Sam Zell is all fired up. And it’s not just motorbikes he’s passionate about, but also preaching the gospel of REITs overseas. Catherine Wheatley talked to him
In the conservative world of US real estate, Sam Zell, America’s top office landlord and self-proclaimed evangelist for real estate investment trusts (REITs), is something of a revolutionary.
The billionaire head of Chicago-based Equity Group Investments, who dresses in jeans and rides round town on an enormous motorbike, is on a mission to transform the industry by sweeping away the hordes of medium-sized firms run by rich and powerful private developers such as Donald Trump. In the place of these companies he wants to see public property companies monitored by analysts and accountable to shareholders.
Zell has been preaching reform in the US ever since he launched his first REIT five years ago. Now he is taking the gospel to Europe with Equity International, the overseas investment fund he eventually plans to float.
Sitting in his plush offices above Chicago’s Northwest railway station with grandson Aaron on his knee, the diminutive and highly persuasive 56-year-old warms to his theme. “In America, the public market is instilling discipline into one of the last undisciplined industries. Why should real estate be run differently from any other business? It’s just the same as Coca-Cola or McDonald’s.”
“The key to running a successful property business – and this is something that the UK market has never understood – is that it must be predictable, transparent and accountable,” he adds.
Zell’s fervent belief in securitisation and a quoted property sector stem from his earlier experiences as head of a privately held conglomerate.
After graduating from the University of Michigan and discarding a law career after just a week, Zell laid the foundations of his empire by managing local apartments. He went on to make a fortune by buying and fixing broken companies that dealt in everything from mattresses to mobile homes, a highly profitable strategy that earned him his “grave-dancer” nickname.
But during the property crash of the late 1980s he watched the fruits of his hard work shrivel as his property assets became worth little more than their fire-sale prices. “I came out of that period recognising that if you can’t sell something, then it has no value,” he says.
So liquidity became a goal for Zell, and REITs emerged as a way to achieve it. Following the crash, he was no longer able to tap newly cautious banks for hefty loans without personal liability so, like other long-time investors, he turned to REITs and the stock market instead.
Equity Residential Properties Trust, the largest publicly owned apartment landlord in the US, and Manufactured Home Communities, Zell’s mobile home REIT, both floated in 1993. And Equity Office Properties, the nation’s biggest office owner, followed last year.
Rewards of concentration
Zell believes that building his three REITs into dominant businesses has been a crucial part of his strategy. “Concentration gives you pricing power. To be successful, you have to be one or two in the market,” he explains. He adds that economies of scale have cut the price of supplying electricity to his 111 office buildings, and reduced by a third the cost of painting his 12,000 apartments in Seattle.
His other key philosophy is to shun the risks of property development in favour of management, a policy that delivers the predictable returns he says institutional investors crave. “Development is the most understated risk in the business world. Yet a developer would build a project for a lesser margin than a big industrial company would find acceptable,” he says.
Since the start of the year, Zell’s companies have lost ground along with the rest of the REITs sector. Shares in Equity Office, with assets of $3.9bn including properties amassed through four Merrill Lynch-backed opportunity funds, are 22.4% down this year.
As a result, the company is likely to scale back a domestic acquisitions programme, which has included buying up its leading rival, Boston Properties, for $4bn in the biggest-ever deal involving REITs. In the meantime, additions to the portfolio totalling $1.7bn so far this year mean that funds from operations (a proxy for profits) are still rising.
Zell, whose private holding company Equity Group has a 9.1% stake in the office business, is philosophical about the present cycle. “The property market goes up and down at different times all over the world. That’s why we’re trying to create a diverse income stream ,” he says.
The diversification he refers to is Equity International, the $1bn vehicle he launched in April to buy and manage property around the world. But instead of winding up the closed-ended fund after five years, Zell plans to float it, in accordance with his theories on liquidity.
Zell is eyeing Europe not just because he sees potential – the fund’s projected internal rate of return is 20% – but because he believes there is huge demand for an investment that delivers passive cash flows from around the world.
Peter Linneman, the hot-shot former head of Wharton Business School, one of America’s top business and management universities, is managing the fund. He will initially buy in Eastern Europe, where yields are higher than in the West. Despite Zell’s zeal for concentration, the fund’s scope will include retail, offices and sheds. “In the USA, the scale of the real estate available means you can afford to have a $12bn company focusing only on offices. That’s not the case in Poland or the Czech Republic,” Zell says.
Despite the REITs sector’s poor performance, Wall Street is still betting on Zell’s future success. “His team goes way beyond the entrepreneurs that went public a few years back,” notes Sheila McGrath at Dresdner Kleinwort Benson, which has Equity Office as a buy.
Nick Paumgarten, head of mergers and acquisitions at JP Morgan in New York, says there is plenty of US interest in Zell’s overseas project. “The returns he has given investors over the past 10 years have been pretty damn good,” he observes. “He loves his work – whether I’m with him on a chairlift or in an aeroplane, that’s what he’s talking about.”
But Zell gives the impression of enjoying the rest of his life as well. Aside from three-year-old Aaron, his lived-in office includes sculptures, paintings and a catalogue from the Guggenheim Museum exhibition, “The Art of the Motorcycle”.
His energy will leave an impression on the European market. “I’m an evangelist,” he chuckles. “Liquidity has been an age-old desire in real estate and I’m intrigued to see if we can accomplish it elsewhere.”
