Sam Zell Discovers the Black Swan

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Last week on Methods of Prosperity

It was 1959 when Sam Zell moved into a fraternity house. He studied political science at the University of Michigan. He moved out of the frat house due to his solitary nature. During his junior year, an opportunity arose. He learned that a landlord was building a student apartment complex. Without prior experience, Sam and a friend pitched to manage it. They secured a deal that included free lodging. This marked Sam’s first foray into real estate. As his venture expanded, Bob Lurie joined them. Bob was an organized and detail-oriented engineer. His personality complimented Sam’s. Bob balanced Sam's lack of attention to detail. He helped Sam turn their management project into a business. Over the summer, Sam honed his sales skills, selling cosmetics door-to-door. He learned resilience to rejection, a crucial entrepreneurial trait. His parents pressured him to pursue a traditional career. That’s why Sam attended law school. He gained critical thinking skills that later proved useful in complex deals. In 1965, during his second year in law school, he bought his first apartment building. At 23 years old, lacking financial expertise didn’t hold him back. His reputation grew, leading to larger management contracts and attracting investment opportunities. Sam expanded his holdings. His ventures thrived on his boldness and ability to build relationships. Sam acquired a full block of land by persuading each homeowner to sell. This experience also showed him how conniving people can be.

Part 76. Sam Zell (continued).

You can find this week’s TL;DR here.

Key Lessons:

• Treat yourself as royalty, and treat your neighbor as yourself.

• The Golden Rule is, the one with the gold makes the rules.

• You’re not going to get rich renting out your time.

• Money is a proxy for value created.

• The purpose of wealth is freedom.

• Money has no intrinsic value.

• Wealth is not a number.

• Find the Black Swan.

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Remember that money has no intrinsic value. For example, the US dollar is a fiat currency. That means its value is not based upon anything except by decree. It’s not backed by a physical commodity like gold or silver. The US government prints it through the Federal Reserve. The Federal Reserve buys financial products called Treasury bonds. They do this as part of its open market operations to control the money supply and interest rates. This adds to the money supply, which allows banks to lend. That allows the banks to create credit for the lender. When a bank issues a loan, that creates money out of thin air to deposit into the borrower’s account. The act of lending increases both the bank’s assets (the loan) and liabilities (the deposit). Out of thin air, banks add new money to the economy.

That’s why wealth is not a number. There’s no limit. But the money is only a proxy for the value created. You can create value for others out of thin air. It has very little to do with the hours you put in. The only reason to put in hours is to get good at something, not to get paid by the hour. You can work fifty or sixty hours a week and still not get ahead of your bills. Because your inputs match your outputs. You get paid by the hour, but there’s a limit to the hours. Instead, you need to detach the inputs from your outputs. For example, a lawyer can work long hours and get paid well. Compared to a real estate investor who gets paid by the value of the deal, that lawyer won’t get paid as well.

We’ll talk about how Sam Zell discovered this fact later in his story. Before we get to that part of his story, recall how Sam’s parents taught him to live. They taught him by their actions that economic success is freedom. His parents instilled the belief that he needed a profession. That’s why he went to law school. His parents never imagined the possibility that instead of having a job, Sam could be a deal maker. Real estate would make Sam Zell a billionaire.

While he attended law school, he bought real estate. First one apartment building, then another, and the house in between. He kept at it until one day, he owned the whole block. In the process, he encountered human nature. How easy it was for one neighbor to throw another neighbor under the bus. Sam would be developing the land for his student housing project and tearing down the houses. Sellers of one of the houses insisted that their house was worth more than their neighbor’s. Sam argued that if he paid them more, he would have to pay their neighbor more. “Pay us more, and we won’t tell them.” That’s what the seller expected, and it wasn’t fair. Sam refused. These people had been friends and neighbors for twenty five years. For $1000 they were willing to deceive them.

You’ve heard of the Golden Rule? The one with the gold makes the rules. And Sam had the heart of gold. The first rule of prosperity is don’t only treat your neighbor as yourself. Treat yourself as royalty, and treat your neighbor as yourself.

It was 1965. Sam had put down payments on eight houses at $1000 each. At closing, Sam and his business partner didn’t have the money. They needed $160,000. Of which $60,000 was equity. Sam’s father provided fifty percent of capital. Over the years, he’d become a successful real estate investor. He invested in syndication deals in primary markets, cities like Ann Arbor. They were low-risk. Sam’s father would later decline to invest in Sam’s higher-risk deals.

A wealthy man in Chicago owned the last property Sam wanted on that block in Ann Arbor Michigan. The man’s niece occupied the house. Her name was Mrs. Dee. He let her live there because she was caring for his mother. His mother, her aunt, was now deceased and buried in the cemetery across the street. Sam visited Mrs. Dee and gave her the pitch. He explained that it was in her best interest to sell. Sam was going to build a large student housing complex on the block. With the value of the property, she could move into a much better house on the other side of town. She explained that her uncle owned the house, and Sam would have to talk to him. He was president of a large public energy company and he lived in the better part of the Chicago area.

Sam called Mrs. Dee’s uncle and arranged to meet him. Sam told him that he owned the surrounding property. He was going to build an apartment building that would be full of students. The uncle’s niece was fifty five years old. Her husband was sixty. The house was around one hundred years old and falling apart. “Let’s find her another, bigger, better house on the other side of town for the same value and do a tax-free swap.” The uncle agreed. “If you can arrange it so I don’t have to put up any more money, and I don’t have to pay taxes, I’ll do it.” The uncle continued, “The only criteria is that you have to make her happy.”

Sam assumed they had a deal. He went ahead and found five houses in the same price range for what he was going to pay for the land, $32,000 – $34,000. Every one of the five houses were three times better than the house Mrs. Dee lived in. One day, Sam drove her around to see them. She walked through each one, but never said a word. At the end of the day, as he drove her back home, they noticed a drunk man leaning against a lamp post on the corner.

That’s when Sam uncovered a Black Swan. It’s a figurative reference. What is the significance of a black swan? This is a concept from Never Split the Difference: Negotiating as if your life depended on it. This book by Chris Voss with Tahl Raz is mandatory for our Methods of Prosperity community. The origin of Black Swan theory originates from Nassim N. Taleb. Read his book, The Black Swan: The Impact of the Highly Improbable. Things happen that were previously considered impossible. More often, a Black Swan is never considered at all.

Here’s the metaphor. Until the seventeenth century, people could only imagine white swans. All swans ever seen had possessed white feathers. In the seventeenth-century, it was common to refer to impossible things as “Black Swans”.

Until one day in 1697, there was a Dutch explorer named Willem de Vlamingh. He went to western Australia, and what did he discover? You guessed it. A black swan. The following is from Never Split the Difference:

“Suddenly the unthinkable and unthought was real. People had always predicted that the next swan they saw would be white, but the discovery of black swans shattered this worldview.”

Mrs. Dee pointed out the drunk man on the corner. It was her brother. He lived with her and her husband. Her brother gets drunk at the local bar every night. He can’t drive, and needs to be within walking distance from the bars. The houses Sam took her to look at are too far away from the bars. That’s why Mrs. Dee didn’t like them. That was a major unknown factor. It’s a Black Swan.

To be continued…

I like you,

– Sean Allen Fenn

Methods of Prosperity newsletter is intended to share ideas and build relationships. To become a billionaire, one must first be conditioned to think like a billionaire. To that agenda, this newsletter studies remarkable people in history who demonstrated what to do (and what not to do). Your feedback is welcome. For more information about the author, please visit seanallenfenn.com/faq.