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Edited Transcript of BRP.TO^C15 earnings conference call or presentation 13-Nov-19 8:00pm GMT

Q3 2019 Brookfield Residential Properties Inc Earnings Call

CALGARY Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Brookfield Residential Properties Inc earnings conference call or presentation Wednesday, November 13, 2019 at 8:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan Norris

Brookfield Residential Properties Inc. - Chairman & CEO

* Thomas Lui

Brookfield Residential Properties Inc. - Executive VP & CFO

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Conference Call Participants

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* Lee Dickson Brading

Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst

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Presentation

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Operator [1]

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Thank you for standing by. This is the conference operator. Welcome to the Brookfield Residential Properties Third Quarter 2019 Conference Call. (Operator Instructions) And the conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to Thomas Lui, Executive Vice President and CFO. Please go ahead.

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [2]

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Thank you, and good afternoon. Thank you for joining us for Brookfield Residential's 2019 Third Quarter Conference Call. With me today is Alan Norris, our Chairman and Chief Executive Officer.

This call is intended for current holders and beneficial owners of Brookfield Residential's debt securities as well as prospective investors, securities analysts, market makers and other interested parties. I would, at this time, remind you that in responding to questions and in talking about new initiatives, our financial and operating performance, we will make forward-looking statements, including forward-looking statements within the meaning of applicable Canadian and U.S. securities laws. These statements reflect predictions of future events and trends that do not relate to historical events, are subject to known and unknown risks, and future events may differ materially from such statements.

For more information on these risks and their potential impact on our company, please see our historical filings with the security regulators in Canada and in the U.S. and in the information available on our website.

Brookfield Residential had an active third quarter as we continue to maintain our land and housing operation and also completed several corporate initiatives, which included a bond offering and U.S. reorganization transaction. Net income attributable to Brookfield Residential for the 3 months ended September 30, 2019, was $48 million compared to $44 million for the same period last year. The increase of $4 million was primarily the result of a decrease in general and administrative expense of $12 million and an increase in equity earnings from our land and housing and consolidated entities of $5 million. This was partially offset by a decrease in gross margin of $9 million due to lower housing gross margins, an increase in lease expense of $3 million and an increase in interest expense of $1 million.

Housing revenue and gross margin for the third quarter was $348 million and $61 million, respectively, compared to $429 million and $88 million for the same period in 2018. The decrease in housing revenue and gross margin was primarily the result of 153 fewer home closings and higher incentives provided on the closings. Gross margin percentage decreased 3% as a result of mix of homes sold and the incentives provided.

When looking at our housing activity by operating segment, our Canadian segment had fewer home closings and a 5% lower average home selling price. This was primarily from the mix of homes closed in a slower Calgary market as a result of local economic conditions. Our California segment decreased due to 66 fewer home closings but 2% lower average home selling prices as a result of the product mix of homes sold in Southern California. The Central and Eastern U.S. segment decreased as a result of 39 fewer home closings, partially offset by a 9% increase in the average home selling price due to product mix with higher average home selling prices in our Austin market.

At September 30, 2019, we had 1,484 units in our backlog with a value of $744 million compared to 1,738 units with a value of $955 million at September 30, 2018. The decrease is primarily a result of the slower sales pace in early 2019 and the impact of the lower backlog entering the year. Our Canadian segment at September 30, 2019, decreased by 93 units when compared to the same period in the prior year. And this was mainly due to the execution of our backlog with lower net new home orders in 2018 from our Ontario market. Our Canadian segment decreased mainly due to a decrease in net new home orders in 2019. The Central and Eastern U.S. segment decreased by 63 units due to the decrease in net new home orders in 2019 compared to same period in 2018 primarily in our Washington, D.C. market.

Land revenue totaled $113 million for the 3 months ended September 30, 2019, an increase of $40 million, and land gross margin totaled $44 million, an increase of $18 million compared to the same period in 2018. When we look at our operating segments for 2019, land revenue and gross margin for our Canadian segment increased primarily as a result of closing 134 raw and partially finished acres in our Calgary operations. In California, land revenue and gross margin increased primarily due to 74 additional single-family lot closings. Land gross margin percentage increased 12% with a 12 -- there were 14 family -- single-family lot closings at Playa Vista in the Southern California where that was a major contributor to the increase. Our Central and Eastern U.S. land revenue and gross margins increased primarily due to lower single-family lot closings due to timing of activity from our Denver market.

Moving to our balance sheet. As of September 30, 2019, our assets totaled $5.6 billion. Our land and housing inventory and investments in land and housing unconsolidated entities are our most significant assets with a combined book value of $3.5 billion or approximately 63% of our total assets. Land and housing assets increased when compared to December 31, 2018, due to land acquisition for $290 million and land development and home construction activity partially offset by sales activity. Our investments in land and housing unconsolidated entities increased as a result of continued development of land and construction of our inventory within our joint ventures.

During the quarter, the company and Brookfield Residential US LLC co-issued a private placement of $600 million of unsecured senior notes. These notes have an 8-year term and are due 2027 and bear interest at a fixed rate of 6.25%. The net proceeds of the offering were used to redeem the $600 million aggregate principal amount of the unsecured senior notes due in 2020.

Transaction costs relating to the issuance of the 6 senior notes due 2027 of $11 million was capitalized towards notes payable balance. Previously capitalized issuance costs relating to the 2020 bonds of $2 million were expenses -- other expense as part of our unconsolidated segment operations.

We also repaid $200 million notes outstanding under a deposit agreement with a subsidiary of BAM, which was a fund drawn on our unsecured revolving credit facility. At September 30, 2019, we were drawn $242 million under our North American credit facility.

The previously announced U.S. reorganization transaction was completed in the third quarter. Due to the timing of the transaction at the end of September, there were no equity earnings picked up on a consolidated segment of operations, and the main changes were noted on the consolidated balance sheet. And as a result of the transaction and the application of common control accounting, the company recorded an unconsolidated equity investment in Brookfield US Inc. of $617 million, noncontrolling interest of $976 million and the remainder to additional paid-in-capital and the reduction in return in earnings in equity.

The company received consent to amend the indentures of our unsecured notes due 2022, 2023 and 2025 and our credit facility to implement the reorganization transaction. $8 million of these costs were capitalized to our notes payable balance. Consent solicitation fees that were not paid directly to bondholders such as legal and agent fees of $6 million were expensed as other expense on our consolidated statement of operations.

The liquidity available at September 30, 2019, included $64 million of cash and $374 million available on our North American unsecured revolving credit facility. Our net debt to total capitalization at September 30 was 41% compared with 44% at December 31, 2018.

I will now pass the call to Alan, who will provide an overview of our operations and our markets.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [3]

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Thank you, Thomas, and good afternoon. Brookfield Residential had an active third quarter of 2019 with continued land development and home construction activities, improvement in net new home orders and the accomplishment of several strategic, corporate and capital initiatives.

Our overall results, however, for the first 9 months of 2019 were down from the prior year due to the slower U.S. housing market conditions experienced in the latter half of '18 and early 2019, resulting in lower backlog entering the year. So far this year, we have closed 2,048 homes, 1,592 single-family lots and 134 raw and partially finished acres at an overall gross margin of 19%.

With the fourth quarter historically giving us the greatest contribution of activity in the year, we anticipate that 2019 will be no different, and Q4 will represent approximately half of the year's income before income taxes. Based on our current forecast, we reaffirm our previously provided limited guidance of closing 950 homes and 850 lots in Canada and 1,950 homes and 1,650 lots in the U.S. We continue to project the number of additional multifamily, commercial and industrial parcel sales in both countries.

U.S. housing market conditions are similar to the previous quarter where we're encouraged by the return of the market but continue to remain cautious as affordability is a key consideration in markets such as California and Denver. Consumer confidence continues to be affected with trade tensions and potential tariffs, providing some degree of uncertainty. However, overall activity in our housing operation reflect an improvement in all of our U.S. housing markets where for the third quarter of 2019, we had net new home orders of 501 homes, an 11% increase over the same period of 2018.

We are seeing positive activity in our communities where New Haven, which is a part of the Ontario Ranch master plan community in Southern California, was ranked #7 and Eastmark in Mesa, Arizona was ranked #8 in U.S. master plan communities listed in the midyear report from RCLCO.

Our Canadian operations continue to be impacted by different market conditions in Alberta and Ontario. The federal election was held in October, and with a minority government formed, it's expected that the Alberta economic environment will remain challenged with limited future investments in the energy sector. In Ontario, the housing markets produced an increase in home orders where interest in new communities has been positive and with terra firma on house prices. As a result, our net new home orders in Canada for the third quarter of 2019 increased 40% with orders of 267 homes.

During the third quarter, the company completed the previous financial reorganization transaction which combined all of the direct U.S. investments of our parent, Brookfield Asset Management, into one corporate group to facilitate operational and administrative synergies. The reorganization transaction at Brookfield Residential contribute the capital stock of its U.S. land and housing holding company in exchange for a minority economic interest in the capital of stock of Brookfield US Inc., a subsidiary of BAM.

As mentioned earlier, we also continued to execute on our capital plan with the issuance of $600 million of unsecured notes due in 2027, where net proceeds were used to redeem our $600 million of unsecured senior notes due in 2020.

We extend our sincere thanks to all our supportive stakeholders for your continued support of Brookfield Residential and our endeavors relating to the strategic corporate initiatives and the execution of our capital plan.

That wraps up the review of the results. And thanks for joining us. But I'll now turn the call back to the operator, who will moderate questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Lee Brading with Wells Fargo.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [2]

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Looking at -- just jumping in here on -- I guess the land side was a little better than I expected this quarter just because I just modeled it looking at historical kind of patterns. I guess, is there anything we should read into that from Q3 better than last year's Q3 should continue and a pickup in Q4 as well and, I guess, as we look at from the land side of things?

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [3]

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Yes, Lee. It's Alan here. Yes, a couple of things. We did -- we exited the Playa Vista community in Q3 by selling off a few remaining lots with high margins, so that's a bit of a one-off. I mean it was -- obviously, we've been selling Playa up to that point, but we're virtually done. There's a few homes left in Playa. And then we had a parcel sale of 134 acres that we mentioned in the prepared script, was a land assembly that was noncore for us in Calgary, and we recorded some marginal in that sale as well. So a little bit of a nonrecurring in there. So nothing -- I wouldn't say it's necessarily replicable. So I just want to point out those 2 specific things.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [4]

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Got you. Okay. Got you. And then in debt to cap, you guys have done a good job of bringing that down, and you finished this quarter with low 40s. Is it -- and you talked about Q4 should be kind of similar to what you've done in history -- historically. Should we expect that to dip into the high 30s by year-end?

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [5]

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Yes, Lee. This is Thomas here. So as you noted there, there was a decrease in our net debt-to-capitalization ratio as a result of the quarter's activity. A big piece of that decrease is due to the accounting of the U.S. reorganization and bringing in a noncontrolling interest piece that really increased our equity and overall capitalization.

We anticipate that we will continue to have not-good activity, as Alan mentioned earlier, in the fourth quarter. Our goal, as we try to do each and every single year, is to reduce as much debt that we have drawn throughout the year, and that is no different this year. So if all goes well, we probably will track in a very similar direction in terms of the reduction in net debt to potentially high 30s as long as all the activity to expenses paid comes through.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [6]

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Got you. Okay. Great. And then synergies, you've talked about that. I guess if you could just maybe elaborate a little bit more. Kind of doubling, what, from 2% to 4%. Are you seeing any let-up there? Should -- going forward here in Q4, is it still -- I guess talk about the environment for incentives.

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [7]

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Are you referring to incentives in Canada, Lee? Is that correct?

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [8]

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Well, yes, I guess I was just looking at overall, it's kind of, except for Central and Eastern U.S., I guess Canada and California incentives basically doubled year-over-year. And I -- you could talk about that, I guess, 5% in Canada, 4% in California and prior year there at 2%.

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [9]

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Yes, sure. So I'll start off with kind of speaking from a numbers perspective and just the reflection of the homes that we closed during the quarter and to your point. We're still, from an incentive perspective, working through on the homes closed during the quarter. These orders were the ones that were kind of placed in the latter half of last year and early this year when the market in California was a little bit slower from that perspective. And then on Ontario, a lot of the homes that we've closed this year, we did provide some incentives very similar to get it back to that price that Alan mentioned earlier of kind of the homes that we had closed in previous years. We did provide some incentives to get homes closed there. In Calgary and Edmonton, they did creep up a little bit just due to the continued market sentiment. But Alan could probably -- can speak to kind of heading forward.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [10]

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Just a little bit on Alberta, for instance, Lee, I think we've found a decent pricing. We've got some terra firma not only in Ontario but also in Alberta as well. So hopefully, we will see that the incentive side decline somewhat because I think we've managed to find some sweet spots in certain product types. And it's still a tough market in Alberta, but I think that we've found this sort of sweet spot with respect to that. And as I said, Ontario was getting back to sort of a more -- we're starting to move back to a more normalized level.

California was still a bit of a challenge up in Northern California with respect to things, and we're still challenged somewhat on affordability. Albeit the lower-priced product in most of the markets is actually doing well across the country, but California, which is a big part of our business, was challenged a little bit just on the affordability, which as Thomas said, I'd like to see -- we think we'll see the incentives decline somewhat because a lot of it was from the beginning of the year and the end of last year for Q3 closings. But hopefully, we'll see some decline in that as we go forward because with good spring and some decent sales, good traffic here in the fall, we are seeing in most of the markets.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [11]

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Got you. And I guess the traffic on the fall and the absorption pace, looking just on a year-over-year basis, it seems like, I guess with the exception maybe of Central and Eastern U.S., I believe, if I got my numbers right, that California and Canada, a pickup in orders on a community basis. Are you -- what is kind of the pace out there? It seems like we're getting a second or third wind, I guess, from a housing standpoint.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [12]

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Yes, a little bit of that. And some of that is going to be coming a little bit from Toronto, the GTA. We virtually didn't have too much activity at all. If you recall from -- just when things soften, we really just started working with our backlog customers, and we're not actively trying to sell against that backlog for a period of time. So some of that is a reflection there. I will say that's probably the biggest part, mostly. Anything else, Thomas?

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [13]

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Yes. There has been some kind of pickup in Calgary just for some new product and mix coming through.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [14]

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Right, I guess the stuff I talked about, a little bit of pricing terra firma (inaudible) in terms of stuff.

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [15]

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Your biggest one is still Ontario where last year we had minimal sales at this point.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [16]

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Right.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [17]

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Got you. And then on the gross margin, it kind of goes, I guess, with the incentive side. It's still challenging year-over-year. But on a sequential basis, it continued to show improvement overall. And are we getting to a point where -- I guess, are we -- I guess my question is, should we continue to see this improvement sequentially on a gross margin basis but probably still challenging year-over-year?

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [18]

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Yes. It's a little bit of definitely mix within the operating segments. In Ontario, we did have some better-margin product that did close last year and that we will continue to kind of be moderately kind of at the same pace as where it was with some improvement. I think what you are seeing is, in the Central and Eastern operating segment, as we continue to increase our operations there, we should continue to see kind of better stabilization in our costs and continue to see some slight improvement in margins there. That would help a little bit with our prices.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [19]

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Okay. And then my last question, just on your guidance, on the housing guidance. Just backing into what you've said from a delivery standpoint of, what, 950 in Canada and, what, 1,950 in the U.S. Is it just that units would be down at 23% this fourth quarter? I just want to make sure that that's -- I mean, that's the right guidance.

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Thomas Lui, Brookfield Residential Properties Inc. - Executive VP & CFO [20]

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Yes. So Lee, the kind of overall guidance here is kind of where we are tracking towards, as Alan mentioned earlier. As we continue to focus, we are trying to get more and more activity that we try and spread out more throughout the year. So that does have an impact in terms of an operational consideration from our perspective. But from a results and kind of income perspective, we do expect Q4 to continue to be a meaningful impact on the company's overall bottom line for the year.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [21]

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They're very similar to what we've done to date, quite honestly, with that. We try and spread, as Thomas said, but just with the way the cycle goes, and this goes with most of our competitors as well, there's a lot happening just because of spring selling, and it was a little bit slower to start this year as we pointed out. So we had a lot more activity in sort of May, June and early summer, which lends itself to Q4 closings.

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Lee Dickson Brading, Wells Fargo Securities, LLC, Research Division - MD, Head of Credit Research and Senior High Yield Analyst [22]

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Got you. And then just how was the order patterns seem to be in October or maybe early November right now?

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [23]

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I would say it's not too bad across the country. I mean I think we'll get excellent sales traffic, I would say, in most -- there's a degree of hesitancy in some other areas. But the lower-priced product is definitely going very well. Higher price is doing okay. It's doing okay. I mean I would say that with -- mortgage rates and all of that stuff are just now -- there's probably a better feeling from those with existing homes. So it just takes a little bit of time for them to realize that they've got equity and their homes is going to be one of the better positions they've been in.

So the housing market is doing relatively well across the platform. But it is a little bit more challenging in California on affordability issues, especially up in Northern Cal at this point. But I do believe candidly that there's still great job creation up in the East Bay and Northern California, and I do think we're just creating a little bit of pent-up demand, and unless people adjust and -- I think we'll be fine.

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Operator [24]

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(Operator Instructions) This concludes the question-and-answer session. And I'll turn the conference back over to Mr. Alan Norris for any closing remarks.

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Alan Norris, Brookfield Residential Properties Inc. - Chairman & CEO [25]

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Thanks very much. I appreciate everyone joining in. Not too many questions, but I think we've gone through a lot of stuff with the restructuring, et cetera, and there's been a lot of dialogue and a lot of information that's gone out over the last month or 2. So I totally understand that there's a lot of information that's already gone out.

So thanks very much, and I look forward to chatting with you in February. Thank you.

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Operator [26]

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This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.