I want to start the week talking some more about real estate. As I mentioned Friday, I believe that real estate, along with jobs, will be essential to the recovery of the U.S. financial markets and eventually the economy.
They are closely related. If jobs pick up, then home buying will also. If home buying picks up, then building and remodeling will start again, and that will create jobs. If the collateral value quits falling, the small and mid-size banks will start lending once again. That can also be a job creator. We just need to see the destructive cycle we have been trapped in for the past few years become a virtuous cycle that creates jobs and wealth.
The weakness in real estate pricing has created some enormous bargains in real-estate-related securities. Investors who have a long enough time horizon and a stomach for some volatility should reap ample rewards from buying real estate in the stock market.
As usual, I have to confess that I started buying into the sector far too soon. When I started getting interested in real-estate-related investments at the end of 2009, I really thought we would see more improvement by now. According to the most recent Case-Shiller report, residential real estate prices continue to show year-over-year declines.
The Moody's REAL Commercial Property Index readings are not any better. Although the index shows a slight upturn in pricing, almost all of the price gains have come from the apartment sector. As a result of foreclosures, apartment demand has been high, and that has pushed prices higher for multi-family dwellings. Industrial, retail and office properties are still flat to down on the year. The combined index trades at more than 40% below the levels of 2007. All of this is reflected in the pricing of real estate securities. The S&P Global Property Index is down 11% year to date, with hotels and industrial property companies being the biggest losers so far.
One of my first forays into real estate companies clearly demonstrates the volatility and patience required with this sector. My first purchase of Avatar Holdings (AVTR) was done at almost three times the current price. The Florida-based company has had to write down its real estate and land holdings on a regular basis. Tangible book value has been written down by more than a third since the real estate markets began to collapse in 2007.
The company has had to turn to the convertible bond market to raise funds and recently announced that it will be selling land holdings that do not fit into its long-term plans. Contract signings and closings for the company's homes are showing an increase this year but are still far below peak levels.
Owning a stock that has dropped by two-thirds is not necessarily a lot of fun, but I have seen this movie several times during my career. When the economy begins to create wealth and jobs, Florida and sunshine will once again be desired commodities, and I believe the company and the stock will rebound sufficiently for a happy ending. I believe the stock is a buy at this level and will add to my position soon.
Alico (ALCO) offers another interesting way to play an eventual real estate recovery in Florida. The Fort Myers-based company owns almost 140,000 acres of land in the Sunshine State. Much of the land is currently used for agricultural purposes, chiefly citrus groves, cattle and sugar cane. Alico's agricultural operations have shown impressive year-over-year revenue gains this year, and this should be a growth business going forward.
The real estate value of the company is a little less than $1,000 an acre, so I suspect the book value of $15.39 is understated in terms of potential real estate value. Management appears to believe the shares are cheap, as there has been some insider buying, and the company is buying back stock.
My foray into real estate operating companies has been a mixed bag so far. Avatar has clearly not worked well yet. Alico has tracked pretty much sideways since I first purchased a small stake. Real estate management and investment firm W.P. Carey (WPC) has been a huge success so far, rising almost 40% and paying a fat dividend yield over the past two years.
I expect that I will have large variations in returns form these companies in the short term, but over the next decade I believe I will be more than compensated for the volatility. Real estate is just too cheap not to own at these levels.