Digging for Value in the Real Estate Rubble by Zeke Ashton

It has been a long time since we’ve had extreme fear in the U.S. equity markets, an observation supported by the historically low volatility in recent years and the low prices one could pay for disaster protection in various forms (U.S. equity index puts, credit default swap spreads, etc) prior to this summer’s credit crunch driven sell-off.

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Clearly, we’ve got fear now, and at the epicenter of that fear is the U.S. real estate market. This fear is reflected in extraordinary volatility and stock price declines for those companies seen most vulnerable to the real estate bust – most notably homebuilders, mortgage lenders, and mortgage guarantors – coupled with all-time high prices for disaster protection on these names.

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But as all value investors know, fear brings opportunity. One of the axioms of fear-based selling is that everything viewed as being in proximity to the danger gets sold. Panic selling does not lend itself to careful consideration of relative risk. The market often does not begin to discriminate between those securities with truly high risk and those with low risk until after the crisis has abated. Once time has allowed for a more appropriate discernment of value and risk, the value of those securities that were unjustly marked down inevitably recover the full measure of their value. There is opportunity in virtually any crisis for those investors willing to carefully pick through the rubble. It is never easy, and getting the timing perfect is virtually impossible, but we believe that the recent fear in the real estate sector has provided us with actionable bargains.

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We have identified two investments in particular that we believe offer us a unique combination of compelling value and reasonable safety: Fidelity National Financial (FNF) and LandAmerica Financial (LFG). Both are engaged in the somewhat esoteric business of title insurance.