Bill Ackman (Trades, Portfolio) has held Howard Hughes Corp. (HHC, Financial) in Pershing Square's equity portfolio since the fourth quarter of 2020.
For the majority of this time, it was a relatively small position, although that changed in the first quarter of 2020. Around this time, the hedge fund manager reaped a huge profit from his bets against equity markets, which sold off aggressively when the pandemic closed economies around the world.
The derivative bets earned Pershing $2.6 billion and he reinvested this cash back into his equity portfolio to take advantage of distressed equity valuations in the middle of the pandemic.
One of the positions he increased significantly was Howard Hughes. He increased the holding from around 2 million shares to just over 12 million shares in a couple of months, buying the stock at a price of around $50 per share compared to the $130 per share it was trading at before the pandemic.
While the stock recovered some of its losses, trading just above $100 per share, it has since collapsed into the mid-$50s range.
And following these declines, the shares are trading at a price-book value of just 0.8, which looks particularly cheap considering that most of the assets are real estate.
Undervalued real assets
Howard Hughes owns a portfolio of real estate assets across the United States, encompassing residential, commercial and mixed-use assets. It has created a lot of value over the past six years, with book value increasing at a compound annual growth rate of 7.6%.
However, a lot of financing for this growth has come from shareholders, with the number of shares in issue rising significantly.
As a result, book value per share has only increased at a compound annual rate of 1.2% since 2016.
And there is something else to consider here as well. While the company might look cheap compared to the value of its assets, we have to understand that valuing real estate can be an incredibly subjective process. Just because one party says the asset is worth $100 million does not necessarily mean that someone will come along and pay that much for it.
What’s more, with interest rates increasing, properties are going to decline in value as the cost of acquiring and developing buildings increases.
That being said, real assets can be a good hedge against rising prices as the replacement cost will increase with the rising cost of materials. This could offset some of the impacts of rising interest rates on demand and asset values. Rising prices will also allow Howard Hughes to increase the rent it charges to customers, adding another layer of protection against higher prices and increased interest rates.
These issues do not just apply to this company. Every business in the real estate sector is currently facing similar pressures. Interest rates are increasing, which will have an impact on property values, although they will be able to offset this with higher rents.
But amid all this confusion, it is becoming increasingly difficult to determine how much real estate assets are worth. This seems to be why the stock has underperformed so significantly year to date. It is off 45%, compared to 25% for the S&P 500.
So while Howard Hughes might look cheap, I think it must be cautiously approached.
Real estate assets are becoming increasingly difficult to value in the current environment, meaning experience is required. Just because a stock looks like it is trading at a discount to the value of its assets does not necessarily mean that it is, especially if those assets are losing value themselves.
