Five Point Holdings, LLC 10-K

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated audited financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including but not limited to those described in the “Item 1A. Risk Factors” section of this report. Actual results could differ materially from those set forth in any forward-looking statements. See “Cautionary Statement Regarding Forward-Looking Statements.” Overview Our Company We conduct all of our business in or through our operating company, Five Point Operating Company, LP (the “operating company”). We are, through a wholly owned subsidiary, the sole managing general partner and owned, as of December 31, 2020, approximately 62.5% of the operating company. The operating company directly or indirectly owns equity interests in: • Five Point Land, LLC, which owns The Newhall Land & Farming Company, a California limited partnership, the entity that is developing Valencia (formerly known as Newhall Ranch), our community in northern Los Angeles County, California; • The Shipyard Communities, LLC (the “San Francisco Venture”), which is developing Candlestick and The San Francisco Shipyard, our communities in the City of San Francisco, California; • Heritage Fields LLC (the “Great Park Venture”), which is developing Great Park Neighborhoods, our community in Orange County, California; • Five Point Office Venture Holdings I, LLC (the “Gateway Commercial Venture”), which owns portions of the Five Point Gateway Campus, a commercial office and medical campus located within the Great Park Neighborhoods; and • Five Point Communities, LP and Five Point Communities Management, Inc. (together, the “management company”), which provide development and property management services for the Great Park Neighborhoods and the Five Point Gateway Campus. The operating company consolidates and controls the management of all of these entities, except for the Great Park Venture and the Gateway Commercial Venture. The operating company owns a 37.5% percentage interest in the Great Park Venture and a 75% interest in the Gateway Commercial Venture and accounts for its interest in both using the equity method. Please review “Structure and Formation of Our Company”, “Our Communities” and “Commercial” under Part I, Item 1 of this report for a description of our organizational structure, each of our communities and our commercial venture. Operational Highlights In 2020, we continued our horizontal land development activities at Valencia by investing in the community’s infrastructure, including grading and utility improvements. In the fourth quarter, we sold 487 homesites for a gross purchase price of $115.4 million and closed escrow on 442 of the homesites, resulting in gross proceeds of approximately $102.2 million. The remaining 45 homesites are expected to close in the latter part of 2021. In May 2020, we also closed 70 previously sold homesites at Valencia with a base purchase price of $16.6 million. Since our first land sales at Valencia in December 2019, we have sold or entered into sales contracts for 1,268 homesites. Our guest builders continue to prepare for the opening of the first development areas at Valencia, and we expect homes sales to begin in Summer 2021. 31 Table of Contents In 2020, the Gateway Commercial Venture closed on the sale of three buildings and approximately 11 acres of land at the Five Point Gateway Campus for a combined purchase price of $463.0 million. The sale of the buildings and land resulted in a total gain to the Gateway Commercial Venture of approximately $112.2 million, net of transaction costs. Additionally, the Gateway Commercial Venture made debt payments of $275.0 million to its lender and made total distributions of approximately $182.0 million to its members, of which approximately $136.5 million was distributed to us. Following these sales, the Gateway Commercial Venture retains ownership of one building and approximately 50 acres of commercial land with additional development rights at the campus. In the first quarter of 2020, the Great Park Venture closed the second take down of a two-take down purchase and sale agreement. The first take down closed in 2019. The gross proceeds of the second take down were $20.3 million, representing the base purchase price for land entitled for 35 homesites. In December 2020, we entered into a joint venture formed to provide land banking opportunities to homebuilders acquiring homesites at Valencia (the “Valencia Landbank Venture”). We made an initial contribution of $4.2 million and have a 10% interest in the Valencia Landbank Venture. 210 of the homesites sold at Valencia in December 2020 were sold to the Valencia Landbank Venture, and the Valencia Landbank Venture concurrently entered into option agreements with homebuilders for these homesites. We expect the Valencia Landbank Venture will continue to facilitate land sales at Valencia to certain homebuilders who are pursuing balance sheet alternatives to land acquisition and just-in-time delivery of homesites. In response to the COVID-19 pandemic that was declared in early 2020, we took immediate steps to protect the health and well-being of our associates and to preserve the financial strength of the company. Beginning in March 2020, all our associates started working remotely with access to necessary systems and resources to ensure business continuity. Substantially all our associates are continuing to work remotely, however, our executive team has been working at our corporate headquarters, and certain field operations associates are working at our project sites. Our executive team analyzed the impact of projected land sale revenues being delayed and then assessed which variable expenditures should be deferred, accordingly. As a result, we immediately limited development activities at our communities to only those activities essential to supporting active homebuilding by builders and to meet our contractual obligations. Despite continued economic volatility, homebuilding ended up being a bright spot in 2020 due to consumer demand for more space and a historically favorable mortgage environment. At the Great Park Neighborhoods, after a significant but brief decline in home sales in March and April of 2020, our guest builders returned to consistent rates of home sales in the second half of 2020. We are optimistic that favorable market conditions will continue for our guest builders and have therefore resumed regular development activities. As we monitor trends in COVID-19 cases in California, we will manage our development activities and expenditures to coincide with projected demand for homesites by our guest builders. Factors That May Influence our Results of Operations Fluctuations in the Economy and Market Conditions Our results of operations are subject to various risks and fluctuations in value and demand, many of which are beyond our control. Our business could be impacted by, among other things, downturns in economic conditions at the national, regional or local levels, particularly where our communities are located, inflation and increases in interest rates, significant job losses and unemployment levels, and declines in consumer confidence and spending. Supply and Demand for Residential and Commercial Properties We generate most of our revenue from land sales, which are dependent on demand from homebuilders, commercial developers and commercial buyers, which is in turn dependent on the prices that homebuyers, commercial buyers and renters are expected to pay. In addition, sales of homesites typically include participation provisions that allow us to share in the profits realized by the homebuilders if the overall profitability of a block of homes exceeds an agreed-upon margin. Because our revenue is influenced by the prices that homebuyers and commercial buyers are willing to pay for homes or commercial buildings in our region, our results of operations may be influenced by, among other things, the overall supply and demand for housing and commercial properties, the prevailing interest rates for mortgages, and the availability of mortgage financing for residential and commercial developers and residential and commercial buyers. 32 Table of Contents Timing of Obtaining the Necessary Approvals for Development Activities As a developer of real property in California, we are subject to numerous land use and environmental laws and regulations. Before we can begin developing our communities or development areas within them, we must obtain entitlements, permits and approvals. Depending upon the type of the approval being sought, we may also need to complete an environmental impact report, remediate environmental impacts or agree to finance or develop public infrastructure within the community or applicable development area, each of which would impose additional costs on us. In the event that we materially modify any of our existing entitlements, approvals or permits, we may also need to go through a discretionary approval process before the relevant governmental authority or go through an additional or supplemental environmental review and certification process. In addition, laws and regulations governing the approval processes provide third parties with the opportunity to challenge our entitlements, permits and approvals. The prospect of these third-party challenges creates additional uncertainty. Third-party challenges in the form of litigation can adversely affect the length of time or the cost required to obtain the necessary governmental approvals to develop, or result in the denial of our right to develop the particular community or development area in accordance with our current development plans. Furthermore, adverse decisions arising from any litigation can increase the cost or length of time to obtain ultimate approval of a project, if such approval is obtained at all, and can adversely affect the design, scope, plans and profitability of a project, which can negatively affect our financial condition and results of operations. See Part I, Item 3, of this report for a discussion of legal proceedings. As a result of many of the factors described above, we have historically experienced, and expect to continue to experience, variability in results of operations between comparable periods. Segments Our four reportable segments are Valencia, San Francisco, Great Park and Commercial: • Our Valencia segment (formerly Newhall) includes operating results related to the Valencia community and agricultural operations in Los Angeles and Ventura Counties, California. • Our San Francisco segment includes operating results for the Candlestick and The San Francisco Shipyard communities, as well as results attributable to the development management services that we previously provided to affiliates of Lennar Corporation (“Lennar”) in the San Francisco Bay Area. Our management agreement with Lennar with respect to the Concord community was terminated in early 2020. • Our Great Park segment includes operating results for the Great Park Neighborhoods community and development management services provided by the management company for the Great Park Venture. • Our Commercial segment includes the operating results of the Gateway Commercial Venture’s ownership in the Five Point Gateway Campus and property management services provided by the management company for the Gateway Commercial Venture. Results of Operations The following tables and related discussions on the results of operations are for the fiscal years ended December 31, 2020 and 2019. Refer to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Part II of our annual report on Form 10-K for the fiscal year ended December 31, 2019 for financial data and related comparative discussions on results of operations for the fiscal years ended December 31, 2019 and 2018. 33 Table of Contents The Company The following table summarizes our consolidated historical results of operations for the years ended December 31, 2020 and 2019. Year Ended December 31, 2020 2019 (in thousands) Statement of Operations Data REVENUES: Land sales $ 69,398 $ 140,020 Land sales—related party 53,219 923 Management services—related party 28,132 39,580 Operating properties 2,870 3,857 Total revenues 153,619 184,380 COSTS AND EXPENSES: Land sales 85,753 97,113 Management services 20,486 28,492 Operating properties 5,127 5,565 Selling, general, and administrative 83,504 103,586 Total costs and expenses 194,870 234,756 OTHER INCOME: Interest income 1,369 7,844 Gain on settlement of contingent consideration—related party — 64,870 Miscellaneous 356 48 Total other income 1,725 72,762 EQUITY IN EARNINGS FROM UNCONSOLIDATED ENTITIES 42,364 2,327 INCOME BEFORE INCOME TAX PROVISION 2,838 24,713 INCOME TAX PROVISION (1,744) (2,445) NET INCOME 1,094 22,268 LESS NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS 1,522 13,235 NET (LOSS) INCOME ATTRIBUTABLE TO THE COMPANY $ (428) $ 9,033 Revenues. Revenues decreased by $30.8 million, to $153.6 million for the year ended December 31, 2020, from $184.4 million for the year ended December 31, 2019. The decrease in revenues was primarily due to fewer land sales at our Valencia segment in 2020 compared to 2019. Cost of land sales. The cost of land sales decreased by $11.4 million, to $85.8 million for the year ended December 31, 2020, from $97.1 million for the year ended December 31, 2019. The decrease in cost of land sales was attributable to fewer land sales at our Valencia segment in 2020 compared to 2019. Cost of management services. Cost of management services decreased by $8.0 million, or 28.1%, to $20.5 million for the year ended December 31, 2020, from $28.5 million for the year ended December 31, 2019. The decrease was primarily due to less intangible asset amortization expense at our Great Park segment. Selling, general, and administrative. Selling, general, and administrative expenses decreased by $20.1 million, or 19.4%, to $83.5 million for the year ended December 31, 2020, from $103.6 million for the year ended December 31, 2019. The decrease was primarily attributable to a decrease in employee related expenses. 34 Table of Contents Other income. Other income for the year ended December 31, 2019 consisted primarily of a $64.9 million gain recognized by our San Francisco segment pertaining to the settlement of a contingent consideration liability. Equity in earnings from unconsolidated entities. Our consolidated results reflect our share in the earnings or losses of our interests in our unconsolidated entities, including the Great Park Venture and the Gateway Commercial Venture, within equity in earnings from unconsolidated entities on our consolidated statement of operations. Our segment results for the Great Park segment and the Commercial segment present the results of the Great Park Venture and the Gateway Commercial Venture at the book basis of the ventures within the respective segments. Equity in earnings from unconsolidated entities increased by $40.0 million, to $42.4 million for the year ended December 31, 2020, from $2.3 million for the year ended December 31, 2019. The increase was primarily due to an increase in earnings from the Gateway Commercial Venture due to gains from the sale of land and three buildings during the year ended December 31, 2020. The increase was offset by fewer land sales at the Great Park Venture during year ended December 31, 2020 compared to the same period in 2019. At the end of the first quarter of 2020, we recognized an other-than-temporary impairment of $26.9 million attributed to our investment in the Great Park Venture that is included in equity in earnings from unconsolidated entities in our consolidated statement of operations. The impairment was primarily a result of expected delays in both the timing of land sales to builders and distributions to us causing a decline in the fair value of our investment in the Great Park Venture. In determining that the impairment was other-than-temporary, we concluded that it was uncertain if a near term recovery of value that was lost as a result of delays to expected land sales from the impacts of the COVID-19 pandemic would occur. See Note 4 to our consolidated financial statements included under Part II, Item 8 of this report. Additionally, included in the results of operations of our Valencia segment is our 10% interest in the Valencia Landbank Venture that was formed in 2020 to take assignment of land purchase and sale agreements for residential lots within the Valencia community and enter into option and development agreements with homebuilders who intend to purchase the lots from the Valencia Landbank Venture to ultimately construct and sell homes. Income tax provision. All operations are carried on through our subsidiaries, the majority of which are pass-through entities that are generally not subject to federal or state income taxation, as all of the taxable income, gains, losses, deductions, and credits are passed through to the partners, including the partners of the operating company and the San Francisco Venture. We are responsible for income taxes on our allocable share of the operating company's income or gain. Pre-tax income of $2.8 million for the year ended December 31, 2020 resulted in a tax provision of $1.7 million. The tax provision was primarily the result of a $2.9 million decrease to our net deferred tax asset offset by a $1.9 million decrease to our deferred tax asset valuation allowance. Additionally, we recognized approximately $0.8 million of current state tax provision as a result of California Assembly Bill 85, which suspends the use of net operating losses in tax years 2020 through 2022. We assessed the realization of the net deferred tax asset and the need for a valuation allowance, based on positive and negative evidence, and determined that at December 31, 2020 it is more likely than not that such net deferred tax assets will not be realized. Pre-tax income of $24.7 million for the year ended December 31, 2019 resulted in a tax provision of $2.4 million. The tax provision was the result of a $5.5 million decrease to our net deferred tax asset offset by a $3.1 million decrease to our deferred tax asset valuation allowance. Our effective tax rate, before changes in valuation allowance, for the year ended December 31, 2020 was substantially similar to our effective tax rate, before changes in valuation allowance, for the year ended December 31, 2019. Net income attributable to noncontrolling interests. Until exchanged for our class A common shares or, at our election, cash, noncontrolling interests represent interests held by other partners in the operating company and members of the San Francisco Venture. Net income attributable to the noncontrolling interests on the consolidated statement of operations represents the portion of earnings attributable to the interests in our subsidiaries held by the noncontrolling interests. Valencia Segment (formerly Newhall) Our Valencia property consists of approximately 15,000 acres in northern Los Angeles County and is designed to include approximately 21,500 homesites and approximately 11.5 million square feet of commercial space. Valencia is the continuation of our master-planned community where already today approximately 20,000 households reside and approximately 60,000 people work. We began selling homesites in the first development area 35 Table of Contents at Valencia in 2019, and as of December 31, 2020 we had sold 1,268 homesites, comprised of 1,223 homesites that closed in either 2019 or 2020 and 45 homesites expected to close in the latter part of 2021. The following table summarizes the results of operations of our Valencia segment for the years ended December 31, 2020 and 2019. Year Ended December 31, 2020 2019 (in thousands) Statement of Operations Data Revenues Land sales $ 69,398 $ 140,020 Land sales—related party 53,219 38 Operating properties 2,275 3,132 Total revenues 124,892 143,190 Costs and expenses Land sales 85,753 97,113 Operating properties 5,127 5,565 Selling, general, and administrative 11,629 14,782 Total costs and expenses 102,509 117,460 Other income 379 49 Equity in loss from unconsolidated entity (1,569) — Segment income $ 21,193 $ 25,779 Land sales revenues and Land sales revenues—related party. Total land sales revenues decreased by $17.4 million, or 12.5%, to $122.6 million for the year ended December 31, 2020, from $140.1 million for the year ended December 31, 2019. The decrease in total land sales revenues was attributable to the recognition of revenue from the sale of land entitled for an aggregate of 512 homesites on approximately 52 acres during the year ended December 31, 2020 compared to the recognition of revenue from the sale of land entitled for an aggregate of 711 homesites on approximately 59 acres during the year ended December 31, 2019. The base purchase price was $118.7 million for the 2020 sales. We also recognized additional revenue of $3.7 million in the transaction price as an estimate of the amount of variable consideration from marketing fees that we expect to be entitled to receive. The base purchase price was $135.2 million for the 2019 sales. We also recognized additional revenue of $4.7 million in the transaction price as an estimate of the amount of variable consideration from marketing fees that we expect to be entitled to receive. In 2020, 210 of the homesites sold were purchased by the Valencia Landbank Venture, in which we own a 10% equity interest. Revenues associated with these closings are reported as land sales — related party. When we sell land to the Valencia Landbank Venture, we eliminate our pro-rata share of the intra-entity profits generated from the sale through earnings (loss) from unconsolidated entities until the land is sold by the Valencia Landbank Venture to third party homebuilders. All of the homesites sold in 2019 were sold to an unaffiliated land banking entity whereby a related party retained the option to acquire the homesites in the future from the land bank entity. Cost of Land Sales. Cost of land sales during the years ended December 31, 2020 and 2019 were $85.8 million and $97.1 million, or 69.9% and 69.3% of total land sale revenues, respectively. The cost of land sales includes both actual and estimated future capitalized costs allocated based upon relative sales values. Since this method requires us to estimate future development costs and the expected sales prices for future land sales, the profit margin on subsequent parcels sold will be affected by both changes in the estimated total revenues, as well as any changes in the estimated total cost of the project. Selling, general, and administrative. Selling, general, and administrative expenses decreased by $3.2 million, or 21.3%, to $11.6 million for the year ended December 31, 2020, from $14.8 million for the year ended December 31, 2019. The decrease was mainly attributable to a decrease in employee related expenses, offset by an 36 Table of Contents increase in community related selling and marketing expenses as we began to increase master marketing activities in anticipation of expected builder openings in the first half of 2021. Equity in loss from unconsolidated entity. During the year ended December 31, 2020, we recognized equity in loss of $1.6 million from the Valencia Landbank Venture as a result of eliminating our pro-rata share of the intra-entity profits generated from the related party land sales. San Francisco Segment Located almost equidistant between downtown San Francisco and the San Francisco International Airport, Candlestick and The San Francisco Shipyard consist of approximately 800 acres of bayfront property in the City of San Francisco. Candlestick and The San Francisco Shipyard are designed to include approximately 12,000 homesites and approximately 6.3 million square feet of commercial space. In October 2019, we received approval from the City of San Francisco on a revised development plan for the first phase of Candlestick that is currently planned to include approximately 750,000 square feet of office space, 1,600 homes, and 300,000 square feet of lifestyle amenities centered around retail and entertainment. As currently planned, Candlestick ultimately is expected to include approximately 7,000 homes. Our development at Candlestick and The San Francisco Shipyard is not subject to San Francisco’s Proposition M growth control measure, which imposes annual limitations on office development and is applicable to all other developers with projects in the city. This means the full amount of permitted commercial square footage at Candlestick and The San Francisco Shipyard can be constructed as we determine, including all at once, even though Proposition M may delay new office developments elsewhere in San Francisco. In 2018, our disposition and development agreement with the City of San Francisco was amended to increase the total amount of commercial use at Candlestick and The San Francisco Shipyard by over two million square feet, most of which we anticipate will be for office use, and increases our total commercial space to approximately 6.3 million square feet. At The San Francisco Shipyard, approximately 408 acres are still owned by the U.S. Navy and will not be conveyed to us until the U.S. Navy satisfactorily completes its finding of suitability to transfer, or “FOST,” process, which involves multiple levels of environmental and governmental investigation, analysis, review, comment and approval. Based on our discussions with the U.S. Navy, we had previously expected the U.S. Navy to deliver this property between 2019 and 2022. However, allegations that Tetra Tech, Inc. and Tetra Tech EC, Inc. (collectively, “Tetra Tech”), contractors hired by the U.S. Navy, misrepresented sampling results at The San Francisco Shipyard have resulted in data reevaluation, governmental investigations, criminal proceedings, lawsuits, and a determination by the U.S. Navy and other regulatory agencies to undertake additional sampling. As part of the 2018 Congressional spending bill, the U.S. Department of Defense allocated $36.0 million to help fund resampling efforts at The San Francisco Shipyard. An additional $60.4 million to fund resampling efforts was approved as part of a 2019 military construction spending bill. These activities have delayed the remaining land transfers from the U.S. Navy and could lead to additional legal claims or government investigations, all of which could in turn further delay or impede our future development of such parcels. Our development plans were designed with the flexibility to adjust for potential land transfer delays, and we have the ability to shift the phasing of our development activities to account for potential delays caused by U.S. Navy retesting, but there can be no assurance that these matters and other related matters that may arise in the future will not materially impact our development plans. We have been, and may in the future be, named as a defendant in lawsuits seeking damages and other relief arising out of alleged contamination at The San Francisco Shipyard and Tetra Tech’s alleged misrepresentations of related sampling work. See Part I, Item 3 of this report for additional information. Given the preliminary nature of the claims to date, we cannot predict the outcome of these matters. 37 Table of Contents The following table summarizes the results of operations of our San Francisco segment for the years ended December 31, 2020 and 2019. Year Ended December 31, 2020 2019 (in thousands) Statement of Operations Data Revenues Land sales—related party $ — $ 885 Operating property 595 725 Management services—related party 835 2,385 Total revenues 1,430 3,995 Costs and expenses Land sales — — Management services 488 1,102 Selling, general, and administrative 11,297 17,873 Total costs and expenses 11,785 18,975 Other income—gain on settlement of contingent consideration, related party — 64,870 Segment (loss) income $ (10,355) $ 49,890 Management services—related party revenues. Management services revenues decreased by $1.6 million, or 65.0%, to $0.8 million for the year ended December 31, 2020, from $2.4 million for the year ended December 31, 2019. The decrease was primarily attributable to the termination of our management agreement with Lennar with respect to the Concord community in early 2020. Selling, general, and administrative. Selling, general, and administrative expenses decreased by $6.6 million, or 36.8%, to $11.3 million for the year ended December 31, 2020, from $17.9 million for the year ended December 31, 2019. The decrease was mainly attributable to a decrease in employee related expenses. Other Income. We were previously a party to an agreement with a related party that had planned to construct a retail shopping district at Candlestick. In early 2019, we were released from obligations to convey parcels of property on which the retail project was intended to be developed. As a result of the relief of these obligations, we recognized a gain of $64.9 million during the year ended December 31, 2019. Great Park Segment We have a 37.5% percentage interest in the Great Park Venture, and we account for our investment using the equity method of accounting. We have a controlling interest in the management company, an entity which performs development management services at Great Park Neighborhoods. We do not include the Great Park Venture as a consolidated subsidiary in our consolidated financial statements. However, because of the relationship between the management company and the Great Park Venture, we assess our investment in the Great Park Venture based on the financial information for the Great Park Venture in its entirety, and not just our equity interest in it. As a result, our Great Park segment consists of the operations of both the Great Park Venture and the development management services provided by the management company at the Great Park Venture. Great Park Neighborhoods consists of approximately 2,100 acres in Orange County and is being built around the approximately 1,300 acre Orange County Great Park, a metropolitan public park that is under construction. Great Park Neighborhoods is designed to include approximately 10,500 homesites and approximately 4.9 million square feet of commercial space. 38 Table of Contents The Great Park Venture sold the first homesites in April 2013 and, as of December 31, 2020, had sold 6,196 homesites (including 709 affordable homesites) and commercial land allowing for development of up to 2 million square feet of commercial (research and development) space for aggregate consideration of approximately $2.6 billion. Interests in the Great Park Venture are either “percentage interests” or “legacy interests.” Holders of the legacy interests are entitled to receive priority distributions in an amount up to $565.0 million, and holders of percentage interests are entitled to all other distributions. In early 2020, the Great Park Venture made a distribution of $76.3 million to the holders of legacy interests, reducing the remaining aggregate distributions to the holders of legacy interests to approximately $134.0 million. Of the remaining $134.0 million, the first $45.0 million will be paid to the holders of legacy interests prior to the commencement of distributions to the holders of percentage interests. See Note 4 to our consolidated financial statements included under Part II, Item 8 of this report for additional discussion of distribution priorities at the Great Park Venture. The following table summarizes the results of operations of our Great Park segment for the years ended December 31, 2020 and 2019. Year Ended December 31, 2020 2019 (in thousands) Statement of Operations Data Revenues Land sales $ 22,165 $ 137,699 Land sales—related party 2,662 133,271 Management services—related party 26,900 36,873 Total revenues 51,727 307,843 Costs and expenses Land sales 15,304 179,836 Management services 19,998 27,390 Selling, general, and administrative 35,823 37,436 Management fees—related party 4,378 22,301 Total costs and expenses 75,503 266,963 Interest income 1,272 3,489 Segment (loss) income $ (22,504) $ 44,369 39 Table of Contents Revenues. Revenues decreased by $256.1 million, or 83.2%, to $51.7 million for the year ended December 31, 2020, from $307.8 million for the year ended December 31, 2019. The decrease was primarily attributable to the recognition of revenue from the sale of land entitled for an aggregate of 35 homesites on approximately four acres during the year ended December 31, 2020 compared to the recognition of revenue from the sale of land entitled for an aggregate of 587 homesites on approximately 48 acres during the same period in 2019. Initial gross proceeds from the 2020 sale were $20.3 million, representing the base purchase price. The Great Park Venture also recognized $0.5 million in the transaction price as an estimate of the amount of variable consideration from marketing fees that it expects to be entitled to receive. Initial gross proceeds from the 2019 sales were $255.4 million, representing the base purchase price. We also recognized $6.0 million in the transaction price as an estimate of the amount of variable consideration from marketing fees that we expect to be entitled to receive. During the years ended December 31, 2020 and 2019, revenues also included changes in estimates of variable consideration, including profit participation, from those amounts previously recorded by the Great Park Venture. During the years ended December 31, 2020 and 2019, the Great Park Venture recognized $3.6 million and $8.8 million in profit participation revenue, respectively. Revenues generated by the management company from development management services provided to the Great Park Venture include a base management fee, reimbursement for certain defined project team costs and the right to receive certain variable incentive compensation. Reduction in management services related party revenue was mainly attributable to changes in estimates of the amount of variable consideration pertaining to incentive compensation. Cost of Land Sales. Cost of land sales in 2020 and 2019 was $15.3 million and $179.8 million, or 61.6% and 66.4% of total land sales revenues, respectively. The cost of land sales includes both actual and estimated future capitalized costs allocated based upon relative sales values. Since this method requires the Great Park Venture to estimate future development costs and the expected sales prices for future land sales, the profit margin on subsequent parcels sold will be affected by both changes in the estimated total revenues, as well as any changes in the estimated total cost of the project. Management services costs and expenses. Included within management services costs and expenses are general and administrative costs and expenses incurred directly by the management company’s project team that is managing the development of the Great Park Neighborhoods. We also include amortization expense related to the intangible asset attributable to the incentive compensation provisions of the development management agreement with the Great Park Venture. Corporate and non-project team salaries and overhead are not allocated to management services costs and expenses or to our reportable segments and are reported in selling, general, and administrative costs in the consolidated statement of operations. During the year ended December 31, 2020, management services costs and expenses decreased by $7.4 million, or 27.0%, to $20.0 million, from $27.4 million for the year ended December 31, 2019. The decrease was primarily a result of changes in estimates in the utilization of the intangible asset. Intangible asset amortization expense was $8.6 million in 2020 compared to $15.6 million in 2019. Selling, general, and administrative. Selling, general, and administrative expenses are comprised of the Great Park Venture’s marketing related costs, property maintenance expenses, project team and other administrative costs. Project team and certain other administrative costs that are reimbursed to the management company per the terms of the development management agreement are not eliminated for segment reporting. Selling, general, and administrative costs decreased by $1.6 million, or 4.3%, to $35.8 million for the year ended December 31, 2020, from $37.4 million for the year ended December 31, 2019. The lower expense during the year ended December 31, 2020 was mainly attributable to a decrease in marketing fee expenses incurred at the Great Park Neighborhoods. Management fees—related party. Management fees decreased by $17.9 million, to $4.4 million for the year ended December 31, 2020, from $22.3 million for the year ended December 31, 2019. Management fees incurred by the Great Park Venture were comprised of base development management fees and incentive compensation fees. In general, incentive compensation fees will be paid as a percentage of distributions made to holders of the Great Park Venture’s percentage interests. When payments are deemed probable of being made, the Great Park Venture recognizes the expense ratably over the period services are expected to be provided. When estimates of the amount of incentive compensation probable of being paid change, the Great Park Venture records a cumulative adjustment in the period in which the estimate changes. The Great Park Venture recognized a credit of $2.4 million and $15.7 million in expense for incentive compensation fees during the years ended December 31, 2020 and 2019, respectively. 40 Table of Contents The table below reconciles the Great Park segment results for the years ended December 31, 2020 and 2019 to the equity in (loss) earnings from our investment in the Great Park Venture that is reflected in the consolidated statements of operations for the years ended December 31, 2020 and 2019, respectively. Year Ended December 31, 2020 2019 (in thousands) Segment net (loss) income from operations $ (22,504) $ 44,369 Less net income of management company attributed to the Great Park segment 6,902 9,483 Net (loss) income of Great Park Venture (29,406) 34,886 The Company’s share of net (loss) income of the Great Park Venture (11,027) 13,082 Basis difference amortization (2,073) (6,900) Other-than-temporary investment impairment (26,851) — Equity in (loss) earnings from Great Park Venture $ (39,951) $ 6,182 Commercial Segment We have a 75% interest in the Gateway Commercial Venture that is held through a wholly owned subsidiary of the operating company, and we serve as the manager of the Gateway Commercial Venture. However, the manager’s authority is limited. Major decisions by the Gateway Commercial Venture generally require unanimous approval by an executive committee composed of two people designated by us and two people designated by another investor. Some decisions require approval by all of the members of the Gateway Commercial Venture. We do not include the Gateway Commercial Venture as a consolidated subsidiary in our consolidated financial statements. However, as a result of our 75% economic interest and our role as manager, we assess our investment in the Gateway Commercial Venture based on the financial information of the Gateway Commercial Venture in its entirety, and we include the Gateway Commercial Venture’s financial results within the Commercial segment. Additionally, the management company has been engaged by the Gateway Commercial Venture to provide property management services to the Five Point Gateway Campus. We include the management company’s results of operations related to these property management services within the Commercial segment. The Five Point Gateway Campus is a commercial campus consisting of approximately 73 acres of land in the Great Park Neighborhoods acquired by the Gateway Commercial Venture in 2017. The Five Point Gateway Campus currently includes approximately one million square feet planned for research and development, medical and office space in four buildings, which are designed to accommodate thousands of employees. In 2020, the Gateway Commercial Venture sold three of the buildings and approximately 11 acres of land at the campus, generating $463.0 million in gross proceeds. Our corporate headquarters are located in the fourth building, which remains owned by the Gateway Commercial Venture. In addition to the fourth building, the Gateway Commercial Venture owns approximately 50 acres of commercial land with additional development rights at the campus. 41 Table of Contents The following table summarizes the results of operations of our Commercial segment for the years ended December 31, 2020 and 2019. Year ended December 31, 2020 2019 (in thousands) Statement of Operations Data Revenues Rental and related income $ 15,797 $ 25,881 Rental and related income—related party 8,444 8,276 Property management services—related party 397 322 Total revenues 24,638 34,479 Costs and expenses Rental operating expenses 5,347 7,120 Interest 8,857 16,892 Depreciation 7,299 10,972 Amortization 2,113 4,129 Other expenses 1,040 184 Total costs and expenses 24,656 39,297 Other income—gain on asset sales, net 112,260 — Segment income (loss) $ 112,242 $ (4,818) Revenues. Revenues decreased by $9.8 million, or 28.5%, to $24.6 million for the year ended December 31, 2020, from $34.5 million for the year ended December 31, 2019. The decrease in revenues was mainly attributable to the Gateway Commercial Venture no longer receiving rental income attributed to the buildings that were sold in 2020. Other Income. In May 2020, the Gateway Commercial Venture closed on the sale of approximately 11 acres of land and an approximately 189,000 square foot building to City of Hope for a purchase price of $108.0 million. The sale of this land and building, which had a carrying value of approximately $67.5 million, resulted in a gain of approximately $37.4 million, net of transaction costs. Concurrently, the Gateway Commercial Venture made a debt payment of $30.0 million to its lender and made total distributions to its members of approximately $75.0 million, of which approximately $56.3 million was distributed to us. In August 2020, the Gateway Commercial Venture closed on the sale of two buildings, comprising a total of approximately 660,000 square feet of research and development space currently leased to one tenant under a triple net lease for a purchase price of $355.0 million. The sale of the buildings, which had a carrying value of approximately $278.0 million, resulted in a gain of approximately $74.8 million, net of transaction costs. Concurrently, the Gateway Commercial Venture made a debt payment of $245.0 million to its lender and made total distributions to its members of approximately $107.0 million, of which approximately $80.3 million was distributed to us. Costs and expenses . Costs and expenses decreased by $14.6 million, or 37.3%, to $24.7 million for the year ended December 31, 2020, from $39.3 million for the year ended December 31, 2019. As a result of the Gateway Commercial Venture’s asset dispositions and related debt repayments in 2020, cost and expenses, including interest, depreciation, and amortization expenses, were lower for the year ended December 31, 2020. 42 Table of Contents The table below reconciles the Commercial segment results for the years ended December 31, 2020 and 2019 to the equity in earnings (loss) from our investment in the Gateway Commercial Venture that is reflected in the consolidated statements of operations for the years ended December 31, 2020 and 2019, respectively. Year ended December 31, 2020 2019 (in thousands) Segment net income (loss) from operations $ 112,242 $ (4,818) Less net income of management company attributed to the Commercial segment 397 322 Net income (loss) of Gateway Commercial Venture 111,845 (5,140) Equity in earnings (loss) from Gateway Commercial Venture $ 83,884 $ (3,855) Liquidity and Capital Resources At December 31, 2020, we had $298.1 million of consolidated cash and cash equivalents, compared to $346.8 million at December 31, 2019. As of December 31, 2020, no funds had been drawn on the operating company’s $125.0 million revolving credit facility. However, letters of credit of $0.3 million were issued and outstanding under the revolving credit facility as of December 31, 2020, thus reducing the available capacity to $124.7 million. Our short-term cash needs consist primarily of general and administrative expenses and development expenditures at Valencia and the Candlestick and The San Francisco Shipyard communities, interest payments under our senior notes and payments under a related party reimbursement obligation. In 2021, we will make interest payments of $49.2 million on our $625.0 million senior notes due 2025, and we expect to make $35.5 million in principal payments under our related party reimbursement obligation. Reimbursement payments may be deferred when our related party receives an extension on the maturity date of the associated EB-5 loan liability. The development stages of our master-planned communities continue to require significant cash outlays on both a short-term and long-term basis, and we expect to invest significant amounts on continued horizontal development at Valencia in 2021. While our current financial position is strong, and the new home market has seen a recovery from the initial reaction to the COVID-19 pandemic, the pandemic has had a significant impact on the U.S. and California economies and our business, and the extent and duration of the current environment is unknown. We will continue to manage our development activities and expenditures to coincide with projected demand for homesites by our guest builders. We expect to meet our cash requirements for at least the next 12 months with available cash, in addition to proceeds from land sales in Valencia, distributions from our unconsolidated entities and collection of management fees under our various management agreements. Our long-term cash needs relate primarily to future horizontal development expenditures and investments in or vertical construction costs for properties that we may acquire or develop for our income-producing portfolio. We budget our cash development costs on an annual basis. Budgeted amounts are subject to change due to delays or accelerations in construction or regulatory approvals, changes in inflation rates and other increases (or decreases) in costs. We may also modify our development plans or change the sequencing of our communities in response to changing economic conditions, consumer preferences and other factors, which could have a material impact on the timing and amount of our development costs. Budgeted amounts are expected to be funded through a combination of available cash, cash flows from our communities and reimbursements from public financing, including community facilities districts, tax increment financing and local, state and federal grants. Cash flows from our communities may occur in uneven patterns as cash is primarily generated by land sales, which can occur at various points over the life cycle of our communities. 43 Table of Contents We currently expect to have sufficient capital to fund the horizontal development of our communities in accordance with our development plan for several years. The level of capital expenditures in any given year may vary due to, among other things, the number of communities or neighborhoods under development and the number of planned deliveries, which may vary based on market conditions. We may seek to raise additional capital by accessing the debt or equity capital markets or with one or more revolving or term loan facilities or other public or private financing alternatives. These financings may not be available on attractive terms, or at all. We are a party to a tax receivable agreement (“TRA”) with current and former holders of Class A units of the operating company and the holders of Class A units of the San Francisco Venture. The TRA provides for payments by us to such investors or their successors in aggregate amounts equal to 85% of the cash savings, if any, in income tax that we realize as a result of (a) increases in tax basis that are attributable to exchanges of Class A units of the operating company for our Class A common shares or cash or certain other taxable acquisitions of equity interests by us, (b) allocations that result from the application of the principles of Section 704(c) of the Code and (c) tax benefits related to imputed interest or guaranteed payments deemed to be paid or incurred by us as a result of the TRA. We expect the TRA payments to be substantial, however, the actual amount and timing of any payments under the TRA will vary depending upon a number of factors, including the timing of exchanges of Class A units of the operating company, the price of our Class A common shares at the time of such exchanges, the extent to which such exchanges are taxable and our ability to use the potential tax benefits, which will depend on the amount and timing of our taxable income and the rate at which we pay income tax. In 2004, our defined benefit pension plan was amended to cease future benefit accruals for services provided by participants of the plan and to close the plan to new participants. We do not anticipate making contributions to our pension plan over the next twelve months. We believe the pension plan is currently appropriately funded, however, declines in the value of the plan’s assets could result in increased funding requirements in the long-term. We are committed under various letters of credit (“LOCs”) to perform certain development activities and provide certain guarantees in the normal course of business. Outstanding LOCs totaled $1.3 million and $2.4 million at December 31, 2020 and 2019, respectively. At December 31, 2020 and 2019, we had $1.0 million and $1.4 million, respectively, in restricted cash and certificates of deposit securing certain of our LOCs. Additionally, under our revolving credit facility, we are able to utilize undrawn capacity to support the issuance of LOCs. As of December 31, 2020, we were using approximately $0.3 million in capacity under the revolving credit facility to support LOCs. As a part of the entitlement and development process, we are required to provide performance bonds to ensure completion of certain development obligations. We had outstanding performance bonds of $229.6 million as of December 31, 2020. At December 31, 2020, the San Francisco Venture had outstanding guarantees benefiting a municipal agency for infrastructure and construction of certain park and open space obligations with aggregate maximum obligations of $198.3 million. 44 Table of Contents Contractual Obligations The following table aggregates certain of our cash contractual obligations and commitments as of December 31, 2020: Payment due by period (in thousands) Total Less than 1 year 1-3 years 3-5 years More than 5 years Senior notes payable $ 625,000 $ — $ — $ 625,000 $ — Interest commitment on senior notes 246,094 49,219 98,438 98,437 — Operating lease obligations 29,085 5,017 11,003 4,969 8,096 Water purchase agreement (1) 33,822 1,315 2,759 2,941 26,807 Interchange funding agreement (2) 8,862 8,862 — — — Valencia approval settlement (3) 15,000 1,500 9,000 3,000 1,500 Related party reimbursement obligation (4) 95,144 38,543 43,031 13,570 — Total $ 1,053,007 $ 104,456 $ 164,231 $ 747,917 $ 36,403 (1) We are subject to a water purchase agreement requiring annual payments in exchange for the delivery of water for our exclusive use. The agreement has an initial 35-year term, which expires in 2039 with an option for a second 35-year term. (2) In January 2012, we entered into an agreement with Los Angeles County pursuant to which we agreed to finance construction costs of an interchange project that Los Angeles County is managing. The interchange project is a critical infrastructure project that will benefit Valencia. Under the agreement, we have committed to pay the remainder of the actual construction costs, up to $8.9 million. We currently expect this amount to be paid within twelve months of December 31, 2020. (3) In September 2017, we reached a settlement with key national and state environmental and Native American organizations that were petitioners in various legal challenges to Valencia’s regulatory approvals and permits. Under the settlement terms, we agreed to fund certain environmental and cultural investments and protections at Valencia and the surrounding region. (4) Prior to our acquisition of the San Francisco Venture, certain subsidiaries of the San Francisco Venture entered into EB-5 loan agreements with lenders that are authorized by the United States Citizenship and Immigration Services to raise capital from foreign nationals who seek to obtain permanent residency in the United States. Prior to our acquisition, related parties assumed the EB-5 loan liabilities, and the San Francisco Venture entered into reimbursement agreements pursuant to which it agreed to reimburse the related parties for a portion of the EB-5 loan liabilities and related interest. The amounts set forth in the above table include interest based on the weighted average interest rate of 4.4%. Reimbursement payments may be deferred when the related parties receive an extension on the maturity date of the associated EB-5 loan liability. Summary of Cash Flows The following table outlines the primary components of net cash provided by (used in) operating, investing and financing activities (in thousands): Year ended December 31, 2020 2019 Operating activities $ (78,499) $ (232,040) Investing activities 52,940 311 Financing activities (23,541) 83,206 45 Table of Contents Cash Flows from Operating Activities. Cash flows from operating activities are primarily comprised of cash inflows from land sales, management services and operating property results. Cash outflows are comprised primarily of cash outlays for horizontal development costs, employee compensation, and selling, general, and administrative costs. Our operating cash flows may vary significantly each year due to the timing of land sales and the development efforts related to our master-planned communities. Net cash used in operating activities decreased by $153.5 million for the year ended December 31, 2020, compared to the year ended December 31, 2019. Major components of operating cash used in both periods consist of our continued investment in horizontal development at our communities and selling, general, and administrative costs. During the year ended December 31, 2020, we received total distributions of $136.5 million from the Gateway Commercial Venture, of which $79.0 million is reflected as a return on our investment (operating activity). During the years ended December 31, 2020 and 2019, we received $118.5 million and $135.2 million, respectively, in net proceeds upon closing escrow from land sales at our Valencia segment. During the years ended December 31, 2020 and 2019, we made total interest payments of $49.2 million and $42.4 million, respectively on our senior notes. Cash Flows from Investing Activities. Net cash provided by investing activities was $52.9 million for the year ended December 31, 2020, compared to the net cash provided by investing activities of $0.3 million for the year ended December 31, 2019. For the year ended December 31, 2020, we received total distributions of $136.5 million from the Gateway Commercial Venture, of which $57.5 million is reflected as a return of our investment (investing activity). We made a capital contribution of $4.2 million and received a 10% interest in the Valencia Landbank Venture in 2020, and we also received a distribution of $1.7 million from our indirect legacy interest in the Great Park Venture. Cash Flows from Financing Activities. Net cash used in financing activities was $23.5 million for the year ended December 31, 2020, compared to net cash provided by financing activities of $83.2 million for the year ended December 31, 2019. For the year ended December 31, 2020, we made a tax distribution of $4.6 million to a noncontrolling interest in accordance with the operating company's Limited Partnership Agreement (“LPA”). The tax distribution is treated as an advance distribution under the LPA. We also made payments of $13.5 million to reduce our related party reimbursement obligation during the year ended December 31, 2020. For the year ended December 31, 2019, we issued an aggregate of $125.0 million principal amount of 7.875% senior notes due 2025. We used $5.5 million and $4.1 million during the years ended December 31, 2020 and 2019, respectively, to net settle certain share-based compensation awards with employees for tax withholding purposes. Additionally, during the year ended December 31, 2019, we received cash proceeds of $25.0 million related to the issuance of San Francisco Venture Class C units to an affiliate of Lennar (see Note 5 to our consolidated financial statements included under Part II, Item 8 of this report) and repaid a promissory note of $65.1 million in connection with the termination of the retail project at Candlestick. Changes in Capital Structure During the year ended December 31, 2020, our ownership percentage in the operating company increased to 62.5%, primarily due to the operating company issuing us additional Class A units in connection with our issuance of Class A common shares under our share-based compensation plan. Additionally, we reacquired approximately 436,675 restricted Class A common shares from employees for income tax withholding purposes that resulted in the operating company retiring an equal number of Class A units of the operating company we previously held. The table below summarizes outstanding Class A units of the operating company and Class A units of the San Francisco Venture, which are redeemable on a one-for-one basis for Class A units of the operating company, at December 31, 2020 and 2019 held by us and those held by noncontrolling interest members. 46 Table of Contents Year ended December 31, 2020 2019 Class A units of the operating company: Held by us 69,051,284 68,788,257 Held by noncontrolling interest members 41,363,271 41,363,271 110,414,555 110,151,528 Class A units of the San Francisco Venture held by noncontrolling interest members 37,870,273 37,870,273 148,284,828 148,021,801 At December 31, 2020, we had 79,233,544 Class B common shares that were held by the noncontrolling interest members of the operating company and the Class A unitholders of the San Francisco Venture. The Class B common shares will automatically convert to Class A common shares at a ratio of 0.0003 Class A common shares for each Class B common share. The conversions will occur when the holders of Class A units of the operating company, including Class A units that have been issued upon redemption of Class A units of the San Francisco Venture, are redeemed for our Class A common shares or cash, at our election. Related Party Revenues In the ordinary course of our business, we have sold and expect to continue to sell homesites to Lennar, which is our largest equity owner, or its affiliates, subsidiaries or joint ventures in which it is a member. During the years ended December 31, 2020, 2019 and 2018, we recognized $0.1 million, $0.9 million, and $0.9 million, respectively, of such revenue. We did not sell homesites directly to Lennar during the years ended December 31, 2020, 2019, and 2018 but did recognize revenues related to certain fees or profit participation associated with homesites sold directly to Lennar in prior periods. During the year ended December 31, 2020, we sold homesites to the Valencia Landbank Venture, our equity method investee, and recognized $53.2 million of such revenue. During the year ended December 31, 2019, we sold homesites to an unaffiliated land banking entity and recognized $139.9 million of such revenue. Lennar retained the option to acquire these homesites in the future from the unaffiliated land banking entity that acquired the homesites from us in 2019. Additionally, we previously provided certain management services for ventures in the San Francisco Bay Area in which Lennar is a significant participant. For the years ended December 31, 2020, 2019 and 2018, we recognized $0.8 million, $2.4 million, and $4.4 million, respectively, of revenue related to these agreements. However, we do not expect these arrangements to contribute material revenues in future periods. We also provide management services to the Great Park Venture pursuant to a development management agreement. In addition to our 37.5% percentage interest in the Great Park Venture, Lennar owns a 25% legacy interest in the Great Park Venture. Lennar, along with an affiliate of Castlelake, also owns interests in an entity that owns a 12.5% legacy interest in the Great Park Venture. For the years ended December 31, 2020, 2019 and 2018, we recognized $26.9 million, $36.9 million, and $35.1 million, respectively, of revenue from management services provided to the Great Park Venture. Other than the Valencia Landbank Venture and the Great Park Venture, no related party customer accounted for more than 10% of our revenue during the years ended December 31, 2020, 2019 and 2018. In addition to the related party revenues, during the year ended December 31, 2020, we also sold homesites to a third party home builder and recognized $59.1 million of such revenue, which accounted for more than 10% of total consolidated revenues. Other than the third party home builder and the unaffiliated land bank entity, no third party customer accounted for more than 10% of our revenue during the years ended December 31, 2020, 2019 and 2018. 47 Table of Contents Critical Accounting Policies and Estimates Critical accounting policies and estimates are those that are both significant to the overall presentation of our financial condition and results of operations and require management to make difficult, complex or subjective judgments. Our critical accounting policies and estimates are those applicable to the following: Consolidation Voting Interest Entities (“VOE”) and Variable Interest Entities (“VIE”): We consolidate all subsidiaries or other entities in which we have a controlling financial interest. The consolidation guidance requires us to perform an analysis to determine if an entity should be evaluated for consolidation using the VOE model or the VIE model. Under the VOE model, controlling financial interest is generally defined as a majority ownership of voting rights. Under the VIE model, controlling financial interest is defined as (i) the power to direct activities that most significantly impact the economic performance of the entity and (ii) the obligation to absorb losses of or the right to receive benefits from the entity that could potentially be significant to the entity. For those entities that qualify as a VIE, the primary beneficiary is generally defined as the party who has a controlling financial interest in the VIE. We consolidate the financial position and results of operations of every VOE in which we have a controlling financial interest and VIEs in which we are considered to be the primary beneficiary. Revenue Recognition and Cost of Land Sales Revenues from land sales contain both fixed (stated purchase price of the land) and variable consideration. A form of variable consideration is profit participation whereby we receive from homebuilders a portion of profit after the builder has received an agreed-upon margin. If the project profitability falls short of the participation threshold, we receive no additional revenues. In most contracts, at the time of the land sale we expect to constrain our estimate of profit participation, if any, as there are significant factors outside our control that will impact whether participation thresholds will be met. In addition, some residential homesite sale agreements contain a provision requiring the homebuilder to pay a marketing fee per residence sold, as a percentage of the home sale price. We estimate such fees as a variable consideration and include an amount we expect to be entitled to receive in the transaction price. At the end of each reporting period, we reassess the variable considerations to ensure changes in circumstances or constraints are appropriately reflected in the estimated transaction price. Changes in estimates of variable components of transaction prices could result in cumulative catch-up adjustments to revenue. Capitalized inventory costs include land, horizontal development, indirect project costs, real estate taxes and interest related to financing development and construction. The allocation of capitalized inventory costs to individual parcels within a project utilizes the relative sales value method. Under the relative sales value method, each parcel in the project under development is allocated costs in proportion to the estimated overall sales price of the project. Since this method requires us to estimate future development costs and the expected sales price for future land sales, the profit margin on subsequent parcels sold will be affected by both changes in the estimated total revenues, as well as any changes in the estimated total cost of the project. Revenues from management services are recognized as the customer consumes the benefits of the performance obligation satisfied over time. The transaction price pertaining to management services revenue may be comprised of fixed and variable components, including incentive compensation fee provisions that are contingent on the performance of our customer. In making estimates of incentive compensation we expect to be entitled to receive in exchange for providing management services, we make significant assumptions and judgments in evaluating the factors that may determine the amount of consideration we will ultimately receive. In doing so, we typically utilize cash flow projections for our communities. When changes in our estimates and assumptions occur, our estimate of the amount of incentive compensation we expect to be entitled to receive may change, resulting in a cumulative adjustment being recorded in the period of the change. 48 Table of Contents We believe that the accounting estimates related to revenue recognition and cost of land sales are critical accounting estimates because of the use of projected cash flows in each estimate. Cash flows are significantly affected by estimates and assumptions related to market supply and demand, the local economy, projected pace of sales of homesites, pricing and price appreciation over the estimated selling period, the length of the estimated development and selling periods, remaining development obligations and the cost of completing development, general and administrative costs, and other factors. In determining these estimates and assumptions, we utilize historical trends from our past development projects, in addition to internal and external market studies and trends, which generally include, but are not limited to, statistics on population demographics and unemployment rates. Using all available information, we calculate our best estimate of projected cash flows for each asset. While many of the estimates are calculated based on historical and projected trends, all estimates are subjective and change as market and economic conditions change. Investments in Unconsolidated Entities For investments in entities that we do not control, but over which we exercise significant influence, we use the equity method of accounting. Our judgment with regard to our level of influence or control of an entity involves consideration of various factors, including the form of our ownership interest, our representation in the entity’s governance, our ability to participate in policy-making decisions and the rights of other investors to participate in the decision-making process to replace us as manager or to liquidate the entity. Investments accounted for under the equity method of accounting are recorded at cost and adjusted for our share in the earnings (losses) of the venture and cash contributions and distributions. Any difference between the carrying amount of the equity method investment on our balance sheet and the underlying equity in net assets on the entity’s balance sheet results in a basis difference, which is adjusted as the related underlying assets are depreciated, amortized or sold and the liabilities are settled. We generally allocate income and loss from unconsolidated entities based on the venture’s distribution priorities, which may be different from its stated ownership percentage. We evaluate the recoverability of our investments in unconsolidated entities by first reviewing each investment for any indicators of impairment. If indicators are present, we estimate the fair value of the investment. We typically estimate the fair value of our investments using a discounted cash flow of distributions we expect to receive from the venture. The determination of fair value also requires discounting the estimated cash flows at a rate that we believe a market participant would determine to be commensurate with the inherent risks associated with the investment and related estimated cash flow streams. The discount rate used in determining each investment’s fair value generally depends on the investment’s projected life and development stage. If the carrying value of the investment is greater than the estimated fair value, management makes an assessment of whether the impairment is “temporary” or “other-than-temporary.” In making this assessment, management considers (1) the length of time and the extent to which fair value has been less than cost, (2) the financial condition and near-term prospects of the entity and (3) our intent and ability to retain our interest long enough for a recovery in market value. If management concludes that the impairment is “other-than-temporary,” we reduce the investment to its estimated fair value. We believe that the accounting related to investments in unconsolidated entities is a critical accounting estimate because our impairment evaluation uses significant estimates in determining the fair value of our investments, including projected cash flows and the selected discount rate. 49 Table of Contents Income Taxes We record income taxes in accordance with ASC 740, which requires an asset and liability approach, whereby deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and attributable to operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or paid. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the changes are enacted. A valuation allowance is provided to reduce deferred tax assets to the amount of future tax benefit when it is more likely than not that some portion of the deferred tax assets will not be realized. When assessing the need for a valuation allowance, we consider, among other things, the nature, frequency and severity of prior cumulative losses, forecasts of future taxable income, the duration of statutory carryforward periods, our utilization experience with operating loss and tax credit carryforwards and tax planning alternatives, to the extent these items are applicable. Any increase or decrease in a valuation allowance could have a material adverse effect or beneficial effect on our income tax provision and net income or loss in the period the determination is made. We recognize interest or penalties related to income tax matters in income tax expense. Recently Issued Accounting Pronouncements and Developments See our consolidated financial statements included under Part II, Item 8 of this report for a discussion of new accounting pronouncements applicable to us. In November 2020, the SEC issued Final Rule Release No. 33-10890, Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information. This rule, which became effective on February 10, 2021, amended certain SEC disclosure requirements in order to modernize, simplify and enhance certain financial disclosure requirements in Regulation S-K. Specifically, the amendments eliminate the requirement for Selected Financial Data, streamline the requirement to disclose Supplementary Financial Information, and amend Management's Discussion and Analysis. The final rule is applicable for fiscal years beginning after December 31, 2020, however, early adoption on an Item-by-Item basis is permitted after February 10, 2021. We early adopted the amendments to two items resulting in the elimination of Item 301, Selected Financial Data, from Part II, Item 6 of this report and the omission of Regulation S-K Item 302(a), Supplementary Financial Information, from the notes to our consolidated financial statements in Part II, Item 8 of this report. Off-Balance Sheet Arrangements We had no material off-balance sheet arrangements as of December 31, 2020. Seasonality Our business and results of operations are not materially impacted by seasonality. Inflation Inflation poses a risk to our business due to the possibility that higher prices would increase our development expenditures. In particular, our development expenditures are influenced by the price of oil, which is used in our development activities, including grading and paving roads. However, inflation can also indirectly improve our revenues by increasing the amount that homebuyers and commercial buyers are willing to pay for newly constructed homes and commercial buildings, which in turn, increases the amount that homebuilders and commercial developers are willing to pay for our residential and commercial lots. In addition, because sales of homesites typically include participation provisions that allow us to share in the profits realized by the homebuilders if the overall profitability of a block of homes exceeds an agreed-upon margin, we may be able to receive additional benefit in the event of inflation. 50 Table of Contents