This Office REIT Has 1 Big Differentiator From the Competition

Empire State Realty Trust (ESRT 1.72%) is primarily an office REIT, owning the iconic Empire State Building and a portfolio of mostly office properties in the New York City area. However, keep in mind that the Empire State Building isn't just an office property -- it's also a must-see tourist attraction. 

In this Fool Live video clip, recorded on Jan. 28, Empire State Realty Trust CFO Christina Chiu explains the economics of the Empire State Building observatory and why it's such a differentiator for the company. 

Matt Frankel: The observatory, for those who don't know, just underwent a big renovation ending in 2019, if I'm not mistaken. It was probably the worst possible timing given the pandemic. Obviously, you couldn't have known that. But you just finished putting a lot of money into the observatory. The observatory makes up just a tiny portion of your square footage, but it's actually a pretty meaningful chunk of your revenue. Can you talk about just the economics of where the observatory fits in?

Christina Chiu: Sure, prior to COVID, we're fully operating with all our visitors, the observatory was 25% of the company's total net operating income. Clearly, it was a large portion of the business. We think it's a great business and you mentioned timing of CapEx being met. I think I can argue both ways. I understand what you mean. You spend the money and then you have a slowdown in the market.

But at the same time, it was very much a forward-looking perspective on keeping it a highly competitive top attraction, which is where we stand when you look across New York City attractions and across the various observatory options. I would say the capex was very well spent in terms of forward investing. We love the business because as New York City tourism recovers, its instantaneous contribution to the bottom line. It's sustained upside for the company.

It also is a great inflation hedge. You talk about pricing power and I think with tourism, with the ticket pricing, dynamic pricing, we're really able to get that translated across the business. Also as good high operating margins. During COVID, as the business slow down, we've demonstrated our ability to tightly manage expenses and bring that down depending on customer volumes. Having that strong margin and ability to flex is really important and the capex is spent. We don't have that. As the market recovers, it goes straight to the bottom.

I'd just add one more thing which is, we mention these attributes and you get very few data points on what these assets are worth over time. Not because they don't really trade. In 2021, we actually had two very strong data points. No. 1, KKR. Some of you might have read, bought majority stake in the edge over at Hudson Yards. Number two, Vanderbilt, New York Grand Central has the summit up top and they obtained very attractive financing that attributed a very high value to the summit. Both of which we think are very good data points to demonstrate these are institutional asset classes with very strong attributes.

Frankel: You mentioned the two other observations as, I guess you would call them. I grew up right here in New York. Every time I come back to the city, it seems like there's another building that's just taller than the ones built before it. The buildings just keep getting taller and taller. Do you see that as hurting your competitive advantage overtime with the observatory? Because it used to be the Empire State Building was the only place to go look at New York city for my end.

Chiu: Yeah, I think a couple of things. Any business, especially good businesses will attract competition. I think the fact that pricing power has been strong, you see where ticket prices are from other businesses, shows there is some pricing power. People are very attracted to experiences.

The second thing is differentiation and competitive standpoint. Empire State Building, observatory is an iconic attraction. We have that historical component. We're very brand relevant. The company and our marketing team has done a great job in maintaining that presence, that dominance. We have the 4th of July fireworks, fashion shows, there are lighting shows.

I think that authentic New York City iconic experience is a truly differentiating factor. The other attractions will bring their own factors. Some of them go for novelty, some of them are going for another thrilling or different perspective. There's something for everyone. Anybody in a dominant position can never sit pretty at the top and just say, we're dominant. I think it's a lot of work to continue to drive a positive experience. Great reviews from your visitors, continue to have presence in the space. How do you utilize social media and marketing to continue to command a leading spot among attractions? So, I think that iconic, authentic New York City is clearly a huge piece and the other parts are really managing the business very well.