Sam Zell on Global Growth: “Where’s the Demand?”


Sam Zell on Global Growth: “Where’s the Demand?”, CFA Institute, August 16, 2017

  • “Opportunities are completely connected to demand. I’m a student of demand and when demand is there, I look at the cost of fulfillment”
  • Fundamental law of supply and demand is one of Zell’s governing principles in his investment decisions, whether he’s looking at commercial real estate, asset-intensive industries like oil and gas, or manufacturing in developed or emerging markets
  • “Much of my career has been about understanding and acting on this basic tenet”
  • Today, his biggest worry about where global economic growth is headed is the overall lack of demand
    • “If there is a worldwide shortage or crisis, it is a shortage of demand”

Excess Supply: US Commercial Real Estate Markets

  • After the financial crisis, real estate markets seized up and despite low interest rates, industry participants stayed on the sidelines. Then two or three years into the recovery, everyone started building at the same time, leading to the excess supply scenario we have across nearly all CRE sectors in the US today
  • “Last year, I was saying that the CRE industry was relatively benign and supply and demand was in balance. In the last 18 months, however, there has been an enormous increase in supply”
  • Growth in multifamily residential units is at an all-time high, with 380,000 being added in 2017 – a pace not seen since 1972, a time when the sector was the only game in town
  • Office space supply is rising when occupancy rates are on the decline. Due to secular shifts in the way we work – towards higher density workspaces and more efficient use of space – occupancy has fallen from 240 square feet per employee to 180 square feet, maybe less
  • Retail space has a difficult road ahead given excessive supply, though he believes there will always be room for brick and mortar
    • “Only the very top-end malls and the very bottom ones are doing okay”
  • Hotels in major cities like New York and Chicago are overbuilt by about 20%
  • The only segment that has an appeal from a supply-and-demand perspective is mobile homes because of how difficult it is to obtain park permits and because of the “not in my backyard” stigma associated with them
  • Delay of marriage is the single largest demographic trend that is transforming the market
    • “Now we’re replacing suburbia with 24/7 cities”
    • This has had a negative effect on bedroom communities, starting with the upper end

Opportunity for Growth and Scale in Emerging Markets

  • In the 1990s, Zell and his team were intrigued by the opportunities in emerging market real estate platforms and other types of emerging market companies and started investing
  • Even though the potential for returns was much higher, Zell’s team wasn’t deluded about the trade-offs
    • “Investing in emerging markets is a bet on growth. But what’s being given up is the rule of law”
    • That compromise is one he never takes lightly
  • One of the ways Zell manages risks in emerging markets is by finding the right local partners
    • “Many times the quality of the investment is based on the quality of your partner who can give you a much better chance of success”
  • Ability to scale is another key driver in Zell’s emerging market investment decisions
  • He likes Mexico and Brazil in particular because of their potential for growth, scale, and important geographical locations
  • Investing in emerging markets requires more agility than in the US
    • Over the years, he has been in and out of Brazil
    • Now with signs that the Brazilian economy is turning, he’s back in

What’s the Difference Between Quantitative Easing (QE) and Printing Money?

  • We don’t yet know the unintended consequences of monetary policies in the US, the Eurozone, and Japan since the financial crisis
  • “When I was coming along, ‘printing money’ was called inflationary. Now it’s QE. I’m not sure I know the difference”
  • After 8 years, Zell believes the economic recovery is long in the tooth and that some kind of recession is likely
  • As to whether healthcare, tax, and infrastructure reforms will be passed by the US Congress, Zell is skeptical
  • “President Trump will go down in history as having had an extraordinary opportunity. Whether or not he’s able to take advantage of the opportunity remains to be seen”
  • Zell has never seen a period in his lifetime with more headwinds or more questions without answers than today. He believes conventional wisdom is mistaken by looking at geopolitical risks one at a time. He tries to view each part of a whole
  • “We have a different world today and there are lots of players with different values. There is enormous unsettledness”
    • This manifests itself in a lower global growth rate
  • As for his views on interest rates, Zell said that rates are a function of demand. Risk-free rate averaged 5.6% over the last 25 years, not counting the last seven. Will it return to that level? Unless there’s a change in demand, Zell said the answer is no
    • “But I’m not ready to X demand just yet”

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