Talk of the titans
Oct. 19, 2021 - Leila UginciusAndrew Florance, founder and CEO of CoStar Group, has been in the real estate business for a long time — 30-plus years. But he had never met one of his industry heroes until last week, when he sat down virtually with Sam Zell as part of the VCU Kornblau Real Estate Program’s Industry Talk series.
The 80-year-old Zell was recognized in 2017 by Forbes as one of the 100 Greatest Living Business Minds. He is a global industry entrepreneur and investor with a long track record of turning around troubled companies and assets, leading industry consolidations and bringing companies to the public markets.
Zell is chairman of Equity Group Investments, the private investment firm he founded more than 50 years ago. He also chairs five companies listed on the New York Stock Exchange. He is an active philanthropist with a focus on entrepreneurial education and has led the sponsorship of several entrepreneurship university programs. His current investments are in logistics, health care, manufacturing, energy and real estate.
Founded in 1987, CoStar fundamentally changed the way commercial real estate professionals access, use and share information. Today the company is a publicly traded enterprise. With 27 brands, CoStar is a global provider of commercial real estate information, analytics and online marketplaces. Florance's enduring commitment to innovation has been recognized by Forbes magazine, which has named CoStar Group among the 100 most innovative growth companies in the world, as well as one of Forbes’ Fast Tech 25 and Fortune magazine's 100 fastest-growing companies.
During the industry talk on Thursday, Oct. 14, Zell shared his insights and wisdom about the real estate market and the economy, answering questions from Florance.
Below are excerpts, edited for length and clarity.
A lot of folks are trying to understand where we are in the market. We've obviously had a lot of federal stimulus to deal with the pandemic … a good attempt to mitigate the economic damage. Do you think the government has potentially overshot the stimulus and do you think we've got a situation where we're going to have something more troubling than transitory inflation?
I must admit I've been a pseudo economist for 50 years, and that I've never heard the word “transitory” before as it related to inflation. I also know that I'm old enough to be one of the few people around who lived through rampant inflation and lived through the late ’60s and all through the ’70s. Anybody since 1982 has seen interest rates only go down and inflation become less and less of a factor. I still remember what an inflationary environment was like. I certainly feel like the current environment is much more than just transitory and that this is not just a short-term bottleneck, but a combination of changing times, too much financial stimulation all over the world. The aim and shooting of fiat currency makes popcorn look like a slow-growing animal.
I think this is an all-time new rate of adding liquidity and it's affecting everything and everybody. If I'm forced to make a call, I'd say we probably have overstimulated and added too much liquidity. … Certainly, I can't see how we wanted to add more liquidity to a system that I think is overburdened already.
Going back to the '70s, I remember inflation and the impact of inflation and it was significant. It really turned real estate and everything else on its head. Can you tell us a bit more about what it was like operating in real estate and how it impacted businesses and our economy when we got into the double-digit inflation?
Well, inflation is probably best described as erosion, where your profit margins are eroded because your costs are going up. … From my own perspective, we made one of our biggest financial decisions and we became, in the '70s, the largest buyer of real estate, basically believing that it was kind of a one-shot opportunity. Most people came up to us afterwards and said, "Wow, you guys really identified which properties to buy because you did so well."
And I said, "No, I don't think you understand. In that period of time, what we created was $3 billion worth of debt. And the $3 billion worth of debt was non-recourse and was below market." I remember we closed the deal in 1987 where we were creating debt at 5% and 6% and the inflation rate was [more than] 13%. So we ended up basically creating a giant arbitrage. Somebody asked me a really interesting question the other day. They said, "Well, you know, when you have these inflationary adjustments to people's compensation, does it ever go down?" And I said, "No, it never goes down."
Then in the same manner, in an inflationary environment costs get permeated throughout the system. The separation of the men from the boys tends to be those companies that are able to prognosticate what their costs are going to be and make sure that their pricing is constantly in line with their cost structure, because in the end, it's all about margin – even in real estate.
What do you think the best source of value is in the years to come as we are dealing with inflation? How does one think about where to invest and how to hold value?
Particularly in real estate, value comes from land. ... When you look at a real estate project, it costs so much per square foot, and sometimes it costs more, sometimes less, but it's basically the land that's the scarcity.
Especially right now, with the U.S. fiat currencies under erosion or attack, or overspending, do you think cryptocurrency might become a more legitimate store of value?
I have been approached about all kinds of crypto-this and crypto-that. I'm not a believer. I think when it's all said and done, control of currency is part of the definition of government and I therefore have spent little or no time thinking about crypto and have not included that in my definition of a well-diversified portfolio.
Reading books about you and reading your autobiography, I was very impressed with your father's ability to see what was happening and act to escape the horrors of Nazi Germany, and the fact that he was a grain trader and was more worldly and had more contacts that allowed him to see what was happening. And sadly, there were too few like him.
I often think, would I be able to see what was going on if something horrible like that was happening? And you just don't know. I would say you are similarly worldly as your father. And I've heard that you've begun, for the first time in 80 years, investing in gold. Is there any balance in that decision that goes beyond looking at the eroding value of fiat currency? Is some of your decision to invest in gold based on your concern about stability in our political system?
Remember, I am where I am because my parents had a lot of “liquid assets” that allowed them to travel for 18 months and in effect go from place to place, and achieve independence and ultimately freedom. Obviously a refugee's mentality starts and ends with liquidity. The day my father died, he had a safe deposit box full of diamonds and gold — not so much — but the point being, a refugee's ready to go forward.
So from my perspective, the assault on fiat currencies is somewhat disturbing. I don't think that I'm ever going to get enough gold exposure to have any meaningful — nor would I want it —percentage of my net worth. But at the same time, when I see the kind of printing that's going on, the idea of starting to put together a pool of liquid resources, mostly because I don't know what happens. The world changes and there's time for certainty.
We've seen labor participation in the past 20 years fall from 67% down to 60%, and it's remaining low post-pandemic at 62%. We've got millions less in the workforce today. … We're seeing a severe labor shortage everywhere. How much of that do you think is a result of the over stimulus from government and how much the result of child-care issues, COVID-19 retirements, lifestyle re-evaluation? How do you think this labor shortage is going to impact the economy and real estate over the next five years?
The answer to your question is all of the above. The basic demographics cover a lot of territory. I mean, let's just start with a simple idea called immigration. ... We've grown from nothing to 300 million people by being the world's melting pot. I am strongly in favor of legal immigration. I'm very much against illegal immigration. I believe that immigrants create competition in society and may start out doing jobs that nobody wants to do, but eventually the importance to them of freedom is really the critical part of wanting to be part of the United States.
I think we should understand who we are, what we are and how we're going to stay there. And that's by becoming, and continuing to be, an open arena for growth. As far as job involvement, in 1996, I think, Bill Clinton did welfare reform based on need. And somehow or other, it's become fashionable to get the word "need" out of, in effect, providing subsidies. And I think what's going on right now is, we, in effect, created subsidies and methodologies and definitions creating way too much money, connecting people to the federal government. We've just got to become much more realistic and the sooner the better. Labor is a question of incentives. We need some labor policy and we'll stop worrying about protecting everybody that's already protected by the fact that we don't have enough people to do the jobs required.
Do you think that the biggest challenge for the office market right now is an oversupply problem, or do you think it's a weak-demand issue? And since you're my favorite distressed investor, do you see an opportunity for distressed investing potentially coming? And how would that emerge?
The elephant in the room that you haven't brought up is the concept of working from home. And the idea that working from home is going to make office buildings obsolete. Unequivocally, I disagree with that. I think work from home is an increasing necessity during a pandemic, but it's not the way you build profits and not the way you build the community, not the way you build achievements and not the way you intelligently evaluate people and their contributions. So I guess I start by saying that I think over a relatively short period of time — couple of years — you're going to see basically a return to “normal” in terms of office-building usage. A lot of people are worried about the office-building business and talk about the vacancy factor as connected to the pandemic.
My own view is that the office market was massively oversupplied before the pandemic. ... Companies basically created the appearance that they were “creating occupancy” for five years from now. So all of a sudden the statistics started saying we're going to have a shortage. And everybody used those statistics to create supply. What we’ve got today is a good old-fashioned massive oversupply. I think it's going to take a number of years. I think that to some extent, all this [environmental, social and governance] stuff and green buildings may in fact end up being a methodology of separating the wheat from the chaff, but the net effect is we have too much space. We have an enormous amount of obsolete office space. I don't know what they can convert it to, but how you deal with those values is going to be very important.