How REITs Really Work: Sam Zell, Boston Properties, and $4 Billion in Real Estate Deals

Steven M Weinstock: 0:01 Hi everyone, and welcome back to the Wealth Clock with Steven Winestock. I'm Steven Winestock, real estate investor, fund manager and founder of We Capital and the Goel Capital Fund, where we buy properties in cash lock in deep discounts, and scale smarter after a refinance. As always, this show is not about me. It's about learning from operators, founders, industry leaders who are making big moves and sharing what actually works. Today, I'm privileged. I'm joined by Professor Jonathan Morris, one of the most respected voices in the REIT space, real estate investment trust space. Over a career spanning nearly three decades, Jonathan has served as a chief investment officer, CEO. And board member for some of the biggest names in the REIT world, including Boston Properties, Charles E. Smith Residential. He's completed more than a $4 billion in transactions, and pioneered the use of UpREIT structures and has spent over a decade as a professor at Georgetown University. Now he's the founder of WREATH Academy. An educational platform designed to fill the knowledge gap in the REIT industry, helping professionals, executives, investors, truly understand the mechanics, the strategies, and the metrics that drive REIT performance. We're going to cover a lot. Professor Jonathan, thank you so much for being here. I appreciate it. Thank you for having me. Steel for those new to the space, what is a REIT in plain English? Jonathan Morris: 1:46 In plain English a reit, a Real Estate Investment Trust is a type of legal entity that. You can set up to own multiple properties in unlike a limited partnership, which has always been the traditional method of commercial real estate ownership. A REIT has two different entities, one of which is a C corporation. The other is an operating partnership, which is also a limited partnership. There are many benefits to the UpREIT structure. The Upper UpREIT structure was invented in November of 1992. A year earlier the we had something called the dawn of the modern REIT era, which is when new comp companies that were formally decades old companies with brand names converted to a reit. Went public due to the fact that there was virtually no capital available for commercial real estate. So the pivot, if you will, was to take your portfolio, create a reit, move your assets one by one into the reit, and then using that as your base, sell a portion of your portfolio. Into the stock market and overnight you be, you are now a public company with your stock trading on a daily basis. But that was a huge benefit to many companies at the time. And many of those companies today are the leading REITs in the market. Steven M Weinstock: 3:28 Can you explain the difference between a public REIT and a private REIT and private partnerships? Jonathan Morris: 3:34 Sure. So the first question, public versus private. A lot of people might form a private REIT because the structure itself is flexible. For example, if you wanna a, if you run a private REIT and you wanna acquire a property. That property is say 20, 25 years old, but it's very well located. It's in great shape, and the seller is interested in selling it. You can bid on the property and you can bid cash for it, but you can also buy it in another venue. That venue is exchanging equity in the REIT for the property. The seller pays no capital gains taxes on that deal, and as long as the equity is valuable and you can define it as such, then the seller may be inclined to do that with you due to the fact that they've depreciated the property significantly over the years. Any sale for cash would incur a large amount of recapture of depreciated basis. So they might sell it for $25 million, but they may end up paying $8 million in taxes. The public REITs are those companies that I mentioned earlier. That were sizable, had big portfolios and were very well thought of the investment bankers that approached those companies. One was, one big one was Merrill Lynch, another was Goldman Sachs. Their focus was to have them create the REIT. Move their assets into it and sell a portion of the company, be it 5% or 10% of the company into the public market, and therefore the company becomes a publicly traded reit. And as a result of that. Everything that goes on at that company is intended to be transparent. So they need to file documents with the Securities Exchange Commission at a minimum quarterly with all their financial statements, and the good REITs will file more often. So if there's a material event that occurs, they're gonna buy a property, they're gonna hire a very senior executive they, they have a big CapEx issue at a property. Most of that gets filed with the SEC, and you and I can go on the SEC's website and read those filings in real time. The difference between either a public REIT or a private REIT and a limited partnership is it's pretty stark. The. The way a REIT works at its core is by its ownership. Remember I said there's two parts? The bottom part is an operating partnership that is actually a limited partnership. Okay? The top part of the structure is a C corporation. The C corporation is the general partner of this operating partnership. So the benefits are many. When you create a reit, you move your assets into the operating partnership, and in that way, you are effectively trading. Quote, like kind equity, so the equity in the asset comes into the operating partnership in exchange for equity in the operating partnership. To the former owner of the property. Now the property is in a large pool of assets and it benefits significantly from that. For example, if there were five properties that you owned each in its own limited partnership, and let's say two or three of them are doing fine, they've got good cash flow, you're reserving some cash for future CapEx, but let's say one. Has not been doing particularly well and it needs a new roof. There may not be enough capital in reserve to pay for the new roof. You may not be able to borrow against it to put on a new roof, and you may need to make a capital call to the limited partners. If it's inside of an operating partnership of a reit, it can access cash from any place to put that new roof on. So the people who sell their properties into a REIT in exchange for equity, they get equity in the reit, which means instead of owning all the equity in one asset. They're exchanging that equity for equity in a very big pool of assets. So they get the diversification, they get the upside. They get a lot of benefits from that, and most importantly, they defer capital gains as a result. Steven M Weinstock: 8:35 Professor, tell us a little about yourself. How did you get into real estate? Is this the first career you had? Were you flipping burgers? No. How did you get into this business? Jonathan Morris: 8:47 I was delivering newspapers for a while. Actually when I went to undergrad in Baltimore, and by the way, I went on a track scholarship. I ran the sprints, the hundred, the 200, the 400. But my interest was really peaked when I took a class on what's called securities, which is stocks, bonds, et cetera, et cetera, and I really enjoyed the class. I took a follow-up class with the same professor. I took finance classes and I thought, okay, I would like to be involved in this, but I'm from Washington, DC and Washington DC doesn't have offices or corporate offices of Merrill Lynch or any of the big firms. So I ended up going to work for what was called the National Association of Securities Dealers, which is the Association for the Securities Industry. So I got a little bit of my objective, stated, but not a lot. I ended up getting my first real estate opportunity as I think a lot of people, at least at my age do through relationships. Steven M Weinstock: 17:42 What are some of the barriers to become a public reit? How large are we talking about? Could I own 1200 apartments spread out over three properties with a total value of $26 million and open it up to the public and become a publicly traded reit. What are some of the high level barriers to get in? Jonathan Morris: 18:09 That's a good question. Today there's a couple ways to go. Now if you take what we created now, we owned 33 high-rise apartment buildings that had been developed ground up by the company from the early mid sixties all the way through the early mid nineties. And they were all done by the company on ground that Mr. Smith had either acquired or owned, and the portfolio was worth many billions of dollars. So if you went to an investment banker today, what they would tell you is if your company has a billion dollars worth of assets, that's the starting point. But then the assets need to be similar. You need to have a constant theme through those assets, and they have to be in great condition and they have to be well maintained. Several years ago, however, the SEC came out with some new regulations called Regulation A and Regulation A Plus. And the objective of those regulations was to effectively make the opportunity to become a public company much more efficient. For example, regulation A allows you to raise 20 million a year. Public offering funds and regulation A plus I think is up to 70 million per year. So the baby regulation A is very slipstream. You could take those 1200 units and put them into a reg a structure. Raise money around it and be a public reit. It wouldn't be a big public reit, but it would be a public reit. Steven M Weinstock: 20:04 So you have different REITs that are out there, and for the most part, these REITs own the same class of properties that you'll have warehouse REITs, you'll have residential REITs office space REITs. There's never a mix where it could just be a hodgepodge. Great assets, whether it's a fancy hotel on the water in Florida and a downtown skyscraper in Manhattan. Do you never have that? It's always similar. Jonathan Morris: 20:32 Yeah. Let me tell you why first. Okay. The whole essence of a REIT and the way REITs got started was back in the late 1950s, there was a growing desire objective groundswell by the newly formed middle class. And I'm sure American history. We went through the Great Depression. We went through World War I, world War ii. And the country was in complete disarray during those times, but by the late 1950s and 1960 in particular, the country and the economy had time to heal from all that. And what evolved from that was something called the middle class, which was educated people getting good jobs. Good income, buying their first home and having families. And as a result of that, they were very conservative and they saved as much as they could for investment, but there were few investments available back then. So in the real estate space, these guys, the fathers who would drive to work and drive back, they would drive by apartment buildings, they would drive by retail stores. They would drive by office buildings. And they were thinking, I've saved up a lot of money. I was wondering if I could invest in one of this. Steven M Weinstock: 34:48 You founded REIT Academy to fill an education gap in the industry. Tell us about REIT Academy. What inspired you to create it? Jonathan Morris: 34:58 So everything that we're talking about, I experienced firsthand, and when I started, or shortly after I started, REITs were being created very often. You don't remember this, but leading up to the 1990s we experienced in the US a horrible situation for commercial real estate. Most of the eighties was up and away. Every major city was growing rapidly. DC was growing like crazy and office buildings were being built left and right, and they were also getting leased left and right. However, by 87, 88, things had slurred down a lot, but developers still had buildings going up. And what happened was those last 10 or 20 buildings got completed. They never got leased. And within 18 or 20 months, the lenders foreclosed on those buildings and took them away from the developer. We had something called the SNL Crisis in the late 1980s, and by 1990 the Congress of the United States, they got wind of all this and they worried that the situation in the commercial real estate industry was going to impact the US economy negatively. So they created something called the Resolution Trust Corporation, or RTC, and they did it using emergency legislation. Steven M Weinstock: 37:29 Were they taking them off the balance sheet of these SNLs? Just to give an example they foreclosed on a $20 million building, but the bank is struggling, holding onto this building. The government created this legislation and basically handed a check for $20 million and now took ownership of the building, or did they? Or was that the original plan and it just never went that way? Jonathan Morris: 37:58 I don't think anybody got a hundred cents on the dollar back. But what happened was that the SNLs themselves implode, so they were worthless. So Sam Zell had gotten a reputation during times of tough times in the economy and this period was made for him. So he ended up sending a team of three or four young folks to Washington who every day would show up at the RTCs offices on H Street, and they would wait for the incoming list of properties, which would be sometimes in the hundreds. Merrill Lynch put together a $500 million fund to bank Sam Zell in this effort. Sam Zell ate through that first fund. They opened a second fund. He ate through that 500 million. He ended up doing four funds with Merrill and he put out $2 billion worth of equity for all this failed real estate. He went undercover for a while, but what he did was he took all those properties that he acquired inexpensively, by the way, and he separated them into their quote sector. So over here, he put the apartments over here and put the office building. He's over here. He put the shopping centers. And over here he put the industrial building. So he got four big piles of real estate. He took each one of them and created a REIT and took it public. So Sam Zell used all this cash to buy a lot of properties inexpensively, and then he allocated them to their own property type and took them public. And that's how Equity Residential, for example, came about. That's how Equity Office came about. Equity Lifestyle came about. Steven M Weinstock: 48:49 Jonathan, this was great. Professor Jonathan Morris joined us here. Jonathan Morris: 48:56 Wait a minute. I got one last thing to mention. I love your glasses. Where did you get them? How long have you had them? Steven M Weinstock: 49:04 My wife got it for me somewhere local in Brooklyn. I've had it for about a year and a half. And if my wife listens then she will appreciate that comment. Thank you very much, professor. I appreciate it. Jonathan Morris: 49:15 Yep. They look good. They look good on it. Steven M Weinstock: 49:18 Thank you. Again, thank you so much for joining me. If I was sitting next to you on a plane to Australia and the wifi was down, I would still have plenty to talk to you about. You are extremely interesting. It was a lot of fun and I really liked this. Tell the audience where they could reach out to you, contact you, et cetera. Jonathan Morris: 49:38 Sure. You can reach out to me at Jonathan, J-O-N-A-T-H-A-N dot Morris, M as in mother, O-R-R-I-S at REIT academy.com. Steven M Weinstock: 49:53 Okay, great. You're also active on LinkedIn. LinkedIn and your website is reit academy.com. Jonathan, I had a great conversation with you. I appreciate you sharing not only your deep industry knowledge. Your passion for educating everybody else, it's clear that your work is helping shape the next generation of real estate leaders and investors. For those listening, make sure to check out reit academy.com to learn more about Professor Jonathan Morris's programs and the upcoming executive REIT masterclass. And don't forget to subscribe to the Wealth Clock with Steven Weinstock, so you never miss an episode. Thank you very much. Till the next time. Thank you.