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Zell details profitable real estate strategies

Real estate mogul Sam Zell, whose personal fortune has been estimated at more than $1 billion, spoke to a full house in Wong Auditorium last Tuesday on the recent history and impending Phoenix-like rebirth of the real estate industry.

Mr. Zell is chairman of the board of Great American Management and Investment, Inc., and of Equity Group Investments, Inc. (EGI), both based in Chicago. His talk was titled "Brave New World: Real Estate in the Millenium."

President Charles M. Vest, introducing Mr. Zell, described the Chicago native as a "contemporary business leader whose interests are so various and wide-ranging that his appearance had to be co-sponsored by two organizations: the MIT Center for Real Estate and the Sloan School of Management. Sam Zell's unique combination of counterintuitive insight and full-throttle enthusiasm have enabled him to build one of the greatest real estate empires of modern times."

In sharing his vision of the brave new world of real estate, Mr. Zell dispatched the old world of real estate in a few bold strokes. The industry used to be private, opaque, development-oriented, and supposedly noncorrelative, he said.

"It was private, meaning capital was available. It was opaque, meaning information on what was going on in the industry was not available. It was development-oriented in that the measure of success used to be the height of your building," Mr. Zell said. "The standard was [that] the developer was the entrepreneur and his brother-in-law was the manager. It was supposedly noncorrelative, meaning somehow it performed contra-cyclically to the rest of the economy. This was proven to be [nonsense], since the real estate market collapsed in 1990 just when junk bonds and the stock market did--and yet it was cyclical in its own way, with buildups followed by slowdowns.

"In 1990, everything stopped--no buying, no selling, no financing, no nothing. The only source of capital was the public market. Equitization was the only alternative. And now, with the new competition for capital, the real estate industry gets to be like any other business," Mr. Zell said with relish.

Considered a pioneer in the securitization of the REIT industry, Mr. Zell was among the first real estate investors to tap the capital markets by taking his REITs public rather than relying on mortgage financing. (An REIT is a fund that is exempt from corporate income tax, paying its investors 95 percent of its annual income instead.) His method has become the dominant trend in the real estate industry.

He contrasted the 1980s with the 1990s in a tone and at a pace worthy of the Tom Wolfe novel The Bonfire of the Vanities.

"In the 1980s, we consumed capital by making a whole bunch of dumb, dumb decisions. In the 1990s, we invest capital. In the 1980s, decisions about real estate were made by a bunch of business school guys in windowless rooms on Wall Street. In the 1990s, the new leaders of the real estate industry know the business itself. They know profits in real estate will come from operating, not from creating, buildings," he said.

Mr. Zell's other major innovation has been to de-emphasize rapid buying and selling of properties in favor of looking for properties that are currently unmarketable but have significant appreciation potential. For example, in 1995 Equity Office Properties bought 28 State Street (his first Boston property), despite the fact that it had asbestos problems and was vacant and burdened by debt. He focused on its prime location and projections of a boom in the market for first-class downtown office space.

His real estate trusts, all publicly traded, now make him the second-largest owner of apartments in the United States and, following the acquisition of The Beacon Companies in December 1997, the largest office-building owner in the country. He foresees the current number of 216 REITs to be in "the midst of a Darwinian process even as we speak. I don't see more than 20 REITs in the next few decades," he said.

The huge future success of a few highly adaptable real estate industry leaders and of the real estate industry itself depend on whole new standards of performance, Mr. Zell said.

"This amounts to transparency, predictability and accountability. These new standards will eliminate excuses such as bad weather and will also materially reduce volatility in the industry," he said. Mr. Zell also noted that the new profitability arising from new standards will attract more business- and management-oriented leaders as opposed to developers which in turn drive the industry's performance up.

Mr. Zell's excitement about the opportunities ahead was reflected in his answer to a question about whether it might be too late to profit. "It's still a very exciting and dramatic area. The changes are awesome and so are the opportunities. I look forward to them all," he declared.

Mr. Zell received the BA (1963) and JD (1966) degrees from the University of Michigan and began investing in real estate in Chicago in the late 1960s. Within a decade, he foresaw the first big property crash, and, with his partners, began buying up distressed real estate. He has called himself the "Grave Dancer" because of his appetite for buying troubled properties.

Mr. Zell's personal interests mirror his adventuresome and individualistic business practices. He is an avid skier and racqetball player as well as a motorcycle devotee. His motorcyle club, Zell's Angels, made a 50-person appearance at a gala he hosted to open the Chicago segment of the Guggenheim Museum's touring show, The Art of the Motorcyle. Mr. Zell underwrote the exhibit's Chicago stay.

A version of this article appeared in the April 7, 1999 issue of MIT Tech Talk (Volume 43, Number 25).

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