2023-07-10 07:00:00 ET
Summary
- Sam Zell died with an estimated net worth of around $6 billion and much of his success can be attributed to dancing around the skeletons of other investors' mistakes.
- He was considered to be a founder of the modern REIT era, was chairman of Equity Commonwealth and created several REITs as well.
- This article is the first in a series that I will write featuring lessons from Sam Zell, widely known as "The Grave Dancer".
I decided to dedicate my upcoming book, REITs For Dummies , to the late billionaire investor Sam Zell. I met with Mr. Zell just over a year ago to provide him with a copy of another book I wrote called The Intelligent REIT Investor.
There are so many valuable lessons to learn from Mr. Zell, and as a tribute to him, I decided to put together a series here on Seeking Alpha called Lessons From The Grave Dancer .
A few weeks ago, I ran across an article written by Mr. Zell in 1975 called “ The Grave Dancer ” which served as a “guide to the risky art of resurrecting dead properties”.
Zell wrote,
...“ investors in distressed property are motivated primarily by the exception that the equity value of a real estate asset acquired at less than its original cost-to-construct will in time increase to a point that justifies its original indebtedness.”
He added,
“…the successful grave dancer must generate cash flow by achieving and maintaining high occupancy rates in an overstocked market through good management. And he must be able to carry the property long enough to realize equity value appreciation.”
Zell died with an estimated net worth of around $6 billion and much of his success can be attributed to dancing around the skeletons of other investors mistakes.
Zell, considered to be a founder of the modern REIT era, was chairman of Equity Commonwealth and created several REITs as well.
These businesses included Equity Residential ( EQR ) and Equity LifeStyle Properties ( ELS ). Another one, Equity Office Properties – a company Zell sold to Blackstone for $39 billion in 2006 – was the first REIT named to the S&P 500 Index in October 2001. And Equity Residential followed a month later.
At some point, I may turn this series into a book, which would be extremely valuable to readers and investors. I’m confident that Mr. Zell would concur, as many REITS are being priced as if they’re going bankrupt, as he wrote,
“The opportunity of acquiring real estate in its current distress offers the greatest single economic opportunity for investors in our time, one that is not likely to occur again.”
Again, Mr. Zell penned the article in 1975 when the economy was emerging from a recession (late 1975) in which inflation was falling from double digits to around 7%. The prime rate peaked at 12% in July 1974 and gradually declined to 7% by June 1975.
Employment fell from around 9% in 1975 to below 6% in 1979.
In 1979, the Iranian Revolution increased the price of oil dramatically, causing the 1979 energy crisis. Tight monetary policy to control inflation (soared to 14% as seen below) led to another recession.
And rates soared in the 1980’s but the recession sparked a decline in rates. In fact, after every recession (in yellow) rates declined, which serves as an indicator that “what goes up, will always come back down”…sooner or later.
What this all means is that we believe we’re getting closer to the time in which REITs will become suitable for grave dancing .
The Federal Reserve is attempting to balance the tightrope, by nudging rates up and hoping to reduce inflation to its target level of 2%. As I explained in a recent article,
“While we can’t predict when the rate cycle will end, we do know that when it does it will be a very good environment for REITs. In fact, U.S. REITs have historically produced returns above 15% over the six months following the end of a Fed hiking cycle.”
Quoting Mr. Zell again from the 1975 article,
“Grave dancing is an art that has many potential benefits. But one must be careful while prancing around not to fall into the open pit and join the cadaver. There is often a thin line between the dancer and the danced upon.”
Supply and Demand
Mr. Zell was keenly aware of the principle of “supply and demand” as he explained,
“The slower rate of new construction, expansion, and development will force an increase in the rentals and sales prices of all forms of real estate. It is the shift in the revenue side of the equation that provides the greatest lure to the grave dancer…To those with staying power, patience, and management ability, the potential rewards are tremendous.”
On the Q1-23 earnings call , Digital Realty’s ( DLR ) CEO, Andy Power, said
“While an economic recession could slow capital spending, third-party data centers also benefit from the trend towards outsourcing. Customers often make the decision to lease rather than build on the availability of capital. We saw the same thing during the great financial crisis.
For many of our customers, data centers can also help drive revenue growth will facilitate lower costs or even enhance overall productivity. We are optimistic that our business will remain resilient in 2023 and for years to come.”
In Q1-23, DLR signed $155 million of renewal leases with pricing increases of 4.5% on a cash basis, the company’s strongest renewal pricing quarter since the early days of the pandemic.
In addition, renewal spreads continued accelerating +4.6% on $118 million of volume, nearly 400 bps faster than it was in Q4-21, and more than 100 bps better than full year 2022.
DLR’s full year guidance, including cash and GAAP re-leasing spreads over 3%, same-capital cash NOI growth of 3% to 4% and year-end portfolio occupancy between 85% and 86%, are all solid indicators that suggest “wide moat” attributes.
Our team is bullish with increased AI demand, as the CEO summed up at a recent REITWeek conference in New York City,
“I think we're going to have a place to play in supporting the growth of AI. And what we're trying to do is navigate it to do that in the most value-add to the end customers' deployments to create a more sustainable business model around it.”
iREIT® maintains a Buy (+8.4% since June 13, 2003 deep dive ) as shares trade at $113.80 with a dividend yield of 4.3%. DLR has become a core position for me (happy that I accumulated during the Hedgeye short ) as we expect to see above average returns based on analyst growth estimates of 7% in 2024.
Pricing Power
Another quote from Mr. Zell’s article,
“The thesis advanced here is distinctly different from the concept that ‘inflation will bail out past mistakes.’ Inflation bailout is the expectation that rents will rise faster than total expenses, because a large portion of expense is fixed debt service. The grave dancer relies on the theory that a major increase in rents is probable because of a significant shift in the demand-supply equation for real estate.”
Simply put, owning real estate with pricing power can benefit landlords during periods of high inflation.
One of my favorite pricing power picks is Extra Space ( EXR ), a leading self-storage landlord that has an impressive portfolio of 2,388 properties (owned and managed) in 41 states.
While most don’t consider EXR to be a technology play, I consider the company to be a tech-savvy player due to their customer acquisition and data analytics capabilities.
EXR has doubled in size since I began coverage (in 2013) from just over 1,000 facilities to over 2,300, and should merge with Life Storage ( LSI ) in the second half of 2023 to become the largest self-storage landlord in the world – with over 3,500 properties and close to 13% market share in the U.S. (PSA has 10.1% market share).
In Q1-23 EXR’s occupancy remained very strong, ending at 93.5%, the highest first quarter result outside of the COVID years. This allowed the company to increase rates (pricing power), driving same-store revenue growth of 7.4%. Analysts are forecasting 7% growth (in AFFO) for 2024 and this provides meaningful upside for stakeholders.
Shares are now trading at $148.12 with a dividend yield of 2.7%. That’s low for income-focused investors, but keep in mind that EXR has a history of increasing its dividend (108% over 5 years) and shares are cheap, based on a P/AFFO of 18.3x (normal is 22.9x).
Stay Tuned for More Lessons from The Grave Dancer…
I hope you enjoyed my first edition of The Grave Dancer series and I look forward to future editions.
Mr. Zell was a legend and I’m excited to share more insights in hopes that readers find attractive REITs to buy with a margin of safety. Remember however,
“There is often a thin line between the dancer and the danced upon.”
Brad Thomas
RIP Mr. Zell
Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
For further details see:
Lessons From The Grave Dancer