By Aaron Kazam ’15 and Martín Kielmanowicz ’14
|Keynote:||Sam Zell, Chairman, Equity Group Investments|
|Opening Remarks:||Lynne B. Sagalyn, Earle W. Kazis and Benjamin Schore Professor of Real Estate and Director, Paul Milstein Center for Real Estate and MBA Real Estate Program, Columbia Business School; and Michael Berman ’86, Chief Financial Officer, GGP, and Chair, 2013 Real Estate Symposium Steering Committee|
Professor Sagalyn and Michael Berman ’86 opened the sixth annual Columbia Business School Real Estate Symposium. Berman introduced Sam Zell as a pioneer in the REIT industry.
The opening remarks were followed by a lively fireside chat between Zell and Sagalyn, starting with a question about how REITs became an asset class. Zell recalled that when President Eisenhower signed the REIT bill in the 1960s, this allowed the “little old lady from Pasadena an opportunity to invest in commercial real estate in the form of a tradable security.”
Thirty to forty years ago, public real estate companies were not desired, not stable, and run by “cowboys” who entered the market when it made sense to raise capital. Zell’s 1993 speech at the NAREIT annual convention urged REITs to offer a “fair deal” to potential investors in order to grow as a publicly traded asset class. Zell touched on the components of this fair deal, which embody the ideals of public companies in general: transparency, good governance, and predictable earnings. Following this structure, very few REITs misled Wall Street in the industry’s hundred-fold expansion from $7 billion in 1992 to $700-plus billion today.
When Sagalyn asked about the REIT industry today, Zell responded that it is still in the early stages of evolution. According to Zell, over time, as much as 75 percent of high-quality real estate should become REIT assets. However, there is not much REIT formulation in lower-quality assets. Investors interested in lower-quality assets are high yield-oriented and often want to flip those assets—a strategy that would not match with REIT assets, which are typically more stable.
Sagalyn shifted the discussion to how the rise of REITs has affected the private market. Zell argued that there has been an enormous impact on the private market, stating, “We can now look up comps much more easily. The public market has forced transparency onto the private market.” Zell suggested that the commercial real estate market has benefited from REITs spewing information. Private companies can no longer say, “I didn’t know.”
Zell next commented on the real estate market today. “The market is frothy, and not all boats are rising/falling at the same time. Liquidity is staggering and unprecedented, rates are low. When I started in real estate, no one bought anything all cash.” Office market rents are still not where they were pre-recession. “Utilization of office space is different nowadays. For example, at a time when we were looking at 250 square feet per employee in the U.S., Hong Kong was looking at 90 square feet per employee. Demand is muted, there is no appreciation other than cap rate compression. The multifamily market is very strong. However, I wouldn’t feel so strongly about Dallas and Atlanta, where access to capital is easy and building is simpler.”
As one of the pioneers in real estate investing in emerging markets, Zell explained his rationale: “It all comes down to one word: Demand. Demand in the western world is slowing down, and it has been for some time. To capture growth, we needed exposure to emerging markets.” He emphasized the need for a strong international partner with strong local connections. “Internationally, you’re trading growth for the rule of law.”
So how does Zell determine the timing and location of emerging market investments? His strategy involves following countries on their way to becoming investment grade. “When Mexico was very close to best in grade, they behaved beautifully for a number of years until they achieved the grade.”
In closing, Sagalyn directed the conversation toward entrepreneurship. Zell described entrepreneurs as people who have an appetite for risk and for whom failure is not an option: “Failure is not in the entrepreneurial lexicon.” Zell constantly measures an investment’s risk-reward ratio. He recalled a quote from the 20th-century American financier Bernard Baruch, who once said: “Nobody ever went broke taking a profit.” Zell doesn’t focus on the upside. Instead, “We spend most of our time looking at how bad it could get.” He offered an example of his acquisition of a large western department store chain in 1993. Zell asked his team to look at the worst-case scenario: liquidation. After the transaction, “We had riots, earthquakes, and fires. We decided to get out. We sold the deal at our worst-case price. Even though it was sold at a loss, I still view this as a successful transaction, because we assessed the risk-reward relationship correctly.”
Throughout the talk, Zell shared his dynamic perspectives on the REIT industry, real estate emerging markets, and entrepreneurship. We are left with his compelling words of advice to embrace risk, understand the downside, and not fear failure.
The sixth annual Real Estate Symposium took place on December 9, 2013, at the Columbia University Club of New York, drawing 200 attendees representing classes from 1959 to 2013. Please visit the event page for more details and reports on other speakers. Hosted by the Paul Milstein Center for Real Estate and the Real Estate Circle of Columbia Business School, the Real Estate Symposium is an annual educational forum that brings together accomplished Columbia Business School alumni and top industry leaders for a broad-based discussion of topical issues, high-profile transactions, trends, and challenges facing the real estate industry.