Words from the Pro

Sam Zell discusses his industry experiences at a recent conference.

On April 27, Sam Zell, president and chairman of Equity Group Investments in Chicago, spoke at the second annual real estate forum of the Jeffrey E. Smith Institute of Real Estate at the University of Missouri in Columbia, Mo.

Zell has been the chairman of five publicly traded companies including the largest real estate investment trust in the country, which was sold to the Blackstone Group for $39 billion in February. Recently, Zell bought The Tribune Co. in Chicago, which included the Chicago Cubs Major League Baseball team. For this discussion, addressing both students and real estate professionals throughout the U.S., Zell dove into his experiences in the commercial real estate industry.

Zell started by discussing liquidity and the impact it has had on global real estate. He explained that one of the most significant issues for real estate today is the availability of access to capital. The world is on a trend of liquidating more assets to capital than in the recent past, he said. This, along with a relatively low capital gains tax of 15 percent, an aging population that needs to generate income, and increased disposable income due to the younger generation delaying marriage, has created an “eruption of liquidity” in the U.S. The result is a healthy real estate environment with plenty of capital to invest in projects with strong value.

Zell also discussed the evolution of the modern REIT. Beginning as a solution for the small investors to have a stake in real estate, from 1960 to 1992, REITs only grew by $6 billion. When hard times hit real estate investors in the late 1980s and early 1990s, dedicated lenders went belly up, and REITs needed to search for new sources of capital. Real estate entities realized they needed to be accountable, which led Equity Office Properties Trust to be the first REIT included in Standard & Poor’s index. By adding REITs to public markets, the real estate industry was included as a true benchmark for investors. Since 1992, REITs’ assets have grown from around $6 billion to $500 billion.

Zell warned the audience of relying too much on an investment’s internal rate of return and not enough on the absolute rate of return. Zell stated that IRR is used to create value in order to sell to someone else. Absolute rate of return is used to create wealth, he explained, using the recent sale of Equity Office Properties Trust as an example.

The sale yielded a CAP rate equal to 5 percent with 3 percent after capital expenditures, which resulted in negative cash flow to the buyer. The first bid included a very small breakup fee of $200 million. Zell used the low breakup fee to let capital markets know his company was still open for business. This strategy opened the door for higher bids for the REIT as analysts compared the stock value with the bid. As a result, this transaction became a capital markets transaction instead of a real estate transaction, Zell explained.

Zell also described the current real estate situation as a sort of golden age. “We are only in the first inning in terms of worldwide liquidity,” Zell said, predicting a “frothy environment” with great availability to capital. Although the overall economy may be slowing, the credit crunches from the past seem to be long gone. Zell expects less development in the future where modification and use of real estate will be key. Affordability is another important issue for the industry, as assets’ values and rental rates continue to reach new heights.

Zell concluded with an explanation of his current projects, which include opportunities in Mexico, Brazil, China, and Egypt. He then told the audience the importance of executing global investment decisions, which should be based on an initial opinion and a country’s risk should always be part of the investment equation.

William E. Early, CCIM, SIOR

William E. Early, CCIM, SIOR, is vice president of First Scout Realty Advisors in Kansas City, Mo. Contact him at (816) 960-0555 or wearly@tfs.com.