Zell on Investing

By Ramesh Akkineni

Sam Zell in an interview

BL: How did you get started in the real estate business?
SZ: I was a junior at the University of Michigan and a friend of mine lived in a small town house. The guy who owned the house came to my friend one day and said “I bought the house next door. I’m going to rip the house down and build a fifteen unit apartment building”. I said to my friend why don’t we convince him to let us rent the apartments – we’re students we know what they want. We put together a little brochure and presented it to him. He bought it. That was my first exposure to the real estate business. It turned out we were really good. The result was that other owners came to us and gave us more buildings. Then I started buying buildings. By the time I graduated law school we managed about 4000 apartments and owned about 100-200 apartments.
BL: How did you pick up the name “Gravedancer”?
SZ: The nickname came from an article I wrote for New York University Review. They had come to me in ’74 or ‘75 and said we are aware of some of your activities and would love for you to write an article on it. As I was trying to come up with a theme for the article I said, “I am really a gravedancer”. In the mid- 70’s I did $3 billion worth of distressed acquisitions and was able to do them with very little cash. At the time the standard of the banks was that if you could make the case that in five years the property would recover they didn’t have to take a write-off. The banks focus was on band-aid deals so they didn’t have to take a write-off – and I was perfect for that.
BL: Where did you develop your philosophy of becoming a distressed investor?
SZ: I’ve always thought simply. I look at situations and act when I think the problems are temporary. I believed if you could buy assets with sufficient ability to carry them then over time you could not lose. In the early 70’s we were buying apartment units at $10k and they cost $20k to build. My thesis was that if it was a good location and reasonably built then I was competing in the market at $10k and new people would have to compete at $20k or $25k. I didn’t believe there was any way you could lose assuming you had the ability to carry it.
BL: Do you think there are certain times in the real estate cycle when you are not active because prices are too high?
SZ: Absolutely. Right now Equity Residential and Equity Office are probably going to sell ten times as much stuff as they are going to buy. Five years ago they bought ten times what they sold. In 1981, my partner and I didn’t like the real estate business and we didn’t like it for three reasons. First, the whole key to the real estate business has been inefficient markets and the markets had become efficient. Second, you always got tax benefits for the lack of liquidity in real estate but by 1981 assets were valued at X and sellers were adding on Y for the tax benefits. And third, all great wealth in real estate has been made off of fixed rate debt and beginning in 1981 the providers of debt went from 30 year loans to five year bullets. All of a sudden you didn’t have the arbitrage of long-term fixed rate non-recourse debt against changing operations on a day-to-day basis. That is when we started operating outside of real estate. And throughout the eighties we were really a minor player in real estate. We were a major owner but a minor player – because we didn’t get it. And when we didn’t get it we didn’t do it.
BL: What did you branch out into in the eighties?
SZ: The history of Sam has been a history of change. I look around and see what has changed. In 1981 the government changed the rules on net operating loss carry forwards or NOLs. Prior to that, a NOL could be applied up to three years back and three years forward. In 1981 Congress changed the rules so that NOLs could be applied for up to fifteen years. I looked at that and said “It went from three years to fifteen years that dramatically changes there value”. Yet when I looked at companies on the NYSE that had huge NOLs, they had not changed in value at all. So I went out and bought NOLs. I accumulated well over a billion dollars worth of NOLs and then went about creating businesses to absorb the NOLs. We consolidated the rail car business in the US in eighties, we built from scratch a billion dollar agriculture/chemical business and we did other stuff as well.
BL: Do you have any ideas where you might be active in the coming years?
SZ: When it is all said and done I am a professional opportunist. What has always intrigued and attracted me are scenarios where I believe there is significant inherent value beyond the price I am paying.

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