Investment Thesis –

HHC is undervalued real estate company with high quality assets in desirable areas

Its core MPC strategy is well past its initial riskier phases and thus deserves a lower discount rate

The COVID backdrop is a tailwind to the value of HHC’s suburban communities as they serve as an alternative to more dense urban environments for both residents and office tenants, while also offering greater value in terms of schools, convenience and other amenities. We’ve already seen this demand dynamic begin to playout in certain markets such as the suburban areas of NJ closest to NYC.  

Longer term, HHC’s largest core MPCs are located near lower cost and more business-friendly cities (Houston & Las Vegas), which should ensure that the development and population growth outperforms the national average over the next few decades. The hard asset nature of HHC’s business makes it solid play against inflation.             

Near term, the economic situation is already showing signs of a rebound according to the metrics most relevant for HHC, such as continued improve in both retail sales and housing data vs. April lows. Monetary easing will continue to support low interest rates and record low mortgage rates (~3.4%) thereby bolstering the value and affordability of HHC’s land within the MPC’s.

Although Mgmt recently changed, HHC still enjoys direct support and direction from Bill Ackman, who has served as HHC’s chairman since it was spun out of GGP nearly 10yrs ago. Ackman/Pershing invested $500m of a recent $600m equity raise in Q1’20, which effectively quadrupled his stake in HHC and has sold put options that could increase this even more. Given his tenure as Chairman, increased stake and vocal touting of HHC, its unlikely Ackman is going anywhere until shares recover.

Thanks to the capital raise, HHC has ample liquidity to weather a recession and Mgmt claims it can weather an extremely low revenue scenario until YE’22. Meanwhile, HHC’s stabilized NOI projections are 33% above current levels and are only ~3yrs away.

At ~$54-55/sh HHC is only 10% above the late March offering price and more than 50% below its pre-COVID19 level of $120 per share and -56% YTD. By contrast, MSCI US REIT index (RMZ) is down -19% YTD, while homebuilders (XHB) are down less than 4% YTD.

HHC shares are worth ~$84 according to a NAV based on a relatively conservative SOTP, resenting ~50% upside vs. current levels.

Under a more bullish scenario, HHC is worth >$105/sh.

Situation:

Including the $600m raised in late March, HHC ended Q1 with ~$1b of cash on hand.

Mgmt has also made significant progress pushing out maturities and refinancing existing loans.

HHC has ~$535m of combined debt due in 2020 and 2021, however the bulk of this has been pushed into 2021 and at least ~$130m of that can be extended into 2022.[1]

On the Q1 call in mid-May, Mgmt claimed that they can last until the end of 2022 even if COVID situation persists such that there are no land sales, condo sales and hotels/retail/entertainment assets have no revenue.

This was obviously a very harsh scenario and we have already seen conditions improve meaningfully on several fronts.

-          At a recent industry conference Mgmt noted that it has seen a meaningful acceleration in home sales at one of its Houston MPCs and given trends in May they think that MPC land sales could be ~$190-200m in FY’20 (vs. $330m in FY’19), which is a much better outlook vs. April and May. Recent housing data also seems to support continued strength in the housing market.[2]

-          Multi-family rents have remained solid meanwhile, as Mgmt. noted that rental collections have remained at ~95% (which is line or slightly better than commentary from most public multi-family REITs)

-          Office rent collections were also unscathed at ~95%

-          On the retail and hospitality side, performance was much weaker

o    Hospitality properties (including hotels which were ~10% of NOI) were closed since March 22^nd

o    Retail rents (~30% of NOI last year) were much weaker at ~38-45% in April and May. Mgmt has yet to quantify June but said it has been improving recently meanwhile given recent re-opening milestones in key states[3] and retail sales data[4], this should continue to accelerate markedly in June, July and rest of Q3.

HHC can easily weather a brutal Q2 and crummy Q3, and still have sufficient liquidity to cover commitments to see the rebound in H2’20 (particularly in Q4) or 2021[5].

Mgmt estimates annualized NOI based on Q1’20 of $271.7m and projects stabilized NOI of ~$363m, with estimated time until stabilization of 2.4 years.

Renewal risk from existing tenants doesn’t look too material as there is not much in terms of major tenant renewals over next few years.[6]

Assuming things rebound in Q3 and Q4, and continue to normalize throughout 2021, HHC can conservatively generate ~$250m of NOI next year, which less $50m of interest expense, leaves ~$200m EBT which can be used to pay down debt.

Meanwhile selling off non-core assets will provide proceeds additional funds for deleveraging[7]

Once NOI stabilizes HHC can likely access debt markets again for longer term borrowing at a cheaper cost while using FCF to repurchase shares

Company Overview: Howard Hughes Corp is a collection of real estate assets, the most notable of which are its master planned communities or MPCs, which span a combined 80k gross acres. These communities have attracted key commercial tenants looking to establish sizeable offices near a major urban area but without being directly inside of the city. In terms of operating assets, (excluding projects still under construction), HHC has 9m sqft of retail and office space, along with another 2.9k multi-family units and 900 hotel rooms.  

HHC’s reporting segments are MPCs; Operating Assets; Strategic Developments (typically operating assets that are still in the development/early phases, and which will transition into the Op asset category once stabilized) and Seaport District (which mgmt. aims to develop into a unique “culinary, fashion and entertainment destination”)

MPC’s: There are technically 6 MPCs, but only 4 are Core MPCs (listed below). HHC also has 2 high density urban MPCs including Ward Village (Honolulu, HI) and South Street Seaport in NYC.

-          HHC has 3 communities in the suburbs of Houston (Woodlands & Woodland Hills both 30-45min North of Downtown Houston and Bridgeland which is ~30 miles North East of the city)

-          Columbia Maryland (roughly equidistant between DC and Baltimore)

-          Summerlin, NV (~20-30min west of Las Vegas Strip).

Operating Assets:

-          The vast majority of HHC’s operating assets are within the MPCs

o    71 assets including JV’s, consists of 14 retail, 32 office, 9 multi family, 3 hospitality and 13 other assets/investments. Also includes several assets under construction.

Strategic projects + Seaport:

-          The Chicago tower (110 North Wacker) saw construction continue during COVID19 as it was considered an essential business.

o    The building continues to have an anticipated completion date in Q4 and is 74% pre-leased.

-          Construction work in NYC was also recently allowed to resume as the city entered Phase 1, which means that HHC will begin having to spend the remaining balance on construction, but also opens door to potentially selling a stake or bringing in a partner.

Strategy & Other Highlights: HHC is purposely not structured as a REIT so that it can use inflows from land sales to fund the development of operating assets within the MPCs (commercial projects such as stores, restaurants and office space). The cashflow from these operating assets are used for strategic developments and amenities for the MPCs, which leads to greater demand for land and more operating assets. HHC’s communities have already made the important step of attracting key commercial tenants looking to establish sizeable offices near a major urban area (but without being directly inside of the city).

-          Ultimately this creates a virtuous circle for the developer as the loop repeats itself over and over until the MPC is fully developed, upon which time the assets will be generating significant NOI.

o    The reliance on internal cashflows helps prevent overdependence on leverage, which can be fatal for developers when real estate slumps

o    Meanwhile control over the land allows for longer term and more careful planning (which can also help in weathering downturns)

o    Ideally HHC can leverage its land as a contribution in a JV where its partners pay the construction costs, and thus HHC eventually derives significant income without much upfront expense

-          The MPC model has been proven by others in the past and the Woodlands basically proves HHC’s ability to execute

o    Recall Ackman pointed to the success of Billionaire Donald Bren as being the result of successfully executing this strategy with his Irvine Ranch MPC in California.

§  Woodlands is already home to several fortune 500 companies’ HQs & regional offices[8], and has some of Texas’ top golf courses 

§  Ackman even made a customized ad video pitching Elon Musk on considering one of HHC’s MPC (most likely Summerlin, NV) for TSLA’s new HQ should they choose to move from California. 

§  HHC is also planning to move its own corporate HQ from Dallas to the Woodlands this year, but this move is temporarily delayed by COVID.

-          Houston is 4^th most populous city in the US and has the 5^th most populous MSA

o    Greater Houston has been among the fastest growing MSA’s in the US and is starting to challenge sprawl of LA and Dallas-Ft Worth, surpassing that of Atlanta.

o    Woodlands claims 4.1% overall vacancy and has 28% open space of its 28k acres.

§  Residential land is 99% developed at the Woodlands, and Mgmt’s goal is to direct future demand into nearby Woodland Hills or the Bridgeland MPC.

-          HHC’s Summerlin MPC has significant room for growth, and while Las Vegas has experienced a sizeable hit from COVID-19, the target demographic in Summerlin is somewhat less exposed given it is aimed at retirees and higher income residents (70% of residents above 150k income, and 26% above $300k).

-          The Columbia, Maryland MPC is near full maturity, as it has already seen its residential land fully develop, and thus the story is more on the commercial side. HHC only has several operating assets under construction in this MPC.

Valuation: Using a SOTP valuation based on conservative estimates derives a value of $84/share under Base case scenario (see breakdown below)

Core MPC Land = ~$75/share

·        Assumes remaining MPC land (both residential and commercial) is sold proportionally according to Mgmt’s time-line and value estimates with cashflows discounted by 5% (8% discount rate less 3% appreciation)

Operating Assets = ~$73/share

·         Stabilized Assets = ~$54 per share

o    Assumes 2021 NOI of $223m at a 6.75% cap rate (blended average cap rate based on 50% office, ~25% retail and 25% Multi-fam, storage & Other, with respective cap rates of 7.1%, 7.75% and 4.9%), discounted back 1 year at 10%

§  NOI of $223m vs. Q1’20 annualized NOI of $213.5m and Mgmt’s projected stabilized NOI of $232.5m

·         Un-stabilized Assets = ~$15/share

o    Assumes 2022 NOI of $77m at a 7.5% cap rate (blended cap rate of 50% office, 30% hospitality (~7.5% cap rate), 25% multi family and 5% retail) discounted back 2 years at 10% per year

§  NOI of $77m vs. Q1’20 annualized at $58m and Mgmt’s projected stabilized NOI of $96.5m

·         Assets Under Construction = $4/sh

o    Assumes 2023 NOI of $20m at a 7.5% cap rate (75% multi-family and 25% retail) discounted back 3yrs are 10% per year

Other Assets = ~$19/share

·         Hawaii Condos = ~$4/share

o    Assumes 193k sqft (262 units) remains at ~$1,300/sqft discounted 2yrs at 10%

·         NYC Seaport = ~$11/share

o    Assumes 2023 NOI of ~$40m with a 5% cap rate discounted back 3yrs at 10%

·         Chicago Tower =~$4/share

o    Assumes completion by YE’20

§  With 2021 NOI of $10.7m (from 74% pre-leased portion) at 5.5% cap rate discounted back 1yr at 10%

§  Additional NOI in 2023 of $4m at 6% cap rate discounted back 3yrs at 10%

Cash & Deposits of $23.50/share

·         $1.04b in cash + $270m in restricted cash as of Q1’20

Debt of ~($99)/share

·         Current debt of $4.375b as of Q1’20 + $1.12b to be drawn for current project pipeline

Cash Burn + Remaining Equity Commitments of ~($8)/share

·         ~$248m of equity commitments (per most recent 10Q) to complete current project pipeline

·         Interest expense through YE’20 of $105m (~$35m/Q over next 3 quarters)

·         Shortfall in FFO of $90m (~$30m/Q over next 3 quarters)

Risks

·         Oil Price Exposure

o    HHC’s exposure to Houston and major tenants being large E&P’s and OFS companies resulted in HHC’s shares being highly correlated to oil prices during last downturn

§  At recent industry conference, Mgmt admitted that unlike last oil industry downturn in ’16-17 where they saw no real impact to Houston portfolio, this time they are seeing more pressure on tenants and are expecting “mild” issues

·         COVID Disruption

o    As mentioned above, COVID19 should be a relative tailwind for suburban housing demand, however HHC’s Hospitality assets in Houston and Summerlin taking a hit as is NYC retail at Seaport

§  Trends here are somewhat obscure given HHC disclosures don’t show certain metrics for identifying trends at these assets such as hotel specific metrics like RevPar or SSS for retail/restaurant assets

o    Construction delays (especially at NYC and Chicago assets) due to COVID

·         Activism + New Mgmt team took over late last year

o    Ackman initially joined board of GGP after it emerged from Bankruptcy in 2010 and became chairman of HHC after GGP spun it off in late 2010

§  Ackman recently increased his stake in HHC, showing a willingness to support the company, buying $500m worth of shares at $50/share. Ackman was also increasing his stake in HHC prior to the COVID downturn (Ackman increased Pershing’s stake in HHC notably since 2018 (did not sell any shares from 2010 through 2017)

·         Now at ~20% (Went from ~9% to nearly 11% in 2017 and back to ~3% in 2018 and 5% at end of 2019).

o    When Ackman took over as Chairman he personally sought out HHC’s prior Mgmt (Weinreb + his partner Herlitz), and they committed millions in their own money for non-transferable warrants in HHC

§  Weinreb has been replaced by Paul Layne, who has been with HHC since 2012 prior to which he was an Exec VP at Brookfield

·         Valuation –

o    Valuation for HHC is unique given the company is not a REIT and thus usual metrics such as FFO multiples are not very effective at measuring value of combined HHC

§  The discount rate, forecasted appreciation of real estate and timeline for landsales are all highly subjective and can be lumpy in reality