Alternative Investment Series: He Might Swear Like a Sailor, But He’s Worth Following Each Day

Listen to this post

About five decades ago, Jay Pritzker, the billionaire co-founder of Hyatt Hotels, wanted to hire a mid-20s real estate mogul.

Who on earth was this hot shot?

It was Sam Zell.

Zell ticked all of Pritzker’s boxes: He was a young, brilliant lawyer who had shown success as an entrepreneur at an age when most people are still finding themselves.

“I told him,” Zell has said several times, “if I met all of those criteria, why the f— would I want to work for you?”

Now 79, Zell maintains the same real estate prowess and penchant for cursing. He’s a regular at hedge fund events like the SALT Conference and television shows where he expounds on his views of the markets… and how dumb he believes others to be.

Occasionally, a show or event will issue an apology for his language. But Zell is a legend, and clearly doesn’t care.

It’s hard not to like a person who speaks his mind and has the data to prove his success.

Today, I want to talk about an alternative investment that offers a lot of promise for you, and what you need to know about Zell.

A Secret of the Elite

Real estate investment trusts (or REITs) are companies that own, operate, and generate income from real estate properties.

REITs trade on public exchanges and have long been a preferred income strategy of hedge funds, billionaires, and other institutional investors. But Americans of all income levels own REITs as well. According to the National Association of Real Estate Investment Trusts (NAREIT), about 145 million Americans own REITs through retirement accounts, pension funds, or other investment funds.

Yes, it’s that big of a market. NAREIT notes that these trusts own more than $3.5 trillion in total assets around the United States in more than 500,000 properties. And various trust managers specialize in different types of real estate.

There are 13 categories of REITs, including office, industrial, retail/mall, residential, medical, and farming/timberland.

As I mentioned yesterday, VICI Properties is a company that generates gobs of income by renting casino properties to gambling operators and vendors like shopkeepers and restaurants.

If there’s a category of property, there’s likely a REIT somewhere behind it.

And there’s a reason why these assets are so popular and continue to explode in size and scope.

When a property REIT leases space and collects rent from tenants, it generates cash flow that it can pay to shareholders. Due to a rule in the tax code, in order to qualify for a REIT, the trust must pay out at least 90% of its taxable income directly to shareholders.

One of the key benefits of this rule is that the REIT bypasses a first round of corporate income taxes. Once the cash flow is “passed through” to investors, the government will tax it as ordinary income. That’s a pretty sweet deal when you see that REITs typically pay higher-than-average dividends to shareholders.

Now, before we get back to Sam Zell, I want to articulate one thing.

As I mentioned, this is an alternative investment.

An alternative investment can be identified by one of eight factors that differentiate it from a traditional investment like stocks or bonds, according to the Chartered Alternative Investment Analyst Association (CAIA).

Those are: structure, regulatory factors, institutional factors, compensation structure, trading strategies, incomplete markets, information asymmetries, or innovation.

REITs have a variety of characteristics that naturally qualify them as an alternative investment.

• REITs are structured as a partnership, making them different from a traditional corporation. These partnerships allow for pass-through income to the shareholders.

• That pass-through income factor also results in additional regulation, as REITs have different tax implications and different regulatory oversight.

I want to highlight these factors because they’ll be essential to understanding future conversations about other alternative investments that can deliver market-beating returns.

Now Meet the Grave Dancer

Back to Sam Zell.

Zell is the chairman of a REIT that presents a lot of opportunities for investors.

It’s called Equity Commonwealth (EQC). In 2014, the REIT was operated by a notorious family called the Portnoys, who had a habit of charging investors high management fees on the 125 properties they owned. Shareholders were furious with the Portnoys for raking in big fees and delivering lackluster performance.

So, activist investors asked Sam Zell to join them in their bid to oust the current chairman.

Zell was already a billionaire with a stellar reputation in the real estate industry. In the 1980s, he started buying assets right after real estate collapsed from a tax reform bill. He bought low, made a fortune, and built a reputation. This earned him the nickname the “Grave Dancer.”

Also, he famously sold his firm Equity Office Properties to Blackstone Group for $39 billion in 2007 before the mortgage crash.

Clearly, he knew the market tops and bottoms.

It was evident that shareholders would gladly install Zell over the Portnoys, and so they did.

Later in 2014, Zell became the head of the REIT. And instead of buying properties, he started selling them and raising cash. Over five years, he sold all but five properties from the original portfolio. Today, the company is down to four.

Zell has been biding his time, waiting for the markets to fall and bargains to emerge.

At the end of 2020, Equity Commonwealth sat on $2.98 billion in cash and just $258 million in investments. When you combine the amount of leverage it could obtain, you’re looking at  a group with upwards of $10 billion in real estate purchasing power. It’s just a matter of time, it seems, before Zell aims to dance on the  graves of previous investors in the real estate space.

Waiting things out has been a hallmark of Zell’s career. However, in order to profit from his patience, we too will need to be patient.

EQC is currently in the TradeSmith Finance Health Indicator Red Zone , and it’s had negative momentum, in a downtrend for more than two months.

I am adding this stock to my watch list; it could become a breakout stock the moment that Zell redeploys capital. I’ll let you know when that day comes.