Howard Hughes Holdings Inc. (HHH) Earnings Call Transcript & Summary

Welcome to the 7:30 session at Citi's 2020 Global Property CEO Conference. I'm Anthony Pettinari with Citi Research, and we're pleased to have with us Howard Hughes Corporation and CEO, Paul Layne. This session is for investing clients only. If media or other individuals are on the internal line, please disconnect now. Disclosures are available up here and on the webcast on the disclosures tab. And for those in the room or on the webcast, you can sign onto liveqa.com and enter the code Citi2020 to submit any questions or you can just raise your hand. Paul, we'll turn it over to you to introduce Howard Hughes and provide kind of the reasons why investors should buy your stock now and then we can jump into Q&A.

Thank you very much. I'm Paul Layne, CEO of Howard Hughes Corporation. On my right is David O'Reilly, Chief Financial Officer. On my left is Dave Striph, Executive Vice President of Investor Relations and Asset Management. We are delighted to be here today, and appreciate the opportunity. I want to first talk a little bit about our company, and then I'll move into questions. So Howard Hughes Corporation was created a little over 9 years ago, when 34 assets were emerged from GGP's bankruptcy and created a incredible opportunity of very separate and different type of properties. These properties range from Hawaii to Manhattan, including the Woodlands, 28,000 acres in Houston; Bridgeland, 11,000 acres; Summerlin, 22,000 acres; 8 miles west of the strip in Las Vegas, 60 acres, owned fee simple in Honolulu with the rights to build over 2,400-foot high-rise condos and 1 million feet of retail. The Seaport District in lower Manhattan, including Pier 17, downtown Columbia, Maryland, all exciting opportunities that most we consider a very large and organized master-planned community. So in these master-planned communities, we create what we call a virtuous cycle of development. And the virtuous cycle is simply where we go in and do the horizontal development required to create neighborhoods or actual cities. So we develop the land, we put in the streets. We create a community. We sell lots in Houston, super pads in Vegas to homebuilders, homebuilders build homes, sell houses, the home buyers then need all types of services that we are very happy to provide, things like retail, restaurants, office buildings, hotels, self-storage, things that we rent and create our net operating income. And we self-fund our operating property development from this NOI, approximately about $1 billion a year. Last year, we had, probably it was the best year ever. The fourth quarter was phenomenal. Our stock had come back up until last week, like everyone else's. But we -- 4.5 months ago, a new plan was enacted at our company, leadership change, and we were able to announce a 3 pillars of our new strategy. We announced that we would get lean as a company, frugal, you might say, by eliminating $45 million to $50 million on an annualized basis of reduction in G&A and overhead. That's from $130 million, almost 1/3. We would get focused. And we have definitely gotten very focused in the last 4 months. By selling $2 billion of assets, all noncore, for net proceeds of $600 million. Generally speaking, these noncore assets were individual properties in single locations, not in our master-planned communities. And we'll talk more about those in detail during the question-and-answer session. And lastly, we announced that we would focus more on a decentralized model of operations by eliminating approximately 65 of our team members, mostly from corporate, and empower the 5 regional presidents that run our regions and are the experts in their community to be able to move in a more nimble and rapid fashion to get developments out of the ground. A perfect example of this nimbleness is an acquisition that we closed on December 30 of last year in the Woodlands, and those of you that don't know, the Woodlands is about 27 miles north of Houston. Anadarko Petroleum was the largest employer. They were bought by Occidental Petroleum. Occi wanted to shed some of their assets. We were able to quickly negotiate a purchase of 1.4 million square feet of AAA quality office buildings, far and away the best office product in all of North Houston. And we negotiated a total of over 900,000 square feet of 13-year leases, investment-grade tenant both for an 808,000-foot office building and some flex building warehouse space. We also received 9 -- over 9 acres of what I think is probably the best office development land in the Woodlands. And it also provided us almost 600,000 feet of AAA quality office space that we now are able to lease in a tight market. All of our other buildings in the Woodlands were approximately 95% leased, and it worked out great for our company. We had also announced in October that we were going to relocate our headquarters from Dallas, where we have no operating properties, to the Woodlands. But in all of our buildings in the Woodlands, we didn't even have one full floor of space available. So by buying this, it selfishly helped us with a couple of floors that we desperately needed. So with that, I'd like to open it up to questions. And we'll do our best to answer it quickly and promptly. Thank you.

Great. I'll just start off. The October announcement, I think, highlighted a bit more of a defensive financial profile. Can you just discuss that? And sort of where you think we are in the cycle?

I'll take your second question first about where we are in the cycle. Prior to last week, my crystal ball is a little clear. And I think it broke last week. In all sincerity, we had -- so last year, our Board of Directors announced that the company was going to evaluate strategic options. And they -- it was more -- much more than just thinking about selling the company. It was a true evaluation of the company. The day that was announced, our stock went up 41%. Approximately 4 months later, when we announced that we were making a leadership change and announced some of the things that I just mentioned in my speech, the stock dropped 18%. So since that 18% drop, we had trended up nicely and felt very good about the cycle. And a little later, our CFO, David O'Reilly, will talk directly about some of the numbers that we finished the year with, which have been really outstanding. But we've trended up very nicely. So I'm feeling good about our cycle. One of the other things that we've done in empowering our 5 regional heads is we have looked out now for 18 to 24 months in each one of our regions outside of New York, of where every single development would be in a priority structure on a risk-adjusted return, whether it's multifamily, office, retail, and we'll be ready to know exactly when we'll have GMPs for each of these and be ready to start construction when the equity is available, when the market is ready and when we believe it's the highest priority to spend our equity on those. David, did you want to add...

Yes. Look, I don't know that our financial philosophy changed with the strategic announcement. We still remain very committed to the same principles that we've had for years at Howard Hughes, which is we don't start new development until we have all the equity on our balance sheet sitting there in cash and liquidity. We maintain low leverage of 30% to 35% net debt to enterprise value. And we're only starting new developments when our existing portfolio is full and we see ample demand. We have always done a tremendous amount of development, but always done it as if today is the last day of the cycle. We're never building for building's sake. We're just building to meet the underlying demand that we see in our communities. And because we control supply of both the residential land that's sold to homebuilders and the amount of new office, multifamily, retail, hotel that are built in any one of our cities, we're able to maintain that discipline so that supply-demand doesn't fall out of balance, meaningfully de-risking our development relative to many others.

Just to add on to that, by cutting $45 million to $50 million out of our overhead, adjust our growing stabilized NOI, without selling any lots in our master-planned communities or selling any condos in Hawaii, we can remain a profitable company for -- even in a downturn. So we've positioned ourselves, I think better and more conservatively than ever in the history of the company.

Paul, you talked about Houston in a little bit of detail. I'm just wondering looking at some of your other communities, can you talk about what you're seeing in terms of demand from homebuilders and maybe the pricing power that you have in some of these master-planned communities?

Sure. So let's start with Summerlin in Las Vegas. If you haven't been to Summerlin, you should go. Spring is a great time so we -- in the 22,000 acres, it is adjacent to the Red Rocks, beautiful hiking and biking area. Of course, there's casinos there that we don't know, but it's a very fun and gorgeous place. So we own a Downtown Summerlin, which is 127 retail stores and restaurants. Adjacent to that, we own the Triple-A baseball team, the Aviators, which we changed the name tying to the Howard Hughes theme. And this 22,000 acreage was historically land that Howard Hughes actually had assembled. Summerlin was named after -- it's his mother's maiden name, believe it or not. And so we built a stadium, and the team is there. Happy to get you tickets, if you want to go. We also have the -- there's a new hockey -- professional hockey team, where we have the practice facility, did a ground lease for that, which I being from Houston had no idea that hockey practice facilities was a thing. I mean it's packed all the time. They're actually building another facility to handle the demand in Vegas for hockey, but it's -- these amenities draw people out to Summerlin. It's -- I like to say, if I was transferred to Vegas, and being married with children and grandchildren, Summerlin is exactly the kind of place I would want to live. It has the best schools, best communities, best places of worship, and it has a wide range of homes from very modestly priced all the way up into our exclusive communities, The Ridges and our partnership with Discovery Land at The Summit, up to however much you would like to spend, where extravagance is not nearly enough. Great golf, it's fantastic quality of life. And that's really what we provide whether it's the Woodlands or Bridgeland in Houston, Woodlands Hills in Houston, Summerlin, Columbia, Maryland, our master-planned community, Ward Village in Hawaii. It's creating a quality of life, where you can buy a home and all the amenities that you need, we're delighted to provide, and except in Hawaii, where we actually sell condos, all these operating assets are rental, creating a very strong and growing net operating income for our company. Moving to Hawaii. So I mentioned, and a lot of these, especially Hawaii, if we had a slide that I could show, PowerPoint, you'd -- immediately you'd get it. So all you have to do is Google Ward Village and go to our website, and it's a beautiful community right across the street from the beach, incredible architecture, great restaurants, retail, shopping. It's kind of the total package, and you can walk across street to your boat in the Marina, walk across the street to the beach, where there's a very large park. It's provided a -- we believe, the highest quality high-rise condo living. The latest development there, which is our seventh tower, is called Victoria Place. And in 6 weeks of sales, out of 350 total units, we -- in 6 weeks, we sold 53% of the units. And it's a 20% firm down payment. And we're so excited about the velocity of those sales, which has been really tremendous. Columbia, Maryland is located between Baltimore and Washington, D.C. Another phenomenal community that we provide very high-end multifamily and office. It's a great build-to-suit market. Again, it was a 50-plus-year-old master-planned community, a great place to live, raise a family, and we have reenergized it with new product. Some of it wraps around the Merriweather Post outdoor amphitheater, which people from that region -- whenever I say that, they -- it brings a smile to their face because they remember going to concerts, either as a child or a teenager or as an adult, and we now have been able to develop all the way around the amphitheater and bring more people back to Downtown Columbia. The other project I'd like to mention is the South Seaport district in lower Manhattan, which historically was a shopping, basically mall back in the day on a Pier, adjacent to the historic Seaport district, where the tall ships would come in hundreds of years ago. A lot of great history, Cobblestone streets, et cetera. With super-storm Sandy coming through, damaged the Pier. We took the Pier down, rebuild the Pier and built an incredible facility in the shadow of the Brooklyn bridge. If you're in New York, we'll have 41 concerts this year provided by Live Nation. The Fulton, numerous restaurants are opening in the Fulton, like Jean-Georges is open. It's a beautiful setting and great food. I invite you to come and dine with us. It also provides office space and shopping as well as many restaurants, and so we're very excited about the development of that property. And we're building a 50,000-foot food hall also run by the celebrity chef Jean-Georges that will open in approximately 15 months in the historic Tin Building, which for New Yorkers that have studied the history of the Seaport district, also brings a smile to their face because -- in fact, last night, I was told by a gentleman that he remembered as a child going there with his father to buy fish every Saturday. So it's a lot of fun memories that Howard Hughes Corporation is bringing back to life.

We have a question from the line. You mentioned that Hawaii is the only place that you sell condos. Given you can use the cash from condo down payments to fund development, why do you not do condos in any other of your MPs?

Do you want to take that?

Sure. So Hawaii State Law there is a little bit unique where you do get 20% hard deposits that you can use towards construction. That doesn't exist in other states. But where we're doing commercial development in our other master-planned communities or master-planned cities, like I said earlier, we're building to the deepest pocket of demand. If we saw a great demand for a high-rise condo tower in the Woodlands or Summerlin, we could build that. We don't like transitioning into homebuilding business. We do like being Switzerland in treating all of our home building partners equally and not saving the best land for ourselves. And it's also candidly dilutive to our returns. Our cash margins on residential land sales to homebuilders are anywhere from 65% in Las Vegas to 95% in the Woodlands. And for us to get into a mid-teens-type return, vertical homebuilding business that would also pit us against our home building partners, isn't something that we've entertained or think is appropriate for the company.

Great. And are there opportunities to develop new MPCs or make kind of other market entrances or kind of your current focus on your undercurrent communities?

Thank you. We want to focus in our 5 core areas. We have strategic advantages through this virtuous cycle that we -- and also the advantages that we inherited from the original developers such as George Mitchell, who almost 50 years ago, created the Woodlands. We've been able to take advantage of that. And through most of the properties, almost all the properties, for instance, in the Woodlands and Summerlin that come up for sale, we have a right of first refusal. We've been able to enact on that and purchase various properties in a very strategic way. So the focus that I mentioned earlier in our company. We want to do what we do best, and not branch out. At this time, we have 50 million square feet of development entitlements, which will keep us going for many, many years to come. The amount of land that we have to develop is amazing by any standards. So we're well positioned for development growth.

And in terms of your kind of operating asset mix, can you kind of elaborate in terms of office versus retail versus multifamily, with regards to sort of your pro forma's stabilized NOI?

Sure. Let me start, and then I'll turn it over to David. But we really study each of our markets and where the demand is on a risk-adjusted return. If -- we love multifamily and office, and we have focused on those 2. But we also for instance, in the Woodlands, we built a 205,000-foot medical build-to-suit for MD Anderson Cancer Institute, which we now are selling as part of our $2 billion sale plan. We'll do a reverse 1031 into the Occidental Towers, which we purchased to make a very tax-efficient property sale. We also have decided to sell the 3 hotels in the Woodlands that we own as part of this disposition. Through the study of down cycles in Houston, we realize that the office and multifamily had very little effect because of longer-term leases. In the hotels, when your customers leave every night, there was a sharper reaction to a oil and gas downtrend. And so we have decided to -- we have over 500 employees in the Woodlands running these hotels and our management company. And where -- we are exiting that space. David?

I think you said it well, we're not developing to meet some idyllic pie chart that says we're supposed to be x-percent office or y-percent multifamily. We're building to drive the highest risk-adjusted returns with a motivation daily to drive NAV per share higher. And if we can do that through office, through multifamily, through retail or hotel, that's what we'll do.

A couple of questions on the line. First, can you walk us through the pathway to profitability and a reasonable return on capital for the Seaport district?

Do you want to take that?

Sure. There's really 4 key things that we're focused on in the Seaport district. Each one of them are near-term steps that we believe are achievable in the next 12 to 24 months that will unlock a lot of value and create a lot more profitability at the Seaport. The first is just stabilizing the restaurants. As restaurants open, there's preopening expenses. You're training a staff, perfecting the menu, cooking food and all those losses as we're joint venture partners with those restauranteurs are flowing through our P&L. And they are obfuscating some of the positive results of the lease space and the restaurants that are stabilized. The second is finishing the leasing of the office space on Pier 17 and the third and fourth Fulton market building. Get those 2 spaces leased that will drive an incredible amount of cash flow. The third is opening and stabilizing the Tin Building. We are watertight on the Tin Building working on the interior finishes, and we should be open in June-ish time frame next year. So that's the third pillar. And then the fourth piece of the equation is getting the air rights moved at the Seaport. We have approximately 650,000 square feet of excess air rights above the Pier and the adjacent areas within the historic district, and we're working to get all the approvals necessary to try to move those in a really appropriate way in concert with the local government officials and communities onto the 250 Water Street parking lot that we have. So we do believe that over the next 12 to 24 months, we can accomplish those 4 things and unlock a lot of value to Seaport.

A few more questions. The next question, how many MPCs are in the U.S.? Have there been any new supply of MPCs over the last 10 to 20 years? Is there a private company out there that owns multiple MPCs? Or are they just single assets owned by private individuals or groups?

It's a great question and a little bit of a tricky answer because the way you ally defines an MPC, it could be 2,000 acres. And a 2,000-acre MPC has traditionally just rooftops, just a bedroom community for another neighboring city. The way that we think about our MPCs are not really master-planned communities as much as their master-planned cities. And as Paul said, 28,000 acres in the Woodlands with 100,000 residents and 60,000 people commuting into the Woodlands every day. We're not a bedroom community. We're an employment center. And we have similar dynamics in Columbia and Summerlin as well, where we are, candidly, a little bit different than a master-planned community. There are a lot of master-planned communities out there that are 2,000 acres and up. And there's only a handful that look, smell and feel like how our master-planned cities. Some that have been in public holdings like Forest City owned Stapleton in Colorado. Most of which are in private holdings like Irvine Ranch in Southern California or Lake Nona outside of Orlando. So there's very few public competitors that own multiple master-planned communities the way we do, which unfortunately or fortunately, depending on how you look at it, makes us a comp set of one.

Just to add on, the idea, and those of you who haven't been to our master-planned communities, it really feels like a city. It's -- surprisingly, Summerlin and Woodlands have approximately the same population. But once you're there, you very rarely actually need to leave. I mean that was the thing when I took -- when I left Brookfield 8.5 years ago and came to Howard Hughes, living in the central part of Houston and driving up to the Woodlands, it was an amazing to talk to the Woodlanders that said, "Oh, no, we never have to come to Houston, except maybe if we want to see -- watch a professional football game or baseball game. But all the restaurants we need, the schools are great, you can get a 4-year-college degree by never leaving the Woodlands. It's an environment that provides just about everything that you need. And same thing in Summerlin. So that -- the difference, like David mentioned, 2,000 acres, every developer that buys a piece of land and goes in a little neighborhood, they want to call that a master-planned community. But the infrastructure cost, the way it's developed, the quality of the parks, the amount of green space, we believe that ours are record-setting and create that quality of life, the work, live, play environment that people want today. And we're -- now, we've gone in and especially both in Summerlin and Woodlands and created a walkable environment where you can live in our multifamily restaurants within easy walking distance, office buildings within easy walking distance and provide all you need without necessarily having a car.

Another question. Could you ever become a REIT anytime in the -- could you ever become a REIT anytime in the near future? Or will the land sales massively outweigh the rental income?

David, do you want to take that?

Sure. I think the short answer is we could become a REIT today if we wanted to, but we believe one of the best reasons to own Howard Hughes and one of our greatest competitive advantages is that we're able to self-fund over $1 billion a year of value creation opportunities. And as a C-corp with a meaningful tax shield, and we won't become a taxpayer until late '22 or early '23, we can self-fund all that. If we converted to a REIT, we would be dividending out all that free cash flow and force to come back to raise equity from our shareholders to fund our development opportunities. To us that is detrimental relative to the potential benefits of a REIT conversion. If we're not paying tax, and we're self-funding value creation, we'd rather keep their capital and reinvest it into outsized risk-adjusted return opportunities.

And then just in terms of maybe operating risks, is there -- what do you see as sort of the biggest risks to tenant base over the next 12 to 24 months that could result in occupancy loss? And how does that sort of vary by MPC? And then I guess, the coronavirus question. Obviously, it's a very dynamic situation.

So it's a good question, certainly. We think we have positioned ourselves extremely well. And obviously, one of the reasons that we're cutting up to $50 million out of our G&A is to position ourselves much better. We typically do long-term leases in our office buildings. Our multifamily is the typical year to 1.5 years on our leases. So even in a downturn, what we've studied is in our master-planned communities, different than, for instance, in the Woodlands or in Summerlin, but let's take the Woodlands for example, the occupancy loss or increase in vacancy in office buildings and in multifamily in downturns is much, much less in a master-planned community like the Woodlands. It is the vacancy in Houston was increased up to approximately 20%, where the Woodlands typically was in the 5% to 6% range. Think the high peak was around 9%. So it's somewhat very sheltered environment because people that typically work there, they would like to live there, have a very short commute. As David mentioned, we have a tremendous influx of people coming to our office buildings in the Woodlands and now in Summerlin, but we try to convince them to buy a home, live in the environment, spend their money in our restaurants or retail, lease office space from us. Keep that cycle going where our customers are happy. We're happy because they're spending their money in the communities that we own.

Great. Great. Well, if there are no other questions, we're coming up on time. So Paul, David, Dave, thank you very much.

Thank you very much.