Odd Lots - What Rising Rates and Surging Insurance Prices Are Doing to Real Estate

Episode Date: September 11, 2023

In some respects, the real estate market has been surprisingly resilient in the face of rising interest rates. Homebuilders have generally performed well and home prices have not tumbled the way many might have expected. But looked at in another light, rising interest rates and reduced credit availability mean some real estate projects that might have made sense a year or two ago are no longer penciling out. On this episode of the podcast, we speak with David O'Reilly, the CEO of Howard Hughes Holdings, a major publicly-traded real estate developer with Master Planned Communities all over the country. Thanks to the company's role in the real estate market, David has perspective on all aspects of real estate, from housing to offices to retail development. We discuss the impact of higher rates, costlier insurance, and inflation.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Oh, and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal. And I'm Tracy Allaway. Tracy, I don't know if I've ever like said it to you directly before. Uh-oh. No, but I've said it to others. I believe there is no limit on the number of real estate related episodes we could do. There's literally one. I feel like there are two topics in business media that everyone loves reading about and opining on.

And one is transportation. So airlines and cars. And the other one has to be real estate because it kind of touches everyone's lives in one way or another. Well, absolutely. And one of the most powerful impulses to read anything is anxiety. And the nice thing about real estate is no matter where you are, you're anxious, right? Like if you own a house or something or if you own like an investment property, you're anxious the prices are going to go down or rents might go down. And if you don't own anything in your renter, then you're anxious like, oh, rents are going to go up and... Or if you want to buy a house. Or the cost to buy a house is going to surge. And see, you're anxious too. So there is no, like, person in the world who does not have real estate anxiety at some point. That's perfect. Whichever way the market is going, there is someone who is de facto worried about it. Yes. And so I would say there's a lot of things in real estate right now that are particularly

interesting. So we talk about it a lot, but we've talked a lot about why haven't higher rates affected the home buying industry, the secondary market and housing. And we've talked about lack of supply, et cetera. And of course, we've talked about commercial real estate and, you know, some of the concerns about work from home and return to office and occupancy rates, et cetera. But it still feels like there's more to do on both fronts, particularly as it relates to sort of higher rates, the impact that is on like developing new properties in one sector or another. Well, absolutely. So there's been a lot of focus on what's going on with existing properties for somewhat obvious reasons. But over the past year, we've seen this really interesting

dynamic where the existing home sales, for instance, are almost in complete stasis, just frozen. But meanwhile, a lot of the home builders have been ramping up their activity. We've seen some of their share prices, really surge. Warren Buffett is making investments in some public publicly traded developers, which, you know, if you're talking about things that get people's attention, that has to be one of them. And so I think we really need to dive into what's happening with the actual construction versus, I guess, the existing buildings. Of course, construction is affected by rates. It's also affected by commodity inflation, labor costs. So there's just a lot, a lot to get into. Let's do it. Well, I'm really excited. I do believe we have the perfect guess because

we're going to be speaking to someone with a sort of like very broad view of the real estate market. involved in many different angles. We're going to be speaking to David O'Reilly. He is the CEO of Howard Hughes Holdings, which is involved in real estate in many different ways. I'm going to have him explain what the business is. So, David, thank you so much for coming on Odd Lots. Thrilled to be here. Thanks for having me.

Why don't you give us the sort of quick summary across the different lines? What constitutes Howard Hughes Holdings? Howard Hughes is a community builder. We build small cities or large-scale master-playing communities where we're We're not just a bedroom community for the adjacent city, but we're also an employment center. We prepare land, prepare it horizontally, sell it to home builders, take that capital and use it to invest in building office, multifamily, shopping, dining, experiences, amphitheaters, art, whatever the consumer needs we build. The more homes we sell, the more residents move into our communities, the more they need those amenities. The more amenities we have, the more desirable those communities are, the more residents we're.

want to move there, and that cycle goes on and on and on. Wow. So sort of multi-use projects, give us some specific examples. Like, what are, I guess, the most prominent projects that you've worked on? Well, right now, we're across six major regions. The largest, or not the largest, but the most dense right now is the woodlands, which is 28,000 acres just north of Houston. It's about two times the size of Manhattan. We have 120,000 residents and one and a half jobs per rooftop. 120,000 residents in an area, twice the size of Manhattan. I'm jealous already. A third of the space was dedicated as permanent green space.

And that's part of the amenity base that we think make our community so attractive. What are some of the others? You mentioned the woodlands. Where else are you? We have Summerlin, which is just west of the Las Vegas strip in Las Vegas. Okay. We have 60 acres on the island of Oahu on Al-Mawahua Beach Park. We have the South Street Seaport or the Seaport District here in Manhattan.

Columbia, which is the oldest master plan community, started by Jim Rouse in the late 60s. And then a year and a half ago, we bought 37,000 acres, today population zero, known as Terravalis, just west of Phoenix, that will become what we think is the next great community in America. Wow. So when you say you're a community builder, how different or unique is that business model versus, say, a residential property developer or a pure commercial property developer? Right. We do do development. We do residential horizontal development. We do commercial vertical development. We do a billion and a half of that a year. I think the mindset of a community builder is different than a traditional real estate developer. A real estate developer acquires a piece of land and does everything they can to maximize the value on that piece of land, irrespective of what that does to the surrounding area. A community builder is equally as focused on that piece of land as the impact on the residents that live nearby. and all of the land surrounding it. Because we own the majority of that land surrounding it. We're residents.

Our kids go to school there. We live there. We want it to be a better place to live, a better place to raise a family, a better place to work. So our developments have to be not just great on the four corners of the bricks and sticks. They have to have a great impact

on everything around it. Real quickly, you mentioned the tin building. That's the one sort of Manhattan-based property. It's the one that I've definitely been to. I may have been driven through the woodlands before. not sure. But do you own the whole seaport? What do you have down there? Under a long-term ground lease with the EDC, we have the cobblestone streets on the west side of the FDR. We have the tin building on the east side and pierce 17 on the east side. That's all part of the Howard

Hughes Seaport district. Got it. I really like the tin building. I went to the one of the Jean-George restaurants there. One of they, it was very interesting. Well, there's 21 different outlets in there. They're all personally curated by John George himself. And it, the foot traffic, the revenue has been nothing short of spectacular as it's reinvented the seaport and become a great catalyst for growth in that area. Well, why don't I ask the obvious question? How has your business changed in 2023 versus, say, pre-pandemic when rates were a lot lower?

Well, I think there's a number of different changes that have occurred since the pandemic. Pandemic initially hit, the brakes got hit everywhere. and it was, oh my God, what's going to happen? Anybody going to live in a home again? 60 days later, home sales came ripping back. Low rates, free money, cost to build was relatively low. We saw incredible demand across our communities for new home buyers coming in. And that was-

How surprising was that to you? Because I feel like we are not in the real estate business, so we don't necessarily have a lot of skin in the game. But I feel like if you're a developer during the pandemic, you're probably thinking this is the end of the world. And then just two months later, everything comes roaring back. Oh, I was shocked by the change. And when you think about the impact that the pandemic had on travel and tourism, and as I said, we have properties outside of Las Vegas and Hawaii, New York City, the impact that the pandemic had on energy. We have a project outside of Houston. It was a perfect storm of bad news for Howard Hughes.

So we had hunkered in. We had recapitalized our balance sheet, extended debt material. charities did everything we could to weather what we thought would be a prolonged storm. The last thing that I expected was when we're not allowed to leave our homes and we're socially distancing that we wanted to buy homes. But I think that what led to that was the real acceleration of the migratory patterns that had existed for a couple of years, that flight to better quality of life out of the northeast, out of the west coast, employees that were seeking a better quality of life, better education

for their children, better connectivity to outdoor space, more square footage, twice a house for half the price. And the pandemic, as we were all working from home, gave them the flexibility to move with alacrity. And that really accelerated home buying. I want to ask about the new development outside Phoenix and some of the economics that you're seeing there. But before we do... Joe, you're always going to Arizona, aren't you? Yes. You can't resist it. Before I do, I just remember something, so just real quickly, the tin building property, it's still not profitable, right? Correct. I read, I think I was reading through the transcript, the one quarter that it was profitable, Tracy, I think was the board apes, had like a four-day festival there,

and they just like brought tons of money on. Well, that was, that was actually at the pier itself. Okay, that was the pier. Yeah, the Tim Building wasn't open at that point in time. Yeah, they had an incredible festival for the board ape owners up there with some private concerts. I love that, like, the NFT craze was so wild at the peak that it was like. showing up on the earnings of big publicly traded real estate investment companies as moving the dial for some of their properties. Wait, well, can I ask, why isn't that property profitable? Because that's, you know, a premier property in an up-and-coming, like, quite trendy area of

the greatest city in America. Like, what's going on? So we just opened the tin building. And when you open a new restaurant, you have operating losses. You have to get the menu right. You have to get the pricing right. You have to get the overhead right. in the tin building, we opened up 21 restaurants all in the same day.

Wow. Go away from the tin building and you look at the rest of the pier. We have five restaurants on the ground floor with David Chang, Andrew Carmillini, John George. I bet to that David Chang one. They're doing quite well. Okay. Quite profitable.

Our rooftop concerts series where we have over 60 concerts, it's the most profitable in the history of the company right now. ESPN and Nike are in the office space on the third floor, doing very well. So the tin building is in its. infancy, and it's learning how to go from crawl to walk. And over the next year, if John George's track record is any indication, we're going to be turning the tin building to profitability, which will change the whole dynamic for the seaport. Got it. One thing that I think we really want to sort of wrap our heads around in this conversation

is basically, you know, like how is the real estate business overall been affected by the surge in interest rates? And of course, different aspects of the real estate business, particularly residential versus commercial may be different. But you look at a new project, you know, TerraVallis, previously known as Douglas Ranch, you announced this in October 2022. So already rates had gone up. But why don't you talk a little bit about like how the math pencils out on something like that long term in a time of 8% rates to borrow it versus a 5% rate environment. How much does that affect how fast you move or how aggressively you can develop it? No, 37,000 acres. Terravallis, it's a 40 or 50 year project.

Okay. The only thing I know for sure over 40 or 50 years is that rates are going to change. Yeah. Right? We didn't make that decision because we expected 2% rates for the rest of our lives. We made that decision because we saw household formations that outpaced new home construction. We saw 100,000 people moving a year for 10 years into the Arizona to the West Valley of Phoenix. It was the fastest growing county and the fastest growing city.

in the United States of America, and we have a unique opportunity to create a community like we have in the Woodlands in Summerlin at Terrevalis and meet the demand of home buyers that are out there that we're struggling because of affordability. Phoenix in general is one of the more affordable cities in the state, in all the states. And when you think about the median income to purchase a home in Phoenix, it's a third of San Francisco, less than half in New York and half of Los Angeles. And we thought, we could build a product for the next 40 years that would meet that migratory shift, that need for affordable housing and that demographic shift of workers fleeing to lower tax, higher quality of life locations? When you're deciding whether or not to embark on a project, what's the most

important factor? Is it the pure maths on the financing? Is it the opportunity? Is it location, the price at which you can acquire the land? How are you balancing all those different factors? Price of the land is incredibly important, but if you think about the price of the land relative to the investment you're making in wastewater treatment plants, water treatment plants, roads, parks, community centers, the land purchase price is a fraction of the investment. The more important factors for us is, is it near good transportation? Is it near a major freeway? Does it connect closely to an airport? Is it proximate to a large city where you have great amenities and great opportunities for your residents to have. have experiences with their families. And is it in the path of growth? Now, it's not often.

It may be once every 10 years that you can find 20 or 30,000 acres that are fully entitled, ready to go, that meet those criteria and are priced appropriately. So these are not things that we trip over, you know, every day of the week. We're thrilled that we were able to acquire TerraValles, but we may not find another one like this for another decade. Does availability of contractors enter into that equation as well? Like, have there been sites that you've identified and said this would be fantastic, but it's too hard maybe to get the labor to build it out? Occasionally there are labor shortages.

There are material shortages. We feel like we're at a competitive advantage in that we'll be building this community for 40 years. And you tend to get the attention of contractors pretty easily if you can keep them busy for more than a decade. June Grasso inviting you to join me for the Bloomberg Law podcast. Every weekday, we help you make sense of the legal story. that shape the nation and the world. Listen for complete analysis of the biggest court cases,

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That's the Bloomberg Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. I'm reading over your most recent conference call in your President L.J. Cross, had this comment. So talk about the economics of new developments. He said, increase construction costs and operating expenses of outpaced growth and rental rates, meaningfully impacting anticipated returns on new developments. So let's start with that part of the question. What are some examples right now where between inflation, labor cost, rates, et cetera, in 2023, you're making different development decisions than you might have in 2021.

Oh, I think it's across every potential development is impacting our decision making. property or insurance has in most instances doubled. Wow. Utilities continue to outpace inflation. And if you layer in just taxes in a lot of the municipalities in which we work, those rates are going up faster than inflation. Now, despite the fact that we're showing double digit same store growth and rental rates in our multifamily properties and our office properties, it's struggling to keep

up with the increase of expenses of operating those properties. Layer into that higher labor, higher material costs. though stabilizing. We're still flattening this year. You have seen the stabilization in 2023. So far, knock on wood, and higher interest rates, it's harder to create value for our shareholders with new development. With that said, we still see great opportunities, specifically within the multifamily segment to meet demand of consumers that are willing to pay more for great properties and in great locations. Now, then later on, he says, that's not to say we are pencils down. He said, our development teams in each region are actively

engaged in pre-development so that once the market returns to a more normalized environment, will be ready to go. What does normalized mean in that context? Is that a rate thing? Is it like that do you believe that like rates are sort of unsustainably high here? Is it the inflation, labor aspect? What does normal mean? No, I think normal means in terms of return expectations. Okay. And a lot of things can impact that. It can be higher rental rates. It can be lower operating expenses. It could be lower interest rates. The pendulum is swung a little bit and it's tilted slightly out of favor. It's usually half a minute before it swings back the other way. We're having you on, so maybe we're jinks in it. Maybe there's a jinks in the other direction. It's all right. We have patience.

We're going to be here for another 40 years. What are you seeing from consumers in terms of demand? Because obviously, mortgage rates are a lot higher than they used to be, as we were talking about in the intro. Do you see that crimping demand or maybe changing the types of properties that people are interested in? From a consumer perspective, there is still a demand for homes. It's slightly lower today than it was, about 7% lower than it was in the middle of 2022. But I would tell you that higher rates has impacted supply as much as it's impacted demand. That the resale home market is non-existent. And for the past 20 years, resales have averaged about 87% of all home sales.

Today, they're about 70. that means new home sales have doubled as a percentage of the total home sales, and that trend is continuing to go higher every day. As a result, builders are still making very strong margins. They're still selling lots of new construction homes, and they're still in the market to buy our land. I would tell you that the price per square foot has maintained very steady over the past year in terms of what consumers are paying for home. It hasn't fallen as many would have expected, because that demand is there. What we have seen is the average size of a home come down about 15%. Interesting.

As higher rates clearly are impacting affordability, right? No doubt about that. People still that want to buy a home are going to buy a home. They may trade the office, the third bedroom, the third car garage, may wait on the pool for two years, but they're transacting. They're still forming households. They're still having children. They're still moving for jobs.

They still need a place to live. Sorry, I want to go back to the development component a little bit more. And I'm not sure if there's like a sort of normalized pace. I mean, one question, are you still buying land? We have 80,000 acres. Yeah. We're good. Because I mean, this has been a question where the home builders are buying land,

etc. Well, we have 20 years of land to sell the home builders. Okay. We have 50 years of land to do commercial development. We don't need to buy land to keep our business model moving. What type of development right now doesn't, pencil out to break ground on right now. In terms of like, okay, yes, you say the multifamily, yes, there's still demand or maybe home building in general that, you know, maybe people just

want smaller lots, what are the types of things that in the current non-normal environment, whether it's rates, inflation, et cetera, does not make sense to work on right now? That's a very market-specific question for us. To peel that. Sure. The layer of the onion, just the hair, it is very difficult to get financing for certain product types. Okay. And that becomes a bigger barrier. Right now, if I wanted to do an office building, it would be almost impossible to go office construction loan done. With that said, we're working on multifamily projects. We're working on storage projects. We're working on medical office. We're working on senior housing. And we're hopeful to get a movie studio construction project started here in the next six months

or so in the Las Vegas Valley out in Summerland. That's exciting. Well, talk to us a little bit more about financing. What does your financing mix actually look like at the moment? How do you fund a lot of these projects? And how does it differ for, say, a residential project versus an office project where I understand a lot of the anxieties in the market are more focused on at the moment? We rarely finance our horizontal development. If we're selling land to home builders, putting in roads, water, sewer infrastructure, we're not generally borrowing against that. capital availability doesn't impact that business. And that's largely because in the municipalities in which we work, there's municipal financing for that. In Texas, they're called muds. In Nevada,

they're called SIDS. In Arizona, they're CFDs. But they're all basically the same thing. Developer puts in water, sewer infrastructure curbs. When the homes get sold and they create a tax basis, that tax payment becomes a debt service that services bonds. Those bonds are issued and repay the developer for the infrastructure. That is the primary tool of why housing is much more affordable in those areas. That type of municipal financing really doesn't exist in the Northeast. Interesting. You don't see it in a ton of locations, but where you see it, housing is generally much more affordable for that very reason. So we're not relying on financing there. We're doing a billion to a billion and a half of development a year. We need construction loans to get those going.

they're more expensive, they're lower leverage, they're harder to get. And then those construction loans mature two to three years later, we're terming them out with permanent financing. And that market is a little bit sideways right now. What does that mean? Well, taking a step back, the big banks balance sheets aren't growing. Okay. And they're not getting the repayments that they would have expected.

Those office loan maturities aren't getting paid off the way they thought. And if they're not growing their balance sheet, that means very little new loans. Regional banks out of the market. post-signature, they're hunkered in on their capital. Right. So the balance sheet capacity that we've been talking about for a while and lots of people have been talking about constrained banks, like it's showing up for you in certain areas. Like it's noticeable. Absolutely. Absolutely. Are there alternate forms of financing when that happens? Like, you know, we hear a lot about private credit getting into various parts of the market. Is that? You hear about the big mortgage rates,

the XYZ private equity funds that they're the ones that are naturally going to fill the gap. But they rely on usually either letters of credit, lines or credit, repo facilities, or some sort of financing from the big banks. And if the big banks don't want to backstop an office loan directly, they don't want to backstop it secondarily. So those players have largely been out of the market. And, you know, I think that there's a segment, and myself included, that feel like CMBS could be part of the solution here. And going back to the securitized mortgages, the typical conduit in large loans that we did for years and years and years back in my investment banking days, that right now those bond spreads are pretty wide, I think, probably too wide relative to the

value that's in the loans under them. But if those bond investors come back to the market, CMBS could be the relief valve that would help this bottleneck right now in the capital markets. It is kind of weird that we've seen recently a big boom in like vanilla bond issuance, corporate bonds, but a lot of the ABS market seems to have stalled. It's kind of strange. Can you talk a little bit about there's this sort of ongoing question of whether the impact of higher rates has really been felt by the economy. And like economists always debate this like,

oh, is there going to be this lagged effect? Right now, my impression is that you've issued on a corporate level a fair amount of debt prior to the rate surge and that a lot of that is locked in and that you haven't seen a big jump. Can you talk about your overall sort of like debt profile? file, like how people should think about it. And like, at what point would it result in a big jump in monthly cost or whatever financing costs? When does it have to be restructuring? The looming maturity wall. Yeah, and people talk about the maturity wall. Tracy, that Tracy, that was the phrase I was looking

for. Yeah. And I think that the maturity wall is often just looked at in terms of the debt maturities that show up on schedule. And unless folks look a little bit deeper and say, well, what are your swap maturities? What are your hedging? What are your derivative maturities? Okay. That's a much more important question in this market. For Howard Hughes, we did $2 billion of financing in 2022, a billion of which in the fourth quarter of 2022, which puts off all meaningful debt maturities for five years. Okay. Average, weight of average maturity we have is six and a half years right now at locked in fixed rate financing. We do have just over a billion dollars of swaps that have floating rate to fixed, and those expire staggered over the next four years.

Most of those are associated with construction loans. And those construction loans on condos in Hawaii, for example, pay off when we close on the condo tower. The buyers give us their money. They take back their condo. And we use those proceeds to pay off the loan. So it doesn't roll to a new higher rate that would impact us. So we feel like we're pretty well insulated in that area. Can you talk a little bit more about the swaps?

Because I feel like this is kind of maybe an underappreciated aspect of why we haven't yet seen a huge impact from higher rates. a lot of companies. Like there are these hedging strategies in place to help insulate them in one way or another. Yes. It's not uncommon for a borrower or large corporate, especially in real estate, to get a floating right loan. But I think investors pay public real estate companies to take real estate risk, not interest rate risk. So therefore, the natural inclination is to hedge that to fixed. Sometimes those hedges are shorter durations than the notional maturity of the underlying loan, and that's where you take the interest rate risk, not where the loan gets paid off. When the loan gets paid off, that's where the principal risk comes in. And if I think about the

public real estate companies today, a lot of them are hunkered down with their capital and going to be relying on the bond market as much as they can. If you have an office loan that's maturing in the next several years, you're hopeful that your lender will blend and extend and push that off in some way, because if you have to refinance it, not only is the rate higher, but the proceeds are going to be much lower. And it's really going to put a strain on the cash that you have available and a strain on the liquidity of a number of these property owners. Sorry, I keep, you know what, I keep going back and looking at all of your corporate, you know, I'm reading your transcripts while we're doing this. I'm looking at your latest investor presentation, and it's 142 pages. And like, it looks like dozens of pages are about this development pipeline.

and what you're adding to existing communities. So it's like in the woodlands, there's like something about a Rivarot multifamily and a corporate campus that you're planning on building. It's something that looks like a really, it's going to be maybe a really nice spot for a grocery store or something like that. Like are these the types of things that are not, are they being constructed as fast in 2023 as they would have been in 2021? Some of these things on the presentation. Our strategy has always been to build to meet consumer demand. Okay. And if there's demand, we build.

If not, we're ready for when that day comes. You know, those projects that you mentioned, Riva Roe, are multifamily projects across the woodlands, six of them, we're 98% leased with 15% same sore growth. We need more product in the woodlands because we don't have enough. If you're 98% leased, you need more product, more supply to meet that demand. The corporate campus that you referenced, that's really the pinnacle of what we're trying to do is recruit businesses to come into our. communities. And we're ready to go, whether you are a tenant that's 2,000 square feet or 2 million square feet, I have an office solution for you. And unlike a lot of office developers, when I meet

with those CEOs, I'm not solving your office needs. Well, I am, but not just your office needs. I'm solving for where you live, where your employees will live, will they go to school, will your church will be. You know, we just did a corporate relocation for a cosmetics company out of San Diego. They moved into the woodlands. And I met with their CEO and I asked her, what was the driving factor? Was it taxes, politics, crime? And I was surprised that she said she did an employee survey, average age of her employees in the mid-40s. And the results of that survey was that over half of them said that they didn't think they would ever be able to own a home. And more than half of them didn't think they would ever be able to send their children in college in California

because they would have to get into state school to be able to afford it. And the application pool and the challenges of getting into state school in California are so high. And she said that was the flare that went off that said we needed a change. They moved to the woodlands. Almost all of her employees moved with her. And now they're homeowners in the woodlands and spring and all the local area. And they're pursuing education for their children with the University of Texas, Texas A&M, or any one of the great schools that are out there that are perhaps more affordable.

and a little bit easier to get into. You know, Joe and I were in Jackson Hole, Wyoming recently, and I remember joking that I really wanted Mike Bloomberg to start a company town in some beautiful part of Wyoming, and we can all live there happily and, you know, go into the office. Maybe while you're in the office here, you could convince our boss to start a company town. You don't need a company town. I have them. No. Like, you just come right into our town.

We'll welcome you with open arms. Tracy really wants one in Montana, though. So if you could please open a master plan community. Preferably in the middle of a national park. Can you make that happen? Tracy would be extremely appreciative. I have a question about the broader market. So as you say, like a lot of these developments that we're looking at on this deck

might be like, okay, you're going to like try to fulfill some solution for some company. In terms of like competition, like people want to move to Texas, one of the stories is that there's been a lot of supply just generally in the last couple years, especially across the sunbelt. booming. You're pricing it in Arizona on other pieces of land that aren't yours. I'm sure you're seeing it in Nevada. I'm sure you're seeing it in Texas. And that at least in the short and medium term, there's just a lot of capacity coming on and that there's a lot of spec building, that a lot of not everyone is building with a specific customer in mind. Can you talk a little bit about what you see as the sort of competitive market in the short and medium term in some of these boom areas like

Arizona, Nevada, Texas, et cetera? No doubt that when capital was cheap, there was a lot of folks that built and hope they would come. I think the benefit that we have is that we are the master developer within our communities. And within the 28,000 acres of the woodlands, there's only one company that can really add new supply. And we only do it one building at a time. And it insulates us from that oversupply risk. So when we're developing, we're not competing with developer on the second, third, and fourth corner of the intersection to be first, to be best. Sure. You're competing with Howard and Hughes. And you get the same answer no matter which one you ask. And that allows us to not only insulate us from oversupply, but drive better results when we bring on a new project, right?

Well, we have new multifamily that come online. Typically, when you open a new multifamily project, the project that's across the street cuts their rates to keep their tenants. They don't want them moving to the competitor across the street. We do the opposite. We slightly increase our rates. We own the competitive property across the street. And if people want to move, great.

They're moving into another one of our units. And it really allows us to drive better results in both the exact. property and the new property, giving that kind of dominant market share that we have of Class A space, both of office and multifamily across our communities. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report delivered right to your podcast feed.

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we're all over the world. Listen to the latest from Bloomberg News Now on Apple, Spotify, or anywhere you listen. Joe and I started out the conversation talking about the discrepancies between existing home sales and new construction at the moment. And I think the difference between new and existing home sales

is at something like a more than decade high, I believe. Oh, absolutely. And this has surprised a lot of people because we thought that interest rates going up would impact affordability and demand. And instead, we saw the market prove relatively resilient. And this seems to have incentivized a lot of home builders to ramp up construction. I know we've been focused on your business, but maybe talking more generally. What do you think would be the thing that would give home builders caution? I think what has impacted home sales more than the face on the rate, the rate of change.

When rates are volatile, home buyers pause, 60, 90 days, and if rates stabilize, and then they can predict their payment and they can predict what they can afford, they'll transact. We have, depending on which research you read, 3, 5 million home shortfall relative to household formation since the GFC. So the demand is there. I think home builders realize that. I think Warren Buffett's investment in the public homebuilder signified that he sees that long-term supply demand and balance out there. What gives them pause, look, if rates fell precipitously, would they pause for a second? Maybe. I just think that long-term supply demand and balance is going to create a great opportunity for

home builders for a long time. That's not to say that every quarter is going to be perfect. We're going to have some volatility in between. But over the long haul, there's a lot of value to be created. And so much demand is coming for those new constructions because the most valuable asset that most Americans have, it's not car. It's not jewelry. It's not art or wine. It's their mortgage. And if they have a two or three percent mortgage in today's seven percent rate world, it's really hard to sell your most valuable

asset. You know, you mentioned the long haul, and this is something I always wondered for a business like property development, but you're talking about projects that take years, perhaps even decades to complete. I think you mentioned the land bank you have is good for, was it 80 years, Something like that. 20 years of residential and much longer than that for commercial. So these are very long time horizons. How do you balance that sort of long-term thinking with you're a publicly traded company? You have shareholders that are looking at your results on a quarterly basis.

How do you balance the sort of short-term with the long-term here? We're really focused on long-term value creation. And our board has been steadfast in directing management to focus on creating, making the decisions that create long-term value for our shareholders. We're never under pressure within our boardroom to make a short-term decision for next quarter's earnings at the detriment of a long-term value creation. And that has been our focus throughout. Due to SEC rules, the first bullet in our earnings release is what our earnings per share is. That's the last time we'll talk about it. And Bill Ackman is your chairman. He's our chairman, yes. He owns over 30 percent,

and he is an incredibly supportive, thoughtful, and articulate member of our our board that's actively engaged. You know, we've been talking about a lot about residential and been talking about rates. The other aspect with office in particular is people are concerned about vacancies. And, of course, that it's different in different cities. So in New York, there's tremendous anxiety, obviously, about work from home and return to office, and there's a story about it every day. What are vacancy rates look like at the commercial offices on your properties and, say,

you know, Houston or Summerland right now? Well, within our portfolio, we're in the single digits, across the board. In terms of vacancy. And how does, uh, sorry, like, what would that, how does that compare to like relative to Houston overall? We're about half. Houston's 20. We're nine. What about for you, say in 2019, those same property, like pre-pend? Very similar. So would you say, I mean, are these markets normalized now? I mean, again, like, I think our listeners maybe like, we probably have a lot of listeners in L.A., San Francisco, New York, who are just like, oh, God, no one's going back to work. But talk to us from your perspective, what you're seeing. There's no market that's immune,

right? And every market has be office buildings in challenging locations that have no business being office buildings. In New York, you can look at Third Ave and Houston, you can look at a certain sub-market. In any market, there's an area where that building's just not going to meet the demand of today's needs of a company, of a corporate user. Companies want to attract employees back to the office. They realize that for several years now, we've been borrowing from the culture bank. And It's time to make some more deposits and get folks back to the office. And to do that, you need highly amenitized space. You need space with access to clean air, hopefully some connectivity in nature, great amenities.

But really importantly, short commutes. Right. Right. I think that those office buildings in New York is no exception. If you're on top of Grand Central or Penn Station, I think you're going to be great long term because you can offer really short commutes. Yeah. And in the woodlands, we're the largest lead pre-certified community. in the country without mass transit.

And I was really worried when we went to get lead certified because it's still Texas. There's still a lot of pickup trucks and everyone drives to work. But your average commute in the woodlands is less than five miles, less than 10 minutes. Wow. You know, we've talked about residential. We've talked about commercial. Can we talk a little bit about retail? Because I feel like this was the preeminent area of concern between sort of 2008 to 2020,

all the dead malls. And then it's sort of, we don't really talk about it anymore. We just ask about the office building. So what's going on with retail? So the dynamic today of nobody's ever going to work in an office again. Rewind the clock 10 years ago, it was nobody's going to shop in person again.

Everything's online. We're never going to go to the store. As I've learned over time, pendulum always swings too far, right? And I think that was a perfect example. But what that did over the past 10 years is it really stopped not completely stopped, but shrunk dramatically the amount of new retail supply that came to the market. And we went from an oversupplied retail market to right now an undersupplied retail market.

And when the pandemic came and it hurt a lot of those weaker performing retailers that they went on to business, they left. If you look at the public real estate companies that are especially in the strip center space, they backfilled those vacancies. Their occupancies are at peaks, even compared to pre-pandemic, at higher rents per square foot, at higher sales per square foot. Because they're backfilling weaker tenants with stronger tenants. It was a Darwin moment. Like the short-knocked giraffes are gone.

You know, I remember a friend of mine during the pandemic, I had this like crazy real estate developer friend. I need to check in with him. But he bought like a sort of like, he bought a mall in like Plano, Texas in like the summer 2020. And I was like, no one was paying their rent. And he's like, look, all of the ones that in there, they all survived like the past downturn. And so they're all going to start paying their rent again. I got to check in. He said he was either going to make him a billionaire or go broke.

So we'll see what happened. I'll see where he is. You know what? There was something you said at the very beginning that I think we really need to hit on again. And yesterday, I was reading through the Fed's beige book. And by and large, there was a lot of comments about, you know, inflation, cooling, supply chain, turning to normal. but the one area that stood out over and over again across districts where they're seeing more inflation is insurance. And you said that in the beginning. Talk to us about why is insurance, first of all, why isn't insurance surging everywhere?

Rates have taken off over the past year in ways that we've never experienced. And I've never seen in 20 years. And I'm told there's a lot of reasons for that. The reinsurance market is drying up. People are reluctant to take risk. there have been more and more natural disasters, making it harder and harder to price insurance appropriately. And there's just fewer and fewer risk takers on the other side of the table to meet the demand of folks that need insurance on this side of the table. When you say rates are taking off like the way you've never seen, can you like put some numbers behind it in terms of just like how different, how crazy is the market or the move, the rate of change in the market in 2023 versus a period that it might be called normal. Most risk managers would define insurance market.

is either hardening or softening. Getting worse or getting better. Every year they always tell me it's hardening. Okay. And I say one of these days it's going to soften. And sometimes it'll soften, but they always manage my expectations by saying it's hardening. Okay.

So this year they said it's hardening, and I kind of rolled my eyes and shrugged and said, okay, here we go again. And we'll suck, you know, we'll take it. We'll take a three to five percent increase. Yeah. It'll be all right. And we came back with 25 percent. Oh, wait, maybe it's 40 percent.

And then some of our peers and some of those that I've talked to in the industry have seen a 50% increase. And it's just there's not as much availability as there used to be. And then therefore, certain pieces of the insurance stack gets more expensive. For a company like Howard used with, you know, six billion of total insurable value, we do what's called the Sheridan layered program like most people do. Okay. Which is think of a CMBS loan or an ABS loan where you take the whole loan and you slice it by risk. Okay. And then you have this Tetris-like grid and you fill it up with insurers. Those that want to take the most risk, get the top, get the highest rate. And then all of a sudden, at the end of the year, when you go to get your policy, there's a big

gap in the middle. Or you can't fill a couple of layers. And then the cost of filling those incremental layers are so pricey that it impacts the pricing of every layer around it. And it's just that there's not enough supply to meet the demand. This might be a dumb question. Do you get volume discounts as a big developer on insurance? Like, is there a size benefit here? There's a diversification discount. Okay. Right.

And there are certain locations that are more susceptible to natural disasters. And if you have locations that offset that, if I have a Las Vegas to offset a Houston, that helps. If I have Columbia, Maryland to offset in New York City, that helps. Oh, so Houston, I guess the concern would be hurricanes or floods. Yes. Do you have a sense of like when you look at these big increases, how much, I mean, I guess, like, of these big 30, 40 percent increases, and I've seen those numbers elsewhere, like, how much would you say is related to like natural disaster risk versus some sort of diminishment and just sort of capacity overall? You mentioned the reinsurers, maybe tightening financial markets. I think your question implies that one didn't create the other.

Oh, okay. Right? And I do think the increase in natural disasters has negatively impacted the amount of supply. on the other side. Just on the topic of climate change, so obviously one thing you can do to mitigate those sorts of disaster risks is not build in areas that are prone to flooding or hurricanes. Is there anything you can do in terms of the actual property development or structures? I've seen a lot of people asking, well, why doesn't America build more homes out of cement versus plywood? Things like that. Absolutely. And it's not just how you build as you mitigate

potential natural disasters. It's how you build to mitigate your carbon footprint and how you build respecting the environment. You know, I mentioned that one of our communities started in the 60s by a gentleman named Jim Rouse, who lived in Baltimore and he saw that he thought that people had lost their way. They stopped taking care of each other and they stopped taking care of their environment. Some of the other new developments around Baltimore were just grazing the landscape, flattening the land, sticking up homes. And he said, I'm going to build a better community. He said, I'm going to build a garden for growing people where we're going to respect the community, respect each other, allow everybody to come in. There will be no redlining allowed in our new construction.

We're going to embrace the environment and we're going to build that idealic community. And that's really the roots of the Howard Hughes Corporation, Howard Use Holdings. And that's what we embrace today. And it's not we're green or inclusive because we check a box on a scorecard and get a better rating somewhere. It's because we create a better community when we do it. more people want to live there. It's a better quality of life for our residents when we do it. And therefore, our land values are higher. Our returns are higher. And it's about just doing the right thing. When Hurricane Harvey came into Houston, one of our largest master plan communities in northwest Houston, known as Bridgland. It's about 11,000 acres, about halfway done so far.

And I was at home on the computer looking at YouTube constantly, just typing in Bridgland flooding, what's going on. And there was a lot of videos posted by some folks in very big trucks. And they would scan around on their phones and go, oh, my God, the roads have flooded. Oh, my God, the lakes have flooded. And I'm watching in between as they're scanning. And I'm like, thank God the homes are dry. Everything worked the way it's supposed to. We built Bridgland to the 500-year floodplain when Code said you only had to build to 100.

And as a result, we didn't have a single home in Bridgland take water darn Harvey. Wow. Because there weren't many places like that. No. David O'Reilly, CEO of Howard Hughes Holdings, thank you so much for coming on. I feel like we could actually probably ask you questions for like four or five hours. Easily.

Because there's just so much here in terms of, you know, construction and utility costs in Texas and all that stuff. But this was great. I learned a lot and I really appreciate you coming on the online. Thanks so much for having. Tracy, I thought that was great. I feel like we really needed that sort of pretty close to 360 degree view on the real estate market. And that was really good.

It was pretty holistic given that we hit residential commercial. and retail as well. Retail, utilities, labor, commodity costs, yeah, we hit a lot in that conversation. Yeah. One thing that stood out to me was David describing the sort of reaction in early 2020 to the pandemic. And I think this partly explains why a lot of the economy has proven to be more rate insensitive than perhaps expected. But, you know, he was talking about how they rushed out and termed out their debt. And then they've been using a lot of debt swaps as well on floating rate loans. Like if you think that every company in early 2020 basically said, we need to do this right now,

like that is a big, big force that's sort of holding back some of that tightening impact. And then the question is, right, are we going to hit the wall, right? I mean, you mentioned, you know, the maturity wall and maybe the maturity wall is not the Joe, when you say maturity wall, you always have to say looming maturity wall. That's the rule. The journalist's role. So you mentioned people talk about that looming, and maybe it's not quite as, like, steep as, maybe it's not literally a wall, maybe it's a hill. But when we think about the sort of potential lagged effect of rate hikes, and it's, you know, one factor might be, you know, there's clearly some slowing already in terms of new development in certain areas.

But one reason maybe we haven't been hit harder is because of that aggressive terming out. No, absolutely. And then the other thing that stood out to me was the discussion of insurance. Yes. And this seems to be really like a growing headwin, not just for individual homeowners in certain parts of the world, but also for property developers, as David laid out. And I think we really need to do an insurance episode soon. We definitely need to do, but it was great to hear from like a big buyer of insurance that, like, yes, this is not like anything we've seen in the past. I mean, it's like, okay, you expect a hardening market, which is a good, I didn't know that phrase. A hardening market is typically 4 or 5 percent maybe, and it's like 30 to 50 percent or 30 to 40 percent is pretty wild.

Well, also the description of how insurance risk is kind of divvied up, like, you know, very similar, I guess, to a CLO. Sorry, my frame of reference is all structured finance. And the idea that you can build this deal, but if you can't sell certain trenches, because the buyers of that specific risk aren't there anymore, then the whole thing becomes pricier. I hadn't heard that description before. That's really interesting. Me neither, but that was great. All right. Shall we leave it there?

Let's leave it there. This has been another episode of the Oddlots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Joe Wisenthal. You can follow me at the stalwart. Follow our guest, David O'Reilly. He's at David O'Reilly.

HHC. Follow our producers, Carmen Rodriguez at Kermann Armin and Dashel Bennett at Dashbot, and check out all of the podcasts at Bloomberg under the handle at podcasts. And for more Odd Lots content, go to Bloomberg.com slash Odd Lots, where we have transcripts, a blog, and a newsletter. And I know there's going to be a lot of talk about this one in the Odd Lot Discord, where people chat 24-7. We have a whole real estate channel in there where people are going to be very interested. Go check it out. People are talking 24-7, chat with fellow listeners, Discord.g.g.

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