Edgar Filing: Empire State Realty Trust, Inc.

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2018



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-36105

EMPIRE STATE REALTY TRUST, INC.

(Exact name of Registrant as specified in its charter)



Maryland		37-1645259
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

111 West 33rd Street, 12th Floor

New York, New York 10120

(Address of principal executive offices) (Zip Code)

(212) 687-8700

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer x		Accelerated filer o
Non-accelerated filer o		Smaller reporting company o
		Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.



Class A Common Stock, par value $0.01 per share		173,008,231
Class B Common Stock, par value $0.01 per share		1,038,804
(Class)		(Outstanding on October 30, 2018)



	EMPIRE STATE REALTY TRUST, INC.
	FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2018
	TABLE OF CONTENTS	PAGE
PART 1.	FINANCIAL INFORMATION

ITEM 1.	FINANCIAL STATEMENTS
	Condensed Consolidated Balance Sheets as of September 30, 2018 (unaudited) and December 31, 2017	2
	Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2018 and 2017 (unaudited)	3
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2018 and 2017 (unaudited)	4
	Condensed Consolidated Statements of Stockholders' Equity for the nine months ended September 30, 2018 (unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017 (unaudited)	6
	Notes to Condensed Consolidated Financial Statements (unaudited)	8

ITEM 2.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	44

ITEM 4.	CONTROLS AND PROCEDURES	44

PART II.	OTHER INFORMATION	45

ITEM 1.	LEGAL PROCEEDINGS	45

ITEM 1A.	RISK FACTORS	45

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	45

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	45

ITEM 4.	MINE SAFETY DISCLOSURES	45

ITEM 5.	OTHER INFORMATION	45

ITEM 6.	EXHIBITS	45

SIGNATURES		46

ITEM 1. FINANCIAL STATEMENTS

Empire State Realty Trust, Inc.

Condensed Consolidated Balance Sheets

(amounts in thousands, except share and per share amounts)



	September 30, 2018			December 31, 2017
ASSETS	(unaudited)
Commercial real estate properties, at cost:
Land	$	201,196		$	201,196
Development costs	7,987			7,986
Building and improvements	2,616,772			2,458,473
	2,825,955			2,667,655
Less: accumulated depreciation	(718,959		)	(656,900		)
Commercial real estate properties, net	2,106,996			2,010,755
Cash and cash equivalents	229,745			464,344
Restricted cash	54,356			65,853
Short-term investments	400,000			—
Tenant and other receivables, net of allowance of $1,616 and $1,422 in 2018 and 2017, respectively	31,342			28,329
Deferred rent receivables, net of allowance of $22 and $185 in 2018 and 2017, respectively	195,455			178,629
Prepaid expenses and other assets	50,663			61,028
Deferred costs, net	244,441			262,701
Acquired below-market ground leases, net	362,355			368,229
Goodwill	491,479			491,479
Total assets	$	4,166,832		$	3,931,347
LIABILITIES AND EQUITY
Liabilities:
Mortgage notes payable, net	$	609,299		$	717,164
Senior unsecured notes, net	1,045,362			707,895
Unsecured term loan facility, net	264,023			263,662
Unsecured revolving credit facility	—			—
Accounts payable and accrued expenses	128,340			110,849
Acquired below-market leases, net	55,662			66,047
Deferred revenue and other liabilities	32,175			40,907
Tenants’ security deposits	42,520			47,086
Total liabilities	2,177,381			1,953,610
Commitments and contingencies
Equity:
Empire State Realty Trust, Inc. stockholders' equity:
Preferred stock, $0.01 par value per share, 50,000,000 shares authorized, none issued or outstanding	—			—
Class A common stock, $0.01 par value per share, 400,000,000 shares authorized, 168,176,734 shares issued and outstanding and 160,424,575 shares issued and outstanding in 2018 and 2017, respectively	1,681			1,604
Class B common stock, $0.01 par value per share, 50,000,000 shares authorized, 1,044,169 and 1,052,469 shares issued and outstanding in 2018 and 2017, respectively	10			11
Additional paid-in capital	1,165,080			1,128,460
Accumulated other comprehensive loss	(2,229		)	(8,555		)
Retained earnings	37,004			46,762
Total Empire State Realty Trust, Inc.'s stockholders' equity	1,201,546			1,168,282
Non-controlling interests in operating partnership	779,901			801,451
Private perpetual preferred units, $16.62 per unit liquidation preference, 1,560,360 issued and outstanding in 2018 and 2017	8,004			8,004
Total equity	1,989,451			1,977,737
Total liabilities and equity	$	4,166,832		$	3,931,347

The accompanying notes are an integral part of these consolidated financial statements

Empire State Realty Trust, Inc.

Condensed Consolidated Statements of Income

(unaudited)

(amounts in thousands, except per share amounts)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Revenues:
Rental revenue	$	123,621		$	122,391		$	369,970		$	360,348
Tenant expense reimbursement	18,627			20,346			52,626			53,889
Observatory revenue	40,241			39,306			96,691			94,212
Lease termination fees	1,185			1,165			2,164			10,354
Third-party management and other fees	312			345			1,151			1,088
Other revenue and fees	2,416			2,993			9,600			7,338
Total revenues	186,402			186,546			532,202			527,229
Operating expenses:
Property operating expenses	42,772			41,270			126,375			122,009
Ground rent expenses	2,331			2,331			6,994			6,994
General and administrative expenses	13,148			12,899			39,001			36,566
Observatory expenses	8,854			8,648			23,868			23,079
Real estate taxes	28,284			26,901			81,771			76,001
Depreciation and amortization	42,475			38,490			121,826			119,868
Total operating expenses	137,864			130,539			399,835			384,517
Total operating income	48,538			56,007			132,367			142,712
Other income (expense):
Interest income	3,485			774			7,209			2,169
Interest expense	(20,658		)	(16,890		)	(58,774		)	(52,109		)
Loss on early extinguishment of debt	—			(2,157		)	—			(2,157		)
Loss from derivative financial instruments	—			—			—			(289		)
Income before income taxes	31,365			37,734			80,802			90,326
Income tax expense	(2,135		)	(2,245		)	(3,330		)	(4,333		)
Net income	29,230			35,489			77,472			85,993
Private perpetual preferred unit distributions	(234		)	(234		)	(702		)	(702		)
Net income attributable to non-controlling interests	(12,654		)	(16,449		)	(34,009		)	(39,916		)
Net income attributable to common stockholders	$	16,342		$	18,806		$	42,761		$	45,375

Total weighted average shares:
Basic	167,657			158,102			165,613			157,796
Diluted	297,478			297,871			297,181			298,089

Earnings per share attributable to common stockholders:
Basic	$	0.10		$	0.12		$	0.26		$	0.29
Diluted	$	0.10		$	0.12		$	0.26		$	0.29

Dividends per share	$	0.105		$	0.105		$	0.315		$	0.315

The accompanying notes are an integral part of these consolidated financial statements

Empire State Realty Trust, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(unaudited)

(amounts in thousands)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Net income	$	29,230		$	35,489		$	77,472		$	85,993
Other comprehensive income (loss):
Unrealized gain (loss) on valuation of interest rate swap agreements	3,884			(1,638		)	9,827			(14,654		)
Less: amount reclassified into interest expense	427			359			1,562			402
Other comprehensive income (loss)	4,311			(1,279		)	11,389			(14,252		)
Comprehensive income (loss)	33,541			34,210			88,861			71,741
Net income attributable to non-controlling interests and private perpetual preferred unitholders	(12,888		)	(16,683		)	(34,711		)	(40,618		)
Other comprehensive (income) loss attributable to non-controlling interests	(1,881		)	586			(5,045		)	6,670
Comprehensive income (loss) attributable to common stockholders	$	18,772		$	18,113		$	49,105		$	37,793

The accompanying notes are an integral part of these consolidated financial statements

Empire State Realty Trust, Inc.

Condensed Consolidated Statements of Stockholders' Equity

For The Nine Months Ended September 30, 2018

(unaudited)

(amounts in thousands)



	Number of Class A Common Shares	Class A Common Stock		Number of Class B Common Shares		Class B Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive Income (Loss)			Retained Earnings			Total Stockholders' Equity			Non-controlling Interests			Private Perpetual Preferred Units			Total Equity

Balance at December 31, 2017	160,425	$	1,604	1,052		$	11		$	1,128,460	$	(8,555	)	$	46,762		$	1,168,282		$	801,451		$	8,004		$	1,977,737
Issuance of Class A shares	284	3		—		—			4,746		—			—			4,749			—			—			4,749
Conversion of operating partnership units and Class B shares to Class A shares	7,444	74		(8	)	(1		)	31,605		(18		)	—			31,660			(31,660		)	—			—
Equity compensation:
LTIP units	—	—		—		—			—		—			—			—			13,795			—			13,795
Restricted stock, net of forfeitures	24	—		—		—			269		—			—			269			—			—			269
Dividends and distributions	—	—		—		—			—		—			(52,519		)	(52,519		)	(42,739		)	(702		)	(95,960		)
Net income	—	—		—		—			—		—			42,761			42,761			34,009			702			77,472
Other comprehensive income (loss)	—	—		—		—			—		6,344			—			6,344			5,045			—			11,389
Balance at September 30, 2018	168,177	$	1,681	1,044		$	10		$	1,165,080	$	(2,229	)	$	37,004		$	1,201,546		$	779,901		$	8,004		$	1,989,451

The accompanying notes are an integral part of these consolidated financial statements

Empire State Realty Trust, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(amounts in thousands)



	Nine Months Ended September 30,
	2018			2017
Cash Flows From Operating Activities
Net income	$	77,472		$	85,993
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	121,826			119,868
Amortization of non-cash items within interest expense	5,142			919
Amortization of acquired above- and below-market leases, net	(4,387		)	(4,154		)
Amortization of acquired below-market ground leases	5,873			5,873
Straight-lining of rental revenue	(16,662		)	(20,590		)
Equity based compensation	14,064			10,808
Settlement of derivative contracts	—			(6,335		)
Unrealized loss from derivative financial instruments	—			2,157
Increase (decrease) in cash flows due to changes in operating assets and liabilities:
Security deposits	(4,566		)	213
Tenant and other receivables	(3,176		)	(12,119		)
Deferred leasing costs	(18,578		)	(21,660		)
Prepaid expenses and other assets	20,308			13,672
Accounts payable and accrued expenses	(1,181		)	(8,917		)
Deferred revenue and other liabilities	(8,732		)	9,108
Net cash provided by operating activities	187,403			174,836
Cash Flows From Investing Activities
Short-term investments	(400,000		)	—
Development costs	(1		)	(27		)
Additions to building and improvements	(169,622		)	(157,579		)
Net cash used in investing activities	(569,623		)	(157,606		)

The accompanying notes are an integral part of these consolidated financial statements

Empire State Realty Trust, Inc.

Condensed Consolidated Statements of Cash Flows (continued)

(unaudited)

(amounts in thousands)



	Nine Months Ended September 30,
	2018			2017
Cash Flows From Financing Activities
Proceeds from mortgage notes payable	160,000			315,000
Repayment of mortgage notes payable	(265,688		)	(344,618		)
Proceeds from unsecured senior notes	335,000			—
Proceeds from unsecured revolving credit facility and term loan	—			265,000
Repayments of unsecured revolving credit facility and term loan	—			(265,000		)
Proceeds from the sale of common stock	4,749			—
Deferred financing costs	(1,977		)	(12,186		)
Private perpetual preferred unit distributions	(702		)	(702		)
Dividends paid to common stockholders	(52,518		)	(49,843		)
Distributions paid to non-controlling interests in the operating partnership	(42,740		)	(44,641		)
Net cash provided by (used in) financing activities	136,124			(136,990		)
Net decrease in cash and cash equivalents and restricted cash	(246,096		)	(119,760		)
Cash and cash equivalents and restricted cash—beginning of period	530,197			615,885
Cash and cash equivalents and restricted cash—end of period	$	284,101		$	496,125

Reconciliation of Cash and Cash Equivalents and Restricted Cash:
Cash and cash equivalents at beginning of period	$	464,344		$	554,371
Restricted cash at beginning of period	65,853			61,514
Cash and cash equivalents and restricted cash at beginning of period	$	530,197		$	615,885

Cash and cash equivalents at end of period	$	229,745		$	432,105
Restricted cash at end of period	54,356			64,020
Cash and cash equivalents and restricted cash at end of period	$	284,101		$	496,125

Supplemental disclosures of cash flow information:
Cash paid for interest	$	56,597		$	53,918
Cash paid for income taxes	$	3,690		$	5,004

Non-cash investing and financing activities:
Building and improvements included in accounts payable and accrued expenses	$	92,506		$	72,130
Derivative instruments at fair values included in prepaid expenses and other assets	9,944			—
Derivative instruments at fair values included in accounts payable and accrued expenses	—			13,378
Conversion of operating partnership units and Class B shares to Class A shares	31,660			11,087

The accompanying notes are an integral part of these consolidated financial statements

Empire State Realty Trust, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. Description of Business and Organization

As used in these condensed consolidated financial statements, unless the context otherwise requires, “we,” “us,” “our,” the “company,” and "ESRT" mean Empire State Realty Trust, Inc. and its consolidated subsidiaries.

We are a self-administered and self-managed real estate investment trust ("REIT") that owns, manages, operates, acquires and repositions office and retail properties in Manhattan and the greater New York metropolitan area.

As of September 30, 2018, our total portfolio contained 10.1 million rentable square feet of office and retail space. We owned 14 office properties (including three long-term ground leasehold interests) encompassing approximately 9.4 million rentable square feet of office space. Nine of these properties are located in the midtown Manhattan market and aggregate approximately 7.6 million rentable square feet of office space, including the Empire State Building. Our Manhattan office properties also contain an aggregate of 513,437 rentable square feet of retail space on their ground floor and/or contiguous levels. Our remaining five office properties are located in Fairfield County, Connecticut and Westchester County, New York, encompassing in the aggregate approximately 1.9 million rentable square feet. The majority of square footage for these five properties is located in densely populated metropolitan communities with immediate access to mass transportation. Additionally, we have entitled land at the Stamford Transportation Center in Stamford, Connecticut, adjacent to one of our office properties, that will support the development of an approximately 380,000 rentable square foot office building and garage. As of September 30, 2018, our portfolio included four standalone retail properties located in Manhattan and two standalone retail properties located in the city center of Westport, Connecticut, encompassing 205,748 rentable square feet in the aggregate.

We were organized as a Maryland corporation on July 29, 2011 and commenced operations upon completion of our initial public offering and related formation transactions on October 7, 2013. Our operating partnership, Empire State Realty OP, L.P. (the "Operating Partnership"), holds substantially all of our assets and conducts substantially all of our business. As of September 30, 2018, we owned approximately 55.8% of the aggregate operating partnership units in the Operating Partnership. We, as the sole general partner in the Operating Partnership, have responsibility and discretion in the management and control of the Operating Partnership, and the limited partners in the Operating Partnership, in such capacity, have no authority to transact business for, or participate in the management activities of, the Operating Partnership. Accordingly, the Operating Partnership has been consolidated by us. We elected to be taxed as a REIT and operate in a manner that we believe allows us to qualify as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2013.

2. Summary of Significant Accounting Policies

There have been no material changes to the summary of significant accounting policies included in the section entitled "Summary of Significant Accounting Policies" in our December 31, 2017 Annual Report on Form 10-K.

Basis of Quarterly Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), for interim financial information, and with the rules and regulations of the Securities and Exchange Commission (the "SEC"). Accordingly, certain information and footnote disclosures required by GAAP for complete financial statements have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, all adjustments and eliminations (including intercompany balances and transactions), consisting of normal recurring adjustments, considered necessary for the fair presentation of the financial statements have been included.

The results of operations for the periods presented are not necessarily indicative of the results that may be expected for the corresponding full years. These financial statements should be read in conjunction with the financial statements and accompanying notes included in the financial statements for the year ended December 31, 2017 contained in our Annual Report on Form 10-K. We do not consider our business to be subject to material seasonal fluctuations, except that our observatory business is subject to tourism seasonality. During the past ten years, approximately 16.0% to 18.0% of our annual observatory

revenue was realized in the first quarter, 26.0% to 28.0% was realized in the second quarter, 31.0% to 33.0% was realized in the third quarter and 23.0% to 25.0% was realized in the fourth quarter.

We consolidate entities in which we have a controlling financial interest. In determining whether we have a controlling financial interest in a partially owned entity and the requirement to consolidate the accounts of that entity, we consider factors such as ownership interest, board representation, management representation, authority to make decisions, and contractual and substantive participating rights of the partners/members. For variable interest entities ("VIE"), we consolidate the entity if we are deemed to have a variable interest in the entity and through that interest we are deemed the primary beneficiary. The primary beneficiary of a VIE is the entity that has (i) the power to direct the activities that most significantly impact the entity's economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could be significant to the VIE. The primary beneficiary is required to consolidate the VIE. The Operating Partnership is a variable interest entity of our company, Empire State Realty Trust, Inc. As the Operating Partnership is already consolidated in the financial statements of Empire State Realty Trust, Inc., the identification of this entity as a variable interest entity has no impact on our consolidated financial statements.

We will assess the accounting treatment for each investment we may have in the future. This assessment will include a review of each entity’s organizational agreement to determine which party has what rights and whether those rights are protective or participating. For all VIEs, we will review such agreements in order to determine which party has the power to direct the activities that most significantly impact the entity’s economic performance and benefit. In situations where we or our partner could approve, among other things, the annual budget, or leases that cover more than a nominal amount of space relative to the total rentable space at each property, we would not consolidate the investment as we consider these to be substantive participation rights that result in shared power of the activities that would most significantly impact the performance and benefit of such joint venture investment.

A non-controlling interest in a consolidated subsidiary is defined as the portion of the equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. Non-controlling interests are required to be presented as a separate component of equity in the condensed consolidated balance sheets and in the condensed consolidated statements of income by requiring earnings and other comprehensive income to be attributed to controlling and non-controlling interests.

Accounting Estimates

The preparation of the condensed consolidated financial statements in accordance with GAAP requires management to use estimates and assumptions that in certain circumstances affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Significant items subject to such estimates and assumptions include allocation of the purchase price of acquired real estate properties among tangible and intangible assets, determination of the useful life of real estate properties and other long-lived assets, valuation and impairment analysis of commercial real estate properties and other long-lived assets, estimate of tenant expense reimbursements, valuation of the allowance for doubtful accounts, and valuation of derivative instruments, senior unsecured notes, mortgage notes payable, unsecured term loan and revolving credit facilities, and equity based compensation. These estimates are prepared using management’s best judgment, after considering past, current, and expected events and economic conditions. Actual results could differ from those estimates.

Short-term Investments

Short-term investments include time deposits with original maturities of greater than three months and remaining maturities of less than one year. The fair values of these investments approximate their carrying values.

Reclassification

The prior year balance of other revenues and fees has been reclassified to separately present lease termination fees and interest income and conform to our current year presentation.

Recently Issued or Adopted Accounting Standards

During August 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force), which contain amendments that align the requirements for capitalizing implementation costs

incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). Accordingly, for entities in a hosting arrangement that is a service contract, costs for implementation activities in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and post-implementation stages are expensed as the activities are performed. The amendments in ASU No. 2018-15 also require the entity (customer) to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The amendments are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption of the amendments is permitted, including adoption in any interim period. The amendments in ASU No. 2018-15 should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. We are evaluating the impact of adopting this new accounting standard on our consolidated financial statements.

During January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which contain amendments that modify the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. An entity no longer will determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. Because these amendments eliminate Step 2 from the goodwill impairment test, they should reduce the cost and complexity of evaluating goodwill for impairment. ASU No. 2017-04 should be applied on a prospective basis and the amendments adopted for the annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We are evaluating the impact of adopting this new accounting standard on our consolidated financial statements.

During January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which contain amendments to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in ASU No. 2017-01 provide a screen to determine when an integrated set of assets and activities (collectively referred to as a “set”) is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. Real estate acquisitions that do not meet the definition of a business will be accounted for as asset acquisitions and the corresponding acquisition costs will be capitalized rather than expensed. These amendments narrow the definition of the term output so that the term is consistent with how outputs are described in Topic 606, Revenue from Contracts with Customers. ASU No. 2017-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The amendments are applied prospectively on or after the effective date. No disclosures are required at transition. We believe that acquisitions of real estate properties will generally be considered asset acquisitions.

During November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which contain amendments that require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU No. 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. We adopted this standard on January 1, 2018 using a retrospective transition method. The adoption did not have a material impact on our consolidated financial statements.

During August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We adopted this standard on January 1, 2018 using a retrospective transition method. The adoption did not have a material impact on our consolidated financial statements.

During June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which contains amendments that replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU No. 2016-13 will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Earlier adoption as of the fiscal

years beginning after December 15, 2018, including interim periods within those fiscal years, is permitted. The amendments must be adopted through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified retrospective approach). We are evaluating the impact of adopting this new accounting standard on our consolidated financial statements.

During February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires that a lessee recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. ASU No. 2016-02 leaves the accounting for leases by lessors largely unchanged from previous GAAP. ASU No. 2016-02 will be effective for fiscal years beginning after December 15, 2018 and subsequent interim periods. The new standard must be adopted using a modified retrospective transition, and provides for certain practical expedients. Transition will require application of the new guidance at the beginning of the earliest comparative period presented. This ASU is expected to result in the recognition of a right-to-use asset and related liability to account for our future obligations under our ground lease agreements for which we are the lessee. As of September 30, 2018, the remaining contractual payments under our ground lease agreements aggregated $76.3 million. In addition, under ASU 2016-02, lessors may only capitalize incremental direct leasing costs. As a result, we expect that we will no longer capitalize our non-contingent leasing costs and instead will expense these costs as incurred. These costs totaled $4.5 million for the year ended December 31, 2017. During July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases, which contains amendments which are intended to clarify or to correct unintended application of ASU No. 2016-02. Also during July 2018, the FASB issued ASU No. 2018-11, Targeted Improvements to Topic 842, Leases, which provides another transition method in addition to the existing modified retrospective transition method by allowing a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. The amendments in ASU No. 2018-11 also provide lessors with a practical expedient, by class of underlying asset, to not separate nonlease components from the associated lease component provided that (1) the timing and pattern of transfer are the same for the nonlease components and associated lease component and (2) the lease component, if accounted separately, would be classified as an operating lease. For entities that have not yet adopted ASU No. 2016-02, the effective dates and transition requirements for ASU No. 2018-10 and ASU 2018-11 will be the same as the effective date and transition requirements in ASU No. 2016-02. We continue to evaluate the impact of adopting these new accounting standards on our consolidated financial statements.

During May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which replaces all current GAAP guidance related to revenue recognition and eliminates all industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted this standard on January 1, 2018 and it did not have a material impact on our consolidated financial statements.

3. Deferred Costs, Acquired Lease Intangibles and Goodwill

Deferred costs, net, consisted of the following as of September 30, 2018 and December 31, 2017 (amounts in thousands):



	September 30, 2018			December 31, 2017
Leasing costs	$	171,865		$	164,751
Acquired in-place lease value and deferred leasing costs	218,810			237,364
Acquired above-market leases	53,208			67,415
	443,883			469,530
Less: accumulated amortization	(206,210		)	(215,102		)
Total deferred costs, net, excluding net deferred financing costs	$	237,673		$	254,428

At September 30, 2018 and December 31, 2017, $6.8 million and $8.3 million, respectively, of net deferred financing costs associated with the unsecured revolving credit facility was included in deferred costs, net on the condensed consolidated balance sheet.

Amortization expense related to deferred leasing costs and acquired deferred leasing costs was $6.3 million and $5.8 million for the three months ended September 30, 2018 and 2017, respectively, and $18.4 million and $17.9 million for the nine months ended September 30, 2018 and 2017, respectively. Amortization expense related to acquired lease intangibles was $2.9

million and $4.0 million for the three months ended September 30, 2018 and 2017, respectively, and $9.3 million and $13.0 million for the nine months ended September 30, 2018 and 2017, respectively.

Amortizing acquired intangible assets and liabilities consisted of the following as of September 30, 2018 and December 31, 2017 (amounts in thousands):



	September 30, 2018			December 31, 2017
Acquired below-market ground leases	$	396,916		$	396,916
Less: accumulated amortization	(34,561		)	(28,687		)
Acquired below-market ground leases, net	$	362,355		$	368,229



	September 30, 2018			December 31, 2017
Acquired below-market leases	$	(120,568	)	$	(132,026	)
Less: accumulated amortization	64,906			65,979
Acquired below-market leases, net	$	(55,662	)	$	(66,047	)

Rental revenue related to the amortization of below-market leases, net of above-market leases, was $1.7 million and $1.6 million for the three months ended September 30, 2018 and 2017, respectively, and $4.4 million and $4.1 million for the nine months ended September 30, 2018 and 2017, respectively.

As of September 30, 2018, we had goodwill of $491.5 million. Goodwill was allocated $227.5 million to the observatory reportable segment and $264.0 million to the real estate segment.

4. Debt

Debt consisted of the following as of September 30, 2018 and December 31, 2017 (amounts in thousands):



	Principal Balance						As of September 30, 2018
	September 30, 2018			December 31, 2017			Stated Rate		Effective Rate⁽¹⁾		Maturity Date⁽²⁾
Mortgage debt collateralized by:
Fixed rate mortgage debt
Metro Center	$	92,372		$	93,948		3.59	%	3.66	%	11/5/2024
10 Union Square	50,000			50,000			3.70	%	3.97	%	4/1/2026
1542 Third Avenue	30,000			30,000			4.29	%	4.53	%	5/1/2027
First Stamford Place⁽³⁾	180,000			180,000			4.28	%	4.44	%	7/1/2027
1010 Third Avenue and 77 West 55th Street	39,177			39,710			4.01	%	4.20	%	1/5/2028
10 Bank Street	33,988			34,602			4.23	%	4.35	%	6/1/2032
383 Main Avenue	30,000			30,000			4.44	%	4.55	%	6/30/2032
1333 Broadway	160,000			66,602			4.21	%	4.26	%	2/5/2033
1400 Broadway
(first lien mortgage loan)	—			66,632			—		—		—
(second lien mortgage loan)	—			9,172			—		—		—
111 West 33rd Street
(first lien mortgage loan)	—			74,045			—		—		—
(second lien mortgage loan)	—			9,369			—		—		—
1350 Broadway	—			37,144			—		—		—
Total mortgage debt	615,537			721,224
Senior unsecured notes - exchangeable	250,000			250,000			2.63	%	3.93	%	8/15/2019
Senior unsecured notes:⁽⁶⁾
Series A	100,000			100,000			3.93	%	3.96	%	3/27/2025
Series B	125,000			125,000			4.09	%	4.12	%	3/27/2027
Series C	125,000			125,000			4.18	%	4.21	%	3/27/2030
Series D	115,000			115,000			4.08	%	4.11	%	1/22/2028
Series E	160,000			—			4.26	%	4.27	%	3/22/2030
Series F	175,000			—			4.44	%	4.45	%	3/22/2033
Unsecured revolving credit facility⁽⁶⁾	—			—			⁽⁴⁾		⁽⁴⁾		8/29/2021
Unsecured term loan facility⁽⁶⁾	265,000			265,000			⁽⁵⁾		⁽⁵⁾		8/29/2022
Total principal	1,930,537			1,701,224
Unamortized discount, net of unamortized premium	(2,315		)	(3,370		)
Deferred financing costs, net	(9,538		)	(9,133		)
Total	$	1,918,684		$	1,688,721

______________


(1)	The effective rate is the yield as of September 30, 2018, including the effects of debt issuance costs and the amortization of the fair value of debt adjustment.


(2)	Pre-payment is generally allowed for each loan upon payment of a customary pre-payment penalty.


(3)	Represents a $164 million mortgage loan bearing interest at 4.09% and a $16 million loan bearing interest at 6.25%.


(4)	At September 30, 2018, the unsecured revolving credit facility bears a floating rate at 30 day LIBOR plus 1.10%. The rate at September 30, 2018 was 3.36%.


(5)	The unsecured term loan facility bears a floating rate at 30 day LIBOR plus 1.20%. Pursuant to an interest rate swap agreement, the LIBOR rate is fixed at 2.1485% through maturity. The rate at September 30, 2018 was 3.35%.


(6)	At September 30, 2018, we were in compliance with all debt covenants.

Mortgage Debt

During January 2018, we refinanced and increased our mortgage debt on 1333 Broadway from $66.6 million to $160.0 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.

Principal Payments

Aggregate required principal payments at September 30, 2018 are as follows (amounts in thousands):



Year	Amortization		Maturities		Total
2018	$	925	$	—	$	925
2019	3,790		250,000		253,790
2020	3,938		—		3,938
2021	4,090		—		4,090
2022	5,628		265,000		270,628
Thereafter	41,744		1,355,422		1,397,166
Total	$	60,115	$	1,870,422	$	1,930,537

Deferred Financing Costs

Deferred financing costs, net, consisted of the following at September 30, 2018 and December 31, 2017 (amounts in thousands):



	September 30, 2018			December 31, 2017
Financing costs	$	25,312		$	24,446
Less: accumulated amortization	(9,006		)	(7,039		)
Total deferred financing costs, net	$	16,306		$	17,407

Amortization expense related to deferred financing costs was $1.1 million and $1.0 million for the three months ended September 30, 2018 and 2017, respectively, and $3.1 million and $3.6 million for the nine months ended September 30, 2018 and 2017, respectively, and was included in interest expense.

Unsecured Revolving Credit and Term Loan Facility

During August 2017, through the Operating Partnership, we entered into an amended and restated senior unsecured revolving credit and term loan facility (the “Facility”) with Bank of America, N.A., as administrative agent, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Wells Fargo Securities, LLC as Joint Lead Arrangers and Joint Bookrunners, Wells Fargo, National Association and Capital One, National Association, as co-syndication agents, and the lenders party thereto.

The Facility is in the original principal amount of up to $1.365 billion, which consists of a $1.1 billion revolving credit facility and a $265 million term loan facility. We may request the Facility be increased through one or more increases in the revolving credit facility or one or more increases in the term loan facility or the addition of new pari passu term loan tranches, for a maximum aggregate principal amount not to exceed $1.75 billion.

The initial maturity of the unsecured revolving credit facility is August 2021. We have the option to extend the initial term for up to two additional 6-month periods, subject to certain conditions, including the payment of an extension fee equal to 0.0625% and 0.075% of the then outstanding commitments under the unsecured revolving credit facility on the first and the second extensions, respectively. The term loan facility matures on August 2022. We may prepay the loans under the Facility at any time, subject to reimbursement of the lenders’ breakage and redeployment costs in the case of prepayment of Eurodollar Rate borrowings.

Exchangeable Senior Notes

Issued in August 2014, the $250.0 million 2.625% Exchangeable Senior Notes (“2.625% Exchangeable Senior Notes”) are due August 15, 2019. The 2.625% Exchangeable Senior Notes will be exchangeable into cash, shares of Class A

common stock or a combination of cash and shares of Class A common stock, at our election. We have asserted that it is our intent and ability to settle the principal amount of the 2.625% Exchangeable Senior Notes in cash. As of September 30, 2018, the exchange rate of the 2.625% Exchangeable Senior Notes was 51.9443 shares per $1,000 principal amount of notes (equivalent to an initial exchange price of approximately $19.25 per share of Class A common stock), subject to adjustment, as described in the related indenture governing the 2.625% Exchangeable Senior Notes.

For the three and nine months ended September 30, 2018, total interest expense related to the 2.625% Exchangeable Senior Notes was $2.4 million and $7.3 million, respectively, consisting of (i) the contractual interest expense of $1.6 million and $4.9 million, respectively, (ii) the additional non-cash interest expense of $0.7 million and $2.0 million, respectively, relating to the accretion of the debt discount, and (iii) the amortization of deferred financing costs of $0.1 million and $0.4 million, respectively. For the three and nine months ended September 30, 2017, total interest expense related to the 2.625% Exchangeable Senior Notes was $2.4 million and $7.3 million, respectively, consisting of (i) the contractual interest expense of $1.6 million and $4.9 million, respectively, (ii) the additional non-cash interest expense of $0.7 million and $2.0 million, respectively, relating to the accretion of the debt discount, and (iii) the amortization of deferred financing costs of $0.1 million and $0.4 million, respectively.

Senior Unsecured Notes

During December 2017, we entered into an agreement to issue and sell an aggregate principal amount of $450.0 million of senior unsecured notes consisting of $115.0 million of 4.08% Series D Senior Notes due 2028, $160.0 million of 4.26% Series E Senior Notes due 2030, and $175.0 million of 4.44% Series F Senior Notes due 2033. We issued and sold the Series D Senior Notes in December 2017 and the Series E and F Senior Notes in March 2018. In connection with the March 2018 issuance of the notes, we repaid our mortgage indebtedness on 111 West 33rd Street and 1350 Broadway, before their maturity dates in early April 2018.

5. Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consisted of the following as of September 30, 2018 and December 31, 2017 (amounts in thousands):



	September 30, 2018		December 31, 2017
Accrued capital expenditures	$	92,506	$	71,769
Accounts payable and accrued expenses	31,841		32,509
Interest rate swap agreements liability	—		436
Accrued interest payable	3,447		5,687
Due to affiliated companies	546		448
Total accounts payable and accrued expenses	$	128,340	$	110,849

6. Financial Instruments and Fair Values

Derivative Financial Instruments

We use derivative financial instruments primarily to manage interest rate risk and such derivatives are not considered speculative. These derivative instruments are typically in the form of interest rate swap and forward agreements and the primary objective is to minimize interest rate risks associated with investing and financing activities. The counterparties of these arrangements are major financial institutions with which we may also have other financial relationships. We are exposed to credit risk in the event of non-performance by these counterparties; however, we currently do not anticipate that any of the counterparties will fail to meet their obligations.

We have agreements with our derivative counterparties that contain a provision where if we either default or are capable of being declared in default on any of our indebtedness, then we could also be declared in default on our derivative obligations. As of September 30, 2018, we did not have any derivatives in a net liability position.

As of September 30, 2018 and December 31, 2017, we had interest rate LIBOR swaps with an aggregate notional value of $515.0 million and $265.0 million, respectively. The notional value does not represent exposure to credit, interest rate

or market risks. As of September 30, 2018, the fair value of our derivative instruments amounted to $9.9 million which is included in prepaid expenses and other assets on the condensed consolidated balance sheet. As of December 31, 2017, the fair value of our derivative instruments amounted to $(0.4) million which was included in accounts payable and accrued expenses on the condensed consolidated balance sheet. These interest rate swaps have been designated as cash flow hedges and hedge the future cash outflows on our exchangeable senior notes and also on our term loan facility that is subject to a floating interest rate. As of September 30, 2018 and 2017, our cash flow hedges are deemed highly effective and a net unrealized gain (loss) of $4.3 million and $(1.3) million for the three months ended September 30, 2018 and 2017, respectively, and a net unrealized gain (loss) of $11.4 million and $(14.3) million for the nine months ended September 30, 2018 and 2017, respectively, are reflected in the condensed consolidated statements of comprehensive income. Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are made on the debt. We estimate that $(2.3) million of the current balance held in accumulated other comprehensive income (loss) will be reclassified into interest expense within the next 12 months relating to interest rate swap contracts in effect as of September 30, 2018.

As of September 30, 2018 and December 31, 2017, the deferred net losses from terminated hedges amounted to $14.1 million and $15.1 million, respectively, which are included in accumulated other comprehensive income (loss) related to derivatives. We will reclassify into earnings, as an increase to interest expense, approximately $1.5 million within the next 12 months related to the deferred losses from the terminated hedges. For the nine months ended September 30, 2017, we recognized a loss of $0.3 million from derivative financial instruments, incurred in connection with the partial termination and re-designation of related cash flow hedges on a $20.0 million notional amount.

The table below summarizes the terms of agreements and the fair values of our derivative financial instruments as of September 30, 2018 and December 31, 2017 (dollar amounts in thousands):



							September 30, 2018				December 31, 2017
Derivative	Notional Amount		Receive Rate	Pay Rate	Effective Date	Expiration Date	Asset		Liability		Asset		Liability
Interest rate swap	$	265,000	1 Month LIBOR	2.1485%	August 31, 2017	August 24, 2022	$	7,300	$	—	$	—	$	(436	)
Interest rate swap	125,000		3 Month LIBOR	2.9580%	July 1, 2019	July 1, 2026	1,316		—		—		—
Interest rate swap	125,000		3 Month LIBOR	2.9580%	July 1, 2019	July 1, 2026	1,328		—		—		—
							$	9,944	$	—	$	—	$	(436	)

The table below shows the effect of our derivative financial instruments designated as cash flow hedges on accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2018 and 2017 (amounts in thousands):



	Three Months Ended						Nine Months Ended
Effects of Cash Flow Hedges	September 30, 2018			September 30, 2017			September 30, 2018			September 30, 2017
Amount of gain (loss) recognized in other comprehensive income (loss)	$	3,884		$	(1,638	)	$	9,827		$	(14,654	)
Amount of gain (loss) reclassified from accumulated other comprehensive income (loss) into interest expense	(427		)	(359		)	(1,562		)	(402		)

The table below shows the effect of our derivative financial instruments designated as cash flow hedges on the condensed consolidated statements of income for the three and nine months ended September 30, 2018 and 2017 (amounts in thousands):



	Three Months Ended						Nine Months Ended
Effects of Cash Flow Hedges	September 30, 2018			September 30, 2017			September 30, 2018			September 30, 2017
Total interest (expense) presented in the condensed consolidated statements of income in which the effects of cash flow hedges are recorded	$	(20,658	)	$	(16,890	)	$	(58,774	)	$	(52,109	)
Amount of gain (loss) reclassified from accumulated other comprehensive income (loss) into interest expense	(427		)	(359		)	(1,562		)	(402		)

Fair Valuation

The estimated fair values at September 30, 2018 and December 31, 2017 were determined by management, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The fair value of our senior unsecured notes - exchangeable was derived from quoted prices in active markets and is classified as Level 2 since trading volumes are low.

The fair value of derivative instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. Although the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by ourselves and our counterparties. The impact of such credit valuation adjustments, determined based on the fair value of each individual contract, was not significant to the overall valuation. As a result, all of our derivatives were classified as Level 2 of the fair value hierarchy.

The fair value of our mortgage notes payable, senior unsecured notes - Series A, B, C, D, E and F, and unsecured term loan facility which are determined using Level 3 inputs, are estimated by discounting the future cash flows using current interest rates at which similar borrowings could be made to us.

The following tables summarize the carrying and estimated fair values of our financial instruments as of September 30, 2018 and December 31, 2017 (amounts in thousands):



	September 30, 2018
			Estimated Fair Value
	Carrying Value		Total		Level 1		Level 2		Level 3
Interest rate swaps included in prepaid expenses and other assets	$	9,944	$	9,944	$	—	$	9,944	$	—
Interest rate swaps included in accounts payable and accrued expenses	—		—		—		—		—
Mortgage notes payable	609,299		574,238		—		—		574,238
Senior unsecured notes - Exchangeable	247,114		251,563		—		251,563		—
Senior unsecured notes - Series A, B, C, D, E and F	798,248		773,375		—		—		773,375
Unsecured term loan facility	264,023		265,000		—		—		265,000



	December 31, 2017
			Estimated Fair Value
	Carrying Value		Total		Level 1		Level 2		Level 3
Interest rate swaps included in prepaid expenses and other assets	$	—	$	—	$	—	$	—	$	—
Interest rate swaps included in accounts payable and accrued expenses	436		436		—		436		—
Mortgage notes payable	717,164		707,300		—		—		707,300
Senior unsecured notes - Exchangeable	244,739		275,723		—		275,723		—
Senior unsecured notes - Series A, B, C and D	463,156		460,352		—		—		460,352
Unsecured term loan facility	263,662		265,000		—		—		265,000

Disclosure about the fair value of financial instruments is based on pertinent information available to us as of September 30, 2018 and December 31, 2017. Although we are not aware of any factors that would significantly affect the

reasonable fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.

7. Rental Income

We lease various spaces to tenants over terms ranging from one to 21 years. Certain leases have renewal options for additional terms. The leases provide for base monthly rentals and reimbursements for real estate taxes, escalations linked to the consumer price index or common area maintenance known as operating expense escalation. Operating expense reimbursements are reflected in our condensed consolidated statements of income as tenant expense reimbursement.

8. Commitments and Contingencies

Legal Proceedings

Except as described below, as of September 30, 2018, we were not involved in any material litigation, nor, to our knowledge, was any material litigation threatened against us or our properties, other than routine litigation arising in the ordinary course of business such as disputes with tenants. We believe that the costs and related liabilities, if any, which may result from such actions will not materially affect our condensed consolidated financial position, operating results or liquidity.

As previously disclosed, in October 2014, 12 former investors in Empire State Building Associates L.L.C. (“ESBA”), which prior to the initial public offering of our company (the "Offering"), owned the fee title to the Empire State Building, filed an arbitration with the American Arbitration Association against Peter L. Malkin, Anthony E. Malkin, Thomas N. Keltner, Jr., and our subsidiary ESRT MH Holdings LLC, the former supervisor of ESBA, as respondents. The statement of claim (also filed later in federal court in New York for the expressed purpose of tolling the statute of limitations) alleges breach of fiduciary duty and related claims in connection with the Offering and formation transactions and seeks monetary damages and declaratory relief. These investors had opted out of a prior class action bringing similar claims that was settled with court approval. The respondents filed an answer and counterclaims. In March 2015, the federal court action was stayed on consent of all parties pending the arbitration. Arbitration hearings for a select number of sessions started in May 2016 and concluded in August 2018. Post-hearing briefing is currently scheduled to be completed by January 17, 2019.

The respondents believe the allegations in the arbitration are entirely without merit, and they intend to continue to defend them vigorously.

Pursuant to indemnification agreements which were made with our directors, executive officers and chairman emeritus as part of our formation transactions, Anthony E. Malkin, Peter L. Malkin and Thomas N. Keltner, Jr. have defense and indemnity rights from us with respect to this arbitration.

Unfunded Capital Expenditures

At September 30, 2018, we estimate that we will incur approximately $91.5 million of capital expenditures (including tenant improvements and leasing commissions) on our properties pursuant to existing lease agreements. We expect to fund these capital expenditures with operating cash flow, additional property level mortgage financings, our unsecured credit facility, cash on hand and other borrowings. Future property acquisitions may require substantial capital investments for refurbishment and leasing costs. We expect that these financing requirements will be met in a similar fashion.

Ground Leases

Aggregate required payments on ground leases at September 30, 2018 were as follows (amounts in thousands):



2018	$	380
2019	1,518
2020	1,518
2021	1,518
2022	1,518
Thereafter	69,816
	$	76,268

Concentration of Credit Risk

Financial instruments that subject us to credit risk consist primarily of cash and cash equivalents, restricted cash, short-term investments, tenant and other receivables and deferred rent receivables. At September 30, 2018, we held on deposit at various major financial institutions cash and cash equivalents, restricted cash and short-term investment balances in excess of amounts insured by the Federal Deposit Insurance Corporation.

Asset Retirement Obligations

We are required to accrue costs that we are legally obligated to incur on retirement of our properties which result from acquisition, construction, development and/or normal operation of such properties. Retirement includes sale, abandonment or disposal of a property. Under that standard, a conditional asset retirement obligation represents a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within a company’s control and a liability for a conditional asset retirement obligation must be recorded if the fair value of the obligation can be reasonably estimated. Environmental site assessments and investigations have identified asbestos or asbestos-containing building materials in certain of our properties. As of September 30, 2018, management has no plans to remove or alter these properties in a manner that would trigger federal and other applicable regulations for asbestos removal, and accordingly, the obligations to remove the asbestos or asbestos-containing building materials from these properties have indeterminable settlement dates. As such, we are unable to reasonably estimate the fair value of the associated conditional asset retirement obligation. However, ongoing asbestos abatement, maintenance programs and other required documentation are carried out as required and related costs are expensed as incurred.

Other Environmental Matters

Certain of our properties have been inspected for soil contamination due to pollutants, which may have occurred prior to our ownership of these properties or subsequently in connection with its development and/or its use. Required remediation to such properties has been completed, and as of September 30, 2018, management believes that there are no obligations related to environmental remediation other than maintaining the affected sites in conformity with the relevant authority’s mandates and filing the required documents. All such maintenance costs are expensed as incurred. We expect that resolution of the environmental matters relating to the above will not have a material impact on our business, assets, consolidated financial condition, results of operations or liquidity. However, we cannot be certain that we have identified all environmental liabilities at our properties, that all necessary remediation actions have been or will be undertaken at our properties or that we will be indemnified, in full or at all, in the event that such environmental liabilities arise.

Insurance Coverage

We carry insurance coverage on our properties of types and in amounts with deductibles that we believe are in line with coverage customarily obtained by owners of similar properties.

9. Equity

Shares and Units

An operating partnership unit of the Operating Partnership ("OP Unit") and a share of our common stock have essentially the same economic characteristics as they receive the same per unit profit distributions of the Operating Partnership. On the one-year anniversary of issuance, an OP Unit may be tendered for redemption for cash; however, we have sole and absolute discretion, and sufficient authorized common stock, to exchange OP Units for shares of common stock on a one-for-one basis instead of cash.

Long-term incentive plan ("LTIP") units are a special class of partnership interests in the Operating Partnership. Each LTIP unit awarded will be deemed equivalent to an award of one share of stock under the First Amended and Restated Empire State Realty Trust, Inc. and Empire State Realty OP, L.P. 2013 Equity Incentive Plan ("2013 Plan"), reducing the availability for other equity awards on a one-for-one basis. The vesting period for LTIP units, if any, will be determined at the time of issuance. Under the terms of the LTIP units, the Operating Partnership will revalue for tax purposes its assets upon the occurrence of certain specified events, and any increase in valuation from the time of grant until such event will be allocated first to the holders of LTIP units to equalize the capital accounts of such holders with the capital accounts of OP unitholders. Subject to any agreed upon exceptions, once vested and having achieved parity with OP unitholders, LTIP units are convertible into OP Units in the Operating Partnership on a one-for-one basis.

LTIP units subject to time based vesting, whether vested or not, receive the same per unit distributions as OP units, which equal per share dividends (both regular and special) on our common stock. Performance based LTIP units receive 10% of such distributions currently, unless and until such LTIP units are earned based on performance, at which time they will receive the accrued and unpaid 90% and will commence receiving 100% of such distributions thereafter.

The following is net income attributable to common stockholders and the issuance of our Class A shares in exchange for the conversion of OP Units into common stock (amounts in thousands):



	Three Months Ended,				Nine Months Ended,
	September 30, 2018		September 30, 2017		September 30, 2018		September 30, 2017
Net income attributable to common stockholders	$	16,342	$	18,806	$	42,761	$	45,375
Increase in additional paid-in capital for the conversion of OP Units into common stock	5,765		1,953		31,605		11,087
Change from net income attributable to common stockholders and transfers from non-controlling interests	$	22,107	$	20,759	$	74,366	$	56,462

As of September 30, 2018, there were 303,333,599 OP Units outstanding, of which 169,220,903, or 55.8%, were owned by us and 134,112,696, or 44.2%, were owned by other partners, including certain directors, officers and other members of executive management.

Dividends and Distributions

Total dividends paid to common stockholders were $17.7 million and $52.5 million for the three and nine months ended September 30, 2018, respectively, and $16.7 million and $49.8 million for the three and nine months ended September 30, 2017, respectively. Total distributions paid to OP unitholders, excluding inter-company distributions, were $14.1 million and $42.7 million for the three and nine months ended September 30, 2018, respectively, and $14.8 million and $44.6 million for the three and nine months ended September 30, 2017, respectively. Total distributions paid to preferred unitholders were $0.2 million and $0.7 million for the three and nine months ended September 30, 2018, respectively, and $0.2 million and $0.7 million for the three and nine months ended September 30, 2017, respectively.

Incentive and Share-Based Compensation

The 2013 Plan provides for grants to directors, employees and consultants consisting of stock options, restricted stock, dividend equivalents, stock payments, performance shares, LTIP units, stock appreciation rights and other incentive awards. An aggregate of 12.2 million shares of our common stock is authorized for issuance under awards granted pursuant to the 2013 Plan, and as of September 30, 2018, 4.3 million shares of common stock remain available for future issuance.

In March 2018, we made grants of LTIP units to executive officers under the 2013 Plan. At such time, we granted to executive officers a total of 386,876 LTIP units that are subject to time-based vesting and 1,737,917 LTIP units that are subject to performance-based vesting, with fair market values of $6.1 million for the time-based vesting awards and $9.6 million for the performance-based vesting awards. In March 2018, we made grants of LTIP units and restricted stock to certain other employees under the 2013 Plan. At such time, we granted to certain other employees a total of 67,449 LTIP units and 39,608 shares of restricted stock that are subject to time-based vesting and 223,950 LTIP units that are subject to performance-based vesting, with fair market values of $1.7 million for the time-based vesting awards and $1.1 million for the performance-based vesting awards. The awards subject to time-based vesting vest ratably over four years from January 1, 2018, subject generally to the grantee's continued employment. The first installment vests on January 1, 2019 and the remainder will vest thereafter in three equal annual installments. The vesting of the LTIP units subject to performance-based vesting is based on the achievement of absolute and relative total stockholder return hurdles over a three-year performance period, commencing on January 1, 2018. Following the completion of the three-year performance period, our compensation committee will determine the number of LTIP units to which the grantee is entitled based on our performance relative to the performance hurdles set forth in the LTIP unit award agreements the grantee entered into in connection with the award grant. These units then vest in two installments, with the first installment vesting on January 1, 2021 and the second installment vesting on January 1, 2022, subject generally to the grantee's continued employment on those dates.

In 2017, our board of directors determined to reinforce the alignment of our executive officers’ interests with that of stockholders by designing a new bonus election program, under which named executive officers could elect to receive their annual incentive bonus in any combination of (i) cash or vested LTIP's at the face amount of such bonus or (ii) time-vesting

LTIP's which would vest over three years, subject to continued employment, at 125% of such face amount. In February 2018, we made grants of LTIP units to executive officers under the 2013 Plan in connection with the 2017 bonus election program. We granted to executive officers a total of 238,609 LTIP units that are subject to time based vesting with a fair market value of $4.0 million. Of these LTIP units, 25,158 LTIP units vested immediately on the grant date and 213,451 LTIP units vest ratably over three years from January 1, 2018, subject generally to the grantee's continued employment. The first installment vests on January 1, 2019 and the remainder will vest thereafter in two equal annual installments.

In May 2018, we made grants of LTIP units to our non-employee directors under the 2013 Plan. At such time, we granted a total of 65,000 LTIP units that are subject to time-based vesting with fair market values of $1.0 million. The awards vest ratably over three years from the date of the grant, subject generally to the director's continued service on our Board of Directors.

Share-based compensation is measured at the fair value of the award on the date of grant and recognized as an expense on a straight-line basis over the vesting period. For the performance-based LTIP units and restricted stock awards, the fair value of the awards was estimated using a Monte Carlo Simulation model. Our stock price, along with the prices of the comparative indexes, is assumed to follow the Geometric Brownian Motion Process. Geometric Brownian Motion is a common assumption when modeling in financial markets, as it allows the modeled quantity (in this case the stock price) to vary randomly from its current value and take any value greater than zero. The volatilities of the returns on our stock price and the comparative indexes were estimated based on implied volatilities and historical volatilities using a six-year look-back period. The expected growth rate of the stock prices over the performance period is determined with consideration of the risk free rate as of the grant date. For LTIP unit awards that are time-based, the fair value of the awards was estimated based on the fair value of our stock at the grant date discounted for the restriction period during which the LTIP units cannot be redeemed or transferred and the uncertainty regarding if, and when, the book capital account of the LTIP units will equal that of the common units. For restricted stock awards that are time-based, we estimate the stock compensation expense based on the fair value of the stock at the grant date.

LTIP units and restricted stock issued during the nine months ended September 30, 2018 were valued at $23.6 million. The weighted-average per unit or share fair value was $8.54 for grants issued in 2018. The per unit or share granted in 2018 was estimated on the respective dates of grant using the following assumptions: an expected life of 5.6 years, a dividend rate of 2.30%, a risk-free interest rate of 2.50%, and an expected price volatility of 17.0%.

No other stock options, dividend equivalents, or stock appreciation rights were issued or outstanding in 2018.

The following is a summary of restricted stock and LTIP unit activity for the nine months ended September 30, 2018:



	Restricted Stock		LTIP Units		Weighted Average Grant Fair Value
Unvested balance at December 31, 2017	90,791		3,588,609		$	11.20
Vested	(30,693	)	(492,877	)	14.58
Granted	39,608		2,719,801		8.54
Forfeited or unearned	(7,811	)	(103,490	)	8.52
Unvested balance at September 30, 2018	91,895		5,712,043		$	9.68

The LTIP unit and restricted stock awards will immediately vest upon the later of (i) the date the grantee attains the age of 60 and (ii) the date on which grantee has first completed ten years of continuous service with our company or its affiliates. For award agreements that qualify, we recognize noncash compensation expense on the grant date for the time-based awards and ratably over the vesting period for the performance-based awards, and accordingly, we recognized $0.4 million and $1.7 million for the three and nine months ended September 30, 2018, respectively, and $0.2 million and $0.9 million for the three and nine months ended September 30, 2017, respectively. Unrecognized compensation expense was $1.2 million at September 30, 2018, which will be recognized over a weighted average period of 2.2 years.

For the remainder of the LTIP unit and restricted stock awards, we recognize noncash compensation expense ratably over the vesting period, and accordingly, we recognized noncash compensation expense of $4.5 million and $12.4 million for the three and nine months ended September 30, 2018, respectively, and $3.7 million and $9.9 million for the three and nine months ended September 30, 2017, respectively. Unrecognized compensation expense was $32.0 million at September 30, 2018, which will be recognized over a weighted average period of 2.3 years.

Earnings Per Share

Earnings per share for the three and nine months ended September 30, 2018 and 2017 is computed as follows (amounts in thousands, except per share amounts):



	Three Months Ended,						Nine Months Ended,
	September 30, 2018			September 30, 2017			September 30, 2018			September 30, 2017
Numerator - Basic:
Net income	$	29,230		$	35,489		$	77,472		$	85,993
Private perpetual preferred unit distributions	(234		)	(234		)	(702		)	(702		)
Net income attributable to non-controlling interests	(12,654		)	(16,449		)	(34,009		)	(39,916		)
Earnings allocated to unvested shares	(10		)	(11		)	(26		)	(28		)
Net income attributable to common stockholders - basic	$	16,332		$	18,795		$	42,735		$	45,347

Numerator - Diluted:
Net income	$	29,230		$	35,489		$	77,472		$	85,993
Private perpetual preferred unit distributions	(234		)	(234		)	(702		)	(702		)
Earnings allocated to unvested shares	(10		)	(11		)	(26		)	(28		)
Net income attributable to common stockholders - diluted	$	28,986		$	35,244		$	76,744		$	85,263

Denominator:
Weighted average shares outstanding - basic	167,657			158,102			165,613			157,796
Operating partnership units	129,821			138,287			131,567			138,593
Effect of dilutive securities:
Stock-based compensation plans	—			762			1			848
Exchangeable senior notes	—			720			—			852
Weighted average shares outstanding - diluted	297,478			297,871			297,181			298,089

Earnings per share:
Basic	$	0.10		$	0.12		$	0.26		$	0.29
Diluted	$	0.10		$	0.12		$	0.26		$	0.29

There were 541,947 and 458,698 antidilutive shares and LTIP units for the three and nine months ended September 30, 2018, respectively, and 954,533 and 840,092 antidilutive shares and LTIP units for the three and nine months ended September 30, 2017, respectively.

10. Related Party Transactions

Supervisory Fee Revenue

We earned supervisory fees from entities affiliated with Anthony E. Malkin, our Chairman and Chief Executive Officer, of $0.2 million and $0.3 million for the three months ended September 30, 2018 and 2017, respectively, and $0.9 million and $0.9 million for the nine months ended September 30, 2018 and 2017, respectively. These fees are included within third-party management and other fees.

Property Management Fee Revenue

We earned property management fees from entities affiliated with Anthony E. Malkin of $0.1 million and $0.1 million for the three months ended September 30, 2018 and 2017, respectively, and $0.3 million and $0.2 million for the nine months ended September 30, 2018 and 2017, respectively. These fees are included within third-party management and other fees.

Other

We receive rent generally at market rental rate for 5,351 square feet of leased space from entities affiliated with Anthony E. Malkin at one of our properties. Under the lease, the tenant has the right to cancel such lease without special payment on 90 days’ notice. We also have a shared use agreement with such tenant, to occupy a portion of the leased premises as the office location for Peter L. Malkin, our chairman emeritus and employee, utilizing approximately 15% of the space, for which we pay an allocable pro rata share of the cost to such tenant. We also have agreements with these entities to provide them with general computer-related support. Total revenue aggregated $0.1 million and $0.1 million for the three months ended September 30, 2018 and 2017, respectively, and $0.3 million and $0.3 million for the nine months ended September 30, 2018 and 2017, respectively.

One of our directors, James D. Robinson IV, is a general partner in an investment fund, which owns more than a 10% economic and voting interest in one of our tenants, OnDeck Capital, with an annualized rent of $4.1 million as of September 30, 2018.

11. Segment Reporting

We have identified two reportable segments: (1) real estate and (2) observatory. Our real estate segment includes all activities related to the ownership, management, operation, acquisition, redevelopment, repositioning and disposition of our real estate assets. Our observatory segment includes the operation of the 86th and 102nd floor observatories at the Empire State Building. These two lines of businesses are managed separately because each business requires different support infrastructures, provides different services and has dissimilar economic characteristics such as investments needed, stream of revenues and marketing strategies. We account for intersegment sales and rent as if the sales or rent were to third parties, that is, at current market prices.

The following tables provide components of segment profit for each segment for the three and nine months ended September 30, 2018 and 2017 (amounts in thousands):



	Three Months Ended September 30, 2018
	Real Estate			Observatory			Intersegment Elimination			Total
Revenues:
Rental revenue	$	123,621		$	—		$	—		$	123,621
Intercompany rental revenue	23,805			—			(23,805		)	—
Tenant expense reimbursement	18,627			—			—			18,627
Observatory revenue	—			40,241			—			40,241
Lease termination fees	1,185			—			—			1,185
Third-party management and other fees	312			—			—			312
Other revenue and fees	2,416			—			—			2,416
Total revenues	169,966			40,241			(23,805		)	186,402
Operating expenses:
Property operating expenses	42,772			—			—			42,772
Intercompany rent expense	—			23,805			(23,805		)	—
Ground rent expense	2,331			—			—			2,331
General and administrative expenses	13,148			—			—			13,148
Observatory expenses	—			8,854			—			8,854
Real estate taxes	28,284			—			—			28,284
Depreciation and amortization	42,458			17			—			42,475
Total operating expenses	128,993			32,676			(23,805		)	137,864
Total operating income	40,973			7,565			—			48,538
Other income (expense):
Interest income	3,485			—			—			3,485
Interest expense	(20,658		)	—			—			(20,658		)
Income before income taxes	23,800			7,565			—			31,365
Income tax expense	(277		)	(1,858		)	—			(2,135		)
Net income	$	23,523		$	5,707		$	—		$	29,230
Segment assets	$	3,904,454		$	262,378		$	—		$	4,166,832
Expenditures for segment assets	$	52,613		$	14,507		$	—		$	67,120



	Three Months Ended September 30, 2017
	Real Estate		Observatory		Intersegment Elimination			Total
Revenues:
Rental revenue	$	122,391	$	—	$	—		$	122,391
Intercompany rental revenue	23,301		—		(23,301		)	—
Tenant expense reimbursement	20,346		—		—			20,346
Observatory revenue	—		39,306		—			39,306
Lease termination fees	1,165		—		—			1,165
Third-party management and other fees	345		—		—			345
Other revenue and fees	2,993		—		—			2,993
Total revenues	170,541		39,306		(23,301		)	186,546
Operating expenses: