Company Positioned for Real Estate Recovery : Development: Newhall Land’s unusual tax status provides advantages that are expected to make the partnership an attractive investment.
President Clinton’s new tax law makes publicly traded partnerships like real estate developer Newhall Land & Farming Co. more attractive investments.
Publicly traded partnerships, sometimes called master limited partnerships, trade just like stocks.
But publicly traded partnerships have a unique tax wrinkle. Part of what these partnerships pay out to investors in quarterly cash distributions--similar to dividends--is considered by the IRS as capital gains. And capital gains are still taxed at just 28%, as opposed to ordinary stock dividends that are now taxed at rates as high as 39.6%, up from 31% previously.
Another reason analysts believe Newhall Land’s unit prices might climb is that any comeback in the real estate market will quickly drive up the prices of raw land--which Newhall has plenty of.
“When Wall Street rings a bell and finally decides California isn’t going to slide into the Pacific, nobody will be saying what a stupid investment real estate is. They’ll be saying, ‘Hey, look at Newhall,’ ” said Burl East, a real estate analyst at Chicago-based Kemper Corp.
Newhall’s pride is Valencia, a master-planned community with a population of 30,000 that is so far just half-finished. Eventually, it will sprawl across 10,000 acres.
Newhall also owns an additional 37,000 acres in the Santa Clarita Valley. About half of that land has development potential, Newhall’s Chairman Thomas L. Lee said, and Newhall owns all of it debt-free.
Most of the company’s real estate is part of the Newhall Ranch, property the company’s founders began accumulating in the 1800s by purchasing Spanish land grants.
Raw land has suffered more than any other kind of real estate in recent years, Lee said, and raw land prices are down as much as 75% from 1989.
Lee thinks the real estate recovery will start next year and pick up momentum in 1995.
“My own feeling is we are bouncing along the bottom now,” he said. “When things start to get better, raw land prices will have more room to move.”
Part of Newhall’s residential strategy is to sell ready-to-build lots to other developers. But the housing market has been so weak--and credit so tight--other builders haven’t been buying. Newhall’s last major land sale was a year ago.
As a result, Newhall earned just $1 million on $21 million of revenue in the second quarter ended June 30, compared to a $2.3-million second-quarter profit on revenue of nearly $17 million a year earlier.
Last year Newhall earned $17 million on $128 million of revenue, down from its record profit of $69 million in 1989 on $234 million of revenue.
Not surprisingly, Newhall’s units have nose-dived and trade at less than half their price in 1990. Newhall’s units closed Monday at $14. At this price, they are probably a bargain if held until the real estate market recovers, said Jim Schmitt, president of Westcountry Financial, a Camarillo investment research firm.
Newhall’s performance would be even worse except the company is pushing ahead with its commercial projects, which are providing healthy rental income. Its $80-million Valencia Town Center, one of only two big shopping malls to open in the state last year, is nearly 100% leased.
Newhall’s Valencia Industrial Center, where 14,000 people work at jobs ranging from manufacturing to making movies, is the third-largest such center in Los Angeles County. But of all the company’s moves, perhaps its most important was in 1985 when it converted to a publicly traded partnership.
In 1985, corporate taxes were “in the neighborhood of 50%,” said David E. Peterson, Newhall’s tax director. When the company sold land, “We figured why give half of all that appreciation to the government?”
Now as a publicly traded partnership, Newhall doesn’t pay corporate taxes on any kind of income, Peterson said.
So, even though the new tax law raised the corporate-tax rate to 35% from 34%, the hike has no effect on Newhall.
Last year for example, Newhall sold 6,750 acres of farm land in California’s Central Valley for $21.7 million and paid no taxes on that profit, even though it included a big capital gain.
However, all of that gain was passed through to Newhall’s unit holders, or as Newhall’s calls them, “partners.” Thus, it was the investors, or unit holders, who paid taxes on the gain.
Moreover, Newhall’s unit holders came out better on the farmland sale than they would have if Newhall had been a corporation for another reason. Why? As a corporation, 43% of the gain would have gone to pay combined federal (35%) and state (9%) taxes, leaving that much less for Newhall to reinvest into the company. Moreover, the profit that was paid to its “partners” would have been taxed again if it had been paid out as ordinary dividends.
In 1987 Congress clamped down on publicly traded partnerships because all sorts of other businesses were converting to such partnerships to escape corporate taxes, and there were unscrupulous tax-shelter syndicators who were also “rolling up” dozens of soured limited partnerships into these publicly traded investments, knowing they were worthless.
But Newhall and some other publicly traded partnerships can operate indefinitely under certain conditions, Peterson said.
Westcountry Financial’s Schmitt says Newhall’s earnings should get better in the fourth quarter, when several big land sales in Valencia are scheduled to close.
For the full year, Schmitt believes Newhall might earn $10 million on revenue of $85 million.
Because housing is dormant, Newhall isn’t planning any new residential developments. A court dispute with environmentalists has halted its 1,880-home Westridge project.
About 300 acres of the 800-acre development is in an area Los Angeles County has designated as ecologically sensitive primarily because of its valley oak trees and savanna grasses.
Two weeks ago, a Los Angeles Superior Court judge invalidated Newhall’s permits for Westridge and sent it back to the developer and the county for further study.
Lee agreed that Newhall’s earnings should meaningfully improve in the next few months.
He also expects to sell smaller agricultural parcels the company owns in Central and Northern California.
