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The Z factor

For the past 40 years, Sam Zell has been one of the biggest and most successful players in the US real estate market. Always opinionated, never boring, Zell recently sat down with PERE to discuss his views on the global real estate market, his unconventional holiday gifts and why he likes Libya and Brazil. By Paul Fruchbom

At a time when so many investors are bemoaning the frothiness in the US real estate market, perhaps it's not surprising that Sam Zell is upbeat. After all, the man who has made billions by investing against the conventional wisdom has never been one to go along with the crowds.

“I think the US market is a wonderful place to invest,” says Zell, relaxing in his office overlooking the Chicago River, his voice as calm and casual as his work attire—today an orange cashmere sweater and blue jeans.

Having invested in every real estate cycle of the past 40 years, however, Zell concedes the need for caution. He warns that investors today need to be much more discerning than they may have been in the past, adding that prospects for opportunity funds in the US are limited—one reason why his private equity real estate vehicle, Equity International Properties, is focused primarily on foreign countries like Brazil and Mexico. But he adds: “If your objective is safety and relatively less volatility, and therefore less risk, then I think [the US] is a great environment.”

Given Zell's position as chairman of two of the largest publicly traded real estate investment trusts in the country, Equity Office Properties and Equity Residential, his optimism may be understandable. As Zell himself points out, “I have a significant amount of my own net worth invested here.” But a man who anointed himself the “Gravedancer” for his ability to pick up distressed properties on the cheap is not necessarily someone you'd expect to be so bright and cheery about a hot market.

Zell, of course, has always had his own unique style. He still rides a Ducati motorcycle to work, prefers jeans to a suit and tie, sports the same slim, chin-curtain beard he's worn for years and sprinkles his conversation with expletives. He is opinionated, candid, a maverick in an industry filled with mavericks. The “Gravedancer” dances to the beat of his own drum.

Unlike many high-profile investors who are content to focus on a specific area of expertise, Zell has never been one to limit himself— he once remarked that “the definition of a schmuck is someone who reaches their goals.” Throughout the 1970s he and his late partner, Robert Lurie, created a real estate empire by buying properties from beleaguered real estate investment trusts. In the 1980s they diversified into corporate buyouts, turning moribund or bankrupt companies such as Itel (now Anixter) and General American Management & Investment into multi-billion dollar conglomerates. By the end of that decade, Zell had returned to real estate, raising one of the first opportunity funds ever and eventually launching four publicly traded REITs. Along the way, he raised a $1 billion private equity fund targeting distressed buyouts and when the dot-com era busted and the economy went into recession, he went hunting for junk bonds as well.

Being a renaissance man in the world of finance, however, doesn't always translate into favorable press. In reading the countless articles that have profiled Zell over the years, one gets a picture of a hardcharging, brash and unforgiving businessman: he has been called irreverent, abrasive, even ruthless. Yet in person, Zell comes across as soft-spoken, charming and, dare it be said, gentle. It could be that the “Gravedancer” is mellowing with age—he is 64 years old. But perhaps the reality is something else entirely. Maybe one of the greatest real estate investors of the modern era simply defies categorization.

CHANGING WITH THE TIMES
Zell's business acumen was honed at a young age. The son of Polish Jews who fled the Nazis, Zell grew up in Chicago and quickly developed the work ethic and hard-nose spirit that defines poet Carl Sandburg's “City of the Big Shoulders.” He often speaks of one of his first business ventures: buying Playboy magazines for 50 cents and then selling them to his high school classmates at a significant markup. Fellow Chicago native and entrepreneur Hugh Hefner would (perhaps) be proud.

During law school at the University of Michigan, Zell teamed up with a fraternity brother, Lurie, to manage nearby student housing properties. Following a very brief stint as a lawyer, Zell went back to the real estate business, founding Equity Group Investments with Lurie in 1968. Throughout the 1970s the symbiotic pair—Zell the dealmaker, Lurie the financial whiz—built up a sizable portfolio of residential and office properties throughout the country. Capitalizing on their ability to turn around distressed assets, the duo also benefited from readily available financing and a relative lack of competition.

“When I first started investing in commercial real estate, it was very much a club,” says Zell. “And it was pretty undemocratic. Those were the days of 100 percent financing…it was just a great deal. And then like any deal, the word got out and the business changed.”

Change has been a hallmark of Zell's career, something that he has been adept at not only managing, but also anticipating. In 1987 he wrote an article entitled ‘‘From Cassandra, With Love,’’ in reference to the Greek mythological princess who can see the future, predicting the commercial real estate bust that soon followed. In the midst of the ensuing savings and loan crisis, Zell presciently gave a speech at the Urban Land Institute, encouraging people to “stay alive ‘til ’95.” And at the peak of the Internet bubble, Zell designed a statue of a naked tech geek called “The Emperor Has No Clothes.” He sent it out as a holiday gift in December 1999. A few months later, the NASDAQ collapsed.

“If you look back through the annals of history,” Zell says, “the truly successful people have been those who have been most adept at managing change.”

Zell's success is evident. A self-made man, he has vacation houses around the world. Forbes estimates his fortune at $2.3 billion. And he is often considered, for good reason, the father of both the modern day REIT and private equity real estate industries.

In the late 1980s and early 1990s, he raised four opportunistic vehicles with Merrill Lynch that eventually formed the basis for Equity Office Properties Trust, now a publicly traded REIT with a market capitalization of more than $12 billion and the largest owner of office properties in the country. Several years earlier, Zell had also taken public Equity Residential, the largest owner of apartment buildings in the country, and Manufactured Home Communities, a national owner of mobile home parks, now known as Equity Lifestyle.

During the past two decades Zell has also branched into corporate buyouts. The $1 billion Zell/Chillmark fund, raised in 1990, acquired a broad array of companies such as the mattress manufacturer Sealy, the drugstore Revco and the radio station owner Jacor. The latter transaction was particularly successful: an initial equity investment of $70 million reportedly turned into a profit of more than one billion. Today Zell has a substantial equity stake in publicly traded companies with a combined market capitalization of more than $30 billion (see table).

Nevertheless, there have been some missteps. Lurie's tragic, premature death in 1990 cast a pall over the pair's holdings and a concurrent credit crunch in the real estate industry led to a brief, but scary, liquidity crisis at Equity Group Investments. A recession and the impact of September 11 cost Zell a reported $100 million investment in cruise ship operator American Classic Voyages. And he was roundly criticized for Equity Office's $7 billion acquisition of Spieker Properties, a Silicon Valley REIT, just as the high-tech office market dried up—the recently announced 34 percent cut to the company's dividend has obviously not been received well by the market.

But Zell's approach to business has always been about speed, shrewdness and intuition rather than infallibility—to borrow one of his favorite quotes: “Trying to be right 100 percent of the time leads to paralysis.” It's one of several sayings that he has packaged in a small booklet that comes complete with accompanying cartoons. Zell hands them out to visitors and employees alike. A sampling: “We suffer from knowing the numbers,” “With a longterm asset such as real estate it's a lot better to be early than late” and “If you're not moving forward, you're falling behind.”

GOING GLOBAL
Where Zell is moving these days is towards the international arena. Though he still spends a significant amount of time focused on his domestic real estate portfolio and his corporate holdings—two companies he's involved with, Adams Respiratory Therapeutics and American Commercial Lines, went public last year—Zell is branching overseas much the way he and Lurie branched into corporate buyouts more than 20 years ago: aggressively. In 1999, Zell and Gary Garrabrant co-founded Equity International Properties, closing their first fund on $370 million.

Though Zell had limited experience in foreign real estate, he had a name—and a thick Rolodex of investors who would back him on faith alone. “To be honest, the first fund was raised as much on a ‘Trust Me’ basis as anything else,” he says.

Thus far, that trust has been rewarded. One of the fund's biggest successes has been Homex, a Mexican homebuilder that EIP invested in three years ago. Since the company went public on the New York Stock Exchange in 2004, the stock price has risen by more than 75 percent; EIP's initial $32 million investment has now grown to approximately $350 million—a third of that stake will be monetized in an upcoming secondary stock sale. Zell and his team are now raising a follow-on vehicle.

While Zell's international investments have been primarily focused on Mexico—the first fund made five investments in the country— Equity International Properties has recently branched into Brazil. Last summer, the private equity real estate fund acquired a $50 million minority stake in Gafisa SA, a residential developer based in Sao Paolo. Zell calls Brazil the “most interesting place” to invest in the world.

“If you look back through the annals of history, the truly successful people have been those who have been most adept at managing change.”

“Let's start with 180 million people,” he says, responding to what he finds attractive about the country. “It's already elected its leftist president and we know what he's done. And just like Mexico, little by little, inch by inch, it's moving to investment grade. So whatever other crazy shit is going on, the bottom line is that there's an awareness and an attractiveness to what I'll call economic stability.”

Despite his interest in Brazil, Zell is less enthusiastic about the prospects for other BRIC countries, particularly the two that have garnered most of the attention. He believes China, for instance, is a good place to be a developer of real estate, but not necessarily an owner. “It's still a command economy,” he says. “If you own an office building in Pudong or Shanghai and the government says they want another 100 million square feet, they build it.”

India is a different story, he points out, but it's also a story rife with burdensome laws and regulations, things Zell has little patience for. Of the several statues that sit in the lobby of his Chicago office, one is a bureaucrat sitting in a pot of boiling water; another is a businessman covered in red tape.

“India has a whole different patina to it,” Zell says. “If you think that we have bureaucracy in this country, you have never seen anything like this. You know how in some places, they create free trade zones? In India, they are creating free-reg zones. They can't change the rules, so they take some place and say, okay here, the rules don't apply.”

Zell nevertheless admits that Equity International has been looking at opportunities in both India and China. Thus far, however, the risk-reward scenario has not been compelling. “Our objective is profit,” he says bluntly. “And while there is enormous activity going on, whether that activity is available on a profitable basis, so far we haven't been overwhelmed. But I would suggest that in both cases it's real early. There's going to be a lot of speed bumps between here and stability in both places.”

Interestingly enough, Zell sees opportunity in a part of the world that few other investors are talking about: Libya. He points to the country's hydrocarbon production, the fact that 80 percent of the country has not been tested for oil, as well as its “world-class ruins and 700 kilometers of Mediterranean coastline with nothing on it.”

A voracious traveler who spends 1,200 hours a year in the air, Zell first came across Libya on one of his famous motorcycle trips. In what has become an annual tradition, Zell and a group of friends travel to a foreign land and spend a couple weeks riding through the countryside—Zell is quick to point out that it's “riding, not racing.” Some of Zell's favorite locations include Italy, the Swiss Alps, Corsica and Sardinia, and this year the group is off to Brazil and New Zealand. Nevertheless, “Zell's Angels,” as they affectionately call themselves, don't ride Harley-Davidsons. The motorcycle of choice is the Italian brand Ducati. A few years ago, Zell even tried to buy the company but lost out to Texas Pacific Group.

Motorcycles may be an apt metaphor for the type of aggressive, risk-loving persona Zell has cultivated over the years. But his initial attraction to riding was stoked by something much more mundane: simple transportation. Nevertheless, his choice of vehicle would typify the businessman he would later become: one unconstrained by precedent or convention.

“When I went to the University of Michigan, you couldn't have a car until you were a senior,” Zell recalls. “Most people had bicycles, but I decided that wasn't very efficient. So that's when I got my first motor scooter and it just progressed from there.”

SAM'S CLUBStakes in publicly traded companies held by Sam Zell and related entities

Market Cap Approx. ownership stake*
Company ($bn) % ($bn)
Equity Office Properties 12.3 4.8% 0.6
Equity Residential 11.3 3.3% 0.4
Equity Lifestyle 1.0 16.1% 0.2
Covanta 2.1 16.4% 0.4
Homex 1.6 21.1% 0.4
Anixter International 1.5 13.8% 0.2
Adams Laboratories 1.3 15.1% 0.2
American Commercial Lines 0.9 19.5% 0.2
Capital Trust 0.4 6.2% 0.0
Rewards Network 0.2 23.0% 0.0
TOTAL $32.6 $2.6