Empire State Realty OP, L.P. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unless the context otherwise requires or indicates, references in this section to “we,” “our,” and “us” refer to the Operating Partnership and our consolidated subsidiaries, or the Operating Partnership and ESRT, as the context requires. This Management’s Discussion and Analysis provides a comparison of our performance for the three and six month periods ended June 30, 2023 with the corresponding three and six month periods ended June 30, 2022 and reviews our financial position as of June 30, 2023. The following discussion related to our consolidated financial statements should be read in conjunction with the financial statements and the notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report. FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “ Securities Act "), and Section 21E of the Securities Exchange Act of 1934, as amended (the “ Exchange Act ”). We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and are including this statement for purposes of complying with those safe harbor provisions. You can identify forward-looking statements by the use of forward-looking terminology such as “aims," "anticipates," "approximately," "believes," "contemplates," "continues," "estimates," "expects," "forecasts," "hope," "intends," "may," "plans," "seeks," "should," "thinks," "will," "would" or the negative of these words and phrases or similar words or phrases with the intention of identifying statements about the future. In particul ar, statements pertaining to ESRT's capital resources, portfolio performance, dividend policy and results of operations contain forward-looking statements. Likewise, all of our statements regarding anticipated growth in our portfolio from operations, acquisitions and anticipated market conditions, demographics and results of operations are forward-looking statements. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control, and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise, and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements: (i) economic, market, political and social impact of, and uncertainty relating to, any catastrophic events, including pandemics, epidemics or other outbreaks of disease, natural disasters and extreme weather events, terrorism and other armed hostilities, as well as cybersecurity threats and technology disruptions; (ii) a failure of conditions or performance regarding any event or transaction described herein, (iii) resolution of legal proceedings involving us and/or ESRT; (iv) reduced demand for office, multifamily or retail space, including as a result of the changes in the use of office space and remote work; (v) changes in our business strategy; (vi) changes in technology and market competition that affect utilization of our office, retail, observatory, broadcast or other facilities; (vii) changes in domestic or international tourism, including due to health crises and pandemics, geopolitical events, including global hostilities, currency exchange rates, and/or competition from other observatories in New York City, any or all of which may cause a decline in Observatory visitors; (viii) defaults on, early terminations of, or non-renewal of, leases by tenants; (ix) increases in the Company's borrowing costs as a result of changes in interest rates and other factors; (x) declining real estate valuations and impairment charges; (xi) termination of our ground leases; (xii) changes in our ability to pay down, refinance, restructure or extend our indebtedness as it becomes due and potential limitations on our ability to borrow additional funds in compliance with drawdown conditions and financial covenants; (xiii) decreased rental rates or increased vacancy rates; (xiv) our failure to execute any newly planned capital project successfully or on the anticipated timeline or budget; (xv) difficulties in identifying and completing acquisitions; (xvi) risks related to any development project (including our Metro Tower potential development site); (xvii) impact of changes in governmental regulations, tax laws and rates and similar matters; (xviii) our failure to qualify as a REIT; (xix) environmental uncertainties and risks related to climate change, adverse weather conditions, rising sea levels and natural disasters; (xx) incurrence of taxable capital gain on disposition of an asset due to failure of use or compliance with a 1031 exchange program; and (xxi) accuracy of our methodologies and estimates regarding ESG metrics and goals, tenant willingness and ability to collaborate in reporting ESG metrics and meeting ESG goals, and impact of governmental regulation on our ESG efforts. For a further discussion of these and other factors that could impact the Operating Partnership’s future results, performance or transactions, see the section entitled “Risk Factors” in our Annual Report and other risks described in documents subsequently filed by us from time to time with the Securities and Exchange Commission. While forward-looking statements reflect the Company's good faith beliefs, they do not guarantee of future performance. Any forward-looking statement speaks only as of the date on which it was made, and we assume no obligation to update or revise publicly any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events, or other changes after the date of this Quarterly Report on Form 10-Q, except as required by applicable law. Prospective investors should not place undue reliance on any forward-looking statements, which are based only on information currently available to the Company (or to third parties making the forward-looking statements). 28 Overview Highlights for the three months ended June 30, 2023 • Net income attributable to common unitholders of $35.9 million. • Core Funds From Operations attributable to common unitholders ("Core FFO") of $69.2 million. • Commercial portfolio 90.3% leased, Manhattan office portfolio 91.6% leased. • Signed a total of 336,314 rentable square feet of new, renewal, and expansion leases. • Empire State Building Observatory generated $24.8 million of net operating income. • ESRT repurchased $7.4 million of its common stock in the second quarter of 2023 and through July 25, 2023. Results of Operations The discussion below relates to our results of operations for the three and six months ended June 30, 2023 and 2022, respectively. Three Months Ended June 30, 2023 Compared to the Three Months Ended June 30, 2022 The following table summarizes our historical results of operations for the three months ended June 30, 2023 and 2022, respectively (amounts in thousands): 29 Three Months Ended June 30, 2023 2022 Change % Revenues: Real Estate Segment Observatory Segment Total Real Estate Segment Observatory Segment Total Rental revenue $ 154,603 $ — $ 154,603 $ 149,339 $ — $ 149,339 $ 5,264 3.5 % Observatory revenue — 33,433 33,433 — 27,368 27,368 6,065 22.2 Lease termination fees — — — 18,859 — 18,859 (18,859) (100.0) Third-party management and other fees 381 — 381 326 — 326 55 16.9 Other revenues and fees 2,125 — 2,125 2,130 — 2,130 (5) (0.2) Total revenues 157,109 33,433 190,542 170,654 27,368 198,022 (7,480) (3.8) Operating expenses: Property operating expenses 39,519 — 39,519 37,433 — 37,433 (2,086) (5.6) Ground rent expenses 2,332 — 2,332 2,332 — 2,332 — — General and administrative expenses 16,075 — 16,075 15,876 — 15,876 (199) (1.3) Observatory expenses — 8,657 8,657 — 7,776 7,776 (881) (11.3) Real estate taxes 31,490 — 31,490 29,802 — 29,802 (1,688) (5.7) Depreciation and amortization 46,237 43 46,280 58,254 50 58,304 12,024 20.6 Total operating expenses 135,653 8,700 144,353 143,697 7,826 151,523 7,170 4.7 Operating income 21,456 24,733 46,189 26,957 19,542 46,499 (310) (0.7) Intercompany rent revenue (expense) 20,942 (20,942) — 17,109 (17,109) — Other income (expense): Interest income 3,289 50 3,339 426 5 431 2,908 674.7 Interest expense (25,405) — (25,405) (25,042) — (25,042) (363) (1.4) Gain on disposition of property 13,565 — 13,565 27,170 — 27,170 (13,605) — Income before income taxes 33,847 3,841 37,688 46,620 2,438 49,058 (11,370) 23.2 Income tax expense (197) (536) (733) (38) (325) (363) (370) (101.9) Net income 33,650 3,305 36,955 46,582 2,113 48,695 (11,740) 24.1 Private perpetual preferred unit distributions (1,051) — (1,051) (1,051) — (1,051) — — Net loss (income) attributable to non-controlling interests in other partnerships (1) — (1) 159 — 159 (160) (100.6) Net income attributable to common unitholders $ 32,598 $ 3,305 $ 35,903 $ 45,690 $ 2,113 $ 47,803 $ (11,900) 24.9 % Real Estate Segment Rental Revenue The increase in rental revenue was primarily attributable to the reversal in the three months ended June 30, 2023 of a one-time straight-line rent receivable reserve recorded in the three months ended March 31, 2023 tied to Signature Bank entering receivership. See "Financial Statements - Note 8. Leases" for more information. Property Operating Expenses The increase in property operating expenses reflects higher repairs and maintenance, cleaning, and payroll costs. Real Estate Taxes Higher real estate taxes were primarily attributable to higher assessed values for multiple properties and the inclusion of real estate taxes from our most recently acquired multifamily property net of real estate taxes from disposed properties. Depreciation and Amortization 30 The decrease in depreciation and amortization reflects accelerated depreciation at one property recorded in the three months ended June 30, 2022 and depreciation expense in the three months ended June 30, 2022 on properties that were sold prior to June 30, 2023. Interest Income The increase in interest income in the three months ended June 30, 2023 reflects higher interest rates compared to the three months ended June 30, 2022. Gain on Disposition of Property Reflects the gain on disposition of 500 Mamaroneck in Westchester County, New York in April 2023. Observatory Segment Observatory Revenue Observatory revenues were higher driven by increased visitation as compared to the three months ended June 30, 2022. Observatory Expenses The increase in observatory expenses was driven by increased operating hours, which increased variable costs such as marketing, labor and maintenance costs compared to the three months ended June 30, 2022. Income Taxes The increase in income tax expense was attributable to higher taxable income for the observatory segment for the three months ended June 30, 2023. Six Months Ended June 30, 2023 Compared to the Six Months Ended June 30, 2022 The following table summarizes our historical results of operations for the six months ended June 30, 2023 and 2022 (amounts in thousands): 31 Six Months Ended June 30, 2023 2022 Change % Revenues: Real Estate Segment Observatory Segment Total Real Estate Segment Observatory Segment Total Rental revenue $ 294,694 $ — $ 294,694 $ 296,853 $ — $ 296,853 $ (2,159) (0.7) % Observatory revenue — 55,587 55,587 — 40,609 40,609 14,978 36.9 Lease termination fees — — — 20,032 — 20,032 (20,032) (100.0) Third-party management and other fees 808 — 808 636 — 636 172 27.0 Other revenues and fees 4,075 — 4,075 3,926 — 3,926 149 3.8 Total revenues 299,577 55,587 355,164 321,447 40,609 362,056 (6,892) (1.9) Operating expenses: Property operating expenses 81,563 — 81,563 76,077 — 76,077 (5,486) (7.2) Ground rent expenses 4,663 — 4,663 4,663 — 4,663 — — General and administrative expenses 31,783 — 31,783 29,562 — 29,562 (2,221) (7.5) Observatory expenses — 16,512 16,512 — 13,991 13,991 (2,521) (18.0) Real estate taxes 63,278 — 63,278 59,806 — 59,806 (3,472) (5.8) Depreciation and amortization 93,601 87 93,688 125,325 85 125,410 31,722 25.3 Total operating expenses 274,888 16,599 291,487 295,433 14,076 309,509 18,022 5.8 Operating income 24,689 38,988 63,677 26,014 26,533 52,547 11,130 21.2 Intercompany rent revenue (expense) 36,856 (36,856) — 27,729 (27,729) — Other income (expense): Interest income 5,847 87 5,934 575 5 580 5,354 923.1 Interest expense (50,709) — (50,709) (50,056) — (50,056) (653) (1.3) Gain on disposition of property 29,261 — 29,261 27,170 — 27,170 2,091 — Income (loss) before income taxes 45,944 2,219 48,163 31,432 (1,191) 30,241 17,922 (59.3) Income tax (expense) benefit (395) 881 486 (182) 1,415 1,233 (747) 60.6 Net income 45,549 3,100 48,649 31,250 224 31,474 17,175 (54.6) Private perpetual preferred unit distributions (2,101) — (2,101) (2,101) — (2,101) — — Net loss attributable to non-controlling interests in other partnerships 42 — 42 222 — 222 (180) (81.1) Net income attributable to common unitholders $ 43,490 $ 3,100 $ 46,590 $ 29,371 $ 224 $ 29,595 $ 16,995 (57.4) % Real Estate Segment Rental Revenue The decrease in rental revenue was primarily attributable to our dispositions of 383 Main Avenue, 10 Bank Street, 69-97 and 103-107 Main Street, and 500 Mamaroneck in April 2022, December 2022, February 2023, and April 2023, respectively. Property Operating Expenses The increase in property operating expenses reflects higher repairs and maintenance, cleaning, and payroll costs. General and Administrative Expenses The increase in general and administrative expenses primarily reflects higher payroll and equity compensation costs. Real Estate Taxes Higher real estate taxes primarily attributable to higher assessed values for multiple properties and the inclusion of real estate taxes from our most recently acquired multifamily property net of real estate taxes from disposed properties. Depreciation and Amortization 32 The decrease in depreciation and amortization reflects accelerated depreciation at one property recorded in the six months ended June 30, 2022 and depreciation expense in the six months ended June 30, 2022 on properties that were sold prior to June 30, 2023. Interest Income The increase reflects higher interest rates in the six months ended June 30, 2023 compared to the six months ended June 30, 2022. Gain on Disposition of Property Reflects the gain on disposition of 500 Mamaroneck in Westchester County, New York in April 2023 and 69-97 and 103-107 Main Street in Westport, Connecticut in February 2023. Observatory Segment Observatory Revenue Observatory revenues were higher driven by increased visitation as compared to the six months ended June 30, 2022. Observatory Expenses The increase in observatory expenses was driven by increased operating hours, which increased variable costs such as marketing, labor and maintenance costs. Income Taxes The decrease in income tax benefit was attributable to lower taxable loss for the observatory segment for the six months ended June 30, 2023. Liquidity and Capital Resources Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, including lease-up costs, fund our redevelopment and repositioning programs, acquire properties, make distributions to our securityholders and fulfill other general business needs. Based on the historical experience of our management and our business strategy, in the foreseeable future we anticipate we will generate positive cash flows from operations. In order for ESRT to qualify as a REIT, ESRT is required under the Internal Revenue Code of 1986 to distribute to its stockholders, on an annual basis, at least 90% of its REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gains. We expect to make quarterly distributions, as required, to our securityholders. While we may be able to anticipate and plan for certain liquidity needs, there may be unexpected increases in uses of cash that are beyond our control and which would affect our financial condition and results of operations. For example, we may be required to comply with new laws or regulations that cause us to incur unanticipated capital expenditures for our properties, thereby increasing our liquidity needs. Even if there are no material changes to our anticipated liquidity requirements, our sources of liquidity may be fewer than, and the funds available from such sources may be less than, anticipated or needed. Our primary sources of liquidity will generally consist of cash on hand and cash generated from our operating activities, debt issuances and unused borrowing capacity under our unsecured revolving credit facility. We expect to meet our short-term liquidity requirements, including distributions, operating expenses, working capital, debt service, and capital expenditures from cash flows from operations, cash on hand, debt issuances, and available borrowing capacity under our unsecured revolving credit facility. The availability of these borrowings is subject to the conditions set forth in the applicable loan agreements. We expect to meet our long-term capital requirements, including acquisitions, redevelopments and capital expenditures through our cash flows from operations, cash on hand, our unsecured revolving credit facility, mortgage financings, debt issuances, common and/or preferred equity issuances and asset sales. Our properties require periodic investments of capital for individual lease related tenant improvement allowances, general capital improvements and costs associated with capital expenditures. Our overall leverage will depend on our mix of investments and the cost of leverage. ESRT's charter does not restrict the amount of leverage that we may use. At June 30, 2023, we had $315.4 million available in cash and cash equivalents, and $850 million available under our unsecured revolving credit facility. 33 As of June 30, 2023, we had approximately $2.3 billion of total consolidated indebtedness outstanding, with a weighted average interest rate of 3.9% and a weighted average maturity of 5.9 years. As of June 30, 2023, excluding principal amortization, we have no outstanding debt maturing until November 2024. Portfolio Transaction Activity On February 1, 2023, we closed on the sale of 69-97 and 103-107 Main Street in Westport, Connecticut at a gross asset valuation of $40.0 million. On April 5, 2023, we closed on the sale of 500 Mamaroneck Avenue in Harrison, NY at a gross asset valuation of $53.0 million. Unsecured Revolving Credit and Term Loan Facilities See "Financial Statements - Note 5. Debt" for a summary of our unsecured revolving credit and term loan facilities. Mortgage Debt As of June 30, 2023, our consolidated mortgage notes payable amounted to $896.4 million. The first maturity is in November 2024. See "Financial Statements - Note 5. Debt" for more information on mortgage debt. Senior Unsecured Notes The terms of the senior unsecured notes include customary covenants, including limitations on liens, investment, distributions, debt, fundamental changes, and transactions with affiliates and require certain customary financial reports. The terms also require compliance with financial ratios including a maximum leverage ratio, a maximum secured leverage ratio, a minimum fixed charge coverage ratio, a minimum unencumbered interest coverage ratio, and a maximum unsecured leverage ratio. The agreements also contain customary events of default (subject in certain cases to specified cure periods), including but not limited to non-payment, breach of covenants, representations or warranties, cross defaults, bankruptcy or other insolvency events, judgments, ERISA events, the occurrence of certain change of control transactions and loss of real estate investment trust qualification. As of June 30, 2023, we were in compliance with the covenants under the outstanding senior unsecured notes. Financial Covenants As of June 30, 2023, we were in compliance with the following financial covenants: Financial covenant Required June 30, 2023 In Compliance Maximum total leverage < 60% 33.8 % Yes Maximum secured leverage < 40% 13.2 % Yes Minimum fixed charge coverage > 1.50x 3.1x Yes Minimum unencumbered interest coverage > 1.75x 5.3x Yes Maximum unsecured leverage < 60% 25.1 % Yes Leverage Policies We expect to employ leverage in our capital structure in amounts determined from time to time by ESRT's Board of Directors. Although ESRT's Board of Directors has not adopted a policy that limits the total amount of indebtedness that we may incur, we anticipate that ESRT's Board of Directors will consider a number of factors in evaluating our level of indebtedness from time to time, as well as the amount of such indebtedness that will be either fixed or floating rate. ESRT's charter and bylaws do not limit the amount or percentage of indebtedness that we may incur nor do they restrict the form in which our indebtedness will be taken (including, but not limited to, recourse or non-recourse debt and cross-collateralized debt). Our overall leverage will depend on our mix of investments and the cost of leverage. ESRT's Board of Directors may from time to time modify our leverage policies in light of the then-current economic conditions, relative costs of debt and equity capital, market values of our properties, general market conditions for debt and equity securities, fluctuations in the market price of ESRT's common stock and our traded OP units, growth and acquisition opportunities and other factors. Capital Expenditures The following tables summarize our leasing commission costs, tenant improvement costs and our capital expenditures for each of the periods presented (dollars in thousands, except per square foot amounts). Office Properties (1) 34 Six Months Ended June 30, Total New Leases, Expansions, and Renewals 2023 2022 Number of leases signed (2) 46 76 Total square feet 527,295 634,582 Leasing commission costs per square foot (3) $ 18.52 $ 22.14 Tenant improvement costs per square foot (3) 72.34 62.15 Total leasing commissions and tenant improvement costs per square foot (3) $ 90.86 $ 84.29 Retail Properties (4) Six Months Ended June 30, Total New Leases, Expansions, and Renewals 2023 2022 Number of leases signed (2) 4 5 Total square feet 11,076 4,289 Leasing commission costs per square foot (3) $ 25.95 $ 16.64 Tenant improvement costs per square foot (3) 26.07 — Total leasing commissions and tenant improvement costs per square foot (3) $ 52.02 $ 16.64 _______________ (1) Excludes an aggregate of 497,786 and 496,311 rentable square feet of retail space in our Manhattan office properties in 2023 and 2022, respectively. Includes the Empire State Building broadcasting licenses and observatory operations. (2) Presents a renewed and expansion lease as one lease signed. (3) Presents all tenant improvement and leasing commission costs as if they were incurred in the period in which the lease was signed, which may be different than the period in which they were actually paid. (4) Includes an aggregate of 497,786 and 496,311 rentable square feet of retail space in our Manhattan office properties in 2023 and 2022, respectively. Excludes the Empire State Building broadcasting licenses and observatory operations. Six Months Ended June 30, 2023 2022 Total Portfolio Capital expenditures (1) $ 25,987 $ 19,697 _______________ (1) Excludes tenant improvements and leasing commission costs. As of June 30, 2023, we expect to incur additional costs relating to obligations under existing lease agreements of approximately $138.4 million for tenant improvements and leasing commissions. We intend to fund the tenant improvements and leasing commission costs through a combination of operating cash flow, cash on hand, additional property level mortgage financings and borrowings under the unsecured revolving credit facility. Capital expenditures are considered part of both our short-term and long-term liquidity requirements. We intend to fund capital improvements through a combination of operating cash flow, cash on hand and borrowings under the unsecured revolving credit facility. Off-Balance Sheet Arrangements As of June 30, 2023, we did not have any off-balance sheet arrangements. Distribution Policy We intend to distribute our net taxable income to our security holders in a manner intended to satisfy REIT distribution requirements and to avoid U.S. federal income tax liability. Before we pay any distribution, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and obligations to make payments of principal and interest, if any. However, under some circumstances, we may be required to use cash reserves, incur debt or liquidate assets at rates or times that we regard as unfavorable or make a taxable distribution of our shares in order to satisfy REIT distribution requirements. 35 Distribution to Equity Holders Distributions and dividends amounting to $20.3 million and $21.6 million have been made to equity holders for the six months ended June 30, 2023 and 2022, respectively. Stock and Publicly Traded Operating Partnership Unit Repurchase Program ESRT's Board of Directors authorized the repurchase of up to $500 million of ESRT Class A common stock and the Operating Partnership’s Series ES, Series 250 and Series 60 operating partnership units from January 1, 2022 through December 31, 2023. Under the program, ESRT may purchase ESRT Class A common stock and we may purchase our Series ES, Series 250 and Series 60 operating partnership units in accordance with applicable securities laws from time to time in the open market or in privately negotiated transactions. The timing, manner, price and amount of any repurchases will be determined by ESRT and us at our discretion and will be subject to stock price, availability, trading volume and general market conditions. The authorization does not obligate ESRT or us to acquire any particular amount of securities, and the program may be suspended or discontinued at ESRT and our discretion without prior notice. See "Financial Statements - Note 10. Capital" for a summary of ESRT's purchases of equity securities in each of the three months ended June 30, 2023. Cash Flows Comparison of Six Months Ended June 30, 2023 to the Six Months Ended June 30, 2022 Net cash . Cash and cash equivalents and restricted cash were $395.8 million and $412.8 million, respectively, as of June 30, 2023 and 2022. The decrease was primarily due to the acquisition of real estate property in December 2022 and higher spending for capital expenditures, partially offset by net proceeds from the disposition of properties in December 2022 and February and April 2023 and lower repurchases of common shares. Operating activities . Net cash provided by operating activities increased by $22.2 million to $105.9 million due to increased observatory operating income and changes in working capital. Investing activities . Net cash provided by investing activities increased by $69.3 million to $12.7 million primarily due to net proceeds from the disposition of 69-97 and 103-107 Main Street in Westport, Connecticut, and 500 Mamaroneck in Harrison, New York. Financing activities . Net cash used in financing activities decreased by $51.4 million to $37.5 million primarily due to lower repurchases of common shares. Net Operating Income ("NOI") Our financial reports include a discussion of property net operating income, or NOI. NOI is a non-GAAP financial measure of performance. NOI is used by our management to evaluate and compare the performance of our properties and to determine trends in earnings and to compute the fair value of our properties as it is not affected by: (i) the cost of funds of the property owner, (ii) the impact of depreciation and amortization expenses as well as gains or losses from the sale of operating real estate assets that are included in net income computed in accordance with GAAP, (iii) acquisition expenses, loss on early extinguishment of debt and loss from derivative financial instruments, or (iv) general and administrative expenses and other gains and losses that are specific to the property owner. The cost of funds is eliminated from NOI because it is specific to the particular financing capabilities and constraints of the owner and because it is dependent on historical interest rates and other costs of capital as well as past decisions made by us regarding the appropriate mix of capital which may have changed or may change in the future. Depreciation and amortization expenses as well as gains or losses from the sale of operating real estate assets are eliminated because they may not accurately represent the actual change in value in our office or retail properties that result from use of the properties or changes in market conditions. While certain aspects of real property do decline in value over time in a manner that is reasonably captured by depreciation and amortization, the value of the properties as a whole have historically increased or decreased as a result of changes in overall economic conditions instead of from actual use of the property or the passage of time. Gains and losses from the sale of real property vary from property to property and are affected by market conditions at the time of sale which will usually change from period to period. These gains and losses can create distortions when comparing one period to another or when comparing our operating results to the operating results of other real estate companies that have not made similarly-timed purchases or sales. We believe that eliminating these costs from net income is useful to investors because the resulting measure captures the actual revenue, generated and actual expenses incurred in operating our properties as well as trends in occupancy rates, rental rates and operating costs. However, the usefulness of NOI is limited because it excludes general and administrative costs, interest expense, depreciation and amortization expense and gains or losses from the sale of properties, and other gains and losses as stipulated by GAAP, the level of capital expenditures and leasing costs necessary to maintain the operating performance of our properties, all of which are significant economic costs. NOI may fail to capture significant trends in these components of net income which further limits its usefulness. 36 NOI is a measure of the operating performance of our properties but does not measure our performance as a whole. NOI is therefore not a substitute for net income as computed in accordance with GAAP. This measure should be analyzed in conjunction with net income computed in accordance with GAAP and discussions elsewhere in this Management’s Discussion and Analysis of Financial Condition and Results of Operations regarding the components of net income that are eliminated in the calculation of NOI. Other companies may use different methods for calculating NOI or similarly titled measures and, accordingly, our NOI may not be comparable to similarly titled measures reported by other companies that do not define the measure exactly as we do. The following table presents a reconciliation of our net income, the most directly comparable GAAP measure, to NOI for the periods presented (amounts in thousands): Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 (unaudited) (unaudited) Net income $ 36,955 $ 48,695 48,649 31,474 Add: General and administrative expenses 16,075 15,876 31,783 29,562 Depreciation and amortization 46,280 58,304 93,688 125,410 Interest expense 25,405 25,042 50,709 50,056 Income tax expense (benefit) 733 363 (486) (1,233) Less: Gain on disposition of property (13,565) (27,170) (29,261) (27,710) Third-party management and other fees (381) (326) (808) (636) Interest income (3,339) (431) (5,934) (580) Net operating income $ 108,163 $ 120,353 $ 188,340 $ 206,343 Other Net Operating Income Data Straight-line rental revenue $ 11,859 $ 8,597 $ 12,415 $ 11,192 Net increase in rental revenue from the amortization of above-and below-market lease assets and liabilities $ 675 $ 1,675 $ 1,378 $ 3,459 Amortization of acquired below-market ground leases $ 1,958 $ 1,958 $ 3,916 $ 3,916 Funds from Operations ("FFO") We present below a discussion of FFO. We compute FFO in accordance with the “White Paper” on FFO published by the National Association of Real Estate Investment Trusts, or NAREIT, which defines FFO as net income (loss) (determined in accordance with GAAP), excluding impairment write-off of investments in depreciable real estate and investments in in-substance real estate investments, gains or losses from debt restructurings and sales of depreciable operating properties, plus real estate-related depreciation and amortization (excluding amortization of deferred financing costs), less distributions to non-controlling interests and gains/losses from discontinued operations and after adjustments for unconsolidated partnerships and joint ventures. FFO is a widely recognized non-GAAP financial measure for REITs that we believe, when considered with financial statements determined in accordance with GAAP, is useful to investors in understanding financial performance and providing a relevant basis for comparison among REITs. In addition, we believe FFO is useful to investors as it captures features particular to real estate performance by recognizing that real estate has generally appreciated over time or maintains residual value to a much greater extent than do other depreciable assets. Investors should review FFO, along with GAAP net income, when trying to understand an equity REIT’s operating performance. We present FFO because we consider it an important supplemental measure of our operating performance and believe that it is frequently used by securities analysts, investors and other interested parties in the evaluation of REITs. However, because FFO excludes depreciation and amortization and captures neither the changes in the value of our properties that result from use or market conditions nor the level of capital expenditures and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our results of operations, the utility of FFO as a measure of performance is limited. There can be no assurance that FFO presented by us is comparable to similarly titled measures of other REITs. FFO does not represent cash generated from operating activities and should not be considered as an alternative to net income (loss) determined in accordance with GAAP or to cash flow from operating activities determined in accordance with GAAP. FFO is not indicative of cash available to fund ongoing cash needs, including the ability to make cash distributions. Although FFO is a measure used for comparability in assessing the performance of REITs, as the NAREIT White Paper only provides guidelines for computing FFO, the computation of FFO may vary from one company to another. 37 Modified Funds From Operations ("Modified FFO") Modified FFO adds back an adjustment for any above or below-market ground lease amortization to traditionally defined FFO. We believe this a useful supplemental measure in evaluating our operating performance due to the non-cash accounting treatment under GAAP, which stems from the third quarter 2014 acquisition of two option properties following our formation transactions as they carry significantly below market ground leases, the amortization of which is material to our overall results. We present Modified FFO because we believe it is an important supplemental measure of our operating performance in that it adds back the non-cash amortization of below-market ground leases. There can be no assurance that Modified FFO presented by us is comparable to similarly titled measures of other REITs. Modified FFO does not represent cash generated from operating activities and should not be considered as an alternative to net income (loss) determined in accordance with GAAP or to cash flow from operating activities determined in accordance with GAAP. Modified FFO is not indicative of cash available to fund ongoing cash needs, including the ability to make cash distributions. Core Funds From Operations Core FFO adds back to Modified FFO the following items: IPO litigation expense, severance expenses and loss on early extinguishment of debt. The Company believes Core FFO is an important supplemental measure of its operating performance because it excludes items associated with its IPO and formation transactions and other non-recurring items. There can be no assurance that Core FFO presented by the Company is comparable to similarly titled measures of other REITs. Core FFO does not represent cash generated from operating activities and should not be considered as an alternative to net income (loss) determined in accordance with GAAP or to cash flow from operating activities determined in accordance with GAAP. Core FFO is not indicative of cash available to fund ongoing cash needs, including the ability to make cash distributions. In future periods, we may also exclude other items from Core FFO that we believe may help investors compare our results. The following table presents a reconciliation of our net income, the most directly comparable GAAP measure, to FFO, Modified FFO and Core FFO for the periods presented (amounts in thousands): Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 (unaudited) (unaudited) Net income $ 36,955 $ 48,695 $ 48,649 $ 31,474 Noncontrolling interests in other partnerships (1) 159 42 222 Private perpetual preferred unit distributions (1,051) (1,051) (2,101) (2,101) Real estate depreciation and amortization 44,887 56,571 90,911 121,985 Gain on disposition of property (13,565) (27,170) (29,261) (27,170) FFO attributable to common unitholders 67,225 77,204 108,240 124,410 Amortization of below-market ground leases 1,958 1,958 3,916 3,916 Modified FFO attributable to common unitholders 69,183 79,162 112,156 128,326 Loss on early extinguishment of debt — — — — Core FFO attributable to common unitholders $ 69,183 $ 79,162 $ 112,156 $ 128,326 Weighted average Operating Partnership units Basic 262,903 270,078 263,694 271,834 Diluted 264,196 270,085 264,736 271,837 Factors That May Influence Future Results of Operations Leasing Due to the relatively small number of leases that are signed in any particular quarter, one or more larger leases may have a disproportionately positive or negative impact on average rent, tenant improvement and leasing commission costs for that period. As a result, we believe it is more appropriate when analyzing trends in average rent and tenant improvement and leasing commission costs to review activity over multiple quarters or years. Tenant improvement costs include expenditures for general improvements occurring concurrently 38 with, but that are not directly related to, the cost of installing a new tenant. Leasing commission costs are similarly subject to significant fluctuations depending upon the length of leases being signed and the mix of tenants from quarter to quarter. As of June 30, 2023, there were approximately 0.9 million rentable square feet of space in our portfolio available to lease (excluding leases signed but not yet commenced) representing 9.7% of the net rentable square footage of the properties in our portfolio. In addition, leases representing 3.4% and 5.4% of net rentable square footage of the properties in our portfolio will expire in 2023 and in 2024, respectively. These leases are expected to represent approximately 3.4% and 5.6%, respectively, of our annualized rent for such periods. Our revenues and results of operations can be impacted by expiring leases that are not renewed or re-leased or that are renewed or re-leased at base rental rates equal to, above or below the current average base rental rates. Further, our revenues and results of operations can also be affected by downtime after space is vacated and the costs we incur to re-lease available space, including payment of leasing commissions, redevelopments and build-to-suit remodeling that may not be borne by the tenant. Observatory Operations For the three months ended June 30, 2023, the observatory hosted 666,000 visitors, compared to 573,000 visitors for the three months ended June 30, 2022. Our return of attendance to pre-pandemic levels is closely tied to national and international travel trends, our new reservations-only model of operation, and our desire to provide a better experience with fewer crowds to visitors from whom we receive higher revenues per person. Observatory revenue for the three months ended June 30, 2023 was $33.4 million, compared to $27.4 million for the three months ended June 30, 2022. The observatory revenue increase was driven by higher visitation levels in 2023. Observatory revenues and admissions are dependent upon the following: (i) the number of tourists (domestic and international) who come to New York City and visit the observatory, as well as any related tourism trends; (ii) the prices per admission that can be charged; (iii) seasonal trends affecting the number of visitors to the observatory; (iv) competition, in particular from other new and existing observatories; and (v) weather trends. Outlook The first half of 2023 saw sustained demand for our properties, marked by solid leasing activity and observatory performance. The global economy, including the real estate sector, currently navigates an environment of uncertainty around inflation, rising interest rates, weakness in real estate loans from institutional lenders, questions on the direction of capital markets, risk of recession and geopolitical unrest. In particular, there have been concerns about the softening of the commercial real estate market, and particularly the office, amidst refinancing challenges of existing low interest rate loans and associated reduced new loan availability and increased costs of loans and related increased expectations of equity returns, coupled with the gradual pace of return-to-office and its impact on the physical utilization of space and asset valuations. Additionally, the risk of a global economic recession could impact the number of visitors to the Empire State Building Observatory, as well as our pricing power. Despite this global economic backdrop, we believe that our modernized, amenitized, energy efficient New York City-focused portfolio with indoor environmental quality initiatives, characterized by its competitive rental rates, strong leased percentage, sustainability leadership and diversified drivers of income across office, retail, multifamily and the Empire State Building Observatory, is in a good competitive position. Our business is further fortified by the continued performance of our Observatory, which was ranked the #1 attraction in the U.S. by Tripadvisor’s 2023 Travelers’ Choice Best of the Best Awards for a second consecutive year. In addition to our diversified portfolio, our business is supported by leading balance sheet strength, modest leverage and access to liquidity as set forth herein. The absence of near term debt maturities or floating rate debt exposure gives us an added degree of security in a rising rate environment. We have been able to execute on capital recycling, acquisitions, and buybacks. As we navigate these uncertain times, we continue to be prepared for various challenges and economic scenarios. Critical Accounting Estimates Refer to our Annual Report for a discussion of our critical accounting estimates. There were no material changes to our critical accounting estimates disclosed in our Annual Report. 39