New York Office Assets Will Maintain Revenue Amid Rising Risks

Key Takeaways

• Empire State Realty Trust's diverse tenants and modern buildings support stable revenues despite market fluctuations and slower revenue growth expectations.
  
• Strategic capital allocation and constrained office supply could enhance future revenue growth through increased rents and share buybacks.
  
• Rising costs and decreasing occupancy rates present risks to revenue and earnings, exacerbated by reliance on stable macroeconomic and geopolitical conditions.

Catalysts

Empire State Realty Trust, Inc. (NYSE: ESRT) is a NYC-focused REIT that owns and operates a portfolio of modernized, amenitized, and well-located office, retail, and multifamily assets.

• Empire State Realty Trust's diversified tenant base and high lease percentages position it to maintain stable revenue streams, even in fluctuating market conditions. This may help offset potential decreases in revenue growth expectations.
  
• The company's focus on modernized, well-located buildings with strong amenities could attract tenants seeking quality spaces, potentially leading to higher occupancy rates and stabilizing rental revenue.
  
• The Observatory's dynamic pricing and high operating margins, along with digital marketing initiatives, seek to enhance revenue despite potential downturns in tourism due to geopolitical or macroeconomic factors.
  
• The strategic capital allocation, including potential share buybacks and acquisitions, could help manage earnings per share growth, aligning it with the company's operational cash flows and market conditions.
  
• The constrained supply of high-quality office spaces in New York City, coupled with increased asking rents and decreased concessions, may support future revenue growth from rent increases, although at a potentially slower rate than in thriving market conditions.

Empire State Realty Trust Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Empire State Realty Trust compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Empire State Realty Trust's revenue will grow by 2.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 6.7% today to 2.3% in 3 years time.
• The bearish analysts expect earnings to reach $18.8 million (and earnings per share of $0.07) by about May 2028, down from $51.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 158.0x on those 2028 earnings, up from 24.3x today. This future PE is greater than the current PE for the US Office REITs industry at 46.9x.
• Analysts expect the number of shares outstanding to grow by 1.31% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.34%, as per the Simply Wall St company report.

Empire State Realty Trust Future Earnings Per Share Growth

Risks

• The Observatory's visitation dropped by 4.6% year-over-year, and potential macroeconomic risks such as geopolitical tensions and currency exchange rates could further impact tourism and reduce revenue from this segment.
  
• Rising operating expenses driven by real estate taxes, payroll, and repair costs, which outpace same-store property cash NOI growth, could compress net margins and erode earnings.
  
• The New York City office portfolio saw a decline in leasing rate from 94.2% to 93%, with expectations for improving occupancy sitting at a modest 89% to 91% by year-end, which might hamper revenue growth if not achieved.
  
• The ongoing reliance on macroeconomic and geopolitical stability to drive tourism revenue from the Observatory presents a risk, as any deviation towards instability could negatively affect earnings.
  
• Elevated construction and replacement costs could limit new supply and renovations, potentially impacting the ability to command higher revenues without significant capital expenditure, thus affecting profit margins.

Valuation

• The assumed bearish price target for Empire State Realty Trust is $8.45, which represents one standard deviation below the consensus price target of $9.67. This valuation is based on what can be assumed as the expectations of Empire State Realty Trust's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $11.0, and the most bearish reporting a price target of just $7.5.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $807.5 million, earnings will come to $18.8 million, and it would be trading on a PE ratio of 158.0x, assuming you use a discount rate of 7.3%.
  
• Given the current share price of $7.41, the bearish analyst price target of $8.45 is 12.3% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.