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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.
My takeaway was a whole new respect for simplicity. Development required multiple steps, and every step meant one more chance for something to go wrong. When Jay and I liquidated the Tahoe investment years later, I noticed that we had forgotten something critical, so I called him. “Listen,” I said, “the deal is closed, but I just realized we never drew up a formal partnership agreement between the two of us. If the IRS comes and reviews this thing, we’re going to look like idiots if we don’t have documents.” “Yeah, yeah,” he said, not really interested. That was indicative of Jay. Trust was one of his abiding principles. He’d always bet a lot more on the person than on the deal.
I was the pitchman. I went to each of the houses, sat on a lot of couches, and flipped through dozens of family photo albums as I explained to the homeowners that we were going to build student housing and they could either stay and put up with loud music at night and beer cans on the lawn, or they could move to the other side of Ann Arbor. It worked. I kept buying houses and eventually acquired one full block of land. They were all cash deals, $1,000 each to tie up the properties with deferred closings requiring around $20,000.
The Jacor story was all about seeing micro opportunities in macro events. In this case, the macro event was legislation similar to the impact of the Economic Recovery Tax Act of 1981 on NOLs. But I find implications for opportunity everywhere — in world events, economic news, and conversations. I’ve always been on the lookout for big-picture influencers and anomalies that will direct the course of industries and companies.
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.
I figured the deal was as good as done, and I returned to Ann Arbor and identified five houses that were all in the same price range for what I was going to pay for the land, about $32,000 to $34,000. These five houses were beautiful — every one of them was three times better than what Mrs. D lived in. One day I drove her around to see them. She walked through each one but never said a word. I couldn’t get any response at all. At the end of the day, I drove her back home. As we neared the corner by her house, we saw a man swaying and holding onto a lamppost. I pointed him out, and Mrs. D said, “Oh, that’s my brother. He lives with us and visits the bars every night. That’s why I don’t like any of the houses we went to see — because he can’t drive; he has to be within at least eight blocks of the downtown bars because he goes there every night, gets drunk, and then walks home.” That’s what we call the major unknown factor. “No problem,” I said to Mrs. D, for the first of many times.