In this week's edition of Industry Focus, hosted by Jason Moser, Fool.com contributor Matt Frankel, CFP®, sits down with David O'Reilly, CEO of The Howard Hughes Corp. (NYSE:HHC), one of the most interesting and unique real estate companies in the market. You'll hear what the company does, where O'Reilly sees the biggest opportunities, why the master-planned community business is so attractive, and much more.

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This video was recorded on Oct. 25, 2021.

Jason Moser: It's Monday, October 25th. I'm your host, Jason Moser. On today's Financials show, we're talking real estate with a special guest. Howard Hughes Corporation is one of the most unique real estate companies in the world. Recently, our own Matt Frankel sat down with CEO David O'Reilly to talk more about how the company generates market-beating returns. Why he thinks it has the best risk-adjusted return potential in the publicly traded real estate sector, and much more. We hope you enjoy their conversation.

Matt Frankel: We are joined by David O'Reilly. He is CEO of Howard Hughes Corporation, one of my favorite real estate companies. One that flies under the radar, because they are unique. With that in mind, David, first of all, thank you for joining us today.

David O'Reilly: Thank you for having me, good to chat with you, Matt.

Matt Frankel: So for those who don't know what Howard Hughes does, you're in a unique spot in real estate, you're not quite a REIT, you're not quite a real estate developer. Can you give us just a brief overview of what you do?

David O'Reilly: Absolutely. It is very unique and definitely unique within the public markets. But what we are is, we're really a large-scale masterplan. We have communities across the country where we are dominant landowner. Those communities are the Woodlands and Bridgeland in Houston, which represent 28,000 and 11,000 acres, or in the Woodlands is roughly 1.5 time the size of the island in Manhattan. Downtown Columbia in Maryland, 22,000 acres known as Summerlin, just west of the Las Vegas Strip, Ward Village in Honolulu, and the Seaport in New York City. Really, what we do at the end of the day is we play SimCity within these masterplan communities. We decide where the mixed-use urban environments of tomorrow should be built. We did develop where housing is, public infrastructure, fire stations, police, as well as office retail, hospitals. Really creating a place where people and companies want to live, work, and play. It really drive some unique financial synergies for us in that the proceeds that we get from the sale of residential land to homebuilders and the recurring income from our rent collections entirely self-fund over a billion dollars of development a year. That development that we try to build at outsized risk-adjusted returns, it just further amenitize our communities, making them more desirable to live in. Since we've spun out and became a public company 11 years ago, we've built that operating portfolio by developing commercial acres, into over eight million square feet of office, three million square feet of retail, and over 5,300 apartment units. We have an extensive pipeline with 50 million square feet of entitlements that will allow us to develop, not just for years, but for decades to come.

Matt Frankel: What's the most attractive about that type of business model? Like in other words, why not just develop office buildings if that's where you see an opportunity?

David O'Reilly: Absolutely. I think what really sets us apart and what makes us unique and gives us competitive advantages is the unique influence that we have over such large swats of land. If we were just building an office building, we'd make a great office building, but we wouldn't have the impact or the care for the surrounding environment. Howard Hughes, we're looking at the big picture. We're developing the office, the shopping, the hotels, we're focused on the parks and trails in between interstitial spaces that drives great communities. Our business is really formed around what we think is a virtuous cycle value creation, where we take land sale to homebuilders who build homes, residents move in, those residents demand commercial amenities. We build those commercial amenities, which in turn make the resident homes more valuable, make our remaining land more valuable, and continues to drive on and on. I think one of the most rewarding parts of working at Howard Hughes employee comes to work every day. We're defining our success by improving the lives of our residents, consumers, and tenants. If we give them better schools, better trails, better access to nature, better places to work, better places to shop, it drives value for us. That's an incredibly rewarding aspect of our business and something that we take great part in every day.

Matt Frankel: I want to ask this next question a little bit differently than I had planned. You mentioned all your masterplan communities. I was going to ask which has the most value-creation potential, but that's a strange way to ask it. The way I would like to say, can you give us an overview of how mature each community is relatively, which ones are most built-out, which one still have the most vacant land, things like that?

David O'Reilly: Absolutely. Again, I'm glad you asked it that way because I hate to choose between my children. It's like saying which of your kids do you like best? They are all having credible opportunity, but all with different points of the masterplan community cycle. Our youngest community the Woodland Hills and Bridgeland in Houston are rapidly selling homes. We had record home sales over the past two years in those communities. But that is in the generating of residents. At 11 years old, Bridgeland has had that tipping point of just starting commercial development. We have our first two multifamily buildings there and we're just starting the beginning stages of our town center. That live, work, play, mixed-use environment where we will have offices, shopping, and new grocery-anchored, shopping center that are all in the pre-development phases right now. Slightly older and slightly in terms of a masterplan communities 20-years, Summerlin has been around for 30 years selling land since the early '90s, and it still has about 3,000 acres of residential land to go, but endless opportunities for commercial and that city center has really come alive with a million square foot outdoor dining and shopping experience center, two class A office buildings, two class A multifamily buildings. The Las Vegas ballpark, which is home to the Oakland AAA team, the Las Vegas Aviators. That has really started to shift from just residential to a great mix between residential and commercial. In the Woodlands, we have very few residential acres left, but 700 commercial acres are with endless opportunities for more commercial development to meet the demands of the growing businesses than the growing retail companies that want to be in the Woodlands to take advantage of our incredible demographics. Then the oldest community was founded by Jim Rouse and he's the father of masterplan communities developing what he liked to call the garden for people to grow in Columbia, Maryland. There, we don't have any residential land left, it's completely sold out, has been for many years. But we have the opportunity to complete Jim Rouse's original vision by developing downtown Columbia around the Merriweather Post Pavilion and the Columbia Mall and Lake Kittamaqundi bringing in more multifamily medical office, meeting the demands of those consumers that want to be there.

Matt Frankel: I know you recently underwent a little shift in the focus of your business, which I'll get to in just a second, where you're really concentrating on your masterplan communities. I want to just briefly asked about the Seaport real quick. If I were to play a game of one of these things, it's not like the other with your properties. The Seaport would probably be the winner just it doesn't seem like the SimCity like when creation cycle, if you will. Where does that really fit into the long-term strategy?

David O'Reilly: Sure, it's a great question and I appreciate the point. But really, Howard Hughes across the board where we do with all of our assets is we're creating one of kind communities. That's exactly what we're doing in the Seaport District. We're revitalizing one of the great areas of lower Manhattan into a premier entertainment culinary destination on Manhattan's iconic waterfront is setting that is, unlike anything else we believe in Manhattan. We have a variety of restaurant options with John George, David Chang, Andrew Carmellini, unique shopping destinations and an outdoor 1.5 acre roof top space overlooking Brooklyn Bridge, where we used for events, award winning performances, concerts, and outdoor dining experience. It's that revitalization of creating that great mixed-use environment that we're trying to take a special sauce of what we do in our masterplan communities on a much larger scale and brings to the Seaport. I think next year as we finish construction and open the team building, which is a 53,000 square foot food hall by John George, will be a culminating event for a lot of that revitalization. Of course, we're still in the process with New York City to finalize our approvals for 28-story mixed-use building at 250 Water Street, which will have a meaningful residential component. It is a much smaller scale. It's only on a handful of acres, not 20,000 but it has a lot of those same dynamics of creating great environments for people to live, work, and play.

Matt Frankel: I know in Manhattan, in particular, the ability to create value doesn't take as much space as it does everywhere else.

David O'Reilly: It does take longer though.

Matt Frankel: It does. I think 250 Water Street, people have been trying to redevelop for decades. I'm impressed that you guys were able to get the permitting.

David O'Reilly: Well, we're in that process and we're about halfway through and we're expecting to hopefully get through the remaining stages of it by the end of the year.

Matt Frankel: I know you have a lot of projects from the pipeline in addition to 250 Water Street, I know you just announced I think two billion dollars which accelerated development, I want to say. Our two million square feet, maybe it was. What's the most exciting opportunity in the pipeline to you right now? Is it multi-family, which I know is a particularly hot market right now? Is it building out downtown districts? Is it land sales? Where do you see the best opportunity right now?

David O'Reilly: Well, right now, coming out of the pandemic, we have been firing on all cylinders, and while we've done a lot of new developments in multi-family, we've done a number of office developments in downtown Summerlin and Columbia. It's tough to say that any one is more attractive because it's very much market-driven, location-driven, and our job is not just to find the best risk-adjusted returns, but to meet the demands of those consumers, because those in turn drive the best returns. We haven't talked much about Ward Village yet, which is our beachfront community, 60 acres in Oahu, right between Waikiki and Honolulu and that is among the most exciting projects in the company. Right before the pandemic started in January 2020, we launched our 7th condo tower, Victoria Place. It was right at the beginning of COVID and obviously it was concerning when we did that, but it actually turned out to be our fastest selling tower ever in Ward Village, our 7th, throughout the pandemic on an entirely virtual digital sales campaign, which the team executed incredibly well. As of the second quarter, we were already 93 percent sold on a building that won't complete until 2024. With Victoria Place, we're just under halfway through our entitlements there. There are six or so additional towers that we'll continue to develop their for sale condominiums that will completely revitalize that neighborhood, taking down older, tighter buildings World War 2 vintage retail space and creating first-class shopping, dining, entertainment at the ground floor of these towers.

Matt Frankel: I'm glad you brought up Ward Village because I feel like it's a lot like the Seaport in the sense that it gets overlooked by investors a lot, because it's relatively smaller scale than some of your masterplan communities.

David O'Reilly: It is.

Matt Frankel: A lot of people think of it as a condo development.

David O'Reilly: It's 60 acres, but we very much considered it in masterplan community. It's just a masterplan community that goes vertical. We're going to have 6,000 plus units. Hopefully close to 10,000 residents all living, shopping, playing in the Ward Village community right on Ala Moana Beach Park, and it follows those same principles. For us, we've been able to sell our condominiums at Ward Village in a meaningful premium to any other condos on Oahu. Really because we're not just creating the building, we're creating the overall environment. We're focused on the spaces between the buildings, the walkability, the amenities, the access to great shopping, dining, beach, surfing. All of that plays into how we're creating these environments that we believe drive outsized that.

Matt Frankel: That's rare to find on that scale in Hawaii.

David O'Reilly: Yes, we've been blessed with some incredible assets and with some great forefathers who founded this. Jim Rouse in Columbia, George Mitchell in The Woodlands, Victoria Ward in Ward Village, and we carry their legacies with us and try to execute on it every day.

Matt Frankel: You mentioned COVID in there. Let me just briefly ask you about that. I wrote at the beginning of the pandemic that it was essentially a perfect storm for your company when you consider where your assets are. You're very levered to the Houston market and oil prices went negative at one point. New York and Hawaii people weren't going to, no economy was affected more than Las Vegas during the pandemic. It's like a perfect storm for your assets. What lessons did you learn from that and how has the business rebounded? Has had exceeded your expectations, and what's really surprised you?

David O'Reilly: It's a great question and I think you summed it up very well, and when the pandemic hit, we also viewed it as a potential perfect storm and needed to plan for the worst and hope for the best. What really changed three, four months really starting in June after the pandemic is we saw a flight out of dense urban environments, a flight from the West Coast and Northeast Pacific, Northwest, and even the Midwest, into these great amenity-rich communities with easy access to nature, more outdoor living spaces, and our home sales rebounded incredibly quickly. We saw more and more residents come in, well educated workforce, and then businesses started to follow. What eventually looked like a perfect storm in a bad way, turned into incredible tailwinds for our business. I think one of the more tangible, lasting changes of this pandemic is one that we're experiencing everyday across our communities. Matt, I'm sure I'm older than you are. But I think when I grew up, I defined success as working in a corner office in a big city, in a dense urban environment, and continuing out and it was really all about the job. Coming out of the pandemic, I think a lot of folks are rightfully so redefining success. Not just that corner office in a dense urban environment, but they can work in a small city like Summerlin in Las Vegas at the Woodlands, enjoy that professional success, but also enjoy that personal success. Of a short commute home and spending more time with their family, immediate access to great trails, walking destinations, amenities that allow them to have so much more balance in their life and define success as achieving that balance. Our communities fits squarely right in the middle of the strike zone of that and we've been able to take advantage of that, hitting record home sales in a couple of our communities and accelerating our development, as you mentioned with two million square feet of new projects coming out of the ground earlier this year.

Matt Frankel: Just to expand on that a little bit, we're in a very hot real estate market right now, and it's unusually hot, it's hot in an unusual way. In terms of inventory, it's very, very low. I'd imagine being able to control the inventory of land as an asset right now.

David O'Reilly: It is always is, regardless of the temperature of the market, and that our job is to sell land to homebuilders, just to keep up with underlying home sales. If we sell them too much and the market turns, they'll make a bad decision with that land and impact the value of our remaining land and we have decades to go. If we skip them too little, prices will skyrocket because supply will be down and will impact the affordability of our communities and being affordable is critical to our success, making sure we have the widest range of price points to attract as many residents as we can into our great communities. Again, our competitive advantage comes down to our communities. These 20 plus thousand acre masterplans where we have unique influence and can limit supply just to meet demand, insulates us from the downturns and allows us to accelerate quickly when things get better.

Matt Frankel: I mentioned this is a uniquely hot real estate market. I'm wondering if this has been a good or bad thing for your business because I really can't put my finger on it. One hand, home prices are going through the roof. I know in my market, home prices are up, I think 25 percent year-over-year which is unheard of. But on the other hand, we're seeing a lot of supply chain disruptions. We're seeing a lot of labor shortages, especially in some of the markets where you operate. I'm wondering if overall, if it's a positive or negative right now.

David O'Reilly: Well, right now I think the continued migratory trends, people coming into our communities continue to be positive and they're a partial driver of that price increase if I referenced, Matt. I think more importantly is that some of those supply chain issues have caused a little bit of that pricing and as those start to ease, we've seen lumber come back. But now we're dealing with front doors and some markets roof tiles, and appliances, and as those start to ease and they're getting better every day, I think that pressure on prices will start to abate and then again, we're continuing to deliver lots to homebuilders and we're doing it very prescriptive. When we sell land to the homebuilders, we're finding the size of the home, the price of the home, and where we think it should be set such that we're hitting all the pieces of the affordability spectrum. Not just selling at the highest end, but making sure that we're attracting the greatest number of new residents for our communities and creating affordable places to live. That is one of the great stories of Summerlin, Woodlands, and Bridgeland, is that we have affordable product where if you're coming from a major metropolitan city center, you're going to get closer to nature, you're going to get in at a great price, and you're going to have low crime, and a quality of life that you probably didn't experience where you were.

Matt Frankel: You guys recently gave your business somewhat of an overhaul, you're part of it. You're relatively new in your role. In addition to that, I know you consolidated your headquarters, you decided to dispose of some non-core assets which is still in progress if I'm not mistaken. Can you give us a just an update on that, how is that process going in? Are you seeing results?

David O'Reilly: Absolutely. I think it's going incredibly well. We've been able to cut over $40 million in our general administrative costs, and get down to rightsizing the business as we focus in our core business where we generate those outsized risk-adjusted returns. We've also, as you noted, executed on non-core asset sales and are recycling that capital back into our core development products every day, and so far, we've executed on $376 million of those sales, and there's still a couple of more assets to go. Given our liquidity position at close to a billion and a half dollars of liquidity, we're not in any rush. When we don't have our backs against the wall we can wait for the right time and execute at the best price for our shareholders. Again, we launched two million square feet of new developments as the business is now focused squarely in those MPCs, and really importantly, we've stabilized our senior leadership. I couldn't be happier when Jay Cross joined us almost a year ago. He came to us after having developed Hudson Yards on the west side of New York for 10 years, and part of that being president of the New York Jets, building the Meadowlands, with the Miami Heat, he built American Airlines, and before that Air Canada Center for Toronto. More important than just the buildings that he built, he changed communities, very much focused on those interstitial spaces between buildings, so landscaping the trails, how the buildings communicate together, and how we make these vibrant mixed-use communities come to life. With Jay's expertise and stabilized management team, much reduced overhead and lots of proceeds from non-core asset sales, we're firmly in a position to continue to accelerate the value creation in our business.

Matt Frankel: I know you can't really comment on the stock price. If you did, you'd be the first CEO whoever did it in one of my interviews, at least. I would like to ask you, do you think that the market has a tough time value in your company, just because of how unique the business model is? I feel like a lot of times, analysts don't know really how to place value on your assets, how do you value land that you're going to sell 20 years from now? Do you think the market really has a tough time valuing it and how has that really played into the company's performance over the years?

David O'Reilly: Absolutely. It's a great question, Matt, something that we're very much focused on on the investor relations side. I do think that we are admittedly and a more complicated story than just in multi-family REIT or a homebuilder but that's where the value comes. In a fast-paced world where everybody has too much to do, it's a lot easier to look at earnings-per-share and a multiple and move on to the next company. For us, it takes a little bit more work, and we appreciate that, and we're asking investors to do a little bit more to get up to speed on Howard Hughes. But our job is to make it as easy as possible. To that end, we've started issuing more detailed guidance on each one of our business segments starting last year, we held the Virtual Investor Day in April where we walked through some of the parts analysis on a piece-by-piece basis, illustrating how we think one way it could be done trying to make it easier for any new investor who wants to look at Howard Hughes. I think most importantly, coming out of this pandemic and having been through a downturn, we've proven out the strength of our business model, and we've really prevailed through this pandemic. 

Over the past year, we've outperformed the REIT and homebuilding indexes and we're on a great trajectory to increase our NAV. Now, as much as we all want to shrink our discount and close the gap between intrinsic value in our share price, what we're most focused on is growing our net asset value, converting raw acres of commercial land into income-producing assets at outsized returns, and we've been developing multi-family buildings between 7-8 percent return on costs and what most would argue is a sub-four cap rate environment. If we continue to do that and we continue to drive our net asset value higher at a double-digit rate; even if that discount remains constant, we're going to deliver outsized returns to our shareholders.

Matt Frankel: I wanted to ask you about a couple of your subtypes of properties right now, specifically offices. We have a lot of people that I've heard say that offices are going away, and I know that's a big part of your income producing assets. I think on your own headquarters. I want to say Occidental Petroleum has a very big Houston facility in one of your properties. I think you've just acquired that asset last year, I believe.

David O'Reilly: About a year-and-a-half ago, we acquired two buildings from Occidental Petroleum, one which was fully leased to them for 13 years and the other that we bought entirely vacant. We moved our headquarters there and we've signed a lease with some great companies like Western Midstream to take up some of that vacant space and deliver some value creation. It's been very good and we're excited about it. I'm not a believer, and you can argue, I'm talking my own book that offices are going away. As the CEO, I have been excited and thrilled with how resilient our company has been working remote and how nothing has fallen through the cracks. We've been able to file our financials our IT has been working great. We're delivering great developments in keeping our business moving. But what we're missing is how we're communicating more effectively. We're missing the collaboration and the culture building in a company, and what we've really lost is I believe an entire year of career development of so many of our younger employees that aren't with their bosses, aren't learning from their supervisors over Zoom. We're an apprenticeship culture. We always have been. I know I learned from going into the office and learning from my bosses and my peers and my colleagues, and that's really hard to do in a virtual environment. I think, and I talked to a number of the business leaders across our communities, and they are very anxious and desperate to get back to the office to do so safely. But to get back to enjoy that collaboration in the career development of our junior employees that need to see that next step in their career.

Matt Frankel: Just a couple of more with the few minutes we have left. What do you see as your biggest challenges and risks to your business going forward? Obviously, if anyone could build a 20,000 acre community, and we would do it. What are the challenges in the execution of your strategy?

David O'Reilly: Our limiting factors, if you will, in terms of our ability to continue to grow and create value are two things; demand and capital. Right now, we're sitting with a billion and a half dollars of liquidity. I feel very good on the capital side. We are having increased migration into our cities from all those destinations I talked about that are driving demand. Our risk is really a change in that demand equation. Matt, you mentioned earlier how COVID had an incredible impact, impacting demand in Las Vegas and Hawaii, New York, and Houston. It was unique and then it hit all of them. In past cycles, we've seen demand slowing Houston when there was an oil downturn in '07 and '08. But we saw in Las Vegas and Hawaii were very resilient and strong. We just moved the capital to those areas that we see the deepest pockets of demand, and we can accelerate development in Colombia, which with a tenant base focus on healthcare, education, cybersecurity; was the shining star throughout the pandemic, no doubt about it. It allowed us to allocate capital there where we had to pause capital allocation in Houston and Las Vegas.

Matt Frankel: I get that you don't have a crystal ball and you can't predict the future. Hopefully, you're in the CEO role for 10, 20 years, or more. If you're CEO of Howard Hughes 20 years from now, what does the business look like?

David O'Reilly: That's a great question, and I can sit back at night and think about 10 years from now, what will develop and the picture behind me is Hughes landing and we developed that in just over three years, five office buildings, two multi-family, a whole foods, and the embassy suites hotel, six restaurants, and you think, well, we could do that. But again, our job is to just build to meet that market demand in each one of our markets. When our tenancy and more office we building, when our multi-family is spilled, we built it, when the shopping centers are too crowded, we needed another. It's very difficult for me to predict. What I do know is that we're going to continue to execute the way that we always have, consistent with divisions of our founding fathers, and we're going to follow Jim Rouse's principles of economic, social, and ratio equality. We are going to respect George Mitchell's vision to sustainable building and doing it in a very environmentally friendly way. Honor Victoria Ward's love of land, people, and using land as a gathering place to build connections. Always at Howard Hughes, we embrace our namesake Howard Hughes' vision, drive, and entrepreneurship to think about what is going to come next. We do know it's always changing and we just have to make sure that we're continuing to evolve with it to meet that changing market demand.

Matt Frankel: David, thank you so much for joining me. I want to give you the last word. Is there anything you would like investors should know about Howard Hughes in 2021 or beyond?

David O'Reilly: I think that those investors that have followed the company and those that are new to the company when they just take one little fingernail to peel back the first layer of the onion, I think they can realize what an exciting opportunity we have. Then our ability to improve people's lives, our residents, our consumers, our tenants, drives value creation for this company for decades to come. If you're focused on long-term value creation, I don't think there is a better risk-adjusted return opportunity in all the public real estate sector.

Matt Frankel: There you have it. David, thank you so much for joining us. Hopefully, we'll talk to you again pretty soon and best wishes for a prosperous year or two in this hot and unusual real estate market.

David O'Reilly: I appreciate, Matt. Thanks so much for having me and I know we'll talk soon.

Matt Frankel: Thanks, David.

Jason Moser: That will do it for us this week, folks, you can learn more about Howard Hughes Corporation by going to howardhughes.com. Remember, you can always reach out to us on Twitter @MFIndustryFocus or drop us an email at industryfocus@fool.com. As always, people on the program may have interest in the stocks they talked about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Thanks as always to Tim Sparks for putting the show together for us. For Matt Frankel, I'm Jason Moser. Thanks for listening and we'll see you next week.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.