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 nine-month periods ended September 30, 2023 with the corresponding three- and nine-month periods ended September 30, 2022 and reviews our financial position as of September 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 on Form 10-K. 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 (the "SEC"). While forward-looking statements reflect the Company's good faith beliefs, they do not guarantee 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 September 30, 2023 • Net income attributable to common unitholders of $18.8 million. • Core Funds From Operations ("Core FFO") of $65.9 million attributable to common unitholders. • Signed a total of 248,479 rentable square feet of new, renewal, and expansion leases. • Commercial portfolio 90.5% leased, Manhattan office portfolio 91.9% leased. • Empire State Building Observatory generated $28.1 million of net operating income. Results of Operations The discussion below relates to our results of operations for the three and nine months ended September 30, 2023 and 2022, respectively. Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022 The following table summarizes our historical results of operations for the three months ended September 30, 2023 and 2022, respectively (amounts in thousands): Three Months Ended September 30, 2023 2022 Change % Revenues: Real Estate Segment Observatory Segment Total Real Estate Segment Observatory Segment Total Rental revenue $ 151,458 $ — $ 151,458 $ 148,290 $ — $ 148,290 $ 3,168 2.1 % Observatory revenue — 37,562 37,562 — 33,051 33,051 4,511 13.6 Lease termination fees — — — — — — — — Third-party management and other fees 268 — 268 389 — 389 (121) (31.1) Other revenues and fees 2,238 — 2,238 1,982 — 1,982 256 12.9 Total revenues 153,964 37,562 191,526 150,661 33,051 183,712 7,814 4.3 Operating expenses: Property operating expenses 42,817 — 42,817 42,798 — 42,798 (19) — Ground rent expenses 2,331 — 2,331 2,331 — 2,331 — — General and administrative expenses 16,012 — 16,012 15,725 — 15,725 (287) (1.8) Observatory expenses — 9,471 9,471 — 8,516 8,516 (955) (11.2) Real estate taxes 32,014 — 32,014 31,831 — 31,831 (183) (0.6) Depreciation and amortization 46,593 31 46,624 46,933 51 46,984 360 0.8 Total operating expenses 139,767 9,502 149,269 139,618 8,567 148,185 (1,084) (0.7) Operating income 14,197 28,060 42,257 11,043 24,484 35,527 6,730 18.9 Intercompany rent revenue (expense) 22,113 (22,113) — 19,072 (19,072) — Other income (expense): Interest income 4,410 52 4,462 1,530 34 1,564 2,898 185.3 Interest expense (25,382) — (25,382) (25,516) — (25,516) 134 0.5 Income before income taxes 15,338 5,999 21,337 6,129 5,446 11,575 9,762 84.3 Income tax expense (146) (1,263) (1,409) (359) (1,098) (1,457) 48 3.3 Net income 15,192 4,736 19,928 5,770 4,348 10,118 9,810 97.0 Private perpetual preferred unit distributions (1,050) — (1,050) (1,050) — (1,050) — — Net (income) loss attributable to non-controlling interests in other partnerships (111) — (111) 49 — 49 160 326.5 Net income attributable to common unitholders $ 14,031 $ 4,736 $ 18,767 $ 4,769 $ 4,348 $ 9,117 $ 9,650 105.8 % 29 Real Estate Segment Rental Revenue The increase in rental revenue was primarily attributable to a $5.5 million increase in base rent from new or renewed tenants and higher rents and higher tenant escalations and a net $2.3 million decrease in revenue from our recent transaction activity as disclosed in "Financial Statements - Note 3. Acquisitions and Dispositions." Interest Income The increase in interest income in the three months ended September 30, 2023 reflects higher interest rates compared to the three months ended September 30, 2022. Observatory Segment Observatory Revenue Observatory revenues were higher driven by increased visitation and revenue per visitor during the three months ended September 30, 2023 as compared to the three months ended September 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 September 30, 2022. Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022 The following table summarizes our historical results of operations for the nine months ended September 30, 2023 and 2022 (amounts in thousands): 30 Nine Months Ended September 30, 2023 2022 Change % Revenues: Real Estate Segment Observatory Segment Total Real Estate Segment Observatory Segment Total Rental revenue $ 446,152 $ — $ 446,152 $ 445,143 $ — $ 445,143 $ 1,009 0.2 % Observatory revenue — 93,149 93,149 — 73,660 73,660 19,489 26.5 Lease termination fees — — — 20,032 — 20,032 (20,032) (100.0) Third-party management and other fees 1,076 — 1,076 1,025 — 1,025 51 5.0 Other revenues and fees 6,313 — 6,313 5,908 — 5,908 405 6.9 Total revenues 453,541 93,149 546,690 472,108 73,660 545,768 922 0.2 Operating expenses: Property operating expenses 124,380 — 124,380 118,875 — 118,875 (5,505) (4.6) Ground rent expenses 6,994 — 6,994 6,994 — 6,994 — — General and administrative expenses 47,795 — 47,795 45,287 — 45,287 (2,508) (5.5) Observatory expenses — 25,983 25,983 — 22,507 22,507 (3,476) (15.4) Real estate taxes 95,292 — 95,292 91,637 — 91,637 (3,655) (4.0) Depreciation and amortization 140,194 118 140,312 172,258 136 172,394 32,082 18.6 Total operating expenses 414,655 26,101 440,756 435,051 22,643 457,694 16,938 3.7 Operating income 38,886 67,048 105,934 37,057 51,017 88,074 17,860 20.3 Intercompany rent revenue (expense) 58,969 (58,969) — 46,801 (46,801) — Other income (expense): Interest income 10,257 139 10,396 2,105 39 2,144 8,252 384.9 Interest expense (76,091) — (76,091) (75,572) — (75,572) (519) (0.7) Gain on disposition of property 29,261 — 29,261 27,170 — 27,170 2,091 7.7 Income before income taxes 61,282 8,218 69,500 37,561 4,255 41,816 27,684 66.2 Income tax (expense) benefit (541) (382) (923) (541) 317 (224) (699) (312.1) Net income 60,741 7,836 68,577 37,020 4,572 41,592 26,985 64.9 Private perpetual preferred unit distributions (3,151) — (3,151) (3,151) — (3,151) — — Net (income) loss attributable to non-controlling interests in other partnerships (69) — (69) 271 — 271 340 125.5 Net income attributable to common unitholders $ 57,521 $ 7,836 $ 65,357 $ 34,140 $ 4,572 $ 38,712 $ 26,645 68.8 % Real Estate Segment Rental Revenue The increase in rental revenue was primarily attributable to a $7.1 million increase in base rent from new or renewed tenants and higher rents and higher tenant escalations, and a net $6.1 million decrease in revenue from our recent transaction activity as disclosed in "Financial Statements - Note 3. Acquisitions and Dispositions." Property Operating Expenses The increase in property operating expenses is primarily due to higher repair and maintenance costs, higher cleaning costs, and higher payroll costs in 2023 relating to increased building utilization. General and Administrative Expenses The increase in general and administrative expenses primarily reflects higher payroll due to year-over-year wage growth. Real Estate Taxes The increase in real estate taxes was primarily attributable to a $4.1 million increase in real estate tax expense due to higher assessed values for multiple properties, partially offset by a net $0.4 million decrease from our recent transaction activity as disclosed in "Financial Statements - Note 3. Acquisitions and Dispositions." 31 Depreciation and Amortization The decrease in depreciation and amortization reflects accelerated depreciation during the nine months ended September 30, 2022 relating to the transfer of 383 Main Avenue back to the lender in a consensual foreclosure and depreciation expense in the nine months ended September 30, 2022 on properties that were sold prior to September 30, 2023. Interest Income The increase reflects higher interest rates in the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. Gain on Disposition of Property The gain for the nine months ended September 30, 2023 reflects the gain on disposition of 500 Mamaroneck in Harrison, New York in April 2023 and 69-97 and 103-107 Main Street in Westport, Connecticut in February 2023 while the gain for the nine months ended September 30, 2022 represents a gain on the disposition of 383 Main Avenue in Norwalk, Connecticut in April 2022. Observatory Segment Observatory Revenue Observatory revenues were higher driven by increased visitation and revenue per visitor during the nine months ended September 30, 2023 as compared to the nine months ended September 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 increase in income tax expense was attributable to a $3.9 million increase in income before taxes for the observatory segment for the nine months ended September 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. 32 At September 30, 2023, we had $354.0 million available in cash and cash equivalents, and $850 million available under our unsecured revolving credit facility. As of September 30, 2023, we had approximately $2.2 billion of total consolidated indebtedness outstanding, with a weighted average interest rate of 3.9% and a weighted average maturity of 5.7 years. As of September 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, New York at a gross asset valuation of $53.0 million. On September 14, 2023, we closed on the acquisition of a Williamsburg retail property located on the corner of North 6 th Street and Wythe Avenue in Brooklyn, New York, for a purchase price of $26.4 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 September 30, 2023, our consolidated mortgage notes payable amounted to $893.9 million. We have no debt maturity until 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 September 30, 2023, we were in compliance with the covenants under the outstanding senior unsecured notes. Financial Covenants As of September 30, 2023, we were in compliance with the following financial covenants: Financial covenant Required September 30, 2023 In Compliance Maximum total leverage < 60% 33.2 % Yes Maximum secured leverage < 40% 13.0 % Yes Minimum fixed charge coverage > 1.50x 3.0x Yes Minimum unencumbered interest coverage > 1.75x 5.3x Yes Maximum unsecured leverage < 60% 24.8 % 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. 33 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 Nine Months Ended September 30, Total New Leases, Expansions, and Renewals 2023 2022 Number of leases signed (1) 66 103 Total square feet 772,587 928,598 Leasing commission costs per square foot (2) $ 18.41 $ 19.14 Tenant improvement costs per square foot (2) 78.15 59.20 Total leasing commissions and tenant improvement costs per square foot (2) $ 96.56 $ 78.34 Retail Properties Nine Months Ended September 30, Total New Leases, Expansions, and Renewals 2023 2022 Number of leases signed (1) 5 12 Total square feet 14,263 45,655 Leasing commission costs per square foot (2) $ 47.80 $ 59.85 Tenant improvement costs per square foot (2) 48.17 53.97 Total leasing commissions and tenant improvement costs per square foot (2) $ 95.97 $ 113.82 _______________ . (1) Presents a renewed and expansion lease as one lease signed. (2) 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. Nine Months Ended September 30, 2023 2022 Total Portfolio Capital expenditures (1) $ 38,736 $ 28,823 _______________ (1) Excludes tenant improvements and leasing commission costs. As of September 30, 2023, we expect to incur additional costs relating to obligations under existing lease agreements of approximately $139.3 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 September 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 34 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. Distribution to Equity Holders Distributions and dividends amounting to $30.8 million and $32.2 million have been made to equity holders for the nine months ended September 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, general market conditions, and applicable securities laws. 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. There were no purchases of equity securities in the three months ended September 30, 2023. See "Financial Statements - Note 10. Capital." Cash Flows Comparison of Nine Months Ended September 30, 2023 to the Nine Months Ended September 30, 2022 Net cash . Cash and cash equivalents and restricted cash were $421.0 million and $439.8 million, respectively, as of September 30, 2023 and 2022. The decrease was primarily due to the acquisition of real estate property in December 2022 and September 2023 and increased 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 $22.0 million to $196.0 million due to increased observatory operating income and changes in working capital. Investing activities . Net cash used in investing activities decreased by $49.7 million to $39.4 million primarily due to net proceeds from the disposition of 69-97 and 103-107 Main Street in Westport, Connecticut in February 2023, and 500 Mamaroneck in Harrison, New York in April 2023. Financing activities . Net cash used in financing activities decreased by $69.3 million to $50.4 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. 35 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. 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 September 30, Nine Months Ended September 30, 2023 2022 2023 2022 (unaudited) (unaudited) Net income $ 19,928 $ 10,118 $ 68,577 $ 41,592 Add: General and administrative expenses 16,012 15,725 47,795 45,287 Depreciation and amortization 46,624 46,984 140,312 172,394 Interest expense 25,382 25,516 76,091 75,572 Income tax expense (benefit) 1,409 1,457 923 224 Less: Gain on disposition of property — — (29,261) (27,170) Third-party management and other fees (268) (389) (1,076) (1,025) Interest income (4,462) (1,564) (10,396) (2,144) Net operating income $ 104,625 $ 97,847 $ 292,965 $ 304,730 Other Net Operating Income Data Straight-line rental revenue $ 5,015 $ 7,341 $ 17,430 $ 18,533 Net increase in rental revenue from the amortization of above-and below-market lease assets and liabilities $ 554 $ 677 $ 1,932 $ 4,136 Amortization of acquired below-market ground leases $ 1,957 $ 1,957 $ 5,873 $ 5,873 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 36 (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. 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 September 30, Nine Months Ended September 30, 2023 2022 2023 2022 (unaudited) (unaudited) Net income $ 19,928 $ 10,118 $ 68,577 $ 41,592 Noncontrolling interests in other partnerships (111) 49 (69) 271 Private perpetual preferred unit distributions (1,050) (1,050) (3,151) (3,151) Real estate depreciation and amortization 45,174 45,461 136,085 167,446 Gain on disposition of property — — (29,261) (27,170) FFO attributable to common unitholders 63,941 54,578 172,181 178,988 Amortization of below-market ground leases 1,957 1,957 5,873 5,873 Modified FFO attributable to common unitholders 65,898 56,535 178,054 184,861 Core FFO attributable to common unitholders $ 65,898 $ 56,535 $ 178,054 $ 184,861 Weighted average Operating Partnership units Basic 262,756 266,035 263,379 269,880 Diluted 266,073 267,121 265,269 270,966 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 37 activity over multiple quarters or years. Tenant improvement costs include expenditures for general improvements occurring concurrently 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 September 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 9.5% of the net rentable square footage of the properties in our portfolio. In addition, leases representing 2.9% and 5.3% 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 2.9% and 5.3%, 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 September 30, 2023, the observatory hosted 743,000 visitors, compared to 687,000 visitors for the three months ended September 30, 2022. Our return of attendance to pre-pandemic levels is closely tied to domestic 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 September 30, 2023 was $37.6 million, compared to $33.1 million for the three months ended September 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 Year to date in 2023, ESRT has seen sustained demand for our properties, marked by solid leasing activity and observatory performance. We believe the global economy, including the real estate sector, currently navigates an environment of uncertainty around inflation, rising interest rates, reduced commercial real estate new loans, 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 real estate market, 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 ESRT is in a good competitive position with diversified drivers of income across office, retail, multifamily and the Empire State Building Observatory. ESRT’s New York City-focused portfolio is modernized, amenitized, well-located and energy efficient, with indoor environmental quality, competitive rental rates and strong leased percentages. We believe 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 a well-positioned balance sheet, modest leverage and access to liquidity as set forth herein. The absence of near term debt maturities or floating rate debt exposure provides 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 remain prepared for various challenges and situations. 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. 38