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Praveen Chawla
Praveen Chawla
Articles (33) 

Investment Note: Empire State Realty Trust

The REIT's stock is currently selling at a distressed valuation

June 28, 2020 | About:

Empire State Realty Trust (NYSE:ESRT) owns and operates a portfolio of primarily "pre-war" office and retail assets in Manhattan, including the iconic Empire State Building and its rooftop observatory. It also owns and operates suburban office and retail assets in Connecticut and New York state.

The real estate investment trust's office and retail portfolio covers 10.1 million rentable square feet, consisting of 9.4 million rentable square feet in 14 office properties, including nine in Manhattan, three in Fairfield County, Connecticut and two in Westchester County, New York, and approximately 700,000 rentable square feet in the retail portfolio. Apart from the Empire State Building, the company's portfolio is more "B" class. The company is in the process of investing capital to vacate spaces to redevelop and re-lease them, improving occupancy and creating value. Significant Class A office supply additions in Manhattan (for example the giant Hudson Yard development) presage increasing competition and blunting rent growth for the company’s portfolio of office properties.

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A strong balance sheet and liquidity position should allow the company to weather near-term challenges associated with the coronavirus outbreak. But the pandemic can have damaging long-term effects on Empire State Realty's portfolio of Manhattan office properties by reducing rental rates across the board.


The iconic Empire State Observation Deck continues to be a must-see attraction for tourists visiting New York City. Presently, the venue is closed due to the Covid-19 outbreak, but even after the pandemic is over, faltering demand for the Empire State Building’s observation deck will persist amid increased options for consumers as other observation decks are added on buildings in Manhattan. This will limit the company's ability to charge a premium to access the observation deck. The Observatory alone produces more than $125 million per year (15% of total company revenue) in revenue and has grown at a double-digit annualized rate.

Anthony Malkin is chairman and CEO of Empire State Realty and is the grandson of Lawrence Wien, who originally bought the right to lease the Empire State Building back in the 1960s. He and his family own 14.1% of the voting interest of the company and 32,890,407 shares worth approximately $263 million. That is a significant alignment of interest.

The company's share price had been softening in 2018 and 2019 even prior to the pandemic. This was a result of a significant supply of new Class A office space coming to the market. Since the pandemic hit New York City in February, the stock has been cut in half. I believe this may be a overreaction.

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The company has been growing net operating income, as per the chart below, but the stock is now 60% below where it was when the company went public in 2014. Again, this is evidence of market over-reaction. Currently, the company is paying out a dividend of 6.4% and has an implied capitalization ratio of 9%. (Capitalization ratio = Net operating income / Enterprise value). While it is probable that management may cut dividends if the situation worsens, I think the intrinsic value of the property will remain.

There is a high probability in my mind that ultimately the coronavirus epidemic will pass or become an endemic and treatable illness (like the flu). Right now, we are in the midst of the pandemic and emotions are high. There is a lot of genuine fear that high-rise offices and apartments will be permanently impaired. This is unlikely; I think in five years this pandemic will only be a distant bad memory.

Disclosure: The author is long Empire State Realty Trust via options.

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