Empire State Realty Trust, Inc. (ESRT) Q4 2022 Earnings Report, Transcript and Summary

Greetings, and welcome to the Empire State Realty Trust Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce Heather Houston, Senior Vice President, Chief Counsel, Corporate and Secretary. Thank you. You may begin.

Good afternoon. Thank you for joining us today for Empire State Realty Trust fourth quarter 2022 earnings conference call. In addition to the press release distributed yesterday, a quarterly supplemental package with further detail on our results and our latest investor presentation were posted in the Investors section of the company's website at esrtreit.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements as defined in applicable securities laws, including those related to market conditions, property operations, capital expenditures, income, expense, financial results and proposed transactions and events. 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. During today's call, we will discuss certain non-GAAP financial measures, such as FFO, modified and core FFO, NOI, same-store 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, our Chairman, President and Chief Executive Officer.

Thanks, Heather, and good afternoon to everyone. This is Heather's firsthand on the wheel on our earnings call since the retirement of Tom Keltner. We are delighted to have her here with us and we will always be grateful and appreciative of Tom Keltner's more than 40 years of commitment and contribution to ESRT and its predecessor entities. ESRT is pleased to report strong fourth quarter results to close out the year, provide updates on our capital recycling activities and leasing, and our outlook for 2023. Our ESRT team accomplished a lot this year. ESRT's top priorities are to lease space, sell tickets to the Empire State Building Observatory, make good use of our balance sheet, achieve our sustainability goals, and do all of this with an unrelenting focus on shareholder value. We had a very solid leasing year. We leased over 1 million square feet at consistently positive leasing spreads and made meaningful absorption progress with a 210 basis points increase in Manhattan office occupancy and a 260 basis points increase in Manhattan office leased percentage throughout the year. Our buildings represent affordable options in the flight to quality, the character, full modernization, great locations near mass transit, great amenities in place with more to come and industry leadership in energy efficiency and indoor environmental quality. Our goal is to get the best deal in good times and get the deals in challenged times and draw consistent leasing volumes through cycles. Existing tenants who know and love our product grow in our portfolio. We have completed 258 expansions, which totaled 2.5 million square feet since the company went public. We continue to build our leased percentage and that will drive higher occupancy and earnings in the future. Tom will cover 2022 in more detail, announce a great lease just completed and discuss our 2023 pipeline. Our quality portfolio is resilient and ESRT benefits from the flight to quality trend. Our entirely re-imagined Empire State Building Observatory is the beneficiary of a $165 million renovation and new exhibits completed just prior to the pandemic and our introduction of our timed ticketing operation. The customer experience has been improved by the exhibits and by reduced crowds with generally no lines. Now that we know when customers will be there, we plan better our staffing and control expenses. We now reap the rewards of these efforts. Tripadvisor's number one attraction in the United States, number three in the world is the authentic experience that benefits by comparison to all the other new entrants in the market. We hit our observatory NOI expectations in 2022, largely driven by growth and revenue per capita, prudent expense management, exceptional brand awareness, and a shared commitment to excellence by the entire leadership team. In December 2022, observatory NOI reached 99% of pre-COVID 2019 levels and visitation reached 88% of pre-COVID 2019 levels. We are an international brand. We have spoken about the strength of ESRT's balance sheet for years. It helps us win new tenants who look to partner with a financially stable landlord who will maintain high-quality standards at their assets and deliver on their commitments to tenants. Tenants seek a compelling value proposition and ESRT offers a high-quality experience and trophy assets at our attractive price point. Our balance sheet allows us to be nimble and engage in share repurchases, new acquisitions and capital recycling. We derive our income from diverse sources, office rentals, Observatory income, retail rentals, and residential rentals. The addition of multi-family to our portfolio since December 2021 further diversified our cash flow stream. We have recycled our balance sheet tax efficiently through the sale of various suburban assets and reinvestment into Manhattan multi-family. We have broadened our industry leadership in environmental sustainability and healthy building performance over the past year. ESRT achieved carbon neutrality in 2022 and we continue to make progress towards a goal of zero net -- net zero emissions by 2035. We published the Empire Building Playbook for decarbonization of existing buildings in partnership with the New York State Energy Research Development Authority, a guide for others on how to achieve sustainability goals. We received target validation approval from the science-based targets initiative with their most advanced 1.5 degree target. Platinum recognition with Green Lease Leaders maintained the highest possible GRESB ratings and global sector leadership distinction and achieved re-certifications for WELL, Health-Safety, Fitwel and ENERGY STAR. We are the only New York City commercial landlord on the Local Law 97 implementation Advisory Board, and we are the only New York City commercial landlord on the New York City Sustainability Advisory Board. We have been included in the Bloomberg Gender-Equality Index for two consecutive years. These ESG accomplishments and initiatives are increasingly important both tenants and their employees as well as investors, and remain a top priority for ESRT. Our stock outperformed CBD office peers from 2020 to 2022 and year-to-date for many of these reasons, even though we think it is obvious that it still trades at a crazy discount. Lastly, we introduced guidance for the first time in 2022 to give the Street more clarity on the earnings trajectory and outlook for our company and actual results, which exceeded our initial expectations. This is the work of a great team that is navigated through challenges and rises to the occasion with incredible focus on our company's four priorities and demonstrated progress. We move forward into 2023 with the same goals, lease space, sell tickets to the observatory, proactively manage our portfolio, achieve our sustainability goals, manage our balance sheet, and drive shareholder value. Tom and Christina will provide more detail on our progress and how we plan to accomplish these goals in 2023. Before I turn it over to Tom, I also want to congratulate Christina, on her promotion to Chief Operating Officer in addition to Chief Financial Officer this quarter. Christina is a great partner to all of us, a great leader and has tremendous value. Her new title reflects the role into which she has grown as a great fellow executive officer to Tom and me, and she's involved in every strategic decision. Tom?

Hey, thanks, Tony, and good afternoon, everyone. We had a very solid year in 2022 and 2023 shows real promise. During the year, we signed over 1.1 million square feet of leases, which is consistent with our pre-COVID three-year average lease volume for 2017 to 2019. In our Manhattan office portfolio, we achieved positive mark-to-market lease spreads in each of the last four quarters, experienced steady net effective rent growth throughout the year, and signed major new and expansion leases with quality tenants, including iCapital, Signature Bank, Progyny, Crown Castle, and others, and leased to just shy of 300,000 square feet of pre-built during the year nearly matching our total volume of pre-built leased in 2019. While Manhattan's market wide office availability rate increased in 2022, ESRT's Manhattan office leased percentage rate improved by 260 basis points and occupancy increased by 210 basis points for the year. We benefit from the flight to quality trend and our outperformance demonstrates tenants' desire for our fully modernized, energy efficient and healthy buildings, which are conveniently located in your mass transit with in-building amenities, access to neighborhood amenities and exceptional tenant services, and an attractive price point. In the fourth quarter, office leasing spreads remained positive with new and renewal lease spreads signed at our Manhattan office properties up 5% on a cash basis compared to the prior escalated rents. We signed 29 new and renewal leases totaling approximately 144,000 square feet, which includes 93,000 square feet under our Manhattan office properties dominated by healthy activity in our smaller pre-built suites, 50,000 square feet in our Greater New York Metropolitan office properties and over 1,000 square feet of retail. After year-end, we signed a 16-year 65,000 square foot lease with an engineering firm at the Empire State Building. Combined with fourth quarter leases, we have signed nearly a 100,000 square feet of new leases at the Empire State Building, where we have significantly increased our leased percentage. We have active deals in our pipeline throughout the portfolio, including pre-built suites and several full floor leases that should drive portfolio leased percentage higher. We're well-positioned and confident in our ability to drive our leased rate higher in 2023. We invested approximately $1 billion into our assets since our IPO to create healthy buildings that are fully modernized. We are adding to our robust in-building amenities at the Empire State Building and shared campus amenities in our Times Square South portfolio. Our tenants' spaces are newly built with the best in indoor environmental quality and energy efficiency, which lowers tenants' occupancy costs while increasing employee health and productivity. Our assets are well located near neighborhood amenities and mass transit hubs. The recent opening of the East Side Access to Grand Central Station will greatly benefit us at One Grand Central Place. After years of consolidating smaller spaces to create move-in ready pre-built suites and full floor turnkey spaces, our hard work is done with over 95% of our tenant spaces now redeveloped, and our vacant space is ready for immediate lease up. We proactively managed our rent roll such that only 5.1% or 494,000 square feet of leases are set to expire in 2023. And we have $54 million of contracted incremental rent from signed leases not yet commenced and free rent burn-off. Our strong balance sheet affords the ability to compete in today's environment and gives our tenants and brokers confidence that we will deliver on our promises. We have an exceptional dedicated team that executes daily on behalf of our tenants and their brokers. And although, New York City office using employment has recovered and now exceeds pre-pandemic levels as close to 200,000 office using jobs have been added since the second quarter of 2020. We have demonstrated our ability to lease space through all cycles. We've done the hard work to position ourselves to increase our lease percentage and achieve positive absorption in 2023. Same-store property operating expenses and real estate taxes were up this year as contemplated in our guidance, but were approximately 7% below pre-pandemic levels in 2022 due to a combination of permanent cost saving measures by the excellent work of our operations team and gradual return to office throughout the year. Property operating expenses alone were 13% below pre-pandemic levels and through continued discipline cost control; we forecast 2023 property operating expenses will be approximately 3% below our 2019 actuals. Christina will provide more detail in a moment. Turning to our multi-family assets. As previously announced, we close on the off market acquisition of 298 Mulberry Street in late December and are thrilled to add this property to our growing multi-family portfolio. 298 Mulberry is a 96 unit fully occupied multi-family asset located in a highly desirable neighborhood at the confluence of the NoHo, Nolita and East Village submarkets, which have a limited supply of market rate, full service product and is in walking distance to NYU. Importantly, this asset is 100% free-market and we see upside opportunity through mark-to-market on in-place rents and future rent growth. Total multi-family occupancy, which now includes the newly acquired 298 Mulberry, remains strong at 96.3%, and we continue to see good mark-to-market increases as steady demand across the Board, which validates our investment decision. In summary, as I said at the start, we had a very solid year. We've done the hard work, invested in our assets over many years, and are exceptionally well-positioned to lease space and achieve positive absorption again in 2023 We signed office and retail leases of 144,000 square feet in the fourth quarter and over 1.1 million square feet during the full year. We increased our Manhattan office portfolio leased percentage by 260 basis points and achieved positive absorption of 210 basis points in occupancy over the prior year. We signed a new lease for 65,000 square feet at the Empire State Building after year-end, and we have grown our multi-family portfolio where we continue to see strong fundamentals and performance. And now I'll call -- turn the call over to Christina. Christina?

Thanks, Tom. Let's start out with an overview of results for the year. We reported core FFO of $244 million or $0.90 per diluted share, which compares to core FFO of $195 million or $0.70 per diluted share for 2021. 2022 core FFO exceeded our most recent guidance range of $0.83 to $0.85, largely driven by stronger performance at the observatory towards year-end and lower than expected year-over-year decline in full-year same-store NOI of 4.1%, driven by modest same-store revenue growth offset by an approximate 9% higher property expenses as expected. For the fourth quarter of 2022, we reported core FFO of $59 million or $0.22 per diluted share, which compares to core FFO of $50 million or $0.18 per diluted share for the fourth quarter of 2021. Same-store property cash NOI excluding lease termination fees was down 3.3% year-over-year, largely driven by higher property operating expenses and real estate taxes partially offset by higher revenues from cash rent commencements. The observatory hosted 660,000 visitors and generated NOI of $23.8 million in the fourth quarter, up significantly from 360,000 visitors and NOI of $10.7 million in the fourth quarter of 2021. Observatory visitation recapture in the fourth quarter was 74% of comparable 2019 visitation, which exceeded our revised hypothetical forecast of 66% of comparable 2019 visitation largely driven by strong December demand when visitation exceeded 88% of comparable 2019 levels. Notably, fourth quarter NOI recapture as a percentage of 2019 was 82% and the testament to our team's execution. For the full-year, observatory NOI totaled $74.9 million, which represented NOI recapture as a percentage of 2019 of 79%. We continue to tightly manage expenses at the observatory and generate strong revenue per capita, which were up 18% in 2022 versus comparable 2019 level. As a result, the NOI recovery has outpaced visitation relative to pre-pandemic levels. We will be focused on the NOI outlook going forward as we provide guidance to the Street on the observatory's performance from here. As a reminder, the observatory historically contributed roughly a quarter of the company's NOI and stands at approximately 21% on a trailing 12-month basis through the fourth quarter. Our balance sheet as of December 31, 2022, had total liquidity of $1.1 billion, which was comprised of $264 million of cash and $850 million of undrawn capacity on our revolving credit facility. At year-end, the company had net debt at share of $2.3 billion with a weighted average interest rate of 3.9% and a weighted average term to maturity of 6.4 years. Our ratio of net debt to adjusted EBITDA was 5.7x well below peer averages. Notably, we have no floating rate debt exposure and a well laddered maturity schedule with no debt maturity until November 2024, when a $78 million mortgage matures. Our balance sheet affords us flexibility to engage in activities that generate shareholder value. This includes the repurchase of our shares, the pursuit of investment opportunities that are additive to our New York City focused portfolio and capital recycling. For the full-year 2022, the company repurchased a total of $88.9 million of its common stock at a weighted average price of $7.78. In the fourth quarter, and through February 13, 2023, the company repurchased $8.2 million of its common stock at a weighted average price of $6.70 per share. This brings the cumulative amount repurchased to $281.2 million at a weighted average price of $8.31 per share, which represent approximately 11% of total shares outstanding as of March 5, 2020, the date our share buyback program began. As previously mentioned, we focus on capital recycling and we take a hard look at each and every one of our assets and pursue dispositions where we have executed on the business plan and/or can recycle the proceeds into assets that align with our long-term portfolio cash flow growth objectives. We are pleased that during this period of significant market uncertainty, the company successfully executed on its capital recycling strategy. In terms of dispositions, in the fourth quarter, the company closed on the sale of an office asset located at 10 Bank Street in White Plains, New York, at a gross asset valuation of $42 million. 500 Mamaroneck Avenue in Harrison New York remains under contract for sale for $53 million with an expected closing in the first quarter subject to customary closing condition. Subsequent to year-end in February, the company closed on the disposition of its retail assets located at 69-97 and 103-107 Main Street in Westport, Connecticut, at a gross asset valuation of $40 million. The Westport sale was a related party transaction approved in accordance with the company's protocols. The proceeds from these suburban office and retail dispositions were redeployed in a tax efficient manner into the $115 million acquisition of 298 Mulberry Street that we announced in our December 2022 Business Update. In a market with limited investment opportunities given dislocation in the capital markets, particularly those of high quality, we are pleased that our investment team was able to source this off-market transaction. Importantly, this acquisition enabled the company to redeploy its disposition proceeds in a tax efficient manner into an asset with a more favorable CapEx profile. Further, given ESRT's flexible balance sheet with strong liquidity, we were able to acquire the asset on an unlevered basis and contribute this to our unencumbered pool. This represents ESRT's third multi-family acquisition as we continue to strengthen our position as a New York City focused company with a strong balance sheet and portfolio with multiple sources of upside that include fully modernized office buildings that benefit from tenants in search of quality and a strong value proposition, everyday retail in high foot traffic locations near mass transit, the Empire State Building Observatory, a high margin business, which continues to experience a strong recovery with even stronger brand recognition compared to pre-COVID and our multi-family portfolio of well amenitized well located assets. Turning to guidance. We expect 2023 core FFO to range between $0.82 to $0.86 per fully diluted share. This compares to 2022 core FFO of $0.83, excluding lease termination fee income. As a reminder, our guidance range does not include any meaningful future lease termination fees, which totaled $0.07 in 2022. Let me spend a moment to discuss the assumptions used in our guidance. In 2023, we expect same-store cash NOI, excluding lease termination income to be down in the 4% to 6% range from 2022 levels. The change is primarily due to an approximate 8% forecasted increase in property operating expenses and real estate taxes, which is partially offset by higher reimbursement income. The increase in OpEx is largely tied to assumptions for increased building utilization in 2023. For reference, even with this increase, property operating expenses will be approximately 3% below 2019 levels, which reflect some permanent cost savings and efficiencies we achieve from pre-COVID levels. The increased property operating expenses are partially offset by modest revenue growth anticipated, which assumes same-store occupancy of 85% to 87% by year-end. Similar to 2022 guidance, we have factored in some conservatism on the revenue side, particularly in terms of leasing assumptions and timing of lease commencements. Turning to the observatory. We expect 2023 observatory NOI to be approximately $88 million to $96 million, up from $75 million in 2022. As a reminder, pre-pandemic, the observatory generated $95 million in NOI. This NOI guidance assumes observatory expenses of approximately $9 million per quarter for 2023. The low end of our guidance range reflects the potential for a slower than expected observatory ramp up due to uncontrollable factors that could impact travel and tourism and conservatism around property revenues, particularly in terms of leasing assumptions and timing of lease commencements. The high end of our range reflects a ramp up in observatory performance that marginally exceeds pre-pandemic levels. Please note that the guidance estimates and assumptions just described do not include the impact of any meaningful future lease termination fee income, or any unannounced future property acquisitions, dispositions or capital markets activity. In summary, the company has executed well on its priorities. We executed on our capital recycling strategy with completed dispositions of two suburban office assets, two suburban retail assets, and one additional suburban office asset pending closing. In each instance, the transactions were structured to enable the company to redeploy the proceeds in a tax efficient manner. We source through off-market transactions three attractive Manhattan multi-family assets, which now comprise approximately 5% of ESRT's NOI and contributes approximately $0.04 to 2023 FFO. We remained active and executed on approximately $90 million in share buybacks in 2022, which brings our cumulative buyback total to $281 million or 11% of total shares outstanding since the buyback program began in March 2020. We did all of this while prudently and strategically managing our balance sheet to have no floating rate debt exposure, no debt maturity until late 2024, a revolving credit facility that remains undrawn and matures in 2025, plus has two six-month extensions, a strengthened unencumbered pool that now includes multi-family and continued strong liquidity to enable the company to take advantage of attractive investment opportunities that may emerge in this period of uncertainty and capital dislocation. Our commercial portfolio is now over 85% occupied and over 88% leased, and we continue to benefit from tenants demand for high quality assets, a strong value proposition, and landlords with strong balance sheets who can deliver on their commitments. As we look ahead, ESRT advances into 2023 with a well-positioned and flexible balance sheet, a focus on disciplined capital allocation, and continued commitment to ESG, which we believe will allow us to continue to perform despite the economic headwinds and uncertainties in the market. And with that, I'll now turn to the operator for Q&A. Operator?

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions]. Our first questions come from the line of Steve Sakwa with Evercore ISI. Please proceed with your questions.

Yes. Thanks. Good afternoon. I guess a couple, maybe starting with Tom on the leasing. I guess I'm trying to understand maybe a little bit more to the demand that you're saying and to what extent are you seeing, maybe demand coming out of some of these buildings that are being redeveloped in the Penn market from sort of Class B assets and the Class A assets. And is that pushing some of these more value-oriented tenants into your portfolio?

Yes, Steve. We continue to benefit from a flight to quality as we've seen in the past, and we continue to benefit because we're giving tenants what they want. We're delivering healthy buildings that are fully modernized robust amenities to which we're adding, newly built tenant spaces, great access to mass transit, latest in indoor environmental quality, and all at an accessible price point. So we're seeing tenants from across the market, not just the Penn buildings, but from all areas that generally is this flight to quality. And that's evidenced by the excellent year that we have with over 1.1 million square feet of leases signed, which nearly equals our average -- three-year average from 2017 to 2019, which was a pretty robust leasing market. We just signed, as I mentioned earlier, a 65,000 square foot lease with an engineering firm at the Empire State Building that was signed in January following the close of the quarter. So you look at lease signed over the fourth quarter and into January, we've signed approximately a 100,000 square feet of leases at the Empire State Building. We are marketing a full floor high end pre-built of 26,000 square feet at Empire where we held a broker event last week that's creating some good buzz amongst brokers and I'm excited about what we're doing because we're adding to our robust amenities. We've spoken before about the new multi-sports court that converts to a 400 person town hall presentation room at Empire with the tenant lounge, bar service, two golf simulators, the Starbucks that reserve that opened up in November a 23,000 square feet on three floors. And this is on top of the existing spectacular amenities that we have that include a 15,000 square foot fitness center, executive gym conference center, eight onsite food and beverage options. So I think we're incredibly well-positioned to improve our leased percentage in 2023 that's going to drive our occupancy up.

And Steve, Tony here, I'll add that that tenant 65,000 square feet that just came to -- just leased at Empire and they have not announced to their own people yet. So we will announce that at the beginning of March, what the name of the tenant is. It's great tenant is actually come from Park Avenue South, so an area that was hot before and they're coming to quality with more amenities, energy efficiency, indoor environmental quality with a specific mandate to get a space that will be an attraction to talent and the retention for talent.

Okay. Second question, just on the observatory, as you guys think about the continued recovery and using the ticketing system that you've got, how are you sort of balancing volume and price? You've obviously been able to dramatically increase the average ticket price through COVID. I'm just wondering as tourism comes back, Tony, how do you sort of think about that balance between volume and price?

Look, we will always go for NOI over volume. That's part one. Part two; we are very happy with the performance of the observatory. In 2022, we're very happy with the month of January, which has been quite strong. When we look at our goals, we keep in mind the fact that we can always add hours to the observatory based on demand. Right now, because we're all reservation, we know what hours we need to operate, whereas before we just stayed open in order to capture, provide the opportunity to capture visitors when they came through. So we feel very good. We have the best per caps we've had. When we look at the mix that we've added volume and that means more past programs than still on a comparable basis to at the same ratio. Our per cap is dramatically higher. Our brand has never been stronger. We're a true global brand. The branding opportunities, the co-branding, which we get now people come to us, we don't pay for it, they come to us and that only builds our brand further and that builds more direct demand for the attraction. And as volume increases, we'll add ours. What we won't do, however, is diminish the customer experience and that's what got us to number one attraction in the United States, number three in the world. We'll maintain the customer experience. We are the only authentic play in New York City. Since 2013, I've heard, oh, it's going to be One World Trade Center. Oh, it's going to be the edge. Oh, it's going to be the summit. We've continued to perform and continue to improve our game, and that's what we'll continue to do.

Great. And then last question for me, I don't know who wants to take this. I saw under the transaction activity that you guys sold this $40 million asset up in I guess Westport, Connecticut. And it sort of was described as a related party transaction, I just didn't know what sort of details or information you could sort of provide on that deal and maybe how that was priced and sort of the mechanics behind that deal.

Sure. This is Heather Houston. I can take that one and I'll let Christina add to it. So the buyer was affiliated, it's an entity affiliated with Tony Malkin. And the transaction was conducted in compliance with our related transaction protocol, including that the company reviewed with outside counsel that's practices for related party transactions and took additional precautions to ensure an arm's length process. There were separate counsel and appraisals for both the buyer and the seller. The independent members of our Board conducted an independent review under the guidance of outside counsel and then approved the transaction. And full disclosure of the transaction will be made in our 10-K, which we plan to file next week.

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

Hello. Within your same-store NOI guidance of expecting modest revenue growth, can you please comment on your expectations around leasing spreads in particular for your Greater New York Metropolitan office and retail portfolios?

Sure, Camille. For -- of course, this quarter for in our Manhattan office, we achieved a 5% positive spread. We were -- had negative spreads in the Greater New York Metropolitan office portfolio this past quarter. It's all going to depend. Going forward, the leases spreads are going to depend on the mix of spaces that we lease and what types of spaces they are and what the prior fully escalator rents are. If you look at our in-place rents for - you asked specifically about Greater New York Metropolitan office, we're probably just going to see flat to modest negative spreads in the Greater New York Metropolitan portfolio. As we go forward in leasing up our vacant space in Manhattan, given the prior escalated rent was around $53 per square foot and we're doing deals above $60 square foot and where we can move the needle more significantly, I would expect positive spreads on new leasing in Manhattan. And then on retail, we really don't have a tremendous amount of retail spaces rolling over the next several years. But if there, it's -- if it's flat to markdown, it's going to be more than offset by the value of the lease up of vacant space. That could be in the range of $5 million, $6 million. Well offset any modest negative spreads that we might see on leases expiring.

Okay. And on the point around higher operating expenses due to utilization, does how much of the anticipated impact to your same-store NOI outlook will be front-end weighted, given the tougher comps in the second half of 2022?

You mean how much will be front-end in terms of increased operating expenses? I would expect that we're going to see a gradual increase in operating expenses due to utilization. Some of the increased costs that we're -- that we'll see next year will be things like union rate increases. So that would be spread over the year. And then we've got some one-time expenses that will be a bit lumpy. So basically, it's a bit of a mix. You'll see some of our expenses that will gradually rise due to utilization and others will be a bit lumpy.

Okay. And final question, can you please comment on what's been driving the lower leasing and leasing commissions and tenant improvement costs throughout the year? And if Q4 is a good level of where these costs will be in 2023?

Well, our leasing costs increase this quarter compared to last quarter, the costs, as you see historically vary by quarter and they really depend on the length of term, the space type, whether it's white box, a pre-built, a first-generation and second-generation space. And you're going to see the lease costs per year of term as a percentage of initial rent, this quarter was really in line with the past four-year range. It's kind of in that 15% to 19% range this quarter on an aggregate basis or dollars per square foot, we were around $54 per square foot and that's well below our last five quarters that average about $79 per square foot. But we really think of leasing cost us and we focus on net effective rent and what we saw in 2022 is our average weighted net effective rent increased on a year-over-year basis by about 5%. So we think that that's a very positive stat and that's what we keep our eye on going forward.

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

Great. Thanks. Just maybe on expectations for 2023 guidance, assuming the mid-point with the run rate of $0.22 in the fourth quarter, is this the way that we should be thinking about it? I mean, I'm calculating kind of back in the envelope map. You're getting a 6% benefit for increased NOI in the observatory call an $0.08 impact from higher OpEx and real estate taxes, maybe a $0.01 increase from occupancy. Did those numbers sort of give me toward that, that higher end, maybe a little bit above? Anything else I might be missing there that gets us sort of closer to that mid-point?

Hey, Griff, I think you have it. Those are the key ingredients. So we do try to be very transparent in terms of the building blocks showing exactly what drives the same-store NOI, so you have those components, right? The other thing I would mention is, when you think about whether you can annualize the last quarter I'm just be a little bit cautious with that. There is some seasonality element to the observatory results. You want to careful not to just take the fourth quarter and annualize that in any given year. The second component is you got the NOI decline, but the other component is on the capital recycling. Just to do the quick map for people it's about $0.027 in terms of hit on the FFO offset by $0.017 from the contribution of 298 Mulberry that gets you to another $0.01. But you have the right component.

Great. Thanks. And then maybe we can shift over to multi-family for a second. I mean, it seems like this has been a growth avenue recently. Tony talked about it a bit in his prepared remarks. Looking at the investor deck, the pro forma, including Mulberry, makes up about 5% of the portfolio. You've talked about being more of a New York City focused REIT. I'm just curious how big a piece of the pie you think this could grow to be in sort of the near to medium-term?

Yes. So we've definitely mentioned our interest in any asset class, it makes a ton of sense for us as a New York City focused player to have quality office drivers, to have the everyday retail, to have the observatory business, and having residential demand makes a ton of sense. As we've previously responded to this line of questioning, we don't think it's prudent to put a target out there and say, we'll achieve it, no matter what. Because the reality is multi-family is very thought after, the fundamentals are very healthy. And so we want to balance and say we are interested. We have strong liquidity positioning, but we want to be prudent in the way we source deals and go after transactions.

Great.

I'd just like to add if I may, Griff two things. One -- three actually. One, we really got dumped on when we announced our first multi-family transaction. We thought it was the right time to do it. Everybody thought it was the wrong thing to do. We -- number two, we are omnivorous opportunivores, so we will go where we see opportunity to develop shareholder value. Three, when we note our occupancy of 96% that, that, that Tom noted, we actually have units under renovation in our portfolio. So that is not an adjusted for units, not in circulation. That's the gross number. So there's a little bit of play there. And I just might add again, our focus is on cash, cash delivery, we focus less on FFO and we focus more on cash. So we're really pleased with what we've done and we'll continue to look at that opportunity as we go forward on acquisitions.

That's great, Tony. Appreciate the additional color. That's it for me.

Thank you.

Thank you. Our next question comes from the line of Blaine Heck with Wells Fargo. Please proceed with your questions.

Okay. Thanks. Good afternoon. First question, just to follow-up on the leasing environment, are you seeing signs that tenants are any more likely to look at hoteling or hot desking as a way to kind of efficiently use their office space in a more hybrid environment?

No. Short answer is no, Blaine. The -- there are examples of tenants that were doing hoteling pre-COVID, and there are examples of tenants that are doing hoteling post-COVID. But in an environment where employers are looking to attract and retain talent and all just about everybody speaks about the need to get folks together for things like collaboration creative -- creativity, team building, mentoring, train all of these things, the desire by employees is to have their individual workspace. And that's what drives the demand for office space. But I think that the concept that tenants are moving towards hoteling because of change of work habits is we're just not seeing that.

Yes. I'll just add, I attended a conference back in 2019, in which I was asked with two other prominent execs in real estate to comment on the future of short-term office space use WeWork Convene, Industrious, Knotel. And one person cited a statistic from an economist at Jones Lang LaSalle that by within five years, 30% of all office space would be occupied on short-term users -- by short-term users for short-term flex space. Well, clearly that hasn't happened and it won't happen. I would also comment on the irony of articles of how difficult it is to be fired when you're remote and you don't have an office environment within which to work and to relate to your peers. We feel very confident that ultimately the office plays the central role in businesses going forward. And as per comments we've made in the past, it's probably 2024 before that settles down completely.

All right. That's helpful. Thanks, Tom and Tony. For my second question, I want to switch gears to same-same NOI. Recently as last quarter you guys had guidance for negative 10% to negative 12% same-store NOI in 2022. You significantly beat that number at negative 4.1% for the year. Just using that as context, I guess, how should we think about the negative 4% to negative 6% same-store guidance for 2023, and ultimately, how much conservative is built into that forecast? I guess, is there a scenario in which you could beat that forecast to the degree that you did here in 2022?

Yes. So clarification, so last quarter in our remarks, we did say it was closer to about 8% down. We still beat it, but it was about 8% down. So the print didn't reflect that. And it did reflect conservatism. So a couple of things. OpEx we wanted to make sure it came in and the result was OpEx came in in line -- relatively in line with our expectations. And on the revenue side, we had higher reimbursement revenue, higher rental revenue and a few other income items and that resulted in a better outcome. There is conservatism in 2023, and as much as we can, we hope to outperform what we promise, but we do try to be conservative reflecting the uncertainties in the market and we hope to deliver the results as we increase guidance over any given period.

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

Thank you. Tony, kudos on your stance on legal work, I know a lot of us give you a hard time on that a few years ago. But speaking of blowback, you did receive a lot in the press when Empire State Building celebrated the Eagles NFC Championship victory that irked a lot of New Yorkers, both in the giants and jet side. I guess my question is, any publicity good for the observatory or has your -- has the blowback really reconsidered your stance on which teams you celebrate?

First of all, to be fair that was very funny. Not your question, but the whole event at number one. Number two, we'll always celebrate the major sports events. Our integration into the NCAA tournament, what we do with the World Series, what we did, we do with the Olympics. And I -- so the answer is we're a global brand. The vast majority of our visitors come to us from outside New York City. We have a big driver in our office properties, our retail properties, our residential properties, along with the Empire State Building and the Empire State Building Observatory. And I appreciate your calling attention to what became actually an international phenomenon, and that's what the Empire State Building is.

I agree. It wasn't using when it came out. The question on guidance, I know a lot of people are focused on this, but Christina, you mentioned the same-store revenue being conservative, but I would've thought with increased occupancy that you're expecting this year coupled with escalators that you have in place, that you would start off at a -- starting point in the low-to-mid single-digits on the revenue side. Can you comment on what's offsetting that?

We have the modest revenue increases as you just mentioned. The key driver is we have operating expenses going up as well. So combined that's where we get to the 4% to 6% as year progresses. We allow room for timing to lag and what hits the numbers. We can certainly address that as we get more clarity. But I think it's no secret. This is an uncertain year. We're working very hard to drive positive results and we'll deliver more in communication on guidance as we do that.

And just to clarify, this same-store guidance does not include termination fees, correct?

Correct, excluding.

Okay. My final question is on the Mamaroneck sale. What are the use of proceeds on this? I know you cited that this will be used to fund 298 Mulberry Street, but there are some excess funds on the sale side. So have you determined what the use of proceeds are?

We have not determined on the balance. So most of it will be redeployed. And as we have more information, we will deliver that to the market.

Thank you. Our next questions come from the line of Dylan Burzinski with Green Street. Please proceed with your questions.

Hi guys, thanks for taking the question. Just curious you've done a good job executing the suburban office sales, a little bit of standalone retail. Here's how you're thinking about the portfolio in terms of disposition candidates for the Manhattan office portfolio. I know there's obviously tax considerations that take into account, but just wanted to hear your thoughts on that.

Yes. Thanks for the question. So as I mentioned in the remarks, we take a hard look at all of our assets. So as we think about the characteristics and what makes sense in today's market nothing is redlined in terms of being for sale. We are aware that it's not the most popular time for office. And being that we have balance sheet strength, we have no debt due until November 2024. We have no floating rate exposure. There's no unnecessary pressure on us to force a sale at an inopportune time. So we will monitor the market closely, be very active in how we manage the assets. And when the window opens for us to pursue a sale, we will explore it.

And then, as you guys are kind of looking at acquisitions, I think in the past you mentioned that you're primarily focused on multi-family and retail. Is that still the case where you kind of guys are kind of not looking at office at this point in time?

We've actually said we're focused on New York City office, residential and retail. So it remains those three categories. And it's really predicated on entry price, the amount of capital that goes in, the cash flow profile and growth profile going forward and what makes the most sense for the company. And the common theme if you're seeing is New York City, multiple drivers of upside and we have very strong, diversified, resilient cash flows coming from different sources. We're proud of that and we want to increase our exposure to things that will add to that.

Thank you. There are no further questions at this time. I would now like to hand the call back over to Tony Malkin, Chairman, President, and CEO for closing remarks.

Thanks, everybody. ESRT is well-positioned to perform, take advantage of the flight to quality signed leases that will contribute to earnings and build on our well diversified income stream. Our strong and flexible balance sheet empowers us to take advantage of investment opportunities and repurchase our stock. ESRT is a great way to play New York City. Our portfolio is stronger and more diversified than it was a year ago and we are excited by the opportunity ahead. Thank you all for your participation in today's call. To conclude 2022 marked a year of notable progress towards ESRT's top four priorities: lease space with 1.1 million square feet leased in 2022 and meaningful occupancy and lease percentage good progress; sell tickets to our completely re-imagined observatory, the only authentic brand amongst observatories one can visit; enhanced shareholder value through our capital recycling out of suburban assets and into multi-family, which is now the fourth leg of ESRT's well diversified cash flow stream, coupled with repurchases of our shares and continued leadership in ESG initiatives. We are fortunate to be backed by a strong and flexible balance sheet in this environment and feel confident in the company's ability to execute on our goals and drive growth for shareholders in 2023. Many thanks to our great ESRT team who have worked incredibly hard and I have every confidence we will continue to do a great job on behalf of stakeholders. We look forward to the chance to meet with many of you at non-deal roadshows, conferences, and property tours in the months ahead. Until then, thank you for your interest, onward and upward.

Thank you. That does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.