The Money Chase April 2011

Showdown in the Sunshine State

Two of Wall Street's savviest value investors, Bruce Berkowitz and David Einhorn, pride themselves on their rigorous analysis. Now they're locked in a scorched-earth dispute over the value of some Florida real estate. How could they look at the same facts and reach such wildly different conclusions, and what does that say about the “value” of value investing?

For all the management woes, that optimism isn’t entirely crazy. A new, larger airport opened in May, linking the historically hard-to-reach area with regions outside the Deep South. Though Einhorn’s presentation outlined reasons that the airport will not be the boon that St. Joe claims, Buck Horne of Raymond James, a Florida-based financial-services firm, disagrees. According to Horne, traffic at the new airport is already at nearly triple the level of the old one, and has ample room to expand if necessary. And St. Joe Company, which provided the land for the airport, owns the ring of land immediately surrounding it; since the airport authority’s ability to develop its acreage for non-aviation uses is restricted, that’s a prime spot. Besides, the company still owns a substantial portion of the little remaining undeveloped waterfront not controlled by the state. And no one’s making more shoreline.

As of February 15, when we went to press, the company’s stock was trading up since October, at around $26 a share; a lot of investors still seem to believe in Florida real estate. So do the locals. I stopped in nearby Mexico Beach to see Ryan Harmon, whose family has been selling real estate for 30 years. He says that while prices are down by 50 to 60 percent since the peak of the bubble, they seem to have bottomed and he’s finally making more deals, with volume up 20 percent. And while almost all of his customers used to come from Tennessee, Georgia, or Alabama, he’s now seeing more buyers from Texas and beyond—a change he attributes to the airport. “I don’t think we’ll see prices move much in the next year,” he says, “but I do think we’ll clear out a lot of inventory.”

Of course, along lengthy stretches of the coastal highway, every third or fourth house seems to have a For Sale sign. Can even an influx of buyers from Texas and Maryland really buy up all that excess? More important, can they do it fast enough to save St. Joe Company and its shareholders?

Questions like these reflect the challenge of value investing in the present era. As originally practiced by value investors, stock-picking was something close to a sure thing: you looked for stocks trading close enough to their asset value that they provided a substantial “margin of safety” against loss, and you looked for business fundamentals that offered substantial upside in the future. These were relatively easy to find in the early part of the 20th century, when stocks were still seen as a relatively new, risky form of investing. That was especially true during the Great Depression, which hammered the market so badly that you could regularly find stocks trading below the liquidation value of the company’s assets—conditions that recurred, to a lesser extent, in the 1970s and in early 2009. Many people argue that stock markets have become much more efficient, thanks to more capital, a legion of professional analysts, and computing power that can screen thousands of stocks in a few seconds for anomalies such as a firm trading at less than its book value. As a result, the great deals that were available to famous value investors such as Warren Buffett are a lot harder to find. (See “What Would Warren Do?,” September 2009.)

That means value investing has had to get more sophisticated—and, one might argue, riskier—by taking more short positions, as Einhorn does, which can bankrupt someone who shorted a stock at $20 and has to cover that short at $100; by piling on more debt; or by investing in situations where a total loss is possible. Berkowitz remains on the conservative side, and he talks a lot about looking for that margin of safety, something offered by substantial real-estate assets like those controlled by St. Joe or by Sears Holdings, another longtime Berkowitz project. But even these can plummet in value. As a result, value investing can’t just be about the cool, clear logic of accounting. It involves educated guesses about the messy future of industries, technologies, and the macroeconomy.

Faced with this many intangibles, investors might find their best guide to be history—specifically that of the first Florida real-estate bubble. In the mid-1920s, Florida experienced a land boom that rivaled, even surpassed, the scale of the recent madness. The litany of justifications is eerily familiar: the beaches, the gentle tropical breezes, the endless sun, all were finally opened up to the teeming masses of the northeastern cities by the advent of the automobile. Between 1920 and 1925, Miami’s population more than doubled, as speculators swarmed south. Overstretched railroads devoted more and more of their freight space to food and building materials, and finally gave up on the building materials so that the swollen population could eat; one enterprising contractor found himself with a lot full of bathtubs, and no materials with which to build them into an apartment house. Meanwhile, the price of lots doubled, tripled, rose to 10 or 20 times their original value.

This obviously couldn’t last, and it didn’t; as Frederick Lewis Allen drolly noted, “Just as it began to be clear that a wholesale deflation was inevitable, two hurricanes showed what a Soothing Tropic Wind could do when it got a running start from the West Indies.” Florida land values collapsed, leaving behind bank failures, municipal defaults, and half-finished subdivisions crumbling into the sandy soil. The whole mess was memorialized by the Marx Brothers in their 1929 film, The Cocoanuts: “You can have any kind of a home you want to. You can even get stucco. Oh, how you can get stuck-o!” winked Groucho at feckless speculators, and many did; in the late ’20s, seemingly every town in America had its poor sap who lost his shirt in Florida. But the Florida bubble has been eclipsed by its more famous sibling, the 1929 stock-market crash.

Land values in Florida didn’t recover until after World War II. On the other hand, they did recover. The feverish deals that Groucho mocked ultimately gave us places like Coral Gables, Boca Raton, and Miami Beach, whose foundations were laid during that era. Many of the speculators who built them went broke—but their successors got very rich.

The development of the Florida Panhandle seems almost inevitable; there’s only so much beachfront left in Florida, and these beaches are particularly spectacular. But the pattern of that development, and when it will arrive, is harder to foresee. In the end, Berkowitz and Einhorn and all of us spectators have the same problem with Florida real estate as I did with my GPS. We know where we want to go. But we don’t know how to get there, or how long it will take.

Presented by

Megan McArdle is The Atlantic''s business and economics editor.

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