Sam Zell is a unique businessman and investor. The 75-year-old billionaire is known for his sharp business acumen, frank speaking style, and unique sense of style (he has been known to wear track suits and gold chains to business meetings).
Zell is an accomplished real estate investor but has had tremendous success across many industries.
In this post, we will try to distill the principles that underpin Zell’s investment success.
1. Analyze troubled industries, buy distressed assets at a price well below their replacement values, then hold on for the long-term until the cycle turns.
Zell tends to hunt in industries that are extremely out of favor, including situations in which companies are going bankrupt.
Given that many of his investments (such as real estate) tend to be in tangible assets, he focuses on buying the assets below replacement cost – the cost it would take someone to replicate the asset he is considering buying.
For example, if an apartment building cost $1 million to build and an investor can buy it for $500,000 without considering the value of the land, that could be a compelling purchase. The principle of replacement cost is powerful because builders will not construct a new apartment building if they know the value will be below what it costs to build the new structure. Therefore, supply will shrink or stagnate. Eventually, supply and demand will come back into balance, and the value of the property will likely rise.
Zell has said, “I’ve sold real estate based on cap rates. I don’t buy real estate based on cap rates. So I mean there’s nothing more relevant than replacement cost. And so you can generate values that are way above replacement cost by virtue of very low cap rates. And that’s a sucker’s bet.” In the same interview, Zell added, “I don’t know any other way to sleep at night better than buying…less than it costs somebody to compete with you.”
In defining replacement value, Zell has said, “I’ve bought all kinds of real estate at below replacement cost, before considering the value of the land. Ultimately, what does it cost per square foot to build the property and what is your cost basis?” He also added in the same discussion that barriers to entry are key, saying, “another question to consider is how difficult a particular business or real estate market is to enter…you have to ask yourself, how difficult is it for somebody to compete with you and what is your comparative advantage.”
In a 2004 interview at Kellogg Business School, Zell said, “The biggest fallacy is that comparables matter. That’s how tech stocks got as ebullient as they did in the late 1990s. There has only been one metric that has been entirely consistent through my 40 years of experience – replacement cost.”
Zell is also very long-term focused, saying in an interview with Columbia Business School’s Graham & Doddsville newsletter, “I have to look at my investments as though I’m going to own them permanently.”
2. Use the tax code to your favor.
Zell has structured many of his transactions in a way that minimizes the tax bill, ensuring that more cash flow goes into the pockets of owners – including him. Zell was a pioneer of the real estate investment trust (REIT) structure, which helped real estate companies avoid paying taxes as long as they passed through enough of their income to investors.
In other situations, Zell has bought into companies emerging from bankruptcy that have net operating loss carryforwards (NOLs) that he can use to reduce taxes in the newly emerged entity.
Zell was recently buying energy assets when the energy markets were in a perilous situation. He said, “We’ve got a lot of involvement in net operating loss carryforwards. Where we monetize them. That gives us an edge. Buying in the energy patch when everybody else is running out the door. That’s an edge when you’ve got the staying power and the guts to believe that you’re right.”
3. Be bold and contrarian – both when you buy and sell.
One of the greatest deals of Zell’s career was when he sold the U.S.’s largest portfolio of office properties for $39 billion in 2007 – at the height of the real estate cycle.
Zell has referred to himself as a “grave dancer” for the way he takes advantage of the errors of others. He often seeks to buy the debt of distressed companies; if the company turns around, the value of the bonds he owns goes up. If the company enters bankruptcy, a reorganization often means that bondholders such as Zell will receive equity in a new enterprise that typically has a much better balance sheet, improving the odds the company can successfully turn its fortunes around.
As Zell has said, “When everyone is going right, look left.”
4. Focus on and protect the downside. Keep it simple.
Zell has said, “The key to my success is that my focus is never on how good it’s going to get. My focus is on the percentage that it doesn’t work.” Even in deals that have not turned out in his favor, Zell has structured transactions to put minimal amounts of his own money at risk. Ignoring any moral questions, the deal structures allow Zell to have high potential financial reward with low financial risk.
Zell uses leverage (taking on debt) to skew risk/reward in his favor. Zell has said, “If you are in the real estate business without leverage, that’s like being a boxer in the ring without a glove.”
As he has said, “Business is easy. If you’ve got a low downside and a big upside, you go do it. If you’ve got a big downside and a small upside, you run away. The only time you have any work to do is when you have a big downside and a big upside.” Zell has also stated, “If you can’t delineate your idea in one or two sentences, it’s not worth doing.”
Another important part of protecting downside is to maintain liquidity (the ability to turn assets into cash), which can be challenging in a turbulent economic environment. Zell has said, “Liquidity equals value. At no time in my career has it ever been more clearly brought home to me than [during the 2009 financial crisis.] If you had liquidity, you had value.”
5. Business is personal. Make an effort to see people in person.
An excellent 2007 New Yorker profile of Zell mentioned how Zell spends ~1,200 hours per year on his plane to visit people. As Zell said in the piece, “I want to see everybody in their habitat. When these people see me come halfway around the world to meet them and spend time with them, it creates a level of confidence that translates into other things.”
Recommended sources for additional reading