Alexander & Baldwin, Inc. (ALEX) Earnings Call Transcript & Summary

Sure. The end of last year, home sales tapered off as mortgage rates increased, no surprise. Across our communities, we only had 250 underlying home sales between Houston and Summerlin outside of Las Vegas. Year-to-date through February, we've already hit over 350 sales. So they've really picked up over the past 6 to 7 weeks as mortgage rates while higher have stabilized. And I think the volatility coming out of rates have given consumers the impetus, the confidence to act and transact on that home. I expect that 2023 will be a typical year for Howard Hughes. So our land sale guidance is around $200 million of EBT, which is consistent with what we did in 2015 through 2019 before the pandemic. The past 2 years, we've delivered over $280 million, which has been record years for us, outsize years, and it's just not something that I'm willing to lean into right now in this higher rate environment.

I wanted to touch a bit on the condo sales business in Hawaii, the Ward Village. You had a record year of condo presales in '22 with over 1,000 units and more than $1 billion expected from future sales. Just given the backdrop of the challenging market, how is this able to be accomplished? Where is this demand coming from? Is it local? Is it people from the Mainland? And anything you have there would be helpful.

It's a great question, and it continues to deliver outstanding results for us. We're able to sell 50% to 70% of a new tower in the first 60 to 90 days of our sales process, meaningfully derisking the condo development because in Hawaii, you're able to take a 20% hard deposit that's not refundable. And that provides a meaningful portion of our equity in development. The buyer makeup has been pretty consistent over the past several years with 50% to 55% local buyers from Hawaii, about 30% of those buyers from Asia, predominantly from Tokyo, some from South Korea, some from Hong Kong and then a slightly increasing component of Mainland U.S. buyers predominantly from the West Coast.

And just with affordability being such a challenge for so many homebuyers and potential home buyers and renters out there, is HHC considering a more affordable strategy option in these communities? And is this why HHC launched construction into their first single-family rental community during 2024? And what's the potential opportunity set there?

We are always trying to deliver the maximum range of affordability across all of our communities. When we sell land to a homebuilder, we are prescriptive, the size of the home, the setbacks of the home, the number of bedrooms and the pricing. And we do that intentionally so that we have the widest range of price points of homes within our communities, everything from the low 300s to several million dollar homes and develop multifamily across all of our communities. And as you mentioned, single-family for rent, the vibrancy of the community is dependent on its diversity, diversity of incomes, diversity of race, diversity of religions, and we're always trying to maximize the diversity that we have in all of our communities and accelerate absorption by having the widest range of price points.

If I could just touch on office for a second. You noted that you leased about 500,000 square feet of vacant office space. And I think the recent -- the expectations are for continued momentum in this into 2023, is it something that has to do with the master planned community effect? What's really driving this during a time when you might have traditional office landlords that are experiencing some weakness?

No, I think it's a combination of the master planned community effect where people have short commutes, great amenities, all walkable. And while many are amenitizing office buildings, we're really focused on amenitizing the entire community around the buildings. When you have walkable restaurants, walkable shopping, walkable outdoor space in immediate vicinity of those office buildings, they tend to lease much better. And that's what we're able to do because we own all the land between the buildings in addition to the buildings themselves. But we've also seen an incredible migratory shift from the West Coast Pacific Northwest, Midwest and Northeast of businesses relocating within to our communities, whether that's the Woodlands outside of Houston, Summerlin outside of Las Vegas, where these companies are chasing employees. Employees have picked up and moved during the pandemic and post pandemic out of those higher tax, states -- out of those states that have some social unrest and potentially higher crime, seeking lower taxes, higher quality of life, better education for their children. And now businesses are forced to follow them because we have a shrinking employment base. So seeing California corporate relocations and waving them into the Woodlands has driven a large portion of that positive absorption you mentioned in your question.

And just one on capital allocation, if I may. How does the current interest rate environment impact your decisions, be they related to new development? And do you expect this higher interest rate environment to portend to slow down in 2023?

As it relates to any potential development project, yes, we have higher borrowing costs as it relates to construction loan, but interest expense capitalized into a development project is not the lion's share of cost. When lumber went from $500 a foot to $1,000 a foot, that drove decision-making more than interest rates. I'd say interest rates overall, taking a step back, if we're borrowing today 150 to 200 basis points higher, as that impacts our cost of capital and therefore, the required returns of our new developments, it's influencing our capital allocation. If we're starting that new project, we need to make sure that we're delivering an unlevered return and a meaningful premium to our cost of capital such that we're delivering that risk-adjusted returns our shareholders require as we drive our net asset value higher every quarter.

If I could just switch over to the Seaport for a bit. It's seen considerable improvement in visitorship this year. Yet it continues to generate some losses. What needs to happen to get this asset's profitability? And when do you expect this to occur?

Yes. As you mentioned, we doubled our traffic to the Seaport this year after last year. 2022 was tremendous with 60 concerts on the roof, 90% sell-through named the #1 concert venue in New York by both Pollstar and Red Bull. But we have 2 or 3 major things we need to accomplish to drive profitability there. First, we have 80,000 square feet of office vacancy that we're getting very close with the tenant that we're negotiating with right now, and that would be unlocking a lot of free cash flow and value there. Two, we need to stabilizing that building. We opened it late in 2022, only a couple of days a week given the labor shortages that we experienced and finally got it open to 7 days a week in December. And as we're stabilizing that operation, able to cut back on overhead, drive profitability and margin, we're going to continue to do that with our partner, Jean-Georges. The revenues that we've achieved, the traffic that we've achieved across that venue have been nothing short of remarkable, and it's just a matter of maximizing profitability and making sure we have the right overhead structure to continue to drive that.

Great. And then just lastly on Phoenix. I know you purchased about 37,000 acres of land for kind of the next MPC opportunity. Why Phoenix, what makes this attractive? And anything you could add there would be great.

Sure. 37,000 acres fully entitled for 100,000 homes, 300,000 residents and over 50 million square feet of commercial space. When we're done building it in 50-ish years, it will be roughly the size of St. Louis. It's within 45 minutes of Phoenix, immediately north of the I-10 that connects to Los Angeles and a low tax business-friendly, warmer, less expensive state with a great quality of life. What's driven Phoenix, candidly, has been its affordability. The income you need to afford a median home in Phoenix is about $68,000, roughly 1/3 of San Francisco, less than half of San Diego. And without the state tax, you get to keep a lot more of that income. And to be able to have fully entitled space and the path of growth in a massively affordable business-friendly environment was an opportunity we couldn't pass up.

Thanks, David, appreciate it. Chris, turning over to you, just a question on Alexander & Baldwin. Why the Hawaii-focused strategy? How important is it to have scale in a market that might not have as great a represence?

Yes. Let me -- before I address the Hawaii why the geographic concentration, let me just say how much respect I have for these guys, their companies and their Hawaii assets. They both understand the importance of relationships in Hawaii. And that sort of leads me as a segue into my answer about why are we geographically concentrated because when I took over the real estate business about 12 years ago, 60% of our portfolio was on the U.S. Mainland. We were essentially just clipping coupons. We didn't have employees in those markets. We were just working with fee managers and leasing agents. And when you're doing that, if you're not really adding value to assets, I think you're destroying value. And so we very consciously set out to sell all of those assets, move everything back to the market that we know. As I said before, we've been in Hawaii for 153 years, we've got a very long-standing reputation, but also a set of relationships that allow us to understand the market, create value in the market. And the question -- the second part of your question gets at, well, is there enough scale in a small place like Hawaii, to build a big enough company and really take advantage of the economies of scale. We now that we brought everything in-house at A&B. We've got the bandwidth now to significantly grow our portfolio. And we've also got a lot of headroom in our asset classes. Within grocery-anchored retail, we're about 22% of the market. So we feel we could comfortably grow at least 50%, if not double the size of that part of our portfolio. We're about 2% of the light industrial market in Hawaii. So we've got a tremendous amount of headroom. Size of the market is really not an issue. And now that we're done with our simplification and we've got the balance sheet that we've got, I think we're going to be able to leverage our presence, our reputation and our team in growing the company.

If we could just touch on the retail portion of the business. Why the needs-based grocery anchor properties in your portfolio? And kind of why are these differentiators?

Well, so the sweet spot that we found is that sort of grocery-anchored community center. We do not have power centers to speak of, and we do not have with the exception of 2 properties that are within Neighbor Island resort communities and probably have about 50% dependent on tourism, we're not at the tip of the spear in terms of dependence on tourism. And we've always felt that, that was important. We didn't want to face the huge swings that come when we have ups and downs in the tourism business. So we feel that our portfolio is a little bit more resilient. I also feel extremely good about our portfolio's positioning post COVID because of the sort of de-urbanization that we're experiencing. More and more people are working at home or working in the local community. And I think that, that has really boosted the need for services, the need for restaurants and the need for other retail in the local community, and it's been reflected in our leasing activity. So I feel great about our positioning. Obviously, we didn't know when pandemic was coming, but I think we are feeling even better about our grocery-anchored strategy now than we were pre-pandemic.

Maybe just switching over to industrial. You talked about the market share opportunities in there, the 2% that you currently have versus the continued growth really there. I'm curious if you noticed any synergies between your industrial platform and your retail in terms of maybe integration of last mile delivery or any other aspects like that?

We absolutely have Yes. And I think, again, COVID has accelerated some of that because you see a lot more buy online, pick up in store, a lot more need for warehousing for retailers. Historically, this is largely due to rent levels in Hawaii and the cost of real estate. Historically, retailers in Hawaii inventoried only what they could fit in their very small stores and a little bit of back office space. And so they're not designed with a lot of warehousing on property. And so therefore, the off-site warehousing becomes more and more important. And we have done deals with some retailers like, I believe, Home Depot and others where we've got -- we've been able to sign leases to help them facilitate their growing buy online, pick up in store activity. So that last mile strategy, I think, is only going to get more important as we go forward.

And then maybe we can just touch on external growth for a second. How have rising input costs impacted your yield estimates on potential projects? And I know you've got some in the pipeline right now, if you want to allude to some of those, but then also just higher costs relative to mainland pricing maybe. How does that factor into your underwriting?

Yes, I think that -- so relative to the Mainland, Hawaii has always been a higher cost market, but that adds to the barriers to entry that we've been discussing today. And one of the more -- one of the other reasons that I think it's all the more valuable to be concentrated on that market and to have a team in place, a development team that understands the local market and can do its best to manage those costs. As far as the change in the last couple of years as a result of supply chain and issues and inflation, it certainly has impacted the underwriting of new projects, but we're continuing to find them. We're doing in the last few years, and this gets back to our market presence. We've been able to do redevelopments, repositioning of several assets, and we're currently repositioning the Manoa Marketplace. We're doing a couple of build-to-suits. We're taking steps to expand our NOI through development activity. And while on the margin, we have been impacted by inflation, it hasn't prevented us from moving forward with some decent return expectations.

And just how are you thinking about yields on potential redevelopment issue projects there? It seems like there is some yield uplift from potential there. So any commentary you might have there would be helpful.

Yes. We typically underwrite to a premium, obviously, to what we could buy -- what the cap rates we would pay on an acquisition. And we've been consistently able to get what we think is a nice risk-adjusted premium. So that may be a couple of hundred basis point premium to -- if we can build to, say, an 8% return on an asset we might buy for 6% in industrial, we've been comfortable with that. And we've been -- generally, with these redevelopments we've been doing, particularly in retail, we've been building to premiums to that premium. So we do see -- while internal growth and redevelopment and ground-up development is not going to be our only source of growth. We definitely intend to be acquisitive, and we're in the market looking. We do think that it's going to be a very important part of our growth story is our -- is development.

Can you talk a little bit about the ground lease business? This is such a steady stream of income. Why might this be the case? And how are you able to recognize pretty solid ABR increases on various properties?

Yes.Well, first of all, just with our in-place rents on ground lease assets, it's an incredibly secure asset. There's no CapEx involved. There's just very favorable dynamics. And then you have these ABR -- you have these rent resets that come every 5 years, 10 years, and they typically adjust at market appreciation and with sort of over the long term, 4-plus-percent land price appreciation in Hawaii, over a 5-, 10-year period, you're going to have a pretty significant reset. And we've had resets that have been -- I think we had one this year that was maybe at almost 5x in-place rent. So sometimes they come at longer intervals, sometimes they come at shorter intervals. But over the long term, I think they probably average 4-plus percent a year growth. So they're great from that perspective. But then even more so, when these leases get toward the end of their tenure, maybe within 10 to 15 years of expiration, the landlord, the lessees have a very difficult time underwriting CapEx into the projects. and then they become willing sellers. And we've been able to buy out our lessees interest in the improvements for 25% cap rates in some cases with several years left on the lease. So it's provided us a nice uplift in rent and we have a lot more of those opportunities in our pipeline. And we've also acquired new ground leases, and it's put us in a position to then acquire the improvements. Manoa Marketplace was an example there of that. And so ground leases are definitely a key part of our existing portfolio and a key part of our growth strategy.

And then just maybe lastly, touching on the office portion and then the noncore CRE assets. Clearly, it seems like you have more growth potential and the opportunities from the parts of the business we discussed. But just kind of how are you thinking about each of these in the context of the enterprise? And could we look to see you kind of lighten up exposure just given the issues with these businesses relative to your core business lines?

Great question. So when we began our migration -- and we really -- our migration was twofold. One was from the Mainland back to Hawaii and the other one was from a diversified real estate position into a commercial real estate portfolio. The first priority was selling the mainland assets, doing 1031 exchanges, bringing all that capital back. When that was finished, we pivoted to selling some of our noncore legacy lands. That is coming to conclusion, and we're almost done with that. The next phase, when we have attractive opportunities within our 4 -- I'm sorry, our 3 favorite asset classes of retail, light industrial and ground lease, we will then look to monetize some of the office assets, which are less strategic to us and do 1031 exchanges into them. So I would describe those as sort of coins in our piggy bank that we can use when we have something we want to purchase locally, but nothing that we're rushing to monetize. We'll be very thoughtful about when to monetize the office, but it is indeed nonstrategic to us.

Great, thank you so much.