In 2006, China was suffering from a dearth of available investment capital. Locals were waving in U.S. and other foreign investors with open arms. As you know by now, I love a market or deal that is starved for investors. It creates an environment where sellers and partners are bending over backward for you. I discovered that advantage over and over in my career, and I’m always on the lookout for that dynamic.
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I told David, “Go look at every store and its entire inventory, who we would sell it to and what we would get for it, in case the deal goes south.” It was a basic fire-sale analysis — what we’d get in the worst-case scenario if we had to liquidate the company. David came back and said, “We’d get 80 percent of our purchase price back.” So I knew that what we had to lose was 20 percent.
Some emerging markets will check all the boxes — strong population growth, growing middle class, verge of investment grade, great leadership, and hunger for capital — and then be missing the one ingredient that enables you to monetize your investment: scale. Without scale, you don’t have liquidity. You have no optionality. In essence, you’re stuck.
Years later, people would ask me, “How did you know when and what to buy?” But all I basically did was create a massive arbitrage — a fixed-rate instrument in an inflationary environment. I essentially took on $4 billion of nonrecourse debt at an average interest rate of 6 percent in an environment with inflation of 9 percent or higher. That means I was already making 3 percent returns the second the deal closed — without doing a thing to the assets. Sure, we picked some terrific properties, but every one didn’t have to be Class A.
In the early 2000s, new malls were sprouting up all over São Paulo and Rio, and industry ownership, as I’ve mentioned, was highly fragmented. We partnered with a local private equity firm to create BR Malls as a growth platform in 2006, investing $86 million. Roughly a year later, we led BR Malls in an IPO on Brazil’s Bovespa at an equity valuation of roughly R$2.1 billion. The capital enabled BR Malls to lead the industry in acquisitions. Five years later, the company had nearly fifty malls. Total returns for public shareholders were over 26 percent, and BR Malls had an equity market cap of R$10.7 billion. By the time we fully exited the investment in 2010, BR Malls was the largest mall company in Brazil, and we had achieved a 4.2x multiple, or 48.6 percent IRR.
I was targeting good real estate assets overburdened by excessive debt. Well, I began seeing similar scenarios unfold in the corporate world and realized I could provide equity to those companies for a stake at a discounted price, and that would help them position themselves for when the market recovered.
Equity Office was the largest REIT in the country. We had spent a decade acquiring an irreplaceable collection of over five hundred of the best office buildings in every major market in the U.S. It was my baby. Truth is, had I kept the company private, I probably would have never considered selling. But when I took EOP public, I assumed a fiduciary responsibility to shareholders. In exchange for their capital, I made a commitment to give them the best return possible on their investment. That was my primary obligation. Nothing stood before that.
Around the same time, Congress passed the Economic Recovery Tax Act. Among other things, it extended the life of net operating loss carry-forwards (NOLs) from seven to fifteen years. NOLs allow companies to offset their current year’s taxable income with past losses, thereby reducing current tax liability. The goal of the act was to help struggling companies recover and to enable their shareholders to benefit from the prior losses. We took a look at all of the public companies with large NOLs and found something surprising. These companies had virtually no change in share price as a result of the new legislation. The market was overlooking the significant value added through the extended life of NOLs. That presented us with an enormous opportunity to gain control of those NOLs and create holding companies for businesses whose profits would be shielded. If a company was trading at $3 a share for a total enterprise value of $45 million and it had $350 million in NOLs, we knew we could create profits that were sheltered and convert those NOLs (which were valued at $0) to roughly $100 million of cash, or 25 cents on the dollar over time. And that’s just what we did.
Zeckendorf’s autobiography was packed with colorful stories, but what fascinated me most was his strategy. Zeckendorf viewed assets as a sum of parts, so he could increase the value of the whole. Various parts were more valuable to different buyers, so Zeckendorf could maximize the value of his holding overall, in effect making 1 + 1 = 3. For example, One Park Avenue in Manhattan, which the marketplace had valued at $10 million, was ultimately worth $15 million in Zeckendorf’s hands. He calculated everything separately — the building’s title, the land, the leases, the individual mortgages. I thought this was brilliant. I adopted the approach both inside and, later, outside of the real estate industry.
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The third acquisition was a big single-family house. I found an architect, a small local general contractor, and we created a design for four separate units. Then I went to the bank and got loans to do the renovation. I was twenty-three, with a BA in political science. I didn’t know anything about financing. But it never crossed my mind that I might be too young to start an investment business or that I couldn’t do it. I didn’t know any better, but was able to sell the banks on my ability to get it done. Our management company took over the property, did the renovation, and rented the units. The asset did very well.
Once again, I listened as people told me I was nuts. Emerging markets were largely considered untouchable by foreign investors at the time. They were still under the shadow of loan defaults from the 1980s, and Mexico’s recent Tequila Crisis (the devaluation of the peso) had triggered widespread currency devaluation across Latin America. To top it off, many emerging market countries were reeling from the Asian financial crisis in 1997 and Russia’s default in 1998. Emerging markets at the time were not for the faint of heart. For me, of course, that presented an environment with no competition for assets.