Empire State Realty Trust's (NYSE:ESRT) name says a lot about this real estate investment trust's (REIT's) purpose. But there are some very important things you need to understand about the business before you consider adding it to your investment portfolio.
In fact, once you dig in a little, you might find that you actually don't want to include this iconic landlord in the mix. Here's what you need to know.
A very rough patch
Empire State Realty Trust chose to suspend its third- and fourth-quarter 2020 common dividends in late August. That's not something any REIT wants to do, given that the entire corporate structure is designed to pass dividend income on to shareholders. It's basically an admission that operating conditions are pretty bad.
In fairness, there's a very good reason why the real estate investment trust is struggling today: the global coronavirus pandemic. In fact, there are a lot of REITs that have been forced to cut their dividends as they look to muddle through an economic recession, the increasing number of people working from home, and the introduction of social distancing.
But that doesn't change the big picture for Empire State Realty right now. To put a number on the troubles, its property portfolio was roughly 86% occupied at the end of the third quarter, down from just shy of 90% a year earlier. And while it collected 92% of the rent it was owed in October, that's clearly not as good as 100%.
Some finer details
But there's another layer here that investors need to understand. Occupancy at the company's flagship property, the Empire State Building, was roughly 86.5% in September, down from nearly 93.5% a year ago. This single building accounts for roughly a third of the REIT's rental income. That's a huge amount of concentration in one asset. Worse still, the pandemic has reduced the Empire State Building's observation tower accounts. Those accounts make up roughly 40% of that building's rent roll. So not only is the property disproportionately important to the REIT's earnings, but a good chunk of the rent from the building is tied to tourism.
The story only gets more troublesome from there. While the Empire State Building is the biggest asset in Empire State Realty's portfolio, the REIT isn't exactly very diversified beyond that. Just six properties account for 73% of its top line. Doing some back-of-the-envelope math, that means that after the Empire State Building, five properties account for 40% of the company's rents. And all of them are located in and around New York City.
It shouldn't be much of a surprise then that the COVID-19 pandemic has hit Empire State Realty hard. The companies that rent space in the Manhattan office market still haven't brought employees back in any great numbers. And COVID-19-related travel restrictions mean that tourism isn't anywhere near normal either. Until there's an effective and widely available vaccine, which could take several more quarters, Empire State Realty will be facing material headwinds. And even when the world learns to deal with the coronavirus, there could be lingering impacts like an increasing prevalence of people working from home.
Too much of a good thing
It would be hard to suggest that owning an iconic property like the Empire State Building is bad. However, the fact that Empire State Realty Trust is so concentrated in a small number of properties, including its iconic namesake, is a bit troubling. Add in the heavy exposure to just one region and the concentration risk gets even worse.
You know that diversification is good for your portfolio, but it's also good for the portfolios of real estate investment trusts. Despite a big rally off its 2020 lows, Empire State isn't really appropriate for conservative dividend investors. More aggressive types might like the turnaround appeal of the New York focus, but they should make sure they fully understand the risks they are taking on here.