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

Great. Well, thank you very much for coming. Welcome back to in-person Nareit here in New York. I'm Alex Goldfarb, senior REIT analyst at Piper Sandler. And this morning very excited to be hosting the folks from Howard Hughes. We have CEO, David O'Reilly; CFO, Carlos Olea; and Chief of Staff, John Saxon. It's about 30 minutes. We'll let management speak for a little bit. I'll have a few prepared questions. And then certainly, we'd open it up to the audience to ask. So with that, let me just turn it to David.

Thanks, Alex. Really appreciate it. It is great to be back in person, even though it's back at the hotel with these elevators, which we're all loving every time we go up and down. But it is good to be back in person. For those of you who are unfamiliar with the Howard Hughes corporation, we're a large-scale master-planned community developer, where we're the dominant land owner and master developer of entire communities. Our communities are located in Houston, The Woodlands, Bridgeland and Woodland Hills and out -- just outside of Las Vegas in a community known as Summerlin, Downtown Columbia in Maryland, the Seaport in Lower Manhattan, Ward Village in Oahu of Hawaii, and most recently, Douglas Ranch in Phoenix. In these master planned communities, we essentially play a game of SimCity, where we're deciding where the roads go, where the hospitals go, where the housing is, office buildings, retail shopping centers and we exist to, at the end of the day, improve the lives of those that live in our cities that shop in our cities or work in our cities. And we're continuing to improve the quality of life of all of those folks every single day with our developments. This business plan leads to 2 unique synergies. One is an operational synergy, where we sell land to homebuilders, those homebuilders build homes and residents move in. When you reach that critical mass of residents, they demand commercial amenities, grocery stores to shop and apartments for their kids to live in, office buildings for the work in, amphitheaters to see performing arts shows. We build those at outsized risk-adjusted returns, which enhances their home values, makes the communities more attractive to live in and increase the value of our remaining land. And that virtuous cycle of value creation goes on, on and on for decades. Some of our communities are as old as in 1960s when Jim Rouse first started Columbia, Maryland. It also leads to a unique financial synergy and that we're able to take the free cash flow from our operating NOI, from our land sales to homebuilders, our profitability from selling condos and recycle that into these vertical development opportunities. So we're able to self-fund over $1 billion of development a year. Today, we own about 25,000 residential acres and 13,000 acres of commercial land. Decades of both land sales to homebuilders and decades of vertical development opportunities within these cities. Historically, we've completed about $1 billion of development a year and have generated a 9.7% return on cost, which has led to in excess of a 24% return on equity for all of our developments over the 11 years that we've been public. Over the past 18 months, the benefit of this business plan have really materialized coming out of the pandemic or hopefully, the ending stages of the pandemic. We had record results in 2021 and early 2022, and it really shows how uniquely positioned we are to generate these outsized returns. At a time when inflation, interest rates and supply chain pressures have been prevalent and have disrupted many businesses, we've seen incredible growth, record results and actually experienced an acceleration of our business plan and positioned for accelerating growth even into this year and beyond. A lot of that has been the result of changing migratory patterns. Our communities have become more and more central locations for those leaving higher tax coastal cities for those seeking a quality of life. And as those employees have moved into our communities, the employers have followed and businesses are coming. And we're signing leases with those businesses and building them new office buildings every day. And that ties into our strategy. And it really boils down into how you live is how we build. As we see demand for office, we build it. As we see demand for multifamily, we build it. We don't build for building's sake, only to meet the demand that exists within our communities. I think finally, those last 18 months has been a perfect example of our capital allocation strategy coming to life. We were able to generate enough free cash flow over the past 18 months from, again, the NOI land, sales to homebuilders profitability from condos to announce 3.4 million square feet of new development, to also acquire Douglas Ranch for $600 million. And we did all of this with over 30% less G&A, a $40 million to $50 million reduction in our overhead. And it's really been a testament to the quality of these communities as both residents and businesses have coalesced into these areas that deliver an incredible quality of life. So I'll pause there, Alex, and let you start to fire away.

So maybe we'll just take the big elephant first and then we can get into...

There's only one?

Well, there's only one. It depends which part of the cycle. You guys have a very successful track record of selling condos in Hawaii, the developments, the self-storage, the multifamily, the office, even the aviators, you outpace that softball team from Miami with better attendance. But one area that a lot of people are focused on right now are rising mortgage rates, home prices, recession fears. You guys may not build single-family, but you certainly sell to the homebuilders. Maybe you can just talk a little bit about what you're seeing in your markets. How -- has there been any impact of rising mortgage rates to your land sale/homebuilder sales business and your thoughts as people are concerned about what could happen to single-family in the current environment?

Right. It's a great question, Alex, and it's something that's front and center in our mind, obviously, given the changing affordability levels of single-family homes in this country, driven by, as you said, higher interest rates, but also driven by higher material costs and a higher cost of a home. With that said, within our markets, which have reacted slightly different than the overall United States, where we've seen a slowdown in home purchasing. In Nevada, in Arizona and in Texas, specifically Houston, Summerlin and outside of Phoenix, there has still been growth in new home sales. There is still more demand than there are homes available to buy. And therefore, the homebuilder appetite to buy our land has not waned at all. And in fact, we're transacting. We closed on another super pad in Vegas last week, which is close to record high pricing. And despite the headline headwinds which have not materialized in these communities yet, we're still seeing homes selling in our communities at a strong clip. I think for the past 2 years, the record pace of home sales has been incredible, and it is actually taken seasonality out of the equation altogether. And today, we're starting to see a little bit of seasonality back into play in a more traditional home sales pace than the accelerated pace we saw in the past 2 years. And it's given the homebuilders, the ability to catch up because right now within Houston, within Phoenix, within Las Vegas, there's a meaningful supply demand imbalance. Right now, there's more demand for homes than homebuilders have supply of finished lots. They're running at a record low inventory of vacant developed lots in each one of these areas. And we're working as hard as we can to meet that demand to get this back into equilibrium. Most would argue that equilibrium is about an 18-month supply. These markets are less than 12 months today, and it will take the remainder of 2022 just to catch back up to that level. So I think that's a very long-winded way of saying that there's still incredible demand from our homebuilder partners to buy land in each one of our communities. But our job at the end of the day is to only sell them land to keep up with underlying home sales. It's supply and demand. They never sell them too much, never sell them too little. So you sell them too much, and the market turns, they'll make a horrible decision with that land, which will impact the rest of the land I owned. I can't have that. If I don't sell them enough, we get into a supply demand imbalance and pricing runs out of whack and affordability becomes a challenge. So I have to continue to feed those homebuilders with enough land to keep up with underlying home sales. And the land that we're selling traditionally has been in the Woodlands at a 95% plus profit margin because we're at the very tail end of that community, and a 65% to 75% margin in Summerlin and what we expect to sell at Douglas Ranch.

And maybe you can talk a little bit. I know everyone is excited to be here in New York. I'm sure no one would ever want to be in Hawaii, certainly living on the south side of Waikiki Beach. But for those of you who are interested in procuring a second home or maybe moving to Hawaii, maybe you could just talk a little bit about your experience with the condo there because when you first started there, you were going after the jet set crowd. I think that proved a little bit slow. You retooled, you found the "affordable" and I think the units have been flying off ever since. So maybe you could just talk a little bit about the Hawaiian housing market and how that's translated to your success at Ward Village.

Yes, absolutely. And I don't know that we retooled per se. But I think our job with every new tower that we build is to learn from that and adjust the next tower that we build to meet the deepest pocket of demand. And when we first started building the deepest pocket of demand was $3 million to $10 million condos for ultra-luxury buyers for second homes. And what we've seen is an incredible demand on the island of local buyers that want this quality of life that they can get by living right between Honolulu and Waikiki. And where they may get smaller square footage, but from an affordability perspective, their next best bet is to have a 45 to 1-hour minute commute all the way to the west side of the island. And right now, you can be across the street from Ala Moana Beach Park right next to Ala Moana and the Mall in one of our towers. So we've continued to morph each tower along the way to meet that demand. Today, we've seen an incredible acceleration even throughout the pandemic. Victoria Place, which we launched sales of right before the pandemic hit is 100% sold and we're still in the middle of construction. And when we're selling condos and selling condo sounds risky, it is. But for us in Hawaii, we're benefiting from a meaningful safety nets. The first is that when we presell, we had 20% hard deposit that we can use towards construction. And our cancellation rate over the first 6 towers that we've built have been less than 10 units. We've sold each one of them at a higher price. So the very low default rates, hard deposits, 20% down. We lock in a guaranteed maximum price contract on construction and secure construction financing before we even start construction. In the past 2 towers, we've been over 80% sold before we started construction. So we've taken a lot of the risk out of the system when we build these condo towers. Today, our most recent tower is a second row tower known as The Park Ward Village, where we're kind of a middle price point in the $1.5 million to $2 million range, and we're about 86% sold, and we'll start construction on that project later this year.

And you mentioned Phoenix on the west side, you bought a very sizable track of land for your latest MPC in partnership with an entity that already owned it. But this is your first new MPC. Certainly, you mentioned the company has communities that go back 40, 50-plus years. Colombia, the original that Jim Rouse founded, I think, back in the 60s. Can you talk about what made you guys comfortable to start a new MPC and then also just the knowledge that you have that it takes not just years, but decades for these communities to really come into their own and how you think about starting one from scratch?

Absolutely. For us, it was an incredible opportunity to take all that we've learned from 60 years of developing master planned communities and apply it to building what is. We believe, going to be the city of the future. And as you said, Jim Rouse started Colombia in the '60s, George Mitchell started the Woodlands in the '70s. Howard Hughes started Summerlin in the '90s, the descendants of Jim Rouse when they were working for GGP started Bridgeland in the early 2000s, and now it's our turn. And now it's our turn to take all of those learnings, all of the things that make a great master planned community and apply it to this raw land in the west side of Phoenix, where there is an incredible housing shortfall, where there's huge demand coming in not just from Phoenix growth itself, but from out-of-state migration coming in largely from California and the Pacific Northwest as folks look for that affordability, look for the quality of life that they can't get in those other cities. The average -- the income to afford a median-priced home in Phoenix is about $70,000 compared to over $210,000 in San Francisco, $140,000 in L.A., $120,000 in Boston and New York. It's affordable. It has great educational opportunities, and it has a quality of life that's unmatched. And now we have the ability to build a new community, a new city from scratch to meet that demand. With the quality of housing and a diversity of housing options that we don't think exists in Phoenix today.

And one area, you've obviously spoken about your success in development, you've 9-plus-percent returns, 24% ROE. Maybe Carlos or maybe David, whoever wants to take it, but it requires a balance sheet. And something that developers are not known for is balance sheet management discipline, but you guys have discovered or -- not discovered, but have perfected a sort of self-funding model and even through the various economic times so far, have proven pretty resilient. There was a capital raise in the -- early in the pandemic, but apart from that, you guys have been pretty self-sufficient. So maybe you could talk about how you manage the balance sheet, how you manage capital. If we do go in a recession, should we expect another capital raise similar to what we saw in the pandemic? Or the way that the business is structured, you guys are fine for whatever the economy throws at the company.

Sure. I mentioned in the prepared remarks, and Alex, you highlighted our self-funded business model, where we use the free cash flow from NOI land sales and condo profitability that allows us to launch these new development projects. we don't start a project until we have the capital, the cash on the balance sheet to finish the project. That's first. And we size our new developments based on the cash flow that comes into the company. Our guidance suggests around $225,000 of NOI this year, around the same amount of MPC land sales and about $130 million of profitability from condos that comes into corporate. It covers our G&A and interest, and what's left over is the equity to fund developments or the cash used for share buybacks. We match size our new developments and our share buybacks based on the free cash flow coming in. I think it is incredibly unlikely to ever see us access the capital markets and raise equity again. I think that situation very early in the pandemic was a unique perfect storm that in the abundance of caution led us to over-capitalize our balance sheet. When the pandemic first hit, we felt as if it could be a perfectly bad storm for Howard Hughes and that the industries that were impacted were travel and tourism. New York City, Las Vegas, Hawaii, or energy, Houston. It shut down retail centers. Our entire centers couldn't open. Our baseball team, we lost an entire season because we couldn't have fans. And it was really just a coalition, a culmination of events that worried us meaningfully, were people are going to buy homes going into a pandemic, were we going to have any land sales. So to make sure that we could weather any storm, we raise capital and put it on the balance sheet, and we put it to work ever since creating value. Now in hindsight, if we had known 90 days later that we would have had record home sales, would it have changed that? Absolutely.

You probably would also be living on a beach right now and not here on the stage if you have that.

Yes. My crystal ball is a little broke.

And in fairness, David, I think your experience on Wall Street during the credit crisis gave you an abundance of caution for not assuming that the world will stay together. So I think that's fair. Next question, as you mentioned, the Seaport. It's sort of gone from one of those things that you -- investors were -- didn't have such a positive view of to, now you've received approval for the latest department -- not the latest for 250 for a residential tower, which was -- there was significant opposition to that, but you had local support. You've been able to finally get the restaurants starting to be open. You won big credit down there during COVID with the outdoor facilities that you offered to New Yorkers who were seeking a place to be outside and socialize in a COVID friendly way. So maybe you can just talk about what's going on in the Seaport, both at the Pier, the Historic District, 250 and then obviously, you have your Jean-Georges, you have the Tin Building opening up. So a lot of exciting stuff happening.

Yes, absolutely. And we used the pandemic to take that period where we were shut down and add additional square footage and additional revenue opportunities to the Pier. And Pier 17 now is a 1-acre rooftop that hosts 60 concerts program by Live Nation that overlooked at Brooklyn Bridge and behind the stage and behind the audience is a Statue of Liberty. It's a world-class concert venue and outdoor events venue. The third and fourth floor office space. The third floor is leased to ESPN and Nike. And the fourth floor is vacant right now, but we're working with a couple of tenants right now to take it. So we're excited about that. And then the ground floor is 5 restaurant boxes. We have Jean-Georges, David Chang. Andrew Carmellini has 2 locations. And we also have Malibu Farm by Helene Henderson. All the restaurants post pandemic have been incredible. The revenue and the profitability of the restaurants are hitting record highs, and we're incredibly excited by everything that's going on at the Pier. Immediately adjacent to the Pier next to the FDR is the old Fulton Fish Market, which is going to be a 53,000 square foot food hall, all curated by Jean-Georges. It will be more similar to a Harrods or Takashimaya than Italy. And that is going to soft open this summer, right around 4th of July and grand opened towards the end of the summer. And we're incredibly excited about the 23 different opportunities to experience. Grab and grow food. Buy fresh fish, meat and cheese. Or sit down for vegan restaurant, Asian, tacos, pizza. It has an incredible plethora of opportunities to enjoy Jean-Georges' food in the food hall. And then in the Historic District, which is on the west side of the FDR is the old Cobblestone streets, where we have candidly struggled a little bit coming out of the pandemic. Some of the tenants that were in there before didn't survive. And we're backfilling them as best we can, but ground for retail in New York City is still challenged. We're seeing some good lease-up with some new restaurants and activations like the Lawn Club that's under construction right now and a few others, but that's an area that hasn't come back nearly as fast as the Pier has. And the 250 Water Street is a vacant lot that we acquired a couple of years ago, and we finally finished our entitlement process to move air rights that we owned over the Pier onto that lot that will be over 600,000 square foot mixed-use building that will have ground for retail, a couple of floors of office and then multifamily for rent apartments above it.

Exciting.

There's a lot going on.

One thing early on, you gave me some advice, and I thought it was good. And so I might ask you to share it again with the audience. Howard Hughes is not for the faint of heart. But on the other hand, it's a pretty simple company. So for people who are new to looking at the company, what are some suggestions because your deck is very -- your supplemental is very thorough, but it's easy to get lost. But if you look big picture, there seems to be some common simple themes. What are recommendations, especially, I'm not sure how many people in the audience who are listening to the webcast are new to the company, but what are the recommendations for people looking at the company to understand it without getting lost in all the wonderful data that you guys provide in the supplemental?

Yes. Well, look, a number of our investors that are very familiar with the story like yourself, Alex, and our analysts, ask for a lot of data, and they want to see a lot of numbers. And our job is to be as transparent and clear as possible and to make it as easy for folks to get up to speed on Howard Hughes as possible. So our disclosures are thorough. But at the end of the day, really that we're doing is we're taking raw land and converting it into income-producing assets. And there's no better example than the most recent multifamily building we built in the Woodlands known as Two Lakes Edge. We took a 3-acre plot of land that I think, Alex had in his model $1 million an acre, and we built a $100 million multifamily property that generates $8 million of NOI, 8% return on cost. Now we can all argue what the right cap rate is for multifamily today and arguably, it's a 4-ish maybe. And that means that, that $100 million project is worth $200 million. So we created $100 million of profit on 3 acres of land that were valued at $3 million and most folks NAV. And we do that over and over and over again. And the Howard Hughes story is not an earnings story, it's not an FFO story. It's an net asset value per share story. If you look at us today, you look at us 2 years ago, 3 years ago, look at us next year, that net asset value per share will be ever increasing at an outsized risk-adjusted return. And I thoroughly believe I'm biased, so you can take this with a grain of salt that this is the best risk-adjusted return opportunity in all of real estate because it's unusual that folks can build multifamily in an 8% return on cost, but we're able to do that because we control the vast majority of land, and we're building without competition in these tight communities that we have unique control over. And that's our business plan at the end of the day. And if you want to get very detailed, you can put a cap rate on every single asset, you can value every single acre or you can take a step back and say, we're going to convert raw land into income-producing assets and drive NAV higher every step of the way.

So now let's open it up to the audience if anyone has questions.

Yes, if you take the last part about driving the annual growth and when you think about your assets in New York. As you go forward, that's been stabilized in the portfolio 5, 10 years from now? Or how do you think about the assets of the portfolio?

I'll repeat the question just because I don't know if those online could hear. It was a question about what is the long-term plan for the New York assets given that there's the Seaport is different than the other master planned communities, and it's a great question. We look at all of our assets all the time. And where we think we've maximized value when we've gotten to assets that are low return from this point forward, we'll look to liquidate them. Perfect example is a building in Chicago that we just sold earlier this year where we converted the old GGP headquarters into 1.5 million square foot, A plus AAA best office building in Chicago for at least the next 6 months, well leased, long-term leases, we were able to sell at a meaningful profit and drove a lot of value to our shareholders by executing on that transaction. And I think we'll look at all of our assets through that same lens. We have a little bit of work to do to create that value in New York. We have to lease the remaining office space. We have to stabilize the retail in the historic district, and we have to open the Tin Building. And if we're able to do those things and get to a place where we maximize value, we can look at all different liquidity options for that asset.

Other questions?

Before investing more plot of land, what are the demographics you're looking at?

So the question was, yes, what is the demographics that we're looking at when we think about investing in land? I think the opportunity to invest in large tracts of land like Douglas Ranch, which we did last year, 37,000 acres is not a once-a-year opportunity, it's more of a once-a-decade opportunity. But what do we look for? We look for business-friendly governments. We look for strong demographic trends in terms of in migration. We look for job diversity and a well-educated workforce that companies want to go after. And all of those things lined up perfectly in West Phoenix, and there was no better example of supply-demand imbalance in that area of Phoenix with a housing shortage of 630,000 units that we're going to work really hard to address over the next 4 years.

Other questions? Clearly, you're in development, whether directly or indirectly through the homebuilders. Apparently, it's a little hard to get some sorts of supplies. I've heard construction labor is a little challenging. I've heard municipalities aren't slow on entitlements. Maybe you could just provide a little overview of what you're seeing as far as impact from labor, local approvals, supply chain, et cetera., and how you factor that into your underwriting? And if that has at all impacted returns or the projects that you undertake or land sales that you may or may not do because of homebuilder impact?

So I'll hit that in reverse order. From a land sale perspective, we don't see any impact from the homebuilders and slowing down at all. In fact, they're accelerating their pace under which they want to catch up for the supply-demand and balance we spoke about earlier. From the construction development side, there are absolutely inflationary pressures out there. And I think over the last year, we've seen about probably a little bit less than 1% a month, maybe a 10% increase in our overall construction cost as it relates to inflationary pressures. The returns haven't been impacted, and that's largely because the rates that we're achieving and the lease-up of largely multifamily under construction right now have actually outpaced the cost side of the equation. So we're still able to deliver at the returns that we expected going in. It's just going to be at a slightly higher cost, given what's going on. Given the size of what we're developing in Hawaii in Colombia, in Summerlin, labor hasn't been an issue for us. I know some of our homebuilders had struggled occasionally with roofers walking off jobs or certain trades at some points in time that they're trying to address than playing whack-a-mole one at a time. But when you're developing to the scale and mass that we're doing several hundred million dollars a year in each one of our communities, we tend to get good attention from contractors and subs that want to stay busy for a long period of time.

Okay. And maybe we will wrap up with a fun question that I'd like to ask. David, you are connoisseur of fine food and you now get the benefit of owning a table in one of the best restaurant brands in the world. So do you recommend to folks out there in the audience that they too become investors with a celebrity chef. And what was it about Jean-Georges that attracted you?

Well, the investment for us was not about owning a physical restaurant, but in owning a restaurant brand. It's akin to those of us in the real estate industry to a Hilton where they own the flag, but very little physical assets, and that's the Jean-Georges business model, where he's opening restaurants around the globe at the behest of landlords that are paying him to open and paying all the money to build out the restaurants, he's receiving a management fee and a percentage of profits. And investing in that business for us buying a small minority stake that also thoroughly aligns us with everything that we're doing at the Tin Building in the Seaport, felt like a great investment for us. And it allows us to bring Jean-Georges to our other communities. And they're not all going to be Columbus Circle Jean-Georges, some may be Fulton or ABC concepts to the Woodlands to Summerlin, to Colombia to continue to improve those communities.

Pretty exciting. I would -- just as a plug for the folks, if you find yourself in Vegas, certainly checkout Summerlin, Hawaii, Houston, Columbia and here in the Seaport. Seeing is believing. And I will say, for those of you who would go to Hawaii and have never seen a swimming pool above your head as you walk down the street, you will in Howard Hughes on, you can see why they sell out condos the way they do there, so.

Thanks, Alex.

Thank you very much. I appreciate, and thank you, everyone, for participating today.

Thank you.