Empire State Realty Trust, Inc. (ESRT) Q2 2020 Earnings Report, Transcript and Summary

Greetings. And welcome to the Empire State Realty Trust Second Quarter 2020 Earnings Call. [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 afternoon. Thank you for joining us today for Empire State Realty Trust's Second Quarter 2020 Earnings Conference Call. In addition to the press release distributed yesterday, a quarterly supplemental package with further detail on our results and our latest investor presentation were posted in the Investors section of the company's website at 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 including ongoing developments regarding the COVID-19 pandemic, 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. Certain of our disclosures today are added specifically in response to the SEC's direction on special additional disclosure due to the changes in our business, prompted by the COVID-19 pandemic and are unique to this instruction. We do not expect to maintain the same level of disclosure when we resume normal business operations. 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. 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 Tony Malkin, Chairman, President and Chief Executive Officer.

Thanks, Tom. And good afternoon to everyone. It takes a moment to grasp the magnitude of the dynamic situation we all have confronted and continue to confront since we last reported results. And we have adapted to the constant change, flexes, pivots and challenges as a new normal, that our efforts to respond have been effective and that we are prepared to continue this way for an indeterminate period of time through the end of the pandemic, are all testament to the team that is ESRT. We have made hard choices that have resulted in a great deal of change in our organization, reduction in force and cost have positioned us on our front feet to preserve and create value for our shareholders. I'd like to take a moment to say thank you to my colleague, John Kessler, and to extend to him, once again, my best wishes and those of our Board in his next endeavors. At the same time, a public welcome, thanks and congratulations on a remarkable first 3 months to our new CFO, Christina Chiu, who has worked literally nonstop since her arrival and added a tremendous amount of value to ESRT and its stakeholders. We're all better from her contributions and we'll greatly benefit for years to come. Let me say clearly, I have a great deal of confidence in the future of New York City, in the importance of office buildings to the teams and our current tenants and the tenants to come, who will create the value that will lead our economy forward and that the legions of young, smart and motivated individuals who have made -- have been and are attracted to this great city will continue to come and make their mark in yet another reinvention of our American dream, a better, more compassionate and inclusive American dream. ESRT is committed to continue to change and be a part of that reinvention for the good of our city, its people and the economy that makes us the only capital of the world that is neither a capital of the state nor country. We can and we will. ESRT's leadership and innovation and redevelopment is our competitive edge. Our buildings and their unique combination of location, value and leadership and sustainability of indoor environmental quality have never been more necessary and have never had a better competitive edge. ESRT as a company has also undergone tremendous change and has never been better positioned for the future. Here's a brief recap of what we have done, where we are and look at where we will go. Our plan at our IPO was to modernize our properties with the 21st century, consolidate old spaces and redevelop them for new, bigger, better credit tenants on longer leases. We're going to lead in energy efficiency, indoor environmental quality and sustainability. And we would maintain a strong and flexible balance sheet to execute on our strategy and take advantage of potential opportunities that may arise. The redevelopment plan is largely completed. We only have leasing of our remaining redeveloped space and a small amount of space left to redevelopment. Our 4-year redevelopment of the Observatory was completed in December 2019 to fantastic customer reviews and produced strong revenue growth in the first 2 months of 2020. We believe this long-life investment will yield the best results in the future once tourism returns to normal, and we are thrilled amid uncertainty and challenges to have reopened the Observatory as of July '20. We avoided external growth at market peak pricing. We only commenced stock repurchases when our stock price drops steeply, steered away from co-working and other short-term FADs that are visible for what they are in this new environment. We leased to tenants who filled the spaces they initially leased and then expanded by more than 1.7 million square feet to date. As of the end of the quarter, we held $873 million in cash on hand. We continue to engage in share repurchase activity at these depressed valuation levels. In the aggregate, we have purchased $119 million of our common stock at a weighted average price of $8.67 per share through July 28, 2020, through a combination of open window purchases and an in-place 10b5-1 program. We believe current shareholders will benefit long-term from our purchases. We finalized a series of management changes during the quarter as we, in close consultation with our Board, rolled out thoughtful plans for ESRT version 2.0. We laid out our plans to the Board in late 2018, as we can see, it was time for us to move from our plans at IPO in the logical new areas of focus for ESRT, with both new personnel and perspectives. Let me briefly review some of the key new hires and appointments we made over this period: Suresh Rangarajan as our new Senior Vice President and Chief Technology Officer; Dana Robbins Schneider, our new Senior Vice President and Director of Energy and Sustainability; Christina Chiu as Executive Vice President and Chief Financial Officer; Aaron Ratner, our Senior Vice President and Chief Investment Officer; and an internal appointment of a Director of ESG. Importantly, Aaron has hired 2 of the 3 additional team members we agreed, during our discussions with him, would position us to generate and evaluate opportunities and deploy capital for external growth, focused on opportunities in which our balance sheet strength, buy-and-hold philosophy and redevelopment expertise can be brought to bear. We are in a marathon, not a spread. We will deploy capital when an opportunity that will lead our growth in the next cycle presents itself. We anticipate opportunities will arise during the next 3 to 4 years, in which, we, as omnivorous opportunivores, of course, will focus our potential to expand to create long-term shareholder value. Our team has risen to all the challenges that have arisen from the COVID-19 pandemic as we pivot and flex our way through. We have gone from a shelter-in-place environment to a return to the office in our Connecticut properties first then to a phased implementation process in New York with the gradual return of our office and retail tenants. Our assets are well positioned for changing tenant demands on indoor environmental quality, with the work we have done as part of our redevelopment efforts. We have met and will meet each challenge with our best organized plans and successful execution borne out of our experience with many different cycles. Strong balance sheet in hand, we have also undertaken a rigorous review of our cost structure. My experience through 6 crises in this business has led us to move prudently and swiftly to reduce operating costs, G&A, CapEx and head count. As disclosed in our earnings release and on Page 14 of the investor presentation and our first round of rationalization, we have undertaken cuts to reduce our 2020 general and administrative expenses by 12% to $60 million. Property operating expenses and building improvement capital expenditures have also been reduced that Tom Durels and Christina Chiu will go into more detail. Let me provide some highlights. We have implemented broad-based corporate and property-level base salary reductions through year-end, effective August 1. Starting at the top with my 33% reduction, followed by Tom Durels' 25% reduction of scaling down from there. This is in addition to the salary reduction to $1 that I took in the second quarter. Furthermore, we announced that upcoming 2021 annual equity compensation will be reduced by $3.9 million, which consists of $2.7 million for me and $1.2 million for Tom Durels. We have made permanent headcount reductions as well as instituted departmental budget cuts. This is in addition to COVID-19-related cost savings. We've reduced property operating expenses by $10 million in the second quarter and expect further to reduce expenses by $12 million in the second half of 2020. We expect additional savings from a combination of staffing reductions and operational improvements. Furthermore, we've reduced building improvement capital expenditures planned for 2020 by $24 million relative to 2019 levels. These broad-based cost cuts are start of our efforts to address the current environment, preserve the balance sheet and position ESRT in the long term to thrive and deliver shareholder value. I say start as we are not done. We will take additional measures to reduce costs further after we digest what we have put in place so far. We will see the bright shiny penny of work from home to harness further in the post-COVID environment. We share the belief with the vast majority of businesses that work from home diminishes productivity, team building and culture. Companies that show up and build personal relationships and develop new products and services will always win. That said, we see the pandemic business environment in 4 phases: first, lockdown; second, post-lockdown, pre-vaccine or cure; third, post-vaccine or cure; and fourth, clean up and situation assessment. We are not naive about the current environment. There is no doubt that we will see economic challenges from higher unemployment levels and business failures. We expect the current environment to continue to evolve, but we feel well prepared and ready to flex and pivot to handle whatever challenge lies ahead. That said, New York City is the greatest global economic and cultural capital and one to which people will return for work, to live in and to visit. New York City has come back time and time again for shocks, recessions and tough environments, stronger each time. You'll have an opportunity to touch on these themes more in Q&A. And for now, I would like to turn the call over to my colleague and friend of 3 decades, Tom Durels. Tom?

Thank you, Tony, and good afternoon, everyone. Today, I will comment on the following: our second quarter leasing results, update on rent collections and rent deferral requests, actions taken to reduce operating expenses and capital improvement costs and our in-place health and safety protocols. In the second quarter, we signed 19 new and renewal leases totaling approximately 113,000 square feet. This included approximately 52,000 square feet in our Manhattan office properties, 47,000 square feet in our greater New York metropolitan office properties and 14,000 square feet in our retail portfolio. The 2 most significant leases signed in the quarter were a 36,000 square foot office renewal lease with Ernst & Young at First Stamford Place and a 10,700 square foot retail renewal lease with Charles Schwab at One Grand Central Place. During the second quarter, rental rates on new and renewal office leases across our entire portfolio were up 2.8% on cash basis compared to the prior cash escalated rents. And at our Manhattan office properties, we signed new leases at a positive cash rent spread of 8.7%. Our total portfolio leased percentage is 89.6%, a decrease of 150 basis points from the prior quarter. Occupancy sequentially declined by 310 basis points during the second quarter, mostly due to the anticipated move out of 2 large tenants that we previously announced and reflected on Page 9 of the supplemental from prior quarters. These included the Empire State Building at 157,250 square foot space, was intentionally vacated by Coty in connection with the previously announced expansion lease with LinkedIn, which will commence over 3 years as detailed in our signed lease not commenced schedule on Page 6 of the supplemental. And Thomson Reuters vacated 49,904 square feet of Metro Center as reflected on Page 9 of the supplemental in prior quarters. New leasing activity was impacted during the second quarter by the pandemic and shelter-in-place rules that were in effect for much of the period. During this time period, we instituted a number of online measures to maintain our relationships with brokers and expose our availabilities to the market. While physical tours resumed on June 22 and coincided with the Phase 2 reopening, we expect lower leasing volumes for the third and fourth quarters based on current tenant demand. Moving to rent collections. We have made steady monthly improvements in our rent collections, as shown on -- in the table on Page 10 of our investor presentation. We collected 84% of second quarter 2020 total billings, with 86% for office tenants and 75% for retail tenants. Through July 24, we collected 90% of July total billings with 93% for office tenants and 75% for retail tenants. These collection rates are before application of any security deposits and without any adjustment for deferral agreements. Deferral agreements to date have generally been for no more than 3 months of either rent or replenishment of security deposit. For most of our local retail tenants who have been hit particularly hard, we will convert remaining 2020 fixed rents to a percentage rent structure with the payback of the difference between fixed and percentage rent over a defined period. As shown on Page 6 of our supplemental, there is $42 million of revenue upside by free-rent burn-off and signed leases not commenced. We resumed nonessential construction on June 8 and have updated the timing of lease commencements, specifically the GAAP revenue component on Page 6 of the supplemental. As previously disclosed, we scaled back certain building operations, which will reduce costs until buildings are repopulated. These actions reduced property operating expenses by approximately $10 million during the second quarter from the prior year period and will reduce operating expenses for the second half 2020 by approximately $12 million. The majority of these cost savings are COVID related and are expected to decline as physical occupancies increases. Keep in mind that a portion of the reduction in operating expenses will be offset by a reduction in tenant expense recoveries. We have also implemented permanent cost savings actions of approximately $4 million on an annualized basis from staffing and other reductions. Our buildings are fully open, and we implemented the health and safety protocols as detailed on Page 12 of our investor presentation, including temperature check, facial mask and sanitized hands required prior to building entry; mandatory masks in common areas; footprint decals and signage in lobbies; elevator banks in elevators to encourage social distancing; hand sanitizer dispensers placed in common areas; and increased cleaning of high touchpoints in common areas. Furthermore, we have a comprehensive indoor environmental quality program that is aligned with tenant requests and something that we have been consistently doing for years as part of our ongoing redevelopment work. This program includes MERV 13 filters in all air conditioning controlled by us, meet or exceed ASHRAE's 62.1 Standards, increased ventilation in which typical offices -- or outside air intake provides at least 1 air change per hour, regular air and water quality tests, thorough cleaning and disinfecting of air and water systems and active air purification in select spaces. As mentioned previously by Tony, we have taken action to reduce capital expenditures, and we are near completion of our redevelopment work. We now anticipate that 2020 capital expenditures for building improvements compared to 2019 will be approximately $24 million lower as we focus on mandatory spending and work previously commenced. Now I'll turn the call over to Christina. Christina?

Thanks, Tom. I'd like to begin by saying that I'm very excited about joining ESRT in May of this year. Since then, I've worked closely with the various departments to ensure a smooth transition and to settle into this role. I met many of our investors and analysts virtually at May and June and look forward to meeting more of you over the coming months. Now let me start with our quarterly results. For the second quarter, we reported core FFO of $39 million or $0.14 per diluted share. This is net of $0.03 per share of expense from a reserve against tenant receivables and noncash reduction in straight-line rent balances and excludes $3 million in severance costs and a $4 million impairment charge, both of which I will address later. Same-store property operations, if you exclude onetime lease termination fees and Observatory results from the respective period, yielded an 18% cash NOI increase from the second quarter of 2019. This increase was primarily driven by lower property operating expenses, partially offset by a reserve against tenant receivables. When COVID-related rent deferrals are excluded, same-store property cash NOI increased 9.9% from the second quarter of 2019. More detail on rent deferrals and the breakdown of our collections can be found on Page 10 of the investor presentation. During the quarter, we recorded a number of unique items that are largely noncash and are add back to core FFO. Specifically, we recorded a $4.1 million noncash impairment charge related to the write-off of prior capitalized expenditures on a combined heat and power generation project for the Empire State Building that has been rendered economically unfeasible due to New York City's Local Law 97 and a $3 million onetime charge in G&A expenses related to the departure of our former COO, of which $2.7 million is the noncash accelerated vesting of equity compensation. We also reported a $9.1 million reduction in rental revenue in the second quarter comprised of $1.9 million reserve against tenant receivables and $7.2 million against straight-line rent balance. This equates to 1.6% of our annualized rental revenue as of June 30, 2020 and a $0.03 FFO impact. We reached this determination after a view of each tenant arrear status, security deposit balance and management's assessment of the path towards a resolution and viability of the tenant. Turning to our balance sheet. As of June 30, 2020, the company had total debt outstanding of approximately $2.5 billion on a gross basis and $1.6 billion on a net basis. The company's total debt has a weighted average interest rate of 3.41% and a weighted average term to maturity of 6.9 years. Our consolidated net debt-to-total market capitalization was 43.7% and consolidated net debt-to-EBITDA was 5.2x. We have no near-term debt maturities and a well-laddered maturity schedule. Our revolving credit facility expires in August 2021 and has 2 6-month extension options. Our next maturity isn't until November 2024. As we look ahead to the second half of the year, here are a few items to keep in mind. We noted earlier that we undertook a series of proactive steps to reduce our G&A expenses, property operating expenses and capital expenditures. Tom already covered property operating expenses and CapEx, so I will focus on G&A. We now anticipate 2020 expenses of $60 million, excluding onetime severance charges. This is approximately 12% less than the previously disclosed G&A run rate of $68 million that we provided on our 4Q 2019 earnings call. As detailed on Page 14 of the investor presentation, the reduction fall in 2 categories: named Executive Officer compensation and other corporate overhead. Named executive officer compensation reduction include $400,000 from the reduction in annual base salary for Tony Malkin and Tom Durels through December 31, 2020, $1.2 million from the change in age requirement from 60 to 65 for the accounting vesting period for time-based equity compensation and $2.7 million from the departure of our former COO. Other corporate overhead reductions include $1.5 million of net savings from reductions in corporate staff and corporate salary reductions through December 31, 2020, partially offset by the addition of investment personnel, and the balance is from department budget cuts and lower anticipated spending due to COVID-19. As mentioned by Tony earlier, 2021 NEO annual equity compensation will be reduced by $3.9 million. We currently expect 2021 G&A run rate of approximately $58 million, and we will continue to seek efficiencies and cost reduction opportunities in operating our business. We believe these proactive measures, particularly on G&A expenses are aligned with our stakeholders and reflect our efforts to preserve cash and operate efficiently in uncertain times. We will continue to seek the right balance as market conditions evolve. Now I'll turn the call over to Tony to provide some thoughts on our Observatory business. Tony?

Thanks, Christina. Before we go to Q&A, here is an update on the observatory now that we have reopened the expense picture on a go-forward basis. We started the year on a strong basis following the completion of our Observatory redevelopment program in the fourth quarter of 2019. Revenue for the first 2 months was up 13.2% year-over-year, excluding the impact from the 102nd floor Observatory. This revenue growth occurred despite the absence of Chinese New Year activity in January and a pullback in visitor traffic in March from European countries where COVID-19 was rampant. We followed the mandate of government authorities and closed the Observatory on March 16, and the Observatory remain closed for the entire second quarter. The 86th floor Observatory reopened on July 20 with new protocols and processes under New York State's Phase 4 guidelines. We still await permission to reopen the 102nd floor. We have updated our hypothetical admissions ramp up on Page 18 of our investor presentation. It assumes 2019 monthly levels as the baseline visitation comparison reference point and uses our reopening date of July 20, with a gradual ramp-up towards normalized levels by 2022. We have been open for just under 2 weeks now and slowly rebuild the beach that is our business one grain of sand at a time. Our focus on indoor environmental quality, in which we have been leaders for more than a decade, yielded air filtration through MERV 13 filters, an aggressive response to viruses with AtmosAir and a massive capacity to ventilate the Observatory as part of our redevelopment. Combined with comprehensive protocols and employee training, this has made it possible to reopen. Our expectations for a more gradual ramp-up aligned with our channel checks with other Observatory operations around the world, which have seen to date a gradual volume buildup as they reopen in the respective countries to a 20% to 25% level of prior year's operations. We are confirmed in our anticipation initially that we will have a higher local visitor mix followed by a ramp-up of regionally than nationally sourced travel and then followed by a restoration of our typical visitor mix that is approximately 2/3 international. We do not think we'll achieve normalization until the broader resumption of international air travel, and we presently peg that for some time in 2022. While the Observatory was closed, we remained relevant and active in the promotion of our brand through numerous initiatives from our pandemic fire and lighting over the skyline of New York City to our partnership on the fourth of July with Macy's Fireworks finale with firework shot off the top of the Empire State Building. If you missed it, take a moment and look at our YouTube channel. You'll be impressed and entertained. With our July 20th reopening, we posted a detailed presentation to educate the general public that we are open for business and ready to welcome visitors in a safe and enjoyable environment and have since launched a social media push. No attraction in any city has higher brand value and international recognition than the Empire State Building Observatory, authentic and iconic. We believe when the pandemic passes, we will emerge stronger than ever and remain the brand and icon of New York City. On the expense side, we wanted to share an update on how to think about expenses as we reopened. Previously, we had communicated that we reduced our typical annualized expense run rate by 60% from $35 million in February to $14 million by May. In the second quarter, Observatory expenses totaled $4 million. Now that we have reopened, we calculate our annualized expense run rate to approximately $25.5 million. There are certain fixed staffing and operational costs, regardless of volume levels. For example, we need to maintain staffing to operate the real call desk, security, elevator loading unloading and deck attendance regardless of whether we have 1 or 1,000 visitors at a time. We believe that we have ample bandwidth to handle our anticipated ramp-up in admission volume through 60% of 2019 volume levels with current staffing. With this completed, I'd like to open the call for your questions. To keep the call moving, as always, we ask that each participant limit him or herself to 1 primary question and 1 follow-up. Please do feel free to rejoin the queue if you have additional questions. We will stay on the call as long as we have questions. Operator?

[Operator Instructions] Our first questions come from the line of Craig Mailman of KeyBanc Capital Markets.

Tony, I appreciate your comments at the beginning of the call in kind of the long-term conviction in New York City. But just a question here on -- recently, we've seen some livability issues and quality-of-life issues that hopefully could reverse itself, but who knows how long it lasts. I mean at this point, you guys are ramping your investment team and broadening that out. I mean, is there any thought process on moving beyond just the New York metro area and looking at other markets within the U.S. that could potentially be a good area to deploy capital?

Thanks very much for the question. Appreciate it. We really view ourselves as omnivorous opportunivores. And at this point, in what I view as a 3-4 year opportunity, I really don't want to limit our options on anything. That said, we certainly have certain skills in New York City. I've lived through times of much greater liveability challenges than we presently have in New York. And the fact is every dollar of capital that we have, we have to patiently and prudently evaluate all our options to look and focus on how we generate shareholder value. So while I would like to say that it's very straightforward. I think there are some things, which obviously would fit in with us clearly and comfortably, and there are other things candidly which might be out of the box, and we just have to look at it all against how we use our capital, anything from buying our own stock to buying debt, joint venturing, different product types, different locations.

That's helpful. And then just on the retail portfolio, you guys have 17% of rents coming from that segment. As you guys are looking at the creditworthiness of those tenants, and I realize a lot of it is sort of amenity-based. What's the viability even with going to percentage rents of the majority of those tenants here as the pandemic kind of drags on and restaurant reopenings kind of keep getting kicked down the road?

I absolutely think that when it comes to food service, there are specific challenges. We need the bodies in the buildings in order to justify people and their activities. And as far as in-store dining, that's challenged by the fact that, frankly, people need to deploy the protocols that we have in our spaces, including our retail of MERV 13 filters, AtmosAir and fresh air ventilation. That said, I think that we'll see people pivot in flex. We're at "percentage rent" if people aren't open and they're not doing sales, that means their rent is 0. And I think over time, our strong credits, our strong tenants, those rents are in the bag, and those people have long-term use. We may see failures in the smaller amenity-based tenants. And as people return to the offices, which they will, those people will either restart with new businesses, or we'll have other folks come in. We'll see a downward adjustment in rental pricing. And I think as far as retail in New York is concerned, there are certain very large boxes that have been occupied by tenants that won't be in business anymore that are permanently disabled and need to be redeveloped. And I think that there are certain areas geographically where retailers went or folks opened because that's where they could afford it, and they won't have a lot of business to do there, and they'll be able to get in better locations more centrally located at better rents due to the free up of space.

Our next question comes from the line of Michael Bilerman of Citi.

Tony, just staying on in external growth. I think the way you've sort of framed the sort of 3- to 4-year opportunity seems to be a slower cadence than the excitement that you shared on the last quarter's call, which seem coming to fork in the road and taking it. It seemed a little bit more near term in terms of deploying that capital. Is that fair?

So I think, Michael, the big excitement for us is actually the fork in the road. We look at everything in a long pathway. I think that decisions in real estate that are successful for long-term value creation have to last a cycle, have to endure a cycle. We are not saying that it's between years 3 and 4 that these opportunities will present themselves. Merely saying that I think we'll go into a dip in which pricing and efficiency will first kick-off, and then we'll be able to see perhaps better pricing efficiency as more transactions take place. But then we'll also have to deal with the recovery in the marketplace in general. And I think that as we've seen in most cycles, that creates a buying opportunity that lasts anywhere from 3 to 4 years through a cycle. And that you're really at the beginning of a downturn -- through the downturn at the beginning of a new cycle, have a broad number of months in which to deploy capital. That doesn't mean that we are not active, and I'm just thrilled with Aaron and what he has done. He's already got 2 of the 3 hires that he wanted to put in place selected. One has been working with us for over a month now. And we are looking at just a tremendous number of different opportunities, including a couple of transactions where, frankly, we didn't participate or we were -- had our hair taken off as the trucks carrying the money to the closing deal drove by at high speed. And we're now able to look at the senior debt and the other pieces and say, there are opportunities to re-enter things we've already underwritten. So hopefully, that's helpful. If not, please just press further, and I'll try to respond more clearly.

Yes. No, that's helpful color to have. And I know you acted on the stock buyback again during the quarter. How does where the stock is trading affect your decision to deploy capital in anything, whether it's debt, whether it's an asset in New York outside of New York? I guess, how does -- what is the reference that you and the Board and the rest of the management team goes through in terms of -- because once it's gone, it's gone. Once you spend that money, you don't have it anymore. So how do you sort of manage that side given your stock is severely depressed levels?

So great question. Thank you. I think there's an important footnote to all of our thinking when it comes to our cash. We look at capital allocation very carefully. I don't care if it's -- when we look at new deals that we might -- that we're working on right now compared to how we would use that money and everything from stock buyback to dividend to external reinvestment to where we see things panning out in the cycle. That's part 1. Part 2, we also do have a fantastic partner in the Qatar Investment Authority, who has repeatedly reinforced its willingness to participate with us in opportunities, which we think are worthwhile. And one of the things that I like about the fact that we've bought on Aaron Ratner is his prior experience with joint ventures, his prior experience and work with institutional capital other than just his own at TPG. So we look at our capital as capital that can be levered by other people's capital, where we have an opportunity to deploy not just capital, but to use our own expertise. And I think that as we perform, as we continue to differentiate ourselves in our own unique ways, candidly, I think the stock price will improve. But we always have the opportunity to address things with joint ventures, and we use our money as seed capital for bigger moves.

Our next question comes from the line of James Feldman of Bank of America.

This is Elvis on for Jamie. Tony and maybe Christina, can you talk a little bit about sort of the lingering credit risks/write-downs that not only that occurred in the quarter, but could potentially occur in the future? How should we be thinking about sort of your portfolio versus some of the other write-downs that we've seen across the sector?

Well I'll take the first crack at this and hand this off to Christina. We can only write-off rents that are actually owed to us and not paid. And at that point, we'll take a look at that cash component then also go to the straight-line component. So we have very, very actively engaged on our request for deferrals on our tenants who have not paid. As you can see, we've made really good progress on our rent collections. And I think that it's -- this is performing without a net. It's a live-fire exercise. I wouldn't even say it's an exercise. We're -- as I said last quarter, we're at war. This is the nature of things. I think that as far as what we look at coming forward, I'd throw that over to Christina just to talk about how she has looked at this and worked with the folks in her area and in leasing and on the real estate side, as we assess our collections.

Sure. So when we -- I might refer you to Page 10, which we put together, it's our total billings collection update. And notably we show month by month, and it all adds up to 100 on an unadjusted basis. And I know that to answer your question because this represents the work we do in determining write-offs and flexibility, and we perform a rigorous exercise to evaluate each tenant's arrear sitting down with accounts receivable with the leasing team. And what we're looking for is how much in arrears. What's the pattern? What's the security deposit balance? Is it sufficient to cover those balances? What's management's assessment of a path towards a resolution in getting uncollected amounts paid and what's the viability of the tenant at the end of the day. And based on that, that's how we arrived at the $9.1 million that we wrote down, of which $1.9 million represents the uncollected tenant balances, and we have to watch out for those. The streamline is the other portion, and we'll continue to look at that. Within the chart, if you take a look, we do see improvements. So in July, we've reached 90% in straight collection, again, completely unadjusted, and we have a basket that's uncollected but covered by security deposit and then another basket of uncollected. So we are seeing improvements. And as the period goes on, we'll continue to use these categories to assess very carefully, and certainly, we'll take write-downs as we see that the viability of payback is not there.

Okay. And then maybe one for Tom. Tom, you mentioned on the call having lower expenses but also having lower recoveries. Some of the beats have been on lower expenses. But how does that look sort of within the quarter versus future quarters and thinking about these lower expenses versus collecting lower recoveries for tenants? How should we be thinking about that?

Well the -- as I commented earlier, in the second half of 2020 compared to second half of 2019, we expect to reduce operating expenses by $12 million. And then on a go-forward basis, in 2021, we eliminated $4 million of recurring staffing and other expenses. So these are unrelated to COVID, and these are permanent reductions. A percentage of our expenses will be recovered by operating expense escalations. But as we reduce those expenses going forward, then you'll see strong decrease in operating expense escalation. We haven't given a specific number, but it's not a 100%, but a portion of those expense reductions.

Our next question comes from the line of [indiscernible] of BMO Capital Markets.

It's been just for a week since the Observatory reopened. I'm just curious how has the visitor traffic been so far? And are you considering any possible changes in pricing, either more in premium or conversely possibly promotions to attract more visitors?

Thanks for that question. Tony, here. Look, we aren't going -- we will not disclose in this call any specific numbers, but we're comfortable to say that our visitor numbers align with our expectations. They are also consistent with the reopening path that other tower operators around the world with whom we regularly compare notes have experienced. Most of these people are seeing internal travel that they're seeing people who traveled by cars largely for trips. After a few months of operations, they have gotten to the 20% to 25% range. So from that perspective, it's pretty much in line. We have not changed our ticket pricing. We don't anticipate to change our ticket pricing. We have received fantastic results on social from our visitors who've come through. They're 5 star, interesting and understandably, focused on safety first, then the spectacular view and the experience second. So I think we will see these reviews, and we have seen these reviews encourage others to venture forth. Week 2 is stronger than week 1. Our first weekend was stronger than our week prior. So we look forward to this weekend upcoming. And we also think that over time, recognize that right now, basically, almost all of our sales are direct from our website. As ancillary New York City attractions reopen, such as museums like a Met or the 9/11 Museum, and there's more of a promotion for New York City as the destination, our past partner and online travel agency partners will have more products to sell. So right now, the interesting thing is that our per caps are actually quite high because virtually everybody has purchased a ticket directly from us online. Hopefully, this is helpful. Let me know if you have any further questions.

Yes. No, that was helpful. And then just a follow-up on that. In your hypothetical Observatory assumptions, when do you expect or which quarter to increase the 500 capacity level?

So the 500 capacity level was an arbitrary number that we set. Under Phase 4, we have opened -- under -- as an outside attraction. That's why the 102nd floor is not open at this time, only the 86th floor is open at this time. So that said, we can flex up to a bigger number based on demand, and we can flex to a bigger number, frankly, when we are comfortable that all of the protocols that we have put in place are well observed by our visitors and well enforced by our team, who went through -- the team went through 3 or 4 days of training before we reopened. So we're very conscious that we've been fortunate in the extensive review that was given to us by both the Governor's office and the Mayor's office that both of them agreed that we are in a good position to reopen. We want to demonstrate that we can do exactly what we said we would do, that we can maintain the appropriate protocols as we set them out. And we'll closely and carefully and advise them before we do anything further as far as increasing our capacity.

Our next question comes from the line of Daniel Ismail of Green Street Advisors.

Tony, I was hoping if you can speak to maybe the type of demand you're seeing, albeit with the understanding that demand is lower now because of post-COVID environment we're in. But if you could just speak to the suburbs versus the city and the type of tenants that are looking in both areas and if you've noticed an acceleration afterwards.

Look, I think the comforting news for us is that we actually have seen tours. We have active proposals. We have some approved deals. But for the actual detail as to from where it comes and where it's headed, why don't I hand this over to Tom Durels for him to make comment.

Sure. Thanks, Tony. Lease tours have resumed in Manhattan, as Tony commented, on a comparative basis for the month of July in 2020 compared to 2019 to our volumes, we're at about 40%. Bear in mind that we're -- the Phase 2 opening in Manhattan was June 22. So we're not too many weeks following the Phase 2 opening, but we are pleased that tours have resumed and we're running at about a 40% pace. As Tony just mentioned, we've received some recent proposals, both for full floors at 111 West 33rd Street and an Empire State Building and pre-builds where we have them at 1350 Broadway, Empire State Building and at One Grand Central Place. And then for -- what we saw is for leases that were in negotiation before the shelter-in-place orders, a few of those have been executed and that showed up in our second quarter numbers, a few more that we still remain in negotiation. We hope to get those closed and some deals died. I would say that we do expect lower leasing volumes for the third quarter, particularly. Bear in mind, we're pretty much shutdown for tours for the entire period where the shelter-in-place orders were in effect. But we're pleased that tours have resumed. And I think also you had asked about tenant -- yes, just the tenant type. I can't say that there's one particular tenant. We have seen a good amount of activity in the fire sector, some healthcare, professional services and the like. It's fairly broad-based, not necessarily focused on one specific industry.

Great. That's helpful. And then maybe just on the write-off at the Empire State Building regarding the capital improvement projects. The -- I believe Local Law 97 was passed last year. And I was just curious if you can provide any more color on what made that project uneconomical? And if there's anything else that's being done other properties you guys have?

So that wasn't the only project on which we had actual combined heat power project put together. It made very good economic sense. We had worked with the Governor's office to get an exemption for a pilot program to look at the Con Ed standby tariff rates that previously would have made the -- made it uneconomic. We feel very strongly that even from an environmental perspective, it makes a great deal of sense because the efficiency is extraordinarily high in the recapture of waste heat for steam for the chillers and hot water for the building really tremendously high efficiency. The issue is in Local Law 97, and I am the sole real estate industry representative on the Mayor's advisory board for the implementation of Local Law 97 and that there have been some arbitrary values set for greenhouse gas emission coefficient. And the result of that is that we cannot see a clear pathway under the current rules that the assessment charged for greenhouse gas emissions for a combined heat and power plant will be economical because they add a very significant charge each year for operation. So if we can restructure this, we will. I am, as I mentioned, actively involved with the Mayor's advisory board on the implementation of the law. One of the things, which we will attempt to speak to is how actually to measure the greenhouse gas coefficient of combined heat power plant. However, Christina, on arrival and in review of this said, "Look, the way things are presently set and based on the fact that the rules as they are currently set the levels as they're currently set are -- they render it uneconomic. It's the logical time to expense."

And is it your sense that most building owners or I should say, office building owners in New York City might seek to offset some of those risk by looking at the corporate tax credits as one of your peers have done.

So look, this is a much bigger subject. I'll just say that there is a lot of work that needs to be done on this. There are limitations as to what you can do on carbon tax credits. There's a lot to be sorted through. This was an ideal, logically positive, I think, move. However, it's not a very well thought out bill on many levels. And to the extent that we can be helpful with the city, and which is our goal and the goal of everybody is on the advisory board, to improve the current situation, we will. But we have to be conscious of with what we're dealing. And so with that in mind, we took the write-down that we did.

Our next question comes from the line of Craig Mailman of KeyBanc Capital.

Just a follow-up here. As you think about the OpEx savings and kind of just looking at the fiscal kind of outlook for the city, I mean, how much of this could just be eaten up by higher taxes as we head into '21 and '22, property taxes?

Certainly a risk, Craig. Certainly, a risk. So I think that one of the reasons that we need to be careful to Michael's earlier question about how we look at underwriting opportunity set, got to take a look at what happens on the fiscal scene. Every city in the United States, not just New York City, has been tremendously adversely impacted by the COVID pandemic. I think the good news is, candidly, there's a lot of fat in the New York City budget. During the de Blasio administration, there have been significant increases in a lot of programs, creations of new programs, which are ideologically and I think directionally logical. However, when it really comes down to what makes the difference to deliver services to allow the city to function, there's a lot of fat that could be cut. And I think it's important to note that this Mayor and this City Council, 2/3 of the City Council will be gone as of the next election cycle in 2021. Everybody's term limited out. So it's going to be a very interesting set of developments, I think, as we go forward. And it's one where I think we just need to be careful when we look at committing new capital.

And then just on the CapEx savings you guys have, it sounds like some deferred R&M. I mean, how much of that is just going to land in '21? Is this kind of the timing decision there just because some of that could be passed through to tenants. Do you want to make sure people are in a space to be able to pass it through? Or is some of that permanently avoidable?

Tom?

Sure. Craig, this is Tom. As we commented, we're near the end of our redevelopment program. And so we're seeing the benefit of that. We had anticipated a decline in our CapEx spend going into 2020. But certainly during this environment, we took a look at everything. We've deferred those things where we can get more life out of equipment or systems, and we're focusing on executing and completing the work that we had commenced pre-COVID, and we're prioritizing only those things that are going to generate income. But the big picture is that we're nearing the end of our redevelopment. And so I think we're in good shape. I'm pleased with the reductions. We're closing out a lot of work at the Empire State Building and throughout the portfolio, and that's what we're trying to wrap up this year.

There are no further questions at this time. I would now like to turn the call back over to Mr. Malkin for any closing comments.

Okay. Operator, thank you very much. Thank you very much to everybody else on the call. Clearly, we did this all right. We are socially distanced. We didn't all fit in one conference room. So -- but I think hats off to the team. We pulled it off. All that being said, I think -- I'd just like to thank everyone for the time and effort put into the disclosures this quarter more detailed specifically than normal. However, we think it's good and helpful to you folks to be able to analyze and underwrite it. Please remember that forward-looking statements on plans to ramp up the Observatory and return to business really for discussion purposes only. They're not guidance. We will have to pivot and flex depending upon what happens with travel and with COVID pandemic. Switching gears, I want to express on behalf of the Board and myself, gratitude and appreciation we have for the hard work of all the ESRT's employees during this time. Our team has continued to approach the business with calm mindsets. We've got a smart-work can-do experience and resilience that will carry us through these times. Our balance sheet and proactive cost-saving measure will position us well for what lies ahead. The fact is we've had to say sad goodbyes to team members who have been impacted by a reduction in force to date. People had to tolerate some tough news with regard to compensation reduction. And we have another phase, has been mentioned, of cost examination and reduction to do after these costs settle in. So we look forward to the chance to meet, see many of you virtually either through roadshows or conferences in the months ahead. And we look forward to the opportunity to share our third quarter results in October. Until then, please stay safe and onward and upward folks.

This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.