INTERVIEW: To Zell and back

As the original grave dancer, Sam Zell is eyeing the current real estate distress as an opportunity to put on his dancing shoes once again. However, this time round, the veteran investor has warned the scale of the opportunity won’t be as “significant” as during the RTC.

Interviewed by PERE at the 4th Annual Kirkland & Ellis Real Estate Private Equity Symposium, Zell cautioned against expectations that the massive wave of debt maturities facing US lending institutions would bring about “the end of commercial real estate” or would provide private fund managers with the investment opportunity of a lifetime.

Instead, he argued that despite declines in property values of at least 30 percent, banks were willing to let borrowers “carry” their loans beyond maturity, even if they had little chance of paying them off.

“Everyone is talking about this giant balloon of loans coming due, that the end of the world is coming because we’re never going to be able to refinance. Instead we have a scenario of extend and pretend,” he said. “If an owner has no equity, just an option – a hope certificate – why would he sell unless he was under complete distress? He’ll extend as long as he can keep paying the debt service and the lender will leave him in place.”

As a result, Zell warned: “I don’t think there are going to be significant grave dancing opportunities in equity this time round, other than in the hotel business.”

Zell is credited with creating the first opportunistic private equity real estate fund in 1988, which turned into the Zell/Merrill Lynch series of funds that ran through to 1996. This summer, Zell launched the $625 million Zell Credit Opportunity Fund, seeded with his own capital and that of one other investor. The vehicle will target real estate and corporate debt opportunities, primarily in the US, and will be operated through Equity Group Investments.

Zell told the Kirkland & Ellis symposium, called Real Estate Private Equity: Through the Looking Glass and attended by more than 150 industry professionals, that he saw the greatest opportunity in the illiquid debt markets, particularly in loan-to-own situations. He said banks were slowly in the process of “cleaning up” their balance sheets and the opportunities would come in “waves, at each quarter’s end”.

But he again stressed it wouldn’t be comparable to the savings and loans crisis of the late 1980s and early 1990s. “We are in a demand–recession, but a demand-recession is very, very different from a recession that comes with massive oversupply [as seen in the RTC].

“I just don’t see any opportunities along those lines, other than hotels where I think there will be dramatic blood-letting,” he explained.

Unbelievable incompetence

After more than four decades of investing in real estate, Zell is, figuratively, an industry institution. He needs no introduction at conferences and always lays it down straight. As he reviewed the damage of the current real estate crisis at the Kirkland & Ellis symposium, he offered his opinions on the actions of institutional investors and fund managers in exacerbating the problems they are experiencing today.

“The ability of the institutional market to absorb incompetence – and to come back for more – is truly beyond belief,” he said to general laughter. “If you recall what was done to the institutional investors at the end of the 1980s, it’s been done to them again. Maybe there are different people doing it this time around, but it’s the same scenario.”

I don't think there are going to be significant grave dancing opportunities in equity this time round, other than in the hotel business.”

Sam Zell

But he countered that institutional investors were “getting smarter” and that it was “about time”. Going forward, Zell predicted LPs would be much more discerning and less dependent on gatekeepers. “This is another learning process in the evolution of the business, there’s obviously a demand for professional capability in taking advantage of investment opportunities. Whether that responsibility has been carried out properly, only time will tell.”

Zell, though, saved his greatest criticism for abuses done in the name of opportunistic investing. “The libel and slander that has been done to the word opportunity is unconscionable.

“I take great pride in the fact that in the mid-1990s when the real estate opportunity ended, so did the Zell/Merrill funds. Likewise, in 1990, I did my first corporate opportunity fund and it was terrifically successful, but when the opportunity ended, that fund ended as well.”

Opportunity funds during the past decade were “created by people with little track record other than their ability to flip assets. I just don’t think real estate investment is getting 200 percent IRR in 30 days”. 

‘Could not refuse’

Of course, no interview with Zell could fail to touch upon two of the largest deals of his career: the sale of Equity Office Properties Trust to The Blackstone Group for $39 billion in 2007, and his take-private of Tribune Company in a leveraged $8.2 billion deal less than one year later.

Much has been written about both transactions, and during the symposium Zell said that even though he was concerned about the rising disparity between office valuations and replacement costs, the EOP deal was a “Godfather offer – one you could not refuse”. Blackstone came in with an offer that exceeded Zell’s internal net asset value, and, he said, he had a fiduciary responsibility to shareholders to act.

On the Tribune deal, Zell has already admitted the timing was less than ideal. Addressing the symposium, he said that while it was a tax-efficient transaction, he lost more than $300 million of his own money in the deal, after the recession hit the industry with advertising revenue declines of 30 percent.

“There isn’t any operating business that loses 30 percent in its revenue and survives. That’s why the Tribune and all the other newspaper companies in the country are all going broke – the only question is at what stage do they go broke?” Asked if he would do it again, he calmly added: “The answer is the shareholders who sold did great, the shareholders who bought didn’t do so great, and neither did the lenders.”

Zell is always best in his own words. In wrapping up the symposium, the veteran investor was asked what a 30-year-old Sam Zell would be doing today – would he be investing in real estate or other asset classes?

“I think that there are always opportunities in real estate, just as there are always opportunities in almost every field. I get this

The shareholders who sold did great, the shareholders who bought didn’t do so

Sam Zell

question all the time. Someone will raise their hand and says ‘Yeah, jeez, it was great what you did, but I’m 30-years-old, where’s my opportunity? What’s my chance?’ But you go back 100 years and I suspect that at the end of any entrepreneur’s speech, someone at the back of the room was saying ‘Yeah, you did great, but what’s there for me to do?’.

“The answer is the evolution of our country has always been an evolution of opportunity and hopefully if the government doesn’t infringe too much there will still be opportunity for the next generation.”