Empire State Realty Trust(ESRT) - 2021 Q4 - Annual Report

FORM 10-K Filing Information This section provides basic identification details for Empire State Realty Trust, Inc. as a registrant filing its annual report on Form 10-K for fiscal year 2021 Registrant Information Identifies Empire State Realty Trust, Inc. as a well-known seasoned issuer filing its 2021 annual report on Form 10-K - Registrant: EMPIRE STATE REALTY TRUST, INC., a Maryland corporation[2] - Filing Type: Annual Report on Form 10-K for the fiscal year ended December 31, 2021[2] Indicator Status | Indicator | Status | | :------------------------ | :----- | | Well-known seasoned issuer | Yes | | Large accelerated filer | Yes | Securities and Market Value Details Class A Common Stock trading on NYSE (ESRT) and $2.07 billion market value of voting stock held by non-affiliates Common Stock Details | Security Type | Trading Symbol | Exchange | | :------------------------ | :------------- | :---------------- | | Class A Common Stock | ESRT | New York Stock Exchange | | Class B Common Stock | N/A | N/A | Market Value and Shares Outstanding | Metric | Value | | :----------------------------------------- | :---------------- | | Aggregate market value of voting stock held by non-affiliates (June 30, 2021) | $2,068,792,000 | | Class A common stock outstanding (Feb 18, 2022) | 169,133,348 shares | | Class B common stock outstanding (Feb 18, 2022) | 995,210 shares | Documents Incorporated by Reference Portions of the 2021 Proxy Statement for the Annual Stockholders' Meeting are incorporated by reference into Part III of this 10-K - Portions of the Proxy Statement for the 2021 Annual Stockholders' Meeting (May 12, 2022) are incorporated by reference into Part III of this 10-K[6] Table of Contents Definitions Defines key terms such as 'annualized rent,' 'fully diluted basis,' and 'enterprise value' for consistent report understanding - Key terms defined include 'annualized rent' (base rent + operating expenses/real estate taxes reimbursement), 'fully diluted basis' (Class A common stock + exchangeable OP units + convertible Class B common stock), and 'enterprise value' (fully diluted Class A common stock price + private perpetual preferred units + consolidated debt)[9] - The 'Malkin Group' refers to a specific group of individuals and entities, primarily Anthony E. Malkin and Peter L. Malkin and their descendants, with specific implications for tax protection rights[9] - 'Our company' refers to Empire State Realty Trust, Inc., a Maryland REIT, and its consolidated subsidiaries, including Empire State Realty OP, L.P., which is the 'operating partnership' through which substantially all business is conducted[9] PART I ITEM 1. BUSINESS Empire State Realty Trust, Inc. is a New York City-focused REIT managing office, retail, and multifamily assets, including the Empire State Building - Empire State Realty Trust, Inc. is a New York City-focused REIT owning and managing office, retail, and multifamily assets in Manhattan and the greater New York metropolitan area, including the Empire State Building and its Observatory Experience[13] Portfolio Summary (as of December 31, 2021) | Asset Type | Rentable Square Feet (Office & Retail) | Occupancy (Office & Retail) | Leased (Office & Retail, incl. signed) | Number of Office Properties | Number of Multifamily Units | | :--------------------- | :------------------------------------- | :-------------------------- | :------------------------------------- | :-------------------------- | :-------------------------- | | Office and Retail Portfolio | 10.1 million | 82.4% | 85.7% | 14 | N/A | | Multifamily Properties | N/A | N/A | N/A | N/A | 625 | - The company conducts substantially all business through its operating partnership, Empire State Realty OP, L.P., and has elected to be taxed as a REIT for U.S. federal income tax purposes since 2013[15] Overview Empire State Realty Trust, Inc. is a NYC-focused REIT managing office, retail, and multifamily properties, including the Empire State Building - The company is a New York City-focused REIT, owning and managing office, retail, and multifamily assets in Manhattan and the greater New York metropolitan area[13] - The portfolio includes the Empire State Building, which also features a newly reimagined Observatory Experience[13] Portfolio Composition (as of December 31, 2021) | Asset Type | Rentable Square Feet | Occupancy | Leased (incl. signed) | Number of Properties/Units | | :--------------------- | :------------------- | :-------- | :-------------------- | :------------------------- | | Office & Retail | 10.1 million | 82.4% | 85.7% | 14 office, 6 standalone retail | | Manhattan Office | 7.6 million | 82.5% | 85.3% | 9 | | Greater NY Office | 1.8 million | N/A | N/A | 5 | | Standalone Retail | 0.2 million | 100.0% | N/A | 6 | | Multifamily | N/A | N/A | N/A | 625 units | Impact of COVID-19 The COVID-19 pandemic significantly impacted New York City operations, leading to shutdowns and restrictions, with financial details referenced elsewhere - The COVID-19 pandemic created a global crisis, severely impacting the economy and social systems, especially in New York City and the tri-state region[16] - Government-imposed restrictions, including business shutdowns and travel limitations, have largely been lifted as the pandemic's impact improved due to vaccination[16] - Further information on COVID-19's impact on business and related risks can be found in Part II, Item 7 ('Management's Discussion and Analysis') and Part I, Item 1A ('Risk Factors')[17] Business and Growth Strategies Strategies focus on maximizing shareholder returns and property value via environmental leadership, acquisitions, portfolio management, and Observatory enhancements - Primary business objectives are to maximize cash flow and total returns to shareholders and increase property value[19] - Capitalize on Environmental Leadership: Pioneered energy efficiency retrofits (e.g., Empire State Building), achieved GRESB 5 Star rating, ENERGY STAR Partner of the Year, WELL Health-Safety Rating, and Fitwel Champion. 100% of portfolio contracted for renewable wind energy since January 2021. No exposure to fines in 2024 under NYC's Local Law 97[19][20] - Pursue Attractive Acquisition and Redevelopment Opportunities: Built a dedicated investment team, focusing on NYC office, retail, and multifamily properties. Acquired two Manhattan multifamily assets in December 2021. Holds entitled land for Metro Tower office development in Stamford, CT[21] - Proactively Manage Our Portfolio: Service-intensive approach to asset and property management, focusing on increasing occupancy and rental rates, fostering strong tenant relationships, and extensive tenant diligence. Achieved over 200 tenant expansions totaling 2.5 million square feet since 2013[22] - Enhance and Recover our Observatory Operations: Aiming to return to pre-COVID-19 profitability for the Empire State Building Observatory through enhanced operations (timed-entry), marketing, and health/safety protocols (MERV 13 filters, bipolar ionization). Observatory visitor numbers declined from 3.5-3.8 million (2018-2019) to 0.5 million (2020) and 0.8 million (2021) due to the pandemic[24] Leasing Focuses on a high-quality brand for properties, emphasizing services, healthy buildings, and energy efficiency to attract and retain high credit-quality tenants - Focus on maintaining a brand associated with high quality services, healthy buildings, amenities, and energy efficiency to attract high credit-quality tenants[25] - Emphasizes long-term relationships with brokers and tenants, with senior management actively involved in communication to maximize leasing results[25] Property Management Self-manages all office and retail properties, focusing on proactive maintenance, capital improvements, and aggressive operating expense control - Self-manages all office and retail properties, focusing on routine preventive maintenance and capital improvement programs[26] - Strategies include aggregating smaller spaces to attract high credit-quality tenants, creating efficient pre-built offices, and aggressively managing operating expenses[26] - Energy efficiency retrofitting and sustainability are portfolio-wide initiatives, with cost savings passed on to tenants, making properties more desirable[26] Business Segments Operates two reportable segments: Real Estate (commercial/multifamily) and Observatory (Empire State Building), managed distinctly due to differing characteristics - Reportable segments are Real Estate and Observatory[27] - Real Estate segment: Ownership, management, operation, acquisition, repositioning, and disposition of commercial and multifamily assets in Manhattan and greater New York metropolitan area[27] - Observatory segment: Operates the 86th and 102nd floor observatories at the Empire State Building[27] Regulation Properties are subject to federal, state, and local laws, including ADA and environmental regulations, with potential liabilities for non-compliance and NYC Local Law 97 emission limits - Properties are subject to various laws, ordinances, and regulations, including those related to common areas, ADA, and environmental matters[29][30][33] - Potential liabilities include fines or damages for ADA noncompliance, costs for investigating/remediating hazardous substances (e.g., at 69-97 Main Street, Westport, CT, and 500 Mamaroneck Avenue, Harrison, NY), and issues related to asbestos or mold[32][33][35][36][40][41] - Subject to New York City's Local Law 97, establishing annual greenhouse gas emission limits for large commercial buildings, but expects no fines for the 2024-2030 enforcement period[42] - Certain multifamily units are designated for lower-income households and are regulated by state and federal authorities[43] Insurance Maintains comprehensive liability, property, and terrorism insurance, including through its captive, with substantial self-insurance and exclusions for certain losses - Carries comprehensive liability, fire, extended coverage, earthquake, terrorism, and rental loss insurance for all Manhattan and greater New York metropolitan area properties under a blanket policy[44] - ESRT Captive Insurance Company L.L.C., a wholly-owned captive, provides additional all-risk property and business insurance, including $1.2 billion in terrorism coverage (in excess of $800 million) for the Empire State Building, totaling $2 billion aggregate[44] - NBCR (Nuclear, Biological, Chemical, and Radiological) insurance is held for $50 million in the commercial market, with ESRT Captive Insurance providing an additional $1.95 billion in excess[44] - Policies include substantial self-insurance, significant deductibles, and co-payments. Certain losses, such as those caused by war or business interruption due to pandemics, are not covered[49][50] Competition The real estate leasing market in Manhattan and greater New York metropolitan area is highly competitive, impacting revenues based on rent, location, services, and facility condition - The real estate leasing market in Manhattan and the greater New York metropolitan area is highly competitive[51] - Competition factors include rent, location, services, and property condition, with rivals potentially offering lower rates or better facilities[51] - Faces competition from other real estate companies (REITs, private funds, financial institutions) with potentially greater financial resources[51] - Observatory and broadcasting operations also face competition from new and existing facilities, and adverse travel trends or currency exchange rates could decrease demand[51] Our Tax Status Elected REIT status since 2013, exempting it from federal income tax on distributed income, and uses TRSs for non-qualifying activities subject to corporate tax - Elected to be taxed as a REIT since December 31, 2013, and aims to qualify annually to avoid U.S. federal income tax on distributed net taxable income[52] - REIT qualification requires distributing at least 90% of REIT taxable income annually; failure to do so incurs corporate tax rates and potential excise tax[55] - Must meet gross income and asset tests: at least 75% of assets in cash, government securities, or qualified REIT real estate assets, and limits on securities of any one issuer or TRSs[56] - Uses Taxable REIT Subsidiaries (TRSs) for non-qualifying income activities like the Empire State Building observatory and broadcasting licenses, with rent/fees from these TRSs qualifying as REIT income based on IRS private letter rulings[58][59] Inflation Leases include tax and operating expense escalations and fixed rent increases, expected to partially offset inflation, which historically has not materially impacted financials - Substantially all leases include separate real estate tax and operating expense escalations, and many have fixed base rent increases[60] - These contractual provisions are expected to partially offset inflationary increases[60] - Historically, inflation has not had a material impact on the company's financial position or results of operations[60] Seasonality The observatory business experiences seasonality due to tourism and weather, with higher revenues in Q2 and Q3, while other business is not materially seasonal - Observatory business is subject to tourism trends and weather, leading to seasonality[61] Historical Annual Observatory Revenue Distribution (Pre-COVID-19) | Quarter | Percentage of Annual Revenue | | :------ | :--------------------------- | | Q1 | 16.0% - 18.0% | | Q2 | 26.0% - 28.0% | | Q3 | 31.0% - 33.0% | | Q4 | 23.0% - 25.0% | - The rest of the company's business is not materially affected by seasonal fluctuations[62] Human Capital Management As of December 31, 2021, the company employed 693 people, 484 unionized, prioritizing diversity, talent, learning, and health/safety protocols - As of December 31, 2021, the company employed 693 people, with approximately 484 covered by collective bargaining agreements[63] - Diversity and Inclusion: Strives for a diverse and inclusive workplace, recognized by the 2022 Bloomberg Gender-Equality Index[64] - Talent Acquisition and Retention: Offers competitive compensation, benefits, and equity grants (annual for senior management, multi-year anniversaries for others). Regularly collects employee feedback[65] - Training and Development: Invests in mandatory and voluntary training programs to support productivity, innovation, and retention[66] - Health, Safety and Wellness: Recognized for leadership in indoor environmental quality. Implemented COVID-19 protocols including online screening, temperature checks, air quality tests, remote work options, and PPE[67][68][69] Offices Principal executive offices are in New York, New York, with five regional offices, and current facilities are adequate for present and future operations - Principal executive offices are at 111 West 33rd Street, New York, New York[70] - Maintains five additional regional leasing and property management offices in Manhattan and the greater New York metropolitan area[70] - Current facilities are adequate for present and future operations, with potential for expansion[70] Available Information Provides free online access to SEC filings (10-K, 10-Q, 8-K) and corporate governance documents on its website, with additional reports via the SEC - Company website (http://www.esrtreit.com) provides free access to SEC filings (10-K, 10-Q, 8-K) and amendments[71][73] - Corporate governance documents, including committee charters, governance guidelines, and the Code of Business Conduct and Ethics, are also available on the website[73] - The SEC's website (http://www.sec.gov) also contains reports and information regarding the company[73] ITEM 1A. RISK FACTORS Outlines significant risks that could materially and adversely affect the company's business, operations, financial condition, and REIT qualification - The company faces substantial risks and uncertainties that could materially and adversely affect its business, operations, financial condition, and REIT qualification[75][76] - Key risk categories include the economic and social impact of the COVID-19 pandemic, portfolio concentration in New York and Connecticut, and reliance on a few key properties and tenants[76][83][87][89] - Other significant risks involve real estate market conditions (e.g., shift to remote work, retail industry downturn, competition), non-real estate operations (observatory, broadcasting), debt and liquidity, natural disasters, environmental compliance, human capital, legal/cybersecurity issues, and maintaining REIT status[90][93][96][101][106][110][114][115][124][133][136][140][141][143][145][146][148][150][151][153][155][157][161][163][165][168][170][173][176][177][179][182][184][186][189][191][192][194][196][198][199][201][202] Risks Related to Our Business and Properties Faces significant risks from COVID-19, portfolio concentration in New York/Connecticut, terrorist events, and reliance on key properties/tenants - COVID-19 Pandemic: Serious adverse effects on business, operations, and financial condition due to tenant rent deferrals/defaults, reduced observatory visitor volume (0.5 million in 2020, 0.8 million in 2021 vs 3.5 million in 2019), and potential claims related to protective measures. Impacts human capital, economic demand, capital projects, debt compliance, stock price, and dividend payments[76][77][78][79][80][81] - Portfolio Concentration: Properties are primarily in Manhattan, Fairfield County (CT), and Westchester County (NY), making the business highly dependent on the New York City economy and vulnerable to local economic/regulatory developments, including potential negative demographic shifts due to tax policies[83][84] - Terrorist Event: Threat or occurrence of a terrorist event, especially in New York City, could decrease demand, occupancy, rental rates, and property values, particularly for high-profile assets like the Empire State Building[85][86] - Reliance on Key Properties/Tenants: Six properties account for ~75.5% of rental revenues, with the Empire State Building alone contributing ~31.7%. Observatory operations generated $41.5 million in 2021, significantly down from $128.8 million in 2019. The five largest tenants represent 13.2% of annualized rent, posing risks if they face financial strain or default[87][88][89] Risks Relating to the Real Estate Market Real estate market risks include remote work shifts, adverse economic conditions, tenant bankruptcies, high competition, and multifamily lease volatility - Shift to Remote Work: A sustained shift away from in-person work or increased remote work could adversely affect demand, occupancy, and rental rates for office and multifamily properties[90] - Adverse Economic Conditions: Economic and geopolitical conditions, especially impacting the retail industry (17.1% of annualized rent), could cause reduced demand, rental rates, and occupancy for retail and office space due to online shopping trends and bankruptcies[91][93] - Tenant Bankruptcy/Insolvency: Tenant bankruptcies (e.g., GBG USA Inc. in July 2021) can lead to lease terminations, non-recovery of upfront investments, and substantial costs in enforcing rights. Smaller tenants, which constitute a large number, have a higher failure rate[94][95] - Competition: Highly competitive leasing market in greater New York City, with increased competition from lessors offering concessions, amenities, and certifications, challenging the ability to lease space and maximize effective rents[96] - Lease Renewals/Re-leasing: Risk of being unable to renew leases or re-lease vacant space (1.4 million sq ft vacant, 5.7% expiring in 2022, 6.3% in 2023) on favorable terms, potentially requiring rent concessions or significant capital expenditures for property improvements, especially for older properties[97][98][99] - Multifamily Lease Volatility: Short-term nature of multifamily leases (12 months or less) exposes the company more quickly to declining market rents, increasing revenue volatility[100] Risks Relating to Our Properties Faces risks from ground leases, property development, uncontrollable operating costs, and reliance on third-party multifamily property management - Ground Leases: Interests in three commercial office properties (1350 Broadway, 111 West 33rd Street, 1400 Broadway) are ground leases expiring between 2050 and 2077. Risks include lease termination for breach, inability to renew on favorable terms, loss of operating rights, no share in land value increase, and limited eminent domain compensation[101][103] - Property Development: Exposed to risks in development activities (e.g., Metro Tower at Stamford Transportation Center), including financing availability/pricing, zoning approvals, occupancy rates, construction costs/delays, and timely lease-up. Abandonment of projects could lead to unrecovered expenses[104][105] - Operating Costs: Inability to control operating costs (real estate taxes, insurance, maintenance) which generally do not decrease with lower occupancy or rental rates. Inflation impacts these costs, and lease terms may limit tenant reimbursement[106][107] - Third-Party Property Management: Uses a third-party for certain multifamily properties, exposing the company to risks of non-performance, additional costs, and reputational harm if standards are not met[108][109] Risks Related to Our Non-Real Estate Operations Observatory operations are susceptible to competition, weather, and tourist trends, while broadcasting faces competition and technological changes, with goodwill impairment risk - Observatory Operations: Not traditional real estate, highly susceptible to competition (World Trade Center, Rockefeller Center, etc.), adverse weather, and tourist trends. COVID-19 caused significant revenue decline ($128.8 million in 2019 to $29.1 million in 2020 and $41.5 million in 2021), with uncertainty on return to pre-pandemic levels[110][111] - Broadcasting Operations: Not traditional real estate, faces competition and changes in broadcasting technology. Revenue from licenses ($13.5 million in 2021, down from $21 million peak) has been negatively impacted, with reduced revenue from lease renewals and higher operating/capital expenses. Government regulations may further reduce demand for broadcast licenses[112] - Goodwill Impairment: Balance sheet includes $491.5 million in goodwill (primarily from Empire State Building Company L.L.C. and 501 Seventh Avenue Associates L.L.C.). Ongoing impairment assessments, particularly for the observatory reporting unit ($227.5 million goodwill), are sensitive to future market and economic conditions, and an impairment could materially affect reported earnings[114][115] Risks Relating to Acquisitions and Dispositions Acquisition challenges include competition and unknown liabilities; tax-deferred transactions may dilute securityholders and restrict asset sales; real estate illiquidity hinders dispositions - Acquisition Challenges: Difficulty in identifying and successfully completing acquisitions due to significant competition, especially from private investors. Incurring costs and diverting management attention for uncompleted acquisitions. Successful acquisitions may involve higher-than-budgeted improvements and unknown liabilities[116][117] - Tax Deferred Contribution Transactions: Acquiring properties via tax-deferred contribution transactions in exchange for operating partnership units could lead to securityholder dilution, reduced tax depreciation, and restrictions on asset disposition to protect contributors' tax deferral[118][119] - Inability to Sell/Dispose/Refinance: Real estate investments are illiquid. Restrictions from the Internal Revenue Code on REIT property dispositions may limit the ability to realize investment objectives through timely sales, other dispositions, or refinancing at attractive prices[120][121] Risks Relating to Our Indebtedness and Liquidity Faces interest rate risk from variable-rate debt (LIBOR phase-out), substantial debt ($2.3 billion) with restrictive covenants, and dependence on external capital, impacting financial flexibility - LIBOR Phase-out: Exposure to interest rate risk on revolving credit facility and term loan, which use USD LIBOR. Phase-out by June 30, 2023, and transition to SOFR could result in higher interest rates and market disruption[122] - Debt and Limitations: Total debt of approximately $2.3 billion as of December 31, 2021, with no maturity before November 2024. Loan documents contain covenants (e.g., maximum leverage, minimum fixed charge coverage) that restrict financial and operational flexibility and distributions. Default could accelerate debt and lead to foreclosures[124][125][126][127] - Mortgage Risks: Mortgages expose the company to foreclosure and loss of investment. High mortgage rates or unavailability of debt could make financing/refinancing difficult, reducing net income and cash distributions. Foreclosures could also trigger tax protection agreement indemnification obligations[128][129] - Dependence on External Capital: As a REIT, the company relies on external sources of capital (debt, equity issuances, asset sales) to fund future capital needs, acquisitions, and distributions. Access to capital depends on general economic and market conditions, and market perception of growth potential[130][132] Risks Relating to Disaster Recovery and Business Continuity Properties are vulnerable to natural disasters and climate change, with potentially inadequate insurance coverage and significant environmental compliance costs, including NYC Local Law 97 - Natural Disasters and Climate Change: Properties concentrated in the New York metropolitan area are vulnerable to earthquakes, storms, floods, and hurricanes. Climate change (rising sea levels, extreme temperatures) could impact demand, operations, insurance affordability, and energy costs. Disaster recovery plans may be inadequate[133][134] - Insurance Coverage Limitations: Insurance may not cover all losses (e.g., war, pandemic business interruption). Policies have substantial self-insurance, deductibles, and co-payments. Uninsured losses or exceeding policy limits could incur significant costs. Inability to obtain required insurance could lead to debt default[135][136][137] - Environmental Compliance Costs: Significant costs to comply with environmental laws (air/water quality, hazardous substances, health/safety). Contamination (e.g., at 69-97 Main Street, Westport, CT, and 500 Mamaroneck Avenue, Harrison, NY) could lead to fines, remediation costs, and impair ability to sell, lease, or finance properties. New York City's Local Law 97 on greenhouse gas emissions poses compliance challenges and potential penalties, though no fines are expected for 2024-2030[138][140] Risks Relating to Human Capital Management Success depends on key personnel, especially CEO Anthony E. Malkin, whose outside interests may create conflicts, and maintaining satisfactory labor relations with unionized workforce is crucial - Departure of Key Personnel: Success depends on key personnel, especially Anthony E. Malkin (Chairman, President, CEO), whose leadership and industry reputation are critical. Loss of senior management could materially affect the company[141][142] - CEO Outside Business Interests: Mr. Malkin has outside investments and management obligations that could conflict with his responsibilities to the company, potentially diverting his time and attention[143] - Labor Relations: 70% of the workforce (484 employees) is covered by collective bargaining agreements. Inability to negotiate acceptable renewals could result in strikes, work stoppages, and increased operating costs from temporary replacement workers