Description

Transcontinental Realty Investors is a real estate owner that trades at a 50% discount to its NAV. I expect TCI to start re-rating closer to its BV or NAV after the proceeds from the recent sale of JV assets are reflected in the company’s Q3’22 and Q4’22 financial results. 

TCI is an externally managed real estate company with a portfolio of Class A multifamily apartments, and several commercial buildings and land mostly in Texas. The company is 86% owned by the trust of the late billionaire real estate developer Gene Phillips – his passing in Aug’19 and the trust’s control by his children might have catalyzed the change towards value realization. Recently, TCI completed the sale of 45 joint venture portfolio assets that it held together with Macquire Group.  

As a result of the transaction, TCI has received seven properties with net BV of $170m and $271m in after-tax net cash proceeds. The same assets sat on TCI's books at only $52m.  

Here is how the math works out. As per notes below due to limited disclosures, the figures in the table might not be 100% accurate however should at least be directionally correct. 

A couple of additional notes on the figures in the table:

• The gross value of the 7 properties, that are getting transferred from JV to TCI, is assessed based on the difference between the $2.04bn total transaction value (Jun 21st, 45+1+7 properties) and the value of proceeds received for the sale of 45+1 properties to PE funds (Sep 19th). $70m debt is based on Israeli fillings.

• Another valuation reference point for these 7 properties is the MtM value as reported on the Israeli fillings. This would result in $190m gross value or $120m after encumbrances. Not sure which is the more correct/accurate to use, but the difference of $50m does not change the thesis here.

• The 2nd cash payment from the JV sale was supposed to be only $185m, instead, the company received $204m. This might relate to the sale of +1 property (Sugar Mill Phase III) to the same PE funds directly by TCI. This property had $10m gross carrying value and $9m of debt. Disclosures on how exactly the sale funds flowed are limited and I am just speculating here. The $20m difference does not change the thesis either. 

TCI's BV/share is set to double to $89/share when these proceeds get reflected in the financials. That’s a material uplift from the current BV of $44/share or the $40/share market price. On top of that company will be flush with cash - $336m in total or almost equivalent to the current market cap of $350m. The stated intentions are to use these funds for new investments and to expand TCI multifamily residential property portfolio. So, unfortunately, no buybacks or large dividends, but putting this incremental cash to work will surely generate additional income. 

And there is even more juice from another angle. TCI’s existing real estate assets (aside from the 7 to-be-received JV properties) are materially undervalued on SEC financial statements due to historical cost basis accounting. However, TCI also reports on the Tel Aviv Stock Exchange, where an independent mark-to-market valuation of the company’s assets is performed regularly. These MTM figures in the Israeli financial reports quite accurately reflected the value of JV assets that got sold recently. Based on the same disclosures MTM valuation indicates that the remaining asset portfolio might be worth a further incremental $11/share compared to the US-reported book value. This is based on 2021 annual report, so MTM values of the properties today might be somewhat different given drastic increases in interest rates, but at the very least this confirms that pro-forma TCI book value quite closely reflects its true NAV. 

And finally, TCI also has 1847 acres of developed and undeveloped land that sits on the balance sheet at $65m. The majority of this is 1650 acres ($46m) of Windmill Farms project - the company acquired the land in 2006 and now continues to piecemeal develop and sell:  

• During the year ended December 31, 2020, we sold a total of 58.8 acres of land from our holdings in Windmill Farms for $12.9 million, in aggregate, resulting in gains on sale of $11.1 million.

• During the year ended December 31, 2021, we sold a total of 134.7 acres of land from our holdings in Windmill Farms for $20.2 million, in aggregate, resulting in gains on sale of $10.3 million.

• During the six months ended June 30, 2022, we sold a total of 26.9 acres of land from our holdings in Windmill Farms for $5.1 million, in aggregate, resulting in gains on sale of $4.2 million.

On average these Windmill Farm sales have generated $173k/acre in sale proceeds (or $120k/acre in gains on sale). That’s $285m in total undiscounted pre-tax value if the remaining lots can be sold at similar rates, vs carrying value of only $45m. The lot sales are likely to continue gradually increasing TCI’s book value and generate additional cash for a number of years to come. 

The market has barely reacted to JV sale announcement - the stock is around $40/share for more than a year. So why does this opportunity exist? My wishful thinking says that TCI is simply under-followed and uninvestable for most - only a few trades a day with c. $100k-$200k ADV. It’s an externally managed real estate company that is not a REIT and that does not pay any dividends - so a bit in a no man’s land in terms of investor circle that it might be interested in this type of setup. Also, quite a bit of crucial information is in Hebrew, and google translate is only helpful to an extent. This makes the whole situation at least partially hidden from the eyes of U.S. investors. In the end, nobody cares to add 2+2 and will ignore it till the undervaluation of TCI will be visible in plain sight - luckily that’s Q3’22 or Q4’22 results so no need to wait for long. And the downside is very well protected at these levels.

Should TCI trade at some discount to its NAV? Probably yes, especially given its limited scale, loans to its external manager, and high management fees ($10m per year + G&A expenses). However, related party notes are generating high-interest income which approximately covers interest expenses on TCI’s mortgages and bonds. Even after capitalizing management fees at 10x and deducting it from the fair book value as a wasteful excess, the company still trades at a 40% discount to its NAV. The 7 properties that are transferred from JV will generate c. $1/share in NOI. Deploying $300m of cash into real estate development projects (as notes receivables with 8%-12% interest rates) would boost pre-tax income by a further $3/share. Looking at it this way puts TCI not only at a wide discount to NAV but also on a path to substantially boost its income over the coming year.

Catalyst

Q3’22 or Q4’22 results that will see material boost TCI book value.