Necessity is the mother of invention … .
by Sam Zell
In the early 1990s the commercial real estate market faced the greatest peril in its history. The industry was overleveraged, underoccupied, and bleeding cash. Its traditional sources of capital were out of business. By turning to the public markets for the first time, an industry comprising 15 percent of the nation’s economy was forced to change radically and begin an equitization effort—a process that took public equity from $6 billion to $150 billion in less than 10 years.
The seeds of the revolution were sown with the 1991 initial public offering of Kimco Realty, the first modern real estate investment trust. Kimco was followed by the shot heard ’round the world: the IPO of Taubman Centers. Taubman legitimized the UPREIT structure in the eyes of the investment community and thus paved the way for the industry’s shift from private to public companies. Hundreds of initial and secondary offerings created a new sector of investing almost overnight. For investors, REITs offered share price appreciation and dividend income as well as a chance to own the apartments we live in, the office buildings we work in, and the malls we shop in. For REITs, the freshly raised capital provided the funds for growth and the opportunity to create companies with portfolios of a size and scope never seen before. Size allowed REITs to take advantage of economies of scale in contracting for goods and services as well as providing national tenants with one-stop shopping for office and mall space and other corporate housing.
As the industry continued to grow, more and more companies went public. And, as always, Darwin had his say, and the industry began a wave of consolidation that continues today. Smaller, regional property companies were acquired and consolidated into larger, more geographically diverse portfolios, strengthening financial performance and share prices while allowing for more stability through real estate cycles.
1998 presented the first major test for the new REIT as an overenthusiasm for growth led to fear of overdevelopment. Naysayers were sure the industry was doomed to repeat the mistakes of the past. But we had learned a thing or two along the way. The industry was now operating as public companies, and this dynamic acted as a governor on the development community.
The REIT of today is not much different from any other operating company. It is a large, liquid company boasting seasoned, professional management and predictable sources of income. The continued focus on transparency has created an important byproduct—a geometrically expanding base of real estate information available to industry professionals, the investment community, and the public in general.
In view of this history, what does the future hold?
The revolution in our industry—the events of the past 10 years were not evolutionary, but revolutionary—will continue. We are still in the early stages of the reconfiguration of our business; its ultimate shape is still undetermined. But as is typical of any industry whose members are new to the ranks of public companies, consolidation will continue and grow to satisfy investor demands for more efficiency and liquidity.
Investors are becoming more sophisticated in understanding and evaluating companies. Over time the principle of survival of the fittest will prevail. Differentiation between the leaders of each segment will continue, and companies that choose not to follow an acceptable public model—transparency, liquidity, and predictability—will become irrelevant.
The acceptable model will be well-financed and professionally managed companies that are prepared to compete for capital with all other industries. A growing number of industry pioneers will be passing the torch, and the management of the future may not come from our industry.
Future challenges will require more diverse and sophisticated capabilities. The passage of the taxable REIT subsidiary legislation is both an awesome opportunity and a potential pitfall. In the near future, I believe the S&P 500 will include REITs, which would mean the investment community accepts real estate as a relevant segment of investment.
Any look to the future cannot avoid the importance of the events of September 11. The enormous fiscal stimulation is likely to reawaken inflation and unknown future limitations on how we operate. The shock to America has caused all of us to rethink what we do and how we do it. Future challenges will require superior strategy and exceptional execution, something I expect from our country and our industry.
Sam Zell is chairman of Equity Office Properties Trust, Equity Residential Properties Trust, and Manufactured Home Communities.
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