We recommend Owens Realty Mortgage (ORM) as an event-driven opportunity with the first catalyst coming up in the next month and the real catalyst occurring next year. The write-up is short to be timely. 

Owens Realty Mortgage (ORM) for many years was a fund invested in US commercial real estate loans primarily in the Western US with a long-term record of 8.4% annualized net returns from 1989 to 2007. Then the downturn hit and ORM ended up being the proud owner of a variety of commercial real estate properties. 2008-2012 were a tough period for ORM’s primarily yield-driven LPs as ORM froze distributions and liquidity during this period so as not to have to firesale their assets. They came up with an innovative way to provide liquidity to their LPs which was taking ORM public as a REIT which they did in May 2013. This allowed LPs to get liquidity by selling shares, which obviously set up well for non-fundamental related selling pressure.

ORM’s current plan is simple: with the improving commercial real estate market the properties they ended up owning are now worth more than their carrying value as the original acquisition costs were written down heavily during the downturn (the assets are carried at lower of cost or market and per ORM's accounting methodologies can't be marked up). As they have been exiting properties, they have been getting 10-20%+ premiums above carrying value. The plan is to monetize their owned real estate in 2014 and 2015 and redeploy into their traditional commercial real estate loan business and as a REIT, attract the yield seeking investors they always have. However, in the interim, ORM is in a limbo state as it doesn’t offer a yield anywhere near its REIT peers and doesn’t have a natural shareholder base except for potentially value investors.

We like it because to start off with, the downside protection is strong. ORM’s market cap is ~ $164M and tangible book value is $180M or ~ 0.9x book. Asset value primarily consists of the assets they foreclosed on in the downturn (nearly $140M on the books), and as mentioned they have been exiting properties at a premium to this value. There is limited use of leverage and only $20M in total liabilities. I think tangible book value for ORM is a conservative measure of liquidation value.

The upside is by luck, two of the properties they became owners of during the downturn are now quite valuable assets that are difficult to replicate and are in two of the hottest markets in the country. Because they have embedded gains in both of these assets, per management REIT conversion tax rules means they have to wait two years from the conversion date of May 2013 to sell these assets (May 2015).

The first asset is Treasures on The Bay (TOTB) which is a condominium project in Miami that is fully entitled. Condo prices in Miami have been soaring. It’s carried on the books for $33M, you should do your own work but we had a real estate firm we’ve relied on in the past project out costs, velocity, sales price, etc. This firm came up with ~ $60M, and this was done in the summer of 2013 so the value would be higher today given the faster increase in condo prices in 2014 than in their analysis.

The second one is the big one which is a project on Lake Tahoe which is carried for $34M. ORM originally foreclosed on several parcels and just recently acquired adjoining pieces allowing for a complete development. Tahoe is a market extremely difficult to get new entitlements for and this project is fully entitled for a condo tower overlooking the lake. ORM doesn’t plan to develop the condo tower but to sell it to a residential developer who will construct and sell to the final buyers. The real estate firm we engaged did the work of projecting out what that developer could expect to make from end unit sales along with a developer’s margin and discounted it all back and came up with $50M-$60M. The asset has a ~ 400 page appraisal if you search online that valued it at $105M, and this was done in 2009 which wasn’t exactly the height of the market. ORM’s IR, who will discuss TOTB and Tahoe if you ask, indicated a potential FMV much higher than $50M-$60M. Again like TOTB we haven’t done in-depth work here beyond confirming that it’s worth more than carrying value and potentially dramatically more.

So to sum up, if we value their loan book at cost (e.g. $54M), their non TOTB and Tahoe owned real estate at a 10% premium to carrying value or $80M, and TOTB and Tahoe at the values the real estate firm we engaged indicated (~ $100M in total), that is ~ $22 per share. Taxes haven’t been deducted as guidance from ORM is that their historical cost basis is high enough to offset.

Key to the thesis is there are strong catalysts coming up for the market to recognize this value. First, the company recently has appraised all its properties and plans to provide increasing transparency on the fair value of their properties vs. book value as soon as the company’s earnings call for 1Q14 coming up on May 14^th (will be their first earnings call). So as soon as next month, ORM may put out its first NAV figure (potentially ~ $22 per share if my math is right although we expect them to err on the conservative side and the true value not to be known until the assets are sold in 2015). If we assume ORM trades at 0.9x to NAV (in-line with commercial real estate lending REITs like ACRE or ARI, ORM plans to match the expense structure of their comp set), that could be an $18-$20 share price vs. $15 today. The real catalyst comes in 2015 as ORM explicitly plans to list TOTB and Tahoe for sale in early 2015 and sell both assets over 2015.  As such, we see the 2015 investment story as being one quite different than now where investors have a much better sense of the value of the assets from management and there will be speculation and excitement about how much TOTB and Tahoe will be monetized for. As discussed, it’s possible given the supply/demand dynamics in their respective markets that by mid to late 2015 when they are sold, the values will be quite a bit higher than the $100M combined value used above.

So to make a long story short, right now you have an asymmetric situation where you are buying into an improving sector below tangible book, there is optionality to the upside, and there are hard catalysts to make it happen.  In 2-3 years time, ORM will be back to being a commercial real estate lender with assets of only commercial real estate loans and an investor base focused on yield, but in the interim there is an opportunity for value investors.