Empire State Realty Trust Inc

NYSE:ESRT

Earnings Call Transcript 2018-Q3

[Operator]

Greetings, and welcome to the Empire State Realty Trust Third Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Thomas Keltner, General Counsel at Empire State Realty Trust. Thank you, sir. You may begin.

[Thomas Keltner, General Counsel]

Good morning. Thank you for joining us today for Empire State Realty Trust’s third quarter 2018 earnings conference call. In addition to the press release distributed last evening, a quarterly supplemental package with further detail on our results has been posted in the Investors section of the company’s website at empirestaterealtytrust.com.

On today’s call, management’s prepared remarks and answers to your questions may contain forward-looking statements as defined in applicable securities laws, including those related to market conditions, property operations, capital expenditures, income and expense.

As a reminder, forward-looking statements represent management’s current estimates. They are subject to risks and uncertainties, which may cause actual results to differ from those discussed today.

Empire State Realty Trust assumes no obligation to update any forward-looking statement in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements in the company’s filings with the SEC.

Finally, during today’s call, we will discuss certain non-GAAP financial measures, such as FFO, modified and core FFO, NOI, cash NOI and EBITDA, which we believe are meaningful in evaluating the company’s performance. The definitions and reconciliations of these measures to the most directly comparable GAAP measures are included in the earnings release and supplemental package, each available on the company’s website.

Now, I will turn the call over to John Kessler, President and Chief Operating Officer.

[John Kessler, President and Chief Operating Officer]

Good morning. Welcome to our third quarter 2018 earnings conference call. At Empire State Realty Trust, our fully modernized portfolio is centrally located near Mass Transit. Our market position offers tenants a value price point between trophy Class A and Class B properties which provides us with both upside opportunity and downside protection. We have a de-risked embedded growth strategy and generate market-leading leasing spreads from redevelopment of our office space.

We have the lowest levered balance sheet among office REITs, which are not in liquidation, a significant cash position and no outstanding borrowings against our line and we are an industry leader in sustainability and energy efficiency.

Today, Tom Durels will speak about the third quarter's approximately 354,000 square feet of leases, market demand for our properties and our market-leading leasing spreads. Our leasing results this quarter include new leases with Signature Bank at 1400 Broadway and Diligent at 111 West 33rd Street, as well as HNTB's expansion at Empire State Building. And then David Karp will address our financial performance and our balance sheet.

Before I turn the call over to Tom, I want to comment on one additional third quarter item. We were excited to open the new Observatory entrance on 34th Street in late August. We are already seeing staffing efficiencies and faster visitor processing. The new entrance marks the first phase of a re-imagination of the entire visitor journey.

I'll now turn the call over to Tom Durels. Tom?

[Tom Durels, Executive Vice President-Real Estate]

Thank, John, and good morning. Our third quarter numbers reflect further progress on our four drivers of top-line desrisked and embedded growth over the next five to six years. The breakdown of our four revenue growth drivers, which as of September 30, 2018 we estimate to be $105 million, can be found on Page 9 of our investor presentation available in the Investors section of our website. For reference, this compares to $376 million in trailing 12 months cash NOI and $537 million in trailing 12 month cash rental revenue and tenant reimbursements as of September 30, 2018.

Just as a reminder, the $105 million is revenue growth and not all of this will flow through to NOI.

In the third quarter, we signed 43 new and renewal leases totaling approximately 354,000 square feet. This included approximately 315,000 square feet in our Manhattan office properties and 39,000 square feet in our greater New York metropolitan office properties.

Significant new office leases signed during the quarter include a 91,200 square foot lease for three full floors with Signature Bank at 1400 Broadway, a 44,700 square foot new lease for a full floor and a half with Diligent at 111 West 33rd Street and a 26,800 square foot full floor expansion lease with HNTB at the Empire State Building. And subsequent to quarter end, we signed an expansion lease with Uber for a 14,300 square foot full floor at 1400 Broadway.

With these expansions by Uber and HNTB and a 5,300 square foot expansion by Workday, we have now had 152 tenant expansions within our portfolio totaling over 1 million square feet since 2013. We've updated the disclosure on potential base rents and renewals for leases that expire by breaking up the quarters for 2019 and introducing full year disclosure for 2020, which can be found on Page 9 of our supplemental. This chart shows tenants to be relocated within our portfolio and vacates to be replaced by new tenants with whom leases have been signed.

We have continued with our proven strategy to vacate and consolidate spaces, redevelop them and re-lease those spaces at higher rents to better tenants. As a reminder, there is a timing delay between the move out of existing tenants and the commencement of replacement new leases and a further delay between legal commencement and GAAP revenue recognition. The resulting occupancy can vary quarter-by-quarter and these timing lags impact our reported revenue.

During the third quarter, rental rates on new and renewal leases across our entire portfolio were 24.1% higher on a cash basis compared to prior escalated rents and at our Manhattan office properties we signed new leases at a positive rent spread of 27.3%. Of course, leasing spreads always depend on expiring fully escalated rents, in the near-term leasing spreads will be impacted by the lease up of vacant redeveloped office space, which had prior fully escalated rents of $50 per square foot, which is well below current market. Our future leasing spreads will be influenced by rents on future lease expirations which we’ve disclosed on Page 11 of our supplemental.

We continue to see demand for product, locations and price points and feel confident in our offerings. Heading into year end, we have a healthy pipeline of leases in negotiations across our portfolio for both full floors and pre-builts. As a reminder, leasing volume may vary significantly by quarter given the timing of particular deals and we remain focused on our strategy to vacate and redevelop space that will bring the market for future lease-up.

Now, I’m going to turn the call over to David Karp.

[David Karp]

Thanks, Tom. And good morning, everyone. For the third quarter, we reported core FFO of $73 million or $0.25 per diluted share. Cash NOI was $99 million, down slightly from the prior year period. Before I dive into some of the details around this past quarter's performance, I would like to highlight a couple of changes we’ve made in our reporting to assist you with your models.

First, we further improved our signed leases not commenced disclosure within our schedule of initial free rent burn-off on Page 6 of the supplemental to better provide visibility of when the cash contribution to NOI is realized.

Second, we've adjusted our Observatory admissions figure which now reflects the performance against unique visitors within the period. Our calculations are based on the number of unique visitors who pass through the turnstile and we no longer tally visitors who make a second visit at no additional charge. We made this change to give you a more clear number for the revenue per unique visitor. These admissions figure is presented in our supplemental on pages 4 and 16 and the revenue per unique visitor is on Page 21 of our investor deck.

In our Observatory operations which are highlighted on Page 16 of our supplemental, revenue for the third quarter 2018 increased to $40.2 million, or 2.4% from the prior year period. NOI was $31.4 million, up 2.4% from the third quarter 2017 despite a lower visitor count this quarter. A combination of previously announced price increases, implementation of dynamic pricing and a better mix of ticket types drove the year-over-year improvement in NOI.

The Observatory hosted approximately 1.17 million visitors in the third quarter 2018, a decrease of 5.6% compared to the third quarter 2017. For the third quarter, we estimate that bad weather days resulting in approximately 24,000 fewer visitors or approximately 30% of the total decline than in the prior year period based upon the timing of the bad weather days.

For the nine months ended September 30, 2018, Observatory revenue was $96.7 million, a 2.6% increase compared to the prior year period. Net operating income for the first nine months of 2018 was $72.8 million, up 2.4% from the prior year period. This strong performance was achieved despite the fact that 102nd floor observation deck was closed in the first quarter of 2018 for the replacement of the original elevator machinery with a new highest speed glass elevator. Adjusting for first quarter 2018 revenue from the 102nd floor observation deck, due to its closure for that period, which was $1.9 million in 2017, Observatory revenue would have increased 4.7% for the nine months ended September 30, 2018, as compared to the same period in 2017.

The Observatory hosted approximately 2.86 million visitors in the first nine months of 2018, down 3% compared to 2.95 million in the prior year period. As a reminder, we will close the 102nd floor during the portion of 2019 as part of our larger Observatory capital project. We will keep you updated on the progress.

Starting in January 2019, in accordance with the new accounting standard guidance which is applied to all REITs, non-contingent leasing costs can no longer be capitalized and would therefore be recorded as an expense. Going forward, this figure will be dependent upon leasing volume. For context, our capitalized leasing costs were approximately $4 million to $4.5 million per year over the past three years.

Moving to our balance sheet. Our low leverage joint venture free and flexible balance sheet, including significant cash on hand remains a differentiating and competitive advantage for us in any market environment.

As of September 30, 2018, we had total debt outstanding of approximately $1.9 billion and no borrowing under our $1.1 billion unsecured line of credit. The debt has a weighted average interest rate of 3.84% and a weighted average term to maturity of 8.3 years. Our debt maturities are well laddered with only a single $250 million issue maturing before 2022. None of our outstanding debt has variable rates.

During the quarter, we entered into two forward interest rate swap agreements with an aggregate notional value of $250 million with effectively fixed LIBOR over a seven year period at 2.958% related to potential future borrowings. Given all of the work we have undertaken with our balance sheet over the past few years, we are very comfortable with how well positioned we are for a rising rate environment.

As of September 30, 2018, the company’s consolidated net debt-to-total market capitalization was 20.4% and consolidated net debt-to-EBITDA was 2.7 times, and we have cash, cash equivalents and short-term investments of $630 million.

Subsequent to the quarter end, the Board of Directors authorized a $500 million Class A common stock and publicly traded operating partnership unit repurchase program through December 31, 2019. We remain focused on having all the appropriate tools to allocate capital prudently to increase shareholder value.

With that, I would like to open the call for your questions. Operator?

[Operator]

[Operator Instructions]. Our first question is coming from the line of Steve Sakwa with Evercore ISI. Please proceed with your question.

[Steve Sakwa, Evercore ISI]

David and John, I don’t know if you can provide a little more detail on sort of the buyback. I realized that providing guidance and all that is not sort in your DNA but how do we sort of think about the program and given where the stock is, how do we just sort of kind of assume that gets executed?

[David Karp]

Hey. Good morning, Steve. It’s David. First of all, this is an extension and an expansion of a prior authorization. We’re announcing it now because of a new advice that it’s the best practice to do so. We continue to be disciplined in how we evaluate acquisitions and balancing and how we allocate capital. And this authorization ensures that the company, as I said, has all the available tools to allocate capital prudently to create value for shareholders as we continue to execute on the strategic plan to deliver our embedded de-risked growth.

[Steve Sakwa, Evercore ISI]

But there was nothing -- I guess I’m just trying to understand the timing and kind of the evaluation, obviously the stock has been down for quite a while, I guess just what sort of triggers that or is it just we’ll know it when we see it, Just trying to look on any kind of guideposts here?

[David Karp]

I appreciate the question Steve but I think what’s important is that we’ve announced the program and that's what really matters. And beyond that, we really don't have anything else to say on this subject.

[Steve Sakwa, Evercore ISI]

Okay. Maybe just for Tom on sort of the leasing environment, you mentioned kind of a strong pipeline. I was just wondering if you could provide a little more detailed sort of around the pipeline today and maybe how it compares to three or six months ago and the types tenants that are sort of in that pipeline?

[Tom Durels, Executive Vice President-Real Estate]

Steve, I feel really good about our portfolio and our pipeline of deals under discussion. What we see that our product locations and price points absolutely remain in demand and I’m very pleased with our very strong third quarter results of 354,000 square feet of leasing. Like I said is that we got a solid pipeline of activity for our Manhattan office space for both full floors and pre-builts. For us a lot is -- so timing is going to -- lays into this and our results are going to vary by quarter. But as far as the pipeline goes, we’ve got a healthy pipeline of both full floors and pre-built suites.

[Operator]

The next question is coming from the line of John Guinee with Stifel. Please proceed with your question.

[John Guinee, Stifel]

First, it looks David like you're running a burn rate of about 30 million a month if I just look at the last couple of months and your cash balance. Is 30 million going to continue and for how long until the Observatory and all of the base building work is complete?

[David Karp]

John, I’m not sure you say 30 million a month, I’m not sure how you got to that for the quarter. Our cash balances declined by ….

[John Guinee, Stifel]

Not for the quarter, I’m sorry. Not for quarter.

[David Karp]

Yes. You had me worried there for a second John. So the question was where we see in terms of our continued capital expenditure on the Observatory net of CapEx?

[John Guinee, Stifel]

Yes. How long will you continue to burn through your cash and short-term investments until you’re done with all your Observatory work and all of your base builds and renovation?

[David Karp]

Yes, I think we -- go ahead.

[John Guinee, Stifel]

And then we’re assuming that the 250 million of exchangeable gets -- matures in next August, so we’re trying to get to a cash balance when that’s also repaid.

[David Karp]

Right. So with respect to the first question, as we announced the Observatory project is expected to cost us roughly $160 million over a roughly three year period, which started in middle of 2017. To-date, we’ve spent about $79 million on the Observatory. So the balance will be spent pretty much between the end of last quarter and just the end of 2019, may be creeping into a little bit of 2020. With respect to our capital expenditures for lease-up, I think in the past week we've gone through the math on that, given that we have roughly just under 800,000 square feet of space redeveloped and we’ve given the cost per square foot, which should give you a sense for what that total spend should be, we’re using roughly $195, which is the midpoint between our white box and our pre-built. So that would imply approximately $150 million of capital for that. We talked about the capital that we are going to be spending in the greater New York metropolitan area which is roughly $40 million over 30 months period. So that gives you the gross spend.

Now specifically to your question, we see, without giving guidance, roughly by the end of 2019 getting to the point where we’re self funding our capital expenditure program before the dividend.

Now with respect to the exchangeable, the 250 million exchangeable, which is due in August of 2019, we're very happy and that we have a lot of options available to us to address that. Certainly we can use any available cash on the balance sheet. We have availability under our $1.1 billion revolver which nothing is currently drawn. As you know, we’ve successfully accessed the private placement market twice in the past, most recently with the $450 million placement with Prud, Met, Teachers and AIG and certainly that's a market that’s open to us and is always consideration of the public markets. And depending upon where the stock price is at the time, there’s potential for another exchangeable. So I guess what I am saying is we have a lot of options available to us, not all of them necessarily involve the utilization of cash on the balance sheet and as we get closer we will be making determinations as to which way to go.

[John Guinee, Stifel]

Okay. And then the next question John Kessler, I guess. Now when you look at all the deals out there in the marketplace and you look at your return threshold, do you think you’re 5% low at the ultimate trade or 20% low at the ultimate trading price?

[John Kessler, President and Chief Operating Officer]

Yes. Here is the way I’ll address that, John, we are continuing to look at opportunities in the market that we think are good use of the balance sheet. But as we look at those, we are looking also at the returns that we’re getting on our internal redevelopment. And as you know from our materials we’ve averaged about 8% return on that redevelopment over the past 12 months. So, the market continues to be, in our view, the private asset market pretty forward priced reflecting a slight private equity capital that’s there. So, I think there is still -- we still find the best use of our capital is investing in our portfolio, but we’re going to continue to work and be patient.

[Tony Malkin, Chairman and Chief Executive Officer]

And to be clear -- John, Tony here. I guess if John and I sit down, we look at things as we do with -- believe or not we do have an acquisition committee, even though we haven’t done much. And when we look at by what we’re missing, we don’t think anything squeak past us. I would say we’ve definitely been passed by a broader margin than a narrower margin. And that really has a lot to do with that return we’re getting on investment in our own portfolio, the value we’re creating for shareholders in doing so. And going back to the Yogi Bear comment when we come to afford road, we will take it and we don’t see that fork and we haven’t seen that fork. There is nothing that we’ve seen where we look back and say jeez we really missed a good one there In fact, cap rates have gone up and we’d say that it’s a been wise for us to do what we’ve done.

[Operator]

Thank you. The next question is coming from the line of Craig Mailman with KeyBanc Capital Markets. Please proceed with your question.

[Laura Dixon, KeyBanc Capital Markets]

Hey, everyone. This is Laura Dixon here with Craig. Just curious for the 2020 FDIC expiration, which bucket would that be in, is that unknown or vacate?

[Tony Malkin, Chairman and Chief Executive Officer]

We’re currently reporting them as an assumed renewal. We are in negotiation with FDIC currently and we feel positive about the discussions that we are having. Bear in mind that lease-up of 122,000 square feet does not expire until 2020. So, it’s quite early.

[Laura Dixon, KeyBanc Capital Markets]

Okay. And then …

[John Kessler, President and Chief Operating Officer]

I would add to that, not only that but their rent is extraordinarily below market at this time.

[Laura Dixon, KeyBanc Capital Markets]

Would you be able to give an indication of how much below market -- were below market there?

[John Kessler, President and Chief Operating Officer]

I would just say that's not a squeak below-market, it's a broad margin.

[Laura Dixon, KeyBanc Capital Markets]

Okay.

[John Kessler, President and Chief Operating Officer]

Laura, it’s captured on Page 12 of our investor presentation that shows our anticipated lease spreads for all future lease expirations.

[Laura Dixon, KeyBanc Capital Markets]

Okay. Great. Yes, I’ll look at that. And then regarding the new methodology for the Observatory visitors, not to -- if I may have missed this before, but is that -- has that been adjusted for prior periods as well or is that just in the current periods or in 3Q 2018?

[David Karp]

Yes, Laura, it has been adjusted in prior periods.

[John Kessler, President and Chief Operating Officer]

And I would just add Laura, clearly as you can see from our revenue per unique visitor that revenue model of the attraction is not as simple as stating the face price and number of visitors and arriving at a revenue stream of which expense can be applied. If you look at our revenue per unique visitor which can be found on Page 21 of our investor presentation, which is also been adjusted, you will see the percentage of face price which we believe is the highest of a privately owned destination attractions in New York City. Revenue is reduced by sales tax, free admits to certain classes of visitors and arrangements with different tour and travel partners. So again, it's not as simple as taking the face price and multiplying it by the number of visitors that that's a defective calculation. And also remember we've consistently advanced our revenues really beyond and sometimes in contradiction to visitor count performance and that is our unique strategy and execution.

[Laura Dixon, KeyBanc Capital Markets]

That’s helpful. Thank you. Last question just regarding any early data points you may have from the new kiosks that are in Observatory.

[Tom Durels, Executive Vice President-Real Estate]

We would say it’s a premature to quantify any impact at the same time things are processing much more efficiently, so from the visitor experience. So we have very little experience with less than a third of a quarter of operations under the new entrance and we’re very pleased with what we’re seeing.

[Laura Dixon, KeyBanc Capital Markets]

In terms of like demographics in terms of visits per visitors?

[Tom Durels, Executive Vice President-Real Estate]

That goes back to other issues. When we look at the demographic of international cross-ocean visitors coming to New York City we do see lower visitation, and we believe that has been impacted by the less positive perceptions of the United States due to Washington, D.C. rhetoric and the impact of government Visa policies. We would say that well NYC and company tourism forecasts are showing 2018 up, but by international visitors, up 4.1% and New York City hotel showing positive trends, we along with other destination attraction operators and key to our travel partners have not seen this increase, rather we’ve seen the opposite. Recently the NFL experienced in the Grand Ole Opry, Ryman entertainment both in Times Square closed after extremely short periods of operation less than one year from the NFL. We have the Observatory at one World Trade Center by its own numbers experienced a 40% drop September 2018 over September 2017 and our performance has been nothing like that. So we do see an overall -- I would say the questionable performance as far as cross-ocean transit for our visitors but we’re confident, we’re catching a bigger and bigger percentage of visitors who do come to New York and who do come to destination attractions.

[Operator]

Thank you. Our next question is coming from the line of John Kim with BMO Capital Markets. Please proceed with your question.

[John Kim, BMO Capital Markets]

Thank you. On Page 6 your cash NOI contribution from signed leases not commenced, looking at the 2019 estimate, looks like it went down this quarter from what you had previously 6 million from [‘18], but I was just wondering what happened to that?

[David Karp]

So the change -- the calculation changes as leases move in and out of this category and reflects the incremental cash over the prior trailing 12 month period which will change each quarter.

[John Kim, BMO Capital Markets]

So in other words leases commenced.

[David Karp]

Yes, leases commencing and they go into the -- if it’s free rented, they’re going to free rent burn off and then as leases no longer have any free rent they come out of that category. So there’s a constantly moving two buckets as leases commence and reach the end of their burn off at free rent.

[John Kim, BMO Capital Markets]

So that $12 million delta, that was supposed to commence in '19 got moved up to '18, because it doesn't look like it was switched out further?

[David Karp]

Yes, so I think part of that goes John to a change in what we're presenting as I noted in my prepared remarks, we changed the presentation on Page 6 of the signed -- of the free rent burn off signed leases, there's some confusion and that people were looking at that and not understanding how it impacts the actual cash contribution in each year. So we've modified that to show just how much cash is added in that year in connection with those leases as opposed to being the annualized amount in each year. So another way to look at it, if you look at that schedule and you start at a base of zero, what you're seeing in each year is the amount of cash above the base year that gets added as a result of the burn off of free rent and then you see the signed leases not commenced -- commencing.

[John Kim, BMO Capital Markets]

Okay, a follow-up on Steve's question on the buyback. You’ve sold your stock at a high price, you have an opportunity to buyback at a much lower price, it seems like a very straightforward trade. But I am just wondering how committed are you to fully like your buyback program?

[David Karp]

As I said before we are announcing the authorization of $500 million through 2019 and beyond that, there really isn't a whole lot we want to discuss on the topic.

[Tony Malkin, Chairman and Chief Executive Officer]

John, we haven't really changed our view on the subject at all. Again the change is merely new information we received as to best practice from outside counsel as part of our regular review and this is merely an extension of an existing authorization we've had for some time.

[John Kim, BMO Capital Markets]

Got it, okay. Tony, I know in the past you've spoken about WeWork and your reluctance to use them in your portfolio. I'm not really asking you to repeat those comments. But now that they are the largest tenant in the city, maybe a little bit harder to ignore and they are growing pretty vociferously, has you their stance softened at all, given that they just borrow certain assets within your portfolio?

[Tony Malkin, Chairman and Chief Executive Officer]

No, we have found that we have through the good work of Tom Durels, Ryan Kass, and their teams been able to lease directly to excellent tenants on long-term leases with a direct relationship with the tenant, and that's always our preference. So I think that focusing in on WeWork perhaps understates the -- what's going on when you've got WeWork, Industria Serendipity, Novotel, Convene, the New York City market, the shared-office environment is without question and has for sometime been the single largest tenant and we just don't understand why landlords don't pay attention to what is motivating people to go to these different users of space within turnaround and re-let to others. We think that it’s important for landlords to recognize that in New York City alone landlords have probably invested over three quarters of $1 billion in shared-office space providers in the form of tenant installation free rent commissions. And it’s just a very easy thing for people to do and we don't see a reason to do it out. We do see a reason to pay attention to see how we can speed the lease process, reduce the complication of our lease form, look at services that can be provided to our tenants along the lines of the HR compliance and healthcare, IT services at a sense of community, which can be built and these are the places in which we're investing time and money so that we are in a position to satisfy some of those desires of not just the decision-makers but the actual worker populations of those tenants and make sure that we retain a direct relationship to our tenants. And in general, I think you're going to see more, not fewer new options coming out with regard to shared space offerings, Empire has its own offering now, BXP is working on a form of its own offering right now. And candidly, I think that we've been able to get the industry in general to begin to ask the question why are we enabling this disruptor, why are we investing in this disruptor. And I think that from our perspective there’s absolutely no reason to rent them. We've got really lease spreads, very good execution on with high volume of incoming and the quality of our buildings and the quality of our tenants and the quality of our cash flows I think augment our fantastic balance sheet and put us in a position to do much better than others who have rented to these shared space providers.

[Operator]

Thank you. Our final question is coming from the line of Jamie Feldman with Bank of America Merrill Lynch. Please proceed with your question.

[Jamie Feldman, Bank of America Merrill Lynch]

Two questions actually. I think Tony you had commented in a response to an earlier question that you think cap rates have moved up, can you talk about the magnitude of that move in your view?

[Tony Malkin, Chairman and Chief Executive Officer]

Sure. I think we seen two things occur, number one -- three things really. Number one, some of the very big shifters of capital into this market have gone away. There are a few who are there to take their place. But when it comes the really big transactions, there are fewer people who are capable of doing those really big transactions and certainly most of those from a private equity perspective aren’t interested in office in New York. I think as far as the number anywhere from 50 to 280 basis points in increase in cap rate, though I would also say that the quality of the offerings have changed somewhat as well. As capital moves to the sidelines and there are certain people who are reluctant to put properties on the market, we certainly saw that withdrawal of 237 Park after it was put on the market and then pulled off. There are other properties that have been out there testing the waters and they’ve been pulled back.

[Jamie Feldman, Bank of America Merrill Lynch]

Okay. And you think 50 basis points you make across the market or which -- what quality you’re talking about the specifically?

[Tony Malkin, Chairman and Chief Executive Officer]

Well, I think I’d break it into office and retail which are the only things at which we look like now and I think with regard to office we’ve certainly seen that increase and it’s with regard to everything that’s out there. So, again we haven’t seen anything which is truly trophy come on the market when you think about some of the properties which have exchange tenants and which are currently on the market. None of them is -- could be validated I think as a true trophy asset, they’d all be sort of A not AAA.

And in retail I think frankly the cap rates are very difficult to be able to digest because the rental streams are very much influx. But I think we are going to see opportunities presenting themselves there, rental rates in retail are definitely down. There is a market clearing price per rent. I think you’re going to see in the fourth quarter and in the first two quarters of ‘19, some leases get done which would be “breaking rent” from prior market expectations. And I think you will see cap rates against in place income and go up perhaps by even more on the retail side as I think there’s been a real diminution of value there.

[Jamie Feldman, Bank of America Merrill Lynch]

Okay. So from your comments it sounds like maybe we are getting closer to a point where -- and that’s the word you came out with. But maybe you’d be more interested in the buyer, you’ve been sitting on capital for a while. Is that a safe way to look at or a good way to look at it and what kind of moving cap rates do you want to see before you get more active?

[Tony Malkin, Chairman and Chief Executive Officer]

Well, certainly we’d love to see a drastic move in cap rates, but I don’t know if that’s going to happen. And there is -- and I don’t want to -- joking aside, I don’t want to you think for a moment that we haven’t been very eager to be buyers or growers of our business. But I would say that we are keeping our eyes closely on the changes in the office occupancy which we think are coming down the pipe in maybe beginning 2020, but certainly 2021, 2022, 2023 as properties vacate and tenants roll over to the west side and to other new locations to which they’re moving.

We’re very focused on what else we might find coming down the pipe as far as things which will influence outcomes, the billions of dollars that have gone in private equity into New York City over the last 12 months, supporting many businesses which occupy space, which don’t make money. How many of those are in WeWork, how many of those are in the Town South, I don’t know. But I would say Jamie that we absolutely are -- we’re watching extremely carefully and we continue very active efforts on our part. We just haven’t seen anything that’s anything near as good is what we can do with our capital internally. And additionally, we really feel that that balance sheet is -- and it gives us such flexibility we want to use it, but it’s really going to be a reward to our investors.

[Jamie Feldman, Bank of America Merrill Lynch]

Okay. Would you be interested in getting into more of the big tower business or you’re strictly looking at the better complementary or similar to what you are now in terms of …?

[Tony Malkin, Chairman and Chief Executive Officer]

Could you explain me the big tower business?

[Jamie Feldman, Bank of America Merrill Lynch]

Well, if you -- I’m sorry that’s a very good point. You have very big tower. No I mean more of like Sixth Avenue, Park Avenue, more kind of traditional mid-town north of 42nd Street large towers?

[Tony Malkin, Chairman and Chief Executive Officer]

Yes. We have looked at a number of different situations including at least one of the public company on the basis that we thought we could reinvest in those assets and really turn them around. We think that the people were taking the effort -- the time and the effort and money to do that, today are being very well rewarded by new leasing. And we find that very attractive, the trophy is how do I look at my shareholders which includes looking at myself in the mirror and our Qatari partners, investors and any one office street and say okay where you’re going to invest it, in something which is a turnaround and we’ll get to a 5% stabilized cash on cash in let’s say three to four years when we’re averaging 8% return on investment and what we’ve put into our portfolio today and we’re still harvesting that growth which as we said from the beginning we’ll produce uneven bottom-line results. But nonetheless the trend is we think absolutely flattening out that sine wave is very positive and we feel very comfortable about our prospects there.

Why should we be investing today when we are investing and growing the business in our own portfolio? So, believe, it’s just been a subject intense discussion for us certainly in the last 12 months to 18 months, I think I referred to myself recently as a rat in the box constantly going into corners looking for something new, but we continue to work hard and we want to do it for our investors in a smart way and being a very large investor myself, I’ve done a pretty high test for what that means.

[Jamie Feldman, Bank of America Merrill Lynch]

Okay. Thank you. I appreciate it. And then David, just a quick question on, it looks like -- did you talk about the lease termination fees in the quarter, it looks like they’ve picked up versus last quarter and what drove that?

[David Karp]

Each quarter those are going to be lumpy. We take advantage of opportunities when we can’t to take back underutilized space and seek a termination fee in connection with that take back. And this quarter we just continued to proceed on those lines.

[Tony Malkin, Chairman and Chief Executive Officer]

We view this as a part of very active management as I think you understand Jamie, we don’t like spaces to be sublet in our buildings. We like to have direct relationships with our tenants. And we believe we offer our tenants through aggressive management of underutilized space opportunities to get better economic result by paying a smaller price in the beginning and getting out of their direct obligation. And that’s much better for them than leaving it on their balance sheet and losing the money overtime, it’s better for us to have tenants who’re occupied, pay rent and prospect to renew and extend with us.

[Jamie Feldman, Bank of America Merrill Lynch]

Okay. So, I guess I was just wondering if is there a sign uptick of any tenant failures or any downsizing, it sounds like it’s more driven by you than them?

[Tom Durels, Executive Vice President-Real Estate]

Jamie, this is Tom. The situation that led to lease termination payments this quarter were all money making opportunities for us just as Tony explained. In those situations we took back space from existing tenants. We really saw spaces which were new tenants at higher rents for longer term and extracted a termination payment from the prior tenants.

[Jamie Feldman, Bank of America Merrill Lynch]

Okay. Alright. Thank you.

[Operator]

Thank you. We have the reached the end of our question-and-answer session. So, I would like the pass the floor back over to Mr. Malkin for any additional or concluding comments.

[Tony Malkin, Chairman and Chief Executive Officer]

It was a busy leasing quarter. Our momentum continues in the fourth quarter. Excellent leasing results, great spreads, our teams are executing at a high level. We thank you very much for your time and your questions. I’m sorry no one visited us yesterday, you would have seen a very good Halloween parade through our office. Our CFO, David Karp dressed as Grombie, John Kessler as Clark Kent and I don’t even tell you what I was dressed as, but I got out of it by the time I had to go out for lunch. We look forward to reporting our fourth quarter results in the New Year and until then all the best.

[Operator]

Ladies and gentlemen, this concludes today’s conference. We thank you for your participation. And you may disconnect your lines at this time.