The Real Deal New York

For some bidders, Empire State Building buy is a retail play

Would-be investors second guess Malkins, see untapped value in historic tower
By Adam Pincus | September 09, 2013 01:22PM

Over the past seven years, Malkin Holdings has steered the once warren-like Empire State Building from a derided Class B relic to a reinvigorated office tower that competes for large tenants with the city’s most modern Class A properties.

On the retail side, Malkin Holdings, under the direction of Anthony Malkin, moved out smaller tenants and brought in national firms like Starbucks, the Mexican restaurant chain Chipotle and phone company AT&T.

Yet no one would confuse Malkin’s steady, earnest hand with the dynamic flair of the city’s most aggressive retail players like Joseph Sitt of Thor Equities or Jeff Sutton of Wharton Properties, who have made retail development into the industry’s most popular spectator sport.

Despite the refurbishment, the 102-story tower with millions of annual visitors has surprisingly bland retail. In addition to those stores, it has a large Walgreens, a Heartland Brewery, a Men’s Warehouse and discount fashion store Strawberry. In contrast, other buildings on the same block house flashier fashion offerings such as Banana Republic, Desigual, Who A.U. and Aeropostale.

Yet, even as Malkin Holdings modernized the building and amped up the net income, some are talking openly in the media or quietly at beachside gatherings in Deal, N.J., (summer retreat for many of the city’s retail mavens) of more audacious uses for the retail at the base of the 2.9 million-square-foot tower — schemes that would make the current layout look like Lincoln Logs beside the Burj al-Khalifa.

A flurry of proposals from aggressive developers may derail Malkin Holdings’ $5 billion plan to combine the landmark tower into a real estate investment trust as part of an 18-building package that includes additional properties. Just last week, Malkin Holdings reiterated the superiority of the IPO option over a sale, following an analysis by the investment bank Lazard Frères & Co. Malkin Holdings did not respond to a request for comment.

For several of the bidders, and those who may yet enter the fray, unlocking the retail value of the tower is the key to their unsolicited offers. And it’s also an unspoken criticism of the Malkins’ efforts.

Retail ruminations
Among the would-be buyers are Rubin Schron, a substantial owner of residential and commercial buildings through Cammeby’s International, who made the first public offer in mid-June for $2 billion. A partnership of Philip and Michael Pilevsky’s Philips International and Joseph Tabak’s Princeton Holdings quickly followed, submitting a $2.1 billion offer with overseas backing. On June 27, Sitt offered to buy it for an undisclosed price said to exceed $2.1 billion. Then last month, he submitted two more bids, one offering to pay an undisclosed amount — but more than $1.2 billion — for the Empire State Building Associates’ majority stake in the tower and another offering to buy the Helmsley estate’s 63.75 percent stake in the Empire State Building Company, which manages the property.

Finally there was Reuven Kahane, a real estate player virtually unknown in New York City, who put in an offer of $2.25 billion. His family is active in California, and he says he’s got the backing of two Russians and a Ukrainian who made fortunes in the commodities business, but he declined to identify them.

In addition, David Bistricer, the Brooklyn-based multi-family investor and founder of Clipper Equity, is a potential buyer, but he declined to comment. Others expect retail players such as Sutton or developer Joseph Chetrit to jump in.

“The location is fantastic, you can’t find a busier intersection in the middle of the day,” said Robert Futterman, CEO of retail-focused RKF.

But “the retail will always be a little devalued by the landmark status,” he added.

The city’s designation of the Empire State Building as a landmark in 1981 restricts alterations to the facade, depressing store leasing prices, brokers say. The exterior is a particularly tough problem for retailers, which typically want to trumpet their names with a large logo and customize the façade. At the Empire State Building, company names must be written in a common font and height to conform to Landmarks regulations.

“Retail is all about branding,” Futterman said. “When you look at the street — Zara, Levi’s, Aeropostale, Forever 21, Geox — there is a reason none of them are in the Empire State Building.”

While some stores on 34th Street between Fifth and Sixth avenues are paying as much as $500 per square foot, the Empire State Building will likely not get more than $300 or $350 per square foot in the current market, Futterman said.

Tenants holding the two most valuable retail leases are paying just a fraction of those figures, information from U.S. Securities and Exchange Commission filings show. Walgreens pays an average of $75.50 per square foot for a 23,834-square-foot space on the ground and second floors fronting Fifth Avenue, and Bank of America pays an average of $80.97 per square foot for 14,234 square feet on the 34th Street side of the building.

Overall, the 167,788 square feet of retail only take in an average of $108.31 per foot in the 18 leases currently in-place at the building, SEC filings from this month show.

At the same time, much of Soho, one of the city’s most vibrant retail areas, is in a historic district and subject to landmarking rules, as bidder Michael Pilevsky noted. “And the retailers are very happy down there,” he said.

Some retail watchers have their eyes on the corner of 34th Street and Fifth Avenue because it is an intersection of two booming trade areas — 34th Street from the west, where asking rents have shot up more than 75 percent in the last two years, and Fifth Avenue from the north, where prices have jumped by nearly 90 percent, according to second quarter data from CBRE Group.

“It is a giant bummer,” Pilevsky said of the landmarking rules, “but it’s countered by all the foot traffic, and that is the opposite of a bummer.”

Stacking the “deck”
Along with the retail, bidders are looking at another untapped revenue source at the Art Deco tower: the observation deck, which SEC records show pulled in more than 4 million visitors last year.

“The observation deck is a significant business. [Tourists] are coming in droves. Also, you can have a multi-floor retailer like Century 21 that could take three or four floors. That does not exist currently,” said Jason Meister, a vice president at Avison Young who is representing Schron and Sitt.

Sitt has made some of the gutsiest moves in recent years purchasing outlandish retail locations. While his plans for the Empire State Building are unknown, in the past he tinkered with another difficult space, the Takashimaya building at 693 Fifth Avenue, criticized by brokers as having inefficient floor layouts. After nearly three years and some fiddling with the floor configurations, Sitt landed Valentino at $16 million per year in rent, setting a city ground-floor record on a multi-story lease.

Another way to unlock income from the building, California investor Kahane said, was to create copies of the tower or license its image and name around the world.

“It’s a brand. I believe the building has more value than just the building and the [net operating income],” Kahane said. “We want to open other [Empire State Buildings in other nations] as a symbol of America and a country finally making it.”

The Malkins’ control of the tower dates back to 1961, when a partnership led by Lawrence Wien, which included his son-in-law Peter Malkin (Anthony’s father), the late Harry Helmsley and others, purchased a controlling interest in the building. Today, the thousands of investors who make up the Empire State Building Associates sublease the property to the closely held Empire State Building Company, which is responsible for running the property. Malkin Holdings, through many family members, has major stakes in both companies.

Despite being investors for years, the Malkins only took day-to-day control of the tower in 2006 after a long battle with former managers Helmsley Spear. Since then, Anthony Malkin has sought to attract retail tenants that would improve the experience for the new office workers he attracted to the upper floors.

“He wanted more national brands,” said Terrence Oved, a partner with the law firm Oved & Oved who represented several mom-and-pop tenants who Malkin wanted out.

Some longtime tenants left shortly before Malkin took over, including the Riese Organization. The company operated a Houlihan’s restaurant under a lease that ran from 1983 to 2003 at the corner of 34th Street and Fifth Avenue, now a Heartland Brewery.

“I remember that at the time they raised rents significantly, and we did not want to stay at the new rents,” Riese CEO Dennis Riese said. Still, that hasn’t swayed the executive’s opinion of the space: “It was excellent then and it is excellent now.”