Sector doyen Sam Zell’s opinions have always courted an audience. So for PERE's special DECADE magazine, we visited the man at his Chicago offices to hear his most current thoughts on a range of topics, including impacts on the sector from the GFC, property’s green agenda and catalysts for the next downturn.
PERE: From your perspective, what have been the biggest and lasting impacts of the global financial crisis on private real estate investing?
Sam Zell: The 2007 meltdown was the first time since World War II that we went into a recession and real estate was not in oversupply. That made it very different than other downturns in which I was “the grave dancer.” Historically, oversupply in real estate was a catalyst for the crisis. I remember in the mid-eighties sitting in my office looking out the window and seeing ten construction cranes. There was a huge building boom. Everyone was giddy about it. But it worried me. If there were ten cranes going in Chicago, putting up new buildings, you had to ask who was going to occupy those buildings. At the time, the population of Chicago was not growing. So while supply was booming, demand was flat. That oversupply led to a crash in 1991, but it also provided me with plenty of opportunities to buy distressed properties and turn them around. But 2008 was different. There were relatively few grave-dancing opportunities because the cause of the crisis was not oversupply.
One positive impact of the most recent recession on commercial real estate was that the US went to a zero interest rate policy. This lowered the carrying cost, thereby delaying problems that otherwise would have occurred if interest rates had been normal. Zero interest rates were a tremendous benefit for the commercial real estate market, because they increased the value of buildings, thereby hastening the recovery. In two cities, New York and San Francisco, it was especially strong, and the rest of the country has shown slow but steady improvement.
If you want to talk about long-term impact, it’s probably the change in perception that the value of single-family homes will always go up. The belief that homes are an appreciating investment has been uprooted, and without that premise, the responsibility of owning a home is a lot less appealing. That is a cultural shift that has significant implications, particularly when combined with changing demography.
PERE: Demographic trends are perennially informative in terms of property occupation, a vital consideration for any real estate investor. What do you reckon were the most important demographic trends to have impacted private real estate investing in the decade?
SZ: There are four striking demographic trends that impact real estate. One: 24/7 cities. Two: deferral of marriage. Three: the destruction of the belief that a home is a good investment. And four, the aging of America. These trends are shaking the ground beneath our social order—particularly the suburban bedrock that has been developing since before World War II. These trends suggest the real possibility of a coming depopulation of suburbia, and exurbia too. The 24/7 city is about connectivity and experiencing the environment and convenience. These are viewed by the younger generations as more important than the space. People are taking less space because they can’t afford it, but they don’t care because most of their lives are lived outside of their apartments. They’re delaying marriage and childbearing, which has an impact not only on real estate but on commerce. E-commerce is challenging the retail sector. The Internet is the home of commodities. The big regional malls continue to prosper because they are activity centers as much as shopping centers. But everything in between the local strip center that provides you with milk and the regional mall is subject to obsolescence.
PERE: How is the aging of the population affecting real estate trends? Isn’t there a demand for new kinds of housing?
SZ: Yes, there are emerging opportunities for senior living. The demand is growing. But the demand is complicated by economics. There’s a question of affordability. We’re going to have a significantly greater number of elderly people than we’ve ever had before. The dependency ratio is also part of this equation, meaning the number of working people contributing to social security relative to the number of people who are retired. At one time in this country, the number was five to one. Now it’s moving to three to one. It’s a real challenge.
PERE: You were involved in arguably the most important property transaction of the last decade, the sale of Equity Office Properties Trust to Blackstone for $39 billion. What should the history books say about it?
SZ: I think the most important take away from the Equity Office sale is that nobody believed it would ever happen because nobody believed I would ever sell. It was a company I had built for over a decade. It was my baby. But, I didn’t look at it that way. One of my abiding principles is this: Every day you’re not selling an asset that’s in your portfolio, you’re choosing to buy it. And I didn’t want to “buy” EOP at that price. Selling was the right thing for the shareholders. But, in the beginning it seemed doubtful we’d get an acceptable price. We had what I believed was a very accurate idea of what EOP was worth, and Blackstone eventually came through with what I call the “Godfather offer”—too good to refuse. It’s worth noting that the Equity Office IPO was $21 a share in 1997. We sold at $55.50.
PERE: What impact has the current regulatory environment had on real estate development and growth?
SZ: There are many regulatory issues, but I want to single out one area that is making development more difficult—and that’s the growth of environmental awareness, the desire for sustainability, and the whole climate change issue. They might well be admirable goals, but we have to be clear about the fact that all of them ultimately affect growth. These regulations make construction or development more expensive and more complicated. Forty years ago, if you wanted to develop a big track of land, you’d start digging. Today, you’ve got to have a development plan, an eco-plan, and all the agencies on board. The whole process is much more difficult, and much more expensive. If this is what the public wants, they’re going to have to pay for it. And that’s a sticking point, because people don’t want to pay for it.
I think that the problem with any regulatory costs is not the initial intent. It’s what happens when it becomes part of a bureaucracy and all of a sudden, the federal government tells you how many times a day you’re supposed to brush your teeth or how many times you’re supposed to water the lawn. That’s where it becomes really expensive. When bureaucrats start micromanaging sweeping environmental goals, often with little understanding of the realities on the ground, everyone takes a hit—even those who think it’s what they want.
PERE: Admitting this is a slightly unfair question, may we ask you to identify one particular firm and one particular person operating in the private real estate investment universe that has impressed you the most (excluding your own colleagues) and for you to tell us why?
SZ: I am constantly impressed by the talent in our industry. I enjoy being in the company of innovative thinkers. But I’ll turn the question around a bit and say that the most remarkable talent I ever knew was [Hyatt Hotel founder] Jay Pritzker. To this day I’m proud to have been mentored by him. Jay wasn’t just smart, he was amazingly intuitive. He had a rare ability to grasp an extremely complex situation and immediately locate the weakness. He taught me how to look at the landscape with the right focus. He also possessed qualities that meant a lot to me as a young man. If he worked with you, he trusted you. Period. He was a great human being and role model. He’d always bet a lot more on the person than on the deal, and if he bet on you, it was really something.
PERE: Let’s finish with a crystal ball question: there is a growing consensus that the world’s gateway commercial property markets are reaching their cyclical zeniths and that downturns are around the corner. Clearly lessons have been learned since the 2008 crisis though, so, in your opinion, how will the next downturn play out?
SZ: There’s a lot of optimism in the commercial real estate market. Exuberance even, in some quarters–at least for the short-term. How will the next downturn play out? My answer is that it will probably be caused by a slowdown in world trade as a result of the instability of currencies.
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