Howard Hughes Holdings Inc. Q1 FY2022 Earnings Call

Good morning, and welcome to the Howard Hughes Corporation First Quarter 2022 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to John Saxon, Chief of Staff. Please go ahead.

Good morning, and welcome to the Howard Hughes Corporation's First Quarter 2022 Earnings Call. With me today are David O'Reilly, Chief Executive Officer; Jay Cross, President; Carlos Olea, Chief Financial Officer; Dave Striph, Head of Operations; and Peter Riley, General Counsel. Before we begin, I would like to direct you to our website, www.howardhughes.com, or you can download both our first quarter earnings press release and our supplemental package. The earnings release and supplemental package include reconciliations of non-GAAP financial measures that will be discussed today in relation to their most directly comparable GAAP financial measures. Certain statements made today that are not in the present tense or that discuss the company's expectations are forward-looking statements within the meaning of the federal securities laws. Although the company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that these expectations will be achieved. Please see the forward-looking statement disclaimer in our first quarter earnings press release and the risk factors in our SEC filings for factors that could cause material differences between forward-looking statements and actual results. We are not under any duty to update forward-looking statements unless required by law. I will now turn the call over to our CEO, David O'Reilly.

Thank you, John. Good morning, everyone, and thank you for joining us on our first quarter earnings call for 2022. To start off today's call, I will provide a brief overview of our first quarter segment performance and highlight the results of our master planned communities in the Seaport. Our Head of Operations, Dave Striph, will cover the performance of our operating assets, followed by remarks from our President, Jay Cross, who will provide updates on our development projects and Ward Village. Our CFO, Carlos Olea, will conclude with a review of our financial results before we open up the lines for Q&A. Looking at the results for the quarter, each of our operating segments performed well as demand for both residential housing and commercial amenities continues to remain plentiful. MPC land sales revenue rose 64%. Operating asset NOI increased 19%, and condo units contracted at Ward Village were 33% higher, all compared to the first quarter of 2021. These strong results are impressive, especially considering the challenging macro backdrop that was present for much of the first quarter and is a testament to our business model that has time and again proven its ability to outperform during periods of volatility and uncertainty. In March, we sold our equity stake in 110 North Wacker, generating $169 million in net proceeds. The sale of this 1.5 million square foot office tower marks one of the final non-core asset dispositions from our portfolio and adds a considerable amount of cash to our already robust balance sheet. To date, we have generated $570 million in net proceeds from non-core asset dispositions with only a few select retail assets remaining to be sold. During the first quarter, we repurchased 1.8 million shares of stock for $171 million. These shares were repurchased at an average price of $97, well below our intrinsic value target of $170 per share, as we outlined during our Investor Day in April. In February, we completed our initial $250 million share buyback program. With our shares still trading at a wide discount to NAV, we received authorization for an additional $250 million repurchase in March. Subsequent to quarter end, we repurchased an additional 1.1 million shares for $109 million, leaving us with $124 million in available buyback capacity. Moving over to our MPC segment. Our performance this quarter saw significant price per acre growth across each of our communities. This price appreciation, coupled with a large commercial land sale in Summerlin had a meaningful impact on our first quarter results with MPC land sales of $61 million, marking a 64% increase versus the same period last year. These rising prices have also impacted home sales in our communities as the value of these new homes rise, the implied value of land rises with it. Once a new home is sold in our MPCs, we receive our participation from the builder based on the increase of the implied land value. This builder price participation revenue was $14 million in Q1, up over 2x compared to the first quarter of last year as prices continue to escalate. While MPC revenue was up substantially during the quarter, segment EBT of $60 million was 6% lower compared to the first quarter of 2021 due to a decrease in earnings achieved at the Summit, our premier gated community in Summerlin. Earnings from the Summit came in at $6 million during the quarter versus $28 million reported in the same period last year. This reduction in earnings is largely the result of the 555-acre community nearing the end of its remaining inventory, having closed on just under $900 million in sales since its inception in 2015. Looking at the performance of Summerlin more broadly, we sold a couple of custom lots during the quarter at an implied price per acre of $4.6 million. This is in comparison to several custom lot closings during the first quarter of 2021 that sold for an average price per acre of $1.7 million. These results clearly demonstrate the robust price appreciation at this MPC. Summerlin also saw an 85% increase in builder price participation revenue during the quarter as home values continue to escalate higher. Additionally, we sold 17 acres of commercial land to Roseman University at $1.6 million per acre. Roseman is using this land to develop a medical school campus that will house over 800 students and employees and adds to the growing list of amenities and educational opportunities that continue to set Summerlin apart from other MPCs in the Las Vegas Valley. In Bridgeland, we saw similar trends as the residential price per acre rose to $495,000 during the period, an 8% increase compared to the first quarter of 2021. This growth in land value helped push Bridgeland's EBT 18% higher versus last year despite selling approximately 10% fewer acres. And finally, the first quarter results in Woodland Hills continued their strong performance. EBT was 9% higher compared to the prior year period, fueled by strong land sales that achieved a price per acre increase of 17% over the first quarter of '21. Another growth component was builder price participation revenue of $1.1 million in the quarter, compared to only $78,000 during the same period last year. Overall, we continue to see positive signs of demand in our MPCs as homebuilders remain willing to pay a higher premium for our land and homebuyers continue to purchase homes at an accelerated pace. More broadly, supply still remains at historically low levels in each of our markets. This supply-demand imbalance has created a unique situation. From our view, we expect to see continued strength in housing despite the recent rise in mortgage rates. Historically low inventory and materially higher home prices from a year ago. Due to the strong demographics of residents who are migrating to our MPCs and predominantly from higher cost states, mortgage rates and higher home prices have been less of a concern given their pricing power. While we saw our quarterly new home sales fall to 604 homes compared to 929 homes in the prior year period, we are still seeing activity at elevated levels compared to historical norms. When it comes to residential land sales, we have not seen and do not expect to see a slowdown anytime soon, as homebuilders still need to replenish their record low inventory to meet homebuyer demand. Given these dynamics, we remain confident that demand will persist and supply constraints will ease over time, thus leaving our full year MPC guidance intact for 2022. Shifting over to the Seaport. We continue to see a pickup in revenue, with the first quarter delivering $10 million in sales, a 44% increase over the same period last year. This sharp rise was largely driven by the opening of new restaurants at Pier 17 that continue to draw more traffic to the area. The Seaport reported a net operating loss of $8.3 million during the period compared to a net operating loss of $4.4 million during the first quarter of 2021. This was largely due to increased operating expenses from the opening of these new restaurants as well as $2.3 million of preopening costs at the Tin Building as we prepare for the grand opening of this much-anticipated marketplace which remains on track to open this summer. To further expand our Jean-Georges' partnership with the Seaport with the Tin Building and Fulton, we acquired a minority stake in Jean-Georges' restaurants during the quarter. This investment offers us a unique ability to expand new restaurant offerings, both within our existing MPCs and globally with significant upside potential. With that, I'll hand the call over to our Head of Operations, David Striph.

Thank you, David. Following the record year in 2021, our operating assets continued their strong momentum with the delivery of $57 million in net operating income during the first quarter. This reflected a 19% increase over the same period last year and a 12% increase on a same-store basis. The majority of this increase was seen in our multifamily assets, which produced quarterly NOI of $11 million, a very strong 94% increase versus the prior year. This is largely due to the rapid lease-up of our four recently built multifamily assets in the Woodlands and Downtown Columbia. For several quarters now, we have seen an accelerated pace of lease-up at these newer developments, which continue to drive positive results. The most recent project, Creekside Park, The Grove in the Woodlands began leasing 9 months ago and stabilized during the first quarter. To stabilize a 360-unit asset in this amount of time is unprecedented and speaks volumes about the robust demand we are experiencing. Retail NOI of $13 million rose 12% over the prior year period, with Ward Village making up a considerable portion of the quarter-over-quarter increase. Travel to the island of Oahu has been largely restricted over the last 2 years due to statewide COVID-19 mandates. With these restrictions beginning to ease, traffic to our retailers has greatly improved and we have seen a quarter funding improvement in our results with first quarter retail NOI Ward Village, rising 53% compared to the same period last year. Another component of our strong operating performance was attributed to our share of NOI from JV-owned assets. Quarterly NOI of $6.8 million was up 63% over the first quarter of 2021 driven by two factors. First was related to a larger distribution from our share in Summerlin Hospital, which has paid out during the first quarter of every year. Following a strong year with higher profits, we received a distribution of $4.6 million, a 24% increase over the prior year period. The second factor was the absence of net operating losses at 110 North Wacker. During the first quarter of last year, this asset lost $1.6 million versus no losses this quarter since we closed on the sale of this office tower in March. And finally, office NOI of $25 million during the quarter declined 3% from the prior year period. This decrease was a result of recently signed lease renewals that included abatements as well as certain lease expirations in the Woodlands. It is important to note, however, that a large majority of this vacated space has since been backfilled by new tenants. Through April, we have executed 58,000 square feet in office leases since the start of the year in the Woodlands, and another 51,000 square feet of leases are under negotiation. The office performance in Downtown Columbia fared well during the quarter with NOI at 6,100 Merriweather, arising from a quarterly net operating loss of $1 million last year to positive NOI of $868,000 this quarter as free rent from our anchor tenant begins to burn off. With that, I will now turn the call over to our President, Jay Cross.

Thank you, Dave, and good morning, everyone. We are making significant progress in our development pipeline with more than 1,100 multifamily units currently under construction, along with a 267,000 square foot office building in progress and 53,000 square feet of medical office buildings that have just started construction. All of these projects are on schedule for timely completion. Although we have experienced slight increases in construction costs over the past few quarters, we anticipate yields to remain in the 7% to 8% range. As we mentioned during our recent Investor Day in April, we have several upcoming projects that we plan to start within the next year. Among these new projects, we expect to begin construction on our 86,000 square foot medical office building in Columbia's Lakefront District in the next few months. This development is already 20% pre-leased and signifies the start of our major development initiatives in that area. At the Seaport, our latest project, the Tin Building, is in its final phase of interior fit-out and is on track for a grand opening this summer, as Dave mentioned. We expect the Tin Building to attract a large crowd to the Seaport, especially alongside our summer concert series and the wide variety of restaurant and retail options available at Pier 17 and in the historic district. Additionally, we have commenced early foundation work at 250 Water Street after receiving approval from the city of New York. We aim to complete vertical construction later this year and will share more updates then. Moving to Ward Village in Hawaii, we contracted 61 condo units in the first quarter, marking a 33% increase from the same period last year. We generated $20 million in condo sales revenue with the closing of 24 units at 'A'ali'i, which was completed last quarter. There are 55 units left to sell in this tower, which we anticipate selling throughout 2022. Regarding our two towers currently under construction, Ko'ula and Victoria Place, we contracted 14 units and are on target with our expected delivery timelines. Ko'ula ended the first quarter with 92% presold, and we expect to complete this tower in the third quarter. Victoria Place ended the quarter 99.7% presold, with just one unit left. Following the quarter's end, we contracted for this final unit, making this tower fully sold out. The sales pace for our next tower at Park Ward Village is robust, as shown by the 24 units contracted this quarter. We are now 89% presold and plan to start construction on this project in the third quarter. Lastly, in March, we initiated presales for our ninth tower, Ulana, which is entirely focused on workforce housing. Ulana fulfills our remaining requirements for this product type within the Ward Village Master Plan. Since launching our new lottery system in March, we have presold 83% of the 696 available units in Ulana. Now, I will pass the call to our CFO, Carlos Olea.

Thank you, Jay. During the first quarter, we were able to deliver strong results across all of our segments signifying a great start to the year following a record-breaking performance in 2021. In summary, during the first quarter, our MPCs generated land sales revenue of $61 million, a 64% increase over the first quarter of 2021 and $60 million of EBT, a 6% decrease compared to the prior year period. Our operating assets delivered $57 million of NOI, a 19% increase compared to the prior year period. At Ward Village, we closed from 24 condo units at 'A'ali'i, resulting in $5.4 million of condo profit, a 102% increase compared to the prior year period. At the Seaport, we recorded an $8.3 million net operating loss, a $3.9 million decline compared to the prior year period. Despite this decline, quarterly revenue of $10 million rose 44% over the same period last year. Given the strength of our business segments in the quarter, we reiterate our full year guidance outlook for 2022 as outlined in our first quarter earnings release. Shifting over to our balance sheet. We ended the quarter with $688 million of cash on hand, leaving us with plenty of capital to continue executing on our development pipeline and repurchasing shares. Even with an extensive runway of projects currently underway, the remaining equity contribution needed to fund this development is $181 million. In other words, we are still left with plenty of runway to launch additional developments throughout the year. During the quarter, we closed on $129 million in financing for five assets at favorable rates and terms. Of this amount, $116 million was related to three nonrecourse loans for office assets in Summerlin and Downtown Columbia. The remaining $13 million was for our construction loan to fund the development of our two medical office buildings under construction in the Woodlands. Looking at our $4.7 billion of debt balance as a whole, we have limited near-term maturities with only $63 million maturing in 2022 and a substantial portion of the remaining balance maturing in 2026 or later. During this rising rate environment, it's important to note that 82% of our debt is either fixed or swapped to a fixed rate, which significantly mitigates our interest rate risk. And with that, I would like to turn the call back over to David for closing remarks.

Thank you, Carlos. To wrap up today's call, I just want to touch on a few key points. First, the results of the quarter demonstrate that our strength from last year has carried forward its momentum into 2022. And we are confident of a similarly strong year ahead. Our full year guidance remains intact, and our segments are all operating at an optimal level despite the headwinds we're seeing today; second, the uniqueness of our business makes HHC an attractive investment opportunity, especially during periods of market volatility as we've recently seen. In today's inflationary environment, we are benefiting from rent growth that is outpacing inflation at our multifamily properties and the majority of our retail and office leases allow us to pass on at least a portion of increased costs to our tenants. When it comes to single-family housing and condos, we are positioned in markets that are undersupplied, but have high demand resulting in outsized price appreciation. Couple these fundamentals with the strength of our balance sheet, and it's clear to see that we are well positioned to outperform as we navigate through the remainder of the year; third, we are flushed with capital and expect our operating segments to continue to generate meaningful cash flow throughout the year. We remain laser-focused on allocating this capital appropriately to achieve the highest risk-adjusted returns through new developments and share buybacks, both of which unlock considerable value for our shareholders and drive NAV higher on a per share basis. With that, we'll now open the call up for Q&A. We'll start by answering the first few questions that have been generated by Say Technology and will be read by John Saxon. John, can you read the first question?

Sure, David. Our first question asked, what kind of tenants do you foresee for the second level of the Tin Building? Jay, would you like to take that question?

Sure. Thanks, John. All three floors of the Tin Building have been fully programmed by Jean-Georges. So, it's 21 different concepts throughout the building. The ground floor is a more traditional market with a raw bar, cheese shop, bakery, candy shop, cafe, etc., and the ability for customers to come and shop and do e-commerce and get delivery as well. As one proceeds to the second floor, it's more of a sit-down dining environment with vegan and Asian restaurants, a cocktail bar, Craft Beer Bar, at the head of the escalator and a cooking studio. And then finally, the third floor is 100% occupied by kitchen, storage and staff facilities. So at this point, we're burning in kitchens, finishing the final FF&E touches, and we're looking forward to a summer opening of this extremely exciting marketplace.

Thanks, Jay. So our next and last Say question asked, to protect the company with the extra cash, do you think you are better off doing share buybacks or paying down higher interest rate loans? Carlos, would you like to take that one?

Sure. Thank you, John. As we stated in our opening remarks, our balance sheet exposure to interest rate risk is recovering very impressively low. We have 82% of our debt that is either fixed or hedged to a fixed rate. Last year, we were able to decrease our weighted average interest rate by about 40 basis points. So because of those facts, at this point, we believe that share buybacks and new developments are a much better use of our capital.

Thanks, Carlos. So that's the end of our Say questions. So operator, I'll hand it over to you, and we can open the line to those with questions on the call.

Our first question comes from Alexander Goldfarb with Piper Sandler.

I have a few questions. Carlos, I appreciate your comments about 82% of the debt being fixed or swapped. However, regarding the remaining floating debt, could you clarify how much of that is related to construction financing as opposed to normal operations? I understand that your focus is on NAV rather than earnings, but I’m curious how much of that floating debt will impact the P&L, particularly in relation to construction projects like condos, which will be settled upon the sale closure.

Right. So the majority of what is floating relates to construction loans. We do have some caps on construction loans, but the majority of the construction loans are floating. So that variability will end up capitalized from the balance sheet.

Okay. And then as far as the builders, the homebuilders taking down more land. What do you guys see in your markets or from the homebuilders as far as their appetite for land in your communities versus elsewhere in the markets in which you operate? So I'm sort of curious, when you talk about the in-migration, is it that Houston, Vegas, now Phoenix are all just growing overall from the in-migration or are your communities disproportionately seeing more of that inbound such that the builders may be dialing back their land purchases elsewhere in their markets, but continuing to a healthy pace in your MPCs?

Alex, our fingers aren't quite on the pulse of the other communities within the cities as much as they are within our MPCs. But in general, what I can tell you is that we're seeing migration into these cities broadly. I believe, and from what I've seen on the ground, I think we are disproportionately benefiting to a modest extent, and we're getting better than our fair share of home sales and therefore, sales to homebuilders for land within our MPCs because we tend to outperform the broader markets. But in general, the broader markets continue to outperform. We continue to see great in-migration to Houston, Phoenix, and Las Vegas. And recently, there was an article on CNBC just 2 days ago that highlighted those three cities as the three largest cities for new entrants over the past year.

Okay. And then the final question is maybe a flip on the email question on debt versus cash paydown. As you guys look to use excess cash to fund development or buybacks, do you see a trade-off between one or the other? Or as you look at your liquidity and what you have planned in the development, you can balance both. I'm trying to figure out if buybacks make more sense now than development versus being more even keel or maybe development is still the better use of cash versus buyback?

Yes. I don't think it's an all or nothing decision. It's not either/or. I see it as a strategy where we're able to invest capital in both areas. Some development projects offer significant returns and are worth pursuing compared to buybacks. Conversely, some projects may be paused due to inflation and stagnant rent growth, allowing us to use that capital for buybacks instead. Each project undergoes a thorough evaluation by both management and our capital allocation committee, as well as our Board, to ensure that we're investing our capital in ways that will maximize NAV growth per share over time.

The next question is from Anthony Paolone with JPMorgan.

My first question relates to the builder price participation. Can you talk a little bit more about how much of your lot sales have that sort of participation? And is there any way to think of like is there some backlog of participation in that factor that we could think about?

It's a great question, Tony. It's one of the most challenging aspects to forecast in our profit and loss statement. The majority of the lots we sell have builder price participation, which can vary from 16% to the low 20s, typically around 20%. However, it largely depends on the willingness of home buyers to pay for view premiums and upgrades. I can't predict from one quarter to the next how many buyers will opt to pay more for those lots or enhance their homes, which affects our participation. Ideally, we would have perfectly priced each lot upon sale, resulting in zero participation. Nonetheless, this participation provides some protection for us, especially in today's market where prices are rising rapidly, and we can be assured of receiving full value for the land sold to homebuilders, even from months prior, given the swift increase in home prices.

Okay. So is it a matter of if home buyers add on some of the features and do some of these different things that are pretty high margin for the builders that, that just helps accrue to your participation because that value kind of drops effectively to the land. Is that kind of what happens?

Yes. Generally speaking, if we sell a lot to a homebuilder and agree on a selling price of $500,000 for the home, our participation reflects a builder price of 20%, which indicates our implied land value is $100,000. If the home sells for $600,000, regardless of whether that's from base pricing, a view premium, or upgrades, we are entitled to 20%, which amounts to $20,000 of that $100,000 increase in price. This can come from various factors, including general price appreciation, view or lot premiums, or any upgrades made by the homebuyer.

Got it. That's helpful explanation. And then I guess just as we think about MPC EBT for 2022, you'd basically given some guidance around to think about that. Are there any particular MPCs that you think are going to drive things this year? Or also, do we think about this year being maybe fewer lots, but higher prices? Or just any further details around how you're thinking about this year shaping up?

Man, there's so much underlying assumptions that go into that. It would be hard to crystallize it into one or two sentences because in some communities like Woodland Hills, we're expecting a higher price per lot and more lots. And in Summerlin, we're expecting a higher price per acre, but perhaps fewer acres given that massive superpad sale we had in the fourth quarter of last year. So it's tough to crystallize it down into one or two bullets that are driving those assumptions. There's so many nuances to each one of our MPCs that are driving those results.

Fair enough. And then just going back to some of the earlier discussion around capital allocation, you guys have done a nice job executing on the buyback programs that you've put in place and it's occurring in a market that's been going down. How do you think about potentially putting in place further buybacks as the year progresses if you continue to see the stock price under pressure with the market here? Or is there just a limit at which you've already allocated enough to the buyback for 2022?

Well, I think it will be largely determined by the liquidity that we have, the free cash flow that we generate and the amount of new developments that we're able to still continue to drive NAV higher by. If we're able to generate some incremental liquidity because we have a great quarter or two, some of the developments aren't ready to get launched as quickly as we had hoped, then that excess liquidity could, in fact, be used for buyback. It's tough to predict right now. I think we still have a little bit of powder left in the chamber to use on our current plan. And after we get through earnings, given the most recent performance, we expect to use it.

The next question is from Hamed Khorsand with BWS.

I just wanted to see if there was a general update on Douglas Ranch since you didn't bring it up on the script?

No, I'd say that everything is progressing as we expect. We're hopeful that this quarter we'll contract our first set of lots as we had anticipated at the announcement. We're moving dirt right now, grading land, putting in roads, putting in infrastructure. So things are going as expected, but there isn't a contract or an announcement to make on this call that would provide any material changes from what we've said previously.

And is there an update as far as being able to source or purchase water rights for Douglas Ranch?

Again, I would say that everything is consistent with what we've said in the past in terms of the water rights that we already have approved for Trillium in the first four phases of Douglas, as well as the advantages that we have being on top of the River Basin, proximity to the Central Arizona project as well as the diversified sources we continue to see.

On that note, the last question, how about water rights for Summerlin, are you pretty much set?

We feel that we have the water that we need to finish out the remaining development in Summerlin, all the way up through Summerlin West and including the commercial developments that we anticipate over the next several years.

This concludes our question-and-answer session. I would like to turn the conference back over to David O'Reilly for any closing remarks.

Once again, we appreciate you joining us for our call this quarter. Look forward to seeing you on future calls. And if there's ever questions in the interim, we're always available to help. Thank you again.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.