A Real Estate Investment for the Long Haul

When the Texas Pacific Railway Company went bankrupt more than a century ago, it put 3 million acres of land into the hands of three trustees to manage and to sell off if the right price came along. To say that the trustees and their successors haven't been in a hurry to unload the acreage, most of which is ranch land in sparsely populated parts of west Texas, is an understatement.

Today, nearly 1 million acres remain in the trust. It is one of the oldest, least-known and most unusual listings on the New York Stock Exchange, and its shares might interest investors looking for a long-term real estate play, says one Dallas-based money manager.

At the stock's April 8 closing price of $44.25, the market values Texas Pacific Land Trust's holdings at about $450 an acre, says Eric Marshall, director of research for Hodges Capital Management. The firm, which operates the Hodges fund and the recently launched Hodges Small Cap fund, owns a little more than 3% of the trust. Marshall thinks the land could be worth as much as $500 an acre, or $50 a share, on average. Oil and gas royalty rights could add another $20 a share in value, he says.

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But that potential value of $70 a share won't necessarily be realized anytime soon. The trust (symbol TPL) operates in a low-key manner under terms set out in the 1888 trust agreement. The trust has only eight employees and no Web site, although it will soon launch one to satisfy an NYSE requirement. Its trustees, who are elected by shareholders, serve until death or retirement and earn $2,000 a year (the chairman gets $4,000).

The trustees do not advertise their land or actively solicit sales, and developers aren't exactly clamoring for it. About 98% of its 964,813 acres is classified as ranch land in places like Hudspeth County, Texas, where a total population of 3,300 is spread out over nearly 4,600 square miles.

The value of the land can vary widely according to the local economy, agricultural conditions and the rate of residential and commercial development nearby. Recent land sales bring this out. In 2007, the trust sold 1,554 acres for $1.9 million, or an average of $1,244 an acre. The previous year it sold 37,121 acres for $8.2 million, an average of just $221 per acre.

Keeping it simple

The trust's business operations are a portrait of simplicity, with no off-balance-sheet transactions and few non-cash charges (land is carried on the books at no value, so there are no charges for depletion). Most of the trust's income comes from perpetual oil and gas royalty rights under nearly 500,000 acres. It earned $10 million in royalties last year, plus another $3.9 million in grazing lease payments, interest on self-financed land sales and other items. This income is returned to shareholders as an annual dividend payment, which was 18 cents this year (representing a 0.4% yield on the current share price).

Although royalty income has been growing steadily with the price of oil and natural gas, the trust's income tends to be irregular because of the nature of its land sales. As a result, share value is almost entirely dependent on the perceived value of the land rather than the income it generates.

The trust typically uses proceeds from land sales to buy back shares of the trust. In last year's fourth quarter, it repurchased 24,700 shares for $1.2 million, leaving about 10.3 million shares outstanding. As long as the trust sells land for an average value greater than the $450 or so implied by its share price, remaining shareholders should profit from those repurchases.

Last summer, the trust split its shares, 5 for 1, at the urging of one of its largest shareholders. The shares surged to a split-adjusted $63 in anticipation of that event, although they have since surrendered most of those gains. Clearly, there is not a lot of momentum in this stock.

Location location location

Still, there are a number of factors that could boost both the value of the land and the share price within a reasonable period of time, Marshall says. West Texas did not see the growth in real estate values that many other parts of the U.S. saw, "and it has some catching up to do," he says. Farmers and ranchers who sold land elsewhere and want to reinvest it in land could be attracted to west Texas, which has some of the cheapest land values in the country, Marshall says.

Rising prices for agricultural commodities should eventually work its way into prices for grazing land and farmland. Rising oil and gas prices are already increasing the income from the trust's royalty holdings (it was up 14% in 2007). Marshall says he calculated the $20-a-share value of the trust's royalty holdings using pricing assumptions that could prove conservative in the long run: $6 to $7 per thousand cubic feet for gas (versus about $9.60 currently in the spot market for immediate purchase) and $70 a barrel of oil (compared $105 currently in the spot market).

In addition, Texas has one of the fastest-growing populations in the U.S., and that growth could push its way into land owned by the trust near cities such as El Paso, Abilene, Midland and Odessa.One other potential catalyst comes from the west Texas wind. Marshall notes that Texas Pacific's acreage could prove fertile ground for Texas' booming wind power industry. Texas is the nation's top producer of wind energy, and last year installed 5,244 megawatts of wind power, increasing its capacity by 45% in a single year.

Oilman T. Boone Pickens's Mesa Power is proposing to put up nearly 2,000 wind turbines on nearly 200,000 acres in the Texas panhandle. It would pay landholders a fee for each turbine installed, plus payments based on the amount of energy produced. Although those plans do not include land owned by Texas Pacific, they represent great potential for the trust. Wind energy "could be a catalyst that drives the value of its surface acreage over the next decade," Marshall says.

While waiting for these slow-moving events to occur, patient investors can be comforted by the thought that raw land is a good hedge against inflation. "It is a long-term investment," says Marshall. "That's true of pretty much any land investment, and this one has been 100 years in the making."