding balance on our revolver and $441 million in cash and cash equivalents. The sequential change in our cash balance reflects the payment of real estate taxes, capital expenditures, dividend payments, and a reduction in our debt balances. Our leverage ratio reflected by consolidated net debt to total market capitalization was 15.5%, and our consolidated net debt to EBITDA was 3.3 times. I'll now update you on our redemption requests. For operating partnership units, our lockup period expired 1 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 June 30, 2017, we have had conversions from operating partnership units and Class B common shares to Class A common shares totaling 31 million shares or approximately $644 million at the closing share price of $20.77 on June 30, 2017. This represents a 37% 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 second quarter of 2017. This dividend was paid on June 30 to shareholders of record on June 15. With that, I would like to open up the call for questions. Operator.

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from John Guinee from Stifel. Please proceed with your question.

Hey, good morning, guys. This is actually [indiscernible] here. A quick question for you on Page 14, the largest leases are almost all long-term here, but at lower rent, Global Brands, 689,000 square feet at $44 a square foot; Coty, 313,000 square feet at $49 a square foot; LinkedIn, 282,000 square feet at $52; PPH [ph], 217,000 at $42. Can you get any of that space back and release?

Aaron, good morning, this is Tom. First, I'm very glad you asked that question. I'd like to point out that all of those tenants you just mentioned are excellent credit tenants. All have grown with us at market rent each time that they have taken and expanded with us over time. This is an example, I think, of more long-term upside growth potential with the added benefit of downside protection. An example of where we have recaptured space some time ago, we captured the third floor at Empire State Building when we released the entire floor to LinkedIn at market rents. We recaptured that space from Global Brands Group, released it to LinkedIn at market rents and captured a positive mark-to-market spread. So over time, I think it does set us up for excellent opportunities and more growth potential down the road.

Okay, great. Yes, I hope those come. The second question, a quick one maybe for Anthony. With the renovation or remodel of the Empire State Building entrance, the annual stair-climb, how are we going to get in there to do the stair-climb?

Ha, ha, ha. We'll still - you'll still continue at the moment to use the lobby, but I think when we get done with the redo, people may like a reroute for the experience that they'll get. By the way, before I go any further, I want to make sure that we wish Tom Durels a happy birthday today because it is his birthday. And in honor of his birthday, we gave him the longest part of the presentation that he's ever done on an earnings call. So happy birthday, Tom.

Thank you. There is no place I’d rather be on my birthday than with all of you.

Thank you. Our next question today is coming from Craig Mailman from KeyBanc. Please proceed with your question.

Hey, good morning, guys. Maybe a follow-up on the capital plan over at the ESB. You guys, it looks like you're going to spend about $120 million to $150 million over the next three years. Could you just give us a sense of the return expectations, kind of where that comes from, office leasing rents versus retail rents? Kind of give us a sense of the decision to put this capital to work here versus maybe gotten by an asset or redevelop another part of the portfolio.

Hey, Craig, it's David. Good morning. We believe that the investment is really going to provide long-term benefits to the office and the retail tenants, being it's going to enhance the Observatory visitor experience. And we think it's going to increase Observatory revenue per capita, and overall improve the company's bottom line and shareholder value. And those are the factors we took into consideration as we made the decision for the capital expenditure project.

If we put it in terms of what you guys are getting of the redevelopment, would it be kind of low end of the range, high end of the range? Kind of where would it fall in the returns spectrum?

Yes, I guess as you know, Craig, we don't project Observatory results; we only report them. So I think I'd just like to leave it at that.

But I would add one thing and another part to your question, Craig. Tony here. This will not, in any way, shape or form, detract from the reinvestment in our portfolio for office and retail. A major driver of this was the recognition that we could continue to elevate the Empire State Building for office tenants and their visitors by making the Fifth Avenue entrance more accessible, and reducing the amount of Observatory traffic through there by more than 50%. Don't forget, a portion of our Observatory visitors exit through Walgreens, the second floor, as it is. In addition, by moving the entrance to the west side of 34th Street, and having the exit on Fifth Avenue, we create much more foot traffic in front of our retail on 34th Street, which we think will be a big plus and increase the desirability and marketability by capturing those 4 million-plus visitors a year, enabling them, the retail tenants, to capture those more than 4 million-plus Observatory visitors a year. So we really view this as forward-looking planning that's going to provide real benefits to the core office and retail real estate of the Empire State Building. And it will allow us to increase our per cap revenue of the Observatory. It's all dedicate to driving the bottom line and a big component of that is elevating the office and office visitor experience by restoring office use to the Fifth Avenue lobby.

Okay. That's helpful. And then just to follow up on the Observatory, I guess if I adjust for the kinds of visitors you guys said got hit with bad weather, it looks like visitation may have been up closer to 6.5%. Just given the shift of the Easter weekend, is that kind of where you guys would've expected the incremental year-over-year to come in with that shift? And there's been concern about tourism to New York under the new administration. Is there anything you guys are seeing from you data that is looking like a trend on that front, or is it kind of too early to tell?

First of all, I would encourage people to take David up on his offer for an explanation of how we arrived at the number which we estimate is the reduction due to bad weather. We've been spending a lot of time looking at actual data, historical data, and coming up with the metrics by which we can calculate that. It's a little complicated, so I think that folks who want to ask that question, please do, and David will be happy to speak to you after the call, number one. Number two, there is an Easter bump; I think we captured the Easter bump. I think the Easter bump was diluted by the bad weather. Number three; there was a Reuters article on June 13 discussing a leaked cable to the U.S. Consulate instructing changes and practices, granting U.S. Consulates in China. So you realize the visa granting U.S. Consulates in China, we believe that the instruction they have given have resulted in a decrease of visits of Chinese to the United States. We will tell you, other than that we don't see many Observatory visitors from the 6 countries with proposed travel restrictions. And New York City remains one of the top international tourist destinations in the world. We really don't see the international tourism, given the weakening of the dollar. I think over time - go back to the slide we presented at our 2015 Investor Day showing there really has been no discernible correlation between foreign currency movements and Observatory revenues. But I believe we go back to this one point where we have seen, specific to instructions by - we connect through the instructions, which were leaked and were noted in this July (sic) 13 Reuters article of instructions to the U.S. Consulate, where they were told to make changes in how they grant visas.

That's helpful. And then just maybe one last one for Tom here, I wouldn't want to ignore him on his birthday. On the leasing front, there's been concerns about slowdown that parts of the City may be under 100,000 square feet. Just curious kind of the depth of the demand flow you're seeing for your availabilities across the New York portfolio; and maybe conversations you're having and you're kind of feeling the ability to push rents here.

I feel very good about the market for our portfolio and our activity. Our activity and deal flow is strong. We have solid activity across the portfolio with leases in negotiation and proposals at advanced stages. We're in negotiation or advanced discussion on full floors at 250 West 57th Street, 1400 Broadway, Empire State Building and 111 West 33rd Street. And bear in mind that these full floors are generally on the smaller sides, anywhere from 10,000 square feet to 26,000 square feet. The largest single floor we have is on 40,000 square feet. So that, combined with the fact that we have good activity on our pre-builts, I think is reflective of a parameter on, I'll call it the small to midsize user. I feel good about the results that we posted in the second quarter with 330,000 square feet of leasing done; the 2 full-floor lease with Gap for 81,000 square feet [a year] at 111; the full floor at One Grand Central Place for 17,000 square feet with iCapital Network. I think that these results speak for themselves and I think that the pipeline that we have in front of us is quite strong. So all in all, I feel quite positive.

Great. Thanks, guys.

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

Great, thanks. Speaking with Tom, happy birthday. So can you - speaking with kind of the leasing story, can you talk about the leases that you did when - maybe what those tenants were also considering? Were they looking at new construction; were they looking at - were they [indiscernible] older buildings? Were they new expansions in the City? Then also, just I think the TIs for New York City picked up in the quarter. Can you maybe talk about that number as well?

I'll make a general comment about the alternatives that those tenants were seeking and generally, they were not seeking new construction. In some cases, those tenants were contemplating a renewal, possibly renewal and expansion and renovation in place, or shopping the market in our sell markets for those particular buildings. But none of those deals that we did this quarter, or certainly none of the small users, were looking at new construction. As far as concessions and TI, I'd like to point out, as I stated before, that this number is going to vary quarter-to-quarter depending on the mix of spaces leased, including white-boxed, pre-built, first or second-generation space, or the ratio of new to renewal leases, and fortunately, this quarter, most of our leasing done in our Manhattan office portfolio was for new leases. We did 208,000 out of 249,000 square feet, or 83% was for new leasing. I view this as quite positive and as I look back on prior quarters and comparing what we did this quarter with the third quarter of 2016 where we spent $90 a square foot in all-in leasing cost, during which we also had a high percentage of new leasing. Our leasing costs this quarter were actually lower in the second quarter at $86 a square foot.

Okay. That's helpful. I guess going back to the first part of my question, were these tenants targeting your sub-market specifically, like that Broadway 34th Street Corridor, or [indiscernible] in Midtown?

Yes, so in the cases of Gap, Renfro, iCapital Network, all of them were targeting those particular submarkets. So in the case of Gap and Renfro, basically, the Times Square sell, some market in iCapital Network was looking around the Grand Central area.

And what is it about those submarkets they wanted?

Location, access to transit, convenience to amenities. It's really the convenient location with great access to all that Midtown offers, and the access to transportation.

Okay. And can you guys give an update of your thoughts on street retail, especially near your building?

Sure. Well, first, our portfolio, our retail portfolio is 96% leased. We've done a great job leasing up our retail space. During the quarter, as I mentioned, the leasing we did with this quarter was predominantly the renewal of two garages, which I don't really consider not really street retail. We did a fantastic job of, as you know, releasing the space at 112 West 34th Street, where we achieved a $19 million positive mark-to-market spread in just under a year's time. So overall, we're in a really solid position. We only have about 6% of our retail portfolio rolling over the next 24 months. Our remaining significant retail space is at the Empire State Building of about 14,000 square feet, but only about 5,600 square feet of that is on ground. And with the announcement of our Observatory entrance relocation bringing additional foot traffic to 34th Street in front of the Empire State Building, that combined with a unique space, world-renowned address at the intersection of 34th and Fifth Avenue, I think that we've got a very unique space. And I'm very optimistic that a retailer will take that and do quite well there. So all in all, we're in really good shape on the retail front.

I do - Tony here - I'll probably get kicked under the table by David for this, for chiming in, but I'll just say, as I said in the last quarter, there's additional supply coming on in retail from new development. There's additional supply coming in retail from retailers downsizing and retailers themselves are in a bit of a much right now. So there's no question that if you're not in fantastic locations with excellent foot traffic, you're challenged in retail in New York City.

Okay. And then you've got a balance sheet still in really good shape here for investment. Anything you're seeing out there that's interesting either on the office side, or would you dip your toe retail here, do you start to see some in this location?

Hey, Jamie, it's John here. As it relates to external growth, we're going to continue to be patient and disciplined. When we look at returns on external transactions, we're certainly comparing that to the 4% to 18% returns we're getting on redevelopment in our portfolio. And we don't feel pressured and make external acquisitions to grow NOI. And as David mentioned, we posted 9% growth in our cash NOI in the second quarter as one example. But when we can invest and we see something where we can invest at prices, which do compete with this internal investment, we're going to do it. What we'd like to do is find that when others have problems, we'd like to be the solution and bring our management team's skills and our balance sheet and low leverage and liquidity to help solve problems. Finally, I'd say we're looking for investments that we will deliver for us over the long-term for the next 10 year and thereafter. And we're prepared to wait for these while we continue to redevelop our portfolio. And as you know, we still have about a million feet of undeveloped space in the portfolio.

And I'll just chime in here with John. John and I spend a tremendous amount of time, along with the team, on underwriting and looking at opportunities. But against the background of quarter-after-quarter, we have outperformed the market and delivered above-market these new spreads an outside contribution to our NOI from execution from our strategy of reinvestment and redevelopment in our portfolio. We expect this to continue regardless of any market conditions. ESRT's portfolio is best insulated from the oversupply of Class A trophy office. As tenants move to new buildings and take less space, and from the disruption in the retail environment, we are in the unique position, due to our price point, our locations and our rent spreads. And we don't compete with these impacted assets. So, we see better performance from our asset types, locations, pricing and the rent spreads we're achieving, which go well beyond any of our peers. Additionally, in the current environment, and as we've said in the past, we are far more interested in complicated portfolio transactions either through families or other public or private companies, rather than one-off assets. But our low leverage, internal growth, great locations and assets - and lest I forget, our excellent team, the management - we feel no pressure to do more than we're doing right now; though of course, we are always looking.

Okay. That's helpful. Thank you.

Thank you. Our next question today is coming from Rob Simone from Evercore ISI. Please proceed with your question.

Hey, guys. Good morning. Thanks for taking the question. A lot of my questions have been answered already, but just a follow-up to Craig's question on the Observatory. You guys have previously commented that outside of the Consulate issues, tourists are inbound to New York that are tending to stay, have shorter stays and spend less. And I'm just wondering if you're continuing to see that phenomenon or if anything has changed in Q3?

The data indicates no significant change in this regard. Keep in mind, we have tremendous number of new hotel rooms being made available in New York City, both in Manhattan and in the boroughs - well, certainly in two of the boroughs, two other boroughs. We really like our competitive position throughout what is a bit of disruption in tourist trends, but our view is we've been living through and delivering excellent compounded annual growth rates on our revenue side through disruptions for really two decades. We don't think that's going to change. But in general, we do see disruptions. We do think that the rhetoric and more specifically, some of the policy actions by the current presidential administration [indiscernible]. The good news for us is we draw from around the world and we draw from the United States, and we feel good about our competitive position and how we're doing.

Great. Thanks, Tony.

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

Thanks. Good morning. I just want to follow up on the Observatory. Expenses were up year-over-year for the first time after having been down pretty substantially over the past three to four quarters. Is it fair to say that the tailwind of expense savings may come off and NOI growth can grow from here on out? Or was there anything of one-time nature in that quarter?

Blaine, there's really nothing of a one-time nature. Most of the increase year-over-year would be attributed to payroll. I wouldn't suggest there would be a trend one way or the other in terms of what we're seeing on the expense side.

Okay. That's helpful. And then just a more detailed question just out of curiosity. It looks like you guys pulled around 9,000 square feet out of the Empire State Building's retail space. I guess what happened there? Is that part of the new Observatory entrance or was there something else going on?

Approximately some of that was on ground floor on 34th Street for the new dedicated Observatory entrance, and some of that was on the second floor. We will reconfigure the second floor and there will be some retail space on the second floor.

Okay, great. Happy birthday, Tom.

Thank you.

Thank you. Our final question today is coming from John Kim from BMO Capital Markets. Please proceed with your question.

Thank you. So Hudson Yards continues to lease up in office rents or sign at or above $90 per square foot. How much of a direct impact has it had on your acting rents in your Midtown portfolio?

Really I think very little. We don't directly compete with Hudson Yards. We do the Hudson Yards had a positive impact on our portfolio in a submarket, particularly on 34th Street and Times Square South. We do think that the new leasing at Hudson Yards will have a much greater impact on the aged trophy Class A properties, particularly those that are in that 30 to 40-year vintage. But we think we are unique and I like - like I said, I like the market for our portfolio and we think that we're significantly insulated from the impacts of new supply. But at the same time, the Hudson Yard development I think moves kind of the center of New York more towards 34th Street, and has benefited our submarkets.

I apologize if I missed this, but what are the asking rents today again at the Empire State Building?

Generally, we're in the mid-60s to low-70s per square foot, depending on the particular space, what floor and what it is [indiscernible] floor, but generally, mid-60s to low 70s per square foot.

Okay. So it hasn't really changed that much in the last quarter. At the redevelopment of the Observatory entrance, I know you discussed improving the experience and the per capita revenue. But I was wondering if the results would go to increase volume?

I love the question; I appreciate that. We don't see that the capacity is going to increase, but don't forget that we are below capacity utilization significantly. And what we do, which again, we'll disclose as it's unveiled, and we feel very strongly, will enhance the draw of the Empire State Building in general, and will enhance the draw and prove a reason to go there even during a bad weather day. I don't think we'll see 15,000, 20,000 people a day during a bad weather day, but it will be a much more central experience to a tourist's visit to New York City. So when we put these different things together, we can't increase capacity on a day when we are fully booked with tourists, but that's when we also continue to put ourselves in a position to work our ticket mix, our revenue mix. And we spend a tremendous amount of time on this. We began to discuss this a little over two years ago and we continue to do it; and it’s continued to work with our visitors and with our revenue.

Okay. And then just to follow up on your acquisition opportunities, I know that you're focused on some complex transactions going forward. But I was wondering if, as part of that, you would consider investing in different parts of the capital stack, whether it's providing debt financing or mezz financing?

It's funny, John and I and the team, we talk about this often, a group that hasn't done an acquisition in quite some time. Our regular acquisition meetings do occur, and the fact is we think that that market is incredibly competitive right now. There's a tremendous amount of competition, not just from traditional lenders, but from non-bank lenders, from mezzanine lenders. And we look at what we're doing; we look at how we're driving the bottom line. We look at how we're driving our overall results, and we just don't feel pressured to come up with new ways to put money out. We're looking for fat, juicy [indiscernible] where we can be symbiotic in an acquisition or in a merger, where everyone can benefit from what we can bring to the table and from what a partner brings to the table, a lot of discussions on the work. And in the meantime, we're still just cranking out quarter-after-quarter improvement.

Okay, great. Thanks, Tony.

Thank you. We’ve reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Malkin for any further closing comments.

So we'd like to thank you all for attending today's call. I, John, Kessler and I, and frankly, the whole team are really pleased with the ESR team's execution, because it's demonstrated in our strong results. We continue to deliver on our four growth drivers. We love our competitive position and we are very excited to announce our innovation with regard to the Observatory to improve the experience of our office and retail tenants, and to plan for more growth there. We thank you for your time and your questions, and we look forward to reporting third quarter results in three-months, and until then, all the best, everybody.

Thank you. And that does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.