Greetings. Welcome to the Empire State Realty Trust First Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Greg Faje, Director of Investor Relations for Empire State Realty Trust. Thank you. You may begin.
Good morning. Thank you for joining us today for Empire State Realty Trust's first quarter 2019 earnings conference call. In addition to the press release distributed last evening, a quarterly supplemental package with further detail on our results has been posted in the 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, 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 relating to those forward-looking statements in the company's filings with the SEC.
Finally, during today's call, we will discuss certain non-GAAP financial measures such as FFO, modified and Core FFO, NOI, Cash NOI, and EBITDA, which we believe are meaningful in evaluating the company's performance. The definitions and reconciliations of those measures to the most directly comparable GAAP measures are included in the earnings release and supplemental package, each available on the company's website. Now I will turn the call over to John Kessler, President and Chief Operating Officer.
Good morning. Welcome to our first quarter 2019 earnings conference call. At Empire State Realty Trust, we have fully modernized assets, central locations, and easy access to mass transit. Our four drivers of growth deliver embedded upside and peer-leading Cash leasing spreads. Our portfolio is well-positioned, priced between trophy Class A and Class B properties to outperform in any market. We have a fortress balance sheet with significant cash, undrawn line of credit, and low leverage. We are an industry leader in sustainability and energy efficiency. Today, Tom Durels will speak about the first quarter's approximately 308,000 sq ft of leases, market demand for our properties, and our market-leading leasing spreads. David Karp will address our financial performance and our balance sheet. Finally, Tony Malkin, our chair and CEO, will provide some additional comments in conclusion. I'll now turn the call over to Tom Durels. Tom?
Thanks, John, and good morning, everyone. Our first quarter numbers reflect further progress on our four drivers of top-line de-risk and embedded growth over the next five years. The breakdown of these top-line revenue growth drivers, which as of March 31, 2019, we estimate to be $107 million, can be found on page seven of our investor presentation. For reference, this compares to $540 million in trailing 12-month cash rental revenue and $390 million in trailing 12-month Cash NOI as of March 31, 2019. In the first quarter, we signed 34 new and renewal leases totaling approximately 308,000 sq ft. This included approximately 285,000 sq ft in our Manhattan office properties, 15,000 sq ft in our greater New York metropolitan office properties, and 8,000 sq ft in our retail portfolio.
Significant new office leases signed during the quarter include a 119,000 sq ft renewal lease at the Empire State Building with the Federal Deposit Insurance Corporation, the FDIC, one of our largest 10 tenants. A 25,000 sq ft fourth-floor new lease with Abrams Artists Agency at the Empire State Building, and a 23,000 sq ft expansion lease with Sisense at 1359 Broadway. As a reminder, we maintain updated disclosure on potential vacates and renewals for leases that expire for the remaining three quarters of 2019 and full year 2020 on page nine of our supplemental. This chart shows tenants to be relocated within our portfolio and vacates to be replaced by new tenants with whom leases have been signed. We have continued with our proven strategy to vacate and consolidate spaces, redevelop them, and re-lease those spaces at higher rents to better quality tenants.
Given the timing delay between the move-out of existing tenants and the commencement of replacement new leases, and a further delay between legal commencement and GAAP revenue recognition, our occupancy can vary quarter by quarter, and these timing lags impact our reported revenue. During the first quarter, rental rates on new and renewal leases across our entire portfolio were 13.4% higher on a cash basis compared to prior cash escalated rents. At our Manhattan office properties, we signed new leases at a positive cash rent spread of 21.1%. Of course, leasing spreads always depend on the expiring fully escalated rents. In the near term, cash leasing spreads will benefit from the lease-up of vacant, redeveloped office space, which had prior cash fully escalated rents of $52 per sq ft, which is well below current market.
Our future cash leasing spreads will be influenced by rents on future lease expirations, which we disclose on page 11 of our supplemental. We continue to see demand for our product, location, and price points and feel very confident in our offerings. We have raised our weighted average asking rents in our Manhattan office buildings by over 4% on a year-over-year basis, following increases in our asking rents throughout 2018. We have a healthy pipeline of leases in negotiation across the portfolio for both full floors and pre-builts. Though as a reminder, leasing volume may vary significantly by quarter, given the timing of particular deals. We remain focused on our strategy to vacate and redevelop space that we will bring to market for future lease-up. Now I will turn the call over to David Karp. David?
Thanks, Tom, and good morning, everyone. For the first quarter, we reported Core FFO of $57 million, or $0.19 per diluted share. Cash NOI was $80 million, down approximately 1% from the prior year period. Excluding the $2.8 million settlement with a former broadcast tenant in the prior year period, Cash NOI was up 2%. In the first quarter of 2019, we adopted the new lease accounting standard, under which all rental income earned under tenant leases is reflected in one category. We now show rental revenue inclusive of tenant expense reimbursement. On page 18 of the supplemental, we have included a new schedule breaking out base rent and billed tenant expense reimbursement for the quarter, and we will show that going forward. Historical information for the prior four periods is also shown.
In our Observatory operations, which are highlighted on page 16 of our supplemental, revenue for the first quarter of 2019 decreased to $20.6 million, or 3.2% from the prior year period. Net Operating Income was $13 million, 6.6% lower than the first quarter of 2018, due to a combination of lower revenue resulting from the Easter holiday shift, which I will explain in a moment, and previously noted higher expenses related to the Observatory redevelopment. To put this in perspective, the first quarter is our seasonally lightest quarter, and this roughly $900,000 Net Operating Income decline represents less than 1% of the trailing 12 months Observatory NOI. In early April, we implemented a price increase in our wholesale channel and made a few revisions to our retail pricing strategy. We have moved to two pricing categories versus our prior three tiers and now display retail website prices net of tax.
As reported on page 16 of the supplemental, the Observatory hosted approximately 601,000 visitors in the first quarter 2019, a decrease of 43,000 visitors compared to the first quarter 2018. Of this 43,000 decline, we estimate that approximately 24,000 is attributable to the shift in the Easter holiday, which fell entirely within the second quarter this year, whereas in the prior year, the Easter holiday was split between the first and second quarters. In addition, we estimate that bad weather days resulted in approximately 10,000 fewer visitors than in the prior year period, based upon when those bad weather days occurred within each period. That leaves 9,000 fewer visitors attributable to other factors.
Moving to our balance sheet, our low leverage, joint venture free and flexible balance sheet, including significant cash on hand, give us a competitive advantage to execute our redevelopment plans and opportunities for external growth in any market environment. As of March 31, 2019, we had total debt outstanding of approximately $1.9 billion and no borrowing under our $1.1 billion unsecured line of credit. The debt has a weighted average interest rate of 3.84% and a weighted average term to maturity of 7.8 years. Our debt maturities are well-laddered with only a single $250 million issue maturing before 2022. None of our outstanding debt has variable rates. As of March 31, 2019, our consolidated net debt to total market capitalization was 21.6% and consolidated net debt to EBITDA was 3.6 times, and we held cash equivalents, and short-term investments of $593 million.
With that, I would like to open the call for your questions. Operator?
Thank you. At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Emmanuel Korchman with Citi. Please proceed with your question.
Hey, good morning, everyone. Tom, maybe we could just start with what you're seeing more generally on the concessionary environment in N.Y. It's certainly been a big topic, but if you look at your renewal results, especially, we're not seeing that. Could you just give us an update?
Sure. Manny, actually, we've seen good face in net rent growth year-over-year. As I pointed out in my earlier remarks, we've increased our asking rents by over 4% on a year-over-year weighted average basis for our entire Manhattan office portfolio. For certain spaces, such as full floors of the Empire State Building and 1400 Broadway, we've increased asking rents by as much as 7%-10% on a year-over-year basis. There have been many questions about net effective rent growth. What we saw in our portfolio is an increase in net effective rents for our New York City office of about 5.5% for new Manhattan office leasing on a year-over-year weighted average basis. We're seeing concessions generally leveling off, or at least the pace of concessions of increases has slowed, offset by increased rents.
As you see in our Supplemental, our average leasing cost per lease year for TI and commissions for all new and renewal Manhattan office leases decreased in the first quarter to about $8.33 per sq ft on a weighted average basis compared to fourth quarter.
Great. You guys mentioned 9,000 fewer visitors at the deck given other factors. David, when you guys dig into your best thoughts on what those other factors were, could you share those?
I'll take that if I could, Manny. We look at this and say that there was the difficult weather, there was the shift in Easter, overall, we continue to see a decline in our international. When we look at this, we put this against the fact that over the trailing 12 months, our revenue per capita increased 7.9% versus last year. We've raised our wholesale ticket prices, most recently in April. We've changed our pricing categories from three tiers to two tiers, and we continue to innovate with new offerings to maximize our per cap. Overall, the new observatory entrance has already increased the desirability of our 34th Street retail availabilities. It's improved our Fifth Avenue lobby and cleaned up our Fifth Avenue experience for tourists and office users alike.
Everything on the observatory, as far as we're concerned, is working very well towards the completion of the second floor by the end of July and the new 80th floor and 102nd floors by the end of October. We just think that all of this will put us in the best place from an offensive perspective to maximize on what we are doing with regard to building visitorship, encouraging visitors to come during bad weather days, and continuing to improve our per caps due to the new experience and new revenue-generating opportunities. We can look at all of these other factors. Primarily, we think it's still some slightly interrupted typical tourist trends. We can look at other attractions out there.
The one that's easiest to track, again, is One World Trade Center because they post their attendance every month, and they are down tremendously, and that's in the face of tremendous discounting. Again, in the opposite direction, we're increasing our revenue per capita over the trailing 12 months by 7.9% versus last year.
Great. Thanks, everyone.
Thank you. Our next question comes from the line of Craig Mailman with KeyBanc Capital Markets. Please proceed with your question.
Good morning, guys. Tony, just to clarify, I think you just said end of October for opening up the 80th floor and 102nd. The elevator work on the 102nd floor is going to be a little bit more than nine months than you guys expected?
No, we're still expecting the nine months, whatever that nine-month period is. Certainly, by the end of October, I said that was for 80 and 102. I think nine months is still our target for 102. 80 is going to be perhaps a little longer. The elevator work, if you recall, was done last year. This is not elevator work. This is completely transforming the experience on 102. We put in a glass elevator on that 86th to 102nd floor. We didn't do that just so people could look through the walls of the glass elevator at the walls of the shaft. There's some major changes taking place on 102, which is underway at this time. That work should get done as we addressed in our earlier predictions. That was just looping it together with the work on 80.
Hey, Craig, it's David. Just for your modeling purposes, again, I would still go with an impact to revenue in connection with the closure of 102 in 2019 of just slightly over $8 million.
Okay. That's helpful. On the FDIC lease, good job getting that done. It looks like you're in that kind of right around that 6.8% mark to market. Do you think that's indicative of some of these earlier vintage mark-to-markets on space that has already been redeveloped? Have you guys gone back and kind of tried to do space by space to see where that mark to market could go even after the redevelopment work is kind of done to see what mark to market you guys could keep posting on a normalized basis?
Look, Craig, first of all, the FDIC lease had very low concessions and
We are very happy with the outcome. They are one of our 10 largest tenants, we're thrilled to keep them for 119,000 sq ft at the Empire State Building. Our mark-to-market is going to depend on, obviously, their prior escalated rents. On redeveloped vacant Manhattan office space, our prior escalated rents were about $52 a sq ft. You can do the math. If we end up doing leases in the low to mid-$60s, it's going to represent a healthy mark-to-market. On future leases rolling, our Manhattan office portfolio in-place rents are about $57 a sq ft, generally, we're asking rents in the low $60s all the way up to $86 a sq ft, depending on the space and the floor. That's going to represent future mark-to-market. There is, obviously, in our supplemental, we do provide future mark-to-market in the supplemental.
That's helpful. Could you just remind us, when does the Uber lease at 1400 expire? I know it may be early, but there's obviously reports they're looking for 250,000 to 300,000 sq ft. Any indications from the tenant whether they'd want to keep that space, or if they'd kind of consolidate out of it?
Well, they have just under 50,000 sq ft with us at 1400 Broadway. I would just say that we've got an excellent relationship with them. We have an opportunity to create space at 1400 Broadway, which has seen tremendous activity. We have the opportunity to create additional full floors there going forward. This year alone, we're slated to consolidate about 64,000 sq ft in two full floors, we have additional floors that we can create. We've been very creative in accommodating growth for our existing tenants, I think that's all I'm going to say on that.
Okay. Maybe just one last one for Tony. There's been some stuff coming out of the de Blasio administration about carbon emissions and other things related to green initiatives, which I know you've been a big pioneer in. As you guys look at your buildings, some of the stuff that they're talking about on the carbon side, do you guys feel like the work that you've done would kind of put you in compliance with that, or would there be potentially more capital to put into the buildings to kind of come into compliance?
Well, this is a challenging piece of legislation into which I was active and sought to give constructive input, some of which was incorporated. The rules associated with the legislation, like laws in Congress, a lot of those rules are going to follow the actual passage of the legislation. Our view is to look at how we can most constructively address the opportunities to do better, and certainly to maintain our leadership position on energy efficiency, which is significant. I will say two things. One, this does highlight how the industry's focus on greenwashing like LEED and GRESB, as I have said repeatedly, has been wrong. The proof is in how much people have spent on LEED and how little it does anything to mitigate their exposure to expense under this new legislation. Two, no, our buildings will not meet the requirements at present of this legislation.
We are a moving target and continuing to roll out energy-saving measures in tenant spaces as they are built. That's what tenants are required to do under our leases, and continue to roll out innovations. This, which is being spoken about, is radical. It's absolutely radical, and we're in the best position of any landlord. At the same time, the future's uncertain. The rules still have to be made. Again, anybody who's been spending millions of dollars on LEED and GRESB is wasting their money.
Great. Thank you so much.
Thank you. Our next question comes from the line of Jason Green with Evercore ISI. Please proceed with your question.
Good morning. Just curious, as far as Observatory expenses coming down versus the higher HVAC and IT spend that you experienced in Q4, was there any material change there, or was it just a seasonal decline?
Jason, it's David. On a quarter-over-quarter decrease, what accounted for that was we had lower marketing expenses this past quarter and some lower IT expenses. Those are primarily timing related. We do expect to incur some of those expenses in the coming quarters. We also saw lower security and credit card fees in the quarter. This is attributable to the seasonality. Lower revenue translates to lower credit card fees, which is part of the expenses. When we take a look at the run rate for the Observatory over the coming year, we would still anticipate that what we experienced in the fourth quarter would be a good estimate for that run rate. I will say that a lot of the technology is new. We're still getting our arms around it.
They're new systems. As these systems stabilize, we'll probably have a better sense of how this run rate may change going forward. As we learn, we'll let you know. The labor savings that we realized from the reduction in the cashiers is really being offset by these higher technology costs.
Okay. Just curious on the methodology regarding bad weather days and the impact to visitors. Given you had the same number of bad weather days this year versus last year, I understand there are some timing impacts. Based on the fact that you're recognizing a trend of less international visitation, how do you get comfortable that those 10,000 are truly missing because of bad weather days and not even worse visitation from international travelers or other?
Firstly, the methodology takes into consideration the day of the week when the bad weather occurs. Bad weather on a Wednesday is different than bad weather on a Saturday. It also takes into consideration the number of consecutive days of bad weather. In one period, you may have those 15 bad weather days spread out over a longer period, whereas in another year it could be concentrated, and you could have two, three bad weather days in a row. Once you've lost those visitors, you don't get them back. It also has a function, it relates to the number of whether it's in a peak period or a non-peak period. There's a lot that goes into it. Remember, this is just an estimate based upon trends that we're seeing throughout the quarter, and basically interpolating that into what it means with regard to bad weather days.
I think it's a good estimate. It's not perfect. It takes into consideration a lot of factors. We feel pretty comfortable with that estimate.
Okay. Thank you.
Thank you. Our next question comes from the line of John Guinee with Stifel. Please proceed with your question.
Great. Thank you. Hey, David. It looks like your burn rate over the last 12 months has been about $25 million on cash. If you just look at your balances from March 31 to $100 million, and you still got more observatory, Manhattan office, suburban office. When do you get to cash flow positive and, assuming everything else stays equal, when do you stop having your cash out exceeding your other expenses?
Well, John, that's a good question. Sounds a lot like a question regarding guidance, which you know we don't provide. If we just take a look at this past quarter, our cash from operations was roughly $78 million. We transferred $50 million from our short-term investments into our operating cash. To offset that, we had $61 million of CapEx. We had roughly $1 million of principal repayments, and then we had our dividends of $32 million. Overall, you can see our cash position went up by $34 million. Again, overall, you have to take into consideration that $50 of that came from short-term investments. We did use a little bit of cash this quarter. I think if you look historically and do that same analysis on a quarter-by-quarter basis, you'll see that spend rate is starting to come down.
Certainly, by the end of the year, we should be getting to a position where we're closer to a net generator of cash as opposed to a net user of cash.
Okay. Then, hey, Tony, big picture, what do you think is worse for New York? Is it the far-left political environment, or is it the Trump effect globally on tourism and immigration and that sort of thing?
As a friend of mine once said, the lesser of two evils is still evil. I like to look at job creation, and job creation remains strong. There is a wide ability in New York City to absorb a lot of political perspectives, there's wide ability in the world to overcome the impressions and impacts of one individual. We've seen that in the way cities have recovered from terror attacks. We think New York City is recovering from the Trump presidency as well, as far as tourists from international destinations goes. Overall, again, focusing on job creation, it's good. Space absorption's good.
I think that there's a greater potential impact from the need of, ultimately, WeWork to start to operate as a ordinary company rather than just as a company that's able to spend money to grow than either of the two factors that you commented on. Even that, I think we can absorb.
Last, I think a lot of people have been asking a lot of questions on the observatory, I think between The Rock and One World and Empire, there's maybe about capacity of 10 million people annually, and those three observatories are running at maybe 80% or 90% capacity. You can correct me if I'm wrong on that. It looks like The Edge and One Vanderbilt have about 4 million capacity each. Do you have a sense for how that's going to play out?
I think that we've done the math before, David has said in the past, based on his calculations, that if you look at our true capacity, we're probably operating around 50%. Of course, that takes into account all hours of the day at which we operate and maximum utilization in each hour. That being said, look, I think that the world is about authenticity, values, Instagram when it comes to these destination attraction visits. I think that we win on authenticity. We win on connection to values, our redo of the observatory is already geared to accelerating and improving what is already the number one Instagrammed attraction in New York City. When we look at all of this, look, you've got three Burj Khalifas that are going to be online. One World, 30 Hudson, One Vanderbilt.
I really look at where do people want to go rather than the fact that there's a certain amount of capacity and it's all going to even itself out based on the number of people who go and allocation of visitors.
Great. Thank you.
Thank you. Our next question comes from the line of Jamie Feldman with Bank of America Merrill Lynch. Please proceed with your question.
Great. Thank you. Tony, I want to go back to your comment on the green legislation. My understanding is there's a 2024 benchmark, and then there's a 2029. Are you saying even the 2024, you feel like Empire's portfolio won't be in compliance with? And if not, what's the plan, and what's the cost to get there?
As I said, just like laws in Congress, there's still a lot of rulemaking to be made here. There are still some definitions that need to be codified by the advisory board that's to be set up over the next two years. The fact is that I look at this the same way we talk about how we look at our competitive position from a leasing perspective. Everybody's been asking, most recently down at the Citi conference, is 2019 the year in which net rent growth returns to New York City office? As Thomas Durels pointed out, we've had net rent growth for quite some time. We've said repeatedly, when we look at our position against the market in general, we think we'll outperform any market situation on the basis of our product and our price position, our assets, and our service.
I should probably say our service first, that's the order in which it was said. We get to this particular piece of legislation, all I know is it's going to cost us less. All I know is that we've got a head start on everybody. All I know is that we've been focusing on the right thing first, which is energy efficiency, energy consumption, and that we've deployed it not only through our buildings, but also in our tenant spaces. Additionally, I know that the folks who've been focusing on LEED and GRESB, and who tout how well they're doing on the basis of LEED and how well they're doing on the basis of GRESB, I've said repeatedly, we eschew these standards because they're all soft targets. They don't move the needle.
This particular piece of legislation, I think you should anticipate it's going to be copied around the United States. It's not just New York City. I think you should expect that cities everywhere are going to take this on. From our perspective, we'll follow the rulemaking. We absolutely have been spending a lot of time on this, looking at what the potential costs are. More importantly, it's what are the potential measures we can take, and how can that continue to improve our competitive position?
Okay. I guess it's interesting to me because I've spoken to some of your peers who have said, at least for the 2024, they feel like they're on a glide path to be in compliance. There'll be some additional spending, it's no different than what they've been doing. Are you saying for even the 2024, you don't think that you would be there? I think the 2029 is very different. I'm just trying to understand what you're saying.
Yeah. My comment is anybody who thinks that he or she is on a glide path to accomplishment on the basis of 2024 is making an awful lot of assumptions because the rules haven't been fully laid out yet. From my perspective, I'd rather participate in the process with the advisory board, rather watch that carefully, and I'd rather speak from a perspective of knowledge, rather than assumption. It's very possible that we could be in complete compliance. At the same time, till everything's done, and there are authorities out there still at work, can't make that comment.
Okay. Very recently, we've seen QIA make a big investment in New York City retail with Vornado. I'm just curious, any thoughts? I know they have a big investment with you guys, but just bigger picture, are you seeing an uptick in interest from foreign capital, looking at the market, and just any thoughts on any changes there?
Hey, Jamie, it's John. We certainly saw what QIA did with Vornado, and we think they have a great partner there. Our analysis is that Vornado raised capital, which they're going to use towards reinvestment in Penn Plaza, and that's certainly good for us. As we look at opportunities in the market, we continue to find that the best use of our capital is redevelopment of our own portfolio, and that we've got very substantial internal growth over the next five years, $107 million of top line, including $50-plus million contractual. If you look at pricing of assets, which I think is driven, to your question, in part about foreign capital, the Preqin numbers show more than $300 billion, $330 billion of dry powder. Certainly, people like QIA and other sovereigns are incremental to that.
There continues to be tremendous capital, I think, dedicated and looking for additional investment in the city, and that continues to hold up pricing. Chrysler is an example of that, where we were certainly impressed by the price and also the fact that they were able to finance their investment. We continue to want to focus on growing the business, but we're going to continue to be careful and prudent.
There's a lot of capital out there, Jamie.
Talk to Darcy Stacom. Talk to Adam Spies and Doug Harmon. They're going to be able to tell you who's out there's a lot of capital and a lot of it is cross-border and isn't even tracked by Preqin.
Do you think we'll see a pickup in that capital getting put to work, though? Obviously, with QIA, we did.
We don't pull the trigger on it. All I can tell you is that we continue to work very hard on off-market situations where we can deploy our skills, where we can deploy our balance sheet in a unique way, and where we can take advantage of the use of our operating partnership units. I wouldn't like to be a person in private equity right now deploying the capital, knowing, by the way, that $330 billion is for more than just office in New York City. It's all going to get spent. People aren't going to give money back. I think we should, in general, be looking at price support throughout all sectors in real estate for some time.
Thank you. Finally, Tom, I think in response to an earlier question, you'd said on the concession side, I think you said they're both flat, and then I think you said, "Well, actually, I think the pace of growth is slowing." Can you just clarify which one of those? If it's the pace of growth, what is the growth rate that you're seeing in concessions?
Well, our average leasing cost per lease year for TIs and commissions for all new and renewal Manhattan office leases decreased in the first quarter to $8.33 per square foot on a weighted average basis compared to the fourth quarter. As in, generally speaking, I would say that we've seen a leveling off. Certainly, that means that at least at the very minimum, the pace of concession increases has slowed. We're seeing and have experienced an increase in net effective rents. For our New York City office, for new Manhattan office leasing, our net effective rents grew about 5.5% on a year-over-year weighted average basis.
Okay. All right. Thank you.
Thank you. Our next question comes from the line of Blaine Heck with Wells Fargo. Please proceed with your question.
Thanks. Good morning. Just to follow up on the pricing discussion, I think Tony talked about a 50 to 80 basis point expansion in cap rates a couple of quarters ago. I guess, has that changed at all in your mind, given the amount of capital that's come back to the market, and is at least kicking the tires, or is there still a bit of a gap from where we saw the priciest deals this cycle?
It's a pretty interesting one. How do you figure out the cap rate on the Chrysler Building? In general, I think that two things. One, you've probably seen the adjustment and it's stayed, but it's being supported by the capital. Two, it's back to the better prices going to assets that are not stabilized. If there's more room in people's pocketbooks for assets that have turnover and vacancy, where they can underwrite a dream, than something which is fully locked in and baked.
Okay, that's helpful. This is probably for David. I know you guys have plenty of liquidity at this point between your cash and line of credit, but I guess I'm curious what you think your investment capacity is if a really large deal or series of deals was to come up and you were going to put out kind of the maximum amount while still being comfortable with your leverage stats. How much capacity do you guys have for a deal like that?
If you take a look at where we are right now in terms of our leverage, we're at 21% net debt to total enterprise value, which gives us a fair amount of room to bring that up in connection with a transaction. We have liquidity in place with the cash on the balance sheet. We have the revolver, the $1.1 billion revolver on which nothing has been drawn. We have sources of liquidity, and we have capacity to bring that up. Certainly, if we're at 21%, even potentially doubling that to 40% would not put us in an uncomfortable position. Now, having said that, we enjoy our position of low leverage. We think it serves us well in any market environment.
If we were to bring our leverage up to something in that neighborhood, we would look to a path to restore that to a more comfortable level or a level where we're currently operating over the longer term.
I'd add, don't forget, there's a ton of potential joint venture capital out there. As we've disclosed, QIA has a right of first refusal on any JV that we might like to do. I think it's really a matter of when we see opportunity, what would we be comfortable doing? The answer to that is that we'd be comfortable taking it. We would justify in that action that we take what the balance sheet looks like on the basis of the value of the opportunity that we see.
Right. Okay. Thank you, guys.
Thank you. Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.
Good morning. Thank you. Looking at your free rent burn-off for the remainder of this year, there is $14 million left. Last quarter, there was $23 million for the year. You got $9 million that you used during the quarter. I am just wondering where that $9 million went. When you look at the cash NOI ex-Observatory on Page five of your supplemental, it looks like it was down almost $21 million. $19 million of that was the termination fee. I am still trying to reconcile where that $9 million free rent burn-off went this quarter.
Yeah. John, during the quarter, we had leases representing about $12 million of annual rent in their free rent period and begin paying the cash rent. What this does is it increases the cash rent in subsequent quarters by roughly $3 million per quarter, or $9 million for the period from April of 2019 to December of 2019. Again, as it starts paying the rent, it comes out of that and does not all fall within the one quarter. It gets spread out over the remaining year.
Oh, okay. For some reason, I thought that was not an annualized number.
Well, again, it is the remaining amount. We do this on an annual basis. We say for 2019, how much of that free rent will be recognized in the year 2019. In that instance, $12 million will be recognized in 2019.
There's a significant amount of newly developed space that's going to come to the market over the next couple of years in Herald Square, whether it's Vornado at Penn or potentially now Macy's moving forward with its office development. I'm wondering, how do you think that impacts not only the market, but your ability to attract tenants and what that does as far as capital spend on your assets?
Well, I think, first of all, we're uniquely positioned, as we said before, between a typical Class B office and new development. We're attractively priced and offer a great value with great access to mass transit and convenient central locations. I think we occupy a unique space in the marketplace. All of our properties have been modernized. We've invested heavily as you know. We've redeveloped over 7.3 million sq ft of tenant spaces, renovated all the common areas and building systems and infrastructure. I think we're very well positioned. Look, we delivered great results. We've got a great pipeline of activity for office space in Manhattan for both full floors and pre-builts. We're seeing activity from a wide variety of tenants, including TAMI, FIRE, consumer product, nonprofit, global manufacturing, professional services, you name it.
We are building a quality diversified rent roll, I don't see the level of interest being diminished by new development. In fact, I'd say the new development enhances our neighborhoods, it's all good for us. I think we're very well positioned for the future.
Tom, can you just remind us, the developed vacant space that you have of 530,000 sq ft, is that all available to be leased today, or is some of that meant to be aggregated?
About 450,000 sq ft is redeveloped and vacant and ready for lease-up. Roughly half of that is pre-built and the other half are white box full and partial floors. The balance of that space we'll bring to market over the course of this year and early next year. Some of it's waiting for rollover some adjacent space.
Okay, great. Thank you.
Thank you. Our next question is a follow-up from the line of Emmanuel Korchman with Citi. Please proceed with your question.
Hey, it's Michael calling in with Manny. Tony, using your knowledge rather than assumptions, quote, can you share with us maybe the year-to-date visitors, I don't know, through this weekend, which sort of captures Easter, both last year and this year, to sort of see what the trends would be?
No, Manny, we'll do that at the end of the second quarter. I'm sorry, Michael, we'll do it at the end of the second quarter. We don't give interim updates. We're happy with what we're seeing.
I know you don't give, that's why I ask, because you've made some assumptions based on what it is, I figured talking about the current trends would be more important than talking about hypotheticals and assumptions.
I got you. First of all, as you know from our prior comments, we always look at things on a trailing 12 months because things like the shift of Easter and Passover during this period of time, Passover to a lesser extent, Easter to a much greater extent, do create distortions. Again, we'll give that report at the end of the next quarter.
Well, I'm sure you have matzah available on the 86th floor for people. In terms of the pricing, you said you went down to two tiers versus three. I guess the headline price is $36 and $69 today, just for the regular price. Just remind us where the two tiers were before, and sort of what was the take-up of the three tiers versus what you're seeing the take-up between the two tiers today?
Those different tiers, Michael, are actually what's at the gate. That doesn't refer to premium offerings. That refers to the price to get into the attraction. What we did is we had before what we called our regular, our peak, and our premium. We didn't disclose those to the outside world. What it was just certain days when you showed up or you bought your ticket, or a ticket for entry was redeemed through one of our tour and travel partners
It was at a higher number. What we looked at after doing a lot of study with some outside help, was that it's really a different program that we want to pursue as we look at things overall. We look at what we call our value and our regular periods. It's just a different way of phrasing it, so to speak. Number one. Number two, our alternative products, we just began offering a $500 per person all-access pass. The all-access pass gives the visiting group access to our new green room, where celebrities come and visit, back of the building, things that people don't get to see, personalized treatment throughout, other special benefits, all featured on the website. We have our AM/PM ticket. We have our express ticket. We have a meal with a view at two of our restaurants at the building. We have our sunrise experience.
Those are all the ones where people can opt in for something special. What we find is that we're really focused on looking at our revenue mix and how this stuff works. We're really focused on reducing our discounts. We're really focused on enhancing the consumer experience. By enhancing our consumer experience, we will also, therefore, we feel, be justified in a higher price. The consumer experience is not just the new attraction that we're putting together, but it's also putting limitations on the number of bodies on the deck at any time, so that we increase the sq ft per person, so we get a higher quality experience there. What we find is that we're really focused on the revenue side, and we are less focused on volume.
We figure that the volume will be a derivation of the best mix of revenue, but our focus is on the revenue. When we look at all of these different things together, the movement from three tiers to two tiers was just a component of an overall pricing strategy. One we've been developing over really the last 48 months and perfecting as it goes along, and it's been delivering quarter after quarter after quarter of per cap growth.
Just maybe one for Durels. On the FDIC lease, can you just talk about sort of the term? You're only going out to 2024. Was there any desire, maybe given the interplay between the rent and term, that you could have locked them in for longer, and I guess, why did they go that shorter term?
I'd say first of all, FDIC is happy with their space, but they were limited to a five-year term. We were happy to renew them on the terms that we did. As I pointed out earlier, the lease concessions were very modest, and we're happy with the outcome. I'd point out also that those floors are extraordinarily desirable, and it was a very tough decision for us to renew versus redevelop and make them available. We have a good visibility towards demand for these floors. We thought long and hard about it and concluded that under the present situation that we have, the need to redevelop that space and bring it to market, we felt that we would prefer to do that, and it would flow for us as far as generating the best benefits five years out versus immediately. We're happy with the term.
To go longer, we think, would have sacrificed upside as our next pick on the deal.
Last question for you, Tony, just in terms of using the under-leveraged balance sheet and the capital that you have, how has your thinking potentially changed on stock buyback, given where the stock price is, the liquidity that you have, tied to what potential acquisition opportunities are out there in terms of buying into your portfolio, the portfolio that you know best, and assets that you know best, and just making a capital allocation decision rather than trying to get the stock price up, but buying in at a discount to your portfolio when it trades at a meaningful discount, especially given your view on the observatory and where you think that's going to go?
I appreciate that question because it's an answer that I really like to give. We appreciate that the public market seems out of whack with the private market. We still look to grow our business rather than to shrink it through buybacks of our stock or asset sales. We continue to focus primarily on non-marketed situations and growing our business. We do not see our liquid and low-leveraged balance sheet with availability on our line as a drag on performance, but as optionality for the future. We are actively engaged in off-market opportunities. Whether or not they will come to pass, one that I've been working on for three and a half years and one that I've been working on for five years, there's every reason that they should proceed. Again, they're off market. They are not cash on the barrel.
It involves a different set of motivations and considerations for the parties with whom we've been speaking. We just continue to focus on what are we going to do with that balance sheet to help fix the issues and stabilize the issues of portfolios we might bring in rather than shrink the company by buying back stock or selling off assets and buying back stock.
Okay. Thank you.
Thank you. Our next question is a follow from the line of John Guinee with Stifel. Please proceed with your question.
Great. Thank you. Tony, two other quick questions for you. About a year ago, you were fairly negative on street retail. How has your opinion changed? Do you think Manhattan or some of the markets have hit bottom on retail rents and occupancy? The next question is, I understand the legislation needs to be followed by the rules in terms of the green bill. Is this green bill situation $10 a foot in base building capital needed to be spent, or is it a situation where buildings just can't physically comply with the expected legislation?
Well, I'll answer the first question and then the second. With regard to Actually, I'll do the second one first. With regard to the green bill, to me, it really comes down to, we don't want to give forward-looking comments. Quite frankly, what I don't want to do is to cause any reaction to the folks who are going to be making the rules. I want to be deferential and respectful to them. All right? I think that's the most important piece. As far as costs per square foot, every time we sign a lease, we improve our energy consumption profile, as we recycle old space and the new space is built out more efficiently. Every time we make any capital upgrade of any kind, of any building system, it has a different impact. I want to be careful on that particular subject.
There are a lot of forces at play. There are a lot of things still to be said. I would think it's unwise for me to express an opinion not based on fact, and to think that this is an easy target to reach. Do me a favor and repeat your first question.
Oh, just retail. About a year ago, you.
Right. Yeah, street retail. Sorry about that. Yeah, I was at dinner the other night with someone who's the head of a company that owns a lot of street retail, he made a simple comment. He said that over the last 10 years, street retail pricing in peak popular areas of Manhattan doubled and then fell by half. They're pretty much where they were 10 years ago. At the same time, over that 10-year period, the number of retailers out there has shrunk. You can talk about Casper or Bonobos or Warby Parker or whatever you like. They're not moving the needle.
In our view, we still look at street retail as if you're fortunate to have a good credit tenant that wants to sign for a longer-term lease, you are going to invest more for TI and CapEx, you are going to get less rent. That's a fact.
Good. Thank you very much. Have a good day.
Thank you. Ladies and gentlemen, our final question this morning comes from the line of Craig Mailman with KeyBanc Capital Markets. Please proceed with your question.
Hey, guys. Just two quick ones. Just wanted to follow up on the earlier question about the burn-off of the free rent there. It sounds like 2Q and beyond should have about $3 million from what burned off from that schedule this quarter. As we think about the remaining $12-plus million that's in there, I know you guys don't give guidance, but is it, I guess, some sense of timing of when that kind of hits? Is it more back-end weighted in each of the quarters? I'm just trying to get a sense of trajectory there.
Yeah. Craig, you're correct. It is $3 million. Then if you look at the remaining amount, you can get a sense if you look in our corporate presentation on page 10, it gives you expected base cash commencement dates, and you'll see that a lot of this is going to be more back-end loaded over the year.
Okay. All right. Just the way we should think about the $12.6 million that's in there, that's actually a much higher gross amount, but only a fraction of it comes in during the year.
I'm not sure I follow when you say it's a gross amount that comes in.
The $9 million that's burning off this year is actually $12 million of leases.
Well, because three of that was realized in the first quarter, roughly.
Right. I guess to go back to John's question then, where'd that $3 million go? Was it just offset by space coming offline? Did you recognize the full $3 million in the first quarter, or was it sort of timing-wise, something less than $12 million? I mean, $3 million, sorry.
A little bit less. You don't have the entire $3 million in the first quarter because those commencement dates weren't on January 1. They would occur throughout the quarter, it wasn't the full $3 million.
Then just lastly, any updated plans on what you're going to do with the convert?
We're going to pay it off. How we do that, we're still evaluating our options, which, as we've noted, are many. We have the ability to do it with cash on the balance sheet. We have the ability to draw on the revolver. There's the potential for doing a bank term loan. There's a potential for doing a private placement. We could consider a public bond issuance. A lot of options available to us. As you'll recall, we did, as a precaution and to provide us with greater optionality, enter into a forward starting interest rate swap. We have lots of financing options on that.
Relative to the coupon, where do you think pricing is today for debt that could replace it?
Remember, there's two things to look at when you look at the cost of that exchangeable. One is the cash coupon that we pay, which is 2.625%, and then there's what the GAAP interest accrual is, which takes into consideration the non-cash portion of the equity option as well as the amortization of deferred finance costs. When you take that into consideration, and this is all laid out in our 10-K, you'll see that the GAAP accrual rate is just under 4%, 3.93%. In comparison, let's say we were to do a term loan, seven-year bank term loan. Let's just assume a spread somewhere around 150 basis points. We have the swap, which is 2.958%, say roughly 3%. We'd be all in at around 4.5%. On a cash basis, that would increase our interest cost by just under 2%.
That's roughly $4.7 million on the $250 million notional. On a GAAP basis, however, the incremental interest expense would be about 0.6%, which would be roughly $1.5 million per year on the notional.
Great. Thanks, guys.
Thank you. Ladies and gentlemen, that concludes our question and answer session. I'll turn the floor back to Mr. Malkin for any final comments.
I'll keep it short. Our goal was to produce a very short call. We had 11 minutes of our time talking, we are thrilled by the active Q&A. We really are, we're sorry for going so long. We thank you very much for your time and questions. We look forward to a chance to meet with you all in the months ahead. We have several property tours, events in May read on the calendar for the spring and summer. We look forward to repeating our second quarter results, including our observatory attendance in July. Until then, everybody, all the best.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.