Friday, March 29, 2019

Howard Hughes: Updated Thoughts 2019 Version

It's been about three years since my last post on Howard Hughes Corporation (HHC) and I wanted to updated my mini-model and walk through some updated thoughts on their progress.

Howard Hughes is a real estate development company that was originally spunout of GGP during its restructuring to hold the master planned communities and non-core assets of GGP.  Since the spin, close to 9 years ago now, HHC has focused its efforts on five key markets: Houston, Las Vegas, Honolulu, Columbia MD, and the Seaport District in New York City.  Their story is pretty well known by now in the investment community but HHC shares still provide a compelling long term value for a few primary reasons:
  1. Howard Hughes is a real estate company that is not a REIT and does not pay a dividend, also because of its mixed portfolio, doesn't screen well or fit into any easy to value bucket.  Additionally, much of its value is in land and large assets that aren't currently producing any cash flow (for example, the Seaport).  A counter to this, many REIT funds are including non-REIT real estate companies, for example, Vanguard's switched its mandate from a REIT fund to a real estate fund and included HHC in the process.
  2. Much has been written about the lack of new home construction since the financial crisis, one day this will normalize and HHC will be well positioned, their master planned community ("MPC") assets are highly sought after, providing the raw material homebuilders need and because of their maturity (hundreds of millions have been spent previously on infrastructure), feature high cash margins.  HHC uses these cash flows to self fund commercial construction (office, multi-family, retail) in these MPCs that HHC holds for investment.
  3. NOI (and thus NAV) should continue to grow at a fast clip without needing to raise any equity capital, additionally the company has further growth levers it can pull via several under appreciated assets outside of their core markets that could have significant value.
The easiest way to value the company is to run an net present value calculation on the land sales in the MPCs and the condo sales in Honolulu and add it to a NAV of the current operating properties and strategic developments minus any remaining construction costs and debt.

Master Planned Communities
The company publishes an undiscounted and unappreciated value of their land holdings in their 10-K, this is simply the average recent selling price of their land multiplied by the remaining acres, it doesn't account for the time value of money or any future appreciation in pricing as the remaining acreage should get more valuable over time as Howard Hughes builds out the amenities.  I took those numbers and simple ran an NPV using a 10% discount rate assuming a straight line selling pace until the sell out date with no price appreciation built into it.  Note: I just used book value for The Summit, which is an ultra-luxury community in Summerlin that's being developed with a JV partner, it's been a big success and likely worth more than book.
In 2018, the MPC assets generated EBIT of ~$200MM, this roughly equates to a 10-11x EBIT multiple for the land business if you value it at $2.3B, which seems reasonable to me.  Using roughly the same framework for the condo development business in Honolulu, ~$1300 square foot average selling price and costs of $1100/square foot and running an NPV using a 10% discount rate until the 2028 sell out date equates to about $833MM in remaining value.  This doesn't account for the retail transformation that will happen over that time, just the condos, which the company has mentioned they'll be increasing their pace of tower construction as they have found a niche in smaller pre-furnished units in Oahu's highly supply constrained market.

The company also provides a lot of detailed disclosure on their operating property and strategic developments segments making an NAV calculation fairly straight forward.  Below, sorry its small, but I've taken each property, assigned a cap rate and deducted any property level mortgages or remaining construction costs on the unstabilized properties.

Office Properties
HHC's office portfolio was heavily weighted towards Houston 2-3 years ago, they clearly made a mistake in overbuilding ahead of the oil rout in 2015 and several of the office assets in Houston remain unstabilized years later.  However, since then they've been focusing office construction on Columbia, MD and in Las Vegas, most of these properties are new in the last three years.  Another asset that didn't get much attention until recently is 110 N Wacker, it was a four or five story building that covered an entire city block along the Chicago river, it was previously the headquarters of GGP and was recently demolished.  HHC along with JV partners (HHC owns 33% now, mostly just contributing their land) have commenced construction with a projected finish date in the back half of 2020.
110 N Wacker - 3/29/19
Bank of America will be the anchor tenant, leasing activity was brisk enough that two additional stories were added to the building to meet demand.  It's a prime location on the river and near transportation, despite the building boom in the Loop, I can't imagine them having difficulty fully leasing the building upon completion.  At that point, I'd expect them to sell their stake as it is non-core in that they don't control any properties or land around it, but anyway it's an asset that was an after thought in NAV models until recently, HHC has a couple others that could be even more significant that I'll touch on later.

Retail Properties
The biggest piece to the retail portfolio is the Seaport District located on the East River in Lower Manhattan, it was a tired yet popular tourist attraction until Superstorm Sandy destroyed it in 2012.  Since then, Howard Hughes has been working on redeveloping the area, it has taken longer than originally expected and gone through a few strategic changes (notably switched from a "regular mall" to more of an experiential shopping experience).  I don't like commenting too much on the Seaport's value as I'm not a New Yorker like many in the investment community who might have stronger opinions on the asset, but I mentioned in my year end post that a similar property in Chelsea Market was sold for over $2.4B.  Chelsea Market is roughly twice the square footage as the Seaport, giving rough credit to the $1.25B value I'm putting on the Seaport before the remaining construction costs.  HHC also bought a parking lot for $180MM near the Seaport that it plans to redevelop, likely into multi-family, as the Seaport stabilizes and increases demand around the neighborhood.

Multi-Family, Hotel, Other
They've heavily invested in multi-family properties in recent years, mostly successfully, less successfully on the hotel properties which are located in the Woodlands and were built right before the oil rout, similar to their office portfolio there, these properties have taken longer than anticipated to stabilize.
These are the random other assets that Howard Hughes owns including the new AAA ballpark they built in Summerlin, a ground lease beneath the Vegas Golden Knights practice facility and the marina in Honolulu.

Two of these other assets that I think are interesting and carried at little value on the balance sheet but could be significant drivers of NAV growth over the next 2-5 years are the Fashion Show air rights and Monarch City.
Fashion Show Mall - Las Vegas
HHC owns 80% of the air rights above the Fashion Show mall on the Las Vegas strip across the street from the Wynn and adjacent to Trump Tower on one side and TI on the other side.  Back in 2017, there were rumors that the company was reaching out to design and construction firms for a potential casino resort development, but nothing more has really come of it and Las Vegas is in a mini-slowdown right now.  The mall was owned by GGP, but Brookfield bought GGP last year and likely makes a more natural development partner for the project as Brookfield's stated strategy is to redevelop many of the acquired malls into mixed use properties. It may be another few years before anything happens here, but it's another potential driver of NAV that isn't included in my model or any that I've seen put out by analysts.

Promotional Deck for Monarch City
Another under followed asset that HHC owns is 280 acres of land in Allen, TX on the corner of two highways that was recently renamed Monarch City and has plans for over 9 million square feet of mixed use development.  To put that scale in perspective, HHC has 14 million square feet of entitlements (only a small fraction of which are currently built) in Downtown Columbia, but Monarch City is still large enough be a significant asset and potentially a 6th core market for HHC.  Allen is an attractive market, it is a suburb north of Dallas and right in the heart of a big housing development corridor, fellow long time holding of mine Green Brick Partners (GRBK) is active in the area with several ongoing communities being built within a short drive of Monarch City.  The Dallas metro area is very popular with corporate relocations given its low taxes, Howard Hughes is likely waiting for a big relocation opportunity to anchor the development before breaking ground or publicizing the asset further, if they're able to sign one, Monarch City is large enough to be a nice call option that's not currently factored into the stock price.

Adding it all up, I get a reasonably conservative "today" price of HHC around $140 per share.
Other Thoughts:
  • HHC likes to point to their control of the markets they operate in and the reinvestment opportunities available to them within those tightly controlled locales.  It potentially limits the risk of oversupplying a market (although they did that to themselves in Houston), plus it gives them an advantage when non-HHC owned assets come up for sale.  They've recently purchased underperforming properties in The Woodlands and Columbia that they didn't previously own and have added them to their redevelopment pipeline, creates some synergies and continunity.
  • Three years ago I got some feedback that Ward Village was unsustainable because of Chinese buyers, similar to the impacts Vancouver has seen, but HHC discloses the types of buyers in Ward Village and Chinese make up a low single digit percent, essentially a non-factor, most of the buyers are locals, Japanese and mainland second homes as you'd expect for that market.
  • Mentioned this previously, but one thing I do like about Bill Ackman recruited senior management is he insists on skin in the game, with HHC, CEO David Weinreb put up $50MM out of his own pocket (one could argue he's rolling his previous warrant payday over, but I think the message is still the same) to buy a warrant package with a strike price at $124.64 expiring on 6/15/22.  There's still plenty of time, but the stock price hasn't moved much despite all the activity over the last five years, I think management will do whatever they can to close the gap between the share price and their perceived NAV (which is much higher than mine) over the next 4 years.  The CFO and COO are under similar incentive packages, but they put up significantly less money, $2MM and $1MM respectively.
  • HHC has started publishing an AFFO metric, it was $5.41 for 2018, for approximately a 20x multiple which given the NOI growth path over the next 5-10 years seems cheap compared to many popular REITs.
  • A similar company that I follow (but don't own) is Five Point Holdings (FPH), it's a developer of three master planned communities in California.  It was created out of a partnership with Lennar (LEN) and is much earlier in its life cycle than HHC, but it has a similar plan to develop/sell lots to homebuilders and then build commercial development for investment once demand occurs.  FPH is a broken IPO, trading about half its IPO price from a year or two ago, if anyone has thoughts on them I'd be grateful and interested to hear.
Disclosure: I own shares of HHC

20 comments:

  1. This was great! Thanks for putting this together.

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  2. Nice piece. On FPH, am long based both on what I can discern of the fundamentals (hard to be certain of all, given the early stage) but also for the attributes that make this a no-go for many investors/would tend to explain why market would be undervaluing. A partial list of those include: not REIT (like HHC), LLC structure, money-losing, limited float, uncertainty around both shipyard timing/resolution and attempts to delay their projects elsewhere (e.g., Concord). Not that those attributes are all great (if only the shipyard could be developed now!) but they help explain why an opportunity might exist.

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    1. Thanks - I like it as a long term holding, as I said, don't own it yet, but feels like I will one day.

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  3. Why don't they repurchase shares if the stock is so undervalued? Why buy more development properties? Are the development properties more than 30% undervalued?

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    1. How often do adjacent properties come up for sale? Other than the parking lot near the Seaport, these tend to be small fries. I think there's a balance to be struck there, sure they could be a bigger buyer of their stock but they've done so in one off blocks in the past (bought Fairholme and Brookfield's sponsor warrants at a very opportune time).

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  4. Hi there, thanks for a great write-up. Could you provide some insight into how you decide what cap rates to apply to each property? Do you change them much over time? Thanks!

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    1. Just some light Googling on cap rates for various property types and then I've moved some around that need more stabilizing or redevelopment, tried to be on the more conservative side but everyone can make their own judgements there. Any look way out of whack to you?

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    2. No, no, they look directionally correct to me (not that I know those markets well). They're just always so subjective and drive a huge part of the valuation on any RE company so I was curious how you thought about/settled on them. Some people build them up off interest rates or have absolute figures they won't go below. Again, I don't quite know what the right answer was so was just curious since this was a solid write-up.

      Thanks for the response!

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  5. How does the warrant package at $124.64 affect management's willingness to do buybacks? I assume it discourages them from paying a dividend.

    Management seems pleased with the Q1 results but the stock is back down to $104.

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    1. I'd assume it does too, but I haven't checked to see if the strike price gets adjusted down for dividends like some of the old AIG warrants do. Good to hear the general concern over the floundering share price, I think the market needs to see some progress on the Seaport, it's been constantly pushed out for the past 5+ years. I also agree with management that the complexity is part of the secret sauce of the company, being able to nearly fully control a locale is their competitive advantage, if they spun off a REIT it would eliminate that advantage over time and with the tax cuts, not clear its a significant enough tax arbitrage to be worth the effort anyway.

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  6. Thanks for providing so much detail and sharing your work. As I look at the financials for HHC I see a lot of expenses in the form of SG&A and also property level costs of sales. Do you capitalize any of those expenses in your valuation? These expenses are not trivial. For example, in the most recent Q if I add "Condo rights and unit cost of sales + MPC cost of sales + development marketing costs + SG&A" I come up with $185 million. Annualized for 10 years this adds up to over $7 billion. Are these expenses incorporated in your valuation? I apologize if this has been discussed in other threads.

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    1. The condo and MPC cost of sales would be incorporated in my valuation, but not the G&A, so should trade at some discount due to the expense structure. It's unlikely to get sold anytime soon, but you could come up with an argument that the expense structure is high because of the growth orientation, curious what it would be under an as-is number.

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  7. Some discussion of the Seaport development: https://www.nytimes.com/2019/06/07/nyregion/south-street-seaport-mercury.html

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    1. Thanks - HHC has had a history of trying and failing to get a tower built near the Seaport, doesn't seem to be changing.

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  8. Down under $98 today. Anyone know why?

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    1. Don't know. But they did announce property level financing at the Seaport, was previously funded by their senior notes at the corporate level:

      https://www.prnewswire.com/news-releases/250m-financing-secured-for-seaport-district-redevelopment-300873227.html

      Fixed for two years, then floats based on LIBOR that won't be around six months after it starts floating, but that's a different subject.

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    2. Guess the market thinks borrowing at LIBOR plus 4.10% is expensive. I'm not qualified to have an opinion; I recently saw a deal financing existing class A office space at LIBOR plus 1.75%. What were they paying on the corporate level notes?

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    3. The senior notes are at 5.375%, aren't explicitly tied to the Seaport, but they issued them in order to fund the development several years back (and refinanced them once along the way too)

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  9. You must be tickled with this play!

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    1. It's great news - although as a long term shareholder, I remember it well above this price. I'm still not sure what a spin would accomplish because they would be admitting their local monopoly approach doesn't have value and also because of the tax cuts, the actual tax arbitrage isn't as great. Maybe their strategy is better fit for a private company, but would be a little disappointing not being apart of that value creation, especially if the price is $140-150 where it traded off and on over the years. Maybe its just an acknowledgement, management knows the stock is cheap, cynically Ackman wants a better mark with quarter end coming up and we end up with a status quo once the strategic process runs its course. I'm interested to see how it plays out.

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