Empire State Realty Trust Inc

NYSE:ESRT

Earnings Call Transcript 2017-Q4

[Operator]

Greetings, and welcome to the Empire State Realty Trust Fourth Quarter and Year-End 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Thomas Keltner, Executive Vice President and General Counsel at Empire State Realty Trust.

Thank you, Mr. Keltner, you may begin.

[Thomas Keltner, executive]

Good morning. Thank you for joining us today for Empire State Realty Trust Fourth Quarter 2017 Earnings Conference Call. In addition to the press release distributed last evening, a quarterly supplemental package with further details on our results has been posted in the Investor 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 from -- 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 would turn the call over to John Kessler, President and Chief Operating Officer.

[John Kessler, executive]

Good morning. Welcome to our fourth quarter 2017 earnings conference call. Empire State Realty Trust is a pure play Manhattan and greater New York metro area office and retail portfolio.

Our focus remains on our long-stated plans to redevelop our well-located portfolio and deliver embedded derisk growth, and maintain flexibility for external growth through a strong, flexible and low levered balance sheet.

In the fourth quarter, we signed approximately 275,000 square feet of leases and saw steady demand for our well located, fully modernized for the 21st Century buildings, at our value price point.

2017 leasing volume set a record for us.

In the fourth quarter, we achieved average leasing spreads of 33.9% on new Manhattan office leases and 26.8% on all new and renewal leases across our entire portfolio.

Moving to our balance sheet. During the quarter, we entered into an agreement to issue and sell $450 million of long-tenured attractively priced unsecured notes in a private placement.

As a result of certain financing transactions completed subsequent to quarter end, we have now fully addressed all of our 2018 maturities through a combination of mortgage payoffs and refinancings.

We manage our balance sheet to enable future growth and to create value for shareholders.

This morning, Tom Durels will provide an update on our portfolio including much more detail on our record leasing and how much space we plan to vacate and redevelop. And then David Karp will review financial results in more detail and provide more information for you to model 2018 and beyond.

After that, our team including Tony Melton, are here to answer your questions.

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

[Thomas Durels, executive]

Thanks, John, and good morning, everyone.

Throughout 2017, I reported that we had steady demand and that led to a record leasing year. Thus far in the first quarter of 2018, we continue to see steady demand.

We feel really good about our differentiated product type, our price points, our locations and the brokers and tenants we are attracting.

On today's call, I will provide you with an update on our 4 key growth drivers. Review our leasing activity in the fourth quarter and full year, give an overview of our current and future space availabilities and discuss some of our recent redevelopment work.

To make things easier and cut the length of these calls, certain areas of my quarterly update can now be found in our supplemental.

Our fourth quarter numbers reflect further progress on our 4 long-term growth drivers, which are one, upside from signed leases not commenced of $17 million and burn off of free rent of $26 million, which together, total approximately $43 million of contracted growth. Two, lease up of developed vacant office space of $26 million; three, the mark-to-market on our expiring Manhattan office leases of $18 million; and four, the mark-to-market and lease-up of available retail space of $10 million.

Based on these updated numbers, we estimate these drivers will contribute approximately $97 million of revenue growth over the next 5 to 6 years December 31, 2017. Relative to our trailing 12 months cash NOI of $381 million.

In the fourth quarter, we signed 55 new and renewal leases totaling approximately 275,000 square feet. This included approximately 214,000 square feet in our Manhattan office properties, 38,000 square feet in our greater New York metropolitan office properties and 23,000 square feet of retail.

This brings our 2017 total to 167 new and renewal leases for a company record of approximately 1.29 million square feet.

Significant office leases signed during the quarter include Universal Music Group, PVH, Hoguet Newman and MSG ventures.

And subsequent to quarter end, we signed a new office lease with Uber for a full floor of approximately 35,000 square feet at 1400 Broadway. To make this lease, the prior tenant made payments to terminate its lease early, which allowed us to avoid future downtime and capture revenue while we achieved a 9% positive mark-to-market increase of starting rent over prior fully escalated rent.

Our redevelopment strategy allows us to continue to capture healthy rental growth spreads. During the fourth quarter, rental rates on new and renewal leases across our entire portfolio were 26.8% higher on a cash basis compared to prior escalated rents.

And that our Manhattan office properties, we signed new leases at positive rent spread of 33.9%.

For this quarter and going forward, we will provide detail on our vacancy in our supplemental.

Here are some highlights for our portfolio as of December 31 of 2017.

We had a net total of 792,000 square feet of unleased space, which is comprised of Manhattan office vacancy of 595,000 square feet.

Retail vacancy of 44,000 square feet and greater New York metropolitan office vacancy of 153,000 square feet.

Of the 595,000 square feet of unleased Manhattan office space, approximately 425,000 square feet is consolidated and redeveloped prebuilt and white-boxed space ready for lease up.

Within our Manhattan office portfolio, we currently have available 8 full floors ranging in size from 8,500 square feet to our largest single floor of 42,000 square feet.

These 8 floors total 145,000 square feet and include 3 floors at 111 West 33rd Street, 2 floors at 250 West 57th Street and 1 floor each at 1350 Broadway, 1400 Broadway and 1 Grand Central Place.

We expect our occupancy will go up and down as we continue our strategy to deliver derisked embedded growth and we vacate and consolidate spaces and redevelop and release those spaces at higher rents to get better tenants.

In 2018, we expect to vacate an additional 700,000 square feet. Roughly 2/3 of this space is taken offline in the first half of 2018.

We expect year-end occupancy to be lower than when we started the year.

As we have shown quarter-over-quarter when we redevelop, we lease up at materially higher rents.

This space represents in place fully escalated rents of $49.34 per square foot portfolio wide. Similar to the recent lease with Uber, we are also actively working on opportunities to take back underutilized space that we can in turn lease directly to new or expanding tenants at higher rents.

As always, there is a timing lag between the move outs of existing tenants and when new leases commence, which impacts revenue.

In addition, there is a timing lag between legal commencement and GAAP revenue recognition.

Turning to our retail business. We signed a significantly lease with T.J. Maxx for a 19,000 square-foot full floor expansion and overall lease extension at 250 West 57th Street during the fourth quarter, and T.J. Maxx now leases a total of 47,000 square feet.

Our street retail portfolio located in high-traffic areas with excellent -- within excellent submarkets is 92% occupied and 93.9% leased and strong execution on leasing results delivered by our team has positioned us well with only 8% of our retail spaces expiring in the next 2 years.

As previously announced at the Empire State building. For the first time since the buildings opening, a gut redevelopment of all retail space is underway.

The first phase on 33rd Street has been successfully completed, will be vacated and 100% released approximately 21,000 square feet at grade and 9,200 square feet on the second floor to Walgreens, Juice Press, Starbucks, Sushi-teria, Chopped, STATE Grill and Bar and most recently Tacombi.

Phase II on the 34th Street is in progress where we have vacant and are currently marketing 7,900 square feet on grade and 18,000 square feet of contiguous concourse space.

By December 31 of 2019, we anticipate we will have another 6,700 square feet at grade, 12,000 square feet on concourse and 5,000 square feet on the second floor vacant for redevelopment.

As we have stated before, our new 34th Street Observatory entrance will bring 4 million plus visitors annually, past our stores there and enhance the value of all of our 34th Street retail space.

We remain very confident about our leasing pipeline and in our team's ability to execute. Demand for a well-located and amenity-rich properties is steady as we continue our proven strategy to consolidate, vacate and deliver redeveloped space and lease to new, better credit tenants at higher rents.

It's a reminder, please remember to review our supplemental for information historically provided in this call.

Now I'll turn the call over to David Karp. David?

[David Karp, executive]

Thanks, Tom, and good morning, everyone.

For the fourth quarter, we reported Core FFO of $74.9 million or $0.25 per diluted share.

Cash NOI was $99.7 million, up 2.5% from the prior-year period.

For the full year 2017, Core FFO was $286.9 million or $0.96 per diluted share, which includes approximately $0.045 per diluted share of lease termination income. This was partially offset by the right-off of straight line rent receivables associated with the terminated leases of approximately $0.05 per share. And of course we have reduction in rental revenue from these terminated leases until such time as revenue commences on replacement leases.

Cash NOI was $381 million, up 7% from the prior-year period.

In the first quarter of 2017, we changed our revenue recognition practices for leases in which the tenant constructs tenant improvements in which we share the funding obligation.

We recognize rental revenue at the earlier of cash rent commencement or completion of tenant improvements.

Previously, we started rental revenue recognition when the lease legally commenced.

This new accounting practice resulted in approximately $1.6 million less revenue for the fourth quarter 2017 compared to the practice in place for the prior-year period.

This practice does not represent a reduction in lease revenue but does represent a delay in the GAAP commencement date for new leases, which will continue to have an impact into 2018 and beyond.

This quarter, we added to our supplemental disclosure to assist the investment community to model better our business.

Specifically, we now break out the current year's lease expirations by quarter. We reformatted our quarterly NOI, cash NOI and leasing activity data into a consolidated growing 5 quarter format for easier trend analysis. We added the number and the impact of bad weather days on Observatory attendance.

We provided a detailed schedule of signed leases not commenced and we have added in the detail vacancy breakdown Tom cited earlier.

Moving to our Observatory operations. Revenue for the fourth quarter 2017 declined 2.4% to $32.9 million from the prior-year period.

Supported by lower operating expenses, NOI was $25.7 million essentially unchanged from the fourth quarter 2016.

The Observatory hosted approximately 1.01 million visitors in the fourth quarter 2017, a decrease of 5.1% compared to the fourth quarter 2016.

For the full year 2017, the Observatory hosted approximately 4.05 million visitors, down 4.6% compared to the prior-year period.

Observatory revenue was $127.1 million, up 1.8% compared to the prior-year period while net operating income grew 2% to $96.8 million from the prior-year period.

As a reminder, we always look at the Observatory's results on a holistic annual basis.

Keeping that perspective, we are pleased with the revenue and NOI improvement we reported in 2017.

A combination of active revenue management through ticket price increases, dynamic pricing, mix improvement and new visitor offerings such as the AM/PM experience along with expense management offset the impact of fewer visitors.

In connection with the elevator modernization at the Empire State Building, the elevator servicing the 102nd floor will be impacted with the result of the 102nd floor Observatory will be closed to visitors for the first quarter of 2018.

As a point of reference, sales for the 102nd floor were approximately $1.9 million in the first quarter of 2017.

Turning to our broadcast business. As we discussed last quarter, we have essentially concluded our negotiations with current operators.

Based on the agreements we have completed and which we have discussed previously, we expect that our broadcast revenue inclusive of tenant reimbursements will be reduced from the current annualized revenue run rate of $19.4 million to a stabilized level of approximately $15 million.

The revenue impact from renewals and non-renewals will phase in during 2018 as detailed in the supplemental.

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.

During the quarter, we considered market conditions and made a strategic decision to enter into an agreement to issue $450 million of senior unsecured notes via a private placement.

The notes consist of 3 series with 10-, 12- and 15-year tenures, all with coupons in the 4% to 4.5% range.

The 10-year series was issued in December 2017 and the remaining 2 series will be funded in March 2018.

We will use the net proceeds from these issuances to repay the 111 West 33rd Street and 1350 Broadway mortgage indebtedness before the maturity dates in early April 2018, and to maintain cash balances.

We believe that the ability to take care of opportunity for long-term value creation for shareholders outweighs the short-term cost.

In January 2018, we increased the mortgage debt on 1333 Broadway from $66.6 million to $160 million due February 2033 with interest fixed at 4.21%.

A portion of this increase was applied to release the $75.8 million mortgage lien on 1400 Broadway.

These recent financing activities combined with the mortgage refinancing completed earlier in 2017 and our interest rate hedges will add approximately $12 million or $0.04 per fully diluted share to our 2018 interest expense as compared with 2017.

With the private placement and subsequent mortgage refinancing, we're very pleased to have accomplished several important objectives: first, we've completely addressed our 2018 mortgage maturities. Our debt maturities are well laddered with only a single $250 million issue maturing before 2022.

We made a deliberate decision to go long, resulting in an extension of our weighted average maturities to 6.2 years as of year-end.

With the closing of the 1333 Broadway refinance and the funding of the 12 and 15-year tranches of the private placement in March 2018, our weighted average maturity will further increase to 8.9 years.

Second, we reinforced and expanded our lender relationships with 4 leading life insurance companies.

Lastly, we enhanced our cash balance with these financing transactions leaving us well positioned with liquidity and capacity for redevelopment and external growth opportunities.

As of December 31, 2017, the company has total debt outstanding of approximately $1.7 billion. The debt has a weighted average interest rate of 4.05%. None of our outstanding debt has variable rates.

The company's consolidated net debt to total market capitalization was approximately 16.6% and consolidated net debt to EBITDA was 3.5x.

We have the lowest leverage in the office suite sector and at quarter end hold cash and cash equivalents of $464.3 million.

As we look ahead to 2018, let me provide some further perspective.

As Tom mentioned, as part of our redevelopment program, we currently expect to vacate 700,000 square feet in 2018, which will reduce occupancy during the year.

In total, this space represents about $34.5 million of annual revenue and we expect roughly 2/3 of this space to be taken offline in the first half of the year.

Against this as detailed in the supplemental on Page 6, we had $17 million of signed leases not commenced of which we expect $800,000 to be realized in 2018 revenue with an additional $10 million in 2019 and an additional $6 million in 2020.

Further, we have $26 million of annualized free rent of which $13 million will be realized in 2018 with the majority of the balance in 2019.

Consistent with what we have always said and what you have heard from the team today, the additional vacancy and the impact on revenue in 2018 is inherent in our strategic plan to deliver embedded derisk growth and shareholder value.

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

[Technical Difficulty]

[Anthony Malkin, executive]

Are we live? I want to apologize to everybody for our technical difficulties. We were blocked off of the call. This is Tony Malkin here.

I'll take this opportunity to make a couple of comments if I may. First of all, aside from the conference call, I want to thank the team for the work on the update that we've provided, sorry for the glitch. We just finished our fourth year as a public company. As I look back, I'm very happy with what we have accomplished. We've done exactly what we have said we would do since inception. We have vacated and modernized the New York portfolio for the 21st century, redeveloped our spaces and leased at outsized spreads to better tenants on longer lease terms at higher rents. We are differentiated from our peers and our markets and in our segment. We have delivered outsized growth through our embedded, derisked opportunities within our portfolio. And as the team has laid out, we have more to deliver over the next few years.

Along the way, we have created a best-in-class balance sheet with ample liquidity and flexibility to take advantage of external growth when we see something on which we want to act. We've also built our disclosure to investors and the analyst community and have a truly capable team built around the culture of hard work, service and accountability. Our portfolio is solidly in its own category by combination of quality, price point and locations. 2018 sets the stage for more of our internal growth story.

We are going to vacate a lot of space, redevelop it and we believe the steady demand we see will allow us to execute as we have to date with market and sector-leading leasing spreads.

Looking forward, we are fully engaged and I personally am very excited with our position in growth prospects internally and our ability to take advantage of external growth.

Again, I apologize for the interruption. Maybe if we're lucky, we'll be able to get to questions now.

[Operator]

[Operator Instructions] Our first question comes from the line of Rob Simone with Evercore ISI.

[Robert Simone, analyst]

I was just wondering if you guys can maybe talk about, obviously office REITs broadly have been beaten up pretty severely over the last month and half or so and your stocks trading well below NAV, but I guess I was wondering given how many deals I know that you guys underwrite, have you seen any movement on cap rates on the private side relative to how much public REIT cap rates have moved?

[John Kessler, executive]

Rob, it's John Kessler. I think what we have seen in the capital market is certainly that transaction activity slow down. We saw that in -- certainly in '17. I think as it relates to pricing and cap rates, we haven't really seen in the private market any kind of meaningful movement in pricing. And obviously, we're cognizant where the treasury is and -- but that will be our response.

[Robert Simone, analyst]

Sure, sure. And then on -- just on the cash balance. I came up with an estimated kind of like unrestricted, uncommitted cash balance of about $600 million, plus or minus after you guys completed refinancing. I guess could you maybe speak to what your view on timing is overall to kind of let that sit on earning on your balance sheet. Just assuming that the environment doesn't change all that much and you guys kind of don't see that bigger opportunity you've been waiting for?

[John Kessler, executive]

Well it's the same question really about deploying the balance sheet. We have significant cash as you know and including our undrawn credit facility and as we think about deploying it, we're going to continue to measure investment return on that capital versus the returns we're getting on the redevelopment of our portfolio and as you know our cash NOI in our business grew by 7% in 2017 over the prior year. So we're still getting very good growth. We still have about 1 million -- close to 1 million square feet to redevelop in the portfolio and we're going to continue to remain patient and disciplined. If you see something in the external markets that is attractive relative to the internal return opportunities that we're getting on our own portfolio, we're going to take action but we're going to continue to be patient.

[Anthony Malkin, executive]

Rob, Tony here. As I've said many times the old Yogi Berra-ism "when we come to a fork in the road, we'll take it. " And sometimes that fork is got to be presented to you, sometimes it -- you stumble upon it. Sometimes you have to find it. So in short though, the cash we have on our balance sheet, our primary objective with that the flexibility we have in our balance sheet, the low leverage we have on our balance sheet, the primary objective is directed towards external growth. And our focus remains on growing the business, either through individual acquisitions or private or public M&A. And that's at least the sharp -- the bright shiny penny when we talk about external growth and when we talk about M&A, so I think John's comments are very focused on discipline as they should be. And it's certainly not our intention to look back in 10 years from now and to be proud of the facts we have maintained our, over a 10 year period, our leverage at 17% net debt to enterprise value. That's not our goal.

[Operator]

[Operator Instructions] Our next question comes from the line of John Guinee with Stifel.

[John Guinee, analyst]

Great, great. Not sure who the right person to address this is but 700,000 square feet of renovation out of the 930,000 square feet of lease is expiring in 2018. I assume it's a very low retention rate, one. And then two, how much money should -- is being budgeted per square foot for that 700,000? Is this $200 a foot in base building TIs and releasing cost? Or is it, say, $300 a foot? And then could you also go through the remaining spend on the Observatory? And then also the remaining spend on all of the retail repositioning?

[Thomas Durels, executive]

John, this is Tom. Out of the 700,000 square feet that we expect to vacate in 2018. As a reminder, the in-place fully escalated rent on that is about $49 per square foot that represents an opportunity for significant mark-to-market. About 520,000 square feet is in our Manhattan office portfolio. The balance is part of the retail redevelopment on 34th Street on Empire State Building and our greater New York metropolitan office portfolio. So out of the 520,000 square feet that we are vacating in '18 in our Manhattan office portfolio, we'll redevelop about 300,000 square feet of that. As to cost, as we've said before depending on whether we build space with a cap contribution following a white box or build a prebuild, those all in cost including base building, which is a onetime expense, TI, whether it be a contribution or the build out of a prebuilt and leasing commission can range between $180 to $210 per square foot, all in.

[David Karp, executive]

And John, with your question on the remaining spend on the Observatory. To date, we spent $36 million on the Observatory capital projects and as we have said in the past, we expect that project over the 3 year time horizon commencing in mid-2017 when we started the project through the end to run a total of approximately $150 million.

[John Guinee, analyst]

Okay. And then regarding the Observatory, I think you said that you're going to go down from $19.4 million in net total growth annualized rent down to about $15 million run rate. Essentially, you've got $5 million of lease -- of annualized rent expiring at '18. Is this another way of saying that expect all of the remaining $15 million to go away as these leases expire? Or from '19 on, can you expect to maintain a $15 million run rate indefinitely?

[John Kessler, executive]

John, it's John Kessler. Just to clarify, I assume you meant the broadcast [indiscernible]?

[John Guinee, analyst]

Broadcast. I'm sorry, yes.

[John Kessler, executive]

And the answer is that today, the trailing 12-month revenue is '19. We project as you can see in our supplement that with rollovers, we'll get to approximately $15 million of annual run rate by the end of the year and what we're saying is that we believe that is a reasonable stabilized run rate for that business going forward. In other words, that's where we end up at the $15 million rate.

[John Guinee, analyst]

Okay. No more leakage with the $2 million of lease expirations in '20 or the 1.4 million square feet in '22? When you get this particularly done.

[Thomas Durels, executive]

John, it would be -- really we're pretty much done with all of our lease renewals. We have like 1 radio guy out there but I expect them to stay. And there is going to be some offsets, there is some opportunities from modest improvement in income from point-to-point, some backup situations. So as John said, we view this as stabilized at $15 million.

[John Guinee, analyst]

And then the last question, which I know you won't answer but I'll ask anyhow. Is the $150 million of spent for the Observatory, is that expected to generate increasing NOI or just more of a defensive spend and we expect that maybe the run rate on the Observatory stays about the same?

[Anthony Malkin, executive]

John, Tony here. I certainly look at this as anything that we do, which is offensive inherently as defensive but this is absolutely in our view, offense. That is our hope and intention.

So when I say offense, I mean putting more points on the board.

[Operator]

[Operator Instructions] Our next question comes from the line of Jamie Feldman with Bank of America.

[James Feldman, analyst]

I was hoping just to dig a little bit more into the visitor trends of the Observatory? I guess year-over-year, you did have fewer bad weather days but total visitors were down. So just any insight you can provide on to what you're seeing? What types -- just kind of trends and what's driving volume? And if -- we should expect to see a more subdued volume going forward?

[Anthony Malkin, executive]

Well, we do present certain materials in our presentation on the breakdown on the Observatory and we have made the comment before, which is still consistent, Jamie that the biggest issue is the cross-border. And I'm not referring about tourists from Canada. The U.S. brand as a destination for tourism is definitely damaged by the rhetoric out of DC. And that hurt us in 2017, it hurt the whole industry. I do think that it's best to take a look at what the hotel association and other entities, which have more to say on this subject than we would undertake to go into on this call have to say. But in the meantime, for us, there is a reduction in cross-border and -- we get a little tired I think in the end. We're putting the weather information in the supplemental because to some degree, I feel like we're a retailer talking about coat sales, you know? And I don't want to overdo it. In the end, we look at these things holistically, did we have worse weather in 2017 on specific dates? Yes, although there may have been fewer bad weather days. Overall, we got specifically hit very hard with 0 visibility during peak periods in August where we had just terrible weather. But in the end, the overall trend in 2017 was not positive for cross boarder visitors and that's the majority of our visitors to the Empire State Building.

[James Feldman, analyst]

Okay. Do you see any signs of this changing? Or anything year-to-date that's giving you a different view?

[Anthony Malkin, executive]

I do know that there are a number of industry groups getting together and approaching the White House on this issue specifically. But from our perspective, our job in the end is to get a higher percentage of people coming to New York City by giving them a better attraction, a better reason to come. And in addition, to put more people through the door during off-peak periods, which is where we have a lot of capacity. And again, I think with a better attraction, we'll have a better prospect of doing that. And of course, through all of that, we're looking to drive our per cap revenue.

[James Feldman, analyst]

Okay. And then can you just talk about the Uber -- the Uber -- the lease that Uber's backfilling. What kind of impact that might have on '18 earnings? And the timing for them to backfill?

[Thomas Durels, executive]

Well first, as I mentioned, Jamie that, that was involved a recapture of space from an existing tenant and we achieved about a 9% mark-to-market increase on that over the prior fully escalated rent. The lease will commence this year and then they're going to a free rent period. Generally where -- for the space that they took without going into specifics for confidentiality, I can say we're asking in the low 60s at 1400 Broadway, our ask price all the way to the tower goes up to the high 60s per square foot.

[James Feldman, analyst]

Okay. And is that termination fee, was that recorded in '18 -- I mean '17 or '18?

[Thomas Durels, executive]

2018.

[James Feldman, analyst]

Can you talk about the magnitude?

[Thomas Durels, executive]

No. I prefer not for confidentiality.

[Anthony Malkin, executive]

Obviously it will be reported in our first quarter numbers along with whatever lease -- other lease cancellations we generate.

[James Feldman, analyst]

Okay. And the last question for me is -- and it's hard to tell just kind of on a same-store basis how much rents are growing? Or what leasing spreads are? Given the amount of redevelopment spend in the portfolio. Can you just give us some color on what you think kind of apples to apples rent improvements have been in the portfolio this year?

[Thomas Durels, executive]

Sure. First of all, the rent growth is a function of supply and demand and I feel good about the activity we have in our portfolio and we have strong demand for our product, our locations and our price point. Where we like our position in the market because we're less expensive than Class A. We've delivered better product than Class B. As we look back, we've outperformed the market in terms of rent growth based upon our redevelopment work, particularly at Empire State Building, 111 West 33rd Street and 250 West 57th Street. Whereas we look back over the past 40 months or so, we grew our rent anywhere from 19% to 47%, depending on spaces -- our asking rents in those buildings and the actual taking about 12% to 34%, we think that, that is a significant outperformance of the market. Overall, we see steady activity on our portfolio, the market feels healthy and given that, I think we should see some modest improvement in rent growth in the coming year.

[Operator]

[Operator Instructions] Our next question comes from the line of Craig Mailman with KeyBanc Capital Markets.

[Craig Mailman, analyst]

David, appreciate the incremental color here on kind of the puts and takes for '18. I mean is it fair to say that kind of taking a step back, '18's sort of a transition year for you guys, from an earnings perspective? And to really kind of mark maybe a near-term bottom that you can accelerate off of? Is that how we should think about it?

[David Karp, executive]

Craig, I'll just kind of point you back to Tony's comment that he made at the conclusion of our prepared remarks and that is we're looking at 2018 as an important year in the future growth and the completion of this first phase of our redevelopment process. There is -- as Tom has mentioned, there is a lot of space coming offline and we've tried to quantify what that impact will be in terms of the lost revenue associated with the space that goes down and is offset by the signed leases not commenced and the burn off of free rent that we have to backfill that. But I think we've also indicated that our occupancy -- we do expect our occupancy to drop at the end of the year as compared to the beginning of the year. So it is a very active year for us but it's nothing unusual and it's consistent with what we've been saying all along that our occupancy will go up and down and that we'll be taking space offline, we'll be reinvesting with it all towards the end goal of substantially increasing our recurring revenues as well as enhancing our total shareholder value.

[Anthony Malkin, executive]

Tony here. Just to add to that, it is central to our thesis from the moment of the conception of this company that we had a tremendous amount of tenancy, which was the vast, vast, vast majority of it was undesirable small low-credit short-term leases and unable to pay better rents and many of them unable to pay the rents that they were contracted to make payment. In order for us to redevelop the space, we must vacate the space. That's a basic fact of life. And we view 2018 as an important year for our growth. I can understand how you might look at it from the perspective of well, gee, it's increased vacancy. But for us, this is all upside. And that's the way in which we look at it. All upside.

[Craig Mailman, analyst]

I know and I appreciate that and we all know that you're going to have dips and what not related to the redevelopment. I was just getting at, if you guys are taking 700,000 square feet offline and about 1 million left to redevelop, it seems like most of the dip from taking that space offline was kind of hit in the '18, maybe early '19 and then just trying to get a sense of, is that how you guys are viewing the business that this should be the trough from that activity and...

[Anthony Malkin, executive]

Well do me a favor, maybe Tom could comment on some of the visibility that we have in our presentation with regard to spaces rolling in the future.

[Thomas Durels, executive]

Sure. I mean Craig, as I've gone through those numbers previously. We have the 930,000 square feet that's expiring in 2018. We have given the stat on how much we expect to vacate in that year and then our role in the following years is rather modest. So we view 2018 as a big year of execution for us. But with -- coming off the year at 1.3 million square feet of leasing, which is a record year for us in 2017 and going into the first quarter, we have solid activity and absolute conviction in our strategy, we continue to build value as we execute on that strategy and I feel good about the activity we have for our product and our locations and price point. So I feel good about taking this space back and executing on our strategy to lease that up at higher rents for longer term.

[David Karp, executive]

And Craig, this is David. Just 1 other point, again if you look at our investor presentation, we have a slide in there, which sets forth -- it doesn't set forth what we're vacating but it does set forth what we expect to redevelop. And if you -- and this is on Page 16 I believe of the investor deck and we show that in 2018, we've got a fair amount of redevelopment and you compare -- we're showing 225,000 square feet roughly as redevelopment in 2018 and then we look out over subsequent years, 2019, that drops down to 90,000 and 2020 about 95,000. So again, 2018 very active year for us in terms of vacate and redevelopment, which then feeds that growth for those subsequent years.

[Craig Mailman, analyst]

That's helpful. Then just I know we've talked about the cash balances you guys have and you guys are being deliberate about deploying it. Just -- could you give us thoughts on not using some of that to pay down some of the mortgage debt in the near term and kind of lessen the earnings dilution here from keeping on the balance sheet versus kind of putting to work with that prepayment?

[John Kessler, executive]

Craig, it's John. That question, I think, is similar to the others where we continue to take the view that it's valuable to have the liquidity and the low leverage balance sheet that we have and we like to have the cash and liquidity on hand. I think -- we think there is a difference between liquidity and the leverage and we're going to continue to be -- take the tact that you've seen us take, which is to preserve that liquidity so we can be nimble if we see opportunity in the market.

[Anthony Malkin, executive]

Well, let's be very clear, we have to be nimble when we see opportunity. We know we're going to see opportunity. And we are designed for growth. Not for just the same business being repeated year after year. That's our goal, that's our orientation, Craig.

[Craig Mailman, analyst]

And then just one last one. Taken the 102nd floor offline, is there going to be a similar disruption to the main deck at any point as you guys do the $150 million of spend and also, was there any way to get around taking the full floor offline?

[Anthony Malkin, executive]

Well the 102nd floor is accessed by 1 elevator and that elevator needed to be replaced and it's not practical to have people walk from the 86th floor to the 102nd floor. There will be points in time in which different parts of the Observatory, which you presently walk through are not available due to construction. However, the 86th floor outside deck will remain open 100% throughout the entire construction period. And the reason the 102nd floor elevator is offline now is because between January 1 and Easter is our slowest period. So working with [Otis], we're getting that work done so we're open before I peak periods resume. But at no point will the 86th floor Observatory deck be closed under our present plans.

[Operator]

Our final question comes from the line of John Guinee with Stifel.

[John Guinee, analyst]

Tony, I've got 2 follow-up questions. First, no question with the big growth relocation is coming to Hudson Yards that there's going to be big vacancies in the office world and also that there is going to be big dollars needed to take those tired buildings up to current standard and you guys are obviously good at that but so are a lot of people. How does that get underwritten? What sort of stabilize yield on cost do you think is expected for those kind of deals? That's 1 question. And then the second question is I think you were very public on the upcoming Armageddon in the retail world and Street retail in Manhattan. Do you have any updates on that?

[Anthony Malkin, executive]

Well, what I might do is as much as I'd like to talk about other people's return needs on redevelopment is to say just that from my own perspective, we know we're making a 10% overall -- 10% to slightly higher when we reinvest in our own properties on a ROI basis, not an IRR basis. And that we have seen capital markets deploy capital at what we think are much lower IRR's let alone ROIs. So I do think that with this redevelopment opportunity, look, we've seen many landlords today not improve their buildings or may be put in a new lobby instead of doing anything fairly fundamental. And lease frankly, to secondary tenants at lower rents and give away much higher concession packages. And we don't think that, that is a good strategy. However, when you look at their balance sheets particularly some of the public ones, they're not in a position really to do more. That's what they can afford to do. And I think that there are probably people in the private market who will be looking at that as well. It's difficult to pay very high prices and then have money set aside to do meaningful upgrades to the buildings. End of story. So our hope is that we have higher interest rates with people less able to plow on leverage, with the skills needed in order to do this kind of work that, that will all combine to our benefit from a competitive perspective and also right down to our benefit from a potential yield perspective. I'm going to ask Tom Durels to make a couple of comments on retail just from what we're seeing. Because I do believe that this Armageddon as it were -- I don't think it's coming. I think a, we're in it. But I do think it's selective in nature. And I think it's worthwhile just to talk a little bit about what we see as far as better locations versus non-good locations and what's happening in the market place with retail and then I'll have a comment or 2.

[Thomas Durels, executive]

Sure. I would say that there is no questions that while the retail market is slow and I think that what we've maintained is our retail, which is located in high-traffic areas and in excellent submarkets is always going to be in demand. If I could take a step back and look what we've accomplished as we set forth strategies to release our space -- our retail space at 57th Street, Times Square South, 34th Street and the Empire State Building, we set with the strategy to redevelop all of our street front of 57th Street where we're 100% released 61,000 square feet to tenants like T.J. Maxx, HSBC, AT&T, Starbucks, most recently with the expansion of T.J. Maxx that 61,000 square feet is now on 4 floors fully leased. We've leased all of our availabilities on Broadway. You look at the transformation of that submarket and the influx of interesting food and retailers, we leased all of our space at 112 West 34th Street and all of our 33rd Street to interesting food users. So now we're focused on our 34th Street frontage at Empire State Building. And I feel very good about the product that we have and retail is going to go where there is pedestrian street traffic and we have tremendous street traffic obviously on 34th Street.

[Anthony Malkin, executive]

In short, John, we know Sephora per square foot basis is one of their, if not, their top per square foot floor in North America -- store in North America. Target is doing great. Foot Locker is doing great. So retail is not dead but there is too much retail in places, which don't matter and then there are places where there are certain aspects of retail, which don't really matter at all anymore as the industry and that I think is really seen in SOHO, it's in some of the tourist areas. It doesn't help for the -- for some of these super luxury locations that overseas travel into the U.S. is down. So overall, I think it's not coming, it's here. You're seeing it. And prices are coming way, way, way down. But I think that speaks to demand.

I thought John, you're going to ask something different, which I'd like to close, which is the -- along with thanks to everybody for participating in today and sorry for the glitch. The most important piece of disclosure, which is the order it's been finished, alphabetically not by order of time for the run-up, we have the biggest field ever of analysts participating in the Empire State Building run up and we like to thank Justin Devery, Blaine Heck, Tim Hong, John Guinee, John Kim and Alex Nelson who took on this February's challenge. It was terrific. As an inducement, remember, John Kessler and David Karp buy free beer for everybody who runs up and by the way you can collect those beers before you run or after you run. And any investor who would like to participate, if you meet a certain minimum threshold of ownership of the stock, we can get you on board as well. So sorry for the disruption. We felt it was a great quarter. We're very excited with 2018. Thanks for your time.

[Operator]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.