Wednesday, 29 December 2004

Real Estate Value Strategy:

Looking For Acreage

My current portfolio and many of the recent additions to it bear witness to the fact that I am enamored with real estate. Now, I am not talking about REIT’s, although I believe they can play an important role in a portfolio, but just plain old fashioned land. There are a lot of publicly traded companies out there, some real estate operating companies, many others not, that have vast land holdings, carried on their balance sheets at cost. Much of this land was acquired many years ago, and is now worth significantly more than its carrying value. I like nothing more than to discover these companies, how much land they hold, and where the tracts are located.

It’s no secret that in the past few years, land values have skyrocketed. I don’t need to look any further than the small patch of Long Beach Island (New Jersey) my wife and I purchased in 1998. It’s actually a standard (47 X 100) lot, with a small, original cape cod, built in 1949. A small, cozy cottage, equidistant (250 steps, yes, I actually counted) to the bay and beach, on a beautiful, fairly quiet island.

It was a scary purchase at the time. One Hundred Sixty Thousand dollars, another mortgage, these were heady times. But when the little old lady who owned it approached us, we couldn’t say no. One sixty for our own piece of paradise seemed a no-brainer. And so far, aside from some frozen pipes, it’s been the best purchase we ever made. That little slice of heaven that is part of our family, a refuge, a place where memories have been built, is now worth more than three times what we paid for it less than seven years ago.

That’s just ridiculous. True, we bought it under market value, and demand for second homes is rising, but to me, this still smacks of the 1999 era tech bubble. It really hit home the day I was standing on my property line; a line which had been wrongly surveyed as we were buying it. The surveyors incorrectly placed the stakes five feet closer to our house than they should have. It looked natural at the time. But the seller of the house was nice enough to tell us that the surveyors got it wrong. When they re-surveyed, it showed that our actual property line was less than two feet from the neighbor’s house. I guess the zoning laws were different in the late 1940’s. Since then, it’s always bothered me how close our line is to their house. Just does not give them much room. So I decided to calculate how much that little strip of land would be worth, just in case they wanted to buy it. The answer shocked me. Based on a $475,000 value on the property (excluding the house), that little 5 x 100 strip of sand and gravel is worth: $50,531.91! That, my friends, is $10,106.38 for a 1 X 100 foot strip. Or, if you like, $842.29 for a 1 inch by 100 foot sliver. Per acre you ask? $4 million. That’s insane.

If you think I’m jumping for joy over this, I’m not. Our little cottage, on a quiet street, with the worlds greatest neighbors, people we love, is filled with the laughter of 3 children, memories of sun-soaked summer days, and the hope that, God willing, there will be many more to come. It may look nice on a balance sheet, but it’s not for sale.

What is for sale though, on a daily basis, are the dozens of publicly traded companies sitting on acres and acres of land. Most you have probably never heard of. Some are not even in the real estate business.

My first venture into publicly traded real estate was about 3 years ago, when I bought shares in The St. Joe Company (NYSE, ticker: JOE, $63.85). At the time, shares traded in the $25 range, and I remember being blown away by a presentation given by the company at the Third Avenue Funds conference in New York, back in October, 2001. (Rule # 1 is never be blown away by a companies own presentation, they are always positive, but in this case, my optimism was warranted, after all, if Marty Whitman of Third Avenue is bullish……)

The company, whose main revenue source is from community development, owns approximately 850,000 acres, mostly in Northwest Florida. A substantial portion of this land is gulf, lake, or riverfront. One fact that impressed me at the time was that they have timber operations, a good business in itself, that clears the land until it is designated for development. Still, in the scheme of things, timber is a small part ($36.6 million in 2003, or about 5 percent of revenue).

More impressive to a real estate junkie, such as myself, is the shear size and location of their land holdings. The following is from the company’s 2003 10K:

JOE is one of Florida’s largest real estate operating companies and the largest private landowner in the State of Florida. The majority of our land is located in Northwest Florida. We own approximately 850,000 acres, which is approximately 2.4% of the land area of the State of Florida. Our acreage includes hundreds of miles of frontage on the Gulf of Mexico, bays, rivers and waterways, with nearly 40 miles of Gulf of Mexico coastline, including 5 miles of beachfront. Approximately 387,000 acres of our land are within ten miles of the coast.

To put the 850,000 acres into perspective, 640 acres is a full section, or 1 square mile. JOE’s holdings are 1328 square miles, or an area of roughly 36 by 36 miles! And nearly half within ten miles of the coast!

Valuation wise, St. Joe’s looks expensive, based on its price earnings ratio, which is currently 55. But, P/E’s are not the be all and end all for a company sitting on a huge and valuable portfolio of land.

One way I value companies with land holdings is to calculate their enterprise value per acre. Enterprise value is simply a company’s equity market cap plus their total debt, preferred stock and minority interests if applicable, minus cash. It’s simply a more accurate way to view a company’s perceived value in the marketplace, then just considering equity. In St. Joe’s case, using a recent enterprise value of $5.089 billion, we get an EV/acre of $5,608. In theory, purchasing St. Joes at the current price is like buying Florida real estate for about $5,600 an acre. Compare that to $4 million for an acre on Long Beach Island. (This is not a recommendation to buy or sell the stock, merely an illustration.)

Now, the stock has been on quite a run recently, up nearly 70 percent in 2004. Whenever I start thinking about taking profits, I look at the EV/acre calculation, and the Long Beach Island calculation. I am still holding the stock. But, again, I am a real estate junkie. I am addicted to acreage. I can’t help myself. Stay tuned for more…

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