HHC (2019 - Q2)

Good morning, and welcome to the Howard Hughes Second Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to David Striph, Executive Vice President of Investor Relations. Please go ahead. David St

Good morning and welcome to The Howard Hughes Corporation's second quarter 2019 earnings call. With me today are David Weinreb, Chief Executive Officer; Grant Herlitz, President; David O'Reilly, Chief Financial Officer; and Peter Riley, General Counsel. Before we begin, I would like to direct you to our website www.howardhughes.com where you can download both our second 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 second 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're not under any duty to update forward-looking statements unless required by law. I will now turn the call over to our CEO, David Weinreb.

Thank you, Dave, and thank you all for joining us today. Welcome to our second quarter 2019 earnings call. I am pleased to report that we had another very productive quarter creating value across the portfolio and our core business segments. A few highlights; total NOI from operating assets was up 32% compared to the second quarter of 2018. MPC residential land sales were up 14% compared to the same period last year; and net new home sales, the driver of land sales, we're up 13.4% in our communities. Two of our communities ranked within the Top 11 nationally at the halfway point of the year with Summerlin ranking 4 and Bridgeland, 11th. It is worth noting that home sales in Bridgeland are up 35% in the first half of this year compared to the same period last year. Strong sales at Ward Village continued with another 56 home sales during the quarter. We also have the delivery of the 99% sold Ke Kilohana which provided additional revenue of $12 million. Additionally, in July, we broke ground on our newest building, Ko'ula, that is 64% pre-sold as of June 30. We began construction on a new multifamily project in the Woodlands that will deliver an 8% return-on-cost, and an additional $3.5 million of NOI. Now I'd like to start with some details from our Strategic Development segment, then Grant will talk about our MPCs and operating assets, followed by David O'Reilly on our financial results. We had another strong quarter in our Strategic Development segment with robust sales of condominiums at Ward Village in Honolulu. As I mentioned, we sold a total of 56 homes during the quarter, including 45 at Ko'ula. The building which will have 565 homes and launched sales in January of this year was already 64% pre-sold as of June 30, and 65% pre-sold as of July 31; an incredible pace of approximately 60 home sales per month for this building. A'ali'i which began construction last October was 82% pre-sold as of June 30. We were very pleased to welcome residents to Ke Kilohana which I mentioned delivered during the quarter, the delivery of this building allowed us to pay-off the construction loan in full. To date, we have sold 1,981 homes with total contracted revenue of approximately $2.3 billion, excluding Ko'ula, bringing us to 93% pre-sold on our first five buildings as of June 30. Ward Village has truly become a vibrant vertical master plan community offering its residents a walkable healthy lifestyle that is unique in an Owahu [ph]. We are extremely proud of what the team has accomplished with this asset and given the strong sales momentum we are studying how to increase the pace of development. At the Seaport District, we saw total revenue increase to $12.9 million this quarter compared to $7 million last quarter and $4.5 million in the second quarter of 2018. This is the result of the launch of the 2019 Summer Concert Series along with the Garden Bar being open and higher summer traffic. We were especially pleased that traffic has increased approximately 50% over the same period last year and continues to grow with each new opening. Our highest profile opening in the quarter was John-Georges incredible new seafood restaurant, The Fulton, which opened in late-May and provides a glimpse of the Seaport's long-term potential as a one of a kind destination. The restaurant is receiving outstanding reviews. Subsequent to the quarter-end, we celebrated the opening of David Chang's Bar Wayo on July 25. We are looking forward to the opening of Malibu Farm this month, followed by the opening of Andrew Carmellini's new restaurant next year. Consistent with what we said last quarter, while these openings increased the top line revenues, hope to create critical mass and move the Seaport closer to stabilization, we expect that we will continue to incur pre-opening losses for these new businesses until we have a critical mass of offerings. For the quarter, we had a net operating loss of the Seaport of $2.9 million, which again was primarily due to funding start-up costs for the retail, food, beverage and other operating joint venture businesses. Earlier in the second quarter, we closed on a new loan for the Seaport District, which David O'Reilly will speak to in more detail. As a result of this financing, the total project cost for the Seaport District increased to $768.5 million, up from $731 million, net of Hurricane Sandy insurance proceeds; this cost increase is entirely a result of the loan. As I said last quarter, we remain cautiously optimistic about our long-term success and have not changed our NOI target for the asset in our supplemental. With that, I will now turn the call over to Grant to discuss the details of our operational results.

Thank you, David. In our MPC segment, we continue to see strong demand from homebuilders for our residential land driven by healthy fundamentals and demand drivers in the residential home sales markets in our communities, which are located in lower cost markets with no state income tax. Residential land sales were $58.3 million during the quarter compared to $51 million during the second quarter of 2018, an increase of $7.3 million or 14%. The sales increase was led by Bridgeland, followed by the Woodlands Hills and Summerlin. The increases in each of these communities were partially obscured in earnings before taxes which increased only $651,000 over the second quarter of 2018 due to lower sales at The Summit. At The Summit we have closed on 118 lots totaling approximately $375 million, and we have 14 more under contract for approximately $59 million as of the end of the second quarter. These results reflect a combination of modestly slower sales and a shift from custom lots where the margins are higher to homes built by the joint venture where the margins are lower. With the product mix shifting from custom lots to more built homes as the project progresses, we expect margins to remain lower in the coming quarters. Also, The Summit is an ultra-high end community and sales will always be lumpy from one quarter to the next. With all of that said, the project has exceeded our expectation for sales since the inception, notwithstanding the current quarter-over-quarter decline in EBT from this joint venture. At Bridgeland, there were 217 lot sales this quarter, 110 more lots sold than in the same period last year. Total acres sold were 40.7 this quarter compared to 22.6 in the second quarter of 2018, an 80% increase. In addition, we continue to see robust demand for new homes, which is the underlying driver of land sales to our home builders. In the second quarter of 2019 there were 215 new home sales compared to a 150 in the same period of 2018, a 43% increase. We attribute this increase to the continued maturation of this master plan city and the momentum we are creating there. Bridgeland is in the path of Houston's growth with excellent access to the Greater Houston area via the Grand Parkway, top notch schools, and amenities. As we said last quarter, this is a testament to our team's strength in curating a sought after master plan city environment and a critical reason for our continued success at Bridgeland. We continue to be very excited about the future of this city. At Summerlin, land sales totaled 44.3 acres, an increase of approximately 15% over last year. New home sales are up 8.6% in Summerlin for the quarter with 365 homes sold compared to 336 homes sold in the same quarter of last year. Year-to-date new home sales are down approximately 10.3% with 667 homes sold in the first half of 2019 compared to 744 in the first half of 2018. As we said last quarter, a good portion of 2018 sales were pushed into the first quarter as buyers were attempting to purchase before mortgage rates increased. New home sales during the first quarter of 2018 were almost double that of 2017. We continue to expect that the balance of the year will be very similar to 2017 and 2018, which were both excellent years. Third-party builder sentiment continues to be very positive on Summerlin and the Las Vegas market as a whole given their excellent economy and the fact that 30-year mortgage rates have dropped to below 4%. We have received excellent bids on all of the parcels that we have put out to market so far this year and consistent with our outlook on home sales anticipate another strong year of land sales similar to 2017 and 2018. While the overall weighted average price per acre decreased 2% from $538,000 to $528,000, we actually increased the price per acre in every community except the Woodlands where we are effectively out of residential land. The reduction in the weighted average is purely due to this mix shift of selling more land in our lower priced communities like Bridgeland and The Woodlands Hills, which is bringing down the average. In conclusion, our MPCs performed remarkably during the quarter. Turning to our operating asset segment; we increased our second quarter total NOI by $14.5 million from $45.8 million in 2018 to $60.4 million in 2019, a 32% increase. The increase is largely due to placing the Las Vegas Ballpark into service in March of 2019. We continued stabilization of our existing office and hospitality assets and the placing into service of assets completed since the second quarter of 2018. The Ballpark provided approximately $7.9 million of increased NOI while we saw approximately $3 million of improvement from our office sector led by Aristocrat, 3 Hughes Landing, 2 Merriweather, 1 Summerlin and 2 Summerlin as these assets continue to stabilize. In addition, our hospitality sector NOI increased by approximately $1.9 million or 25% led by the Woodlands Resort and The Westin at The Woodlands; we are very pleased with the performance of our operating assets. Total NOI also increased sequentially from March 31, 2019 to June 30, 2019 by approximately $9 million or 17%. At the same time our stabilized NOI target decreased from $321 million last quarter to $317 million this quarter, a $4 million reduction. This is due to a decrease in the amount of equity that we will invest in 110 North Wacker based upon a loan modification that was completed in May. The modification provided additional loan dollars and therefore decreased our acquired equity contribution which changed our ownership percentage, and therefore our share of the NOI. We continue to expect that the building will achieve an 8% yield on cost but our overall return will improve with a lower equity investment in the same waterfall structure with our preferred equity partner. This prior to the quarter-end, we signed a 120,000-square foot lease, bringing the total lease to approximately 1 million square feet or 67% on a project that is not scheduled to complete until late 2020. The $8 million reduction in NOI from 110 North Wacker was partially offset by the commencement of construction on Millennium Phase 3, a 163-unit apartment project in the Woodlands, which is anticipated to create an additional 3.5 million of NOI or an 8% yield on a cost of approximately $45 million. This quarter is another excellent example of how we continuously create value for our shareholders by transforming our existing land into dynamic operating assets that create additional NOI and shareholder value. And with that, I will turn the call over to David O'Reilly for our financial results.

Thank you, Grant. I'd like to start with a quick overview of our earnings before summarizing our recent financing activity; and then turn to our current leverage and liquidity metrics. I hope that you've been able to review our 10-Q earnings release and supplemental package filed yesterday which contains details of our financial and operational results. First, on the earnings. We completed the second quarter with GAAP earnings of $13.5 million or $0.31 per diluted share as compared to a net loss of $5.1 million or $0.12 for the second quarter of 2018. The increase was driven by the closing of condominium units at Ke Kilohana at Ward Village, the absence of a $13.4 million charge for window repairs at our Waiea condominium tower which was recorded in the second quarter of 2018 but did not recur in 2019. The increases were partially offset by higher operating expenses at the Seaport District. NAREIT defined FFO was 121 per diluted share for the quarter as compared to $0.53 for the second quarter of 2018. The increase is primarily due to the same factors I just noted. Turning to our financings. As David mentioned, we closed on a $293.7 million construction loan for the development of A'ali'i June 6. The loan bears interest at one-month LIBOR plus 3.10% and has a 3-year term with a one-year extension option. During the quarter we also closed on a new construction to permanent loan for $35.5 million for 8770 New Trails in Houston, our build-to-suit for Alight Solutions. The loan bears interest at one-month LIBOR plus 2.45% and has an initial term of 2 years with a 127-month extension option. At the Seaport District, we completed financing of a 5-year $250 million term loan that bears interest at 6.1% initially. It will begin to bear interest at one-month LIBOR plus 4.1% with a LIBOR cap of 2.3% at the earlier of June 20, 2021 where the date-certain coverage ratios are meet. The collateral pledge for this debt includes The Fulton Market building Pier 17, The Museum Block, Shcrimer Horn Road [ph], and The Tin Building. The Tin Building can be removed from the collateral as soon as it is completed with no repayment obligation, no lender consent, and no penalty of any kind. We believe that this is a strong financing for Howard Hughes as it provides non-recourse capital to complete the project, reduces our equity commitment to the Seaport District, and is repayable as early as one year. On June 3, we exercised the second extension option for the 250 Water Street lot and paying that loan down by $30 million to $99.7 million. We also modified the $512.6 million facility for the 1-10 North Wacker joint venture, by increasing the total commitment to $558.9 million, of which the company guaranteed approximately $100.6 million. We modified the loan on the Mr. C Seaport joint venture to increase the total commitment to $41 million. The loan bears interest at one-month LIBOR plus 4.5% and matures in May 2022, but also has one 6-month extension. Lastly on June 5th, as mentioned earlier, we paid off the construction loan for Ke Kilohana. As of the end of the second quarter, our total consolidated debt to total assets was approximately 44.4% and our net debt to enterprise value closed the quarter at 30.2%. From a liquidity perspective, we finished the quarter with approximately $7 million of cash on hand. As of June 30th, we had 28 projects to be completed with anticipated total cost of $4.8 billion. Of that amount we have previously funded approximately $3.2 billion, leaving approximately $1.6 billion in estimated remaining costs. We expect to meet this obligation with a combination of existing construction loans, which at quarter end had approximately $1.2 billion of committed, but undrawn capacity and with an anticipated loan of $31 million for Millennium Phase III Apartments and with approximately $90 million of buyer deposits. This leaves a net remaining equity requirement of approximately $345 million. We expect to fund our remaining equity commitments through a combination of our free cash flow from our operating assets and MPC segments, net proceeds from non-core asset sales and lastly, our existing cash balance. Again, as of the end of the quarter with approximately $650.7 million of cash on hand and net equity requirements of $345 million, we have enough cash and liquidity on hand to meet all of our current funding commitments, without any additional cash being generated from MPC land sales or our operating properties. With that I'd like to turn the call back over to David for closing remarks.

Thank you, David. As you can see, we had another quarter of strong results and we continue to be thoughtful, creative and opportunistic in allocating capital in a manner that we believe best increases the value of the company for our shareholders. Before we end the call, I would like to touch on one other topic. On June 27, the company confirmed that our Board of Directors retained Centerview Partners, to assist in a review of potential strategic alternatives to further drive shareholder value. The Board is committed to exploring this review to best serve the interests of our shareholders. A broad range of options is being considered, including a sale, joint venture or spin-off of a portion of the company's assets, the recapitalization of the company, changes in the corporate structure of the company or a sale of the company. As we said in June, our businesses continue to perform extremely well across our three core segments. However, our stock price continues to lag below its net asset value per share. We are determined to close this gap. We've not set a timetable for the conclusion of this review. We will provide an update as appropriate and do not have anything further to add at this time. As such, we ask that you please limit your questions to our quarterly results, as we will not be taking questions on this subject during Q&A. Lastly, please note that we have uploaded a deep dive on Ward village to our website, so please review that at your convenience. We hope that it will be helpful to you. Thank you for joining us today. And with that I will open up the call to Q&A.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] First question today comes from Alexander Goldfarb from Sandler O'Neill. Please go ahead.

Good morning, David. Listen, I appreciate your comments on the strategic, but obviously it is a big focal point and investors realize the disconnect that exists, but maybe just big picture, maybe you can provide a little bit of color on if the recent market volatility has impacted the process. And two, as you guys talk to folks, is it going as you would have expected, meaning types of buyers, types of projects or outcomes that may be interested, or if there have been some surprises that have come out either on interested parties or interested transactions.

Alex, this is David, it's way too early and it's not appropriate for me to provide any color or details at this time in terms of unexpected outcomes, unexpected parties or anything along that. The only thing I will tell you -- that I would say the language, it's in the press release accurate, it really reflects exactly what we're doing with this, we're trying to turnover every stone to maximize value for our shareholders, to close the gap between our share price and intrinsic value and that it could include anything, from a sale of joint venture, of an asset, to a sale of the company recapitalization, all those things that were listed. I can assure you that it is being treated with the seriousness that it deserves. It’s an incredibly disruptive process and one that you'd prefer not to have public. Just based on the impact it has to our employees and culture that worked so hard every day to maximize value at Howard Hughes, and to give you any color beyond that just is an appropriate at this time.

Okay. And then second question is, you had a big benefit from the Aviators which is great, F&B is active at the Seaport. But on the other hand, these are seasonal businesses. To what extent would the Knights or other parts of your business be able to provide similar benefit in the 4th quarter and first quarter? How much extra ancillary income through your portfolio, through different things like these that aren’t traditional real estate, but clearly are benefiting NOI, do you see in the portfolio?

Alex, this is Grant. I think throughout the portfolio we have different teams working on different streams of ancillary income. The vast majority of it is coming from the sources that you've already outlined, so they won't be a big impact to that. Mow, if you're looking for growth in NOI from our operating assets, you're going to consistently see quarter-over-quarter growth in those operating asset by virtue of the fact of new assets coming online every quarter, free rent burning off from office tenant, retail rents increasing, office rents increasing across the entire portfolio. We still expect to get to that 321 run rate NOI excluding the Seaport and are very pleased with the quarter's results. That shows that progress.

Okay and then just finally, I think you mentioned that the higher Seaport costs were related to the loan but maybe you could just provide a little bit more color on that.

Yes, absolutely. Alex, I mean, pretty straightforward by having a new financing we have loan closing costs, mortgage correlation title and capitalized interest as part of that loan is related to construction at the Tin and tenant fit-out. So the increase in cost is purely associated with the loan and not a change in the underlying cost to construct the Seaport in any way.

Okay. Thank you, David.

Thanks, Alex.

The next question comes from Vahid Khorsand from BWS Financial. Please go ahead.

Good morning and thanks for taking my question. First one, just following up on what Alex. There were reports earlier this summer that Major League Baseball was looking into moving the franchise into Las Vegas. Have you calculated that into the aviators' conversation and is that a ballpark that could be converted into a major league baseball stadium?

This is David Weinreb. We have not. It is possible at some point in the future that Major League Baseball will consider Las Vegas as a new home for one of their teams but at the moment that is not anything being considered.

Okay. I mean, it would be good news for the Summit if that were to happen. Obviously, but next question on the condo sales. I believe in the last call we were told that -- Grant, you were saying that condo sales will be recognized in the second and third quarter, is that still something that's on track.

Well condo sales were recognized that Ke Kilohana because we closed it in the second quarter as well as for IO and any remaining on highway units so that did happen.

Yes. That did close on schedule. We won't see anything in the third quarter of magnitude other than one-off unit sales. And as you know, we have very little remaining units available across the 5 towers that are complete -- 4 towers that are complete. Excuse me.

Okay. And then on the MPC segment on the conversation on gross margin on land sales, just can you provide a little bit more color on how you see gross -- how we should model gross margins going forward on land sales. Thank you.

On a cash basis, we provide guidance within the supplemental, on our MPC pages in terms of where those cash margins will be for land sales over the long term. From a GAAP perspective, those margins change pretty significantly because we're recording costs that were spent associated with those lots. It could be decades ago and from a cost of good sale they get translated into those a lot sales every quarter. This quarter was impacted. A shift in margin overall although I'd say each of their communities were relatively consistent with past quarters and the overall shift in margin was partially driven by lower sales at the Summit that comes through as an equity interest in a joint venture.

But just remember when David speaks about our cash margins. That's really one of the most important things because master-planned cities, in our case, which is our term now for those community because they're so big or the vast majority of the infrastructure early on get spent. And then it's reimbursed through MUD or Municipal Utility District in our receivables and special improvement district. And because we put that cash out upfront those margins are much lower earlier on in the life of the asset and much higher at the end of the assets. So in the Woodlands later in the cycle, you get to 90 plus margins and at Bridgeland 60, 70 together with Summerlin about the same.

Okay, thank you.

Next question comes from Elizabeth Yua [ph], a private investor. Please go ahead.

Hello. Regarding Howard Hughes's investment at 250 Water Street, it has come to my attention there is a significant deposit of elemental mercury at the site. This could prove very costly to clean up and remediate. Has this finding impacted Howard Hughes's plans for 250 Water Street?

Thanks. Elizabeth, this is David O'Reilly. I would say that with all of our plans in all of our projects we are taking the same approach, which is to maximize risk-adjusted returns on all the capital that we allocate across the portfolio. Well, 250 Water Street will be no different. As I'm sure you're aware, we haven't announced any plans for this project yet. And when we do, we'd be happy to discuss it in more detail. Thanks.

Well, I understand that the potential liability from elementary mercury exposure to the surrounding community could be in the hundreds of millions or billions of dollars. How is management limiting exposure and risk to this project?

With all of our projects, we're looking to maximize returns on a risk-adjusted basis and if there is substantial liability associated with that, we will measure that in our investment decision and in our capital allocation decisions.

And -- just, this is David Weinreb I want to add that we take -- any time there is an environmental issue, we take it very seriously. And the appropriate steps are being taken to make sure that if and when it's remediated it's done in the best way possible.

The next question comes from John Peterson with Jefferies. Please go ahead.

Great. I realize that the plots for single-family home sales are relatively lumpy. But we've obviously seen interest rates come down and mortgage rates come down quite a bit just into the third quarter so far. Just curious if you can give any color on how that changes your expectations for land sales?

Yes. So, we evaluate land sales based on home sales and we're seeing a great appetite from all of our builders across all our cities to increase the pace at which they consume lots specifically in Bridgeland which is in the path of really the growth of Houston Northwest. We're seeing a huge run rate increase on lot sales. You can see in our quarter-end, its 43% increase year-over-year. Summerlin 8.6% and Woodlands Hills obviously 136% increase.

All right. And then I guess maybe along a similar line. I'm curious at Ward Village, if you kind of -- if mortgage rates have some of the similar dynamics and maybe the step back, if you could kind of remind us the typical type of buyer there whether it's cash buyer, whether it's foreign, whether it's domestic, where does the demand come from for that project in Hawaii?

John, I'd say that the demand has shifted since of time we first started selling our first Tower Waiea to what we're selling now at Koula. We've seen an increase in local buyers from about 50% to about 2/3. Still a pretty consistent 20% to 25% Japanese and the rest is a little bit of a smattering of other Asians and some mainland U.S. et cetera. That market and the purchases there have a much lower percentage that are buying with mortgages than what we're seeing in our other communities and I would say that the strong sales volume that we've seen in Ward Village while we could attribute part of that success to lower interest rates. I'd like to think that more of it has to do with the culmination of the community, the opening of Whole Foods. The real critical mass that's taken place there as well as the thoughtful design that the team in Ward has put into place to develop products in a product size and unit mix that really matches that local buyer demand pretty well.

And maybe sticking with Ward Village. Just one more for me. I think you guys have been building about one building a year. Just given the demand is there an opportunity to increase the pace of development?

We're cautiously optimistic that we can. I would say that given how quickly we've been able to sell and getting north of 60% of Koula presold on a building that we just launched in January gives us a lot of the positive encouragement in terms of increasing pace of sales. When we say that though, I want to be careful. I don't want to think that we're communicating that all of a sudden, we're going to launch 2 or 3 towers at the exact same time. This is more about going from one tower a year to perhaps one tower every 9 months and see how that goes before we think about accelerating further than that.

Okay, that makes sense. Thank you.

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

Just a quick. Thank you for joining us today. As always, we're available, you can reach us through our Investor Relations page on our website. Feel free to contact us through there if you have any further questions and look forward to being with you again in a short few months. Thank you.

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