I’ve seen hundreds of stock pitches that present a company with a hodgepodge of different assets and operating businesses, some of which have no reason to be under the same roof. They’re often valued on a sum of the parts basis based on comparative metrics for the underlying assets and operating subsidiaries. Something like this:

Pro Forma

Sell Operating Company A: 8x EBITDA = $120M

Sell Operating Company B: 12x EBIT = $250M

Sell Real Estate Parcel A: $80M

Less Debt of $100M

Plus Cash on Hand of $50M

Total Value = $400M vs. current enterprise value of $275M = 45% potential upside

These stories work for patient investors, if the underlying businesses and assets are decent, if management is honest and are savvy capital allocators that aren’t just trying to keep their jobs, but rather to maximize shareholder value.  That’s the exception.  More often than not they’re dead money for years.

Private real estate is different provided a General Partner is honest, competent and has the right incentives.  In private real estate limited partners also get to prospectively select the deals they want with the General Partners they trust.

By the summer of 2016, the “Safari Park House” had already been on the market for ~1.5 years when it caught the eye of Jonathan, with whom I’ve done a couple of dozen deals over the years.  Located in the San Pasqual Valley of Escondido in San Diego County, the house sat on over 8 acres at the top of a hill overlooking the Safari Park–a sister park to the San Diego Zoo.  I heard through the grapevine that the seller had been moved to an assisted living home so we had a forced sale situation.  There were also heirs that were decision makers and like most groups of people it is difficult to reach a lasting consensus especially when it comes to money.  This usually is a positive for buyers when these decision making groups get exhausted by the process over time.

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I’d also heard that the deceased husband of the seller had built the home.  If he did, he was ahead of his time and I want to acknowledge my respect for his vision.  Every single room in the house was large, from the master bedroom, to the living rooms and guest bedrooms.  Our business plan for the house would be straight forward, modernize the floor plan flow and sell the view.  But that’s not what made this deal a “sum of the parts” deal and it’s not how I thought I could add value to the process in any way that Jonathan couldn’t on his own.  Meanwhile Jonathan put the property under contract for $1,100,000.

The deal was interesting to Jonathan because there were two cell towers on the property that paid serious rent to lease the property from the owner.  Verizon had recently signed a new lease with the seller.  Jonathan called me and we discussed it.  Though the towers and the house sat on one fee simple parcel, I was certain there’d be a way to unlock the embedded value of the cell tower lease streams.  We worked with a consultant who pitched the deal to a few lease acquirers.  Ultimately a publicly traded buyer was identified that would purchase the lease streams associated with both towers for $700,000.  This gave us an implied purchase price for the house on its own of $400,000.  Even with the facelift that we knew it needed we believed it was worth $700,000 in as is condition.  We hired an attorney to draw up contracts, easements etc. and agreed that the cell tower lease stream buyer would fund the $700,000 to our purchase escrow prior to close.  In the meantime we found a lender willing to provide a $710,000 first trust deed secured by the house alone.  With an estimated $200,000 renovation even after closing costs we were looking at not coming out of pocket on a beautiful ~3,800 square foot home that we’d then flip for ~$950,000-$1,000,000.  Home run deal right?

But there was a snag, because this is real estate so there’s always a snag.  We had to send out Right of First Refusal (ROFR) letters to the cell operators involved.  Before I knew it I joined the party and I was throwing around the acronym ROFR like I’d grown up saying it.  We then had to wait for the ROFR letters to expire.  When they finally expired unexercised it was early September.  Here’s a quick source and use of funds on our acquisition.

Acquisition

Sources Uses

First Trust Deed *     $710,000 Property Purchase $1,100,000

Flip Cell Tower Lease Streams  $700,000 Renovation $200,000

Reserves (Cash Out?) $110,000

Total   $1,410,000 Total $1,410,000

*For simplicity I’ve ignored closing costs, loan fees, & interest expenses above

The day before the close we got a phone call.  There was another snag, because this is real estate and there’s always another snag.  The lease stream buyer didn’t want one of the two tower leases.  Now these guys look at tower leases, towers and easements all day every day.  I’m hard pressed to think they didn’t know that they didn’t want the second tower all along.  If I was cynical I’d say they preferred to wait until the day before the close until we needed whatever funds they were offering us to close.  But I’m not cynical so I won’t say that.

We now, after renegotiating back and forth, agreed that they would purchase the Verizon tower lease stream for $410,000.  In a pinch we got a private investor to write a check as a second trust deed (it wasn’t cheap).  Here was our revised use of funds.

Sources Uses

First Trust Deed *     $710,000 Property Purchase $1,100,000

Flip Cell Tower Lease Streams  $410,000 Renovation $200,000

Second Trust Deed     $135,000 Reserves $0

Our money     $45,000

Total   $1,300,000 Total $1,300,000

Notice that conspicuously absent from this new sources and uses sheet is anything in the way of reserves.  But this is real estate so there is bound to be some surprises that require more money!

What were the unique risks that we considered in underwriting the deal?

1. Days on market.  We knew that we were marketing a truly unique property at a price point that was pushing the market for that area. We also knew that homes in that area took longer to trade than conventional cookie cutter subdivision production homes.
2. Potential concerns from buyers over having cell towers on the property.

We hired designers, who were worth every penny, to come up with paint and finish ideas.  I’m not going to front like I’m good with colors.  I’ve painted more than a few exteriors of homes twice after realizing I messed up the palette.

Our plan for the house was straightforward.

1. Maximize the views
2. Dramatically improve the master bath
3. Frame up the carport into a garage
4. Convert the office into a flex space that could act as an office or second master with en suite
5. Improve curb appeal from front door

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We ended up spending ~$225,000 renovating the property.  There were repairs that had to be made to the long winding private driveway leading up to the property, we had to sod the backyard twice and we had to trim over a dozen very tall palm trees.  In the end we sold the property for $1,160,000 with the second cell tower included in the sale.  We held tight for our price and a buyer appeared that loved animals!  For an animal lover having unobstructed views of the San Pasqual Valley overlooking the Safari Park is a dream come true.

Sale Price               $1,160,000

Less Transaction Costs           $40,000

Less First Mortgage Payoff   $710,000

Less Second Mortgage Payoff  ~$148,000

Net Proceeds $262,000 less our cash $70,000 less interest expense on First Trust Deed of $57,000 = $135,000 of profit.

What did I learn in this deal? You have to expect the unexpected.  Sometimes you will get lucky–the perfect buyer came along eventually.  Other times you will get a bit unlucky, we got left at the alter on our closing on the second tower and it dramatically affected the economics of the deal.  It went from a home run deal to a solid single because unlevered, we employed a little over $890,000 and earned $135,000 on it for a mid teens return. As a corollary to this, focus on great deals because great deals can withstand bad news and bad breaks.

What I can also tell you is, with the right general partners, the value embedded in a sum of the parts valuation will be realized with a sense of urgency.