Greetings, and welcome to the Empire State Realty Trust Third Quarter 2020 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Anthony Malkin, Chairman and CEO (sic) [ Thomas Keltner ]. Please go ahead, sir.

Good afternoon. Thank you for joining us today for Empire State Realty Trust's Third 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. 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 Tony Malkin. Chairman, President and Chief Executive Officer.

Thanks, Tom, and good afternoon to everyone. ESRT continues to adjust on a daily basis the smooth tenant reentry, collect rents, manage Observatory visits, assist survival of our local retail tenant and ensure ESRT employee safety. Our tenant presence in our buildings in our Greater New York Metro area has grown materially to 45% in our Westchester properties and 55% in our Connecticut properties. Our New York City buildings continue to see slow growth off a low base, with the lowest utilization by our largest tenants with a resultant occupancy below 15%. Our Lower New York City physical occupancy impacts our retail tenants and that is where we have targeted our proactive work, a temporary shift to percentage rents in order to help these small businesses survive. Visits to the Empire State building continue to grow off a very low base, with roughly 2/3 of our typical visitor traffic from overseas. Potential attendance is limited by reductions in capacity to maintain our stringent COVID-19 protocols and also by border controls against interstate and international tourist travel. The Empire State Building Observatory 86 floor deck reopened on July 20 and the 102nd floor reopened on August 24. Despite the travel restrictions, we have seen steady weekly increases in visitors. Through October 25, attendance was nearly 6% of 2019 comparable period attendance, an improvement, but below the 10% projection, hypothetically set forth earlier by us for traffic in October. We are fortunate to be well positioned to manage the challenges that we face with our flexible balance sheet, continued success with collections, successfully implemented cost reduction measures and new management team members. All this works to our advantage as we look to utilize our balance sheet flexibility, no current requirement to pay a dividend and look at ways to deploy our capital…

Thanks, Tony, and good afternoon, everyone. In the third quarter, we signed 18 new and renewal leases totaling approximately 247,000 square feet. This included approximately 137,000 square feet in our Manhattan office properties; 105,000 square feet in our Greater New York metropolitan office properties; and 5,000 square feet in our retail portfolio. The most significantly signed in the quarter were a 103,500 square foot new office lease with Li & Fung at the Empire State Building. Li & Fung replaced an existing Global Brands Group lease for the identical space with no change in rent, tenant concessions or lease term. And a 63,200 square foot new office lease with Berkley Insurance at Metro Center, which backfills the Thomson Reuters move out from the second quarter. Subsequent to quarter end, we signed a 212,000 square foot new office lease with Centric Brands at the Empire State building for space, which Centric had previously subleased from Global Brands Group. This transaction is a triple win. We retained a 212,000 square foot tenant who rejected their sublease in bankruptcy and was closed to signing a lease at 237 Park Avenue, reduced the burden on Global Brands Group who would have had to take rent on space for which it has no need and all with minimal leasing costs. While the leasing spread was negative 15% based on initial face rent, this transaction was approximately neutral on a cash flow basis, inclusive of all related transaction costs and related lease termination fee. Excluding the Li & Fung and Centric leases, new leasing activity in our Manhattan office portfolio during the third quarter was reduced due to the impact of COVID-19 pandemic, and we expect reduced leasing volumes in the fourth quarter. During the third quarter, rental rates on new leases signed at our Manhattan…

Thanks, Tom. For the third quarter, we reported core FFO of $35 million or $0.12 per diluted share. This is net of $0.02 per share of expense from a reserve against tenant receivables and noncash reduction in straight-line rent balances and excludes $3.2 million in onetime charges and expenses, which I will address later. Same-store property operations, if you exclude onetime lease termination fees and Observatory results from the respective period, yielded a 9.3% cash NOI increase from the third quarter of 2019. This increase was primarily driven by lower property operating expenses and free rent burn-off, partially offset by lower revenue. More detail on the breakdown of our collection can be found on Page 10 of the investor presentation. During the quarter, we recorded a number of unique onetime items that are add back to core FFO. Specifically, we recorded a $1.3 million impairment charge net of reimbursement related to the write-off of prior capitalized expenditures on the development project, an $800,000 onetime severance charge due to the elimination of position and $1.2 million onetime accrued expense due to an estimated liability stemming from IPO-related arbitration. We also recorded a $5.8 million reduction in rental revenue or a $0.02 FFO impact in the third quarter, comprised of a $4.4 million reserve against tenant receivables and $1.4 million against straight-line rent balance. The annualized impact of the reserve against tenant receivables equates to approximately 3.2% of our annualized rental revenue as of September 30, 2020. We reached this determination after a review of each tenant arrear status, security deposit balance and management's assessment of the path towards the resolution and viability of the tenant. Turning to our balance sheet. As of September 30, 2020, the company has $1.5 billion of liquidity, which is comprised of $373 million in cash and…

[Operator Instructions] Your first question comes from line of Craig Mailman with KeyBanc Capital Markets.

Just kind of curious here, traditionally, your portfolio has been sort of the value product in your markets, priced below kind of traditional midtown office and then not really competitive with new supply, but clearly, sublease availability is rising in core midtown markets and rents are expected to fall here. Can you guys just give a sense of how you're thinking about -- kind of how your product is positioned today in that environment, your ability to kind of hold rents here? And whether you've seen any changes in tenant profile that are in kind of the leasing pipeline?

Craig, this is Tom. First, I would remind you of the attractive value proposition that we make. We're priced -- have always traditionally been priced below Class A and deliver a better product than Class B. We're incredibly well-located, essentially located mass transit. And I'd remind you that we've invested over $1 billion within our portfolio and to modernize our entire portfolio and have redeveloped 94% of all of our space. So we're delivering modernized product, great location and at a price point that is still incredibly affordable. As far as trends, it's really early to say. There's a limited amount of leasing activity. Certainly, we're operating on lower volumes than this time last year. And so I'd be hesitant to say where the trend is exactly. We have probably given more on concessions than discount on face rents. But if you look at our average net effective rent decreased by about only 3% compared to the second quarter. And that's, I think, reflective of relatively low leasing costs. We are seeing tenants preserve capital. We are trying to preserve capital, but of course, we have space that's been redeveloped, and that helps in that regard. As far as the sublease market, look, there's been an increase in sublease availability in the overall market. We saw some increase within our own portfolio this quarter, but much of that was anticipated. And some of that already appeared on space we expect to get back in 2021, reflected on Page 9. So it really wasn't a surprise or a result of COVID per se.

Okay. That's helpful. And then just quickly on the Observatory, Tony, it was helpful for you to run through the buckets of where the income came from. Just as we move into fourth quarter and next year, how much of those kind of deferred ticket sales do you guys kind of have to come through and give a boost relative to if actual attendance stays at these kind of trough levels here?

Yes. So unused tickets are always part of the business. There are always in the number in some fashion. What's unique this period is the buildup because we didn't take them in during the period where it was closed, expecting that ticket had potential to be used. So the $2 million represents a higher than usual number. We say you can expect a couple hundred thousand per quarter in the next several quarters, keeping in mind tickets have a 1-year expiration period. So by the time we lap second quarter next year, that number would deplete. And one additional point, we've now also moved to time ticketing, which sort of expires on the spot, so we don't have the typical issue.

Our next question comes from the line of Manny Korchman with Citi.

Tony or Christina, if we can just talk about the buybacks for a moment. How do you sort of figure out the pace and the timing of those? You've done $133 million to date, but -- a lower volume here in this quarter when the stock was under pressure. So just as you look at other opportunities, as you look at your own liquidity, how do you think about how much you should be buying each quarter?

Thanks, Manny. As I mentioned, we believe we have a long path ahead going through different phases. And in consultation with our Board, we continue to exercise patience as prudent as we evaluate all of our options. What we really do is we look at the opportunity of how to utilize each dollar at a time when there is competition. We didn't do the dividend because we felt we had an asset on our balance sheet, no requirement to pay a dividend. So we decided to take care of -- take advantage of that as a good capital allocation decision. We will similarly look at repurchase opportunity as a capital allocation decision each time we look at our balance sheet, capital available and what else we might do. So the Board and management continues to review our priorities. And we just don't see a really quick snapback in the economy for New York in our business conditions. That's part of the reason for our pace.

And then just on the Observatory rents, is there any risk that that gift shop rent would get cut for any reason? And understand it's contractual, but at the same time, obviously, that's a tenant that's under a lot of income pressure right now.

We have to talk to all of our tenants all the time about the prospects that they have with their business. We've afforded opportunity for tenants to have rent deferrals, maintenance, changes, and we may end up in a discussion with that particular shop operator. I would not anticipate we end up with a period of no rent but it's possible that the month-to-month rent could be adjusted.

So the $1.2 million, if I'm not mistaken, that was as contractual or that was already adjusted?

Pre adjustment.

That was contractual. And we'll update as and when they develop.

Next question comes from the line of Steve Sakwa with Evercore ISI.

Great. Christina, I know you guys took another kind of large round of charges this quarter. And I guess, relative to the uncollectibles, I think 3%, maybe of the 5% is now effectively on effective cash accounting. And just how do you think about sort of the remaining couple percent that's not collected or not really dealt with? And what sort of resolution do you think you get on [ rent ]?

Yes. We will continue to evaluate. In some instances, as we show on Page 10, we do have a security deposit that covers those amounts, and we will be in continued discussions with the tenants to see if we can collect. So I think that with 3% or 3.2% of the 5%, we've addressed most of it. As mentioned, our key criteria is, again, the arrear status, security, deposit balance, how those discussions are going and whether it's a viable business. And as mentioned in our earlier remarks, for those that are food vendors and really need some support in terms of percentage rent to get through a period where the buildings are experiencing low utilization, we will focus our energy on that and get to a win-win situation, knowing that even if you have a replacement tenant, they'd be in the same situation. We feel pretty good about where we're going, but we will continue this discipline of being very transparent and writing off anything that we deem unpassable.

Okay. And then maybe just kind of circling back on the buyback and the leverage. I think -- I don't remember it was Tony or you, Christina, that said you're 5.6x net debt to EBITDA. Just remind us kind of what are your targets or sort of what is the upper bound that you would take that number to as you think about buybacks and new investments?

Yes. So we think of that a little bit differently. It's not a specific target that we're trying to avoid or try to limit ourselves to. It's really about the availability of capital. So to the extent, if we need to replenish liquidity that you put out, we might have a different view. What we are seeing today is that the market is definitely moving into more a haves and have not environment. Capital is available, but it's becoming a little more selective, favoring certain sectors, favoring specific profile, a building, assets with lease term or not. So we're aware of all those factors, and we'll be extremely prudent and patient in how we deploy capital. I think the buyback activity reflects that, which is when we announce our decision to suspend the dividend for 3Q and 4Q, we made it very clear. We're acutely aware of how attractive our discounted share prices is on the agenda, the opportunity to buy back our portfolio at these per square foot or implied valuation is extremely compelling. Having said that, it is a very uncertain environment, right? So you mentioned several thesis. And even after that, we need a return. So having operating runway is extremely important. We do not want to be in a position where we're forced to sell assets when it doesn't make sense. So taking all those elements into consideration, we will continue with the buyback activity, but it will be at a prudent and measured pace.

Okay. Great. And then last question. You guys mentioned the utilization differences between the suburbs and New York City. I'm just curious if Tom is seeing a real pickup in suburban office demand, either from existing New York tenants, some sort of hub-and-spoke or potentially complete moves out of the city to the suburbs?

Yes. Steve, we've seen some new post COVID activity from tenants coming out of New York City, looking to open up a satellite office and a couple of potential relocations, but it's -- I wouldn't call it a major trend. We signed 3 leases with New York City-based tenants to date, that totals just under 10,000 square feet, returning papers with other tenants that represents a little under 40,000 square feet. A couple of those -- a couple of tenants we may relocate from one of our New York City properties to one of our Connecticut properties. But I think the square footage that I just gave you puts it into context. Of course, we're in a great position to take advantage of any tenant seeking to relocate or have a second office outside New York City because of our reputation, our relationship with the New York City brokers and then our great access to mass transit.

Your next question comes from the line of Blaine Heck with Wells Fargo.

So Tony, it was good to see a little bit of an increase in revenue and activity at the Observatory this quarter. But as you point out, you're still running below your original projection. I guess I'm wondering if there's enough of a difference there to change those expectations and forecast at this point. Or maybe do you think it's just a little delayed here in the beginning, and you still got a chance to kind of catch-up to some of those projections in future quarters?

Well, first of all, I appreciate the question. We are confident that travel will return, and we are confident in the future of New York City. We also believe that we will not be out of the disruptions from COVID-19 until we see free travel in and out of New York City from states and countries. Just this week, we have had reinforced the reality that we are not there now. So the way we look at this is, number one, we do see steady growth. We are basically selling New York to New Yorkers right now. Our hypothetical growth targets remain as represented on Page 18 of our updated investor presentations. We believe that the social media reviews that we have received since we reopened, which are 5 star focus on cleanliness, safety and the enjoyability of it. That is what is encouraging more and more people to visit. We're very comfortable with the way we are outperforming and based on our market intelligence, any other attraction that is comparable to us. That said, we'll take another look as we head into November through December, and recognize that these are very low periods for us at any of any particular year right now, this -- excuse me, any particular year this time is slow. And then if we think we need to take another look at the hypothetical layout that we gave, we will. Just want to make sure that you understanding and everyone is understanding, when we gave the original hypothetical outlook, we were really driven by the guidance from the SEC to address the potential impact of COVID-19 on our business. And we felt it was really important to provide investors with the view that we had that the pandemic would be a long-term impact, something we thought that investors did not have at the time. I think that what we found is that the pandemic's had an even bigger impact than the larger impact that we thought of at the time when we first did this. We will try to update this hypothetical from time to time. I think the best thing to do is to track flights in and out of New York City. It's places from which people can visit, which will drive our business higher. And that's good data. That's what we look at. That's what we track. Hope that's helpful?

Yes. Great. That's helpful commentary. And then second question, just on the Li & Fung lease at the Empire State Building that replaced some of the Global Brands space. I believe Li & Fung is in space at 1359 Broadway as well. And it looks like that lease expires in phases starting at about a year. So I guess, does this lease at the Empire State Building have any implications for the space that will be coming up and expiring at 1359?

Sure. The Li & Fung space at 1359 that as you mentioned, expires in 2021 and then other tranches expire out in 2023 and '27. We do anticipate we'll take some of that space back at 1359 in late 2021, a little over 55,000 square feet, and that's captured on Page 9 of our supplement. We've always anticipated that. And -- but overall, it's a net-net positive for us and it locks Li & Fung into a much longer-term lease for approximately 8 years at Empire State Building for the 103,000 square feet that they took there.

Your next question comes from the line of Jamie Feldman with Bank of America Merrill Lynch.

I guess, Tony, I appreciate all your comments on the WELL rating. Did you have to make any additional investments in the portfolio to hit those numbers? Or are we already on track to get there?

Happily. Actually, Jamie, we were there already. And it's just -- if you've read our stuff in the past, I felt that it was important for us not to cater to other people metrics. We've decided to go ahead and submit ourselves to other people's review, and the WELL rating was just a validation of how far ahead we were of everybody else if it comes to indoor environmental quality and providing safe workspaces for people -- safe and healthy workspaces. So we made no other change.

Okay. Interesting. And then just thinking through the schedule of your largest unknown and tenant vacates through next year, can you provide some color on the true move out risk or maybe the size of some of those leases just so we have some idea of where the risk -- the occupancy risk might be or maybe won't be?

Jamie, if you refer to in Manhattan on the unknown, most of those -- really, all of those leases are below 10,000 square feet and then out in the Greater New York Metropolitan office portfolio in 2021, we have 2 tenants that are a little over 20,000 square feet each. The rest are relatively small. And then the balance that you see on the schedule are either already classified as known renewals, relocations or vacates. So not a whole lot of unknown at this point, only about 80,000 square feet in Manhattan, 62,000 square feet in the Greater New York portfolio.

I just might add to Tom's comment. When we look at what we've got as far as rollover and unknown on the outcomes, we look at all of this stuff with the context that we are in as much contact as we possibly can be with our tenants as to their needs, their uses, their return to office. I think the lease that we did with Centric, combined with Global Brands Group is a huge triple win for us. The fact that we were able to take that space where they were aggressively out in the market through their restructuring team had an active lease underway -- to go to another building. We're able to preserve them at Empire State Building on a direct basis, deliver that to us on a long-term lease and also relieve the burden of our direct tenant, Global Brands Group of the need to cover space that it otherwise would have on its balance sheet obligations with its subtenant moved out. So we'll work super hard with all of our expirations, including the ones that the market throws up at us. And I think we'll be very successful in that.

Okay. And then what about the category of known move outs? I mean how chunky are those?

In Manhattan, in 2021, as I mentioned earlier, that -- in response to Blaine's question, we are getting back a little over 65,000 square feet from Li & Fung at the end of 2021. And that's really our largest vacate next year. And then we've got some tower floors at Empire State Building and One Grand Central, happy to get those back because they're consolidated in their tower floors. And so I anticipate that they'll be in good demand. That's really the largest known vacate next year.

Your final question comes from the line of Frank Lee with BMO Capital Markets.

First question I have on the Observatory. Have you implemented any new marketing or any changes in pricing strategies that you think will help drive traffic?

Look, first of all, we are currently outperforming all of our comps, and we have our highest forecast in our history. We have not adjusted our pricing nor do we intend to. We did raise slightly the pricing that is paid during our subset period, which is our peak period for visitors at the building always has been. So that was always planned for when we reopened, and that's not represented any reduction. It's not created any reduction in our attendance from subset period. And as far as what drives people to us, no, we haven't done any discounting. We know we are capturing the biggest component of the market as far as people go into destination attraction. The Edge is giving away free tickets to first responders. That's been a major source of their traffic. One World Trade is not open yet. They're talking about opening on weekends only. We have good insight as to our performance in comparison to top of the rock. So we really see no reason to discount. We think we will get the visitors who want to come for a clean, safe and uncrowded experience. And we really -- out of all of our TripAdvisor comments since we reopened, we've had 2 negative comments about price. And we've had just a slew of incredibly positive comments about the quality of the experience, safety and cleanliness.

Okay. And then on the direct lease with Centric, are you able to quantify the termination fee associated with the transaction? And should we expect this to be recorded in the fourth quarter?

I'll simply say what I had commented earlier that the transaction is neutral to slightly positive over lease term on a cash flow basis. Beyond that really aren't in a position to share more detail on that. But as Tony mentioned earlier, I think it's a fantastic outcome or fantastic feeling. So great result for the company.

And then on your question on booking, it will be booked over the remaining site of the lease. So nothing chunky.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Mr. Anthony Malkin for closing remarks.

So, look, thank you, everybody. Thank you very much for participating in the call today. We will continue to improve our disclosures in both financial and ESG. We continue to make strides in both, and we're happy about that. Please remember that forward-looking statements on plans to wrap up the Observatory return to business are for discussion purposes only to help you with your models. They are not guidance nor are they guarantees. We feel good, well positioned with our portfolio, our leadership and energy efficiencies, sustainability and indoor environmental quality, combined with their flexible balance sheet and proactive cost reduction actions, really, we think, represent not only long-term planning, but our ability to pivot and flex and meet the challenges of these difficult times. I'd like to just say one thank you to our Board who have been active in direct conversations with our major investors. And also thank our investors for their frank conversations with our Board members. We feel that open dialogue and communication has great value in general, and especially so in today's world. So we look forward to the chance to meet many of you virtually either through roadshows or conferences in the months ahead. We're doing meetings here in our office, which has ventilation MERV 13 filters and active bipolar ionizations. So as Steve and Michael will tell you, it's a safe place to come, a safe place to visit. And until then, we report in February for the full year. Stay safe, be smart and an [indiscernible].

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.