Real estate is the standard for hard to value assets. But there are plenty of models to help reach a reasonable value. The Securities and Exchange Commission has apparently taken the position that it will not challenge absolute valuations, but will challenge flaws in the models that get to the value. A recent SEC case for improper valuation flaws was brought against a real estate company.
The St. Joe Company is Florida’s second largest private landowner, holding over 500,000 acres of land in the state. The developments in question are known as Victoria Park, Southwood, and WaterColor.
The SEC order states that St. Joe deviated from GAAP and had a flaw in its impairment testing for its real estate developments. The model failed to include some necessary non-capitalized cash outflows. If St. Joe had used the correct model, those developments would have seen impairments of $55 million in Q1 2009 and $19 million in Q4 2009. The blame seems to be on the company for using two different models.
St. Joe also failed to take the pending sales price into consideration for one of the developments. The company had a development for sale at $15 million, but it fell through and went to the second place bidder at $11 million. The company failed to reflect that change in the likely realized price as an impairment. The company also told its auditors that the chance of sale was close to nil.
St. Joe’s problems came to light when David Einhorn of Greenlight Capital thought there was a problem with St. Joe’s accounting and began shorting the stock. His take: “Field of Schemes: If you Build It, They Won’t Come.” Mr. Einhorn then began releasing presentations that St. Joe was overvaluing its real estate developments.
Once the company realized there actually was a problem, it changed its models. But, it failed to go back and review prior periods. That would have resulted in a material restatement.
St. Joe also failed to disclose changes in business strategies for its Windmark II and Southwood real estate developments. The company was halting development and planned a future bulk sale of the sites. Unfortunately, St. Joe booked the value in its 2010 10-K as if it were still planning to develop both sites.
These were big issues. When finally recorded in Q4 2011 St. Joe had a 50% reduction in the value of its real estate and reduction of its total assets of more than 35%.
The order has some exact numbers which I assume are taken from St. Joe’s new valuations. The challenge by the SEC was that the company’s procedures were flawed. That lead to the improper valuations.
St. Joe is a public company so there are some differences with the private real estate fund model. However, it seems consistent with what the SEC is saying about private fund valuations.
The SEC was not fighting over small differences in valuations with St. Joe. There were big discrepancies in values. The SEC was not charging that the values were wrong, but that the way the company got to the values was wrong.
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