Could Southland Blow It Again? Yes, Zell Says

He’s the self-described “Grave Dancer” known for buying America’s office towers and commercial real estate at distressed prices. But these days billionaire financier Sam Zell sees a new era for real estate, one that with the help of Wall Street won’t have the wide cyclical booms and busts of previous years.

But, even so, Zell is dancing again in Southern California, recently snapping up 550 S. Hope St., a 28-story office building in downtown Los Angeles, at a price far below what it cost to build in 1991. The purchase came on the heels of his acquisition last year of Two California Plaza, a 52-story Los Angeles office building in foreclosure. Unlike most real estate power brokers--who tend to be developers--Zell made his name by heading public companies that own real estate. These days Zell runs Chicago-based Equity Office Properties Inc., the largest office real estate investment trust in the U.S., with $5 billion in assets. In September, Equity agreed to buy rival Beacon Properties Corp. for $4 billion.

What troubles Zell most about this region’s fledgling real estate comeback can be summed up in a single word: hubris. California’s sense of self-importance is the most serious threat to the future health of its real estate, he said in a recent interview with staff writer Debora Vrana. On Thursday, the opinionated Zell will speak to fellow real estate players at the Urban Land Institute’s Los Angeles District Council at, where else, Two California Plaza.

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Times: You’ve been very outspoken on Southern California’s arrogance when it comes to real estate. There was once a feeling here that real estate downturns suffered by other parts of the country couldn’t occur here. After a five-year-plus downturn, has Los Angeles paid its dues?

Zell: No. If you listen to a lot of people talking in Los Angeles now, they already seem to have suffered a certain amount of an inability to remember. My father was an expert in what I call “selective memory.” I think there’s certainly an awful lot of it going on in Los Angeles these days. A lot of people are talking like the last five years didn’t even occur.

Times: Why is that dangerous?

Zell: Well, I think that part of the reason the whole country suffered the way it did over the last five or seven years is because of hubris--and I think that word is most applicable. I’ve been involved for many years in a group of guys who are basically the movers and shakers in the real estate business nationally. We meet every year and we talk. And in the 1980s, there was a group from California who sat separately. We would talk about oversupply, demand and all those things and they would all look at me and say, “Very interesting, but what does that have to do with us?” And indeed it did, big time.

I gave a speech in Orange County about four years ago and I began by saying that I was happy to have an opportunity to speak in La-La Land. And La-La Land starts with the assumption that real estate only goes one way--up. And it includes the perception that everyone wants to be in California and it’s only a question of opportunity. The exodus of business over the last five years suggests that even California is vulnerable.

Times: But what do you think of our fledgling real estate recovery here? We’ve had reason to be hopeful, with unemployment on the decline, home sales increasing and some very positive economic indicators.

Zell: Hey, I’ve been the biggest buyer in real estate in Southern California, so maybe I recognize that too. I’m not suggesting that there is some negative coming, I’m actually very positive on California. But for my positiveness to bear fruition, it will require intelligent and disciplined participation in the real estate market, not a “Gee, when can I get the lottery going again?” attitude.

Times: Describe our market right now.

Zell: Its health is getting better. But the general perception is that the recovery is bigger, better and faster than reality. That’s always dangerous. There are a lot of people who think, “Well, that was a bad period, now let’s go back to the way we were before.” It’s a totally new world. The allocation of capital is totally different than it’s been in the past. California no longer has the bulletproof nature to it that previously was the case.

Times: You’ve recently bought two major Los Angeles office buildings. Are you still looking at other properties here?

Zell: Absolutely. Wherever--downtown and west and south. I’m very optimistic about the future of the California market. We’re a significant player in Orange County and a significant player in San Francisco and we’re likely to be a significant player up and down the state.

Times: So is the worst over?

Zell: I think the worst is over. The only issue, frankly, is will California and the development community in California exercise the necessary discipline so as not to create a repeat. If you talked to somebody from California in the 1980s they would say that because of the restrictions on development and all this other b-------, California could never get hurt. I think we’ve proven that California can get hurt. And as long as everybody who participates in the real estate community in California continues to maintain a level of fear, then we’re likely to have an extraordinarily positive scenario.

Times: Both of the buildings you’ve purchased in Los Angeles have been downtown. What’s the future for the downtown office market?

Zell: The downtown office market is soft. But the willy-nilly allocation of capital to infrastructure development is a thing of the past. My guess is there is $40 billion to $50 billion of roads that all intersect in downtown Los Angeles. And you’ve been building mass transit. All of those things are infrastructure that I believe capital will not be available for in the future.

Times: What do you see happening with REITS? Will this bubble burst?

Zell: I don’t think so. I think the underlying basis upon which the REIT phenomenon has occurred over the last five years is basically very solid. And, if anything, the equity side of the REIT world is likely to double without much new construction over the next few years. I say that because I believe that most of the major institutions are going to continue to convert from direct to indirect ownership. I would add that pension funds all over the country are awakening to the fact that it makes no sense to be direct owners of real estate.