Note: While reading a book whenever I come across something interesting, I highlight it on my Kindle. Later I turn those highlights into a blogpost. It is not a complete summary of the book. These are my notes which I intend to go back to later. Let’s start!
No one has ever left a meeting with me wondering what I meant. When I say something it is clear, candid, and often blunt. “Am I being too subtle?” is my punch line when I deliver a message I consider obvious. I’ll occasionally add, “I can speak slower if you want,” to ensure my point is received. I can seem gruff. I know that. And I can be impatient. I have an embedded sense of urgency. What I can’t figure out is why so many other people don’t have it. But from an early age I realized that I had a fundamentally different perspective from my peers. And I was willing to trade conformity for authenticity—even when that meant being an outlier, which it usually did, and even if it meant being on my own.
I believe the fundamentals of business—supply and demand, liquidity equals value, good corporate governance, and reliable partners, to name a few—apply across the board. They inform my decision making, or what I do, just like my philosophies guide how I do it.
Reputation is your most important asset. Everything you do, everything you say, is part of the permanent record. Your name reflects your character. No matter how successful I got, I never forgot that lesson. I’ve always strived to be known as a man of my word.
“No problem,” I said. “I’ll be over tomorrow and we’ll figure it out.” Since the purchase price was only $19,000, and the house was on a double lot, we had more options available. I proposed that we build a one-bedroom apartment extension onto the house, side by side. We could design it so that if her brother walked in the front door of his unit and kept walking, he’d end up in the shower. She loved it. And I had completed my acquisition of the last parcel I needed to own the whole block. I remember this event so clearly because it was at this point in my career that I fully realized the value of tenacity. I just had to assume there was a way through any obstacle, and then I’d find it. This is perhaps my most fundamental principle of entrepreneurialism, and to success in general. But my experience with Mrs. D was also about the value of really listening, which is at the heart of any negotiation. Understanding what’s truly important to the other person out of the dozen or so things they might tell you. Mrs. D’s brother had to be taken care of. That was her bottom line. Homing in on that got the deal done. That was my first real investment thesis. If I could replicate what I was doing in Ann Arbor in other markets, I could realize some serious upside. I would build a portfolio of assets in smaller, high-growth markets with a focus on university towns. That all seems logical in hindsight today, but back then nobody was doing it.
“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. Once Jay decided that I was honest and smart, he was on board. He never called me to check on things. He never questioned where we were in our investment. The title to the property was in my name. At the same time, I had no doubt that if it all went south at any time, Jay would have my back. Jay taught me to use simplicity as a strategy. He had an uncanny ability to grasp an extremely complex situation and immediately locate the weakness. He always said that if there were twelve steps in a deal, the whole thing depended on just one of them. The others would either work themselves out or were less important. He had a laser focus on risk. I like to say my father taught me how to be, law school taught me how to think, Jay taught me how to understand risk.
We were having fun, and we were doing extremely well. I realized that the basics of business are straightforward. It’s largely about risk. If you’ve got a big downside and a small upside, run the other way. If you’ve got a big upside and a small downside, do the deal. Always make sure you’re getting paid for the risk you take, and never risk what you cannot afford to lose. Keep it simple. A scenario that takes four steps instead of one means there are three additional opportunities to fail.
In general, the buildings I chose had a few common denominators. First, they had to be available below replacement cost. If I could set rents based on a $10,000-per-unit purchase price, and the sunk costs of new development were $20,000 per unit, a new building would be priced out of the market. Second, they had to be good-quality, well-located properties, which usually perform better than market throughout economic cycles. Tenants tend to stick in the up cycle, and upgrade to nicer space in the down cycle as rental rates fall. So better assets provided more stable cash flow, and that gave us downside protection. Many of the properties I chose also had deferred maintenance. While the structures were good, repairs and upgrades had been neglected. So there was room for improvements that would help us lease more space, often at higher rents, thereby improving the value of the asset.
In 1980, Bob and I sat down and listed the reasons we didn’t like where the real estate market was headed. First, the key to our prior success had been an inefficient market. The real estate industry had always been fragmented, with valuations and projections that often varied widely. That started changing rapidly with the debut of Hewlett-Packard’s financial calculator. All of a sudden, any owner could hire an MBA with an HP-12C to run ten years of cash flows, none of which considered recessions or rent dips, and make an elaborate and sophisticated case for investment—and a bunch of eager investors would show up to check out the property. That was not an arena we wanted to compete in. Second, up until then, lenders made long-term, fixed-rate, nonrecourse loans. But as a result of inflation in the 1970s, they got scared and switched to short-term, floating-rate loans. We believed the real money in real estate came from borrowing long-term, fixed-rate debt in an inflationary scenario that ultimately depreciated the value of the loan and increased the position of the borrower. Finally, we had always looked at the tax benefits of real estate as what you got for the lack of liquidity. All of a sudden, sellers were including a value for tax benefits in their asset pricing. So we said, “If we’ve been as successful in real estate as we have been, aren’t we really just good businessmen? And if we’re good businessmen, then why wouldn’t the same principles that apply to buying real estate apply to buying anything else?” We checked the boxes—supply and demand, barriers to entry, tax considerations—all of the criteria that governed our decisions in real estate, and didn’t see any differences. So we set a goal that we would diversify our investment portfolio to be 50 percent real estate and 50 percent non–real estate by 1990. The oceangoing freight container leasing industry was an oligopoly of about seven providers. Itel was number four. We bought number three, and then we bought number seven and became number one. Our strategy was simple. Let’s say Itel had revenues of $100 million and expenses of $50 million. And number three had revenues of $100 million and expenses of $50 million. Each company had its own extensive operating and logistics system—separate facilities in each city, separate computer systems, and so on. By eliminating the redundancies, we increased margins by 20 percent. This was my first experience listening to proposals about the great “synergies” of mergers. As an investor and a risk taker, my focus has to be on what is specifically attainable. Buying another company based on the perception of opportunities for cross-selling and other intangible benefits generally represents a much higher level of risk than I believe is justified. Therefore, I concentrate on eliminating redundancies, which measurably reduces the capital required to run the business. This epiphany later became relevant across industries from drugstores, to radio stations, to supermarkets, and others. Redundancies are much more predictable and transparent than theoretical opportunities to add value. My focus is always on the downside. Overly optimistic assumptions lead to the graveyard of corporate acquisitions. The most reliable measure of our buildings’ value remained—and had always been, in my opinion—replacement cost. Replacement cost mattered more to me than rents or comparable prices or vacancies or economic growth or stock price. This was because replacement cost determined the price of future competition.
Risk is the ultimate differentiator. I have always had a deep and complex relationship with it. I am not a reckless person, but taking risks is really the only way to consistently achieve above-average returns—in life as well as in investments. My father proved that when he left Poland. I am probably more comfortable with risk than most people. That’s because I do as much as I can to understand it. To me, risk-taking rests on the ability to see all the variables and then identify the ones that will make or break you. Sure, I’m always looking for unlocked potential, for strong fundamentals in a business that suggest a high probability of success. But everybody wants to look at how good a deal can get. People love focusing on the upside. That’s where the fun is. What amazes me is how superficially they consider the downside. For me, the calculation in making a deal starts with the downside. If I can identify that, then I understand the risk I’m taking. What’s the outcome if everything goes wrong? What actions would we take? Can I bear the cost? Can I survive it?
In addition to looking at worst-case scenarios, I look at how hard something is to execute. The simpler the goals and the steps to reach them, the more likely I’ll be successful. And if they aren’t simple to begin with, I look at how I can untangle the complexities.
I’m drawn to emerging markets because of their built-in demand. I’ve always believed in buying into in-place demand rather than trying to create it. To me, international investing is largely a story of demography. Just look at population growth. Most of the developed countries (e.g., U.K., France, Japan, Spain, Italy) have aging populations and are ending each year with flat or negative population growth rates. For instance, we don’t spend much time looking at Western Europe. It’s Disneyland. It’s great for wine and castles and cheese, but there’s no growth there. Further, Europe has the largest population of pensioners in the world. The number of retirees who don’t work is close to double what we have in the U.S. and most of those European countries fund each year’s pensions from taxes. It begs the question, with a shrinking workforce where will that money come from? In contrast, most of the emerging markets (e.g., India, Mexico, Colombia, South Africa, Brazil) have younger populations and higher growth rates. And while growth rates across the board have fallen off a cliff since 2007, emerging markets are still ahead of developed countries. That means more built-in demand. In the early 2000s, demographic trends and fiscal discipline in several emerging markets were rapidly increasing the size of their respective middle classes. I knew that growth would generate demand for housing, retail, and other real estate. So we looked for opportunities in that arena. In addition to demographics, we look at national stability. Political leadership is particularly important in the rapidly changing environments of emerging markets. The ideal is a growth-oriented president who is a fiscal conservative and a social liberal—someone who governs from the middle. In emerging markets, a big clue to national stability is whether a country is on the verge of investment-grade rating. Early on, I came to the conclusion there’s no other time in the life of any country when it’s more disciplined and more transparent than when it’s a year or two away from reaching investment-grade status. The ranking translates into an immediate benefit for a country, so it’s on its best behavior. Investment grade strengthens the country’s currency, leads to increased demand for investment opportunities from foreign direct investors, boosts world confidence in the economy—because the country has demonstrated discipline within the political system—and rewards the country with a lower cost and greater access to capital. We invested in Mexico, Brazil, and Colombia when each was on the verge of investment grade, and we benefited from this impact firsthand. 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. Africa is a great example. I think many countries, such as Botswana, have potential, but the upper and middle classes are too small for me to get involved. Chile is another example. It has the institutions and leadership, but only 17 million people—no scale. I believe in the radius theory of business, where your ability to succeed is ultimately limited by the number of people between you and the decision. That’s because the farther from you the decision is made, the less you control the risk. History shows that businesses get buried when they don’t delegate enough—but also when they delegate too much.
The environment you spend most of your waking hours in reflects who you are and the type of people you want working with and for you. Culture can either inspire ideas or stifle them. It can lay the basis for relationships that last decades or flip through them like a deck of cards. It is the heartbeat of your company.
I tell people, “Don’t parrot back to me what I think, and don’t try to guess what I think. I want to know what you think.” And I do that over and over again until the right answer pops out. When I sit in my office with a group of people, I don’t seek deference; I seek ideas. In that setting, every person is on a level playing field. They also each have a stake in every endeavor.
I give my people a lot of freedom to explore and problem solve while I control the risk through big decisions. This autonomy, coupled with the access to fast decisions, is like crack to my people. They know I trust them. I don’t say it. I show it. When I put millions behind a deal one of my investment people sourced, researched, negotiated, and closed, it creates an electric, exhilarating environment.
I believe my purpose in life is to make a difference, and I define making a difference as driving growth. Whether it’s mentoring a young executive, turning around a faltering business, establishing an incubator for new companies, or whatever, it’s about progress, improvement, forward momentum.
“If you ain’t the lead dog, the scenery never changes.” The origin of this quote was humorist Robert Benchley. I’ve always loved it because it defines my basic approach. In my businesses, I like to be the lead dog, to control the “scenery” in every industry I enter. It means not being less than number two in any industry, and preferably being number one. If you’re not the lead dog, you spend your whole life responding to others. This mentality is on display in my companies. Equity LifeStyle Properties is the biggest operator of manufactured homes and RV parks. Equity Residential is the country’s leading owner of apartment buildings. Until we sold it, Equity Office Properties had the largest portfolio of Class A office properties. Covanta is one of the country’s largest waste-to-energy companies. Sealy Corporation was the largest bedding manufacturer in North America. Revco was the second-largest U.S. drugstore chain after Rite Aid. Let me add that being the lead dog is not just a business strategy. It’s a mind-set. And I think that mind-set is uniquely American. America is the great equalizer. You can come from nothing, you can come with no pedigree, you can be the son or daughter of immigrants, and you have the opportunity to be successful. There’s no other country that doesn’t require some kind of birth heritage, or inheritance, or ingrown advantage. Here, everybody has a shot at being the lead dog.
The minute you acknowledge that a problem is insurmountable, you fail. If you just assume there is a way through to the other side, you’ll usually find it, and you’ll unleash your creativity to do so. I equate this fundamental truth with an entrepreneurial mind-set. It’s tenacity, optimism, drive, and conviction all rolled into one. It’s a commitment to get it done, see it through, make it work. In my world, I call that being an owner. For me, that means investing time as well as money. It means giving whatever it is—a company or a project—space in my head. I constantly think about it, how to make it better and how to introduce it to new opportunities. All with the goal of making a difference, effecting a positive change.