Empire State Realty Trust (ESRT) suffered significantly during the COVID-19 pandemic, as New York City, which is where the company’s properties are located, underwent prolonged lockdowns. One would expect the REIT’s performance to rebound in a post-Covid world. However, Empire State Realty’s performance remains uninspiring. Demand for office properties is likely to remain soft as hybrid workplaces become the norm and companies cut costs in the current environment. I am neutral on the stock.
Is ESRT Stock a REIT?
Empire State Realty Trust is a self-managed real estate investment trust that owns, operates, and purchases primary office and retail properties in Manhattan as well as the greater New York metropolitan area. One of the company’s greatest assets is the Empire State Building, which it boasts as “the most famous building in the world.”
Accordingly, Empire State Realty also owns and runs its signature, recently reimagined Observatory Experience, located on the 102nd floor of the iconic building.
As of its latest filings, the REIT’s total portfolio comprised 9.9 million rentable square feet of office, retail and multifamily space.
Uninspiring Results despite a Post-COVID World for ESRT Stock
With rigid measures to contain the spread of COVID-19 and the quickly rising work-from-home economy, office and retail properties saw their occupancy levels and earnings power compressed substantially in 2020 and 2021. Accordingly, the company’s results were materially impacted during the period. Despite gradually moving towards a post-COVID world, with restrictions virtually completely lifted, the company’s results and outlook continue to remain bleak.
In late July, Empire State Realty Trust reported its Q2 results for Fiscal 2022, with the company exhibiting what initially appeared to be some notable recovery signs. Empire State Realty recorded revenues of $198 million, 29% higher year-over-year. Rental revenues rose slightly by 6% compared to last year. The more noteworthy growth driver was the observatory, which recorded revenues of 27.4 million, up 225% from the prior-year period.
The tremendous increase in observatory revenues was due to visitation volumes picking up from last year’s crumbled levels amid the pandemic. Accordingly, FFO rose 62% to $79.1 million, aided by loftier operating margins. FFO/share rose by $0.11 to $0.29.
While these may appear like great year-over-year improvements, we should frame some context here. Firstly, despite the notable rise in FFO/share, management’s core FFO/share outlook range of between $0.80 and $0.85 remains weak.
Sure, the midpoint of this range indicates a growth of 18.6% compared to the $0.70 seen in Fiscal Year 2021 and a bigger improvement of 33.9% compared to $0.62 in the year before. Nevertheless, FFO/share still hovers below its pre-pandemic levels, when it often surpassed $0.90.
Additionally, even though the observatory number appeared explosive, with triple-digit top-line growth, it’s still a fraction of its past levels. Specifically, the observatory would achieve sequentially higher sales figures almost every year, from $25 million in 2001 to $128.8 million in 2019.
Yet, despite last quarter’s 225% “growth” sounding spellbinding, observatory revenues during the first half of the year were still 24.1% lower compared to the first half of 2019.
Empire State Realty’s soft traction is also demonstrated in its occupancy rate, which hovered at 87.8% at the end of Q2. This was 40 basis points lower than the previous year, implying very gloomy office and retail property markets despite the lack of restrictions.
After all, it makes sense. Not only have employers and employees alike found remote/hybrid working beneficial, but abandoning office spaces is also good for the bottom line. This is especially true in the current environment with profits margins getting compressed, but even more relevant to the company’s properties which are located in very expensive locations. In fact, the current trend is likely to persist based on the underlying market conditions.
ESRT Stock Lacks a Meaningful Dividend, Further Discouraging Investor Interest
An uninspiring outlook, combined with occupancy levels that are not improving, have caused shares of ESRT to plummet. One way to reignite investor interest in the industry is often through a dividend hike. ESRT had entirely suspended its dividend in the second quarter of Fiscal Year 2020 as a means to preserve liquidity in the midst of the pandemic. While the dividend has now been reinstated, ESRT’s current quarterly dividend rate of $0.035 per share is a pinch of its pre-pandemic levels ($0.11/quarter).
The current annualized rate of just $0.14, and the midpoint of the REIT’s FFO/share guidance, imply a payout ratio of just 17%. Thus, there is enough room to grow the dividend and reignite investor interest in the stock despite the challenging market conditions. Still, with management expressing no such intention, the market is unlikely to reward shareholders.
Is ESRT Stock a Good Buy?
Turning to Wall Street, Empire State Realty has a Moderate Sell consensus rating based on two Holds and one Sell assigned in the past three months. At $6.75, the average Empire State Realty stock forecast suggests 6.25% downside potential.
The Takeaway – Not Much to Like about ESRT Stock
While Empire State Realty’s latest results could be interpreted quite positively, when adding some extra context into the mix, the company’s investment case is less appealing than it initially appears. Observatory revenues, while driving revenue growth, have yet to come close to their pre-pandemic levels. Further, the demand for office and retail properties is likely to remain weak as cost-cutting initiatives weigh down declining occupancy levels.
With the lack of a meaningful dividend further disincentivizing investors to buy the stock, it’s more than likely that Empire State Realty’s shares won’t be rebounding anytime soon, despite their steep decline.
