Sam Zell: Real Estate Investment Philosophy

Introduction

Dave Moss introduces the speakers, Jeff de Bourgh and Sam Zell.

Introductions

• Jeff de Bourgh is the founding president and CEO of the real estate roundtable.

• The real estate roundtable brings leaders of the nation's top 150 publicly held and privately owned real estate owners together with the leaders of national real estate trade associations to jointly address key national policy issues in our nation's capital.

• Sam Zell is the chairman of Equity Group Investments for which last 40 years he's had invested interests not just in the United States but all over the world and not just real estate but many industries.

Thank You for Accepting Our Invitation

Dave Moss thanks Jeff de Bourgh and Sam Zell for accepting their invitation to attend See Real Estate Centers 17th Annual Forum.

Gratitude

• The center and all its members are very proud to have Jeff de Bourgh and Sam Zell at their event.

• They could not be more grateful for their participation.

Introduction of Speakers

Dave Moss introduces each speaker, providing a brief overview of their accomplishments.

Jeff de Bourgh

• Under Jeff's leadership, the roundtable seeks to ensure a cohesive industry voice is heard by government officials and the public about real estate and its important role in both the national and global economy.

• He also serves as chairman of national real estate organizations on important matters relating to building security, terrorist threats, and instant reporting.

• His editorials have been published in The Wall Street Journal and USA Today.

Sam Zell

• Sam founded Equity Group Investments, which has invested interests not just in the United States but all over the world across many industries.

• He's recognized as the founding father of today's public real estate industry.

• Sam has demonstrated a commitment to education, endowing the Zell Lurie Entrepreneurial Center at the University of Michigan's Business School and the Zell Real Estate Center at the University of Pennsylvania's Wharton School.

Sam Zell's Accomplishments

Dave Moss provides additional information about Sam Zell's accomplishments.

Equity International

• Sam is also the founder and chairman of Equity International, a private investment firm focused on real estate-related businesses in emerging markets.

• They have taken public the largest home builder in Mexico and the largest retail property owner in Brazil.

Public Companies

• Sam is also chairman of four other public New York Stock Exchange traded companies, including Equity Residential, which is the largest apartment real estate investment trust in the United States.

Commitment to Education

• Sam has endowed Northwestern University's Center for Risk Management.

• He has demonstrated his loyalty to his alma mater by serving on the president's Advisory Board.

Sam Zell's Leadership Style

In this section, the speaker talks about Sam Zell's leadership style and how he built the largest real estate company in the country.

Building a Successful Company

• Sam Zell built the largest real estate company in the country, Equity Office Properties.

• The company grew into the largest cap real estate stock in New York Stock Exchange with 120 million square feet of office space and had 3,200 employees.

• Sam created a culture that facilitated growth by making it fun and encouraging people to test their limits.

• He was always accessible to his employees and encouraged respectful dialogue.

Direct Communication

• Conversations with Sam were always direct and to-the-point.

• He didn't care whether you were right; he cared if you knew what you didn't know.

• He was not afraid to be blunt when necessary.

Personal Anecdotes

• The speaker shares a personal anecdote about accidentally breaking a piece of art at Sam's home during a dinner party.

• Despite his public persona as an industrialist and global entrepreneur, privately, Sam was compassionate, caring, and considerate.

Conclusion

In this section, the speaker concludes by sharing his admiration for Sam Zell's leadership style.

Admiration for Sam Zell

• The speaker admires Sam Zell's leadership style and would consider working for him again if given the opportunity.

Introduction and Reflections on Education

In this section, the speaker talks about his reading habits and how he seeks out anomalies. He also reflects on his education and mentors.

Reading Habits

• The speaker is a voracious reader who reads books, newspapers, magazines, and various writings by savants.

• He reads a book and a half of fiction per week.

• Being optimistic is a wonderful gift that not everyone has. It gives you self-confidence and makes you a more effective player.

Reflections on Education

• The speaker reflects on his education at the University of Michigan and mentions some mentors.

• He believes that part of the definition of an entrepreneur is being an extraordinary observer.

• The speaker tries to be as knowledgeable as possible without clogging his capabilities with useless information.

Optimism in Real Estate Investing

In this section, the speaker talks about optimism in real estate investing and how it can be both beneficial and risky.

Optimism in Real Estate Investing

• Optimism is a condition that not everyone has. It gives you self-confidence and makes you a more effective player.

• However, too much optimism can lead to risks. Every time there's a cycle in real estate, some people become too optimistic and suffer losses.

Managing Risks in Real Estate Investing

• The speaker starts every potential investment focused on what's the downside. If they identify the downside correctly, then he views it as successful even if the transaction didn't work out.

• Their perspective is to be right 70 or 75 percent of the time, but of greater importance is to understand the degree to which they were wrong in the other 30 percent and build that into their risk management strategy.

Lead the Economy Again

In this section, the speaker talks about how Real Estate has historically led economic comebacks and downturns. He also discusses the factors that could impact interest rates, tax reform, and terrorism risk insurance.

Real Estate's Role in Economic Comebacks

• Real Estate has historically been at the forefront of economic comebacks.

• Interest rates are a key factor that will impact Real Estate's ability to lead an economic comeback.

• Tax reform and terrorism risk insurance are other factors that could impact Real Estate's role in leading an economic comeback.

Incentives for Building and Remodeling

In this section, the speaker talks about what incentives are needed for building and remodeling in the real estate business. He also discusses how growth is essential for creating demand in the real estate market.

The Importance of Growth

• The supply-demand scenario for real estate is relatively balanced in Denver today.

• The incentive for building or remodeling anything in the real estate business is dependent on growth.

• Redistribution of wealth cannot create growth, which is necessary for creating demand in the real estate market.

Risk of Stagnation

In this section, the speaker talks about his concerns regarding stagnation in America's economy. He also discusses how technology may not necessarily translate into more employment opportunities.

Risk of Stagnation

• The speaker believes that America's economy is benign but not growing.

• Technology may not necessarily translate into more employment opportunities.

• The speaker questions how the rest of America will be employed if a company like WhatsApp, with only 55 employees, can be sold for $19 billion.

Stimulating the Country and Debt

In this section, the speakers discuss stimulating the country instead of spending on extended unemployment benefits and union things. They also talk about the trillion and a half dollars worth of commercial mortgage-backed securities that are coming due.

Stimulating the Country

• Spending on extended unemployment benefits and union things doesn't make sense.

• The problems at the lower end should be addressed by stimulating growth at the upper end.

• Losing aspiration and motivation will lead to becoming like Western Europe, which is not attractive.

Debt Coming Due

• Interest rates are materially lower today than when those loans were made.

• Recovery has been seen in multifamily housing and single-family but relatively little recovery in office space market.

• Office space requirements have decreased rather than increased, resulting in very little new supply since 2007/08.

• Liquidity is driving markets concerning valuation in office sector but other product types too.

Distressed Debt and Commercial Mortgage-backed Securities

In this section, they discuss Sam's early business endeavors buying distressed debt. They also talk about a trillion and a half dollars worth of commercial mortgage-backed securities that are coming due for the second time.

Distressed Debt

• Sam made a lot of money buying distressed debt as one of his early business endeavors.

Commercial Mortgage-backed Securities

• A trillion and a half dollars worth of commercial mortgage-backed securities are coming due for the second time.

• Many loans were originated with high loan-to-values on them during 2006/07.

• Pig has to go through Python today sort of speed; pretend an extent was applied first time around.

• Levels of debt coming due have benefited from interest rates being materially lower today than when those loans were made.

Office Space Market

In this section, they discuss the office space market and how it has changed over time.

Changes in Office Space Market

• The office space market is much weaker today than it was in 2005/06.

• Almost every major release in major metropolitan areas has seen office space requirements decrease rather than increase.

• Law firm leases have been for less space than they previously occupied.

• We've had very little new supply since 2007/08 primarily because the economics don't work.

• Other product types too driven by liquidity concerning valuation in the office sector.

Real Estate and Liquidity

In this section, Jeff discusses the importance of liquidity in real estate investments and how it affects their value. He also talks about the barriers that foreign capital faces when investing in US real estate equities.

Liquidity Equals Value

• Jeff emphasizes that liquidity equals value in real estate investments.

• He shares an experience from 1992 where he had all these wonderful assets worth a lot of money, but they weren't relevant if he didn't have liquidity.

• Jeff believes that the US represents an opportunity for people from all over the world to seek safety, and their desire to do so is much more today than it was ten years ago.

Foreign Capital in US Real Estate Equities

• Jeff talks about reducing the barrier that the United States has erected regarding foreign capital coming into US real estate equities.

• He argues that it's unfair compared to other industries such as pharmaceutical or auto industry, which are owned by foreign owners up to 20% and 15%, respectively.

• Although Jeff agrees with his interviewer's statement that there is an enormous amount of foreign capital in real estate, he thinks his 2% number is probably much more related to the public format and not showing the private sector.

The Future of Real Estate Industry

In this section, Jeff talks about how he sees the future of the real estate industry globally.

Liquefying Real Estate Globally

• Jeff mentions his early idea of liquefying real estate by putting it into a public format in the '90s and later globally taking real estate and liquefying it.

• He talks about creating public vehicles outside of the United States in emerging markets, which helps the growth of the country by turning illiquid assets into liquid ones.

The Future of Public Real Estate Market

• Jeff predicts that ten years from now, the public real estate market will likely be a trillion five or two trillion as more and more real estate becomes equities and becomes part of the public markets.

• He sees the same kind of thing happening worldwide, where more equitization leads to more liquidity.

Overview of the US Market

In this section, Sam Zell discusses his thoughts on the US market and how it is different from previous years.

The US Market

• Describes the US market as "benign" and lacking animal instincts.

• Developers are not as optimistic as they were in the past.

• The market is more focused on individual opportunities rather than overall growth.

Opportunities in Mexico

In this section, Sam Zell talks about how Mexico has become a major beneficiary of secondary sourcing due to disruptions in supply chains caused by events like the Fukushima disaster.

Secondary Sourcing in Mexico

• Due to disruptions in supply chains caused by events like Fukushima, companies have been forced to look for secondary sourcing options.

• Southwest Mexico near the Verde port has become a major manufacturing center for companies that also manufacture in the Far East.

• Zell's company has made significant investments in land and buildings there.

Impact of Free Trade Agreement with Colombia

In this section, Sam Zell discusses how a free trade agreement between Colombia and the United States has impacted real estate demand in Colombia.

Real Estate Demand in Colombia

• A free trade agreement between Colombia and the United States has led to an increase in demand for real estate.

• Multinational companies who did not previously have a stake in Colombia are now investing there.

• Zell's company is currently developing office and industrial spaces there.

Investing Strategies for Brazil

In this section, Sam Zell talks about his investment strategies for Brazil and other emerging markets.

Investment Strategies for Brazil

• Zell believes that the underpinnings of Brazil are very attractive, including being self-sufficient in food, water, and energy.

• When investing in emerging markets like Brazil, Zell looks for countries that are close to reaching investment grade.

• Zell's company exited most of their investments in Brazil a few years ago but is now going back due to the underlying justifications and reasoning for their investments.

Identifying Opportunities and Creating Scale

In this section, the speaker discusses how they identify opportunities for investment and growth. They emphasize the importance of creating scale in order to achieve growth and exit strategies.

Identifying Opportunities

• The speaker looks all over the world to identify investment opportunities.

• They are very specific about where they invest and tend to avoid countries with a poor business environment.

• The speaker emphasizes the importance of paying attention to what's going on in Washington, as it can greatly affect businesses.

Creating Scale

• Before investing in any country, they ask if it is big enough to create scale that ultimately translates into creating an exit strategy.

• The speaker explains that being the biggest owner in a small space doesn't get you anything. It's important to have enough scale for growth and exit strategies.

Tax Reform Proposal Impact on Real Estate Liquidity

In this section, the speaker talks about a new tax reform proposal from the chairman of the Ways and Means Committee Republican of the Ways and Means Committee. They discuss how it could impact real estate liquidity.

Tax Reform Proposal Impact

• The new tax reform proposal includes increasing capital gains taxes, depreciation recapture taxes, and depreciation periods for all types of real estate.

• Like-kind exchanges could be eliminated which would make liquidity tighter in their industry.

• The speaker emphasizes that people should pay attention to what's going on in Washington as these policies can greatly affect businesses.

China Investment Opportunities

In this section, the speaker briefly touches on China as an investment opportunity.

China Investment

• The speaker mentions that China was a popular investment opportunity in the past but doesn't go into detail.

Investing in China

In this section, Sam Zell talks about investing in China and why he thinks it's not necessary for US developers to go there.

No Need for US Developers to Invest in China

• The Chinese market has more than enough capital available for real estate.

• There is no reason for any US developer to go into China unless they are fulfilling a very specific niche.

• Chinese investors are unlikely to listen to US developers.

Commonwealth Transaction

In this section, Sam Zell discusses the Commonwealth transaction involving Related and Corvex funds.

Background of the Transaction

• Related and Corvex identified a REIT named Commonwealth that was trading at dramatically below its net asset value.

• They accumulated a position of about 10% of the company and challenged the existing management who owned the outside manager and was also chairman of the board of the REIT.

• The conflicts were unbelievable, and the performance over the last 15 years until activists got involved looked like an EKG of a dead person.

Arbitration Process

• They ended up in arbitration because the existing management had put a provision in the Charter saying that shareholders could only go to arbitration, not file lawsuits.

• The arbitrator got rid of poison pills but said they had to go resource list we solicit.

• If successful, they would take over the company and recreate it as an internally managed REIT.

Externally Managed REITs

• Sam Zell thinks externally managed REITs are horrific and filled with conflicts.

• He did this transaction more from an evangelistic perspective to contribute to the non-existence of externally managed REITs.

Sam Zell's Biggest Failure

In this section, Sam Zell talks about his biggest failure in a transaction he did in 1993.

Carter Hollie Hale

• In 1993, Sam Zell bought control of a department store company in California called Carter Hollie Hale.

• The company was worth $50 million less than what he paid for it.

Risk and Reward

In this section, the speaker talks about taking risks and understanding the risk-reward ratio.

Taking Risks

• The speaker took a risk with the Tribune Company and lost $300 million, but he would do it again because the risk/reward ratio was appropriate.

• Understanding where you are at and what your optionality is important when taking risks.

• The integrity of what you do, the focus of what you do, and the degree to which you understand the risk you're taking is what it's all about.

Bank Executive's Line

• A bank executive who has a loan officer who's never had a loss should be fired. It's all about risk.

Tax Reform Proposal

In this section, the speaker discusses tax reform proposals related to capital gains and carried interest.

Carried Interest Fight

• The carried interest fight has been going on for seven years. It is about what your tax rate will be on the promote or carry.

• Private equity managers and hedge fund managers have high returns in excess of their personal investment in a deal. Some argue that this return should be taxed as ordinary income.

Real Estate Partnership Argument

• General Partners in real estate partnerships who get a promote should also be taxed under some people's theory in Washington under ordinary income.

Persistence

• You have to be persistent when arguing for something like this. You have to understand the arguments and make them every day even though everyone is against you.