Introduction and context
I’ve been watching Howard Hughes Corp (HHC) since Bill Ackman of Pershing Square spoke about it at Sohn in 2017. HHC’s is a real estate development company whose primary method of generating returns is building communities such that added developments further increase the value of their remaining holdings. They also hold onto, and operate, the commercial spaces. Ackman is the chairman of the board, and has been invested in HHC since they spun out of General Growth Properties back in 2010. The stock has recently plunged from ~$140 range before COVID hit, to the $50 dollar range, trading between the mid $50’s and mid $60’s since then. Ackman has since significantly increased his holding from ~$100M to ~$650M.1
Ackman believed that the stock was selling at a significant discount to its NAV at $140 a share, with very low solvency and liquidity risk. That is what initially spurred my interest in the stock—as if he is correct, that means it is currently trading at a third (or less) of it’s FMV. To test his hypothesis, I ran a SOTP analysis, diving as deep as I feasibly could into each of their listed properties and assets finding comps, tax assessments, and regional cap rates for each property individually, in order to build out an estimate of their FMV.
What I have found in my analysis is that the stock is not worth $140 per share, however, it may still be significantly undervalued, with a fair market value between $85 and $110 per share.
So why is it misvalued? Likely because the surface level financials are not all that attractive. The commercial real estate market has been hit hard by COVID, and HHC has lost money over the past two quarters with negative net income of -$34M and -$125M respectively. However, when you dig in deeper, you see that much of that impact is not from re-occurring business impediments. For example, in Q1, HHC recorded a ~$97M operating cost to its strategic developments segment for costs to fix construction defect it hopes to recover from their general contractor. In Q2, there was a $45M depreciation charge, giving the company a non-cash tax shield that’s ~$30M higher for H1 20 than for H1 19. Lastly, while their CFOs have not been positive in the first half of this year, there has been obvious reinvestment. Their -$99M in CFO was driven down by $231M in development expenditures.
As the company matures, it can catalyze it’s value by:
1) Continue to convert its for-sale assets such as residential MPC land, condo inventories, and non-core assets to cash
2) Capitalize on its operating assets, which include both commercial real estate holdings and businesses, generating operating cash flows to reinvest or distribute
3) Execute on both MPC and strategic developments to increase the value of its underlying holdings, and
4) Potentially in the long term (after they have finished reinvestment) convert to an REIT as a more efficient capitalization structure, reducing the spread between market share price and NAV
And all of that is in addition to a potential 40% – 70% appreciation, as the assets go from deeply undervalued, to fairly valued.
Additionally, because of its deep misevaluation, the company has a significant margin of error. It trades far enough below “fair” value, with such low liquidity and solvency risk, that it is unlikely to see a significant further impairment, making this a low risk high reward opportunity.
Sum-of-the-parts
HHCs assets can be broken into four major segments; MPCs, Seaport properties, Operating properties, and Strategic developments. Each segment can be further broken down into smaller pieces once again.
MPCs
HHC has 4 listed MPCs; Summerlin (Las Vegas, NV), Bridgeland (Cypress, TX), Columbia (Columbia, MD), The Woodlands (Houston, TX), and The Woodlands Hills (Conroe, TX). HHC own the undeveloped land in these communities, as well as some of the local amenities. The value of the amenities, however, is included in the land value, and so we will value these portions listed only on the available residential and commercial acreage.
The 2019YE 10-K lists both management estimates at value of the land, and average price per acres over the past 3 years. Management estimates are the “weighted-average land value per acre estimated in the Company’s 2020 land models, which include estimates of future pricing over the remaining life of each project.” That sounds a lot like an estimate of future value, which is not what we are looking for, but sometimes the numbers are closer to current sales than expected value. We will consider both these numbers (listed on page 26) as well as the previous 3 years sales (listed on page 49 and 50) as we come up with high, expected, and low estimates.
Summerlin
The Summerlin MPC has 2,991 residential, and 831 commercial, remaining saleable acres listed in their 2019YE 10-K.
Bridgeland
The Bridgeland MPC has 2,166 residential, and 1543 commercial, remaining saleable acres listed in their 2019YE 10-K.
The Woodlands
The Bridgeland MPC has 71 residential, and 722 commercial, remaining saleable acres listed in their 2019YE 10-K.
The Woodlands Hills
The Bridgeland MPC has 1,348 residential, and 175 commercial, remaining saleable acres listed in their 2019YE 10-K.
Columbia
The Columbia MPC has 96 commercial remaining saleable acres listed in their 2019YE 10-K.
Total
In total, the remaining acreage that HHC owns to sell is valued somewhere between $4.13B and $6.23B, with a best estimate of $5.32B.
Seaport
HHC owns a massive seaport development in Manhattan, which is situated across a number of city blocks. The listed properties include the “Uplands”, the Pier 17 development, a 35% stake in Mr C (which they recently sold), a 90% stake in Bar Wayo, the Tin Building, and 250 water street (a parking lot they’re planning to develop conditional on securing the air rights). We’ll split this into three parts to conduct our analysis.
Retail buildings
The uplands, pier 17, and the Tin Building, combined, have approximately 435k sq ft of available retail space (from 10K). From a recent Co-Star report, comp retail space in Manhattan is selling at an average of $2k per square foot, with prices reaching as high as 4k.
As this is a newer development (and much of what is on the market in NY today is old and run down), we expect this square footage to be slightly more valuable than average, at an estimated 2.75K per square foot, less the remaining development costs to be paid ($145M). We’ll use a $2K and $3.5K downside and upside scenario.
85 South Street is a residential building in the same district. There is a lack of NOI information, as well as general secondary, so we’ll just use it’s carrying cost at ~25M, with the down side scenario including depreciation, and the upside scenario as a +5% bump.
Businesses
HHC sold its stake in Mr. C last quarter but retains its stake in Bay Wayo. We will just use the 10-K’s listed carrying cost of $6.75M, with an up and down side scenario of +/- 10%.
250 Water street
250 water street is currently a 1.1 acre empty lot (currently used for parking) situated in the middle of the seaport development. Plans have been leaked for a tall development to potentially be built there, but we must value only the land at the moment. HHC is yet to secure the air rights. Based on a 2105 paper by Barr, Smith, and Kulkarni that lays our value of undeveloped land in Manhattan, we can estimate the value of this lot to be between $50M and $60M. We will use $55M value here as a median.
Total SOTP from segments
In total this puts the seaport development value at $1.1B
Operating assets
HHC makes a significant portion of its operating income from commercial real estate properties, which they manage and lease. The majority of these properties are stable income producing properties with occupancy rates in the mid 90%.
I used a recent CBRE cap rate survey taken during the pandemic to find average cap rates.
and then used a slightly older Q2 2020 survey to find average cap rates where more specific location data was not available.
Set 1
The first set of properties are ones I have found tax appraisal data for, that also had stabilized income. I used the minimum of their a) Q1 annualized NOI and b) management estimate of stabilized NOI to calculate their valuation, and averaged that with the tax appraisal. Tax appraisals are often discounted slightly from FMV, so this I expect this estimate to be both close to fair value, but on the conservative side. These properties were also conveniently 100% owned by HHC. Data below:
The sum of these valuations is ~$1.2B.
Set 2
The second set of properties were similar—all had mostly stabilized NOI, but they didn’t all have tax appraisal data, they were not all strictly real estate assets, but they were not all 100% owned by HHC. As there is no appraisal data to keep this estimate conservative, I used an 8% cap rate for these instead. Data below:
The value of their stake in this set of properties is $1.3B.
Set 3
The remaining set includes a miss-match set of operating assets with varying ownership stakes, operating models, and available information:
In total, these assets are worth an approximate ~$630M.
Total
So in all, we have a total value of operating assets of ~$3,200M
Strategic developments and other assets
Strategic developments required a variety of bespoke methods to value.
The first set of properties we valued at 0 for a variety of reasons.
While others need a variety of methods to find their FMV.
In sum, these properties have a value of approximately $680M. We’ll use a +/- 10% to help set the high / low range.
Total
With all the segments we have discussed so far, we find that HHC’s real estate assets have a fair market value of somewhere between $8.5B and $11.9B, with an expected mid-point of $10.4B.
Valuation
The most recent 10-Q lists a large variety of current assets to be added to their asset list.
They also list all current and long-term debt obligations:
Lastly, as we’re using a book driven method of valuation we need to capitalize the ongoing corporate SG&A. Management estimates an $80M per year charge within the next year or so. Their most recent quarter saw a $22M charge, which is fairly close. We’ll add a range around it for the high and low scenarios.
And with that we can calculate the value of a share of HHC.
Over the past two weeks shares have traded between the high $50’s and low $60’s, indicating a potential 40% to 100% return on investment as the spread to full value is captured, while not including other asset appreciation and capitalization over any given period.
The downside in the above scenario is only the case if all of our assets are at the low end ranges, which is rather unlikely.
If we assume that there is an equal chance that in any given set of valuations the correct number is low, mid, or high then we can run a quick simulation to show what the distribution of prices (and therefore returns would look like). This is in no way a perfect assumption, and this methodology is not robust enough to run it against an option pricing methodology with any accuracy, but it should give us an idea of what the most likely level of returns would be. The distribution appears as follows:
The mode of fair market value is between $90 and $100, and the other percentiles of returns break down as follows:
