Stratus Properties Inc.

Good day, and welcome to the Stratus Properties' year-ended December 31, 2020 Financial and Operational Conference Call. Earlier this morning, Stratus issued a press release announcing its year-ended December 31, 2020 financial results. The press release is available on Stratus' website at stratusproperties.com. Following management's remarks, we will host a question-and-answer session. Please note, this call is being recorded and will be available for replay on Stratus' website through March 20, 2021. Anyone listening to the taped replay should note that all information presented is current as of today, March 15, 2021, and should be considered valid only as of this date. As a reminder, today's press release and certain comments that will be made on this call include forward-looking statements, and actual results may differ materially from those anticipated, expected, projected, or assumed in the forward-looking statements. Please review and refer to the cautionary language included in Stratus's press release issued today and the risk factors described in Stratus's 2020 Form 10-K that could cause actual results to differ materially from those projected by Stratus. In addition, Management will discuss earnings before interest, taxes, depreciation, and amortization, also referred to as EBITDA, and after-tax net asset value per share, or NAV, which are financial measures not recognized under U.S. generally accepted accounting principles, also referred to as GAAP. As required by SEC rules and regulations, these non-GAAP financial measures are reconciled to their most comparable GAAP financial measures and the supplemental schedules of Stratus' press release issued today. Earlier today, the company published on its website under the Investors tab an update to its NAV. I would now like to turn the conference call over to Mr. Bo Armstrong, Chairman, President, and Chief Executive Officer of Stratus Properties.

Thank you for joining our year-end December 31, 2020 Financial and Operational Conference call. Our Chief Financial Officer, Aaron Pickens, is also here with me today. I'd like to spend some time on today's call briefly reviewing the impact we have experienced over the past year to do the COVID-19 pandemic. Announcements we have recently made, including the sale of the St. Mary, board composition refreshment, commentary on our multifamily retail and residential properties, and Stratus' continued exploration of a potential REIT conversion. Erin will speak to our business segments and will provide an overview of our 2020 financial results. I will then close the call with some final remarks regarding our continued optimism around the Texas real estate market. Our world looks much different now than it did one year ago. At this time last year, restrictions on businesses and gatherings were being implemented across the U.S., leading many people to work from home, far fewer people traveling, social distancing measures, and local and state regulations to support the safety and health of our communities, employees, and businesses. At the beginning of the COVID-19 pandemic, Stratus, like many other companies, quickly shifted to a near-term focus on managing its liquidity and evaluating options to support tenants by offering rent deferrals and other concessions as needed. Thankfully, our overall tenant delinquency rate during 2020 for our retail and multifamily portfolio was significantly lower than our original forecast. In fact, by supporting our existing tenants and finding new tenants, we generated record annual revenue from our leasing operations, primarily due to leases at the St. Mary, Kingwood Place, and the Santal. We also significantly increased revenue from our real estate operations compared to 2019 due to the increased interest in single family residential properties in Texas, which we believe was a result of home-centric trends from the pandemic. Due to uncertainty about the duration and ultimate impact of the pandemic, we carefully managed our capital resources focusing on creating value in ways that did not require large investments, including continuing to enhance our entitlements consistent with our established business strategy and pursued options to refinance or sell certain assets. Understandably, the COVID-19 pandemic has had a significant adverse impact on our hotel and entertainment segments, which are part of our Block 21 property. In December 2019, we had entered into an agreement to sell Block 21 for $275 million, which was estimated to generate an approximately $130 million pre-tax gain to Stratus. Due to the pandemic, the buyer terminated this agreement in May 2020 and forfeited its $15 million deposit to Stratus. While our hotel has remained open, average occupancy during 2020 was only 23%, and our entertainment venues were able to to host only a limited number of events. Block 21 continues to be a tremendous asset, and we believe we can manage it successfully through a market recovery. The Stratus team has done a tremendous job at managing our limited events, and artists and patrons trust that we will follow health and safety guidelines. We will consider a gradual ramp up of the capacity in our venues throughout this year to ensure we open safely and correctly. Furthermore, I'm proud to say that through our quick work at the beginning of the pandemic, we were able to support the continued employment of all our employees. They will be critical to restoring the profitability of our business. I want to thank our team, which has been resilient, resourceful, and quick to adapt to the challenges of the pandemic. Although the pandemic will continue to adversely impact our business this year, I'm hopeful that we will begin to see improvement in our markets, particularly as more people have access to the vaccine. As I've said before, Stratus' properties play a critical role in our communities, such as providing housing and locations for communities to obtain groceries and other goods and services, and I'm proud to say that our teams have held an unwavering commitment to serving our tenants, customers, and communities throughout these difficult times. I'll now discuss several announcements we've made over the last few months. In 2020, we focused on leasing up to St. Mary while we monitored the market for an opportunity to create substantial value for our shareholders. As previously announced, Estrada subsidiary completed the sale to St. Mary for $60 million, or an Austin record $250,000 per unit, in January 2021. After closing costs and payment of the outstanding construction loan, the sale generated net proceeds of approximately $34 million. Erin will provide further information regarding our proceeds and pre-tax gain in a moment. The St. Mary is a 240 unit garden style apartment complex in the Circle C community in Austin that remained ahead of schedule and on budget throughout the planning and construction phases in 2019. The sale of the St. Mary demonstrates how our development strategy creates value for shareholders. We start with a piece of undeveloped land and our team then creates value, first by working with the appropriate agencies and community leaders to obtain the necessary permits, then by developing thoughtfully designed and constructed properties, followed by leasing up these properties. Finally, we monitor the market for an opportunity to realize value for shareholders through a sale or refinancing and act upon such opportunities when appropriate. The Stratus team comprises many talented and experienced individuals who know how to navigate the highly complex entitlement design, construction, and leasing processes to meet market demand. In the case of the St. Mary, the team raised third-party capital arranged bank financing, oversaw construction, expedited lease-up, including virtual leasing necessitated by the pandemic, and managed and closed the sale all in less than three years and despite the challenges of the pandemic. We decided it was the right time and price to sell this property and are pleased with the outcome. We monitor the market to determine when is the most opportunistic time to monetize, so this timeline will change project to project. I also want to note efforts our board undertook to bring new talent and fresh ideas to the boardroom. In December 2020 and January 2021, we announced the appointments of Neville Rohn Jr. and Kate Henriksen, respectively, to Stratus' board of directors. These appointments are a result of and continuation of Stratus' ongoing efforts to ensure it has access to the right mix of perspectives and skill sets. Neville brings valued expertise in real estate acquisitions across the country, including numerous successful projects in Texas. He has a track record of reimagining urban mixed-use environments as co-founder and managing partner of ARC Capital Partners. Kate brings a deep understanding of real estate investing and has overseen the underwriting on $8 billion of transactions as co-chief investment officer of RLJ Lodging Trust. I look forward to working with both Neville and Kate. I will now turn to a discussion of some of our active projects. Our multifamily projects have continued to perform well throughout the pandemic. As already noted, we sold the St. Mary in January for a record per unit price. The Santal has also performed well. The Santal is our wholly owned 448-unit garden-style apartment complex in Barton Creek in Austin. Despite greater Austin apartment rents being down nearly 4% in December 2020 from a year earlier, average effective rents at the Santal are currently up 4.4% year-over-year to $1.67 per square foot. Occupancy is on target at 94.4%, heading into the peak spring leasing season, which should support additional upward pressure on rents. We recently commenced initial site work on the St. June project, which is a 182-unit multifamily project within the Amara subdivision in Barton Creek. We expect to begin project construction in the second quarter of 2021, subject to completion of financing. Our retail properties are well located and we have benefited from our strong relationship with the Texas grocery store HEB. While many of our retail tenants remain adversely impacted by the pandemic, I am pleased to report that all of our retail tenants that were open before the pandemic are open today and continue to be an important members of our communities. We continue to apply our decades of experience to new opportunities, such as our Magnolia place project, which will be shadow anchored by HEB. This mixed use project in Magnolia, Texas in the greater Houston area is currently planned for 18,410 square feet of commercial space, nine pad sites, and 194 single family lots and 495 multifamily units. We expect to initiate construction in the first phase in mid 2021, subject to financing and market conditions. The H-E-B grocery store is currently expected to open in mid 2022. We are also evaluating the sale, of the single family residential land component of Magnolia Place. Turning to our residential portfolio. Our residential properties thrived in 2020. Again, demonstrating strong demand for residential real estate in the growing Austin market. Sales have exceeded our internal projections. We have sold essentially all of our home sites in Barton Creek and Amara Villas has performed exceptionally well and we continue to generate interest and execute contracts. As of March 9th, 2021, We had two Amara Villa homes under contract and five Amara Villa contracts out for signatures, which we expect to finalize in the coming days. We also completed the sale of the last W. Austin Hotel and Residences in February 2021. Aaron will provide more information on the sales and our real estate operations shortly. Our proven success with our developments in Barton Creek positions us well for the next development phase of Section KLONN. For several years, we've been methodically working on Section KLO, our last large residential community in Barton Creek, to increase density and broaden our product types using a combination of traditional single-family lots and residential condominium units, which will allow more density. The engineering for roads and utilities for the initial phase of Section KLO has been completed, and we anticipate securing final permits during the second quarter of 2021. We are also evaluating a redesign of Section N. If successful, this new project would be designed as a dense, mid-rise, mixed-use project surrounded by an extensive green space amenity, resulting in a significant potential increase in development density as compared to our prior plans. We will provide updates as we have more to share, but for now, we remain on track and continue to advance the planning and permitting process. Before I pass the call over to Aaron, I would like to reiterate that our board is still in the process of evaluating a potential conversion from a C corporation to a real estate investment trust, also known as a REIT, as we believe that a conversion could provide our company with substantial benefits, including a more tax-efficient structure, regular distributions of income to shareholders, and increased access to the real estate-focused financial community. If the Board determines to move forward, we expect the conversion would occur no earlier than 2022. Once the Board makes the determination, we will provide our shareholders with detailed information. Then, ultimately, it will be up to all of you, our shareholders, whether Stratus converts to a REIT should the Board conclude that it is in the best interest of all of our shareholders. I will now turn the call over to Erin for a review of our 2020 financial results. Erin?

Thank you, Beau. Please refer to the press release announcing our operational and financial results for the year ended December 31st, 2020 issued this morning. Stratus consolidated revenues totaled $61 million in 2020 compared with $92.2 million in 2019. The decrease in revenue in 2020 primarily reflects the decrease in revenue from our hotel and entertainment segments caused by the COVID-19 pandemic, partially offset by an increase in revenues from real estate and leasing operations. Net loss attributable to common stockholders totaled $22.8 million or $2.78 per share in 2020, compared to $2.5 million or 30 cents per share in 2019. Losses resulting from the COVID-19 pandemic contributed to Stratus recording a $10.7 million non-cash tax charge in 2020 to record a valuation allowance for Stratus deferred tax assets. EBITDA totaled $9.5 million for 2020, compared with $21.1 million for 2019. I also want to provide an update on our NAV published this morning. Stratus reported an estimated after-tax NAV per share of $40.65 as of December 31, 2020, compared to $45.55 as of December 31, 2019. The decrease was primarily a result of the reduced valuation of Block 21, following lower travel and entertainment demand during the COVID-19 pandemic and the terminated sale transaction. This drop in estimated value shows how hard hit the hotel and entertainment industries have been this past year. However, we expect to see the value of this iconic property rebound as demand for travel and entertainment recovers from the pandemic. I will now provide brief commentary on our reporting segments. Revenue from our real estate operations segment in 2020 totaled $22.6 million, which is a significant increase of 64% compared to 2019 when we reported total revenue. of $13.8 million. This increase in revenue primarily reflects the sale of two homes built on Amara Drive Phase III lots and an increase in lot sales in 2020, including two premium Amara Drive Phase III hilltop lots. Operating income for the segment was $3.9 million in 2020 compared to $3.8 million last year, which included $3.4 million of municipal utility district reimbursements. We sold seven Amara Drive Phase II lots, 12 Amara Drive Phase III lots, and two homes built on Amara Drive Phase III lots for a total of $21.8 million during 2020. Further, Stratus sold a vacant padside at West Killeen Market for $.7 million. As of December 31, 2020, all developed Amara Drive Phase II lots had been sold, and only five developed Amara Drive Phase III lots remained unsold. Subsequent to year end and through March 9th, 2021, Stratus sold one Amara Drive Phase 3 lot, a multifamily tract of land in Amara Drive, and the last remaining condominium at the W. Austin residences for a total of $5.8 million. As of March 9th, 2021, the last four unsold Amara Drive Phase 3 lots and two Amara Villas homes were under contract. one of which was under construction and one of which we expect to begin construction mid-2021. As Bo mentioned, we have and continue to experience significant interest in our Amara Villas homes. Revenue from our leasing operations segment in 2020 totaled a record $24.1 million, an increase of 24% versus 2019, which totaled $19.5 million. This increase reflects commencement of new leases at the St. Mary, Kingwood Place, and the Sontal. Operating income in our leasing operations segment in 2020 totaled $3.3 million compared with $9.6 million in 2019, which reflects a pre-tax gain recognized in 2019 on the sale of assets totaling $5.7 million, primarily related to the sales of Barton Creek Village and a retail pad subject to a ground lease in the Circle C community. Operating income in 2020 includes higher rental costs of sales and depreciation expense primarily as a result of the completion of construction and the starting of leasing operations at the St. Mary and Kingwood Place. For the period between April and December 2020, when our tenants were impacted by the pandemic, our retail and multifamily-based rent collections were 5% lower than scheduled rents, primarily due to the rent deferrals we offered to manage the initial impact from the pandemic on certain of our tenants. During the COVID-19 pandemic, Stratus experienced increases in revenue in its real estate and leasing operations segments. As Bo mentioned, we believe the sales of residential real estate and leasing of our multifamily properties were positively impacted by home-centric trends resulting from the pandemic and increased interest in Austin as people and businesses continue to move to this city. Conversely, the pandemic continues to have a significant adverse impact on our hotel and entertainment segments. We expect this impact to continue in 2021 as the pandemic continues to affect travel and entertainment industries globally. Stratus hotel revenues decreased to $10 million in 2020, compared with $35.5 million in 2019. This segment's operating loss totaled $9.2 million, compared with operating income of $5.2 million last year. Revenue per available room, or RevPar, was $61 in 2020 compared with $235 in 2019. As we have previously disclosed, our W Hotel has remained open throughout the pandemic, but with significantly reduced occupancy. Average occupancy in 2020 was 23% compared to 73% in 2019. Entertainment revenues declined to $5.2 million in 2020 from $25 million in 2019. The segment's operating loss was $3.5 million in 2020, compared with operating income of $4.7 million in 2019. The number of events hosted at ACL Live declined to 82 in 2020 from 264 events in 2019, and the number of events hosted at 310 ACL Live declined to 102 in 2020 from 201 in 2019. Turning now to capital management, at December 31, 2020, consolidated debt totaled $351.1 million and consolidated cash totaled $12.4 million, compared with consolidated debt of $343.9 million and consolidated cash of $19.2 million at December 31, 2019. As of year-end 2020, Stratus had $16.5 million available under its $60 million Comerica Bank credit facility. From the sale of the St. Mary, Stratus received $21.3 million and expects to recognize a pre-tax gain on the sale net of non-controlling interest of approximately $14 million in the first quarter of 2021. The proceeds of the sale were primarily used to pay down a portion of the balance of our revolving credit facility. And as a reminder, we received $15 million of forfeited earnest money after the buyer terminated the transaction to purchase our Block 21 property for $275 million in May 2020, which was recorded as income in 2020. Purchases and development of real estate properties reflected in operating cash flows and capital expenditures reflected in investing cash flows totaled $20 million for 2020 primarily related to the development of Kingwood Place, Lantana Place, and Barton Creek properties, as well as the purchase of an office building in Austin. This compares with $73.8 million for 2019, primarily related to the development of the St. Mary, Kingwood Place, and Barton Creek properties. Throughout this pandemic, we have remained focused and diligent and have maintained our liquidity. We continue to believe that we will be able to meet our debt service and other cash obligations for at least the next 12 months. Thank you, and I will now turn the call back to Beau for his closing remarks.

As we have discussed, Stratus continues to advance several promising development projects, and we continue to successfully execute upon our strategy of acquiring and developing properties and holding them for lease or selling them, such as we did with the sale of the St. Mary. Our team's knowledge of and deep relationships in the Texas markets have been critical to Stratus' success in identifying attractive opportunities and securing the necessary entitlements and permits. Additional support from our two new directors, Neville and Kate, will prove invaluable to our board and Stratus as we move forward. Even during a pandemic that has significantly impacted our business and relevant industries, our teams have shown resiliency and have maintained strength in our strategies. Because of their hard work, dedication to our development projects, and focus on maximizing shareholder value, we believe we are well positioned as the market recovers. Austin has continued to grow, particularly in its retail, single-family, and multi-family markets, and gained attention as a desirable place to live. Austin has always been key to our portfolio, and I'm even more encouraged to see an influx of tech powerhouses and other businesses moving to Austin. Apple is expanding its 133-acre campus in 2022, and Alphabet, Amazon, Oracle, and Facebook have expanded or announced plans to expand in the area. Tesla is building a new electric vehicle manufacturing plant for their popular Cybertruck and other products in Austin. Stratus indirectly benefits from these companies moving to Austin, and I'm looking forward to seeing what value we can create in the future. Thank you all for listening in. At this time, I will ask the operator to open the line for questions.

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Fred Bertner with Bertner Investments. Please go ahead.

Good morning, Bo and Aaron. I have a few questions for you. Is the structure of the St. Mary that you recently sold a good example of future ownership structures and future developments? Yes.

Pardon me, this is the conference operator. It appears the speaker line has temporarily disconnected from their location. I'm going to get them back online, but please hold on to the line. Thank you. Thank you. Thank you. Thank you. ¶¶

Thank you. Thank you. Thank you. Thank you.

Pardon me, this is the conference operator. I was able to rejoin the speakers. Mr. Bertner, could you please repeat your question for them?

Sure. Is the sale of the St. Mary's structure typical of what we'll see in terms of future developments?

Good morning, Fred. I'm sorry I got cut off. I was just droning on with my answer, and we just were alerted that we were offline. So I apologize for the delay. Good morning. Good question, Fred. So let me at least take a moment to kind of recap the transaction. So that Circle C multifamily land asset was something that the company acquired in the, I guess, early 90s. It goes back a long way with that Circle C acquisition. But we've obviously held it for many years, waiting for the right moment to proceed with development. In that particular instance, we raised third-party equity capital on a promoted basis, as we like to call it. And the returns ultimately to Stratus were, I'm going from memory here, but I want to say from an equity multiple perspective, it was about a 3.9 equity multiple, and I believe our internal rate of return was somewhere mid-60s, which are pretty extraordinary returns. So I think that that is a good model for us. We would like to do that again and again and again, and I think we have the team and the wherewithal to do that. But, you know, that would have been potentially an asset that you may want to hold for a longer term. So we ran a dual process to refinance or sell it. And ultimately, after evaluating both options determined that in this particular instance, it made more sense to sell. Now, of course, we will have about a, I guess, about a $14 million gain on this. And so we will, you know, be subject to C-Corp taxation on that. But even in light of that, we felt that this made good sense. And, again, to answer your question, I do believe that this is potentially a template for us going forward.

Thank you. My next question is you spoke about how the Austin market is strengthening with all these tech companies moving in. How is that impacting Stratus's operations and future development opportunities?

Well, the headlines that I spoke about are quite compelling. I mean, names like Facebook, Google, Tesla, Indeed, those are obviously huge growth companies, and these are the type of businesses that really all cities are trying to attract. So we are, you know, it's good for Austin. I mean, I think Austin has historically been, you know, clearly a growth market, and I think this is just continuing with that. As far as, you know, how it impacts the various kind of what we call food groups, you know, 2020 was a very challenging year. If I were to just kind of go through each of the kind of the segments, if you look at office, you know, office was, you know, I think a down year. I mean, obviously people weren't going to the office, and so I think leasing was anemic at best. I think our, even for the year, I want to say that we had negative absorption. There were some sublease deals, but for the most part I would I would say that the office market in Austin in 2020 was not a good year. Retail was probably flat overall. I think much like us, I think most people were able to hang on to their tenants through concessions or just working with them on some basis. So I think retail was flat. Again, it depends on the type of property. But you know, if you had, for example, a grocery store like we've had, I think you did pretty well. But I think the retail has been quicker to come back than the office. Obviously, hospitality and hotel is just terrible. I mean, that's unlikely to be, you know, a challenge. Certainly some of these larger city center hotels, I think, will face, you know, challenges through this year until the big events come back. The W is a little different in that, you know, we have a bit of a transient business, so I think we're able to attract the weekend crowd and the transient business during the week. But I still think 2020 is going to be a challenge until large groups are gathering. And then, of course, on the music venue, I would say the same. We're building shows for the second and third quarter, but that business is just unfortunately slower to come back than we would like, and we want to do it in such a way that we create confidence among our patrons and our and our performers such that we just don't have any setbacks. And then the real bright spot has been the residential market. I've been in Austin since I went to school here, and I think I've been through four cycles, and I've never seen the residential market as hot as it is now. It is extraordinary. I mean, the prices people are paying, the lack of inventory. So I think when you open the paper and you see, you know, Austin hot, hot, hot, I think a lot of that, really, that anecdotal evidence really emanates from the residential component of our real estate market and not so much the commercial stuff. Now, the commercial stuff, as I said, will come back. It's just 2020 was a challenging year, and we're just all kind of slowly building out of it.

Some of the airline companies in the U.S. are talking about advanced bookings are looking somewhat better. Are you seeing any evidence of that in advanced bookings at the hotel?

We are. You know, one of the things that we monitor pretty closely are these PACE reports, and we have had a lot of people that, you know, had an event on the books, you know, last year defer or move the event to 2021. And so that – and there was a lot of just kicking the can down the road, if you will, as the pandemic raged on. But now, as it appears that there is some, you know, even though there's obviously a lot of suffering, unfortunately, that's still to come, I think that there is light at the end of the tunnel. And people are in earnest booking, rebooking these events. And we're also seeing it on our private event side at the venue. You know, large corporate events are now rebooking and doing what we haven't seen, which are on-site tours. So that's all has picked up. And I see that really beginning to impact us financially in the third and fourth quarter.

Thank you. In terms of the REIT conversion, could you elaborate beyond what you've already said about why the conversion is good for Stratus?

Well, I want to be cautious in that we are still going through an evaluation process, and it is a bit of a complicated accounting exercise. But again, so far, you know, we're still optimistic that it could be a good option for the company. And again, it would be something that would be voted on by the shareholders. So ultimately, the shareholders will determine whether it's the right thing to do or not. I think our job at this point is to, you know, frame up the opportunity and then bring it forward to the shareholders. But, you know, the one thing that just sticks out to me, Fred, is just that the C-Corporate tax rate, you know, is currently at 21%. And I just read this morning that there's some some discussions around raising that to 28%. That's just non-competitive for a real estate company like us. The REITs, which we really don't necessarily compete with, but we kind of do, I mean, they just don't have that level of taxation. That just is a bit, in my view anyways, it just puts us at a disadvantage. So we would like nothing more than to eliminate that second layer of taxation for our shareholders. And there are things that come with that. The the requirement to distribute income and all the things we know about REITs. But we, at this point, feel like it's certainly worth continuing to pursue that option. So we'll be able to report more on that to our shareholders in the weeks and months ahead. But, again, it's something that, just from a pure tax standpoint, seems to make a lot of sense.

Okay. My last question is, is having a diverse director as a priority for the company?

Fred, that's a very good question. I will tell you that the company's philosophy is that there is strength in diversity and that, you know, a variety of perspectives, backgrounds, life experiences, et cetera, leads to really good decision-making. So in a word, yes, that is something that we as a company and as a board believe strongly in. As it pertains to Neville and Kate, our two newest directors, you know, they are both, you know, very thoughtful, well-educated, seasoned real estate investor operators, and we're excited to have them join the board. But thank you. That's a very topical question and something that we feel very strongly about at Stratus.

Thank you. I appreciate that. Keep coming on. Keep doing the good work for us.

Thank you, Fred. Nice to hear your voice, sir.

This concludes our question and answer session, and the conference is also now concluded. Thank you for attending today's presentation. You may now disconnect.