In today’s post, we take a look at my favorite real estate stock, plus some notes from my reading of Prem Watsa’s annual letter as well as Fairfax India’s…
I took the train down to Washington. Walking out of Metro Station, a man tried to sell me a shoeshine. I said no thanks. He belted out a bit of verse:
You out here pimpin’
But yo’ shine is limpin’
Then he let out a half-crazy laugh. I laughed too. And then I headed on my way to meet with a friend for breakfast at Old Ebbitt Grill.
Old Ebbitt is a block from the White House. It’s the oldest bar in city (though it’s moved and changed location). And it’s one of those spots in Washington where you stand a decent chance of seeing somebody “famous.”
After college in 1994, I used to commute to DC. I started out as a corporate credit analyst for Riggs Bank. (Often called the “bank of presidents” because that’s where many past presidents banked. PNC bought it in 2005) I’d take the train to Farragut North and walk a block to 17th and I.
Walking the same streets today, not much has changed. The buildings are the same. Some of the tenants changed, of course. There was no Wework back then. And there were no food trucks crowding around Farragut Square. But otherwise, the same city.
Real estate endures. Well-placed real estate, especially so. Real estate would be a topic of conversation at breakfast, too.
My friend works at a New York-based money manager. We were talking about how many of the ideas we like are ideas that don’t screen well. That is, if you were looking at the usual things investors focus on and that are readily available – price-earnings ratios, book values, dividend yields, etc. – you’d miss them.
I threw out Howard Hughes (HHC) as an example. I recommended it in my newsletter in 2011 at $40 per share and suggested it for the coffee can portfolio. HHC owns a bunch of real estate. Its main properties are The Woodlands in Houston, Ward Village in Honolulu, Summerlin in Las Vegas, the South Street Seaport in New York and properties in Columbia, Maryland. I have visited all of these properties.
Just for kicks I looked back at some of my notes from my first visits. Here is Ward Village in 2012:
“I met with David Striph, the head of Howard Hughes’ Hawaii operations, at his office in the IBM Building on Ala Moana Boulevard. The building itself is an iconic landmark in the city — and Howard Hughes owns it. Built in 1962, the six-story office building is most famous for its distinctive concrete grille. Architect Vladimir Ossipoff designed it as a kind of sun screen…
Ward is a 60-acre site in a plum location between downtown Honolulu and Waikiki. Ward’s retail component consists of six specialty “centers” with 22 restaurants and 135 shops. It has a 156,000-square-foot entertainment center with 16 movie theaters. All told, there is 1.2 million square feet of retail, office and industrial space.
But there is potential for so much more. Howard Hughes inherited a 2009 master plan from General Growth that includes a total of 9.3 million square feet of office, residential and retail space…
After our meeting, we took an elevator to the rooftop of the IBM Building and looked out over the stretch of beach extending to Diamond Head. It is a stunning view and people pay dearly to have condos in sight of it. Ward has the ability to add 7.6 million square feet of residential property and could put several condo towers right along this stretch…”
And here is Summerlin in 2013:
“I saw vacant land everywhere in Las Vegas. I saw it flying in. I saw it driving around. It looks like there is no shortage of land to build anything. But the eyes deceive. The government owns about 86% of Nevada.
“'Most people assume that it’s available,' Kevin Orrock told me. 'It’s not. It is owned by the federal government and most of it is either restricted or designated for recreation, conservation or military use.'
"We looked over a big map of the Las Vegas Valley on his office wall. Most of those vacant spaces would remain so. 'There’s a huge barrier to entry into this market,' Kevin said.
"Kevin Orrock is the president of Summerlin, the master planned community for Howard Hughes Corp. I met with Kevin at HHC’s office on West Charleston Boulevard in Las Vegas.
"There are now 22,500 acres in Summerlin. It’s on the western rim of the Las Vegas Valley and abuts conversation areas west. There are over 100,000 people living here now in over 40,000 residences. There are also many amenities: 26 schools, nine golf courses, parks, trails, etc. In less than 20 minutes, you can drive to the strip. The long-term plan is for 200,000 people in 80,000 homes.
"There are about 6,000 acres remaining to develop. And those acres are basically the main supply for new homes and development in Las Vegas. 'The only way this market can really expand is down through the I-15 corridor to the state line, to California,' Kevin said. 'We dominate the market.'
And in Woodlands in 2014:
“HHC’s HQ in The Woodlands is on the 11th floor of an office tower (built in 2008). It lies on a quiet street across from the Baker Street Pub & Grill and next to a Cinemark theater. Tim Welbes, a native Houstonian and head of operations here, seems to know everything about Houston real estate…
"Housing is the bedrock of The Woodlands, and it is a solid foundation. Everything else feeds off that. Tim showed me a chart of Houston’s population growth. 'Here’s the S&L crisis, the oil bust and Lehman Bros.,' he said pointing at the chart.
You can't see any of those crises in the growing population figures. They are just up and to the right. We’re looking at around 150,000 new people coming to Houston every year until about 2020…”
And on and on… The point is there are a lot of properties here, and they’re in great locations. Even though my notes have dated some, the properties are still there – only further along in the development plan. Since these notes, I have been back to Summerlin and there has been tremendous progress. My friend also has a long history with HHC. And she gushed about the South Street Seaport, which I visited last year. It’s going to be amazing when it’s fully developed.
Now, the usual way to a value real estate companies is to look at the net operating income, or NOI, and put a multiple on that. The problem is that HHC has great assets in development that are not generating cash today.
But the NOI is growing very fast. In 2010, NOI was $49 million. At the end of last year, the annualized NOI was $187 million. And they have a target stabilized NOI of $318 million, up from $255 million a year ago. (Stabilized means when the properties in development are finished and leased). Importantly, this excludes the Seaport, which could chip in $50 million in NOI by itself.
That’s tremendous growth. Yet HHC is self-funding. Here is what CEO Weinreb said on the Q4 call:
"If HHC were to never collect another dollar of rent or sell another condo or acre of land, not something we consider likely, we would have adequate cash balances to complete all of our developments underway."
I also like that Weinreb invested $50 million in HHC in 2017, acquiring warrants. (These have a term of six years and a strike price of $124). Insiders own 10% of the stock and Bill Ackman is chairman.
So what’s all that worth? I’ve seen a several different valuations and none is less than $170 per share. My friend’s firm puts it north of that. Some I’ve seen go over $200 per share. (Ackman pitched it at the Ira Sohn conference in 2017 and put the value at $150, excluding a bunch of stuff. Adding that “other stuff” he’s pushing $200. This is where he famously said he’d never sell it. Then he promptly sold a chunk. You can find his presentation here. Ackman is not part of the thesis, though I like having him as chairman).
I won’t go over the sum of the parts in any detail. (What you get in that valuation is sensitive to interest rates and cap rates.) But even at a high level, you can look at the market cap of $4.6 billion and say the stock trades for 25x NOI – ex Seaport. But you have a 69% growth rate to stabilized NOI (which itself keeps going up), most of which should hit in the next few years. The stock trades for about 15x stabilized NOI – again, ex-Seaport. And you still have a long development pipeline.
As my friend pointed out, there are other catalysts as well. At some point down the road, HHC will convert to a REIT. Or it could sell pieces of itself. There is the potential for more stock buybacks. HHC bought a small amount last year. As Weinreb said on the call:
“Because our stock has traded meaningfully below our net asset value over the last year, we took advantage of the situation in January of last year to purchase approximately 476,000 shares of common stock in a private transaction with an unaffiliated entity at a purchase price of $120.33 per share for a total of approximately $57.3 million.”
The stock is lower now.
In any case, when Woodlock House opened its doors in January, HHC’s stock sat there under $100 per share. I don’t know what HHC is worth exactly. But it’s well north of that. HHC is in our top 4 today.
Now, I just hang on. As that poetic shoeshine man might say:
When the price is right
You just sit tight
*** FFH – annual report notes / Fairfax India
Fairfax Financial’s annual report is out. Prem Watsa’s letter shares a familiar story for FFH shareholders in recent years. Investment results = weak. Underwriting results = good.
Here is Watsa:
“Last year we mentioned to you that we would achieve our target of a 15% return on our shareholders’ equity if we earned 7% on our investment portfolio and our insurance operations produced a combined ratio of 95%. In 2018, we earned only 3.1% on our investment portfolio. What happened?”
What happened is that FFH’s stock portfolio got hammered: Blackberry, down 36%; Eurobank, down 36%; Stelco, down 34%, etc. “Some dramatic drops!” Watsa wrote. FFH had $1.2 billion in unrealized gains in their “associates and consolidated equities” category – which includes Fairfax Africa, Fairfax India, et al – and which “all but disappeared at the end of 2018.”
Their best performers were Seaspan (up 16%) and Kennedy Wilson (up almost 5%). It was that kind of year. But, about half of the decline in the portfolio has reversed since.
I still like it. FFH has a lot of dry powder. As Watsa pointed out in his letter, FFH’s net premiums written to surplus was around 1x. “In the hard markets of 2002 – 2005 we wrote, on average, at 1.5x,” he wrote. “We have unused capacity currently and our strategy during the times of soft pricing is to be patient and stand ready for any hard markets to come.”
FFH also has $1.6 billion in cash. The stock trades for a small premium to book value, likely higher with the rebound in the stock portfolio since year-end, plus add in another quarter of earnings.
Downside seems low here. FFH could just muddle along as it has. But I think things will turn. Watsa acknowledges his macro bets were a mistake and seems to be getting back to his roots of value investing. The upside here could surprise if he hits his 15% target.
That target seems do-able. Again, a 7% return on investments and a 95% combined ratio on the insurance and, boom, you get a 15% ROE. I’d be happy with 15% annually. Of course, if FFH hit that, you’d probably see some lift on the valuation, too. It won’t trade for 1x book. It’ll trade for 1.5x book, or more. A 15% ROE and 1.5x book would still be only 10x earnings.
Fairfax India’s annual letter is out, too, and is also worth reading. I tweeted about one of the most interesting sections: "While the book value per share of Fairfax India is $13.86, we believe that the underlying intrinsic value is much higher... As an example, look at IIFL."
On page 7 of the annual report, they walk you through the valuation of IIFL, a financial firm in India in which they have a 26% stake. (It’s their largest holding after the Bangalore airport). The firm is breaking itself into three pieces, which could be a catalyst for the shares.
We own both at Woodlock House. (Fairfax India is about half the size of FFH). I plan to be at the annual meeting in Toronto in April and will write more about both afterwards.
*** Mailbag
From a reader on Unifirst, with some helpful insights:
“Your thoughts on Unifirst resonated with me and I just wanted to add something. I operate hotels/apartments in NY and we launder our uniforms through Unifirst. I chose Unifirst because it is the most reliable and cost effective method for us. Here are my alternatives:
* I could launder them myself (which would require another full time employee costing $500 a week) or
* I can pay employees to launder it themselves (which would cost $13.80/week per employee or $690/week). This is a NYS law. It's even more expensive in NYC
* I can use Unifirst, which picks up, launders, delivers, and tracks the uniforms for less than $250/week.
It's a no brainer from a business perspective. Being that laundering uniforms is a NYS law, I think Unifirst is structurally advantaged here.
From an investment perspective, the disadvantage is that they are no different than their competitors (ex Cintas). Just my two cents on the company.”
Thanks for reading. Write me at info [at] woodlockhousefamilycapital.com
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Published March 14, 2019
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