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GRAVE DANCER

FOR THE NEXT ten years, the odd yet tight-knit couple of Sam Zell and Bob Lurie snatched up distressed and bankrupt companies, riding out the ugly mid-1970s U.S. economic recession. They shunned the high-risk, high-debt development game, which saw many real estate titans, even the legendary Trammell Crow in Dallas, teeter on the brink of bankruptcy. In doing so, the duo garnered a national reputation for seeing trends that others could not. And Zell remained the front man for the business.

By 1978, editors at the Wharton School of Business’s quarterly magazine, Real Estate Review, were certainly impressed with Zell’s ability to harvest gold from the darkest despair—as well as the increasing depth of his pocketbook. He had donated $35 million to the university to start a new real estate management school, and they felt he was a worthy candidate to write a column for an upcoming issue. Rarely one to shirk an opportunity to tell everyone exactly how he feels, Zell agreed. It was the veritable win-win. His reputation would be cemented in one of the leading journals of the day, and he also was given the type of national platform he craved.

A respectable writer with a flair for blending matter-of-fact candor with a healthy dose of contrarian opinion, Zell thoughtfully penned his ode to the state of the markets. In a bit of sanguine fate, just before his deadline, he concocted the cryptic title “The Grave Dancer.” It seemed only fitting, as he prominently boasted in his discourse that he often “danced on the skeletons of others.” As the last line in the column noted, “You gotta’ dance around the edge. But you don’t fall in.”

The headline became a moniker that would become forever synonymous with Zell, his mantra for the remaining chapters in his business life. And Sam approved. After all, Zell is a true believer in capitalism and the wealth of riches the system can bestow on those who take reasonable risks to achieve reasonable rewards. He is often characterized as a value investor, someone who sees value where others do not or cannot. Rolling up distressed businesses into newly frocked entities and then cashing out when market conditions are appropriate is his pragmatic, free-market approach.

Sensing the changing winds that would soon blow over the real estate industry, Zell and Lurie did something that left most of their investor peers scratching their heads. They closed the spigot on their property investments in the early 1980s. In 1981, they reaped some of what they had sown on their way to cashing out. For example, they sold Chicago’s landmark Field Building for $94 million, making a hefty $42 million profit in just three years.

Zell described the real estate industry at the time as “a really shitty business,” meaning that it had become crowded with investors looking to emulate his strategy. While imitation may be the sincerest form of flattery, Zell eschews copycats and competition.

As partners, as always, Zell and Lurie huddled for hours at a time, discussing the pros and cons of continuing with the new status quo they had set into motion years earlier. They had made millions on property over the past decade, but they wanted more. Ultimately they decided to turn their backs on real estate, for the time being at least. Instead, they would try their hand and test their business mettle in the corporate world. The idea was to diversify, to go outside their comfort zone, so as not to have all of their investment eggs in any one basket.

They carried no preconceived notions about how to buy and sell companies outside of real estate, but they viewed that as an asset rather than a liability. In particular, Zell believed that true entrepreneurs follow their instincts, based on what they see around them, and take a commonsense approach to the game of buying, running, and selling companies. Many in the real estate industry were envious of Zell’s ability to shed his skin so easily. Most were mired, even trapped to a certain extent, in the only business they knew. They were willing to take chances on properties but not on their profession. Others secretly hoped that his outside-the-box forays would bring him crawling back to their bailiwick.

Together, Zell and Lurie started scanning newspaper headlines and talking to wider circles of bankers and other lenders in hopes of finding hidden treasures. They also set no hard-and-fast rules about what companies they would buy. Potential deals merely had to have the same basic characteristics—a company in a growth industry, in financial trouble or distress, which could be managed out of its doldrums into a potential market leader.

Using those criteria as their guide, the duo cobbled together a hodgepodge collection of companies, most having little to do with one another and absolutely nothing to do with real estate. Their goal was diversification, long before the term became just another cool buzzword in corporate lexicon, with half of their investments plowed into real estate and the other half into everything else.

One of their more interesting investments came in 1981, when Zell and Lurie, along with businessmen Jerry Reinsdorf and Eddie Einhorn, took a stake in two local sports franchises, the Chicago White Sox baseball club and the Chicago Bulls basketball team. This bit of offbeat fun was largely Lurie’s baby, for Zell had little patience or appreciation to play the role of spectator in any form of organized sports.

Zell’s primary investment vehicle at the time was the Zell/Chilmark Fund, which he formed in 1985 with Chicago business associate David Schulte, whom Zell had come to know and trust over the years. With this fund, Zell adopted a longer-term strategy, telling investors they might not see significant returns for up to ten or twelve years. But Zell and Schulte traded on their names and reputations, attracting deep-pocketed pension-fund money from the likes of the State of Virginia Retirement System and Chicago’s own Continental Bank.

Bottom fishing was the order of the day, as Zell/Chilmark invested primarily in bankrupt companies. Its first purchase was a shipping-container business called Itel Corporation, which had filed for bankruptcy in 1981. Little did Zell know that he would soon become the world’s most renowned “shipping container maven.” Under his management, by 1988, Itel was trading on the New York Stock Exchange and had quadrupled its annual revenues to $4 billion. The success came largely through both acquisitions and Zell’s trademark approach to squeezing every last dollar out of the company’s operations through tedious day-to-day management. He snatched up competitors and focused on reducing costs and redundancies—consolidating duplicate accounting teams, computer systems, etc.—to increase the company’s value. When Zell sold off a division to General Electric in 1990, he pocketed a $250 million profit.

Other diversified investments ranged from the Delta Queen Steamboat Company to a 20 percent stake in fertilizer maker Vigoro, which he sold in 1995 for $1.16 billion. He even owned Chicago-based Midway Airlines for a time. There seemed to be no rhyme or reason, no core theme at least, among the companies Zell purchased, other than the pursuit of profits. Synergies among his corporate properties were nonexistent, and he liked that just fine. He preferred to chalk up his success in the corporate world to simple blocking and tackling and conducting his own brand of independent research and soul searching before making a commitment.

By the late-1980s, however, distressed turnaround opportunities became scarce. But as one door was closing, a large and unlocked window was ready to open. Zell and Lurie were once again ready to hit the commercial real estate industry. With a vengeance.

NURTURED BY MOTHER MERRILL

Richard B. Saltzman, the head of real estate finance at Wall Street powerhouse Merrill Lynch, was the antithesis of the stereotypical wheeler-dealer—which is exactly why in many respects he was the perfect partner and foil for Zell. Like Lurie, Saltzman was smart with numbers and financing structures. With his thin wire-framed glasses, sandy hair, and bookish charm, he cut a preternatural low-key look, more like a professor than a high-powered investment banker. He was mild-mannered and unassuming and generally kept his business under the radar. And yet he used his position with one of America’s largest financiers to good advantage.

At the time, 1988 to be exact, Merrill Lynch was the eight-hundred-pound gorilla on Wall Street. Under decades of strong and stable leadership, it dominated nearly every field of high-stakes finance—mergers and acquisitions, investment banking, personal finance, and public stock issuances. The firm became known to insiders as Mother Merrill for its nurturing of employees, cultivating talent, and eschewing layoffs even when profits were down. Merrill’s ace in the hole in the late 1980s was its distribution network. Its access to consumers/investors through its stock brokerages made it the clear market leader.

Unlike many of his peers, who played a career game of musical chairs, bounding from one firm to the next in search of advancement—and the fattest bonus check—Saltzman felt right at home at Mother Merrill. He was a company man through and through, and he was amply rewarded for his loyalty, steadily rising through the ranks to eventually top out as chief operating officer of global investment banking in 2003.

Zell’s chance encounter with Saltzman came in New York while he was attending a real estate conference. Saltzman recalled how he was impressed with Zell’s quick and thorough analysis of the opportunity that existed for the right players—with money—in the market.

Together, they saw a train wreck in the making, just over the horizon, for commercial real estate. The late eighties and early nineties had produced an era of easy money, and that train was taking developers down the “build build build” tracks at a breakneck speed. Unfortunately, for that particular breed of risk takers anyway, it was about to jump the rails, and Zell and Saltzman wanted to be there to sweep up the mess with the largest pool of money they could muster.

READY FOR BOOM TIMES

Commercial real estate in the latter half of the 1980s was best characterized as the era of larger-than-life developers and brokers who became the talk of most major cities in America. Think “ free-range chickens” roaming the countryside doing deals by day, while donning society garb to mix and mingle with corporate and civic power brokers by night. They were flush with money—though it belonged to other people most of the time—and everyone wanted to join in the deal-making orgy.

According to the Urban Land Institute in Washington, D.C., more office space was built across America’s skylines in the 1980s than in the previous thirty years combined. Perhaps no American city better exemplified the go-go attitude of the mid-1980s better than Dallas, Texas. Every Thursday night was a real estate party. Tales of largesse abounded. Real estate entrepreneurs were using their newfound riches to open various night clubs, including the Tang-O and downtown’s Stark Club (designed by a then-unknown architect named Philippe Starck).

But developers were mindlessly heading down a golden road that would turn to quicksand. For example, take CityPlace, an incredibly ambitious development proposing twin forty-two-story office buildings spanning Dallas’s central arterial highway, Central Expressway. They would stand like two monolithic stone-clad goalposts against the Dallas skyline. Its jingly slogan spoke volumes about the overblown promise of the times—“The City with a Place for You.”

The groundbreaking alone gave new meaning to the term “breaking ground.” Just as nightfall descended on the city, a fleet of shiny black vans moved in unison, chauffeuring local real estate brokers and civic dignitaries alike deep into the bottom of a three-story pit. This cavernous hole in the ground would later become the first office tower’s underground parking garage. For hours, patrons feasted on tasty Texas barbeque and wined and dined themselves well into Friday morning. But the late hour mattered not. These new titans did not work much on Fridays anyway.

The princely sum for the Texas-sized shindig? A cool $1 million, but that was just the tip of the marketing largesse. There was the limited edition embossed leather-bound brochure created especially for the occasion. The 150 exclusive copies were filled with computer-generated images of the gleaming stone and glass structures superimposed on images of the city’s skyline by day and night. This was technology way ahead of its time for 1985, when a single computerized image cost an estimated $50,000 to reproduce.

Zell and Saltzman scanned the highbrow hubris unfolding before them and saw a confluence of warning signs that spelled trouble ahead. For true vulture investors, it had the makings of a new decade of opportunity. Those with cash to spend could swoop in to pick up distressed buildings at bargain prices. “We as an industry had committed hundreds of billions of dollars to unproductive usages,” Zell observed. “And we had done so because the promise was ‘build it today because it will cost more tomorrow,’ not because there was any economic justification.”¹

THE PERFECT STORM

By 1989, Zell’s reading of the tea leaves would turn out to be spot-on. The U.S. economy’s spinning boom-and-bust dial was about to land in the bust zone again. A precipitous slide into a protracted recession would last through 1992 and the election of former Arkansas Governor William Jefferson Clinton as president. Just as President Ronald Reagan was saying his final farewells in the Oval Office in 1988, he was also closing an era known as the Reagan years, a period of seemingly boundless economic growth and prosperity. But that was all about to change.

The telltale signs were already there. Many called the confluence of events the perfect storm—interest rates were skyrocketing; free-lending bankers had fueled years of property overbuilding; and consumer spending was trickling to a standstill.

Certainly there is one generally infallible tenet when it comes to real estate developers—no matter how “disciplined” they might presume themselves, given access to easy money, they will feed at the trough and overindulge. They are, after all, human.

“If you go back and study all of the oversupplies, all are a result of excessive loan-to-value, thereby reducing the developer’s risk,” said Zell. “When you reduce the developer’s risk, he becomes insensitive to building. If you don’t have to put up real money—your money—and you don’t have to take risk, then your ability to be an optimist is unlimited. It’s an edifice complex.”² This was one case in which the money talked, and the bullshit stubbornly refused to leave, like a bibulous guest overstaying his welcome at the party.

That million-dollar barbeque party back in Dallas, and many more just like it, were quickly generating a toxic by-product. Soon there would be a ten-year supply of freshly built office space in shiny glass-and-steel “see-through”—aka empty—skyscrapers all over Dallas. And Los Angeles. And Miami. And Chicago. You get the picture.

Banks and savings and loans were starting to feel the pinch of the staggering economy, which eventually led to the nation’s first major mortgage meltdown. Many savings-and-loan executives were indicted and convicted of shady land dealings and extending overly generous credit to sketchy investors, especially on condominium projects and housing developments. The largest offender, Irvine, California-based Lincoln Savings & Loan Association, bilked investors out of billions and saw CEO Charles Keating imprisoned on charges of fraud and mishandling funds.

Wall Street, too, was in full retreat mode. New York Attorney General Rudolph Giuliani doggedly investigated the leading junk-bond firm, Drexel Burnham Lambert. Ultimately Drexel pleaded no contest to six felony charges—three counts of stock parking and three counts of stock manipulation—and paid a record $650 million fine. Then in December 1989, Drexel’s top lieutenant, Michael Milken, the public face of the market, known as the junk-bond king, was fined $200 million and served two years in prison for a variety of securities-trading violations.

The image of Milken’s ghostly mug on the cover of every major newspaper and magazine across the country was the final crack in Wall Street’s facade. Layoffs became the order of the day, as more than thirty thousand once-powerful investment bankers suddenly found themselves without the means to support condos and houses on the Upper East Side and in the Hamptons.

The era was painfully portrayed in Tom Wolfe’s novel The Bonfire of the Vanities, which excoriated the wretched excesses of Wall Street’s overindulgent culture. In junk bonds, Wall Street had created yet another innovative financing mechanism, and once again old-fashioned greed had led to excesses.

As the schizophrenic decade was nearing its close, 1989 proved to be a big year for government intervention. On February 9, the U.S. government formed the Resolution Trust Corp., or RTC, to help financial institutions and property owners work through the inevitable foreclosures and asset sales. Under the auspices of the Federal Deposit Insurance Corporation, it was also there to restore some order and discipline after years of easy money and loose lending.

RAISING BILLIONS

Zell, too, had joined in a bit of the junk-bond hijinks, raising more than $1 billion, thanks in large part to Milken’s help. But ultimately he remained deeply skeptical of the structure designed to heap enormous amounts of debt on companies while brokerage firms made short-term profits. He sensed the times were too frothy, so rather than wait for the impending bust, he unloaded assets even though it meant losses. He could never quite sign on to the long-term viability of junk bonds, viewing them as yet another example of Wall Street’s unflinching addiction to short-term financial engineering.

Over the years, Zell has been accused of many things, but he adamantly defends his long-held belief in the long-term nature of real estate value. “I don’t know anybody in the country who’s a more long-term real estate investor than I am. I graduated from law school in 1966. I bought an apartment complex in Toledo, Ohio, in 1966 and paid off the mortgage in twenty-five years. I own it. There aren’t very many people who can say that.”³

Together Zell, Lurie, and Saltzman eschewed the junk-bond frenzy by creating two large “opportunity funds” in 1988 and 1989 that tapped the country’s largest pension funds as primary investors. In other words, they were using other people’s money, but people who could afford the admission price, were long-term investors, and were more accountable to their constituents.

Zell and Lurie’s name cachet and promise of long-term mega-returns proved an immediate draw. The two funds raised more than $1 billion in only thirteen months—at the time considered an astounding achievement. And despite Zell’s long-held belief that the lead dog in any pack has the best view, he recalled that it was actually lonely being in front of the crowd.

By now, it was also hard for Zell not to notice the declining health of his twenty-year business partner. Just when their little college-born venture was about to reach inconceivable heights of success, Lurie had developed colon cancer that would soon prove terminal. His untimely death in 1990 rocked Zell for a time. Only forty-eight years old, Lurie was survived by his wife, Ann, and six young children. Years later, Zell is still at a rare loss for words when trying to describe the relationship.

During Lurie’s illness, Zell developed a habit of calling his partner every night, no matter where he was in the world, to catch up on business. After Lurie’s death, he maintained the habit with Ann out of a sense of responsibility to the family Robert left behind.

Zell also eulogized his partner with major contributions to academic studies. In 1998, he permanently gifted the Wharton School at the University of Pennsylvania to found the Samuel Zell and Robert Lurie Real Estate Center. In 1999, Zell and Ann Lurie jointly donated $10 million to establish the Samuel Zell & Robert H. Lurie Institute for Entrepreneurial Studies at the University of Michigan’s Ross Business School.

While the business world took notice of Lurie’s passing, it inexorably moved on. One thing Wall Street abhors is a vacuum, and it wasn’t long before others took notice of Zell’s fund-raising success, spawning a bevy of imitators.

If Merrill Lynch was “Mother Merrill” on the Street, the stately matriarch of purebred financial power, then chief among her rivals was Goldman Sachs & Co., the new-monied interloper. Through its new private equity program known as Whitehall Funds, Goldman quickly invested more than $2 billion in pools of distressed RTC loans from 1991 to 1994 and either resold the properties or restructured the loans for a profit.

Goldman was not alone. The usual suspects—Lehman Brothers, First Boston, Apollo, the Blackstone Group, and George Soros—all created their own private equity funds to invest in problem properties. The vultures had turned to sharks, smelling blood in the water. Thanks to a fresh source of healthy capital, they were eagerly feasting on the dying assets that swashbuckling entrepreneurs had built as monuments to their own greed.

And they were racking up millions in the process as the economic recovery first began to take hold in 1992, just in time to start the roller-coaster boom-and-bust cycle all over again. In March, for example, Zell/Merrill Lynch Real Estate Opportunity Partners L.P. II purchased the Bank One Center complex in downtown Indianapolis from Citicorp for $115 million. And while Citicorp lost $30 million on the deal, Zell, ever the opportunist, positioned himself to earn long-term fees by signing on to manage the property while the markets found more solid footing. Between 1988, when Zell launched the first opportunity funds with Merrill Lynch, and 2008, private equity funds raised more than an estimated $100 billion to invest in commercial real estate.

Meanwhile, Zell was still plowing money into a variety of corporate ventures. In only a five-month period from December 1992 to April 1993, the Zell/Chilmark fund invested in mattress maker Sealy Corporation, the Schwinn Bicycle Company, and an oil and gas concern called Santa Fe Resources. It also bought a significant stake in the Revco drug store chain and took a 75 percent interest in Carter Hawley Hale Stores, rescuing the retailer from the clutches of bankruptcy.

Without Lurie’s guidance, though, years of corporate financial engineering finally caught up with Zell. On paper anyway, he was worth a billion dollars. But as many investors learned the hard way during the early 1990s, paper meant nothing without something to back it up, namely cash in the bank to pay the bills. Just when those bills were coming due, credit became a scarce commodity, and Zell found himself in a market where it became impossible to refinance his loans through the use of junk bonds.

Enormous debt bills were coming due, soon, and there wasn’t enough cash flow from his businesses to pay them. Zell’s estimated debt payments totaled $518 million in 1992, with another $539 million coming due in both 1993 and 1994. This period tested even Zell’s stubborn resolve. Plagued by many sleepless nights, he watched his empire slowly withering under the weight of his debt obligations.

But soon, Zell’s past relationships bailed him out. Mother Merrill came riding to his rescue, loaning him enough cash to buy time to sell off selected assets to pay down some of his debt. He sold a 64 percent stake in his Manufactured Housing Communities Inc., which owned mobile-home parks in sixteen states. The plan was to package the stake as a mortgage-backed security to sell to the public. In other words, he was selling investors a piece of the debt pie. His lead underwriter on the deal? Merrill Lynch.

Therein lay another unique Zell trait—he quickly rebounds from his miscues, never losing sight of the next possible opportunity lurking just around the corner. This time around, an entirely new and complex industry had already caught his eye—broadcasting.

THE JACOR EXCURSION

One morning in 1993, while consuming his usual five newspapers over breakfast, Zell chanced upon a Cincinnati-based owner of radio stations called Jacor Communications. For months, Congress had shown a proclivity for easing regulations on the tightly controlled telecommunications industry. Though still mired in his debt issues, Zell decided to take a flyer on the company when he thought Congress would do even more, snapping up Jacor for the pittance of $50 million. As an opportunistic play, his timing was on the mark. Thanks to the U.S. Telecommunications Act of 1996, the broadcasting business was deregulated overnight.

Zell and Jacor CEO Randy Michaels cranked up the volume and went on a buying spree, growing the company from only 17 radio stations in 1996 to 234 by 1999, spending $2 billion over a single two-year period.

Zell then delivered on his promise to cash out at the peak of the market, selling Jacor to Clear Channel Communications for $4.4 billion after it won a bidding war with CBS Radio. Zell’s initial investment of $50 million turned into a $1.3 billion payday in only six years. That was an impressive return by any metric. It also helped cement Zell’s national reputation as an astute countercyclical investor. He had become much more than a real estate mogul, although he never strayed far from his first true love.

BACK IN THE GAME

A renowned multitasker, Zell had also been keeping a keen eye on the commercial property markets. By 1993, he was already plotting his next moves as he quickly realized the game had changed. Debt, his least favorite four-letter word, was out. So he rolled with the punches and threw his entire organization into a radical 180-degree turn. Equity, aka going public via the stock markets, was in.

Zell had learned a valuable lesson in the previous cycle—the real estate markets were big, but they were one-dimensional and ponderously slow in reacting to change. Real estate is notoriously illiquid. It is all about tangible bricks-and-mortar physical stuff, and it is worth whatever the prevailing “market” says it is worth. Zell had bigger plans for the industry. He wanted to create a way to sell off pieces of buildings to individual investors by issuing stock. So once again, he turned to Wall Street for a few answers.

After spending the past decade amassing millions of square feet of space in apartments and office buildings, he discovered a unique investment structure created by the loathsome (to Zell anyway) U.S. government in 1960. Back then, Zell was still just a college freshman, but the real estate investment trust, or REIT, was about to make him one of the richest human beings on the good planet Earth.

On the road to REIT-land, the years that followed would see Zell involved in two of the most monumental events in commercial real estate history. The first was an epic, hard-fought takeover battle over the right to own New York’s iconic Rockefeller Center. The second would see Zell cashing in on his status as REIT ringleader, selling off a huge chunk of his real estate empire in one whopper of a deal.