Is Empire State Realty Trust, Inc. (NYSE:ESRT) A Healthy REIT?

Empire State Realty Trust, Inc. is a US$4.8b mid-cap, real estate investment trust (REIT) based in New York, United States. REITs are basically a portfolio of income-producing real estate investments, which are owned and operated by management of that trust company. They have to meet certain requirements in order to become a REIT, meaning they should be analyzed a different way. In this commentary, I’ll take you through some of the things I look at when assessing ESRT.

See our latest analysis for Empire State Realty Trust

REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of ESRT’s daily operations. For ESRT, its FFO of US$279m makes up 72% of its gross profit, which means the majority of its earnings are high-quality and recurring.

NYSE:ESRT Historical Debt, April 10th 2019
NYSE:ESRT Historical Debt, April 10th 2019

Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for ESRT to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 15%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take ESRT 6.9 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.

Next, interest coverage ratio shows how many times ESRT’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 3.5x, it’s safe to say ESRT is generating an appropriate amount of cash from its borrowings.

In terms of valuing ESRT, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. ESRT’s price-to-FFO is 16.93x, compared to the long-term industry average of 16.5x, meaning that it is fairly valued.

Next Steps:

Empire State Realty Trust can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I’ve only covered one metric in this article, the FFO, which is by no means comprehensive. I’d strongly recommend continuing your research on the following areas I believe are key fundamentals for ESRT:

  1. Future Outlook: What are well-informed industry analysts predicting for ESRT’s future growth? Take a look at our free research report of analyst consensus for ESRT’s outlook.
  2. Valuation: What is ESRT worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ESRT is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.