Investing In The World’s Most Famous Office Building

This is the first in a 12-part series of articles by Swen Lorenz, reporting on easy-to-access investment opportunities in high quality real estate around the world. This month, Swen has travelled to the Big Apple to visit an American icon.

Of the world’s record-breaking real estate locations, none beats more records than that tiny island in the Hudson River – Manhattan!

Despite being just 87 square kilometres in size, it is home to a larger number of Fortune 500 corporate headquarters than any other metropolitan area in the US. Its economic output per square kilometre is mind-boggling, and that’s not just because of its role as the leading financial hub of the world’s largest economy. A few smaller US cities claim records in a number of other aspects, such as San Francisco’s extraordinarily high median income due to the tech elite’s sky-high salaries; San Francisco, however, is not on the same scale. Manhattan’s sheer overall size is staggering. Together with its neighbouring boroughs, which feed into its economy and provide its workforce, it has twice the economic output as the US’s next largest metropolitan area, Los Angeles.

As a real estate location, it has come a long way since changing hands in 1626 for beans and trinkets worth about $24. Being a densely populated island, space is naturally restricted in Manhattan which in turn fuels price increases. Following the most recent price spurt, the properties located in Manhattan represent a combined value of nearly $4 trillion – that’s $4,000 billion. To put this into context, just imagine four million suitcases containing a million dollars each.

Even in New York, prices sometimes fall

My first acquaintance with America’s foremost economic centre happened in 1990. Visiting as a high school student, I experienced Manhattan when it had reached its lowest point in decades: rampant crime, businesses leaving for greener pastures, and depressed real estate prices. It took a heavy-handed mayor, Rudolph “Rudy” Giuliani, to clean up the mess and get New York back on track.

No market goes up in a straight line, and that counts for New York property, too. The city experienced two major declines, both lasting longer than most investors would have kept their patience. Between 1974 and 1980, as well as from 1989 to 1996, prices declined.

However, despite such troughs, in the long run the market always did what the overall economy of New York does: outperform the rest of the US, and by a margin. Since 1974, prices are up eight-fold across the board.

But how does one best gain access to the growth of this market, especially as a typical private investor, with insufficient funds to buy a building or even a studio flat? (Especially since the latter can nowadays easily set you back half a million dollars.) And how can one avoid having to deal with nagging tenants, burst water pipes, and different legal systems?

Owning Manhattan through Real Estate Investment Trusts

Luckily for private investors, there is a convenient, safe and effective way for investing in Manhattan property, with a minimum investment that’s within any investor’s reach. They are called Real Estate Investment Trusts (REITs), and anyone with a brokerage account can buy into them.

REITs were designed as tax efficient investments funds purely aimed at investing in real estate. Among those focusing on Manhattan and the wider New York area, one that stands out is the Empire State Realty Trust, a $5 billion company listed on the New York Stock Exchange (ticker symbol: ESTR).

As its name indicates, this REIT holds one of the most treasured pieces of property of the New York real estate market and quite possibly the most famous historic office building in the world: the Empire State Building.

This landmark building is the flagship for the trust’s entire portfolio, of which it makes up nearly 30%. It’s located in the midtown district of Manhattan where demand for office space is particularly high. In order to make it attractive to modern companies, the building has undergone extensive refurbishments, including significant investments into energy-saving technology and other steps to make the offices greener and more sustainable. Its tenants now include tech companies such as LinkedIn and Shutterstock. These are more likely to be able to pay top dollar for space than many old economy companies, and they are also helping to give the building a more modern image. Occupancy is up from 75% since it was refurbished a few years ago to 84% currently, but has further to rise to catch-up with the current market average of over 90% occupancy.

The world-famous observatory deck is an additional feature of the building. A top New York City tourist attraction with 4.3 million visitors in 2014, it generated $111.5 million in revenue in 2014, double the equivalent figure 10 years ago. If ever there was a property investment that you could go to visit, inspect and enjoy yourself, the Empire State Building is it! On my own recent visit, I bought the express ticket to by-pass all queues and I paid a staggering $75. The platform is now open from 8am to 2am and despite nascent competition from the new platform in the World Trade Center, it is bound to go from strength to strength. King Kong climbed up the outside of the Empire State Building, and virtually every tourist visiting the city has the building high up on the priority list of once-in-a-lifetime visitor sites. Furthermore, to help compete with the new World Trade Center, the Rockefeller Center and other comparable sites, the management of the Empire State Building has recently been investing heavily in state-of-the-art, interactive attractions.

Besides the Empire State Building, the fund owns a further 8 high-rise buildings in Manhattan, which together with the Empire State Building make up 80% of the portfolio and offer a mix of office and retail space. A further 20% of the investments are located through the wider metropolitan area of New York. ESRT is clearly as pure a bet on the future of New York City’s economy as you can get. The company publishes the full list of its buildings and you can stroll around Manhattan for a day and visit all of them.

Is it a buy?

For a start, ESRT has funded its portfolio with 75% equity and just 25% debt. In other words, not only would an economic crisis be unlikely to lead to the company running into difficulties; there is even room to expand the portfolio further, and to do so without getting to an irresponsible debt level for quite some time. That makes it, at least for now, eminently suitable for long-term investors. There is also still significant scope for creating value through replacing older tenants, modernising space, and upping the rents of existing tenants – all of which the current management is currently doing.

The downside is that Manhattan real estate prices have now been increasing significantly for 5 years already. Is the market at its top? Will interest rate hikes lead to a downturn in real estate prices? As the historical figures show, the real estate market isn’t a one way street, not even in New York.

Trading at $19 per share, the REIT had earnings per share of $0.89 last year. With estimated earnings per share between $0.90 and $0.95 in 2015 and an expected dividend payment of $0.36 (yield: 1.9%), the shares aren’t extremely expensive, but it’s not a screaming bargain either. The company does not provide the “net asset value per share” that REITs used to provide in the past, and instead reports on the basis of earnings adjusted for depreciation and one-off sales gains. On balance, investors are not yet paying a huge premium to get in on this opportunity, but neither are they able to pick up these assets at a discount.

What’s in it for investors? The world’s super-wealthy have come to regard global mega-cities such as New York as a safety deposit box for their nest eggs, and properties in New York are bought as a long-term safe-haven asset. Much is to be said in favour of such an approach, and ESRT makes this strategy available to those who have more modest sums to invest. Outside of that, owning a stake in the Empire State Building is guaranteed to give you bragging rights at next week’s family party.

Next month: Swen pays a visit to Germany to check on opportunities there.