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Steve's note: With all the volatility in real estate stocks this week, it's time to go back to basics. Sam Zell is known as the Godfather of modern real estate investing. Today we learn how he amassed his fortune... and what to look for when it's finally time to buy real estate again...

The Story Of The Grave Dancer

By Dr. Steve Sjuggerud
Saturday, July 28, 2007

Until the 1980s, real estate had been a highly fragmented, locally based industry financed for the most part by savings and loans, banks, and, to a lesser extent (for bigger projects), insurance companies. Wall Street or some other investment banking entity would occasionally also step in to raise capital for a major development.

When the United States entered into a severe real estate depression, induced partly by the elimination of key tax incentives to the industry, highly leveraged borrowers could no longer repay loans. Defaults collapsed numerous financial institutions, most notably the thrifts.

Zell, who a decade before had hypothesized about opportunities available in down cycles, swung into action so effectively that he became known as the "grave dancer."

Zell borrowed heavily and bought up scores of properties at bargain prices. He very quickly became one of the largest investors in real estate during the downturn in the late 1980s and early 1990s, adds Rod Petrik, a managing director with Legg Mason Wood Walker. "There was blood on the streets and Zell was one of the first and certainly one of the largest investors in buying real estate in that down cycle."

As the steam began to leak out of the booming 1980s real estate cycle, Zell astutely visualized the continuum of events that was beginning to unfold. The excessive leveraging of properties could not continue, he surmised. Lenders would be forced to foreclose, and then they would need to unload these distressed properties to reduce their real estate loan exposure.

To amass a war chest for such deals, Zell joined forces with Wall Street and formed Zell-Merrill I, a pioneering opportunity fund that raised what seemed at the time to be a huge amount of capital—$409 million.

As the decade of the 1990s rolled in, lenders were foreclosing on properties at a frantic pace. Finally, the federal government stepped in, accumulating vast pools of nonperforming real estate loans in the foreclosure of insolvent financial institutions via the Resolution Trust Corporation. Zell-Merrill I was often the only potential buyer for the RTC's high-quality properties.

When Realtor magazine listed the most influential people in real estate in 2000, it said of Zell, "With key partners, Zell cobbled together huge investment funds in the 1980s that enabled him to control one of the largest office and apartment portfolios in the country. And he did it in the way that other investors dream about: by taking undervalued properties off the hands of financially distressed owners—in other words by buying low.

Born in 1942 and raised in Chicago, Zell became interest in real estate at an early age. The story he likes to tell is about when he was at the University of Michigan and managed an Ann Arbor apartment complex for students. In exchange for rent, it was his job to fill the apartment building. He did this job so admirably, the owners gave him another complex to manage and started paying him as well. The management business, he used to say, was a good way to meet girls.

It was at the University of Michigan that he met his business partner, Bob Lurie, when they both pledged the same fraternity. In the mid-1960s, the two eventually assembled a mini-empire of apartment buildings in Ann Arbor.

When asked, years later, if he was a long-term player, Zell responded, "I graduated from law school in 1966, I bought an apartment complex in Toledo, Ohio, in 1966. I paid off that mortgage in 25 years. I own it. There aren't many people who can say that.

Always a bit ambitious, Zell concluded that Ann Arbor was not a big enough arena. "I was basically arrogant, and wanted to see what I could do in the real world," Zell said. "So, I sold the business to Lurie and said, ‘When you get through screwing around and want to play with the big boys, call me.' " With that, Zell moved to Chicago. Lurie eventually saw the light and joined Zell in the Windy City two years later.

When Lurie arrived in Chicago, Zell had already put in motion his plan to syndicate real estate. After starting out as a minority partner, Lurie eventually became a full partner as the business grew.

During the 1970s, Zell and Lurie bought ailing Midwest and Sunbelt properties, eventually selling for big gains. What Zell recognized then was that real estate was still an inefficient market and that he and Lurie could do it better.

"Zell is one of the greatest forces in the institutionalization of real estate. He is the godfather of modern institutional real estate," says Barden Gale, managing director of the real estate unit for ABP Investments U.S. The Netherland-based ABP Investments ranks as one of the five largest pension funds in the world and is an active investor in U.S. real estate markets.

"People think there is nothing to operating real estate, you just own a bunch of bricks and people pay rent," Gale adds. "But Equity Residential and Equity Office are as good as it gets in modern real estate operating companies."

Although Zell might relish the appellation "grave dancer," what that actually means is that he is an extraordinary contrarian, gutsy investor, and one tough negotiator.

Steve Bergsman

Market Notes


For this week's chart, we compared the interest rates on emerging market bonds to the interest rates on U.S. Government Treasuries. To represent emerging bonds, we used the yield on the Lehman Brothers Emerging World Bond Index.

The "spread" is the difference between the two interest rates. When the spread is narrow, investors are saying that emerging market bonds are almost as safe as U.S. bonds. But when the spread is wide, it shows investors are nervous about the credit ratings of emerging market governments, such as, Turkey, Mexico, and Russia... and they require high interest rates to entice them to loan money to these governments.

Right now, spreads have just bounced off all-time lows... at just less than a 2% spread over Treasuries. In other words, investors have such faith in emerging market governments, they'll accept just 2% above Treasury rates. Given that the historical norm is more like 4.5%, and the spread has just started rising again, it doesn't look good for emerging market bonds right now.

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