Earnings Call Transcript - ESRT Q2 2020

Operator, Operator

Greetings and welcome to the Empire State Realty Trust Second Quarter 2020 Earnings Call. As a reminder, this conference is being recorded.

Thomas Keltner, Executive Vice President and General Counsel

Good afternoon. Thank you for joining us today for Empire State Realty Trust's Second Quarter 2020 Earnings Conference Call. In addition to the press release distributed yesterday, a quarterly supplemental package with further detail on our results and our latest investor presentation were posted in the Investors section of the company's website at empirestaterealtytrust.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements as defined in applicable securities laws, including those related to market conditions, property operations, capital expenditures, income and expense. As a reminder, forward-looking statements represent management's current estimates. They are subject to risks and uncertainties including ongoing developments regarding the COVID-19 pandemic, which may cause actual results to differ from those discussed today. Empire State Realty Trust assumes no obligation to update any forward-looking statement in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements in the company's filings with the SEC. Certain of our disclosures today are added specifically in response to the SEC's direction on special additional disclosure due to the changes in our business, prompted by the COVID-19 pandemic and are unique to this instruction. We do not expect to maintain the same level of disclosure when we resume normal business operations. Finally, during today's call, we will discuss certain non-GAAP financial measures, such as FFO, modified and core FFO, NOI, cash NOI and EBITDA, which we believe are meaningful in evaluating the company's performance. Definitions and reconciliations of these measures to the most directly comparable GAAP measures are included in the earnings release and supplemental package, each available on the company's website. Now I will turn the call over to Tony Malkin, Chairman, President and Chief Executive Officer.

Anthony Malkin, Chairman, President and Chief Executive Officer

Thank you, Tom, and good afternoon to everyone. It is important to understand the significant challenges we have faced and continue to face since our last report on results. We have adapted to the ongoing changes, challenges, and the new normal, which reflects the effectiveness of our responses and our preparedness to continue navigating this period throughout the pandemic. This is a testament to the efforts of the entire ESRT team. We have made difficult decisions resulting in substantial changes in our organization, including reductions in force and costs that have positioned us favorably to preserve and create value for our shareholders. I want to take a moment to express my gratitude to my colleague, John Kessler, and extend my best wishes to him in his future endeavors. I also want to publicly welcome and congratulate our new CFO, Christina Chiu, on her outstanding contributions during her first three months. Her hard work has added significant value to ESRT and its stakeholders, and we will greatly benefit from her contributions in the years ahead. I am confident in the future of New York City and the essential role of office buildings for our current and future tenants, who will contribute to our economic recovery. I believe that the talented and driven individuals attracted to this city will continue to pursue their ambitions, contributing to a more inclusive American dream. ESRT is committed to being part of this transformation for the well-being of our city and its economy. Our leadership in innovation and redevelopment provides us with a competitive edge, and our buildings' unique locations and focus on sustainability have never been more crucial. ESRT has undergone significant changes and is now in a strong position for the future. To recap, our IPO plan included modernizing our properties for the 21st century, consolidating older spaces, and redeveloping them for larger, more stable tenants on longer leases. We aim to be leaders in energy efficiency and sustainability while maintaining a strong balance sheet to act on future opportunities. Our redevelopment plan is mostly complete, with just a small amount of leasing and space left to redevelop. The transformation of the Observatory was finished in December 2019 and received excellent reviews, leading to strong revenue growth in early 2020. We believe this investment will yield positive returns once tourism normalizes, and we are pleased to have reopened the Observatory in July 2020. We avoided external growth during peak market pricing and only began share repurchases when our stock price significantly declined. We have leased to tenants who have filled their spaces and expanded by over 1.7 million square feet. By the end of the quarter, we held $873 million in cash. We continue to engage in share buybacks at these lower valuations and have repurchased $119 million of our common stock at an average price of $8.67 per share. We believe these buybacks will benefit long-term shareholders. During the quarter, we made a series of management changes, in collaboration with our Board, to roll out our plans for ESRT 2.0. We presented our plans to the Board in late 2018, signaling the need for us to evolve from our IPO strategies towards new areas of focus, supported by fresh personnel and perspectives. Some new appointments include Suresh Rangarajan as Senior Vice President and Chief Technology Officer, Dana Robbins Schneider as Senior Vice President and Director of Energy and Sustainability, and Aaron Ratner as Senior Vice President and Chief Investment Officer. Aaron has expanded our team to maximize our ability to identify opportunities and utilize our capital for growth. We are approaching this as a long-term process and will invest when the right growth opportunities arise in the next few years. Our team has overcome the challenges presented by the COVID-19 pandemic as we transition from shelter-in-place to a phased return to the office, starting with our Connecticut properties and gradually implementing the same in New York. Our assets are well-prepared to meet evolving tenant demands for indoor environmental quality due to our redevelopment initiatives. We are ready to tackle each challenge with organized plans and execution based on our diverse experiences. With a solid balance sheet, we have conducted an extensive review of our cost structure, taking prudent actions to decrease operating costs, G&A, capital expenditures, and workforce. We have worked to cut general and administrative expenses by 12% for 2020 and have reduced property operating costs and capital expenditures for building improvements. We've implemented broad salary reductions across the organization and announced cuts to upcoming equity compensations. We are continuing to make permanent cuts to headcount and departmental budgets, in addition to savings related to COVID-19. We've achieved a $10 million reduction in property operating costs in the second quarter and expect to save another $12 million in the latter half of 2020. We have also decreased planned capital expenditures for 2020 by $24 million compared to 2019. These initial cost-cutting measures aim to strengthen our balance sheet and position ESRT for long-term success. We recognize that this is just the beginning, and we will continue to seek further reductions as we adapt to the current environment. We believe that the move toward remote work will have consequences for productivity, teamwork, and company culture. Companies that emphasize in-person collaboration will lead the way. The pandemic environment presents four phases: lockdown, post-lockdown without a vaccine or cure, post-vaccine or cure, and cleanup and assessment. We acknowledge the current challenges, including high unemployment and business failures, but we are ready to adapt to whatever lies ahead. New York City remains the premier global economic and cultural hub, and we believe people will return to work, live in, and visit this city. New York has a history of bouncing back stronger from difficulties, and we are eager to address these topics further in the Q&A session. Now I will turn the call over to my colleague, Tom Durels.

Thomas Durels, Executive Vice President

Thank you, Tony, and good afternoon, everyone. Today, I will comment on our second quarter leasing results, updates on rent collections and rent deferral requests, actions taken to reduce operating expenses and capital improvement costs, as well as our in-place health and safety protocols. In the second quarter, we signed 19 new and renewal leases totaling approximately 113,000 square feet. This included about 52,000 square feet in our Manhattan office properties, 47,000 square feet in our greater New York metropolitan office properties, and 14,000 square feet in our retail portfolio. The two most significant leases signed in the quarter were a 36,000 square foot office renewal lease with Ernst & Young at First Stamford Place and a 10,700 square foot retail renewal lease with Charles Schwab at One Grand Central Place. During the second quarter, rental rates on new and renewal office leases across our entire portfolio increased by 2.8% on a cash basis compared to the previous cash escalated rents. In our Manhattan office properties, new leases were signed at a positive cash rent spread of 8.7%. Our total portfolio leased percentage stands at 89.6%, reflecting a decrease of 150 basis points from the prior quarter. Occupancy saw a sequential decline of 310 basis points during the second quarter, primarily due to the anticipated move-out of two large tenants we previously announced. This includes the Empire State Building, which had a 157,250 square foot space vacated by Coty as part of a previously announced expansion lease with LinkedIn, set to commence over the next three years. Additionally, Thomson Reuters vacated 49,904 square feet in Metro Center. New leasing activity was affected during the second quarter by the pandemic and shelter-in-place rules that were in effect for much of the period. During this time, we implemented several online measures to maintain our relationships with brokers and showcase our availabilities in the market. While physical tours resumed on June 22, coinciding with the Phase 2 reopening, we expect lower leasing volumes for the third and fourth quarters based on current tenant demand. Regarding rent collections, we have seen steady monthly improvements, collecting 84% of total billings for the second quarter of 2020, with 86% for office tenants and 75% for retail tenants. By July 24, we had collected 90% of total July billings, with office tenants at 93% and retail tenants at 75%. These rates do not include any application of security deposits or adjustments for deferral agreements, which, to date, have generally been limited to no more than three months of rent or security deposit replenishment. For many local retail tenants facing significant challenges, we plan to convert the remaining fixed rents for 2020 to a percentage rent structure, allowing for the payback of the difference over a defined period. There is $42 million of revenue potential from free-rent burn-off and signed leases not yet commenced, as shown in our supplemental materials. We resumed nonessential construction on June 8 and updated the timing of lease commencements, specifically regarding the GAAP revenue component outlined in our supplemental. As previously noted, we scaled back certain building operations, which helped reduce costs until buildings are fully occupied. These actions lowered property operating expenses by approximately $10 million in the second quarter compared to the previous year and are expected to save another $12 million in operating expenses for the latter half of 2020. Most of these cost savings are related to COVID-19 and will likely diminish as occupancy increases. It's important to note that part of the reduction in operating expenses may be counterbalanced by a decrease in tenant expense recoveries. We have also implemented permanent cost-saving measures of around $4 million annually through staffing and other reductions. Our buildings are now fully open, and we have instituted health and safety protocols, including requiring temperature checks, face masks, and hand sanitization before entry; mandatory masks in common areas; footprint decals and signage; social distancing measures in elevators; hand sanitizer dispensers; and enhanced cleaning of high-touch surfaces. Additionally, we have a comprehensive indoor environmental quality program tailored to tenant requests, which includes MERV 13 filters, compliance with ASHRAE 62.1 Standards, increased ventilation, regular air and water quality testing, and thorough air and water system cleaning. As Tony mentioned, we have taken steps to reduce capital expenditures and are nearing completion of our redevelopment work. We now expect that capital expenditures for building improvements in 2020 will be approximately $24 million lower than in 2019 as we concentrate on mandatory spending and previously initiated work.

Christina Chiu, Executive Vice President and Chief Financial Officer

Thanks, Tom. I'd like to begin by saying that I'm very excited about joining ESRT in May of this year. Since then, I've worked closely with the various departments to ensure a smooth transition and to settle into this role. I met many of our investors and analysts virtually in May and June and look forward to meeting more of you over the coming months. Now let me start with our quarterly results. For the second quarter, we reported core FFO of $39 million or $0.14 per diluted share. This is net of $0.03 per share of expense from a reserve against tenant receivables and noncash reduction in straight-line rent balances and excludes $3 million in severance costs and a $4 million impairment charge, both of which I will address later. Same-store property operations, if you exclude one-time lease termination fees and Observatory results from the respective period, yielded an 18% cash NOI increase from the second quarter of 2019. This increase was primarily driven by lower property operating expenses, partially offset by a reserve against tenant receivables. When COVID-related rent deferrals are excluded, same-store property cash NOI increased 9.9% from the second quarter of 2019. More detail on rent deferrals and the breakdown of our collections can be found on Page 10 of the investor presentation. During the quarter, we recorded a number of unique items that are largely noncash and are added back to core FFO. Specifically, we recorded a $4.1 million noncash impairment charge related to the write-off of prior capitalized expenditures on a combined heat and power generation project for the Empire State Building that has been rendered economically unfeasible due to New York City's Local Law 97 and a $3 million one-time charge in G&A expenses related to the departure of our former COO, of which $2.7 million is the noncash accelerated vesting of equity compensation. We also reported a $9.1 million reduction in rental revenue in the second quarter comprised of $1.9 million reserve against tenant receivables and $7.2 million against straight-line rent balance. This equates to 1.6% of our annualized rental revenue as of June 30, 2020 and a $0.03 FFO impact. We reached this determination after a view of each tenant arrear status, security deposit balance and management's assessment of the path towards a resolution and viability of the tenant. Turning to our balance sheet. As of June 30, 2020, the company had total debt outstanding of approximately $2.5 billion on a gross basis and $1.6 billion on a net basis. The company's total debt has a weighted average interest rate of 3.41% and a weighted average term to maturity of 6.9 years. Our consolidated net debt-to-total market capitalization was 43.7% and consolidated net debt-to-EBITDA was 5.2x. We have no near-term debt maturities and a well-laddered maturity schedule. Our revolving credit facility expires in August 2021 and has 2 6-month extension options. Our next maturity isn't until November 2024. As we look ahead to the second half of the year, here are a few items to keep in mind. We noted earlier that we undertook a series of proactive steps to reduce our G&A expenses, property operating expenses and capital expenditures. Tom already covered property operating expenses and CapEx, so I will focus on G&A. We now anticipate 2020 expenses of $60 million, excluding one-time severance charges. This is approximately 12% less than the previously disclosed G&A run rate of $68 million that we provided on our 4Q 2019 earnings call. As detailed on Page 14 of the investor presentation, the reduction falls into 2 categories: named Executive Officer compensation and other corporate overhead. Named executive officer compensation reduction includes $400,000 from the reduction in annual base salary for Tony Malkin and Tom Durels through December 31, 2020, $1.2 million from the change in age requirement from 60 to 65 for the accounting vesting period for time-based equity compensation and $2.7 million from the departure of our former COO. Other corporate overhead reductions include $1.5 million of net savings from reductions in corporate staff and corporate salary reductions through December 31, 2020, partially offset by the addition of investment personnel, and the balance is from department budget cuts and lower anticipated spending due to COVID-19. As mentioned by Tony earlier, 2021 NEO annual equity compensation will be reduced by $3.9 million. We currently expect the 2021 G&A run rate to be approximately $58 million, and we will continue to seek efficiencies and cost reduction opportunities in operating our business. We believe these proactive measures, particularly on G&A expenses are aligned with our stakeholders and reflect our efforts to preserve cash and operate efficiently in uncertain times. We will continue to seek the right balance as market conditions evolve. Now I'll turn the call over to Tony to provide some thoughts on our Observatory business.

Anthony Malkin, Chairman, President and Chief Executive Officer

Thanks, Christina. Before we go to Q&A, here is an update on the observatory now that we have reopened the expense picture on a go-forward basis. We started the year on a strong basis following the completion of our Observatory redevelopment program in the fourth quarter of 2019. Revenue for the first 2 months was up 13.2% year-over-year, excluding the impact from the 102nd floor Observatory. This revenue growth occurred despite the absence of Chinese New Year activity in January and a pullback in visitor traffic in March from European countries where COVID-19 was rampant. We followed the mandate of government authorities and closed the Observatory on March 16, and the Observatory remained closed for the entire second quarter. The 86th floor Observatory reopened on July 20 with new protocols and processes under New York State's Phase 4 guidelines. We still await permission to reopen the 102nd floor. We have updated our hypothetical admissions ramp-up on Page 18 of our investor presentation. It assumes 2019 monthly levels as the baseline visitation comparison reference point and uses our reopening date of July 20, with a gradual ramp-up towards normalized levels by 2022. We have been open for just under 2 weeks now and slowly rebuild the beach that is our business one grain of sand at a time. Our focus on indoor environmental quality, in which we have been leaders for more than a decade, yielded air filtration through MERV 13 filters, an aggressive response to viruses with AtmosAir and a massive capacity to ventilate the Observatory as part of our redevelopment. Combined with comprehensive protocols and employee training, this has made it possible to reopen. Our expectations for a more gradual ramp-up are aligned with our channel checks with other Observatory operations around the world, which have seen to date a gradual volume buildup as they reopen in their respective countries to a 20% to 25% level of prior year's operations. We are confirmed in our anticipation initially that we will have a higher local visitor mix followed by a ramp-up of regionally than nationally sourced travel and then followed by a restoration of our typical visitor mix that is approximately 2/3 international. We do not think we'll achieve normalization until the broader resumption of international air travel, and we presently peg that for some time in 2022. While the Observatory was closed, we remained relevant and active in the promotion of our brand through numerous initiatives from our pandemic fire and lighting over the skyline of New York City to our partnership on the fourth of July with Macy's Fireworks finale with fireworks shot off the top of the Empire State Building. If you missed it, take a moment and look at our YouTube channel. You'll be impressed and entertained. With our July 20th reopening, we posted a detailed presentation to educate the general public that we are open for business and ready to welcome visitors in a safe and enjoyable environment and have since launched a social media push. No attraction in any city has higher brand value and international recognition than the Empire State Building Observatory, authentic and iconic. We believe when the pandemic passes, we will emerge stronger than ever and remain the brand and icon of New York City. On the expense side, we wanted to share an update on how to think about expenses as we reopened. Previously, we had communicated that we reduced our typical annualized expense run rate by 60% from $35 million in February to $14 million by May. In the second quarter, Observatory expenses totaled $4 million. Now that we have reopened, we calculate our annualized expense run rate to approximately $25.5 million. There are certain fixed staffing and operational costs, regardless of volume levels. For example, we need to maintain staffing to operate the real call desk, security, elevator loading unloading and deck attendance regardless of whether we have 1 or 1,000 visitors at a time. We believe that we have ample bandwidth to handle our anticipated ramp-up in admission volume through 60% of 2019 volume levels with current staffing. With this completed, I'd like to open the call for your questions. To keep the call moving, as always, we ask that each participant limit him or herself to 1 primary question and 1 follow-up. Please do feel free to rejoin the queue if you have additional questions. We will stay on the call as long as we have questions.

Operator, Operator

Our first questions come from the line of Craig Mailman of KeyBanc Capital Markets.

Craig Mailman, Analyst

Tony, I appreciate your comments at the beginning of the call regarding your long-term confidence in New York City. However, I have a question about the recent livability and quality-of-life issues we’ve encountered. While there is hope for improvement, it's uncertain how long it might take. At this stage, as you expand your investment team, are you considering exploring markets beyond the New York metro area that could be suitable for capital deployment?

Anthony Malkin, Chairman, President and Chief Executive Officer

Thanks very much for the question. I appreciate it. We really view ourselves as omnivorous opportunists. And at this point, in what I view as a 3 to 4 year opportunity, I really don't want to limit our options on anything. That said, we certainly have certain skills in New York City. I've lived through times of much greater livability challenges than we presently have in New York. And the fact is every dollar of capital that we have, we have to patiently and prudently evaluate all our options to look and focus on how we generate shareholder value. So while I would like to say that it's very straightforward. I think there are some things, which obviously would fit in with us clearly and comfortably, and there are other things, which might be out of the box, and we just have to look at it all against how we use our capital, anything from buying our own stock to buying debt, joint venturing, different product types, different locations.

Craig Mailman, Analyst

That's helpful. And then just on the retail portfolio, you guys have 17% of rents coming from that segment. As you guys are looking at the creditworthiness of those tenants, and I realize a lot of it is sort of amenity-based. What's the viability even with going to percentage rents of the majority of those tenants here as the pandemic kind of drags on and restaurant reopenings kind of keep getting kicked down the road?

Anthony Malkin, Chairman, President and Chief Executive Officer

I absolutely think that when it comes to food service, there are specific challenges. We need the bodies in the buildings in order to justify people and their activities. And as far as in-store dining, that's challenged by the fact that, frankly, people need to deploy the protocols that we have in our spaces, including our retail of MERV 13 filters, AtmosAir and fresh air ventilation. That said, I think that we'll see people pivot and flex. We're at 'percentage rent' if people aren't open and they're not doing sales, that means their rent is 0. And I think over time, our strong credits, our strong tenants, those rents are in the bag, and those people have long-term use. We may see failures in the smaller amenity-based tenants. And as people return to the offices, which they will, those people will either restart with new businesses, or we'll have other folks come in. We'll see a downward adjustment in rental pricing. And I think as far as retail in New York is concerned, there are certain very large boxes that have been occupied by tenants that won't be in business anymore that are permanently disabled and need to be redeveloped. And I think that there are certain areas geographically where retailers went or folks opened because that's where they could afford it, and they won't have a lot of business to do there, and they'll be able to get in better locations, more centrally located at better rents due to the free up of space.

Michael Bilerman, Analyst

Tony, just staying on in external growth. I think the way you've sort of framed the sort of 3- to 4-year opportunity seems to be a slower cadence than the excitement that you shared on the last quarter's call, which seemed coming to a fork in the road and taking it. It seemed a little bit more near term in terms of deploying that capital. Is that fair?

Anthony Malkin, Chairman, President and Chief Executive Officer

I believe, Michael, the main source of excitement for us is the turning point we're facing. We view everything as part of a long-term strategy. Successful real estate decisions for creating long-term value must withstand cyclical changes. We're not suggesting that these opportunities will appear strictly between years three and four. Instead, I believe we'll experience a downturn where pricing and efficiency will initially improve, followed by even better pricing effectiveness as more transactions occur. We'll also need to navigate the overall market recovery. Traditionally, this type of cycle creates buying opportunities that can extend over three to four years, and we're currently at the start of a downturn, entering a new cycle and having several months to deploy capital. Although we are actively involved, I'm very pleased with Aaron's progress. He has already selected two of the three hires he aimed to make, and one has been working with us for over a month. We're exploring a vast array of opportunities, including a few transactions we initially passed on or missed out on. Now, we can reassess the senior debt and other components, identifying chances to re-enter ventures we've previously analyzed. I hope this clarifies things, but feel free to ask more, and I'll do my best to explain further.

Michael Bilerman, Analyst

Yes, that's useful information to have. I know you implemented a stock buyback during the quarter. How does the current stock trading price influence your decisions on capital deployment, whether it's towards debt or assets in New York or elsewhere? What criteria do you and the Board, along with the management team, use for these decisions? Once the money is spent, it's gone, so how do you manage that aspect considering the stock is currently at significantly low levels?

Anthony Malkin, Chairman, President and Chief Executive Officer

That's a great question, thank you. I believe it's crucial to consider an important aspect of our cash management. We carefully evaluate capital allocation. When assessing new deals we are currently exploring, we compare them to how we would utilize our funds, including options like stock buybacks, dividends, and external reinvestments, while also considering the overall economic cycle. Additionally, we have a valuable partner in the Qatar Investment Authority, which has consistently shown a willingness to engage with us in worthwhile opportunities. I appreciate Aaron Ratner's background in joint ventures and his experience with institutional capital, which adds value beyond his previous work at TPG. We view our capital as a means that can be leveraged alongside others’, allowing us not only to invest but also to apply our expertise. As we continue to perform and distinguish ourselves in unique ways, I believe our stock price will improve. Moreover, we always have the option to form joint ventures, using our funds as seed capital for larger initiatives.

Elvis Rodriguez, Analyst

This is Elvis on for Jamie. Tony and maybe Christina, can you talk a little bit about sort of the lingering credit risks/write-downs that not only that occurred in the quarter, but could potentially occur in the future? How should we be thinking about sort of your portfolio versus some of the other write-downs that we've seen across the sector?

Anthony Malkin, Chairman, President and Chief Executive Officer

I'll start with this and then pass it to Christina. We can only write off rents that are actually owed to us but have not been paid. At that stage, we'll evaluate the cash component and also consider the straight-line component. We have been actively pursuing deferrals from tenants who haven't made payments. As you've noticed, we've achieved significant progress in our rent collections. I believe this is functioning without safety nets; it's a real-world scenario. I wouldn’t even refer to it as a trial run. As I mentioned last quarter, we are facing considerable challenges. This is the reality we are dealing with. Moving forward, I'll let Christina share her insights on how she’s approached this situation, collaborating with her team in leasing and real estate as we evaluate our collections.

Christina Chiu, Executive Vice President and Chief Financial Officer

Sure. I would like to direct your attention to Page 10, which provides an update on our total billings collection. It clearly lays out our month-by-month performance, which sums up to 100 on an unadjusted basis. To address your question, this reflects our efforts in determining write-offs and providing flexibility; we conduct a thorough review of each tenant's arrears in collaboration with the accounts receivable and leasing teams. We analyze the amount in arrears, the payment patterns, the security deposit balance to see if it suffices to cover those arrears, and management's perspective on how we can resolve the uncollected amounts and assess the tenant's long-term viability. This process led us to the $9.1 million write-down, where $1.9 million pertains to uncollected tenant balances that we need to monitor closely. The remainder of the write-down is from streamlining efforts, which we will keep under review. If you examine the chart, you will notice positive trends; in July, we achieved a 90% collection rate, completely unadjusted. We have a mix of uncollected amounts that are covered by security deposits as well as another category of uncollected balances. Improvements are evident, and as time progresses, we will continue to evaluate these categories carefully, taking write-downs when we determine that the likelihood of repayment is low.

Thomas Durels, Executive Vice President

As I mentioned earlier, we anticipate reducing operating expenses by $12 million in the second half of 2020 compared to the same period in 2019. Moving into 2021, we have cut $4 million in recurring staffing and other expenses, which are unrelated to COVID and represent permanent reductions. While a portion of our expenses will be recouped through operating expense escalations, you will notice a significant decline in these escalations as we continue to lower our expenses. Although we have not specified an exact figure, it will not be a full recovery, just a part of those expense reductions.

Unknown Analyst, Analyst

It's been just for a week since the Observatory reopened. I'm just curious how has the visitor traffic been so far? And are you considering any possible changes in pricing, either more in premium or conversely possibly promotions to attract more visitors?

Anthony Malkin, Chairman, President and Chief Executive Officer

Thank you for your question. We aren’t going to disclose any specific numbers during this call, but we can say that our visitor numbers are in line with our expectations. They are also consistent with the experiences of other tower operators around the world with whom we share insights. Most of these operators are observing that internal travel, primarily by car for short trips, has reached a range of 20% to 25% after a few months of operations. From this perspective, our results align well. We haven't altered our ticket pricing and do not plan to do so. The feedback on social media from our visitors has been excellent, with 5-star reviews, focusing on safety first, followed by the stunning views and experiences. As a result, we expect these positive reviews to encourage more visitors. The second week has shown stronger performance than the first, and our first weekend surpassed the previous week. We look forward to the upcoming weekend. Currently, almost all of our sales are made directly through our website. As other attractions in New York City, like museums, reopen and promotions for the city as a destination increase, our previous partners and online travel agencies will have more products to offer. Interestingly, our per capita spending has been quite high since nearly all ticket purchases have been made directly online. I hope this information is helpful. Please let me know if you have any further questions.

Unknown Analyst, Analyst

Yes. No, that was helpful. And then just a follow-up on that. In your hypothetical Observatory assumptions, when do you expect or which quarter to increase the 500 capacity level?

Anthony Malkin, Chairman, President and Chief Executive Officer

The 500 capacity level was a number we chose arbitrarily. Under Phase 4, we have opened as an outside attraction, which is why the 102nd floor is currently closed and only the 86th floor is available. We can increase our capacity based on demand when we feel confident that all the protocols we have established are being followed by our visitors and enforced by our team. Our team underwent several days of training before we reopened. We are aware of the positive feedback we have received from both the Governor’s office and the Mayor’s office, which have confirmed that we are in a good position to reopen. We aim to show that we can uphold the protocols we set. We will keep them informed and will proceed cautiously before expanding our capacity.

Daniel Ismail, Analyst

Tony, I was hoping if you can speak to maybe the type of demand you're seeing, albeit with the understanding that demand is lower now because of the post-COVID environment we're in. But if you could just speak to the suburbs versus the city and the type of tenants that are looking in both areas and if you've noticed an acceleration afterwards.

Anthony Malkin, Chairman, President and Chief Executive Officer

Look, I think the comforting news for us is that we actually have seen tours. We have active proposals. We have some approved deals. But for the actual detail as to from where it comes and where it's headed, why don't I hand this over to Tom Durels for him to make comment.

Thomas Durels, Executive Vice President

Thank you, Tony. We've resumed lease tours in Manhattan. In July 2020, compared to the same month in 2019, our volume is around 40%. It's important to note that the Phase 2 opening in Manhattan occurred on June 22, so we're still a few weeks into that phase. We are happy that tours have restarted and are currently operating at approximately 40%. As Tony mentioned, we have received some recent proposals for full floors at 111 West 33rd Street and the Empire State Building, as well as pre-builds at 1350 Broadway, the Empire State Building, and One Grand Central Place. For leases that were in negotiation before the shelter-in-place orders, a few have been executed and are included in our second quarter numbers, while a few more are still being negotiated. We expect to finalize those, though some deals did fall through. We're anticipating lower leasing volumes for the third quarter, especially considering that tour operations were essentially shut down during the entire shelter-in-place period. On the tenant front, there isn't one specific type dominating; rather, we’ve observed significant activity across various sectors such as fire, healthcare, and professional services, making it quite broad-based without a clear focus on any one industry.

Daniel Ismail, Analyst

Great. That's helpful. I was wondering about the write-off at the Empire State Building related to the capital improvement projects. I understand that Local Law 97 was passed last year. Can you provide more details on what made that project uneconomical? Also, are there any other initiatives underway at your other properties?

Anthony Malkin, Chairman, President and Chief Executive Officer

So that wasn't the only project where we had a combined heat power initiative. It was economically beneficial, and we collaborated with the Governor's office to obtain an exemption for a pilot program to examine the Con Ed standby tariff rates that would have previously made it unfeasible. We strongly believe that from an environmental standpoint, it makes sense due to the exceptionally high efficiency in capturing waste heat for steam for the chillers and hot water for the building. The challenge lies with Local Law 97, and I serve as the only representative from the real estate industry on the Mayor's advisory board for its implementation. There are some arbitrary values established for the greenhouse gas emission coefficient, which complicates the economic viability of a combined heat and power plant under the current regulations, as they impose significant annual operational charges. If we can amend this situation, we will. As I mentioned, I am actively participating in discussions on the Mayor's advisory board regarding the law's implementation. One focus will be to explore how to accurately measure the greenhouse gas coefficient of combined heat power plants. However, Christina noted that, given the current framework, the existing rules make it unprofitable, indicating it's not an ideal time to proceed with incurring expenses.

Craig Mailman, Analyst

Just a follow-up here. As you think about the OpEx savings and kind of just looking at the fiscal kind of outlook for the city, I mean, how much of this could just be eaten up by higher taxes as we head into '21 and '22, property taxes?

Anthony Malkin, Chairman, President and Chief Executive Officer

Certainly a risk, Craig. Certainly, a risk. So I think that one of the reasons that we need to be careful to Michael's earlier question about how we look at underwriting opportunity set, got to take a look at what happens on the fiscal scene. Every city in the United States, not just New York City, has been tremendously adversely impacted by the COVID pandemic. I think the good news is, candidly, there's a lot of fat in the New York City budget. During the de Blasio administration, there have been significant increases in a lot of programs, creations of new programs, which are ideologically and I think directionally logical. However, when it really comes down to what makes the difference to deliver services to allow the city to function, there's a lot of fat that could be cut. And I think it's important to note that this Mayor and this City Council, 2/3 of the City Council will be gone as of the next election cycle in 2021. Everybody's term limited out. So it's going to be a very interesting set of developments, I think, as we go forward. And it's one where I think we just need to be careful when we look at committing new capital.

Craig Mailman, Analyst

And then just on the CapEx savings you guys have, it sounds like some deferred R&M. I mean, how much of that is just going to land in '21? Is this kind of the timing decision there just because some of that could be passed through to tenants? Do you want to make sure people are in a space to be able to pass it through? Or is some of that permanently avoidable?

Anthony Malkin, Chairman, President and Chief Executive Officer

Tom?

Thomas Keltner, Executive Vice President and General Counsel

Sure. Craig, this is Tom. As we commented, we're near the end of our redevelopment program. And so we're seeing the benefit of that. We had anticipated a decline in our CapEx spend going into 2020. But certainly during this environment, we took a look at everything. We've deferred those things where we can get more life out of equipment or systems, and we're focusing on executing and completing the work that we had commenced pre-COVID, and we're prioritizing only those things that are going to generate income. But the big picture is that we're nearing the end of our redevelopment. And so I think we're in good shape. I'm pleased with the reductions. We're closing out a lot of work at the Empire State Building and throughout the portfolio, and that's what we're trying to wrap up this year.

Operator, Operator

There are no further questions at this time. I would now like to turn the call back over to Mr. Malkin for any closing comments.

Anthony Malkin, Chairman, President and Chief Executive Officer

Okay. Thank you to the operator and everyone else on the call. Clearly, we managed to do this effectively while socially distanced, as we couldn’t all fit in one conference room. Hats off to the team for pulling it off. I want to express my gratitude for the time and effort put into the disclosures this quarter, which are more detailed than usual. We believe this will be beneficial for your analysis and underwriting. Please note that any forward-looking statements regarding plans to ramp up the Observatory and return to business are for discussion purposes only and not guidance. We will need to adapt based on developments related to travel and the COVID pandemic. I would also like to convey on behalf of the Board and myself our appreciation for the hard work of all ESRT employees during this challenging time. Our team has remained committed with a positive attitude, and their resilience will help us navigate through these circumstances. Our strong balance sheet and proactive cost-saving initiatives will prepare us well for the future. Unfortunately, we have had to bid farewell to team members impacted by layoffs, and many have faced difficult news concerning pay reductions. There will be another phase of cost evaluation and reduction as we monitor the impact of these changes. I look forward to connecting with many of you virtually in upcoming roadshows or conferences and to sharing our third-quarter results in October. Until then, please stay safe and keep moving forward.

Operator, Operator

This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.