Sam Zell is the founder and chairman of Equity Group Investments, which started in the real estate business but now owns a range of businesses. Sam Zell’s nickname is “the Grave Dancer” since he is often a distressed asset investor. This is a blog post about Sam Zell the investor. As is the case with all of my blog posts, if you have an issue with the political views of the featured investor, I suggest that you try another blog.
- “The first thing you need to understand is how little you know.” The best investors understand that the more you know, the more you know that there is even more you do not know. Creating a taxonomy that categorizes your lack of knowledge is helpful since problems in life most often come from not knowing what you are doing. There are three categories: (1) you may know the potential future states and the probability that those potential future states may come to pass. This is known as “risk” and is rare. (2) you may know the potential future states, but not the probability that any of those potential future states will happen. This is uncertainty and is most common. (3) you may encounter future states that you had no prior idea were even possible. This is the domain of “ignorance.” This third domain (Black Swans) impacts people’s lives way more than they imagine since even though events in this domain do not happen that often, when they do, it produces massive disruptive change.
- “When everyone is going right, look left.” “I‘ve spent my whole life listening to people explain to me that I just don‘t understand, but it didn‘t change my view. Many times, however, having a totally independent view of conventional wisdom is a very lonely game.” Sam Zell is expressing the same view as investors like Howard Marks who recognize that it is mathematically provable that without being a contrarian in some instances (and being right about that contrarian view in those instances) it is not possible to outperform a market. You simply can’t follow the crowd and beat the crowd. Being contrarian for its own sake is, of course, unwise. Sam Zell is saying that you should “look” left, which does not necessarily mean you should “go” left. But sometimes that look left will give you enough confidence to place contrarian bets since you will see that the odds are substantially in your favor.
- “Listen, 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.” This statement is all about the value of seeking positive optionality. Every once in a while, if you are looking hard for opportunities, you will find a mispriced bet within your circle of competence with a relatively capped downside and a huge potential upside. It is wise to bet aggressively in these cases since it allows you to harvest positive optionality. Betting when the optionality of the situation is negative is a fool’s errand. Situations with a big up side and a big downside are by contrast problematic. This situation is likely to result in the most work and for that reason alone it may be wise to put decisions within it in the “too hard” pile.
- “At all times, we are keenly aware of what our exposure is. As a result we are much more of a Benjamin Graham kind of investor. We are very focused on what the liquidation value is. Barnard Baruch, who was a very famous financier said ‘Nobody went broke taking a profit.’ In the same manner, I have never suffered from any transaction turning out to be too good. The real issue is ‘What is the downside’.” “My own formula is very simple. It starts and ends with replacement cost because that is the ultimate game. In the late 1980s and early 1990s, I was the only buyer of real estate in America. People asked me, ‘How could you buy it?’ How could I project yields? Rents? For me, it came down to these issues: Is the building well built? Is it in a good location? How much less than the cost of replacement is its price? I bought stuff for 30 cents on the dollar and 40 cents on the dollar.” Sam Zell likes to buy assets with a Ben Graham-style margin of safety, even if the asset class is commercial real estate. The value investing formula is simple: buy at a bargain and wait. I suggest that you don’t try to make it more complex than that. Most value investors are happy with a 30% margin of safety, but Sam Zell is saying here that he has sometimes been able to buy real estate at what he considered to be as much as a 70% margin of safety. In doing so Sam Zell is also taking a view similar to Howard Marks in that he is controlling risk. Howard Marks believes: “Success in investing is not a function of what you buy. It’s a function of what you pay.”
- “I pound on my people: taking risk is great. You’ve got to be paid to take the risk. The risk/return ratio is probably the most significant determinant of success as an investor.” “Measuring and gauging the risk reward ratio is the biggest [margin of] safety issue every investor has.” Getting paid for any risk you take is a key part of risk control. In my post on Jeffrey Gundlach I wrote: “Taking in risk for its own sake is a sucker’s bet. More risk does not necessarily mean more investment return.” Sam Zell is talking about the same principle here. What you want to find is mispriced risk or uncertainty so you get paid for taking that risk or uncertainty since as Howard Marks has pointed out: “If riskier investments necessarily delivered higher returns they wouldn’t be risky.”
- “You can have all of the assets in the world you want, but if you have no liquidity it doesn’t matter.” “Liquidity equals value. At no time in my career has it ever been more clearly brought home to me than in the (2008)-09 period. If you had liquidity, you had value. … Everything comes down to liquidity, everything comes down to exit strategies, everything comes down to knowing when you get in how you are going to get out.” A repeating theme of this series on my blog is Harold Geneen’s admonition: the only unforgivable sin in business is to run out of cash. Being in a situation where lots of people have lots of assets but no cash is like being in a big earthquake. You can’t believe it is happening, but there it is. Sam Zell pointed out http://scholarship.sha.cornell.edu/cgi/viewcontent.cgi?article=1069&context=crer that once in 1990 he read in a magazine that he was worth a billion dollars and yet he did not know if he had enough liquidity to make payroll the next Friday.
- “The problem with leverage is that you need to pay it back. The biggest measure of success or failure is how entrepreneurs address and deal with leverage. If you are in the real estate business without leverage, that’s like being a boxer in the ring without a glove.” Some people are more comfortable with debt than others. Some people sleep well knowing that they or businesses they control owe other people billions of dollars. Others can’t seep while owning anyone much of anything. Learning how to manage debt and you reaction to being in debt is a valuable skill. Sam Zell is saying that leverage in his business is a not avoidable so he has learned to be really good at managing leverage.
- “Anytime you don’t sell, you buy. So if we had chosen not to sell Equity Office for $39 billion, we would be buying Equity Office for $39 billion.” Sam Zell is talking about what Charlie Munger calls “opportunity cost” thinking. Munger says: “In life, if opportunity A is better than B, and you have only one opportunity, you do A. There’s no one-size-fits-all. If you’re really wise and fortunate, you get to be like Berkshire. We have high opportunity costs. We always have something we like and can buy more of, so that’s what we compare everything to. We know we’ve got opportunity X, which is better than the new opportunity. Why do we want to waste two seconds thinking about the new opportunity?”
- “I would tell you whatever business I’ve been in — real estate, barges, rail cars — it’s all about supply and demand.” “When there is no supply, real estate performs very well. Almost without regard, within reason to the economic conditions. When there is over supply, it doesn’t matter what’s going on real estate is going to suffer.” Economics is far simpler than most people imagine, especially for a business person. Your task in business is to create a situation where supply is at least somewhat limited by some phenomenon. successfully deal with competitors a business will need what Harvard Business School Professor Michael calls a “sustainable competitive advantage.” Warren Buffett calls this same characteristic a “moat.” Michael Porter: “That free entry dissipates economic profit is one of the most powerful insights in economics, and it has profound implications for strategy. Firms that base their strategies on products that can be easily imitated or skills and resources that can be easily acquired put themselves at risk. To attain a competitive advantage, a firm must secure a position in the market that protects itself from imitation and entry.”
- “Arthur Miller did a huge disservice to entrepreneurship by writing Death of a Salesman. Salesmen are not scummy and dirty – people you would not want to ring your doorbell. In fact, all successful entrepreneurs are salesmen.” Selling is a highly underrated skill in life. Everyone can benefit from learning how to sell better since in addition to products and services people must sell ideas, causes and many other things in life. Salespeople tend to be highly compensated since the activity is (1) hard and (2) requires real skill. Sam Zell has gone as far as to say: “Nothing is bought and everything is sold.”
- “Business schools are beginning to change, but particularly in the ‘80s the business schools focused on if you could just turn the page there’s the formula that tells you how to do it. And the answer is there are no formulas and – and success and failure are – are a combination of judgment and an external event. But it starts and ends with a simple idea.” “Don’t get confused by education: Simpler solutions are most often better solution!” Sam Zell is talking about a point made by Ben Horowitz in his book The Hard Things About Hard Things which I wrote a post about recently https://25iq.com/2015/07/05/a-dozen-things-ive-learned-from-ben-horowitz-about-management-investing-and-business/. The real world of business cannot be navigated successfully simply by applying simple formulas or following a recipe for success. There is no substitute for things like learning from experience, good judgment and hard work in life.
- “Entrepreneurs basically not only see the opportunities, but also the solutions.” “A critical element to a successful entrepreneur- he or she thinks in themes, not in single events.” “I don’t know too many insecure successful entrepreneurs.” “Fear and courage are very closely related. Anybody who does not understand fear does not know courage.” “Entrepreneurs don’t fail – things sometimes just don’t work out. But, that’s it.” “Entrepreneurs don’t just deal with risk, they have risk appetite. They look for change that will make the difference.” “An entrepreneur is a guy who thinks outside of the box, a person who does not accept the conventional. He constantly asks ‘what if?’, ‘could I?’, or ‘should I?’” “There is a Confucian saying: ‘The definition of a schmuck is someone who reached his goal.’ Entrepreneurs always keep going – they never stop. “It is lonely being an entrepreneur. Often, you turn around and ask: where is everybody?” This set of quotes makes an number of important points about being an entrepreneur including the idea that courage is a highly underappreciated driver of the success of entrepreneurs. If you don’t get in the game, you can’t win. Perhaps the best way to end this post is with a joke Sam Zell once told: “I’ll tell you a story that I think is probably the most significant advice that I give young entrepreneurs. A pious Jew is facing bankruptcy, and he beseeches God repeatedly each week to let him win the lottery to save his livelihood. The first week, he doesn’t win. The second week, he doesn’t win. But the third time, a flash of light appears, and from up high, comes a voice — and it’s the voice of God — and he says ‘You’ve got to buy a ticket!’”
Bloomberg Interview http://genius.com/Sam-zell-2-5-2014-bloomberg-interview-annotated