10-Q 1 esrt9-30x1510xq.htm 10-Q 10-Q


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, 2015
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.)
One Grand Central Place
60 East 42nd Street
New York, New York 10165
(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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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  (Do not check if a smaller reporting company)
 
Smaller reporting company  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
 
117,444,264
Class B Common Stock, par value $0.01 per share
 
1,127,650
(Class)
 
(Outstanding on November 2, 2015)
 
 

 




 
EMPIRE STATE REALTY TRUST, INC.
 
 
FORM 10-Q
 
 
TABLE OF CONTENTS
PAGE
PART 1.
FINANCIAL INFORMATION
 
 
 
 
ITEM 1.
FINANCIAL STATEMENTS
 
 
Condensed Consolidated Balance Sheets as of September 30, 2015 (unaudited) and December 31, 2014
2
 
Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2015 and 2014 (unaudited)
3
 
Condensed Consolidated Statements of Other Comprehensive Income for the three and nine months ended September 30, 2015 and 2014 (unaudited)
4
 
Condensed Consolidated Statements of Stockholders' Equity for the nine months ended September 30, 2015 (unaudited)
5
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014 (unaudited)
6
 
Notes to Condensed Consolidated Financial Statements (unaudited)
8
 
 
 
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
30
 
 
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
47
 
 
 
ITEM 4.
CONTROLS AND PROCEDURES
47
 
 
 
PART II.
OTHER INFORMATION
47
 
 
 
ITEM 1.
LEGAL PROCEEDINGS
48
 
 
 
ITEM 1A.
RISK FACTORS
48
 
 
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
48
 
 
 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
48
 
 
 
ITEM 4.
MINE SAFETY DISCLOSURES
48
 
 
 
ITEM 5.
OTHER INFORMATION
48
 
 
 
ITEM 6.
EXHIBITS
48
 
 
 
SIGNATURES
49










1




ITEM 1. FINANCIAL STATEMENTS
Empire State Realty Trust, Inc.
Condensed Consolidated Balance Sheets
(amounts in thousands, except share and per share amounts)
 
September 30, 2015
 
December 31, 2014
ASSETS
(unaudited)
 
 
Commercial real estate properties, at cost:
 
 
 
Land
$
201,196

 
$
201,196

Development costs
7,479

 
6,986

Building and improvements
2,036,187

 
1,931,681

 
2,244,862

 
2,139,863

Less: accumulated depreciation
(445,549
)
 
(377,552
)
Commercial real estate properties, net
1,799,313

 
1,762,311

Cash and cash equivalents
46,388

 
45,732

Restricted cash
64,899

 
60,273

Tenant and other receivables, net of allowance of $2,742 and $1,427 in 2015 and 2014, respectively
32,406

 
23,745

Deferred rent receivables, net of allowance of $99 and $420 in 2015 and 2014, respectively
116,208

 
102,104

Prepaid expenses and other assets
33,759

 
48,504

Deferred costs, net
338,466

 
370,460

Acquired below-market ground leases, net
385,849

 
391,887

Goodwill
491,479

 
491,479

Total assets
$
3,308,767

 
$
3,296,495

LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Mortgage notes payable
$
754,738

 
$
903,985

Senior unsecured notes
589,670

 
237,667

Unsecured term loan facility
265,000

 

Unsecured revolving credit facility
20,000

 

Term loan and credit facility

 
470,000

Accounts payable and accrued expenses
106,699

 
96,563

Acquired below-market leases, net
112,312

 
138,859

Deferred revenue and other liabilities
38,066

 
27,876

Tenants’ security deposits
49,672

 
40,448

Total liabilities
1,936,157

 
1,915,398

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, and 116,839,022 shares issued and 116,823,306 shares outstanding in 2015 and 106,044,560 shares issued and 106,030,449 shares outstanding in 2014
1,168

 
1,060

Class B common stock, $0.01 par value per share, 50,000,000 shares authorized, 1,130,728 and 1,161,438 shares issued and outstanding in 2015 and 2014, respectively
11

 
12

Additional paid-in capital
460,160

 
406,853

Accumulated other comprehensive loss
(1,903
)
 

Retained earnings
57,135

 
60,713

Total Empire State Realty Trust, Inc.'s stockholders' equity
516,571

 
468,638

Non-controlling interests in operating partnership
848,035

 
904,455

Private perpetual preferred units, $16.62 per unit liquidation preference, 1,560,360 issued and outstanding in 2015 and 2014
8,004

 
8,004

Total equity
1,372,610

 
1,381,097

Total liabilities and equity
$
3,308,767

 
$
3,296,495


The accompanying notes are an integral part of these financial statements 

2



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,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Rental revenue
$
110,903

 
$
106,152

 
$
333,827

 
$
288,566

Tenant expense reimbursement
23,096

 
20,034

 
59,878

 
49,491

Observatory revenue
35,702

 
35,684

 
84,525

 
83,374

Construction revenue

 
5,804

 
1,981

 
33,730

Third-party management and other fees
618

 
561

 
1,658

 
1,925

Other revenue and fees
5,460

 
1,206

 
10,565

 
7,829

Total revenues
175,779

 
169,441

 
492,434

 
464,915

Operating expenses:
 
 
 
 
 
 
 
Property operating expenses
41,664

 
38,291

 
122,051

 
109,300

Ground rent expenses
2,331

 
2,066

 
6,994

 
2,964

Marketing, general, and administrative expenses
10,182

 
10,071

 
28,395

 
29,786

Observatory expenses
7,284

 
7,109

 
21,681

 
21,210

Construction expenses

 
6,095

 
3,222

 
33,173

Real estate taxes
23,613

 
21,870

 
69,543

 
58,429

Acquisition expenses
193

 
2,647

 
193

 
3,382

Depreciation and amortization
45,169

 
37,880

 
126,216

 
96,632

Total operating expenses
130,436

 
126,029

 
378,295

 
354,876

Total operating income
45,343

 
43,412

 
114,139

 
110,039

Interest expense
(16,680
)
 
(17,674
)
 
(50,298
)
 
(46,640
)
Income before income taxes
28,663

 
25,738

 
63,841

 
63,399

Income tax expense
(2,578
)
 
(3,004
)
 
(3,283
)
 
(4,153
)
Net income
26,085

 
22,734

 
60,558

 
59,246

Private perpetual preferred unit distributions
(234
)
 
(241
)
 
(702
)
 
(241
)
Net income attributable to non-controlling interests
(14,631
)
 
(14,171
)
 
(34,378
)
 
(36,480
)
Net income attributable to common stockholders
$
11,220

 
$
8,322

 
$
25,478

 
$
22,525

 
 
 
 
 
 
 
 
Total weighted average shares:
 
 
 
 
 
 
 
Basic
115,900

 
97,729

 
112,741

 
96,226

Diluted
265,873

 
263,041

 
265,868

 
250,696

 
 
 
 
 
 
 
 
Earnings per share attributable to common stockholders:
 
 
 
 
 
 
 
Basic
$
0.10

 
$
0.09

 
$
0.23

 
$
0.23

Diluted
$
0.10

 
$
0.09

 
$
0.22

 
$
0.23

 
 
 
 
 
 
 
 
Dividends per share
$
0.085

 
$
0.085

 
$
0.255

 
$
0.255


The accompanying notes are an integral part of these financial statements

3



Empire State Realty Trust, Inc.
Condensed Consolidated Statements of Comprehensive Income
(unaudited)
(amounts in thousands)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Net income
$
26,085

 
$
22,734

 
$
60,558

 
$
59,246

Other comprehensive income (loss):


 


 


 


Unrealized loss on valuation of interest rate swap agreements
(4,384
)
 

 
(4,384
)
 

     Other comprehensive loss
(4,384
)
 

 
(4,384
)
 

Comprehensive income
21,701

 
22,734

 
56,174

 
59,246

Comprehensive income attributable to non-controlling interests
(12,151
)
 
(14,171
)
 
(31,897
)
 
(36,480
)
Comprehensive income attributable to common stockholders
$
9,550

 
$
8,563

 
$
24,277

 
$
22,766


The accompanying notes are an integral part of these financial statements


4



Empire State Realty Trust, Inc.
Condensed Consolidated Statements of Stockholders' Equity
For The Nine Months Ended September 30, 2015
(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, 2014
106,030

 
$
1,060

 
1,161

 
$
12

 
$
406,853

 
$

 
$
60,713

 
$
468,638

 
$
904,455

 
$
8,004

 
$
1,381,097

Conversion of operating partnership units and Class B shares to Class A shares
10,773

 
108

 
(30
)
 
(1
)
 
53,013

 

 

 
53,120

 
(53,120
)
 

 

Equity compensation:
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
 
 
 
 


LTIP units, net of forfeitures

 

 

 

 

 

 

 

 
3,965

 

 
3,965

Restricted stock, net of forfeitures
20

 

 

 

 
294

 

 

 
294

 

 

 
294

Dividends and distributions

 

 

 

 

 

 
(29,056
)
 
(29,056
)
 
(39,162
)
 
(702
)
 
(68,920
)
Net income

 

 

 

 

 

 
25,478

 
25,478

 
34,378

 
702

 
60,558

Unrealized loss on valuation of interest rate swap agreements

 

 

 

 

 
(1,903
)
 

 
(1,903
)
 
(2,481
)
 

 
(4,384
)
Balance at September 30, 2015
116,823

 
$
1,168

 
1,131

 
$
11

 
$
460,160

 
$
(1,903
)
 
$
57,135

 
$
516,571

 
$
848,035

 
$
8,004

 
$
1,372,610


The accompanying notes are an integral part of these financial statements


5



       
Empire State Realty Trust, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
(amounts in thousands)
 
Nine Months Ended September 30,
 
2015
 
2014
Cash Flows From Operating Activities
 
 
 
Net income
$
60,558

 
$
59,246

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
126,216

 
96,632

Amortization of deferred finance costs and debt premiums and discount
1,626

 
2,559

Amortization of acquired above- and below-market leases, net
(14,662
)
 
(8,480
)
Amortization of acquired below-market ground leases
5,873

 
2,602

Straight-lining of rental revenue
(15,165
)
 
(32,102
)
Equity based compensation
4,259

 
2,908

Increase (decrease) in cash flows due to changes in operating assets and liabilities:
 
 
 
Restricted cash
5,268

 
(4,689
)
Tenant and other receivables
(8,661
)
 
(2,475
)
Deferred leasing costs
(26,533
)
 
(9,049
)
Prepaid expenses and other assets
14,745

 
4,361

Accounts payable and accrued expenses
(4,107
)
 
(12,973
)
Deferred revenue and other liabilities
10,190

 
3,094

Net cash provided by operating activities
159,607

 
101,634

Cash Flows From Investing Activities
 
 
 
Decrease (increase) in restricted cash for investing activities
(672
)
 
5,162

Acquisition of real estate property, net of cash received

 
(186,588
)
Development costs
(493
)
 
(512
)
Additions to building and improvements
(103,835
)
 
(82,683
)
Net cash used in investing activities
(105,000
)
 
(264,621
)

The accompanying notes are an integral part of these financial statements























6




Empire State Realty Trust, Inc.
Condensed Consolidated Statements of Cash Flows (continued)
(unaudited)
(amounts in thousands)

 
Nine Months Ended September 30,
 
2015
 
2014
Cash Flows From Financing Activities
 
 
 
Repayment of mortgage notes payable
(143,903
)
 
(57,478
)
Proceeds from unsecured revolving credit facility
615,000

 

Repayments of unsecured revolving credit facility
(595,000
)
 

Proceeds from term loan and credit facility

 
295,600

Repayments of term loan and credit facility
(470,000
)
 
(265,000
)
Proceeds from senior unsecured notes
350,000

 
250,000

Proceeds from unsecured term loan
265,000

 

Deferred financing costs
(6,128
)
 
(3,192
)
Private perpetual preferred unit distributions
(702
)
 
(241
)
Dividends paid to common stockholders
(29,056
)
 
(24,601
)
Distributions paid to non-controlling interests in the operating partnership
(39,162
)
 
(39,926
)
Net cash (used in) provided by financing activities
(53,951
)
 
155,162

Net increase (decrease) in cash and cash equivalents
656

 
(7,825
)
Cash and cash equivalents—beginning of period
45,732

 
60,743

Cash and cash equivalents—end of period
$
46,388

 
$
52,918

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
49,305

 
$
42,226

Cash paid for income taxes
$
3,258

 
$
2,669

 
 
 
 
Non-cash investing and financing activities:
 
 
 
Building and improvements included in accounts payable and accrued expenses
$
47,029

 
$
36,192

Derivative instruments at fair values included in accounts payable and accrued expenses
4,384

 

Conversion of operating partnership units and Class B shares to Class A shares
53,120

 

Issuance of Class A Common Stock, Class B Common Stock, and operating partnership units in connection with the acquisition of real estate properties

 
379,328

Debt assumed with the acquisition of real estate properties

 
182,851

Acquisition of working capital, net of cash

 
(5,155
)

The accompanying notes are an integral part of these financial statements

7





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, or REIT, that owns, manages, operates, acquires, redevelops and repositions office and retail properties in Manhattan and the greater New York metropolitan area. We were organized as a Maryland corporation on July 29, 2011. Empire State Realty OP, L.P., our operating partnership, holds substantially all of our assets and conducts substantially all of our business.
As of September 30, 2015, 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 7.5 million rentable square feet of office space, including the Empire State Building. Our Manhattan office properties also contain an aggregate of 519,845 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, which we refer to herein as Metro Tower. As of September 30, 2015, our portfolio included four standalone retail properties located in Manhattan and two standalone retail properties located in the city center of Westport, Connecticut, encompassing 204,452 rentable square feet in the aggregate.
As of September 30, 2015, we owned approximately 44.1% of the aggregate operating partnership units in our operating partnership. We, as the sole general partner in our operating partnership, have responsibility and discretion in the management and control of our operating partnership, and the limited partners in our operating partnership, in such capacity, have no authority to transact business for, or participate in the management activities of, our operating partnership. Accordingly, our 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.
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, 2014 Annual Report on Form 10-K. Please review the Summary of Significant Accounting Policies set forth in our December 31, 2014 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. For purposes of comparison, certain items shown in the 2014 unaudited condensed consolidated financial statements have been reclassified to conform to the presentation used for 2015.
    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, 2014 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 of our annual observatory revenue, approximately 16.0% to

8



18.0% 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 as well as whether the entity is a variable interest entity (“VIE”) and we are 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. We had no VIEs as of September 30, 2015 and December 31, 2014.
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 percentage of completion on construction contracts, valuation of the allowance for doubtful accounts, and valuation of exchangeable senior unsecured notes 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.
Derivative Instruments
We are exposed to the effect of interest rate changes and manage these risks by following policies and procedures including the use of derivatives. To manage exposure to interest rates, derivatives are used primarily to fix the rate on debt based on floating-rate indices. We record all derivatives on the balance sheet at fair value. We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. For derivatives that qualify as cash flow hedges, we report the effective portion of changes in the fair value of a derivative designated as a hedge as part of other comprehensive income (loss) and subsequently reclassify the effective portion into income in the period that the hedged item affects income. We account for the ineffective portion of changes in the fair value of a derivative directly in income. Reported net income and equity may increase or decrease prospectively, depending on future levels of interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect on cash flows.

We measure the credit risk of our derivative instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Recently Issued or Adopted Accounting Standards
During September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments,

9



which requires an acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. Previously, adjustments to provisional amounts were applied retrospectively. This update requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. ASU No. 2015-16 will be effective for fiscal years beginning January 1, 2016 and subsequent interim periods. The implementation of this update is not expected to cause any material changes to our consolidated financial statements.
During June 2015, the FASB issued ASU No. 2015-10, Technical Corrections and Improvements, which contains amendments that represent changes to clarify the FASB Accounting Standards Codification (“Codification”), correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments in ASU No. 2015-10 that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. All other amendments will be effective upon its issuance. The implementation of this update did not and is not expected to cause any material changes to our consolidated financial statements.
During April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which amends the requirements for the presentation of debt issuance costs and requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU No. 2015-03 is effective for fiscal years, beginning after December 15, 2015 and interim periods within those fiscal years. The implementation of this update is not expected to cause any material changes to our consolidated financial statements other than the reclassification of debt issuance costs from assets to a reduction of liabilities on our consolidated balance sheets.
ASU No. 2015-03 was amended in August 2015 by ASU No. 2015-15, Interest - Imputation of Interest (Subtopic 835-30) - Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, to add to the Codification SEC staff guidance that the SEC staff will not object to an entity presenting the costs of securing line-of-credit arrangements as an asset, regardless of whether there are any outstanding borrowings. The SEC Observer to the Emerging Issues Task Force announced the staff guidance in response to questions that arose after the FASB issued ASU No. 2015-03.
During February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810) - Amendments to the Consolidation Analysis, which amends the criteria for determining which entities are considered VIEs, amends the criteria for determining if a service provider possesses a variable interest in a VIE and ends the deferral granted to investment companies for application of the VIE consolidation model. ASU No. 2015-02 is effective for fiscal years, beginning after December 15, 2015 and interim periods within those fiscal years. We are evaluating the impact of adopting this new accounting standard on our financial statements.
During January 2015, the FASB issued ASU No. 2015-01, Income Statement - Extraordinary and Unusual Items, which eliminates the concept of extraordinary items. However, the presentation and disclosure requirements for items that are either unusual or in nature or infrequent in occurrence remain and will be expanded to include items that are both unusual in nature and infrequent in occurrence. ASU No. 2015-01 is effective for periods beginning after December 15, 2015. We are evaluating the impact of adopting this new accounting standard on our financial statements.
During May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which will replace all current GAAP guidance related to revenue recognition and eliminate 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. This guidance will be effective beginning in 2017 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are evaluating the impact of adopting this new accounting standard on our financial statements.
ASU No. 2014-09 was amended in August 2015 by ASU No. 2015-14 Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU No. 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU No. 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.

10



During April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which changes the definition of a discontinued operation to include only those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. This guidance is effective prospectively for fiscal years beginning after December 15, 2014. The adoption of ASU No. 2014-08 did not have a material impact on our financial statements.        
3. Acquisitions
On July 15, 2014, we acquired the ground and operating lease at 112 West 34th Street (and the fee title to 122 West 34th Street) for $423.6 million, consisting of $87.7 million by assumption of existing mortgage debt, $106.9 million in cash and $229.0 million in shares of Class A and Class B common stock and Series PR Operating Partnership units (the "Series PR OP Units"). In connection with this transaction, we issued 1,217,685 shares of Class A common stock and 77,945 shares of Class B common stock at a share price of $16.65 and 12,457,379 Series PR OP Units at a unit price of $16.65.
On July 15, 2014, we acquired the ground lease at 1400 Broadway for $310.0 million, consisting of $80.0 million by assumption of existing mortgage debt, $79.7 million in cash and $150.3 million in shares of Class A and Class B common stock and Series PR OP Units. In connection with this transaction, we issued 1,338,488 shares of Class A common stock and 32,452 shares of Class B common stock at a share price of $16.65 and 7,658,516 Series PR OP Units at a unit price of $16.65.
4. Deferred Costs, Acquired Lease Intangibles and Goodwill
Deferred costs, net consisted of the following (amounts in thousands):  
 
September 30, 2015
 
December 31, 2014
Leasing costs
$
119,069

 
$
100,653

Acquired in-place lease value and deferred leasing costs
292,428

 
304,916

Acquired above-market leases
82,516

 
84,633

Financing costs
20,909

 
17,334

 
514,922

 
507,536

Less: accumulated amortization
(176,456
)
 
(137,076
)
Total deferred costs, net
$
338,466

 
$
370,460

Amortization expense related to deferred leasing costs was $4.1 million and $2.2 million for the three months ended September 30, 2015 and 2014, respectively, and $9.6 million and $7.0 million for the nine months ended September 30, 2015 and 2014, respectively. Amortization expense related to deferred financing costs was $1.1 million and $2.7 million for the three months ended September 30, 2015 and 2014, respectively, and $5.0 million and $5.1 million for the nine months ended September 30, 2015 and 2014, respectively, and was included in interest expense.
Amortizing acquired intangible assets and liabilities consisted of the following (amounts in thousands):
 
September 30, 2015
 
December 31, 2014
Acquired below-market ground leases
$
396,916

 
$
396,916

Less: accumulated amortization
(11,067
)
 
$
(5,029
)
Acquired below-market ground leases, net
$
385,849

 
$
391,887

 
September 30, 2015
 
December 31, 2014
Acquired below-market leases
$
(166,332
)
 
$
(169,805
)
Less: accumulated amortization
54,020

 
30,946

Acquired below-market leases, net
$
(112,312
)
 
$
(138,859
)

11



Amortization expense related to acquired lease intangibles was $9.8 million and $10.1 million for the three months ended September 30, 2015 and 2014, respectively, and $29.4 million and $20.7 million for the nine months ended September 30, 2015 and 2014, respectively. Rental revenue related to the amortization of below-market leases, net of above-market leases, was $4.8 million and $4.6 million for the three months ended September 30, 2015 and 2014, respectively, and $14.7 million and $8.5 million for the nine months ended September 30, 2015 and 2014, respectively.
As of September 30, 2015, 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.

5. Debt
Debt consisted of the following as of September 30, 2015 and December 31, 2014 (amounts in thousands):
 
 
 
 
 
As of September 30, 2015
 
 
Principal Balance as
of September 30, 2015
 
Principal Balance as
of December 31, 2014
 
Stated
Rate
 
Effective
Rate
(1)
 
Maturity
Date
(2)
 
Mortgage debt collateralized by:
 
 
 
 
 
 
 
 
 
 
Fixed rate mortgage debt
 
 
 
 
 
 
 
 
 
 
10 Union Square
$
20,380

 
$
20,641

 
6.00
%
 
6.74
%
 
5/1/2017
 
10 Bank Street
32,375

 
32,847

 
5.72
%
 
6.21
%
 
6/1/2017
 
1542 Third Avenue
18,327

 
18,628

 
5.90
%
 
6.57
%
 
6/1/2017
 
First Stamford Place
239,675

 
242,294

 
5.65
%
 
6.16
%
 
7/5/2017
 
1010 Third Avenue and 77 West 55th Street
27,200

 
27,595

 
5.69
%
 
6.37
%
 
7/5/2017
 
383 Main Avenue
29,418

 
29,852

 
5.59
%
 
6.01
%
 
7/5/2017
 
1333 Broadway
68,883

 
69,575

 
6.32
%
 
3.79
%
 
1/5/2018
 
1400 Broadway
 
 
 
 
 
 
 
 
 
 
(first lien mortgage loan)
68,977

 
69,689

 
6.12
%
 
3.34
%
 
2/5/2018
 
(second lien mortgage loan)
9,651

 
9,803

 
3.35
%
 
3.35
%
 
2/5/2018
 
112 West 34th Street
 
 
 
 
 
 
 
 
 
 
(first lien mortgage loan)
76,682

 
77,484

 
6.01
%
 
3.28
%
 
4/5/2018
 
(second lien mortgage loan)
9,671

 
9,763

 
6.56
%
 
3.58
%
 
4/5/2018
 
1350 Broadway
38,489

 
38,900

 
5.87
%
 
3.77
%
 
4/5/2018
 
Metro Center
98,430

 
99,845

 
3.59
%
 
3.67
%
 
11/5/2024
 
Total fixed rate mortgage debt
738,158

 
746,916

 
 
 
 
 
 
 
Floating rate mortgage debt
 
 
 
 
 
 
 
 
 
 
One Grand Central Place(3)

 
91,000

 
  
 
  
 

 
1359 Broadway(3)

 
44,146

 
 
 
 
 
 
 
Total floating rate mortgage debt

 
135,146

 
 
 
 
 
 
 
Total mortgage debt
738,158

 
882,062

 
 
 
 
 
 
 
Senior unsecured notes - exchangeable
250,000

 
250,000

 
2.63
%
 
3.93
%
 
8/15/2019
 
Senior unsecured notes:
 
 
 
 
 
 
 
 
 
 
   Series A
100,000

 

 
3.93
%
 
3.96
%
 
3/27/2025
 
   Series B
125,000

 

 
4.09
%
 
4.12
%
 
3/27/2027
 
   Series C
125,000

 

 
4.18
%
 
4.21
%
 
3/27/2030
 
Unsecured revolving credit facility
20,000

 

 
(4) 
 
(4) 
 
1/23/2019
 
Unsecured term loan facility
265,000

 

 
(5) 
 
(5) 
 
8/24/2022
 
Secured revolving credit facility

 
170,000

 
(4) 
 
(4) 
 
 
 
Secured term credit facility

 
300,000

 
(4) 
 
(4) 
 
 
 
Total principal
1,623,158

 
1,602,062

 
 
 
 
 
 
 
Unamortized premiums, net of unamortized discount
6,250

 
9,590

 
 
 
 
 
 
 
Total
$
1,629,408

 
$
1,611,652

 
 
 
 
 
 
 
______________


12



(1)
The effective rate is the yield as of September 30, 2015, 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)
Repaid in 2015.
(4)
The secured revolving and term credit facility was terminated on January 23, 2015 concurrent with entering into the unsecured revolving credit facility. At September 30, 2015, the unsecured revolving credit facility bears a floating rate at 30 day LIBOR plus 1.15%. The rate at September 30, 2015 was 1.34%.
(5)
The unsecured term loan facility bears a floating rate at 30 day LIBOR plus 1.60%. The rate at September 30, 2015 was 1.79%. Pursuant to a forward interest rate swap agreement, the LIBOR rate was fixed at 2.1485% for $265.0 million of the unsecured term loan facility for the period beginning on August 31, 2017 through maturity.
Principal Payments
Aggregate required principal payments at September 30, 2015 are as follows (amounts in thousands):
 
Year
Amortization
 
Maturities
 
Total
2015
$
3,014

 
$

 
$
3,014

2016
12,387

 

 
12,387

2017
10,070

 
355,761

 
365,831

2018
2,880

 
262,210

 
265,090

2019
2,188

 
270,000

 
272,188

2020 and thereafter
11,974

 
692,674

 
704,648

Total
$
42,513

 
$
1,580,645

 
$
1,623,158

Unsecured Revolving Credit Facility

On January 23, 2015, we entered into an unsecured revolving credit agreement, which is referred to herein as the “unsecured revolving credit facility,” with Bank of America, Merrill Lynch, Goldman Sachs and the other lenders party thereto. Merrill Lynch acted as joint lead arranger; Bank of America acted as administrative agent; and Goldman Sachs acted as syndication agent and joint lead arranger.

Concurrently with entering into the unsecured revolving credit facility, on January 23, 2015, we terminated our secured revolving and term credit facility and wrote off $1.3 million of deferred financing costs. In connection with the termination of the secured revolving and term credit facility, all of the guarantors thereunder were released from their guaranty obligations, all liens created thereby were terminated, and all collateral pledged thereunder was released.

The unsecured revolving credit facility is comprised of a revolving credit facility in the maximum original principal amount of $800.0 million. The unsecured revolving credit facility contains an accordion feature that would allow us to increase the maximum aggregate principal amount to $1.25 billion under specified circumstances. As of September 30, 2015, the unsecured revolving credit facility had an outstanding balance of $20.0 million.

Amounts outstanding under the unsecured revolving credit facility bear interest at a floating rate equal to, at our election, (x) a Eurodollar rate, plus a spread that ranges from 0.875% to 1.600% depending upon our leverage ratio and credit rating; or (y) a base rate, plus a spread that ranges from 0.000% to 0.600% depending upon our leverage ratio and credit rating. In addition, the unsecured revolving credit facility permits us to borrow at competitive bid rates determined in accordance with the procedures described in the unsecured revolving credit facility. We paid certain customary fees and expense reimbursements.

The initial maturity of the unsecured revolving credit facility is January 2019. 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 0.075% of the then outstanding commitments under the unsecured revolving credit facility.

The unsecured revolving credit facility includes the following financial covenants: (i) maximum leverage ratio of total indebtedness to total asset value of the loan parties and their consolidated subsidiaries will not exceed 60%, (ii) consolidated secured indebtedness will not exceed 40% of total asset value, (iii) tangible net worth will not be less than $745.4 million plus 75% of net equity proceeds received by us (other than proceeds received within ninety (90) days after the redemption, retirement or repurchase of ownership or equity interests in us up to the amount paid by us in connection with such redemption, retirement or repurchase, where, the net effect is that we shall not have increased our net worth as a result of any such proceeds), (iv) adjusted EBITDA (as defined in the unsecured revolving credit facility) to consolidated fixed charges will not be less than 1.50x, (v) the aggregate net operating income with respect to all unencumbered eligible properties to the portion of

13



interest expense attributable to unsecured indebtedness will not be less than 1.75x, (vi) the ratio of total unsecured indebtedness to unencumbered asset value will not exceed 60%, and (vii) consolidated secured recourse indebtedness will not exceed 10% of total asset value (provided, however, this covenant shall not apply at any time after we achieve a debt ratings from at least two of Moody’s, S&P and Fitch, and such debt ratings are Baa3 or better (in the case of a rating by Moody’s) or BBB- or better (in the case of a rating by S&P or Fitch)).

The unsecured revolving credit facility contains customary covenants, including limitations on liens, investment, debt, fundamental changes, and transactions with affiliates, and will require certain customary financial reports. The unsecured revolving credit facility contains 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, invalidity of loan documents, loss of real estate investment trust qualification, and occurrence of a change of control (defined in the definitive documentation for the unsecured credit facility).

As of September 30, 2015, we were in compliance with the covenants under the unsecured revolving credit facility. 

Secured Revolving and Term Credit Facility

As of December 31, 2014, the secured revolving and term credit facility had an outstanding balance of $470.0 million. The secured revolving and term credit facility was terminated on January 23, 2015 concurrent with entering into the unsecured revolving credit facility described above.

Senior Unsecured Notes

Exchangeable Senior Notes

During August 2014, we issued $250.0 million principal amount of 2.625% Exchangeable Senior Notes (“2.625% Exchangeable Senior Notes”) due August 15, 2019. For the three and nine months ended September 30, 2015, 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, 2014, total interest expense related to the Exchangeable Senior Notes was $1.3 million consisting of (i) the contractual interest expense of $0.9 million, (ii) the additional non-cash interest expense of $0.3 million related to the accretion of the debt discount, and (iii) the amortization of deferred financing costs of $0.1 million.

Series A, Series B, and Series C Senior Notes
During March 2015, we issued and sold an aggregate principal amount of $350 million senior unsecured notes consisting of $100 million of 3.93% Series A Senior Notes due 2025, $125 million of 4.09% Series B Senior Notes due 2027, and $125 million of 4.18% Series C Senior Notes due 2030 (together, the “Series A, B and C Senior Notes”). Interest on the Series A, B and C Senior Notes is payable quarterly.
    
The terms of the Series A, B and C Senior Notes agreement include customary covenants, including limitations on liens, investment, debt, fundamental changes, and transactions with affiliates and will require certain customary financial reports. It also requires compliance with financial ratios consistent with our unsecured revolving credit facility including a maximum leverage ratio, a maximum secured leverage ratio, a minimum amount of tangible net worth, a minimum fixed charge coverage ratio, a minimum unencumbered interest coverage ratio, a maximum unsecured leverage ratio and a maximum amount of secured recourse indebtedness.

The proceeds from the issuance of the Series A, B and C Senior Notes were used to repay outstanding mortgage debt, reduce amounts outstanding under the unsecured revolving credit facility and for other general corporate purposes. As of September 30, 2015, we were in compliance with the covenants under the Series A, B and C Senior Notes. 

Unsecured Term Loan Facility
During August 2015, we entered into a senior unsecured term loan facility, which is referred to herein as the “term loan facility” with Wells Fargo Bank, National Association, as administrative agent, Capital One, National Association, as syndication agent, PNC Bank, National Association, as documentation agent, and the lenders from time to time party thereto.


14



The term loan facility is in the original principal amount of up to $265.0 million, all of which was borrowed at closing. We may request incremental term loans up to an additional $100.0 million under specified circumstances, for a maximum aggregate principal amount not to exceed $365.0 million.

Amounts outstanding under the term loan facility bear interest at a floating rate equal to, at our election, (x) a LIBOR rate, plus a spread that ranges from 1.400% to 2.350% depending upon our leverage ratio and credit rating; or (y) a base rate, plus a spread that ranges from 0.400% to 1.350% depending upon our leverage ratio and credit rating. Pursuant to a forward interest rate swap agreement, we effectively fixed LIBOR at 2.1485% for $265.0 million of the term loan facility for the period beginning on August 31, 2017 through maturity. In connection with the closing of the term loan facility, we paid certain customary fees and expense reimbursements.

The term loan facility matures on August 24, 2022. We may prepay loans under the term loan facility at any time, subject to certain notice requirements. To the extent that we prepay all or any portion of a loan on or prior to August 24, 2017, we will pay a prepayment premium equal to (i) if such prepayment occurs on or prior to August 24, 2016, 2.00% of the principal amount so prepaid, and (ii) if such prepayment occurs after August 24, 2016 but on or prior to August 24, 2017, 1.00% of the principal amount so prepaid.

The terms of the term loan facility agreement include customary covenants, including limitations on liens, investment, debt, fundamental changes, and transactions with affiliates and will require certain customary financial reports. The term loan facility requires compliance with financial ratios including a maximum leverage ratio, a maximum secured leverage ratio, a minimum amount of tangible net worth, a minimum fixed charge coverage ratio, a minimum unencumbered interest coverage ratio, a maximum unsecured leverage ratio and a maximum amount of secured recourse indebtedness. It also contains customary events of default (subject in certain cases to specified cure periods). These terms in the term loan facility agreement are consistent with the terms under our unsecured revolving credit facility agreement.

The proceeds from the term loan facility were used to repay borrowings made under the unsecured revolving credit facility. As of September 30, 2015, we were in compliance with the covenants under the term loan facility.

6. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following as of September 30, 2015 and December 31, 2014 (amounts in thousands):
 
September 30, 2015
 
December 31, 2014
Accounts payable and accrued expenses
$
78,707

 
$
68,488

Payable to the estate of Leona M. Helmsley (1)
18,367

 
18,367

Interest rate swap agreements liability
4,384

 

Accrued interest payable
3,953

 
5,953

Due to affiliated companies
1,288

 
3,755

Accounts payable and accrued expenses
$
106,699

 
$
96,563

___________
(1)
Reflects a payable to the estate of Leona M. Helmsley in the amount of New York City transfer taxes which would have been payable in absence of the estate's exemption from such tax.

7. 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.
    

15



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, 2015, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $4.6 million. If we had breached any of these provisions at September 30, 2015, we could have been required to settle our obligations under the agreements at their termination value of $4.6 million.

As of September 30, 2015, we have three interest rate LIBOR swaps with effective dates of July 5, 2017 and August 31, 2017 and an aggregate notional value of $465.0 million, which fixes interest rates at 2.1485% and 2.5050%, and mature between August 24, 2022 and July 5, 2027. The notional value does not represent exposure to credit, interest rate or market risks. The fair value of these derivative instruments, which is included in accounts payable and accrued expenses on the condensed consolidated balance sheet, amounted to $4.4 million at September 30, 2015. These interest rate swaps have been designated as cash flow hedges and hedge the future cash outflows on our mortgage debt and also on our term loan facility that is subject to a floating interest rate. As of September 30, 2015, these cash flow hedges are deemed effective and an unrealized loss of $4.4 million is reflected in the condensed consolidated statements of comprehensive income. We estimate that the amount of the current balance held in accumulated other comprehensive loss that will be reclassified into interest expense within the next 12 months will be $0.0 million.

Fair Valuation
The estimated fair values at September 30, 2015 and December 31, 2014 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 derivative instruments, which is classified as Level 2, and measured on a recurring basis, is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. As of September 30, 2015, the carrying amount and fair value of such derivative financial instruments is $4.4 million and is included in accounts payable and accrued expenses on the condensed consolidated balance sheet.

The fair value of borrowings, which is classified as Level 3, is estimated by discounting the contractual cash flows of each debt to their present value using adjusted market interest rates, which is provided by a third-party specialist. The following table presents the aggregate carrying value of our debt and the corresponding estimates of fair value as of September 30, 2015 and December 31, 2014 (amounts in thousands):
 
 
September 30, 2015
 
December 31, 2014
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Mortgage notes payable
$
754,738

 
$
762,096

 
$
903,985

 
$
912,365

Senior unsecured notes - exchangeable
239,670

 
253,430

 
237,667

 
253,469

Senior unsecured notes - Series A, B and C
350,000

 
348,481

 

 

Unsecured revolving credit facility
20,000

 
20,000

 

 

Unsecured term loan facility
265,000

 
265,000

 

 

Term loan and credit facility

 

 
470,000

 
470,000

Disclosure about fair value of financial instruments is based on pertinent information available to us as of September 30, 2015 and December 31, 2014. 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.


16



8. Rental Income
We lease various office spaces to tenants over terms ranging from one to 16 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.
9. Commitments and Contingencies
Legal Proceedings
Except as described below, as of September 30, 2015, 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.
In March 2012, five putative class actions, or the "Original Class Actions," were filed in New York State Supreme Court, New York County by investors in certain of the Existing Entities (constituting the predecessor and the non-controlled entities) (the "Existing Entities") on March 1, 2012, March 7, 2012, March 12, 2012, March 14, 2012 and March 19, 2012. The plaintiffs asserted claims against our predecessor’s management companies, Anthony E. Malkin, Peter L. Malkin, the estate of Leona M. Helmsley, our operating partnership and us for breach of fiduciary duty, unjust enrichment and/or aiding and abetting breach of fiduciary duty. They alleged, among other things, that the terms of the consolidation and the process by which it was structured (including the valuation that was employed) are unfair to the investors in the Existing Entities, the consolidation provides excessive benefits to Malkin Holdings LLC (now our subsidiary) and its affiliates and the then-draft prospectus/consent solicitation with respect to the consolidation filed with the SEC failed to make adequate disclosure to permit a fully-informed decision about the consolidation. The complaints sought money damages and injunctive relief preventing the consolidation. The Original Class Actions were consolidated and co-lead plaintiffs’ counsel were appointed by the New York State Supreme Court by order dated June 26, 2012. Further, an underlying premise of the Original Class Actions, as noted in discussions among plaintiffs' counsel and defendants' counsel, was that the consolidation had been structured in such a manner that would cause investors in Empire State Building Associates L.L.C., 60 East 42nd St. Associates L.L.C. and 250 West 57th St. Associates L.L.C. (the “subject LLCs”) immediately to incur substantial tax liabilities.
The parties entered into a Stipulation of Settlement dated September 28, 2012, resolving the Original Class Actions. The Stipulation of Settlement recites that the consolidation was approved by overwhelming consent of the investors in the Existing Entities. The Stipulation of Settlement states that counsel for the plaintiff class satisfied themselves that they have received adequate access to relevant information, including the independent valuer's valuation process and methodology, that the disclosures in the Registration Statement on Form S-4, as amended, are appropriate, that the consolidation presents potential benefits, including the opportunity for liquidity and capital appreciation, that merit the investors' serious consideration and that each of the named class representatives intends to support the consolidation as modified. The Stipulation of Settlement further states that counsel for the plaintiff class are satisfied that the claims regarding tax implications, enhanced disclosures, appraisals and exchange values of the properties that would be consolidated into our company, and the interests of the investors in the Existing Entities, have been addressed adequately, and they have concluded that the settlement pursuant to the Stipulation of Settlement and opportunity to consider the proposed consolidation on the basis of revised consent solicitations are fair, reasonable, adequate and in the best interests of the plaintiff class.
The defendants in the Stipulation of Settlement denied that they committed any violation of law or breached any of their duties and did not admit that they had any liability to the plaintiffs.
The terms of the settlement include, among other things (i) a payment of $55.0 million, with a minimum of 80% in cash and maximum of 20% in freely-tradable shares of common stock and/or freely-tradable operating partnership units to be distributed, after reimbursement of plaintiffs' counsel's court-approved expenses and payment of plaintiffs' counsel's court-approved attorneys' fees (which are included within the $55.0 million settlement payment) and, in the case of shares of common stock and/or operating partnership units, after the termination of specified lock-up periods, to investors in the Existing Entities pursuant to a plan of allocation to be prepared by counsel for plaintiffs; (ii) defendants' agreement that (a) the Offering would be on the basis of a firm commitment underwriting; (b) if, during the solicitation period, any of the three subject LLCs' percentage of total exchange value is lower than what was stated in the final prospectus/consent solicitation with respect to the consolidation by 10% or more, such decrease would be promptly disclosed by defendants to investors in the subject LLCs; and (c) unless total gross proceeds of $600.0 million are raised in the Offering, defendants will not proceed with the consolidation without further approval of the subject LLCs; and (iii) defendants' agreement to make additional disclosures in the prospectus/

17



consent solicitation with respect to the consolidation regarding certain matters (which are included therein). Investors in the Existing Entities will not be required to bear any portion of the settlement payment. The payment in settlement of the Original Class Actions will be made by the estate of Leona M. Helmsley and affiliates of Malkin Holdings LLC (provided that none of Malkin Holdings LLC's affiliates that would become our direct or indirect subsidiary in the consolidation will have any liability for such payment) and certain investors in the Existing Entities who agree to contribute. We will not bear any of the settlement payment.
The settlement further provides for the certification of a class of investors in the Existing Entities, other than defendants and other related persons and entities, and a release of any claims of the members of the class against the defendants and related persons and entities, as well as underwriters and other advisors. The release in the settlement excludes certain claims, including but not limited to, claims arising from or related to any supplement to the Registration Statement on Form S-4 that is declared effective to which the plaintiffs' counsel objects in writing, which objection will not be unreasonably made or delayed, so long as plaintiffs' counsel has had adequate opportunity to review such supplement. There was no such supplement that plaintiff's counsel objected to in writing. The settlement was subject to court approval. It was not effective until such court approval is final, including the resolution of any appeal. Defendants continue to deny any wrongdoing or liability in connection with the allegations in the Original Class Actions.
On January 18, 2013, the parties jointly moved for preliminary approval of the settlement, for permission to send notice of the settlement to the class, and for the scheduling of a final settlement hearing. On January 28, 2013, six of the investors in Empire State Building Associates L.L.C. filed an objection to preliminary approval, and cross-moved to intervene in the Original Class Actions and for permission to file a separate complaint on behalf of the investors in Empire State Building Associates L.L.C. On February 21, 2013, the court denied the cross motion of such objecting investors, and the court denied permission for such objecting investors to file a separate complaint as part of the Original Class Actions, but permitted them to file a brief solely to support their allegation that the buyout would deprive non-consenting investors in Empire State Building Associates L.L.C. of “fair value” in violation of the New York Limited Liability Company Law. The court rejected the objecting investors’ assertion that preliminary approval be denied and granted preliminary approval of the settlement.
Pursuant to a decision issued on April 30, 2013, the court rejected the allegation regarding the New York Limited Liability Company Law and ruled in Malkin Holdings LLC’s favor, holding that such buyout provisions are legally binding and enforceable and that investors do not have the rights they claimed under the New York Limited Liability Company Law.
On May 2, 2013, the court held a hearing regarding final approval of the Original Class Actions settlement, at the conclusion of which the court stated that it intended to approve the settlement. On May 17, 2013, the court issued its Opinion and Order. The court rejected the objections by all objectors and upheld the settlement in its entirety. Of the approximately 4,500 class members who are investors in all of the Existing Entities included in the consolidation, 12 opted out of the settlement. Those who opted out will not receive any share of the settlement proceeds, but can pursue separate claims for monetary damages.
Also on May 17, 2013, the court issued its Opinion and Order on attorneys’ fees. Class counsel applied for an award of $15.0 million in fees and $295,895 in expenses, which the court reduced to $11.59 million in fees and $265,282 in expenses (which are included within the $55.0 million settlement payment).
The investors who challenged the buyout provision filed a notice of appeal of the court’s April 30, 2013 decision and moved before the appellate court for a stay of all proceedings relating to the settlement, including such a stay as immediate interim relief. On May 1, 2013, their request for immediate interim relief was denied. On May 13, 2013, Malkin Holdings LLC filed its brief in opposition to the motion for the stay. On June 18, 2013, the appellate court denied the motion for the stay. On July 16, 2013, these investors filed their brief and other supporting papers on their appeal of the April 30, 2013 decision, which are required to perfect the appeal. On September 4, 2013, Malkin Holdings LLC filed its brief on the appeal, and also moved to dismiss the appeal on the grounds that these investors lack standing to pursue it. Malkin Holdings LLC contended that these investors were not entitled to appraisal under the New York Limited Liability Company Law because, among other reasons (i) they are not members of Empire State Building Associates L.L.C., and only members have such rights; (ii) the transaction in question is not a merger or consolidation as defined by statute, and appraisal only applies in those transactions; and (iii) when Empire State Building Associates L.L.C. was converted into a limited liability company, the parties agreed that no appraisal would apply. Moreover, Malkin Holdings LLC contended that only the 12 investors who opted out of the class action settlement could pursue appraisal, because that settlement contains a broad release of (and there is an associated bar order from the court preventing) any such claims. Malkin Holdings LLC further noted that of the six investors attempting to pursue the appeal, only two had in fact opted out of the class action settlement. On September 13, 2013, these investors filed their reply brief on the appeal, and opposed the motion to dismiss. On September 19, 2013, Malkin Holdings LLC filed its

18



reply brief on the motion to dismiss. On October 3, 2013, the appeals court denied the motion to dismiss without prejudice to address the matter directly on the appeal, effectively referring the issues raised in the motion to the panel that was to hear the appeal itself. The appeals court heard argument on November 21, 2013, and in a Decision and Order dated February 25, 2014, it affirmed the trial court’s ruling.
In addition, on June 20, 2013, these same investors, and one additional investor who also opposed the settlement of the Original Class Action, filed additional notices of appeal from the trial court’s rulings in the Original Class Actions. These notices of appeal related to (i) the order entered February 22, 2013 granting preliminary approval of the Original Class Action settlement and setting a hearing for final approval; (ii) the order entered February 26, 2013, refusing to sign a proposed order to show cause for a preliminary injunction regarding the consolidation; (iii) an order entered April 2, 2013, denying the motion to intervene and to file a separate class action on behalf of Empire State Building Associates L.L.C. investors; (iv) the order entered April 10, 2013, refusing to sign the order to show cause seeking to extend the deadline for class members to opt out of the Original Class Action settlement; (v) the Final Judgment and Order entered May 17, 2013; (vi) the order entered May 17, 2013 approving the Original Class Action settlement; and (vii) the order entered May 17, 2013 awarding class counsel attorneys’ fees and costs. On January 6, 2014, Class counsel moved to dismiss these additional appeals on the grounds that they were not timely perfected by filing an appellate brief and record. On February 6, 2014, the appeals court granted the motion unless the appeals were perfected by March 17, 2014.
On March 27, 2014, the investors who challenged the buyout provision moved in the appellate court for reargument or in the alternative for leave to appeal the appeals court’s ruling to the New York Court of Appeals. Opposition to the motion was filed on April 7, 2014. The appellate court denied the motion on May 22, 2014. The investors moved in the New York Court of Appeals for leave to appeal on June 26, 2014. Opposition to this motion was filed on July 11, 2014 and the court dismissed the motion by order dated September 18, 2014. On October 20, 2014, the investors moved to re-argue that dismissal. That motion was denied on December 17, 2014, and counsel for these investors has represented that the investors do not intend to pursue further appellate review of the court’s April 30, 2013 ruling rejecting the challenge to the buyout provision. On March 3, 2015, plaintiffs' counsel filed a motion with the court for its approval of distribution of the net settlement fund. In that motion plaintiffs' counsel also asked for additional fees and expenses to be paid out of the fund. On March 20, 2015, Malkin Holdings LLC filed a response to that motion in which it supported distribution of the fund and took no position on additional fees and expenses. No opposition to the motion was filed and the court granted the motion. The parties are in the process of distributing the net settlement fund to the class.
On March 14, 2014, one of the investors who had filed a notice of appeal from the trial court’s rulings in the Original Class Actions noted above perfected an appeal from the court’s May 17, 2013 Final Judgment and Order and orders approving the Original Class Action Settlement and awarding class counsel attorneys’ fees and costs. By stipulation of all counsel to the appeal dated September 12, 2014, the appeal was dismissed with prejudice. No other appeals were filed by the March 17, 2014 deadline set by the appeals court in its February 6, 2014 order. The Original Class Actions Settlement is final and non-appealable.
In addition, commencing December 24, 2013, four putative class actions, or the "Second Class Actions," were filed in New York State Supreme Court, New York County, against Malkin Holdings LLC, Peter L. Malkin, Anthony E. Malkin and Thomas N. Keltner, Jr. on behalf of former investors in Empire State Building Associates L.L.C. Generally, the Second Class Actions alleged that the defendants breached their fiduciary duties and were unjustly enriched. One of the Second Class Actions named us and our operating partnership as defendants, alleging that they aided and abetted the breaches of fiduciary duty. The Second Class Actions were consolidated on consent, and co-lead class counsel was appointed by order dated February 11, 2014. A Consolidated Amended Complaint was filed February 7, 2014, which did not name us or our operating partnership as defendants. It seeks monetary damages. On March 7, 2014, defendants filed a motion to dismiss the Second Class Actions, which the plaintiffs opposed and was fully submitted to the court on April 28, 2014. The court heard oral arguments on the motion on July 7, 2014, and the motion to dismiss was granted in a ruling entered July 21, 2014. The plaintiffs filed a notice of appeal on August 8, 2014. On January 12, 2015, the plaintiffs filed a motion to supplement the record on appeal to include additional materials from the Original Class Action, which the defendants opposed. The motion was denied on March 5, 2015. The plaintiffs perfected this appeal by filing their brief and the appellate record with the court on March 23, 2015. Oral argument on the appeal is scheduled for October 28, 2015.
We will incur costs in connection with this litigation. If an appeal were successful and the court were ultimately to rule against the defendants there is a risk that it could have a material adverse effect on us, which could take the form of monetary damages or other equitable relief. At this time, due to the spectrum of remedies which may result from the outcome of the matter and the difficulty in calculating and allocating damages (if any) among the defendants, we cannot reasonably assess the timing or outcome of this litigation and any related indemnification obligations, estimate the amount of loss, or assess their effect, if any, on our financial statements.

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On or about October 14, 2014, the 12 investors (out of approximately 4,500 investors covered by the Original Class Actions) who opted out of the Original Class Actions filed an arbitration with the American Arbitration Association against Peter L. Malkin, Anthony E. Malkin, Thomas N. Keltner, Jr., and Malkin Holdings LLC, as respondents, alleging breach of fiduciary duty and related claims in connection with the consolidation. The statement of claim in that arbitration seeks monetary damages and declaratory relief. The respondents filed an answering statement and counterclaims. On December 18, 2014, these claimants also filed a complaint in the United States District Court for the Southern District of New York alleging the same claims that they asserted in the arbitration. As alleged in the complaint, the claimants filed this lawsuit to toll the statute of limitations on their claims in the event it is determined that the claims are not subject to arbitration, and they plan to move to stay the lawsuit in favor of the pending arbitration. On February 2, 2015, the claimants filed an amended complaint adding an additional claim and making other non-substantive modifications to the original complaint. On March 12, 2015, the court stayed the action on consent of all parties pending the arbitration. Discovery in the arbitration is proceeding and the hearings are scheduled to commence May 28, 2016.
The arbitration is in its early stages, and, as with the prior claims challenging the consolidation and related matters, the defendants believe these allegations are entirely without merit, and they intend to defend vigorously.
    In connection with the Offering and formation transactions, we entered into indemnification agreements with our directors, executive officers and chairman emeritus, providing for the indemnification by us for certain liabilities and expenses incurred as a result of actions brought, or threatened to be brought, against them. As a result, Anthony E. Malkin, Peter L. Malkin and Thomas N. Keltner, Jr. have defense and indemnity rights from us with respect to the Second Class Actions and the above-referenced arbitration.
Additionally, there is a risk that other third parties will assert claims against us, Malkin Holdings LLC, or any other party entitled to defense and indemnity from us, including, without limitation, claims that Malkin Holdings LLC breached its fiduciary duties to investors in the Existing Entities or that the consolidation violates the relevant operating agreements, and third parties may commence litigation related to such claims. As a result, we may incur costs associated with defending or settling such litigation or paying any judgment if we lose.
Unfunded Capital Expenditures
At September 30, 2015, we estimate that we will incur approximately $65.7 million of capital expenditures (including tenant improvements and leasing commissions) on our consolidated properties pursuant to existing lease agreements. We expect to fund these capital expenditures with operating cash flow, additional property level mortgage financings, our unsecured revolving credit facility, other issuances of debt, and cash on hand. 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, 2015 are as follows (amounts in thousands):
2015
$
378

2016
1,518

2017
1,518

2018
1,518

2019
1,518

Thereafter
58,248

 
$
64,698


Concentration of Credit Risk
Financial instruments that subject us to credit risk consist primarily of cash, restricted cash, tenant and other receivables and deferred rent receivables. At September 30, 2015, we held on deposit at various major financial institutions cash and cash equivalents and restricted cash 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

20



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, 2015, 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, 2015, our 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.
10. Equity
Shares and Units
An operating partnership unit ("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 our 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 the 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 our operating partnership. Each LTIP unit awarded will be deemed equivalent to an award of one share of stock under the Empire State Realty Trust, Inc. and Empire State 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. Cash distributions on each LTIP unit, whether vested or not, will be the same as those made on the OP Units. Under the terms of the LTIP units, our 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 our operating partnership on a one-for-one basis.
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 September 30, 2015
 
Nine Months Ended September 30, 2015
Net income attributable to common stockholders
 
$
11,220

 
$
25,478

Increase in additional paid-in capital for the conversion of OP Units into common stock
 
24,428

 
53,013

Change from net income attributable to common stockholders and transfers from noncontrolling interests
 
$
35,648

 
$
78,491

As of September 30, 2015, there were 267,579,408 OP Units outstanding, of which 117,954,034, or 44.1%, were owned by us and 149,625,374, or 55.9%, were owned by other limited partners, including certain directors, officers and other members of executive management.

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Dividends and Distributions
Total dividends paid to common stockholders were $10.0 million and $29.0 million for the three and nine months ended September 30, 2015, respectively, and $8.3 million and $24.6 million for the three and nine months ended September 30, 2014, respectively. Total distributions paid to OP unitholders, excluding inter-company distributions, were $12.8 million and $39.2 million for the three and nine months ended September 30, 2015, respectively, and $14.4 million and $39.9 million for the three and nine months ended September 30, 2014, respectively. Total distributions paid to preferred unitholders were $0.2 million and $0.7 million for the three months and nine months ended September 30, 2015, respectively, and $0.2 million for the three and nine months ended September 30, 2014.
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, 2015, 10.2 million shares of common stock remain available for future issuance.
In January 2015, we made a grant of LTIP units to an employee under the 2013 Plan. We granted a total of 9,531 LTIP units with a fair market value of $0.2 million. The award is subject to time-based vesting and all LTIP units vest on April 1, 2020, subject generally to the grantee's continued employment.
In February 2015, we made grants of LTIP units to executive officers under the 2013 Plan. At such time, we granted a total of 168,033 LTIP units that are subject to time-based vesting and 154,266 LTIP units that are subject to performance-based vesting, with fair market values of $2.9 million for the time-based vesting awards and $1.3 million for the performance-based vesting awards. The awards subject to time-based vesting vest ratably over four years from January 1, 2015, subject generally to the grantee's continued employment. The first installment vests on the first-year anniversary date of January 1, 2015 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, 2015. 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, 2018 and the second installment vesting on January 1, 2019, subject generally to the grantee's continued employment on those dates.

In February 2015, we made grants of LTIP units and restricted stock to certain other employees under the 2013 Plan. At such time, we granted a total of 33,398 LTIP units and 14,315 shares of restricted stock that are subject to time-based vesting and 33,398 LTIP units and 14,315 shares of restricted stock that are subject to performance-based vesting, with fair market values of $0.8 million for the time-based vesting awards and $0.4 million for the performance-based vesting awards. The awards subject to time-based vesting vest ratably over four years from January 1, 2015, subject generally to the grantee's continued employment. The first installment vests on the first-year anniversary date of January 1, 2015 and the remainder will vest thereafter in three equal annual installments. The vesting of the awards 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, 2015. Following the completion of the three-year performance period, our compensation committee will determine the number of LTIP units or shares to which the grantee is entitled based on our performance relative to the performance hurdles set forth in the award agreements the grantee entered into in connection with the award grant. These units and shares then vest in two installments, with the first installment vesting on January 1, 2018 and the second installment vesting on January 1, 2019, subject generally to the grantee's continued employment on those dates.

In February 2015, we made a grant of LTIP units to an executive officer under the 2013 Plan. At such time, we granted a total of 13,736 LTIP units that are subject to time-based vesting and 13,736 LTIP units that are subject to performance-based vesting, with fair market values of $0.2 million for the time-based vesting awards and $0.1 million for the performance-based vesting awards. The awards subject to time-based vesting vest ratably over four years from the date of the grant, subject generally to the grantee's continued employment. The first installment vests on the first-year anniversary date of the grant 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 February 1, 2015. 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

22



award grant. These units then vest in two installments, with the first installment vesting on February 1, 2018 and the second installment vesting on February 1, 2019, subject generally to the grantee's continued employment on those dates.

In June 2015, we made grants of LTIP units to our non-employee directors under the 2013 Plan. At such time, we granted a total of 35,082 LTIP units that are subject to time-based vesting, with fair market values of $0.6 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.
We have made other grants during 2015 with fair market values of less than $0.1 million in the aggregate.
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 units and restricted stock grants that are time-vesting, we estimate the stock compensation expense based on the fair value of the stock at the grant date.
Share-based compensation expense has been adjusted by an amount of estimated forfeitures. Forfeitures are estimated based on historical experience at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Based on an analysis of historical data, we have calculated a 0% annual forfeiture rate for members of the Board of Directors, a 0% annual forfeiture rate for executive officers, and for all other employees a 5% annual forfeiture rate. We reevaluate this analysis periodically and adjust these estimated forfeiture rates as necessary. To the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised.
LTIP units and restricted stock issued during the nine months ended September 30, 2015 were valued at $6.6 million. The weighted-average per unit or share fair value was $13.36 for grants issued in 2015. The per unit or share granted in 2015 was estimated on the respective dates of grant using the following assumptions: an expected life of 3.0 and 2.9 years, a dividend rate of 1.90%, a risk-free interest rate of 0.8% and 1.0%, and an expected price volatility between 24.0% and 29.0%.
No other stock options, dividend equivalents, or stock appreciation rights were issued or outstanding in 2015.
The following is a summary of restricted stock and LTIP unit activity for the nine months ended September 30, 2015:
 
Restricted Stock
 
LTIP Units
 
Weighted Average Grant Price
Unvested balance at December 31, 2014
102,296

 
1,194,660

 
$
13.78

Vested
(7,405
)
 
(59,875
)
 
15.00

Granted
30,020

 
461,180

 
18.11

Forfeited
(8,977
)
 
(5,544
)
 
16.11

Unvested balance at September 30, 2015
115,934

 
1,590,421

 
$
14.96

The LTIP unit and restricted stock award agreements 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 $0.5 million for the nine months ended September 30, 2015 and $0.3 million for the nine months ended September 30, 2014. Unrecognized compensation expense was $0.2 million at September 30, 2015, which will be recognized over a period of 1.4 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 $1.4 million and $3.8 million for the three and nine months ended September 30, 2015, respectively, and $0.9 million and $2.8 million for the three and nine months

23



ended September 30, 2014, respectively. Unrecognized compensation expense was $11.6 million at September 30, 2015, which will be recognized over a weighted average period of 2.5 years.
Earnings Per Share
Earnings per share for the three and nine months ended September 30, 2015 and 2014 is computed as follows (amounts in thousands, except per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2015
 
September 30, 2014
 
September 30, 2015
 
September 30, 2014
Numerator - Basic:
 
 
 
 
 
 
 
Net income
$
26,085

 
$
22,734

 
$
60,558

 
$
59,246

Private perpetual preferred unit distributions
(234
)
 
(241
)
 
(702
)
 
(241
)
Net income attributable to non-controlling interests
(14,631
)
 
(14,171
)
 
(34,378
)
 
(36,480
)
Earnings allocated to unvested shares
(7
)
 
(8
)
 
(19
)
 
(27
)
Net income attributable to common stockholders - basic
$
11,213

 
$
8,314

 
$
25,459

 
$
22,498

 
 
 
 
 
 
 
 
Numerator - Diluted:
 
 
 
 
 
 
 
Net income
$
26,085

 
$
22,734

 
$
60,558

 
$
59,246

Private perpetual preferred unit distributions
(234
)
 
(241
)
 
(702
)
 
(241
)
Earnings allocated to unvested shares and LTIP units
(161
)
 
(127
)
 
(425
)
 
(374
)
Net income attributable to common stockholders - diluted
$
25,690

 
$
22,366

 
$
59,431

 
$
58,631

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average shares outstanding - basic
115,900

 
97,729

 
112,741

 
96,226

Operating partnership units
149,973

 
165,312

 
153,127

 
154,470

Weighted average shares outstanding - diluted
265,873

 
263,041

 
265,868

 
250,696

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.10

 
$
0.09

 
$
0.23

 
$
0.23

Diluted
$
0.10

 
$
0.09

 
$
0.22

 
$
0.23

There were 802,462 and 692,209 antidilutive shares and LTIP units for the three and nine months ended September 30, 2015, respectively, and 674,642 and 607,654 antidilutive shares and LTIP units for the three and nine months ended September 30, 2014, respectively.

11. Related Party Transactions

Supervisory Fee Revenue

We earned supervisory fees from affiliated entities not included in our condensed consolidated financial statements of $0.5 million and $0.5 million for the three months ended September 30, 2015 and 2014, respectively, and $1.4 million and $1.6 million for the nine months ended September 30, 2015 and 2014, respectively. These fees are included within third-party management and other fees.
Property Management Fee Revenue
We earned property management fees from affiliated entities not included in our condensed consolidated financial statements of $0.1 million and $0.1 million for the three months ended September 30, 2015 and 2014, respectively, and $0.2 million and $0.3 million for the nine months ended September 30, 2015 and 2014, respectively. These fees are included within third-party management and other fees.
Other

24



We are reimbursed at allocable cost for 647 square feet of shared office space, equipment, and administrative support, as was done prior to our formation, and we receive rent generally at market rental rate for 3,074 square feet of leased space, from entities affiliated with Anthony E. Malkin at one of our properties aggregating $0.06 million and $0.02 million for the three months ended September 30, 2015 and 2014, respectively and $0.2 million and $0.1 million for the nine months ended September 30, 2015 and 2014, respectively. In each case the space is expected to be temporary, and such affiliate has the right to cancel such lease without special payment on 90 days’ notice.
12. 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 transfers as if the sales or transfers were to third parties, that is, at current market prices. We include our historical construction operation in "Other," and it includes all activities related to providing construction services to tenants and to other entities within and outside our company. As of March 27, 2015, we no longer solicited new business for our construction management business. We completed all projects that were in progress.

The following tables provide components of segment profit for each segment for the three and nine months ended September 30, 2015 and 2014 (amounts in thousands):


25



 
 
Three Months Ended September 30, 2015
 
 
Real Estate
 
Observatory
 
Other
 
Intersegment Elimination
 
Total
Revenues:
 
 
 
 
 
 
 
 
 
 
Rental revenue
 
$
110,903

 
$

 
$

 
$

 
$
110,903

Intercompany rental revenue
 
20,828

 

 

 
(20,828
)
 

Tenant expense reimbursement
 
23,096

 

 

 

 
23,096

Observatory revenue
 

 
35,702

 

 

 
35,702

Construction revenue
 

 

 

 

 

Third-party management and other fees
 
618

 

 

 

 
618

Other revenue and fees
 
5,460

 

 

 

 
5,460

Total revenues
 
160,905

 
35,702

 

 
(20,828
)
 
175,779

Operating expenses:
 
 
 
 
 
 
 
 
 
 
Property operating expenses
 
41,664

 

 

 

 
41,664

Intercompany rent expense
 

 
20,828

 

 
(20,828
)
 

Ground rent expense
 
2,331

 

 

 

 
2,331

Marketing, general, and administrative expenses
 
10,182

 

 

 

 
10,182

Observatory expenses
 

 
7,284

 

 

 
7,284

Construction expenses
 

 

 

 

 

Real estate taxes
 
23,613

 

 

 

 
23,613

Acquisition expenses
 
193

 

 

 

 
193

Depreciation and amortization
 
45,072

 
97

 

 

 
45,169

Total operating expenses
 
123,055

 
28,209

 

 
(20,828
)
 
130,436

Total operating income
 
37,850

 
7,493

 

 

 
45,343

Interest expense
 
(16,680
)
 

 

 

 
(16,680
)
Income before income taxes
 
21,170

 
7,493

 

 

 
28,663

Income tax expense
 
(474
)
 
(2,104
)
 

 

 
(2,578
)
Net income
 
$
20,696

 
$
5,389

 
$

 
$

 
$
26,085

Segment assets
 
$
3,070,234

 
$
235,937

 
$
2,596

 
$

 
$
3,308,767

Expenditures for segment assets
 
$
39,915

 
$
187

 
$

 
$

 
$
40,102




26



 
 
Three Months Ended September 30, 2014
 
 
Real Estate
 
Observatory
 
Other
 
Intersegment Elimination
 
Total
Revenues:
 
 
 
 
 
 
 
 
 
 
Rental revenue
 
$
106,152

 
$

 
$

 
$

 
$
106,152

Intercompany rental revenue
 
19,986

 

 

 
(19,986
)
 

Tenant expense reimbursement
 
20,034

 

 

 

 
20,034

Observatory revenue
 

 
35,684

 

 

 
35,684

Construction revenue
 

 

 
7,292

 
(1,488
)
 
5,804

Third-party management and other fees
 
561

 

 

 

 
561

Other revenue and fees
 
1,206

 

 

 

 
1,206

Total revenues
 
147,939

 
35,684

 
7,292

 
(21,474
)
 
169,441

Operating expenses:
 
 
 
 
 
 
 
 
 
 
Property operating expenses
 
38,291

 

 

 

 
38,291

Intercompany rent expense
 

 
19,986

 

 
(19,986
)
 

Ground rent expense
 
2,066

 

 

 

 
2,066

Marketing, general, and administrative expenses
 
10,071

 

 

 

 
10,071

Observatory expenses
 

 
7,109

 

 

 
7,109

Construction expenses
 

 

 
7,355

 
(1,260
)
 
6,095

Real estate taxes
 
21,870

 

 

 

 
21,870

Acquisition expenses
 
2,647

 

 

 

 
2,647

Depreciation and amortization
 
37,797

 
79

 
4

 

 
37,880

Total operating expenses
 
112,742

 
27,174

 
7,359

 
(21,246
)
 
126,029

Total operating income (loss)
 
35,197

 
8,510

 
(67
)
 
(228
)
 
43,412

Interest expense
 
(17,674
)
 

 

 

 
(17,674
)
Income (loss) before income taxes
 
17,523

 
8,510

 
(67
)
 
(228
)
 
25,738

Income tax expense
 
(94
)
 
(2,857
)
 
(53
)
 

 
(3,004
)
Net income (loss)
 
$
17,429

 
$
5,653

 
$
(120
)
 
$
(228
)
 
$
22,734

Segment assets
 
$
3,038,363

 
$
255,081

 
$
8,572

 
$

 
$
3,302,016

Expenditures for segment assets
 
$
422,175

 
$
99

 
$

 
$

 
$