Monday, February 28, 2011

Real Estate On The Cheap

The real estate downturn in the US has resulted in low land values in many parts of the country. But in some cases, prices are perhaps too low. Consider Income Opportunity Realty Investors (IOT), a public company that invests in real-estate.

The company has a book value of $72 million (comprised mostly of land and notes receivable) and yet it trades for between $11 million and $18 million! (The reason for the big spread there is that the stock is rather volatile!) The land is composed of 203 acres of undeveloped land in Farmer's Branch, Texas, carried at just under $30 million. It is about a 20 minute drive from downtown Dallas, and is situated 15 minutes from the Dallas/Fort Worth International Airport. The land was acquired in May of 2006, so it may be overvalued; but is it worth only one sixth of its carrying value?

The company's notes receivable are mostly the result of recent land/building sales. The main risk with the notes is that they are due from related and affiliated parties. At least one of these parties has a very high debt to equity ratio, and happens to be the parent company of IOT, owning 80%+ of the company!

On that subject, a potential risk to the company is its ownership/management structure. The parent company will likely do what it needs to do to benefit itself, so IOT's actions may not always benefit its minority shareholders. There appear to be conflicts of interest on the board of directors as well, as the company appears to be governed by employees of the company's advisor, which is rarely a good thing for shareholders.

IOT's stock price has absolutely tanked in the last few months, however, offering the company's shares on the cheap. When TCI acquired a large number of shares of IOT in July of 2009, it noted that "The Company’s fair valuation of IOT assets and liabilities at the acquisition date approximated IOT’s book value." Since that time, IOT stock is down 60% and its book value hasn't changed much. In the meantime, the company continues to break even, mostly by collecting interest on the notes outstanding. (This amount is then offset against interest payments and operating expenses.)

Many investors like to identify potential catalysts before investing in a stock. There don't appear to be any catalysts on the horizon here, however. That land could sit undeveloped for a long time, and most of the notes don't mature until 2027! However, it appears clear that the company is trading at a massive discount to its assets, so value investors with long-term outlooks who require no catalyst may find this stock worthy of owning.

Disclosure: Author has a long position in shares of IOT


Anonymous said...

Take a look at this article on TCI management - I would be careful.

Anonymous said...


I read the closing price Feb. 25 at 4.52$/sh, or just under 18$ million total mkt cap. The meteoric rise seems to be in last Friday!

It still looks cheap based on BV, however this stock is very thinly traded. In general I like your recommendations, but this time I'll take a pass!


Unknown said...

You lay out a good case for buying the stock, however that 50% stock price increase last friday scares me a bit.

The fundamentals of the company remain the same of course, but the prospect of buying in now and possibly encountering the dump part of a pump/dump strategy makes me hesitant.

I'm assuming you entered the position before the large runup last friday, because you mention a 60% decrease in stock price since july 09 which currently is only 30%. So I'm wondering whether you would still be buying the stock at the current price?

Thanks for your time

Saj Karsan said...

Thanks for your comments; you guys all make good points. One thing I would suggest is not making an investment decision based on price movements but on price vs value. I realize that the volatility in this one makes it difficult though.

Anonymous said...

According to publicly available property appraisal records and my estimates their real estate, carried at cost, may be carried at a premium of up to 60% to actual market value. But I may be mistaken.

However, the market isn't necessarily valuing the real estate at one sixth. What the market may be confused about is the value of their other assets. The "affiliates" they have granted mortgages to are private companies owned by directors, as well as TCI. The TCI loan is the only one that is properly secured but I have no way of estimating whether the $6.9m is appropriate value for the 10 acres of "Centura land" it's secured against. The other loans are secured against 100% interest in some LLCs (not the actual real estate assets) and $2m is unsecured. The total exposure is $35m. How do we know these LLCs hold any assets and are worth anything?

Like you said, there's also a $49m unsecured exposure to companies like TCI and private companies Arcadian Energy, Inc. (formerly known as International Health Products, Inc.), and Prime Income Asset Management, Inc. There are also $2m in "other assets" without disclosure as to the type of assets.

So, let's hold the real estate value constant, assuming it's indeed worth $29.6m. Less liabilities, that becomes -$14.2m. The market cap right now is $16.7m. So the market is valuing IOT's mortgages, notes and other assets at $30.9m. I haven't got enough information on those debtors to be able to provide an alternative valuation or make any informed decisions.

I also know these debtors aren't servicing their loans in cash. No cash interest is being earned on any assets. IOT only accrues receivables. Would you lend to anyone, affiliate or otherwise, without getting paid interest in cash? Any proceeds from land sales (actual cash) are also immediately sent over to the affiliate, advisor company.

Anonymous said...

Your comments about arms-length holdings and the lack of any cash transactions create a lot of doubt about the viability of a full loan repayment (the LLCs may hold assets worth much much less than the loan amounts, or none). Another point is that raw undeveloped land parcels in Dallas aren't worth much (lack of developments & abundance of land) and appraisal reports in general, 99% of the time, grossly overstate asset values.

Historically the Dallas real estate market only does "well" in a momentum environment (such as '04-'06 with lots development & capital). If there is any value at all, the market will not recognize it for sometime.


Whopper Investments said...

I did I write up on IOT today
thought you might be interested

Anonymous said...


IOT closed at $2.78 on Jun 2. Given some of the comments that have been posted above regarding this stock idea and the company's Q1 2011 filing, do you still consider IOT a potentially worthy investment over the long-term?

Saj Karsan said...

Hi Anon,

I don't think anything has really changed except the price. Good luck with your decision!