Sam Zell stands astride the world of commercial real estate like the Colossus of Rhodes, a legendary billionaire who started managing a student apartment building at the University of Michigan and went on to start Equity Group Investments in Chicago.
Now worth an estimated $5.3 billion, according to Forbes, Zell chairs five public companies, including one of the nation’s largest residential REITs, investing broadly in logistics, health care, manufacturing and energy as well as real estate.
But buildings remain his first love. And while many investors and pundits are downgrading prospects for commercial real estate in central business districts (CBDs) as U.S. business snaps back from Covid, Zell sits in his office high above the Chicago River and relishes the role of contrarian.
Here’s much of what he had to say in a recent interview with Chief Executive:
There’s lots of talk about how the world of commercial real estate might be evolving as we speak. What are you actually seeing on the ground?
Everyone is talking about the end of the office and work from home, and I don’t agree with that. I’ve been at this desk every day since last March. Our company came back to doing “half and half” in the office since October. Everyone who comes back is really excited to be back. If we can keep this vaccine ramp-up going, it’ll be a very uplifting experience.
You can’t motivate by modem; you can’t make deals by Zoom. I believe we’ll go back to more conventional office usage.
Take us through the various sectors of commercial real estate as they’re evolving post-Covid. Let’s start with CBD office space, which is very important to you.
The problem is that on almost a national scale, there is an oversupply. And by the way, this is very attributable to WeWork and similar work-sharing product. What those companies did is rented space way in front of when they had demand. From a statistical point of view, that skewed all the stats in major metro areas, with the result that in Chicago we have five-million-plus square feet of new office space, but we haven’t generated five to six million square feet of new demand.
We’re looking at a 15-percent vacancy rate now and it’s probably on its way to 20 percent. That’s not because people are working from home, but because there’s just too much space.
Another category is hotels. I do believe people will travel again; no doubt tourist traveling will return very quickly. There’s been a lot of speculation that business travel will become much more muted than before: After all, you can talk to people on Zoom, so why waste time with flying?
And I think that thesis will prevail – until you’ve got two people competing for a job, an opportunity, and one of them says, “You know, I bet I have a better chance if I go see the person and sit across the table. They’re going to appreciate the fact that I made the extra effort. That person will get the deal; that will end all this Zoom stuff. People are people, and people relate to people – people achieve sitting across the table from each other.
How long before this old normal becomes the new normal?
No one can say. The general conventional wisdom about the reopening of hospitality space has been missing one big issue: The cost of reopening is very different for a hotel than for an office building. It’s so much more populated and service-oriented.
The first thing already starting to recover is non-service hotels. The last thing that will recover will be giant, full-service hotels. I do think Las Vegas is going to outperform the rest of the country because I think demand for expos and sales and marketing events is going to recover very quickly. No one thinks about the fact that such a big chunk of hotel sales are the result of conventions, not just fun events. Orlando may recover quickly too, certainly faster than New York or Chicago.
What about retail?
Talk about a falling knife. Are people never going to shop in person again? Yes, they will. But be historical about this and understand that in the United States we started out with five square feet of retail per person more than in Europe, and more than Asia for sure. So, Number One, we have a lot of excess retail space. How many apparel stores do you need in a mall?
Number two, the pandemic has clearly moved forward the penetration of online, from probably what it would have been in 2026, to 2021. The result is that it’s had a pretty devastating impact on retail. How much further that will go, I don’t know. I don’t think it’s the case that 10 years from now, shopping will be 95 percent online. But certainly anything commodity-oriented is likely to be affected by online.
You’ve been saying for a while now that industrial distribution is a category to watch.
That category continues to grow. The percentage of online retail has created a tremendous need. It’s still doing extremely well. There’s a lot of demand and a lot of obsolescence in the space. A lot of geographic issues and the classic last mile. So we’re seeing in a lot of places where industrial distribution space is replacing heavy industry. Whereas heavy industry isn’t in cities anymore, that kind of space that wasn’t taken up by residential is being taken up by distribution.
And the single-family residential rental business is extraordinarily strong. That’s probably a reflection of millennials who are unwilling to make commitments; rental single-family housing is really maintaining the ultimate in optionality for them. Initially in Covid, multifamily housing suffered significantly, and the reason for that is it tends to be close to work. But then work didn’t exist.
This takes us back to your ideas about CBDs.
People are coming back to New York City after going to their summer homes during Covid. We have a significant portfolio in New York and San Francisco, and 50 percent of it is CBD. The initial response to the pandemic was probably equivalent to a 25-percent decrease in rates, but not a terrible decrease in occupancy. There was a terrific decrease in rents manifested by significant concessions. That was up until December.
But while normally the time since then is a very quiet period for leasing, and for showing [properties], what’s happened is those numbers have doubled and tripled overnight, for showings and lookers. We’ve started renting units. Concessions have gone from three months to one and a half months. In some cases, we’re actually seeing rental increases – the end of concessions, with some increases. So the supply-demand situation is reflecting the fact that everyone sees the vaccine as everything going back to normal.
In our new survey of CEO attitudes about state business climates, they favored economies that remained more or less “open” during the pandemic. Were they just venting, or will this attitude persist – and materially affect their siting decisions going forward?
That’s a very good question. My only view is that people’s memories are short. Right now, if you’re in one of those states like Illinois or California or even New York, that kind of mentality is true. But in general, the economic climate is very good. It’s a little barbell-ish. If you’re in hospitality, for instance, it’s very tough but getting well rapidly. The economy is getting well. Half of our non-real estate companies are running better numbers from 2020 than 2019, which shocked me.
There’s also a lot of talk about the middle of the country benefiting from emigration by coastal city dwellers. Is this just anecdotal, or substantive?
It’s a short-term response. I live in flyover country. But the reason that 24×7 cities are so attractive is, there’s a lot to do there. In Nowheresville, Iowa, it’s 5 o’clock at the same time as in Chicago, and in Chicago you can go get a drink and see a movie or go off to a museum. In Nowheresville, Iowa, maybe being there for the first month is very unique. But I don’t think that effect is going to last.