Sam Zell – A Tribute to a Legend (REPLAY – EP.253)

0:00Last Thursday, we lost Sam Zell, one of the true investment greats and one of the most popular past guests on the show. As a small tribute to the great man and investor, we're replaying my conversation with Sam. Please enjoy the incredible and entertaining story of Sam Zell, a true contrarian whose common sense generated uncommonly exceptional returns in dollars and in a life well lived. Please enjoy my conversation from last year with Sam Zell.

0:58and their capital. You can join our mailing list and access premium content at capitalallocators .com. My guest on today's show is legendary investor Sam Zell, chairman of Equity Group Investments, a private investment firm he founded more than 50 years ago. Sam has a storied track record of turning around troubled companies and assets, leading industry consolidations, and bringing companies to the public markets. His current investments canvas logistics, healthcare, manufacturing, energy, and real estate. Sam was recognized five years ago by Forbes as one of the 100 greatest living business minds, and he's still going strong.

1:41Our conversation covers Sam's childhood background, early entrepreneurial efforts, formation of his investment strategy, and comfort being a contrarian. We then turn to Sam's thoughts on team development, evaluating people, real estate, generational businesses, emerging markets, and opportunities for the future. Please enjoy my conversation with Sam Zell. Sam, thanks so much for doing this. My pleasure. I thought it'd be fun to start with your background, and we can go all the way back. I know your parents escaped Poland at a key time, and we'd just love to hear how that influenced you as a kid?

2:20Well, I think it's in the most simplistic form. It means that I grew up in a kind of a very unique atmosphere. I was born 90 days after my parents came to this country. So I was growing up with parents who were learning English, learning their way around. Extraordinarily grateful to this country for allowing them to come, just not believing the concept of freedom, what it meant. And yet at the same time, there was a prevalence that don't get over enthused, recognize the fact that anything can happen, and always be prepared for the unprepared. My home, I had an older sister. My father worked seven days a week.

3:18There was a overwhelming pressure on performing. And in the case of my parents, performing was doing well in school. Also, a limited acceptance of the need for quote unquote fun. I remember vividly when my sister was maybe 14, she came home from a basketball game that her high school had lost. And it was in the semifinals or something, and she was crying. And my parents couldn't conceive that anybody could cry over a basketball game. Their whole definition of life had been so different that in terms of priorities, okay so you didn't win what's that got to do it's no different than when i was in high school i went to the basketball game on friday night and the following week i told my parents i wanted to go to the next game and their only reaction was wait a minute you went once why would you want to go again.

4:31So in the same manner, I was continually accosted by my parents' view that I was different, that coming in and saying, well, Johnny's parents said he could do it, well, carried no ice. I mean, he got no support. So I think that what I've tried to describe here is a very unique environment, very much of an immigrant's environment, very much of a real appreciation of what it meant to be here and be in the United States. The constant reference of the Japanese concept of the nail that sticks out gets hit. So this was the kind of an environment that I grew up in, and it created and demanded a level of seriousness at a very young age that was very different from my friends.

5:34I think that's maybe the most important theme was that whereas most of us grow up and evolve somehow in relation to our friends, the message was very clear. You're different. Your expectations are different. And the comparison carries no weight. How did you get your first taste of either entrepreneurship or investing? I think I'd start by saying that I always equated making money or having money as part of the definition of freedom. My father did very well, but there was no excess of money around. There was a constant respect for money. And so I found myself, I couldn't help it, trying to figure out how to acquire capital and what I could do to do that.

6:38And there were a lot of things that I did as a young kid from setting up a Photoshop opportunity at the eighth grade party and then selling the pictures. when I was 12 years old. I lived in Highland Park, which is a suburb of Chicago, and I went into the city every day to go to an advanced Hebrew school. Compared to today, the idea of being a 12 -year -old and getting on the train and going back into the city every day didn't seem particularly unusual. Admittedly, nobody else I knew did that, but that's kind of what I did every day. And being a 12 -year -old alone in the city every day also obviously led to my curiosity.

7:29And I eventually discovered that there were magazine stands underneath the L -Tracks that sold magazines that were different than the ones that were available in Highland Park. In 1953, a guy named Hugh Hefner put out a magazine called Playboy. And I discovered it on the magazine rack. And it was 50 cents, and I bought it. And I read it on the way home on the train. And I mean, it was pictures of naked ladies. But more important, it was stories about things that, as a 12 -year -old, I didn't know anything about. And I got home to Highland Park and I showed it to one of my friends. He had never seen anything like that either.

8:20And he wanted to buy it. And I just flippantly said, okay, three bucks. He said, great. And he gave me $3 for what I just paid 50 cents for. And it obviously dawned on me that there was a market that was unfulfilled. and that there was significant demand. And so I started importing Playboy from Chicago to Highland Park and reselling it to my friends. It was a nice margin business, but it was another example of seeing an opportunity and not only recognizing what it was, but recognizing a way to take advantage of it. Yeah. So that was a few decades ago. I'd love to hear a bit about how you evolved from that curiosity and real entrepreneur as a kid to investing, as you think about it, with your team today.

9:21Well, I mean, that's, again, a very long story in terms of what it means. But I think that I went to law school. I did, for me, reasonably well. I graduated in the top quarter of my class. although I've always said repeatedly that I've never viewed myself as an academic. And of course, my grades reflected that throughout my high school and college and law school years. But I was always good enough and figured out how to, quote, do well enough to reach the next objective that I had set. and I then made a very concerted effort to get a job. I was singularly unsuccessful. I had 44 interviews in which to garner one offer and that was a very depressing result and for an achievement oriented individual I had never experienced rejection like that and I'd never understood it.

10:34And then one day I was in the process of interviewing with a big law firm and I made it through the first interview. And I then went and was called to interview with the senior partner. And I went into his office and I sat down. He got up and he closed the door and he looked at me and he said, tell me about your deals. And I looked at him and I said, tell you about my deals. I want a job. He said, oh, well, we would never hire you. You'd be gone in three months. And I just looked at him and I said, what about Perry Mason? I was 21 years old or 23 years old. But what I learned from that interview was that when I had written my resume, instead of the typical resume that listed, you know, being head of the kindergarten toilet patrol or something, I had basically laid out what I had done while I was an undergraduate and while I was in law school.

11:41And I had built a very successful apartment management business and then started buying buildings. And when you ask about investment acumen, And I'd say that I kind of adopted Abe Lincoln's philosophy of common sense isn't so common. I mean, the first management opportunity we had was I went home one night and visited a friend. And he lived in a house. And he said that the owner of the house had been there the night before and had bought the house next door. And as soon as school was over, he was going to knock down both houses and build an apartment building. 15 units. And I said to my friend, gee, maybe we could con them into letting us run the building.

12:31Maybe each get an apartment for free and return running the building and maintaining it. And after all, we're students and we know more what students need and want. So we put together a little brochure and we went and pitched the guy and much to our amazement and my happiness, they bought my act. And so starting immediately, we took over the responsibility for running this project. And effectively, within a few weeks, we were responsible for everything but construction. We leased all the apartments. We identified the furniture. We followed up on all the stuff. And people, when they hear this story, say, how could you do that?

13:21You were a junior in college. You were 19 years old. And I think it's been a theme of my whole career that nobody told me I couldn't do it. Nobody ever said, well, you know, you've got to be 35 to do this. I mean, you know, there's a provision in the Constitution. You've got to be 35 to be president. But I wasn't becoming president. I was just doing simple logic. And so when I bought my first building, it was a three -flat. And I paid $19 ,500 for it, $1 ,500 down in a land contract for the balance. and what I had done was I had looked at this three flat and it was kind of seedy and I figured if I repainted everything threw out all the furniture and brought in new Scandinavian modern furniture which was all the rage at that time I could significantly increase the rents.

14:26So I bought the building. I repainted the units. I bought new furniture. I doubled the rents. And all of a sudden, I discovered that I had a significant cash flowing asset. And obviously, among other things, what I learned from that was that the merits of cash flowing assets is the only kind of thing that matters. I mean, you can't pay your rent or you can't pay your interest payments with earnings. You can only pay it with cash. And so throughout my period of undergraduate thereafter and law school, our management company grew into the thousands. It became a significant business. We went from owning one building to maybe 10 or 12 or all of which with simple philosophy of how was I going to protect myself from competition?

15:26And to the extent that I could buy at the right price, make minimal improvements that produced outside results, the logic of that was overwhelming. And yet it wasn't rocket scientists. It wasn't anything anybody else said, how did you figure that out? It was that I literally went and did it. And I had enough confidence in my own judgment that doing it really would work. And obviously, I got reconfirmation from the success of what I achieved. So when that guy looked at me and he says, we wouldn't hire you, he then looked at my resume and said, what are you kidding? Nobody can do what you did. Why would you want to be a lawyer?

16:20And that was the first time anybody had ever said to me that what I did was unique. I just thought what I did was de rigueur. And I think that my entire investing career has had lots of different principles that have been relevant. But the overall theme has been just logically doing what I did, not viewing it as a secret formula or a rocket scientist, but just taking advantage of simple, logical assumptions. What are some of those other relevant principles that you've learned along the way? Well, I think it starts with the word competition. We live in this unique capitalist environment where you're taught from day one in school how important competition is and how competition creates and perpetuates price discovery and how it reduces inflation and how it increases efficiency.

17:29All of which seemed very logical to me, with the exception that none of it focused on the producer. It only focused on the consumer. Once I found myself as the producer, whether it be apartments or other things, I all of a sudden looked out and said, wow, competition is awful. Given an opportunity, tell me where I can achieve a monopoly or an oligopoly. But wide open competition is ultimately destructive because there's always someone who's willing to do it for cheaper than you are or do it in a manner that you're just not willing to do. So I think it starts with openly competitive situations.

18:27Situations without barriers to entry are not the things that produce outside results. Keep in mind, I never had any capital to begin with. So from the very beginning, I had to create situations and investments that didn't generate a return as much as generated an opportunity to amass capital, which much later in my life became, how do I invest for a return? But in the beginning, the focus was, how do you amass capital? So obviously, Jack Welch said it all when he said, if you're going to be in an industry, you want to be number one or number two. The lower rank players never have a good outcome.

19:18Supply and demand. I mean, I walked into my first econ 101 class at Michigan and on the wall was the sentence supply and demand. And there's been very little additional help needed to understand how to identify opportunities. So looking at all the different scenarios, they truly begin with how do you avoid competition, polluting your ability to make margins. You've used the phrase often liquidity equals value. you. I'm not sure I fully understand what you mean by that, so I'd love to hear what that means to you. Someone who started out with nothing and was capable of building a fortune, particularly one that wasn't predicated on some invention or something that created massive multiples of the original idea, somebody who operated like that, needless to say, had to, in order to succeed at that level, you had to undertake serious leverage.

20:32So for the first 25 or 30 years of my career, we were always over leveraged. We were always literally living hand to mouth, despite the fact that we were very successful. Nobody's lifestyle reflected that because there was never any cash. And then in various downturns, obviously our medal was tested. And what we learned was that I had an experience in, I think it was 1992, where according to Forbes magazine, I had a net worth of a billion dollars. And it was a Wednesday. And I was worried about how to make payroll on Friday. So I learned that, yeah, I had a lot of assets. But to the extent that those assets weren't liquid, I didn't have any value.

21:30So that's where that phrase comes from. I'm curious, when you went through that whole period of time with significant leverage, there was clearly a lot of risk. Leverage creates its own risk and downturns. How do you think about and evaluate risk? Well, I think I start by saying that evaluating risk is very simple. Bernard Baruch, who was a financier in the 20s and who supposedly sold out of the stock market before it crashed in 1929, had a wonderful phrase, which was, nobody ever went broke taking a profit. And so my definition of risk has never been anything other than what's the downside? And can I figure out what the downside is?

22:27Because if I can do that, then each step of the way represents a commitment to go forward and a reflection that that downside represents the risk I'm taking. So, I mean, one of my most successful deals was the deal we lost $50 million on. But before we did it, we did a risk analysis, concluded that if it didn't work, we were going to lose $50 million. and that's what we lost. And so from my perspective, that was a very successful deal because I had identified the risk, turned out that what I had hoped was going to happen didn't happen, but on the downside, on the fire sale analysis, the risk I had identified was one I could handle.

23:21Now, obviously, every decision about what the downside is has to include the other side, which was, can you handle it? If identifying the risk says, I've got one and the risk I'm taking is three, that's a very, very different view of playing cowboy. You've been labeled grave dancer, kind of the ultimate contrarian. So clearly your assessment of downside risk at times is different from others or the market. I would correct you. I think that the difference is, I think it was Warren Buffett who said, buying when everybody doesn't want to buy creates opportunities. I don't think that most people disputed my approach.

24:08I mean, in the 70s, when we did our first major grave dancing from 73 to 77, we were operating on a very simple premise, and that was that if you could buy stuff at 30 % of replacement cost, and you designed the buying so that you had time, staying power, that how could you lose? Now, I'm not sure anybody really would dispute that logic, But there's a big difference between not disputing and executing. So what do you think it is in your constitution, you and your team, that gives you that comfort in executing in that case or being a contrarian? I think it starts and ends with self -confidence.

25:04It starts and ends with the ability to assess risk, what could go wrong, how much of a Hail Mary do you need in order to achieve your objectives? Do you have enough time? In other words, there are a lot of great investments that if they had the time, the staying power would have proven very well for the people. But they didn't have that staying power. And the result was that the deadline approached before the hallelujah. How have you inculcated that type of approach to your team? So a lot of times you as an individual may have that constitution, but it can be hard to have the culture so that a team can execute, particularly when you've gotten now to a much bigger scale than where you started.

25:58Well, I think it begins with the 11th commandment, which is thou shalt not take oneself seriously. So from the very beginning, I've been very focused on creating and maintaining a culture of activity within our operation. And that culture is one of complete access. So the door to my office has been closed less than five times in 30 years. So what that means is that anybody can wander in, and they do. And the message is sent out that it's okay to wander in. It's okay to ask a question. It's okay to show a weakness, which is maybe you don't know anything. When the boss says, I don't know, that creates a lot of confidence among the people.

27:03The fact that we meet between one and five days a week as a crew and just talk about what we're doing. On the theory that, one, everybody should understand. Everybody should be aware of what the risks are. And everybody should be a willing contributor. I think the other piece of the equation is from the very beginning, everybody who had a decision -making role in our operation had a piece of it. And everybody, peace was dependent upon their willingness to contribute some form of capital so that we were aligned and everybody had skin in the game. When you put together the things that I've just outlined, I think as a group, they all come together and say that's how you create a community where everybody is worried about everybody else.

28:05The bad guys are without. That's why we fight against bureaucracy or fight against the risk of people using information as currency. the antagonisms, the conflicts, all need to be outside of this environment. So that it isn't whoever, I think Doris Kearns wrote this book about Abe Lincoln's cabinet being a team of rivals. I think I view the success of our operation to making sure that we never created a team of rivals. That our rivalry was focused on the outside and competing against other people, not competing against each other. I know you make these fabulous year -end gifts, which is all part of that fun.

28:56And you've mentioned fun a couple of times. How do you bring fun into a serious team and investment effort? Learning to laugh at yourself. In other words, remember, you're the leader. You set the goals. You set the objectives. You create the standards. To the extent that you're willing to laugh at yourself, the extent that you're willing to put your neck on the line by doing a year -end gift or whatever it is, that sets a precedent for other people around you. And I think that more than anything else, that's what contributes to that environment. But it's also tied to accessibility. The story about the door in the office is very, very significant.

29:44Because where in the past I've taken over companies and been involved and find locks on doors, I become very skeptical. What have you learned about assessing people? Well, lots and lots. I think it starts with in almost every interview I've done, I ask the question, are you hungry? Because if people aren't really hungry, if they really aren't motivated, then there may be lots of place for them in this world, but not in my world. So I'm looking for people that are hungry. I'm looking for people that are aligned and loyal, who have a long, there's this oxymoron about long term. Well, I really am a long term investor.

30:35And that goes for real estate and it goes for people. So I'm looking for people that are attached. and as a result we have a very unique age or work history in this organization where people are here for long periods of time. We've only had one serious recruitment away from here in 50 years. Lots of people quit and start their own shop and do other things and I'm very supportive of people pursuing their objectives. But we only had one person recruited away. And within about six months, he came back. So I asked him, I said, well, I don't understand. You got more money, you got a bigger title, you had all this good stuff.

31:28And he looked at me and he said, yeah, but when I worked here, if I had a problem, I would just walk into your office, you and I would solve it. Now I write a memo and wait two weeks if it happens. And that's just not fun. And in the same manner, if you asked me for a theme of this operation, if you didn't fund, we don't do it. And so you look for people that can laugh at themselves, that won't take themselves too seriously, that are willing to take the risk of advancing an opinion knowing they may not make it and they may not be right or they may not get support. But those that aren't willing to do that need to work other places.

32:17I'd love to turn a little bit to current opportunities. We've been in a market at least till recently, where everything felt expensive? And maybe even start with real estate. Where have you been seeing potential opportunities on the horizon? Since the Great Recession of 2809, we have been the least acquisitive of real estate since we began. We run two public companies for which we're responsible for, and they have added to their portfolios, but they're very big companies, and therefore they're subject to being more aligned with the market than being opportunistic. About six years ago, we took over a company called Commonwealth REIT, and we acquired, with that process, a company with about 7 billion of assets.

33:14And over the last five and a half years, we've sold 142 out of 146 properties. We have not bought a single one. And what's really amazing is that I sit here today and I say, okay, I just sold over a five -year period 142 properties. Am I sorry that I sold any of them? And my answer is no. I think that's an indictment of the pricing of the real estate market in this period of time. So I think that if you go back to the end of World War II, real estate is is cyclical. And each time it gets cleaned up, each time it results in kind of a mark to market and it corrects and begins again. In 08 -09, we didn't deal with a mark to market.

34:18We dealt with pretend and extend. So I think that the overall real estate market is probably still inflated. And certainly when the yields that people are willing to buy stuff for today reminds me of the story about shorting a stock at a dollar. Well, the stock may be a lousy company, but the odds are you can make a dollar or you can lose unlimited amounts of money. Well, I don't know that buying real estate at a 3 % yield isn't doing the same thing. So you might not have been able to in Commonwealth, but perhaps in your opportunistic pools, where have you then redeployed capital? Well, we have historically, for lack of a better word, followed themes.

35:08And in the last six or so years, what we've discovered is that there's an interesting phenomena going on. We like to refer to as generational investing. And that means that private companies have been built up over a long period of time. You're now into the second generation. That second generation is maybe eight or ten people. In that second generation, there's one or two that are involved in the business. And the other six or eight wait for a check. and what we've been able to do and do very successfully is provide the capital to take out the ones sitting on the sidelines, allowing the two that are involved to roll over into the future of the company and then we provide both the capital and the discipline and the knowledge of running companies to basically improving these businesses.

36:18What we found is that, number one, I think in the last seven or eight deals, we were not the high bidder, which meant that we were getting credit for what we are and what we do. That's a very important theme because, in effect, the minute you don't get credit, then you're a commodity. Commodity investing doesn't have a long positive track record. So the results have been very successful. We've basically found ourselves providing structure and discipline and hiring and a lot of things. are a lot of companies that succeed without much structure. We bought one company where there was a single second generation entrepreneur.

37:12He did great, but he was like a one man band. And yet he had his hands around a business that could be dramatically improved. And since we did that deal, I think we've doubled the revenue. We've helped him hire a whole bunch of people. He now has a structure. He did a budget for the first time. I mean, it's a business that does four or five hundred million dollars a year, previously run from his hip pocket. And obviously, from our point of view, we end up making very attractive investments with very attractive yields. Frankly, they make thinking about minuscule returns from real estate pretty unattractive.