Avatar Holdings might be in the worst possible business in today's economy, they own land and build houses in Florida and Arizona. But, to paraphrase much wiser investors, there are no such things as bad assets, just bad prices. The following is an argument for why the price might be right for Florida land assets through a long position in Avatar.
Headquartered in Coral Gables, FL, Avatar owns land on which they believe they can build 21,180 homes (as of Sep 30, 2009) in both Florida and Arizona. Of those lots, roughly 80% are in Florida and 20% in Arizona. Most of the lots in Florida are southwest of Orlando, perhaps a 30-minute drive to Disney World, so they're not involved in the worst Florida communities that have condos that may never be absorbed. Just for perspective, Avatar will put those lots on 16,700 acres of developable land, and they'll use another 15,000 acres of property as open space and wetlands.
Until the third quarter of 2009, the company has not purchased any land since 2004 (deal actually closed in 2005). They recently purchased land and a few houses in various stages of completion from a busted development in Port St. Lucie, Florida. In fact, of the 21,180 potential lots, 11,430 of them were purchased before 1980. It's hard to imagine that this land is worth less than book value now that it has been on the books more than thirty years.
So, how should one figure out the value of this land? It's simple, figure out what houses will be selling for in a decade and you've got it. Easy, right?
Let's go back to the year 2001, perhaps the last year before the Great Housing Bubble began in the U.S. In that year, Avatar's average transaction price was $174,000 per unit (that includes closings, bookings, and backlog). It would be hard to argue that 2001 was a robust year, so I use that as a good starting point. Remarkably, the transaction price rocketed to $341,000 by 2006 using the same calculation method.
What if we hadn't experienced a housing bubble? For the moment, let's just say that without a bubble, these properties would have appreciated 1% per year rather than the mind-boggling 14% per year from 2001 through 2006. And, let's assume that the 1% inflation figure is valid through 2009. If that would have happened, the price of an Avatar home would be about $188,000 today (in fact, they averaged about $159K during Q309). Below, we make the assumption that $188,000 is today's "normal" price had we not had the housing bubble and the subsequent hangover.
There are a handful of scenarios that one may wish to consider when thinking about sales prices a decade from now.
Annual Inflation 2019 Housing Price
Now, we're not suggesting the 6% number is even close, but we put that in the mix just to show that housing prices would finally reach the 2006 peak by 2019 using a 6% inflation rate off our calculation of today's "normal" selling price.
In residential real estate analysis, outside of the high cost land areas, one can safely assume that the land is worth roughly 20% of the property value (can be higher, but let's be conservative). In that case, the lots would sell as follows based on the above annual inflation estimates:
Housing Transaction Price Per Lot Value
So, what are we paying for the lots today? Before I answer that specifically, let me backtrack and touch on the current financial condition of Avatar. As of Sep 30, 2009, the company has cash of $220M and TOTAL LIABILITIES of $155M. Just considering debt, the company has ~$100M of net cash. Despite a GAAP loss through the first nine months of 2009, the company actually generated cash flow from operations (I'll ignore that because this is an asset valuation rather than an income statement analysis). My point in highlighting the balance sheet strength, and lack of cash burn, is to show that time is on this company's side with regard to when the Florida real estate market turns.
With all that said, let's assume that through this real estate crash, the company uses all of their net cash to survive. Under that assumption, I'll simply use the market cap of the company rather than the enterprise value to think about valuation.
Today, the market cap of Avatar is $200M, or $9,400 per potential lot. That valuation considers the land available for commercial development to be worth zero ($38M book value). It considers the "amenities" owned by Avatar in some of their developments to be worth zero (despite $51M of value on the balance sheet - and yes, they've already taken writedowns on that property). Just looking at the balance sheet without any adjustments besides those already made by the accountants, the book value of the company is just north of $38/share.
If you believe any of the future housing valuation numbers we outlined above, the annual return on AVTR shares from today's price ranges from 15% to 22% for the next decade assuming all the net cash is used to withstand the pain that is today's Florida real estate market.
It is our opinion that an attractive return opportunity exists as a buyer of Florida residential lots given the range of potential outcomes for prices over the next decade along with the relative financial strength of this balance sheet. In the meantime, the company is actively looking to buy busted developments and land from builders who aren't able to survive the crash. This is a very cheap, tax-efficient mechanism to participate in the distressed Florida real estate market.