Issue link: https://read.dmtmag.com/i/696291
I have a lot of respect for Sam Zell. He is the only American to ever dominate more than one real estate sector, having been the largest owner of apartments, office buildings and manufactured home communities in the U.S. His portfolio stands at around 140,000 lots – which is around seven times larger than our own. He also dis- penses many great quotes, which offer terrific food for thought. "The first thing you need to understand is how little you know." – Sam Zell I think this means that you have to do great diligence and play it safe, as risk is everywhere and you have to stay alert. I see investors from other real estate sectors enter the manufactured home community business and fail miserably because they thought they knew a whole lot more than they actually did. Our customers are a unique de- mographic, and just because you have a mastery of apartments or retail investing does not, in any way, translate into guaranteed success. Zell was an early pioneer in the manufactured home com- munity business, and he knew from the start the limitation of knowledge on what was going to work well. "When everyone is going right, look left." – Sam Zell Zell is well-known as a "contrarian investor" – he buys when others sell and vice versa. When he started buying manufactured home communities in the mid- 1990s (the exact same time that we started buying them), nobody cared about the in- dustry at all. These assets were considered "goofy" and completely out of favor. Zell sensed that it was the time to buy, and has been doing so for the past two decades. His stock price is evidence that his hunch was correct. "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." -- Sam Zell Proper real estate investing is all about risk vs. reward. When you find a deal that has little risk and huge upside, you always buy. When the risk is huge and the reward is small, you never buy. But when the risk and reward are not clearly pointed one direction or the other, the key is to perform proper due diligence and get a firm han- dle on where you stand before you go forward. Benjamin Franklin said that "diligence is the mother of good luck", and that's as true today as it was in 1776. "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 signifi- cant determinant of success as an investor." "Measuring and gauging the risk reward ratio is the biggest [margin of] safety issue every in- vestor has." – Sam Zell This quote highlights the necessity to evaluate risk at all times. While you cannot invest without risk, it's essential to understand what that risk is and make sure that you are being compensated for it. This is particularly true with private utilities. When we don't buy municipal water and sewer, we must buy at a higher cap rate to compensate us for taking on the additional risk and trouble of being in the water or sewer business. "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." – Sam Zell One of the reasons that real estate investing has higher returns than other investing options is the use of leverage. As I've written about many times, what creates the actual return level is the "spread" between the cap rate and the underlying interest rate on the loan. Without leverage, the cash-on-cash return on a manufactured home community is the same as the cap rate. However, with leverage, the cash-on-cash return is much higher. But that can go both ways. That's why it's essential that you maintain that "spread" by locking in low interest rates for as long as you can and continuing to increase the cash flow through higher rents and greater occupancy. It's also im- portant to acknowledge the use of "sensible" lever- age vs. "high risk" leverage. "Sensible" leverage, in our opinion, is debt that includes 20% to 30% down payment, while "high risk" is 100% debt. Look no farther than the 2008 single-family mort- gage collapse to see the risks of zero-down debt. "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 bil- lion." – Sam Zell This is another reinforcement that, when you don't take an offer on a property, you are effec- tively buying it again yourself at that same price. As a result, it's important for any community owner to give fair consideration to all offers and market conditions. It's interesting to note that the buyers of those $39 billion of office buildings were mostly financially destroyed several years later, as the value of most of the buildings plunged below the mortgages on them. Zell sold in 2007, just be- fore the collapse. He knew it was the time to sell and not buy. "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 does- n't matter what's going on real estate is going to suffer." – Sam Zell We completely agree with this quote – that's the reason we started buying manufactured home communities to begin with. The fact that no de- cent city in America will allow a new one to be built gives our sector the most attractive sup- ply/demand position of any form of real estate. One of the problems with apartments is that cities love them and allow them to be built any and everywhere, so the owner is always racing to stay occupied when the market is drown- ing in new supply. This cycle of overbuilding is true in every segment of real estate except one: manufactured home JULY 2016 14 THE JOURNAL Exploring The Mind Of Sam Zell BY FRANK ROLFE COMMUNITY CONSULTANT \ 15