The Real Estate Genius & His Final Advice w/ Sam Zell

The words, you know, supply and demand, also with luck, supply and demand of capital. This all occurred not in a period of a shortage of capital. Not in a period of difficulty in getting bank loans, not in a period of difficulty in getting a mortgage, just the opposite. It was as easy as possible. And the result was that we flooded the market with money. We kept lowering the cost of the money. And also eventually the economy in the United States almost got to negative interest rates and in large parts of the world we got to literally negative interest rates. You know, then all of a sudden everybody says, 'Well, what do I do? What do I do with the money? All of a sudden I've got more money than I ever thought that I had access to all kinds of capital. And I've got to find ways to use it.' Leading institutions that were piling up money, looking for places to invest. And we were all subject to changing flows. I mean, when I first in 1989 was the first time that I quote unquote tapped into the institutional market to raise money for real estate. Imagine how shocked I was to find out that 80% of the institutions that I called upon did not have an allocation for real estate. They didn't have an allocation for stocks, bonds, municipal bonds. Real estate wasn't a quote unquote investable class. Fast forward 20 years, you couldn't find anybody who didn't have a real estate allocation. So they then had a real estate allocation and the question is, how do they fulfill that allocation? Buy more real estate. And they did. And then afraid they're going to be sorry.

Well, I think that I'm 81 years old. So that means I was around in the '70s. I remember in 1978, we closed a loan on an apartment project that we had just bought and the inflation rate that day was 13 and 3/4. 13 and 3/4 was the inflation rate. So I was forced to learn how to navigate a very, very difficult and treacherous environment. Even though it also was an environment that created opportunity to do really, really well. I haven't forgotten that experience. And so, despite all of the excitement and stuff that have occurred over the last 30 years, I haven't forgotten what it meant. I haven't forgotten what it took to generate that kind of inflation. I looked at what the Fed was doing and I looked at what I saw in the fact that interest rates were going significantly below the inflation rate. You don't need to see. All you need to know is that if the cost of money is four or five hundred basis points less than the inflation rate, things are going to get turned upside down. I don't think you need a PhD to figure that out. It's just another example of supply and demand. And where all of a sudden the supply became excessive. The result is that over the last 10 years we sold a lot of real estate. We bought very little. And so I'm waiting and hoping that there'll be an opportunity to reload and buy a bunch more stuff. But I made a fortune buying real estate at below its replacement cost, which therefore guaranteed me that the guy couldn't build something across the street at less than my basis. Everything today is still being priced in dollars at numbers that are above, I think in fact that would allow somebody to build and compete with me at a lower cost. That doesn't make sense.

Raise interest rates. You got to raise interest rates 3 or 4 or 5%. If you have to, we have to make it painful. Everybody's so worried about whether we're going to have a soft landing. I'm worried about what kind of landing we're going to have because if we don't stop the inflation, it's a very, very deleterious thing. I mean, it robs purchasing power of everybody. And until 1971, the world was protected from inflation by the fact that we didn't have fiat currencies. Fiat currencies that were pegged to price of gold. From 1971 we in effect converted from pegged currencies to fiat currencies. And today, there's nothing backing the US dollar. We've increased our debt 7, 8 trillion dollars in 3 or 4 years. How does that work? I don't know how that works now. I know how it works, but still it happened because I think that we just can't, again, supply and demand. You just can't create that much new supply and you have to work. And my big concern for the last 5 years has been loss of the US as the reserve currency of the world. I think that that probably would result in a 20, 25% reduction in the standard of living in the United States. We have this extraordinary benefit of being able to issue paper. If we couldn't issue that paper, or we had to pay the real price of issuing that paper, our life would be different. All you have to do is look at what happened to England after World War II. Up until that time sterling was the reserve currency of the world. And then it wasn't. And then all of a sudden England became part of the sick man of Europe as opposed to a leading economic player in the world that set the standard as opposed to had to come up with it to meet the standard.

You know, you always ask yourself the question, would I buy it at this price? Would I sell it at this price? You have to consider the tax implications. Uncle Sam takes a big bite of everything you sell. So you need to be keenly aware of what your after tax yield is, not your pre-tax yield. And what you paid for is much less important than how much you get left with after you satisfy Uncle Sam.

Well, you're right. It was quite an experience and what was interesting was that I had a bunch of really, really smart guys on the other side. And in the beginning, maybe 6 months before the transaction, someone approached me and wanted to buy Equity Office. And I was really surprised because I thought that Equity Office was just too big for anybody to buy. And then I really at that time thought that we probably own this company forever and be passed on to other generations of real estate because the scale was so large that it just didn't fit anybody doing a buyout of it. That particular offer or inquiry was at a price that frankly I didn't think was attractive even if I wanted to sell or couldn't sell. And so we didn't do anything about it. I said no and that was the end of it. Give or take, and then by the way, as with all of our companies, we continually have looked at our companies and done human analysis of what they thought that they were worth. So that we never were in a position where we weren't prepared to understand what we owned and what we thought what we owned was worth. About 6 months later Blackstone approached us and as opposed to giving us an offer they said, 'What would it take for Sam to sell Equity Office?' And I remember my response being, 'Yes, it would take a Godfather offer,' which is from the Mario Puzo story of the Godfather, and I said it would take a Godfather offer for me to consider selling Equity Office. And I remember responding to the broker and saying that's what it would take. And much to my surprise they came up with one and I was extraordinarily flattered by what they thought the company was worth and I said I was willing to consider it, but I would only consider it if the breakup fee, which is the fee that was paid to a loser if there was a competitive bid, was small enough that it would not discourage anyone from competing, because obviously anytime there is a sale, it's nothing more than price discovery. And I wanted to make sure to protect my investors, to protect myself, that I could say that I had gone through and identified what I thought the real value was. And so we ended up concluding a deal at what is then 36 billion with a 200 million dollar breakup fee. And normally a breakup fee in a deal like that would be to protect 3%. So normally that breakup fee should have been a billion two or something like that. Instead the breakup fee was 200 million, which gave me comfort that no one would be discouraged from bidding based on the fact that there was a humongous breakup fee and at the price the client as this client was so high. So that was one of the first things part of the strategy involved in the sale too. And by the way, I'm a great believer that there's always significant strategy in everything you do, whether you're selling or you're buying, there's a strategy involved and a thought process that's involved. And so we concluded a deal. I think the first price was 48 dollars a share, a 200 million dollar breakup fee, and then there were various people who expressed an interest or theoretically expressed an interest. One never knew until you see the color of their money. So the Blackstone people, John Gray in particular, looked at the situation and said, 'We're vulnerable, somebody could easily outbid us, and we didn't want to be outbid.' And so he came back to us even before we had a second bid and said, 'We'll raise the price if you raise the breakup fee. We'll pay a little more if you'll make it a little more expensive for anybody to compete with us.' We agreed and so then the price went from, I don't remember exactly where they went from 48 to 51, and then there was some discussion and speculation that there was another group that was about to get involved, but that other group had a problem. And the problem was that the banking system had been tied up by Blackstone. Blackstone had in one way and subtle fashion or another suggested that almost everybody could play. And nobody wanted to be on the wrong side of the deal. So literally a potential competitor couldn't finance a competing bid. So then it became my responsibility to sit down with Blackstone, which I did, and in a nice comfortable fashion explain to them that we do have anti-trust laws and that tying up all of the sources of capital for potential competing bid didn't really fit the definition of what was called acceptable behavior. And they ultimately agreed and let go a bunch of financing sources that ultimately became the financing sources for a competing bid. Whereupon the Blackstone people then looked at their situation and said, 'Gee, maybe we ought to raise the bid a little more. We could get a higher breakup fee.' And more important in a breakup fee was that the original provision did not allow Blackstone to have any contact with any potential buyer of the assets of the OP that Blackstone didn't want. Then they came back to us with still a higher bid with a higher breakup fee, but most important allowed, with us agreeing, that they could engage in conversations with potential buyers who wanted to buy pieces of EOP that they didn't want to own. That's how we ultimately made the deal. Where they were given the right to negotiate with potential buyers for parts of the portfolio. We increased the breakup fee to 700 million dollars and then we closed the deal February 7th. It was a great day and I'm still smiling. Interestingly enough, Blackstone to their credit was able to liquidate almost two-thirds of the portfolio at prices well above what they were paying us for the whole. So the net result was that from our perspective the deal was an enormous economic success. From Blackstone's perspective, because they had sold two-thirds of the portfolio at a premium, their measurement of how they did, they did extraordinarily well. The unfortunate part of the story was that almost every single buyer who bought any part of the portfolio from Blackstone ended up losing because they had basically crossed the line and paid too much. So that was my experience with that particular transaction. I learned a lot of lessons from it. Most significant lesson is, if you're a seller, create competition. Sellers who don't create competition don't get the highest price. And at the same time, being the last guy on the totem pole to buy something also doesn't likely produce a positive result.

You know, as a sport or as a hobby, I ride motorcycles. And when you ride a motorcycle and you feel the wind come through your helmet, you realize that you're in total control of what you're doing. There's a sense of freedom that's irreplaceable. In the same mirror, having the resources to not start every conversation with 'Can I afford it?' but 'Whether I want to do it' are very different things. There's nothing more important to me than freedom. I'm a great student of, I read an enormous amount. I'm very understanding and knowledgeable about loss of freedom to all kinds of people from all kinds of different situations, many of them frankly very negative. So I guess what I would say to you is that I view money as a way of eliminating a step to achieve my objectives, but not be constrained by limitations. In the same manner, when it comes to liquidity equals value, that's something that I coined for my own benefit to remind me of the fact that I'm constrained only by the exterior events that occur around me. To the extent that I have liquidity, I can make choices. If I can make those choices without the constraints of liquidity, I don't have to start by saying, 'Where am I going to get the money?' But I'm going to start by saying, 'How do I want to spend the money? What do I think is important?' I think those are criteria that define what I call freedom. And it's certainly been a big part of my life.