How To Make A Profit When the Bubble Bursts

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.

Last week on Methods of Prosperity

Sam Zell and Bob Lurie established a meritocratic partnership in the late 1960s. They transitioned from property management to a major business empire across various industries. After Bob battled colon cancer for two and a half years, he died in 1990. Sam honored their legacy. He dedicated philanthropic efforts in both their names. This included endowments at Wharton and Michigan. The Samuel Zell and Robert Lurie Real Estate Center and Samuel Zell & Robert H. Lurie Institute for Entrepreneurial Studies, respectively.

The Tax Reform Act of 1986 decreased tax incentives for real estate. Subsequent market crashes prompted Sam to advocate for restructuring through modern REITs. He partnered with Merrill Lynch to fund distressed real estate acquisitions. Their efforts expanded the REIT industry from $7 billion in the early 1990s to over $1 trillion by 2016.

Real estate went through it. Later in the 1990s, the dot-com bubble was about to pop.

Do you know about my livestream podcast? It’s called Hidden Secrets Revealed Live (HSRL), and I record it live on 𝕏 every Wednesday. 

Part 83. Sam Zell (continued).

You can find this week’s TL;DR here.

Key Lessons:

• Replacement cost determines the price of future competition.

• Durable businesses have a high barrier to entry.

• Look right when everyone else is looking left.

• Where is revenue coming from?

• No asset is too large to sell.

• Buy undervalued assets.

Now there’s a collectible version of this newsletter! Methods of Prosperity newsletter number 46 is available to collect as of January 11, 2025. If you’re so inclined you can permanently own it!

What did the commercial real estate market and the dot-com boom in the 1990s have in common? Not much. They had opposite trajectories and impacts. The early 1990s saw a significant downturn in the commercial real estate market. Which was a result of the collapse of the savings and loan industry. Property values plummeted, vacancy rates soared, and many private investors faced substantial losses. Banks had exposure to commercial property. Which experienced a wave of failures and consolidations.

It was the worst real estate crisis since the great depression. Sam coined the phrase “stay alive until ‘95”. Most real estate investors had over-leveraged their properties at 80–90%. Falling rents, occupancy and debt service became unsustainable. Many of the top real estate companies of the past were down bad. The commercial real estate market collapsed. Estimates of the losses exceeded $80 billion.

Sam and Merrill Lynch positioned their opportunity fund to cherry-pick the discounted assets. They were so early that sellers had no idea what their properties were worth. They postponed the sale until the market began to stabilize. Lenders became anxious to get real estate off their books. Sam was the only buyer out there. From 1989 until 1996, Sam and Merrill Lynch raised four funds at an aggregate total of $2.1 billion.

By the early 1990s, real estate owners were desperate for capital. There was only one place left to turn – the capital markets. Richard Saltzman of Merrill Lynch was a strong steward of the modern REIT era. Sam took his first real estate company public in 1993. Manufactured Home Communities (MHC) was Sam’s real estate investment trust (REIT). It focused on owning and operating manufactured housing communities, AKA mobile home parks. It was a contrarian investment strategy. Sam called it “looking right when everyone else was looking left.” No large real estate investors cared about “trailer parks”. Zell recognized the untapped potential. Residents owned their manufactured homes. MHC owned and operated the land underneath, leased to the residents. MHC later evolved into Equity LifeStyle Properties (ELS).

Later that year, Sam Zell also took Equity Residential (EQR) public, in August 1993. It’s a 17,000 unit portfolio of apartment buildings. Have you ever seen a banner along the freeway advertising these apartments? It reads: “If you lived here, you’d be home by now.” Today, EQR has a market cap of $27.16 billion.

He amassed an enormous portfolio during that recession. Sam says he “didn’t invent the modern REIT industry, but he helped make it dance.” His team grew the industry from $7 billion in the early 1990s to over $1 trillion in 2016.

The US government had to bail out the savings-and-loan industry in 1989. They passed the Financial Institutions Recovery, Reform and Enhancement Act (FIRREA). That legislation established the Resolution Trust Corp. (RTC). The RTC existed to dispose of undervalued assets on the books of thrift institutions. They sold off assets at a fraction of their assessed values.

The mid to late 1990s saw a recovery in the commercial real estate market. The Federal Reserve lowered the federal funds rate down from 6% to 5.25% between July 1995 to January 1996. The resurgence of the technology sector grew as the economy recovered. The Resolution Trust Corporation (RTC) played a crucial role. It helped to establish pricing and allowed transaction activity to recover.

In contrast, rapid growth and speculation in internet-based companies encouraged the dot-com boom. It coincided with the longest period of economic expansion in the US after World War II. From 1995 to 2000, the NASDAQ Composite Index rose from under 1,000 to more than 5,000, representing an 800% increase. Venture capital poured into tech and internet company start-ups.

It was about a decade after Sam wrote his Cassandra article. The market was in a frenzy over every new website. Let me share some of the most outlandish websites from the dot-com bubble era. These examples exemplify the period’s excess and innovation. Beenz [dot com] attempted to create an early digital currency. Users earned “Beenz” by shopping online and visiting websites. Former US Surgeon General Dr. Everett Koop created Drkoop [dot com]. It was a health information website that raised an astounding $84 million in its IPO. Before its spectacular failure, it reached 1.4 million monthly visitors in 1999. One of the most notorious failures of the era was Webvan. This online grocery delivery service attempted to revolutionize how people bought groceries. InfoSpace could be the most extreme example of the bubble’s valuation madness. It reached a staggering market cap of $31 billion. Its stock price hit $1,305 per share in March 2000. The founder and CEO was a guy named Naveen Jain. That’s another story.

There was a lot of hype. It felt like every IPO was important. The world wide web was going to change everything. Sam Zell couldn’t see where the revenues were going to come from. He recalls,

Everyone acknowledged that they could do it. Which meant that there were no barriers to entry. Sam Zell didn’t invest in Amazon, Google, or any website. The dot com meltdown began on March 10, 2000. The NASDAQ Composite index peaked at 5,048.62 points.

Sam Zell and Robert Lurie founded Equity Office in 1976. Sam converted it to a publicly-traded REIT in 1997 as Equity Office Properties Trust (EOP). They negotiated leases with tech companies including IBM. It became the largest office building owner and manager in the United States. Sam knew Wall Street undervalued it. The most reliable metric for Sam Zell was replacement cost. Replacement cost determines the price of future competition. Equity Office was part of a merger in 2000 which had a negative impact on market perception. That was until they sold EOP seven years later. EOP acquired Spieker Properties in 2001. The acquisition of Spieker Properties was a significant deal. Valued at $7.3 billion, it included $905 million in cash, $431 million in stock, $3.6 billion in equity, and $2.1 billion in debt. Spieker was a Silicon Valley REIT. As a result of the dot com meltdown, companies were walking away from their office space. It baffled the marketplace that EOP acquired Spieker during this time. Sam Zell saw it as an opportunity to buy the offices of Apple, Google, and similar tech giants. By 2006, EOP’s portfolio included class A office space in every major US business district. 

Sam Zell thought EOP’s portfolio was too big to sell. One day, in November 2005, a bid came in for $25 billion. It was from an investment advisor for the California Public Employees Retirement System. They valued it at $35 per share. At that point, Sam valued it at $40 per share, and wasn’t interested. They came back a few months later with a team of advisors from Lehman Brothers. They offered $40 per share. By that time, it was too low for Sam to consider. Over the summer, EOP’s stock price began a sharp rise. Sam still wasn’t selling. Blackstone approached them with an offer of $42 per share in August. Sam still thought that was insufficient, but realized his misconception. EOP wasn’t too big to sell.

To be continued...

I like you,

– Sean Allen Fenn