Notes to Condensed Consolidated Financial Statements
(unaudited)
1. Description of Business and Organization
As used in these condensed consolidated financial statements, unless the context otherwise requires, “we,” “us,” "our," and the "company,” mean Empire State Realty OP, L.P. and its consolidated subsidiaries.
Empire State Realty OP, L.P. (the "Operating Partnership") is the entity through which Empire State Realty Trust, Inc. (“ESRT”), a self-administered and self-managed real estate investment trust ("REIT"), conducts all of its business and owns (either directly or through subsidiaries) substantially all of its assets. We own, manage, operate, acquire and reposition office, retail and multifamily assets in Manhattan and the greater New York metropolitan area. As the owner of the Empire State Building, the World’s Most Famous Building, ESRT also owns and operates its iconic, newly reimagined Observatory Experience.
As of March 31, 2023, our office and retail portfolio contained 9.6 million rentable square feet of office and retail space. We owned 12 office properties (including three long-term ground leasehold interests) encompassing approximately 8.9 million rentable square feet of office space. Nine of these properties are located in the midtown Manhattan market and encompass in the aggregate approximately 7.6 million rentable square feet of office space, including the Empire State Building. Our Manhattan office and multifamily properties also contain an aggregate of approximately 0.5 million rentable square feet of retail space on their ground floor and/or contiguous levels. Our remaining three office properties are located in Fairfield County, Connecticut and Westchester County, New York, encompassing in the aggregate approximately 1.3 million rentable square feet. The majority of square footage for these three properties is located in densely populated metropolitan communities with immediate access to mass transportation. Additionally, we have entitled land at the Stamford Transportation Center in Stamford, Connecticut, adjacent to one of our office properties, that will support the development of an approximately 0.4 million rentable square foot office building and garage. As of March 31, 2023, our portfolio included four standalone retail properties located in Manhattan encompassing approximately 0.2 million rentable square feet in the aggregate. Additionally, as of March 31, 2023, our portfolio included three multifamily properties located in Manhattan totaling 721 units.
We were organized as a Delaware limited partnership on November 28, 2011 and operations commenced upon completion of the initial public offering of ESRT’s Class A common stock and related formation transactions on October 7, 2013. ESRT's Class A common stock, par value $0.01 per share, is listed on the New York Stock Exchange under the symbol "ESRT." ESRT, as the sole general partner in our company, has responsibility and discretion in the management and control of our company, and our limited partners, in such capacity, have no authority to transact business for, or participate in the management activities, of our company. As of March 31, 2023, ESRT owned approximately 59.3% of our operating partnership units.
2. Summary of Significant Accounting Policies
There have been no material changes to the summary of significant accounting policies included in the section entitled "Summary of Significant Accounting Policies" in our December 31, 2022 Annual Report on Form 10-K.
Basis of Quarterly Presentation and Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), for interim financial information, and with the rules and regulations of the Securities and Exchange Commission (the "SEC"). Accordingly, certain information and footnote disclosures required by GAAP for complete financial statements have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, all adjustments and eliminations (including intercompany balances and transactions), consisting of normal recurring adjustments, considered necessary for the fair presentation of the financial statements have been included.
The results of operations for the periods presented are not necessarily indicative of the results that may be expected for the corresponding full years. These financial statements should be read in conjunction with the financial statements and accompanying notes included in the financial statements for the year ended December 31, 2022 contained in our Annual Report on Form 10-K. Our observatory business is subject to seasonality based on tourism trends and the weather. Pre-pandemic, approximately 16.0% to 18.0% of our annual observatory revenue was realized in the first quarter, 26.0% to 28.0% was realized
in the second quarter, 31.0% to 33.0% was realized in the third quarter, and 23.0% to 25.0% was realized in the fourth quarter. Our multifamily business experiences some seasonality based on general market trends in New York City – the winter months (November through January) are slower in terms of lease activity. We seek to mitigate this by staggering lease terms such that lease expirations are matched with seasonal demand. We do not consider the balance of our business to be subject to material seasonal fluctuations.
We consolidate entities in which we have a controlling financial interest. In determining whether we have a controlling financial interest in a partially owned entity and the requirement to consolidate the accounts of that entity, we consider factors such as ownership interest, board representation, management representation, authority to make decisions, and contractual and substantive participating rights of the partners/members. For variable interest entities ("VIE"), we consolidate the entity if we are deemed to have a variable interest in the entity and through that interest we are deemed the primary beneficiary. The primary beneficiary of a VIE is the entity that has (i) the power to direct the activities that most significantly impact the entity's economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could be significant to the VIE. The primary beneficiary is required to consolidate the VIE. As of March 31, 2023, we had a variable interest in and are deemed to be the primary beneficiary of 298 Mulberry, the multifamily asset we acquired in December 2022.
We will assess the accounting treatment for each investment we may have in the future. This assessment will include a review of each entity’s organizational agreement to determine which party has what rights and whether those rights are protective or participating. For all VIEs, we will review such agreements in order to determine which party has the power to direct the activities that most significantly impact the entity’s economic performance and benefit. In situations where we or our partner could approve, among other things, the annual budget, or leases that cover more than a nominal amount of space relative to the total rentable space at each property, we would not consolidate the investment as we consider these to be substantive participation rights that result in shared power of the activities that would most significantly impact the performance and benefit of such joint venture investment.
A non-controlling interest in a consolidated subsidiary is defined as the portion of the equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. Non-controlling interests are required to be presented as a separate component of equity in the condensed consolidated balance sheets and in the condensed consolidated statements of operations by requiring earnings and other comprehensive income to be attributed to controlling and non-controlling interests.
Accounting Estimates
The preparation of the condensed consolidated financial statements in accordance with GAAP requires management to use estimates and assumptions that in certain circumstances affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Significant items subject to such estimates and assumptions include allocation of the purchase price of acquired real estate properties among tangible and intangible assets, determination of the useful life of real estate properties and other long-lived assets, valuation and impairment analysis of commercial real estate properties, right of use assets and other long-lived and indefinite lived assets, estimate of tenant expense reimbursements, valuation of the allowance for doubtful accounts, and valuation of derivative instruments, ground lease liabilities, senior unsecured notes, mortgage notes payable, unsecured term loan and revolving credit facilities, and equity based compensation. These estimates are prepared using management’s best judgment, after considering past, current, and expected events and economic conditions. Actual results could differ from those estimates.
3. Acquisitions and Dispositions
In December 2022, we entered into a purchase and sale agreement for 500 Mamaroneck Avenue in Harrison, NY at a gross asset valuation of $53.0 million. The assets and related liabilities of the 500 Mamaroneck property are classified as held for sale in our condensed consolidated balance sheet as of March 31, 2023 and December 31, 2022 having met the held for sale criteria set forth in ASC 360 Property, Plant, and Equipment. Subsequent to March 31, 2023, we closed on the sale of this property on April 5, 2023.
On February 1, 2023, we closed on the sale of 69-97 and 103-107 Main Street in Westport, Connecticut at a gross asset valuation of $40.0 million, and recorded a gain of $15.7 million, which is included in Gain on sale of property in our consolidated statement of operations. The Westport sale was a related party transaction approved in accordance with the Company's related party transactions policy. See our Annual Report on Form 10-K for the year ended December 31, 2022 for more information.
4. Deferred Costs, Acquired Lease Intangibles and Goodwill
Deferred costs, net, consisted of the following as of March 31, 2023 and December 31, 2022 (amounts in thousands):
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
| Leasing costs | $ | 220,988 | | | $ | 218,707 | |
| Acquired in-place lease value and deferred leasing costs | 160,271 | | | 160,683 | |
| Acquired above-market leases | 27,661 | | | 27,833 | |
| 408,920 | | | 407,223 | |
| Less: accumulated amortization | (229,493) | | | (223,246) | |
| Total deferred costs, net, excluding net deferred financing costs | $ | 179,427 | | | $ | 183,977 | |
At March 31, 2023 and December 31, 2022, $4.4 million and $5.0 million, respectively, of net deferred financing costs associated with the unsecured revolving credit facility was included in deferred costs, net on the condensed consolidated balance sheets.
Amortization expense related to deferred leasing costs and acquired deferred leasing costs was $5.8 million and $7.0 million for the three months ended March 31, 2023 and 2022, respectively. Amortization expense related to acquired lease intangibles was $2.4 million and $4.2 million for the three months ended March 31, 2023 and 2022, respectively.
Amortizing acquired intangible assets and liabilities consisted of the following as of March 31, 2023 and December 31, 2022 (amounts in thousands):
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
| Acquired below-market ground leases | $ | 396,916 | | | $ | 396,916 | |
| Less: accumulated amortization | (69,801) | | | (67,843) | |
| Acquired below-market ground leases, net | $ | 327,115 | | | $ | 329,073 | |
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
| Acquired below-market leases | $ | (64,656) | | | $ | (64,656) | |
| Less: accumulated amortization | 48,075 | | | 46,807 | |
| Acquired below-market leases, net | $ | (16,581) | | | $ | (17,849) | |
Rental revenue related to the amortization of below-market leases, net of above-market leases, was $0.7 million and $1.8 million for the three months ended March 31, 2023 and 2022, respectively.
As of March 31, 2023 and December 31, 2022, we had goodwill of $491.5 million. Goodwill was allocated $227.5 million to the observatory reportable segment and $264.0 million to the real estate reportable segment.
From the quarter ended June 30, 2020 through our annual goodwill testing in October 2022, we bypassed the optional qualitative goodwill impairment assessment and proceeded directly to a quantitative assessment of the observatory reportable segment and engaged a third-party valuation consulting firm to perform the valuation process. This was done in response to the temporary closure of our observatory due to the COVID-19 pandemic and subsequent slow increase in visitors due to continued pandemic-related restrictions impacting tourism and international travel. The quantitative analysis used a combination of the discounted cash flow method (a form of the income approach) utilizing Level 3 unobservable inputs and the guideline company method (a form of the market approach). Significant assumptions under the former included revenue and cost projections, weighted average cost of capital, long-term growth rate and income tax considerations while the latter included guideline company enterprise values, revenue multiples and control premium rates. Our methodology to review goodwill impairment, which included a significant amount of judgment and estimates, provided a reasonable basis to determine whether impairment had occurred. Each quantitative analysis performed concluded the fair value of the reporting unit exceeds its carrying value. For the quarter ended March 31, 2023, we performed an optional qualitative assessment and did not identify any events which occurred between our last quantitative assessment and the current reporting date which would indicate, on a more likely than not basis, that the goodwill allocated to the reporting unit was impaired. Many of the factors employed in determining whether
or not goodwill is impaired are outside of our control, and it is reasonably likely that assumptions and estimates will change in future periods. We will continue to assess the impairment of the observatory reporting unit goodwill going forward.
5. Debt
Debt consisted of the following as of March 31, 2023 and December 31, 2022 (amounts in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Principal Balance | | As of March 31, 2023 |
| March 31, 2023 | | December 31, 2022 | | Stated
Rate | | Effective
Rate(1) | | Maturity
Date(2) |
| Mortgage debt collateralized by: | | | | | | | | | |
| Fixed rate mortgage debt | | | | | | | | | |
| Metro Center | $ | 81,973 | | | $ | 82,596 | | | 3.59 | % | | 3.67 | % | | 11/5/2024 |
| 10 Union Square | 50,000 | | | 50,000 | | | 3.70 | % | | 3.97 | % | | 4/1/2026 |
| 1542 Third Avenue | 30,000 | | | 30,000 | | | 4.29 | % | | 4.53 | % | | 5/1/2027 |
First Stamford Place(3) | 178,068 | | | 178,823 | | | 4.28 | % | | 4.73 | % | | 7/1/2027 |
| 1010 Third Avenue and 77 West 55th Street | 35,616 | | | 35,831 | | | 4.01 | % | | 4.21 | % | | 1/5/2028 |
| 250 West 57th Street | 180,000 | | | 180,000 | | | 2.83 | % | | 3.21 | % | | 12/1/2030 |
| | | | | | | | | |
| | | | | | | | | |
| 1333 Broadway | 160,000 | | | 160,000 | | | 4.21 | % | | 4.29 | % | | 2/5/2033 |
| 345 East 94th Street - Series A | 43,600 | | | 43,600 | | | 70.0% of LIBOR plus 0.95% | | 3.56 | % | | 11/1/2030 |
| 345 East 94th Street - Series B | 7,707 | | | 7,865 | | | LIBOR plus 2.24% | | 3.56 | % | | 11/1/2030 |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| 561 10th Avenue - Series A | 114,500 | | | 114,500 | | | 70.0% of LIBOR plus 1.07% | | 3.85 | % | | 11/1/2033 |
| 561 10th Avenue - Series B | 17,025 | | | 17,415 | | | LIBOR plus 2.45% | | 3.85 | % | | 11/1/2033 |
| Total mortgage debt | 898,489 | | | 900,630 | | | | | | | |
| | | | | | | | | |
Senior unsecured notes:(4) | | | | | | | | | |
| Series A | 100,000 | | | 100,000 | | | 3.93 | % | | 3.96 | % | | 3/27/2025 |
| Series B | 125,000 | | | 125,000 | | | 4.09 | % | | 4.12 | % | | 3/27/2027 |
| Series C | 125,000 | | | 125,000 | | | 4.18 | % | | 4.21 | % | | 3/27/2030 |
| Series D | 115,000 | | | 115,000 | | | 4.08 | % | | 4.11 | % | | 1/22/2028 |
| Series E | 160,000 | | | 160,000 | | | 4.26 | % | | 4.27 | % | | 3/22/2030 |
| Series F | 175,000 | | | 175,000 | | | 4.44 | % | | 4.45 | % | | 3/22/2033 |
| Series G | 100,000 | | | 100,000 | | | 3.61 | % | | 4.89 | % | | 3/17/2032 |
| Series H | 75,000 | | | 75,000 | | | 3.73 | % | | 5.00 | % | | 3/17/2035 |
Unsecured term loan facility (4) | 215,000 | | | 215,000 | | | SOFR plus 1.20% | | 4.22 | % | | 3/19/2025 |
Unsecured revolving credit facility (4) | — | | | — | | | SOFR plus 1.30% | | — | | | 3/31/2025 |
Unsecured term loan facility (4) | 175,000 | | | 175,000 | | | SOFR plus 1.50% | | 4.51 | % | | 12/31/2026 |
| Total principal | 2,263,489 | | | 2,265,630 | | | | | | | |
| Deferred financing costs, net | (11,182) | | | (11,748) | | | | | | | |
| Unamortized debt discount | (7,550) | | | (7,745) | | | | | | | |
| Total | $ | 2,244,757 | | | $ | 2,246,137 | | | | | | | |
______________
(1)The effective rate is the yield as of March 31, 2023 and includes the stated interest rate, deferred financing cost amortization and interest associated with variable to fixed interest rate swap agreements.
(2)Pre-payment is generally allowed for each loan upon payment of a customary pre-payment penalty.
(3)Represents a $164 million mortgage loan bearing interest at 4.09% and a $14.1 million loan bearing interest at 6.25%.
(4)At March 31, 2023, we were in compliance with all debt covenants.
Principal Payments
Aggregate required principal payments at March 31, 2023 are as follows (amounts in thousands):
| | | | | | | | | | | | | | | | | |
| Year | Amortization | | Maturities | | Total |
| 2023 | $ | 6,491 | | | $ | — | | | $ | 6,491 | |
| 2024 | 8,861 | | | 77,675 | | | 86,536 | |
| 2025 | 6,893 | | | 315,000 | | | 321,893 | |
| 2026 | 7,330 | | | 225,000 | | | 232,330 | |
| 2027 | 6,461 | | | 319,000 | | | 325,461 | |
| Thereafter | 22,079 | | | 1,268,699 | | | 1,290,778 | |
| Total | $ | 58,115 | | | $ | 2,205,374 | | | $ | 2,263,489 | |
Deferred Financing Costs
Deferred financing costs, net, consisted of the following at March 31, 2023 and December 31, 2022 (amounts in thousands):
| | | | | | | | | | | | | | |
| | | March 31, 2023 | | December 31, 2022 |
| Financing costs | | $ | 43,473 | | | $ | 43,473 | |
| Less: accumulated amortization | | (27,842) | | | (26,753) | |
| Total deferred financing costs, net | | $ | 15,631 | | | $ | 16,720 | |
Amortization expense related to deferred financing costs was $1.1 million and $1.4 million for the three months ended March 31, 2023 and 2022, respectively.
Unsecured Revolving Credit and Term Loan Facilities
On August 29, 2022, we entered into a third amendment to our amended and restated credit agreement dated August 29, 2017 with Bank of America, N.A., as administrative agent and the other lenders party thereto, which governs our senior unsecured revolving credit facility and term loan facility (collectively, the “BofA Credit Facility”). The BofA Credit Facility is in the initial maximum principal amount of up to $1.065 billion, which consists of an $850.0 million revolving credit facility that matures on March 31, 2025, and a $215.0 million term loan facility that matures on March 19, 2025. The third amendment revised the terms of the BofA Credit Facility to (i) replace LIBOR with SOFR given the phase out of LIBOR and (ii) permit the addition of multifamily assets as Unencumbered Eligible Property (as defined therein) and add a capitalization rate for such assets. As of March 31, 2023, we had no borrowings under the revolving credit facility and $215.0 million under the term loan facility.
On August 29, 2022, we entered into a second amendment to our credit agreement dated March 19, 2020 with Wells Fargo Bank, National Association, as administrative agent, and the other lenders party thereto, which governs a senior unsecured term loan facility (the “Wells Term Loan Facility”). The Wells Term Loan Facility is in the original principal amount of $175.0 million and matures on December 31, 2026. The second amendment revised the terms of the Wells Term Loan Facility to (i) replace LIBOR with SOFR given the phase out of LIBOR and (ii) permit the addition of multifamily assets as Unencumbered Eligible Property (as defined therein) and add a capitalization rate for such assets. We may request the Wells Term Loan Facility be increased through one or more increases or the addition of new pari passu term loan tranches, for a maximum aggregate principal amount not to exceed $225 million. As of March 31, 2023, our borrowings amounted to $175.0 million under the Wells Term Loan Facility.
The terms of both the BofA Credit Facility and the Wells Term Loan Facility include customary covenants, including limitations on liens, investment, distributions, debt, fundamental changes, and transactions with affiliates and require certain customary financial reports. Both facilities also require compliance with financial ratios including a maximum leverage ratio, a
maximum secured leverage ratio, a minimum fixed charge coverage ratio, a minimum unencumbered interest coverage ratio, and a maximum unsecured leverage ratio. The agreements governing both facilities also contain customary events of default (subject in certain cases to specified cure periods), including but not limited to non-payment, breach of covenants, representations or warranties, cross defaults, bankruptcy or other insolvency events, judgments, ERISA events, invalidity of loan documents, loss of real estate investment trust qualification, and occurrence of a change of control. As of March 31, 2023, we were in compliance with these covenants.
Senior Unsecured Notes
The terms of the senior unsecured notes include customary covenants, including limitations on liens, investment, distributions, debt, fundamental changes, and transactions with affiliates and require certain customary financial reports. It also requires compliance with financial ratios including a maximum leverage ratio, a maximum secured leverage ratio, a minimum fixed charge coverage ratio, a minimum unencumbered interest coverage ratio, and a maximum unsecured leverage ratio. The agreements also contain customary events of default (subject in certain cases to specified cure periods), including but not limited to non-payment, breach of covenants, representations or warranties, cross defaults, bankruptcy or other insolvency events, judgments, ERISA events, the occurrence of certain change of control transactions and loss of real estate investment trust qualification. As of March 31, 2023, we were in compliance with these covenants.
6. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following as of March 31, 2023 and December 31, 2022 (amounts in thousands):
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
| Accrued capital expenditures | $ | 39,982 | | | $ | 44,293 | |
| Accounts payable and accrued expenses | 24,322 | | | 32,927 | |
| | | |
| Interest rate swaps liability | 2,171 | | | — | |
| Accrued interest payable | 3,558 | | | 3,509 | |
| Due to affiliated companies, net | 1,572 | | | — | |
| Total accounts payable and accrued expenses | $ | 71,605 | | | $ | 80,729 | |
7. Financial Instruments and Fair Values
Derivative Financial Instruments
We use derivative financial instruments primarily to manage interest rate risk and such derivatives are not considered speculative. These derivative instruments are typically in the form of interest rate swap and forward agreements, and the primary objective is to minimize interest rate risks associated with investing and financing activities. The counterparties of these arrangements are major financial institutions with which we may also have other financial relationships. We are exposed to credit risk in the event of non-performance by these counterparties; however, we currently do not anticipate that any of the counterparties will fail to meet its obligations.
We have agreements with our derivative counterparties that contain a provision where if we either default or are capable of being declared in default on any of our indebtedness, then we could also be declared in default on our derivative obligations. As of March 31, 2023, the fair value of derivatives in a liability position, that includes accrued interest but excludes any adjustment for nonperformance risk, was $2.4 million. If we had breached any of these provisions at March 31, 2023, we could have been required to settle our obligations under the agreements at their termination value of $2.4 million.
As of March 31, 2023 and December 31, 2022, we had interest rate swaps and caps with an aggregate notional value of $574.4 million and $574.8 million, respectively. The notional value does not represent exposure to credit, interest rate or market risks. As of March 31, 2023, the fair value of our interest rate swaps in an asset and liability position were $12.5 million and $(2.2) million, respectively, and are included in prepaid expenses and other assets and in accounts payable and accrued expenses, respectively, on the condensed consolidated balance sheet. As of December 31, 2022, the fair value of our derivative instruments in an asset position amounted to $17.9 million, which is included in prepaid expenses and other assets on the condensed consolidated balance sheet. These interest rate swaps have been designated as cash flow hedges and hedge the variability in future cash flows associated with our existing variable-rate term loan facilities. Interest rate caps not designated as
hedges are not speculative and are used to manage our exposure to interest rate movements, but do not meet the strict hedge accounting requirements.
As of March 31, 2023 and 2022, our cash flow hedges are deemed highly effective and a net unrealized gain (loss) of $(6.7) million and $13.1 million for the three months ended March 31, 2023 and 2022, respectively, relating to both active and terminated hedges of interest rate risk, are reflected in the condensed consolidated statements of comprehensive income (loss). Amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on the debt. We estimate that $5.3 million net gain of the current balance held in accumulated other comprehensive income (loss) will be reclassified into interest expense within the next 12 months.
The table below summarizes the terms of agreements and the fair values of our derivative financial instruments as of March 31, 2023 and December 31, 2022 (amounts in thousands): | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | March 31, 2023 | | December 31, 2022 |
| Derivative | | Notional Amount | Receive Rate | Pay Rate | Effective Date | Expiration Date | | Asset | Liability | | Asset | Liability |
| | | | | | | | | | | | |
| Interest rate swap | | $ | 36,820 | | 70% of 1 Month LIBOR | 2.5000% | December 1, 2021 | November 1, 2030 | | $ | — | | $ | (368) | | | $ | 256 | | $ | — | |
| Interest rate swap | | 103,790 | | 70% of 1 Month LIBOR | 2.5000% | December 1, 2021 | November 1, 2033 | | — | | (1,803) | | | 365 | | — | |
| Interest rate swap | | 10,710 | | 70% of 1 Month LIBOR | 1.7570% | December 1, 2021 | November 1, 2033 | | 432 | | | | 643 | | — | |
| Interest rate swap | | 17,157 | | 1 Month LIBOR | 2.2540% | December 1, 2021 | November 1, 2030 | | 790 | | — | | | 1,070 | | — | |
| Interest rate cap | | 6,780 | | 70% of 1 Month LIBOR | 4.5000% | December 1, 2021 | October 1, 2024 | | 6 | | — | | | 8 | | — | |
| Interest rate cap | | 9,188 | | 1 Month LIBOR | 5.5000% | December 1, 2021 | October 1, 2024 | | 23 | | — | | | 26 | | — | |
| Interest rate swap | | 175,000 | | SOFR Compound | 2.5620% | August 31, 2022 | December 31, 2026 | | 5,563 | | — | | | 8,040 | | — | |
| Interest rate swap | | 107,500 | | SOFR Compound | 2.6260% | August 19, 2022 | March 19, 2025 | | 2,830 | | — | | | 3,766 | | — | |
| Interest rate swap | | 107,500 | | SOFR OIS Compound | 2.6280% | August 19, 2022 | March 19, 2025 | | 2,831 | | — | | | 3,762 | | — | |
| | | | | | | | $ | 12,475 | | $ | (2,171) | | | $ | 17,936 | | $ | — | |
The table below shows the effect of our derivative financial instruments designated as cash flow hedges on accumulated other comprehensive income (loss) for the three months ended March 31, 2023 and 2022 (amounts in thousands):
| | | | | | | | | | | | | | | | | | |
| | | | Three months ended |
| Effects of Cash Flow Hedges | | | | | | March 31, 2023 | | March 31, 2022 |
| Amount of gain (loss) recognized in other comprehensive income (loss) | | | | | | $ | (5,402) | | | $ | 9,763 | |
| Amount of loss reclassified from accumulated other comprehensive income (loss) into interest expense | | | | | | 1,272 | | | (3,294) | |
The table below shows the effect of our derivative financial instruments designated as cash flow hedges on the condensed consolidated statements of operations for the three months ended March 31, 2023 and 2022 (amounts in thousands):
| | | | | | | | | | | | | | | | | | |
| | | | Three months ended |
| Effects of Cash Flow Hedges | | | | | | March 31, 2023 | | March 31, 2022 |
| Total interest expense presented in the condensed consolidated statements of operations in which the effects of cash flow hedges are recorded | | | | | | $ | (25,304) | | | $ | (25,014) | |
| Amount of loss reclassified from accumulated other comprehensive income (loss) into interest expense | | | | | | 1,272 | | | (3,294) | |
Fair Valuation
The estimated fair values at March 31, 2023 and December 31, 2022 were determined by management, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The fair value of derivative instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. Although the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by ourselves and our counterparties. The impact of such credit valuation adjustments, determined based on the fair value of each individual contract, was not significant to the overall valuation. As a result, all our derivatives were classified as Level 2 of the fair value hierarchy.
The fair values of our mortgage notes payable, senior unsecured notes - Series A, B, C, D, E, F, G and H - unsecured term loan facilities and unsecured revolving credit facility which are determined using Level 3 inputs are estimated by discounting the future cash flows using current interest rates at which similar borrowings could be made by us.
The following tables summarize the carrying and estimated fair values of our financial instruments as of March 31, 2023 and December 31, 2022 (amounts in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2023 |
| | | Estimated Fair Value |
| Carrying
Value | | Total | | Level 1 | | Level 2 | | Level 3 |
| Interest rate swaps included in prepaid expenses and other assets | $ | 12,446 | | | $ | 12,446 | | | $ | — | | | $ | 12,446 | | | $ | — | |
| Interest rate swaps included in accounts payable and accrued expenses | 2,171 | | | 2,171 | | | — | | | 2,171 | | | — | |
| Mortgage notes payable | 882,142 | | | 787,481 | | | — | | | — | | | 787,481 | |
| | | | | | | | | |
| Senior unsecured notes - Series A, B, C, D, E, F, G and H | 973,714 | | | 886,358 | | | — | | | — | | | 886,358 | |
| Unsecured term loan facilities | 388,901 | | | 390,000 | | | — | | | — | | | 390,000 | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
| | | Estimated Fair Value |
| Carrying
Value | | Total | | Level 1 | | Level 2 | | Level 3 |
| Interest rate swaps included in prepaid expenses and other assets | $ | 17,936 | | | $ | 17,936 | | | $ | — | | | $ | 17,936 | | | $ | — | |
| | | | | | | | | |
| Mortgage notes payable | 883,705 | | | 783,648 | | | — | | | — | | | 783,648 | |
| | | | | | | | | |
| Senior unsecured notes - Series A, B, C, D, E, F, G and H | 973,659 | | | 865,292 | | | — | | | — | | | 865,292 | |
| Unsecured term loan facilities | 388,773 | | | 390,000 | | | — | | | — | | | 390,000 | |
| | | | | | | | | |
Disclosure about the fair value of financial instruments is based on pertinent information available to us as of March 31, 2023 and December 31, 2022. Although we are not aware of any factors that would significantly affect the reasonable fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.
8. Leases
Lessor
We lease various spaces to tenants over terms ranging from one to 22 years. Certain leases have renewal options for additional terms. The leases provide for base monthly rentals and reimbursements for real estate taxes, escalations linked to the consumer price index or common area maintenance known as operating expense escalation. Operating expense reimbursements are reflected in our March 31, 2023 and 2022 condensed consolidated statements of operations as rental revenue.
Rental revenue includes fixed and variable payments. Fixed payments primarily relate to base rent and variable payments primarily relate to tenant expense reimbursements for certain property operating costs. The components of rental revenue for the three months ended March 31, 2023 and 2022 are as follows (amounts in thousands):
| | | | | | | | | | | | | | | | | | |
| | | | Three months ended |
| Rental revenue | | | | | | March 31, 2023 | | March 31, 2022 |
| Fixed payments | | | | | | $ | 124,564 | | | $ | 133,401 | |
| Variable payments | | | | | | 15,527 | | | 14,113 | |
| Total rental revenue | | | | | | $ | 140,091 | | | $ | 147,514 | |
As of March 31, 2023, we were entitled to the following future contractual minimum lease payments (excluding operating expense reimbursements) on non-cancellable operating leases to be received which expire on various dates through 2040 (amounts in thousands):
| | | | | |
| Remainder of 2023 | $ | 368,524 | |
| 2024 | 498,358 | |
| 2025 | 468,145 | |
| 2026 | 429,747 | |
| 2027 | 411,175 | |
| Thereafter | 1,786,987 | |
| $ | 3,962,936 | |
The above future minimum lease payments exclude tenant recoveries and the net accretion of above and below-market lease intangibles. Some leases are subject to termination options generally upon payment of a termination fee. The preceding table is prepared assuming such options are not exercised.
On March 12, 2023, Signature Bank, a tenant at 1400 Broadway and 1333 Broadway, was closed by the New York State Department of Financial Services and the Federal Deposit Insurance Corporation (“FDIC”) was named receiver. As reported by the FDIC, to protect depositors, the FDIC transferred all the deposits and substantially all of the assets of Signature Bank to Signature Bridge Bank, N.A., (the “Bridge Bank”) a full-service bank that will be operated by the FDIC, in accordance with the terms of a transfer agreement (the “Transfer Agreement”). On March 20, 2023, the FDIC entered into a purchase and assumption agreement (the “Flagstar Agreement”) for substantially all deposits and certain loan portfolios of Signature Bridge Bank, N.A., by Flagstar Bank, N.A., Hicksville, NY (“Flagstar”), a wholly owned subsidiary of New York Community Bancorp, Inc., Westbury, NY.
Our understanding is the terms of the Flagstar Agreement provides Flagstar with the right to accept or not to accept an assignment of Signature Bank’s lease by May 19, 2023. Additionally, the terms of the Transfer Agreement provide the Bridge Bank 120 days, or until July 10, 2023, the right to assume or reject the lease. As of the date of filing, there has been no official announcement from Flagstar or Bridge Bank with regards to Signature Bank’s lease. While the tenant is current on all rent obligations to us through April 2023, uncertainty remains around whether the tenant will fulfill all of its obligations over the remaining term of their lease. Our assessment of collectability of the remaining lease payments due to us is no longer probable and in accordance with ASC 842-30-25-13, we have recorded a $6.4 million reserve on Signature Bank’s straight-line rent receivable balance, that was calculated as the difference between the lease income that was recorded on a straight-line basis and the lease payments which have been collected from our tenant as of March 31, 2023. We will continue to assess the collectability of lease payments due to us over the course of the lease.
Lessee
We determine if an arrangement is a lease at inception. Our operating lease agreements relate to three ground lease assets and are reflected in right-of-use assets of $28.6 million and lease liabilities of $28.6 million in our condensed consolidated balance sheet as of March 31, 2023. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Right-of-use assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. Variable lease payments are excluded from the right-of-use assets and lease liabilities and are recognized in the period in which the obligation for those payments is incurred.
The ground leases are due to expire between the years 2050 and 2077, inclusive of extension options, and have no variable payments or residual value guarantees. As our leases do not provide an implicit rate, we determined our incremental borrowing rate based on information available at the date of adoption of Accounting Standards Update No. 2016-02, Leases (Topic 842), in determining the present value of lease payments. The weighted average incremental borrowing rate used to
calculate the right-of-use assets and lease liabilities as of March 31, 2023 was 4.5%. Rent expense for lease payments related to our operating leases is recognized on a straight-line basis over the non-cancellable term of the leases. The weighted average remaining lease term as of March 31, 2023 was 47.2 years.
As of March 31, 2023, the following table summarizes our future minimum lease payments discounted by our incremental borrowing rates to calculate the lease liabilities of our leases (amounts in thousands):
| | | | | |
| Remainder of 2023 | $ | 1,139 | |
| 2024 | 1,518 | |
| 2025 | 1,518 | |
| 2026 | 1,503 | |
| 2027 | 1,482 | |
| Thereafter | 62,277 | |
| Total undiscounted cash flows | 69,437 | |
| Present value discount | (40,825) | |
| Ground lease liabilities | $ | 28,612 | |
9. Commitments and Contingencies
Legal Proceedings
Except as described below, as of March 31, 2023, we were not involved in any material litigation, nor, to our knowledge, was any material litigation threatened against us or our properties, other than routine litigation arising in the ordinary course of business such as disputes with tenants. We believe that the costs and related liabilities, if any, which may result from such actions will not materially affect our condensed consolidated financial position, operating results or liquidity.
As previously disclosed, in October 2014, 12 former investors (the "Claimants") in Empire State Building Associates L.L.C. (“ESBA”), which prior to the initial public offering of our company (the "Offering") owned the fee title to the Empire State Building, filed an arbitration with the American Arbitration Association against Peter L. Malkin, Anthony E. Malkin, Thomas N. Keltner, Jr., and our subsidiary ESRT MH Holdings LLC, the former supervisor of ESBA (the "Respondents"). The statement of claim (also filed later in federal court in New York for the expressed purpose of tolling the statute of limitations) alleges breach of fiduciary duty and related claims in connection with the Offering and formation transactions and seeks monetary damages and declaratory relief. Claimants had opted out of a prior class action bringing similar claims that was settled with court approval. Respondents filed an answer and counterclaims. In March 2015, the federal court action was stayed on consent of all parties pending the arbitration. Arbitration hearings started in May 2016 and concluded in August 2018. On August 26, 2020, the arbitration panel issued an award that denied all Claimants’ claims with one exception, on which it awarded Claimants approximately $1.2 million, inclusive of seven years of interest through October 2, 2020. This amount was recorded as an IPO litigation expense in the consolidated statement of operations for the year ended December 31, 2020.
Respondents believe that such award in favor of the Claimants is entirely without merit and sought to vacate that
portion of the award. On September 27, 2021, the court denied Respondents' motion to vacate and entered judgement in the
aforementioned amount, inclusive of accumulated interest. Respondents have appealed that ruling. On May 10, 2022, Respondents moved to dismiss the appeal and judgment on the grounds that a recent decision of the United States Supreme Court held that the federal courts have no subject matter jurisdiction over the case. Claimants opposed the motion. On April 20, 2023, the Court granted the motion. On April 21, 2023, Respondents filed a petition to vacate in part and otherwise confirm in New York State court, where it is currently pending. In addition, certain of the Claimants in the federal court action sought to pursue claims in that case against Respondents. Respondents believe that any such claims are meritless. The magistrate judge assigned to the action has issued a Report and Recommendation rejecting Claimants’ claims; the district judge will decide whether to adopt the Report and Recommendation.
Pursuant to indemnification agreements which were made with our directors, executive officers and chairman emeritus as part of our formation transactions, Anthony E. Malkin, Peter L. Malkin and Thomas N. Keltner, Jr., our retired general counsel, have defense and indemnity rights from us with respect to this arbitration.
Unfunded Capital Expenditures
At March 31, 2023, we estimate that we will incur approximately $107.9 million of capital expenditures (including tenant improvements and leasing commissions) on our properties pursuant to existing lease agreements. We expect to fund these capital expenditures with operating cash flow, additional property level mortgage financings, our unsecured credit facility, cash on hand and other borrowings. Future property acquisitions may require substantial capital investments for refurbishment and leasing costs. We expect that these financing requirements will be met in a similar fashion.
Concentration of Credit Risk
Financial instruments that subject us to credit risk consist primarily of cash and cash equivalents, restricted cash, short-term investments, tenant and other receivables and deferred rent receivables. At March 31, 2023, we held on deposit at various major financial institutions cash and cash equivalents and restricted cash balances in excess of amounts insured by the Federal Deposit Insurance Corporation.
Asset Retirement Obligations
We are required to accrue costs that we are legally obligated to incur on retirement of our properties which result from acquisition, construction, development and/or normal operation of such properties. Retirement includes sale, abandonment or disposal of a property. Under that standard, a conditional asset retirement obligation represents a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within a company’s control and a liability for a conditional asset retirement obligation must be recorded if the fair value of the obligation can be reasonably estimated. Environmental site assessments and investigations have identified asbestos or asbestos-containing building materials in certain of our properties. As of March 31, 2023, management has no plans to remove or alter these properties in a manner that would trigger federal and other applicable regulations for asbestos removal, and accordingly, the obligations to remove the asbestos or asbestos-containing building materials from these properties have indeterminable settlement dates. As such, we are unable to reasonably estimate the fair value of the associated conditional asset retirement obligation. However, ongoing asbestos abatement, maintenance programs and other required documentation are carried out as required and related costs are expensed as incurred.
Other Environmental Matters
Certain of our properties have been inspected for soil contamination due to pollutants, which may have occurred prior to our ownership of these properties or subsequently in connection with its development and/or its use. Required remediation to such properties has been completed, other than our post-closing obligations for remediation at our Westport retail assets, as discussed in more detail in our Annual Report on Form 10-K for the year ended December 31, 2022, and as of March 31, 2023, with the exception of these two assets, management believes that there are no obligations related to environmental remediation other than maintaining the affected sites in conformity with the relevant authority’s mandates and filing the required documents. All such maintenance costs are expensed as incurred. We expect that resolution of the environmental matters relating to the above will not have a material impact on our business, assets, consolidated financial condition, results of operations or liquidity. However, we cannot be certain that we have identified all environmental liabilities at our properties, that all necessary remediation actions have been or will be undertaken at our properties or that we will be indemnified, in full or at all, in the event that such environmental liabilities arise.
Insurance Coverage
We carry insurance coverage on our properties of types and in amounts with deductibles that we believe are in line with coverage customarily obtained by owners of similar properties.
10. Capital
As of March 31, 2023, there were 160,339,762 shares of Class A common stock 988,974 shares of Class B common stock and 110,618,164 operating partnership units outstanding, of which 161,328,736, or 59.3%, were owned by ESRT and 110,618,164, or 40.7%, were owned by other partners, including ESRT directors, members of senior management and other employees.
On May 16, 2019, the Empire State Realty Trust, Inc. Empire State Realty OP, L.P. 2019 Equity Incentive Plan (“2019 Plan”) was approved by our shareholders. The 2019 Plan provides for grants to directors, employees and consultants of ESRT and the Operating Partnership, including options, restricted stock, restricted stock units, stock appreciation rights, performance awards, dividend equivalents and other equity-based awards. An aggregate of approximately 11.0 million shares of ESRT common stock are authorized for issuance under awards granted pursuant to the 2019 Plan. We will not issue any new equity awards under the First Amended and Restated Empire State Realty Trust, Inc. and Empire State Realty OP, L.P. 2013 Equity Incentive Plan ("2013 Plan", and collectively with the 2019 Plan, "the Plans"). The shares of ESRT Class A common stock underlying any awards under the 2019 Plan and the 2013 Plan that are forfeited, canceled or otherwise terminated, other than by
exercise, will be added back to the shares of ESRT Class A common stock available for issuance under the 2019 Plan. Shares tendered or held back upon exercise of a stock option or settlement of an award under the 2019 Plan or the 2013 Plan to cover the exercise price or tax withholding and shares subject to a stock appreciation right that are not issued in connection with the stock settlement of the stock appreciation right upon exercise thereof, will not be added back to the shares of ESRT Class A common stock available for issuance under the 2019 Plan. In addition, shares of ESRT Class A common stock repurchased on the open market will not be added back to the shares of ESRT Class A common stock available for issuance under the 2019 Plan.
Long-term incentive plan ("LTIP") units are a special class of partnership interests. Each LTIP unit awarded will be deemed equivalent to an award of one share of ESRT stock under the Plans, reducing the availability for other equity awards on a one-for-one basis.
The vesting period for LTIP units, if any, will be determined at the time of issuance. Under the terms of the LTIP units, we will revalue for tax purposes its assets upon the occurrence of certain specified capital events, and any increase in valuation from the time of one such event to the next such event will be allocated first to the holders of LTIP units to equalize the capital accounts of such holders with the capital accounts of unitholders. Subject to any agreed upon exceptions, once vested and having achieved parity with unitholders, LTIP units are convertible into Series PR operating partnership units on a one-for-one basis.
LTIP units subject to time-based vesting, whether vested or not, receive per unit distributions as operating partnership units, which equal per share dividends (both regular and special) on our common stock. Market and performance-based LTIPs receive 10% of such distributions currently, unless and until such LTIP units are earned based on performance, at which time they will receive the accrued and unpaid 90% and will commence receiving 100% of such distributions thereafter.
Stock and Publicly Traded Operating Partnership Unit Repurchase Program
ESRT's Board of Directors authorized the repurchase of up to $500 million of ESRT Class A common stock and the Operating Partnership’s Series ES, Series 250 and Series 60 operating partnership units from January 1, 2022 through December 31, 2023. Under the program, ESRT may purchase ESRT Class A common stock and we may purchase our Series ES, Series 250 and Series 60 operating partnership units in accordance with applicable securities laws from time to time in the open market or in privately negotiated transactions. The timing, manner, price and amount of any repurchases will be determined by ESRT and us and will be subject to stock price, availability, trading volume, general market conditions, and applicable securities laws. The authorization does not obligate ESRT or us to acquire any particular amount of securities, and the program may be suspended or discontinued at ESRT and our discretion without prior notice.
The following table summarizes ESRT's purchases of equity securities in each of the three months ended March 31, 2023: | | | | | | | | | | | | | | | | | |
| Period | Total Number of Shares Purchased | | Weighted Average Price Paid per Share | | Maximum Approximate Dollar Value Available for Future Purchase (in thousands) |
| January 2023 | 90,054 | | | $ | 6.70 | | | $ | 409,221 | |
| February 2023 | — | | | $ | — | | | $ | 409,221 | |
| March 2023 | 843,333 | | | $ | 6.04 | | | $ | 404,130 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
Private Perpetual Preferred Units
As of March 31, 2023, there were 4,664,038 Series 2019 Preferred Units ("Series 2019 Preferred Units") and 1,560,360 Series 2014 Private Perpetual Preferred Units ("Series 2014 Preferred Units") outstanding. The Series 2019 Preferred Units have a liquidation preference of $13.52 per unit and are entitled to receive cumulative preferential annual cash distributions of $0.70 per unit payable in arrears on a quarterly basis. The Series 2014 Preferred Units which have a liquidation preference of $16.62 per unit and are entitled to receive cumulative preferential annual cash distributions of $0.60 per unit payable in arrears on a quarterly basis. Both series are not redeemable at the option of the holders and are redeemable at our option only in the case of specific defined events.
Distributions
Total distributions paid to OP unitholders were $8.7 million and $9.8 million for the three months ended March 31, 2023 and 2022, respectively. Total distributions paid to preferred unitholders were $1.1 million and $1.1 million for the three months ended March 31, 2023 and 2022, respectively.
Incentive and Share-Based Compensation
The Plans provide for grants to directors, employees and consultants consisting of stock options, restricted stock, dividend equivalents, stock payments, performance shares, LTIP units, stock appreciation rights and other incentive awards. An aggregate of 11.0 million shares of ESRT common stock is authorized for issuance under awards granted pursuant to the 2019 Plan, and as of March 31, 2023, 4.4 million shares of ESRT common stock remain available for future issuance.
In March 2023, we made grants of LTIP units to executive officers under the 2019 Plan, including a total of 552,412 LTIP units that are subject to time-based vesting, 834,456 LTIP units that are subject to market-based vesting and 679,969 units that are subject to performance-based vesting with fair market values of $3.2 million, $3.9 million and $3.9 million, respectively. In March 2023, we made grants of LTIP units and restricted stock to certain other employees under the 2019 Plan, including a total of 229,308 LTIP units and 370,465 shares of restricted stock that are subject to time-based vesting, 111,942 LTIP units that are subject to market-based vesting and 91,211 LTIP units that are subject to performance-based vesting, with fair market values of $1.5 million and $2.6 million, respectively, for the time-based vesting awards, $0.6 million for the market-based vesting awards and $0.6 million for the performance-based vesting awards. The awards subject to time-based vesting vest ratably over four years, subject generally to the grantee's continued employment, with the first installment vesting on January 1, 2024. The vesting of the LTIP units subject to market-based vesting is based on the achievement of relative total stockholder return hurdles over a three-year performance period, commencing on January 1, 2023. The vesting of the LTIP units subject to performance-based vesting is based on the achievement of (i) operational metrics over a one-year performance period, subject to a three-year absolute TSR modifier, and (ii) environmental, social and governance ("ESG") metrics over a three-year performance period, in each case, commencing on January 1, 2023. Following the completion of the respective performance periods, our Compensation and Human Capital Committee will determine the number of LTIP units to which the grantee is entitled based on our performance relative to the performance hurdles set forth in the LTIP unit award agreements the grantee entered in connection with the award grant. These LTIP units then vest in two equal installments, on January 1, 2025 and December 31, 2026, subject generally to the grantee's continued employment on those dates.
In March 2023, we also made one-time additional grants of LTIP units to certain non-executive employees under the 2019 Plan. At such time, we granted to certain other employees a total of 152,542 LTIP units that are subject to time-based vesting, with a fair market value of $1.0 million that vest over four and five year periods.
In 2023, our named executive officers could elect to receive their annual incentive bonus in any combination of (i) cash or vested LTIPs at the face amount of such bonus or (ii) time-vesting LTIPs which would vest over three years, subject to continued employment, at a premium over such face amount (120% for awards granted in 2021, 2022, and 2023; 125% for years prior to 2021). In March 2023, we made grants of LTIP units to executive officers under the 2019 Plan in connection with the 2022 bonus election program. We granted to executive officers a total of 521,571 LTIP units that are subject to time-based vesting with a fair market value of $3.0 million. Of these LTIP units, 446,376 LTIP units vest ratably over three years from January 1, 2023, subject generally to the grantee's continued employment. The first installment vests on January 1, 2024, and the remainder will vest thereafter in two equal annual installments on January 1, 2025 and January 1, 2026. We also granted to our retired general counsel 75,195 LTIP units that vested immediately on the grant date.
Share-based compensation for time-based equity awards is measured at the fair value of the award on the date of grant and recognized as an expense on a straight-line basis over the shorter of (i) the stated vesting period, which is generally three, four or five years, or (ii) the period from the date of grant to the date the employee becomes retirement eligible, which may occur upon grant. An employee is retirement eligible when the employee attains the (i) age of 65 for awards granted in 2020 and after and age of 60 for awards granted before 2020 and (ii) the date on which the employee has first completed ten years of continuous service with us or our affiliates. Share-based compensation for market-based equity awards and performance-based equity awards is measured at the fair value of the award on the date of grant and recognized as an expense on a straight-line basis over three or four years. Additionally, for the performance-based equity awards, we assess, at each reporting period, whether it is probable that the performance conditions will be satisfied. We recognize expense respective to the number of awards we expect to vest at the conclusion of the measurement period. Changes in estimate are accounted for in the period of change through a cumulative catch-up adjustment.
For the market-based LTIP units, the fair value of the awards was estimated using a Monte Carlo Simulation model and discounted for the restriction period during which the LTIP units cannot be redeemed or transferred and the uncertainty regarding if, and when, the book capital account of the LTIP units will equal that of the common units. Our stock price, along with the prices of the comparative indexes, is assumed to follow the Geometric Brownian Motion Process. Geometric
Brownian Motion is a common assumption when modeling in financial markets, as it allows the modeled quantity (in this case the stock price) to vary randomly from its current value and take any value greater than zero. The volatilities of the returns on our stock price and the comparative indexes were estimated based on implied volatilities and historical volatilities using an appropriate look-back period. The expected growth rate of the stock prices over the performance period is determined with consideration of the risk-free rate as of the grant date. For LTIP unit awards that are time or performance based, the fair value of the awards was estimated based on the fair value of our stock at the grant date discounted for the restriction period during which the LTIP units cannot be redeemed or transferred and the uncertainty regarding if, and when, the book capital account of the LTIP units will equal that of the common units. For restricted stock awards, the fair value of the awards is based on the market price of ESRT stock at the grant date.
LTIP units and ESRT restricted stock issued during the three months ended March 31, 2023 were valued at $20.2 million. The weighted average per unit or share fair value was $5.69 for grants issued in 2023. The fair value per unit or share granted in 2023 was estimated on the respective dates of grant using the following assumptions: an expected life from 2.0 to 5.3 years, a dividend rate of 1.7%, a risk-free interest rate from 4.4% to 5.0%, and an expected price volatility from 35.0% to 46.0%. No other stock options, dividend equivalents, or stock appreciation rights were issued or outstanding in 2023.
The following is a summary of ESRT restricted stock and LTIP unit activity for the three months ended March 31, 2023: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Restricted Stock | | Time-based LTIPs | | Market-based LTIPs | | Performance-based LTIPs | | Weighted Average Grant Fair Value |
| Unvested balance at December 31, 2022 | 359,293 | | | 2,713,522 | | | 4,070,537 | | | 510,989 | | | $ | 6.69 | |
| Vested | (106,139) | | | (997,732) | | | (274,402) | | | (1,222) | | | 7.78 | |
| Granted | 370,465 | | | 1,455,833 | | | 946,398 | | | 771,180 | | | 5.69 | |
| Forfeited or unearned | (1,221) | | | — | | | (1,645,223) | | | (8,337) | | | 4.27 | |
| Unvested balance at March 31, 2023 | 622,398 | | | 3,171,623 | | | 3,097,310 | | | 1,272,610 | | | $ | 6.56 | |
The time-based LTIPs and ESRT restricted stock awards are treated for accounting purposes as immediately vested upon the later of (i) the date the grantee attains the age of 60 or 65, as applicable, and (ii) the date on which grantee has first completed ten years of continuous service with our company or its affiliates. For award agreements that qualify, we recognize noncash compensation expense on the grant date for the time-based awards and ratably over the vesting period for the market-based and performance-based awards, and accordingly, we recognized $0.7 million and $1.0 million for the three months ended March 31, 2023 and 2022, respectively. Unrecognized compensation expense was $4.2 million at March 31, 2023, which will be recognized over a weighted average period of 2.9 years.
For the remainder of the LTIP unit and ESRT restricted stock awards, we recognize noncash compensation expense ratably over the vesting period, and accordingly, we recognized noncash compensation expense of $3.7 million and $3.5 million for the three months ended March 31, 2023 and 2022, respectively. Unrecognized compensation expense was $36.2 million at March 31, 2023, which will be recognized over a weighted average period of 2.8 years.
Earnings Per Unit
Earnings per unit for the three months ended March 31, 2023 and 2022 is computed as follows (amounts in thousands, except per share amounts): | | | | | | | | | | | | | | | | | |
| | | Three Months Ended |
| | | | | March 31, 2023 | | March 31, 2022 |
| Numerator: | | | | | | | |
| Net income (loss) | | | | | $ | 11,694 | | | $ | (17,221) | |
| Private perpetual preferred unit distributions | | | | | (1,050) | | | (1,050) | |
| Net loss attributable to non-controlling interests in other partnerships | | | | | 43 | | | 63 | |
| Earnings allocated to unvested units | | | | | — | | | (89) | |
| Net income (loss) attributable to common unitholders – basic and diluted | | | | | $ | 10,687 | | | $ | (18,297) | |
| | | | | | | |
| Denominator: | | | | | | | |
| Weighted average units outstanding – basic | | | | | 264,493 | | | 273,759 | |
| Effect of dilutive securities: | | | | | | | |
Stock-based compensation plans
| | | | | 704 | | | — | |
| | | | | | | |
| Weighted average units outstanding –- diluted | | | | | 265,197 | | | 273,759 | |
| | | | | | | |
| Earnings per share: | | | | | | | |
| Basic | | | | | $ | 0.04 | | | $ | (0.07) | |
| Diluted | | | | | $ | 0.04 | | | $ | (0.07) | |
There were zero and 194 antidilutive shares and LTIP units for the three months ended March 31, 2023 and 2022, respectively.
11. Related Party Transactions
Supervisory Fee Revenue
We earned supervisory fees from entities affiliated with Anthony E. Malkin, our Chairman, President and Chief Executive Officer, of $0.2 million and $0.2 million for the three months ended March 31, 2023 and 2022, respectively. These fees are included within third-party management and other fees.
Property Management Fee Revenue
We earned property management fees from entities affiliated with Anthony E. Malkin of $0.1 million and $0.1 million for the three months ended March 31, 2023 and 2022, respectively. These fees are included within third-party management and other fees.
Other
We receive rent generally at the market rental rate for 5,447 square feet of leased space from entities affiliated with Anthony E. Malkin at one of our properties. Under the lease, the tenant has the right to cancel such lease without special payment on 90 days’ notice. We also have a shared use agreement with such tenant, to occupy a portion of the leased premises as the office location for Peter L. Malkin, our chairman emeritus and employee, utilizing approximately 15% of the space, for which we pay to such tenant an allocable pro rata share of the cost. We also have agreements with these entities and excluded properties and businesses to provide them with general computer-related support services. Total aggregate revenue was $0.1 million and $0.1 million for the three months ended March 31, 2023 and 2022, respectively.
As disclosed in greater detail in our Annual Report on Form 10-K for the year ended December 31, 2022, in connection with the sale of our Westport retail assets in February 2023, we advanced a loan to the buyer to facilitate closing with a principal amount of $0.6 million, which bears interest at SOFR plus 3.5% and requires repayment of principal to the extent of available cash flow of the property. As of March 31, 2023, the amount outstanding under the loan is $0.6 million and is recorded as part of amounts due to affiliated companies, net which is included in accounts payable and accrued expenses on the condensed consolidated balance sheet.
12. Segment Reporting
We have identified two reportable segments: (1) real estate and (2) observatory. Our real estate segment includes all activities related to the ownership, management, operation, acquisition, redevelopment, repositioning and disposition of our traditional real estate assets. Our observatory segment includes the operation of the 86th and 102nd floor observatories at the Empire State Building. These two lines of businesses are managed separately because each business requires different support infrastructures, provides different services and has dissimilar economic characteristics such as investments needed, stream of revenues and marketing strategies. We account for intersegment sales and rents as if the sales or rents were to third parties, that is, at current market prices.
The following tables provide components of segment net income (loss) for each segment for the three and three months ended March 31, 2023 and 2022 (amounts in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
| | Three Months Ended March 31, 2023 |
| | Real Estate | | Observatory | | Intersegment Elimination | | Total |
| Revenues: | | | | | | | | |
| Rental revenue | | $ | 140,091 | | | $ | — | | | $ | — | | | $ | 140,091 | |
| Intercompany rental revenue | | 15,914 | | | — | | | (15,914) | | | — | |
| | | | | | | | |
| Observatory revenue | | — | | | 22,154 | | | — | | | 22,154 | |
| | | | | | | | |
| Third-party management and other fees | | 427 | | | — | | | — | | | 427 | |
| Other revenue and fees | | 1,950 | | | — | | | — | | | 1,950 | |
| Total revenues | | 158,382 | | | 22,154 | | | (15,914) | | | 164,622 | |
| Operating expenses: | | | | | | | | |
| Property operating expenses | | 42,044 | | | — | | | — | | | 42,044 | |
| Intercompany rent expense | | — | | | 15,914 | | | (15,914) | | | — | |
| Ground rent expenses | | 2,331 | | | — | | | — | | | 2,331 | |
| General and administrative expenses | | 15,708 | | | — | | | — | | | 15,708 | |
| Observatory expenses | | — | | | 7,855 | | | — | | | 7,855 | |
| Real estate taxes | | 31,788 | | | — | | | — | | | 31,788 | |
| | | | | | | | |
| | | | | | | | |
| Depreciation and amortization | | 47,364 | | | 44 | | | — | | | 47,408 | |
| Total operating expenses | | 139,235 | | | 23,813 | | | (15,914) | | | 147,134 | |
| Total operating income (loss) | | 19,147 | | | (1,659) | | | — | | | 17,488 | |
Other income (expense):
| | | | | | | | |
| Interest income | | 2,558 | | | 37 | | | — | | | 2,595 | |
| Interest expense | | (25,304) | | | — | | | — | | | (25,304) | |
| | | | | | | | |
| Gain on sale of property | | 15,696 | | | — | | | — | | | 15,696 | |
| Income (loss) before income taxes | | 12,097 | | | (1,622) | | | — | | | 10,475 | |
| Income tax (expense) benefit | | (198) | | | 1,417 | | | — | | | 1,219 | |
| Net income (loss) | | $ | 11,899 | | | $ | (205) | | | $ | — | | | $ | 11,694 | |
| Segment assets | | $ | 3,903,661 | | | $ | 253,702 | | | $ | — | | | $ | 4,157,363 | |
| Expenditures for segment assets | | $ | 34,536 | | | $ | 58 | | | $ | — | | | $ | 34,594 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
| | Three Months Ended March 31, 2022 |
| | Real Estate | | Observatory | | Intersegment Elimination | | Total |
| Revenues: | | | | | | | | |
| Rental revenue | | $ | 147,514 | | | $ | — | | | $ | — | | | $ | 147,514 | |
| Intercompany rental revenue | | 10,620 | | | — | | | (10,620) | | | — | |
| | | | | | | | |
| Observatory revenue | | — | | | 13,241 | | | — | | | 13,241 | |
| Lease termination fees | | 1,173 | | | — | | | — | | | 1,173 | |
| Third-party management and other fees | | 310 | | | — | | | — | | | 310 | |
| Other revenue and fees | | 1,796 | | | — | | | — | | | 1,796 | |
| Total revenues | | 161,413 | | | 13,241 | | | (10,620) | | | 164,034 | |
| Operating expenses: | | | | | | | | |
| Property operating expenses | | 38,644 | | | — | | | — | | | 38,644 | |
| Intercompany rent expense | | — | | | 10,620 | | | (10,620) | | | — | |
| Ground rent expense | | 2,331 | | | — | | | — | | | 2,331 | |
| General and administrative expenses | | 13,686 | | | — | | | — | | | 13,686 | |
| Observatory expenses | | — | | | 6,215 | | | — | | | 6,215 | |
| Real estate taxes | | 30,004 | | | — | | | — | | | 30,004 | |
| | | | | | | | |
| Depreciation and amortization | | 67,071 | | | 35 | | | — | | | 67,106 | |
| Total operating expenses | | 151,736 | | | 16,870 | | | (10,620) | | | 157,986 | |
| Total operating income (loss) | | 9,677 | | | (3,629) | | | — | | | 6,048 | |
Other income (expense):
| | | | | | | | |
| Interest income | | 149 | | | — | | | — | | | 149 | |
| Interest expense | | (25,014) | | | — | | | — | | | (25,014) | |
| | | | | | | | |
| | | | | | | | |
| Loss before income taxes | | (15,188) | | | (3,629) | | | — | | | (18,817) | |
| Income tax (expense) benefit | | (144) | | | 1,740 | | | — | | | 1,596 | |
| Net loss | | $ | (15,332) | | | $ | (1,889) | | | $ | — | | | $ | (17,221) | |
| Segment assets | | $ | 3,998,791 | | | $ | 244,539 | | | $ | — | | | $ | 4,243,330 | |
| Expenditures for segment assets | | $ | 38,884 | | | $ | 291 | | | $ | — | | | $ | 39,175 | |
13. Subsequent Events
None.