What Blackstone Bet Means
For Real-Estate Investors

With its bold move to buy Equity Office Properties Trust in the largest real-estate deal in history, Blackstone Group is betting that commercial real-estate prices haven't gotten out of hand, despite a big run-up in recent years.

Blackstone's move to convert the publicly traded real-estate investment trust into a privately owned business rippled through the REIT industry, lifting shares of such companies across the board by 3.2% in anticipation of more buyouts and mergers.

Analysts said the Equity Office deal underscores a recent trend in the REIT industry: Publicly traded real-estate companies are fetching much more from private firms than they do from the public stock markets, despite a 29% increase in REIT shares so far this year. It also dispels the theory that some real-estate investment trusts are too big to buy out, said Keven Lindemann, real-estate group director at SNL Financial, a research outfit in Charlottesville, Va. A day after the private-equity firm announced it would buy Chicago-based Equity Office for $20 billion plus $16 billion in debt assumption, Equity Office's largest shareholder, Cohen & Steers, questioned whether the company was worth more. Jim Corl, Cohen & Steers's chief investment officer, said the cost of buying all the properties in the company's portfolio would value it "in the $60 range."

The $48.50 price was 8.5% more than the REIT's closing share price on Friday. The stock jumped 7.7% yesterday to $48.14.

Sam Zell, Equity Office's chairman, said in an interview yesterday that Blackstone's bid was unsolicited. He added that the stock market had "underpriced the value of this company" and that no effort was made to find other bidders. "We got what we considered to be a significant offer at a price that we considered to be very attractive, and responded accordingly," he said.

Matthew Ostrower, an analyst with Morgan Stanley, said the price is high compared with Blackstone's recent acquisitions of Trizec Properties Inc. and CarrAmerica Realty Corp., two other office REITs. Blackstone expects to make net operating income totaling 5.5% of its purchase price for Equity Office in the first year -- the so-called capitalization rate. Trizec had a cap rate of 5.8%, and Carr-America's was 6.7%, meaning those companies came much cheaper.

Despite investors hopes for more bidders, the number of players that could buy a company as large as Equity Office is limited. "We can write a large check that other people can't write," said Frank Cohen, a Blackstone managing director of real estate, at a recent industry conference.

Blackstone is betting that corporate tenants will clamor for more space as the economy continues to expand. That, combined with construction and land costs that remain high, should keep office fundamentals strong. At the end of the third quarter, the nationwide vacancy rate was at its lowest in six years and rental rates had surged this year.

Some analysts questioned whether it was a good time for Blackstone to grab Equity Office, which has total or partial stakes in more than 500 office buildings throughout the country, after already gulping huge bites of two other office companies since July.

"I have tremendous respect for the Blackstone Group," said John Lutzius, president of Green Street Advisors, a Newport Beach, Calif., research and trading company. "But this is yet another large deal, and they have a lot of work ahead of them to rationalize all these properties that they've bought and do what they want to do with them."

Reis Inc., a New York real-estate research firm, also notes that the amount of space companies leased in the third quarter dropped significantly compared with the previous two quarters, while construction of new buildings is increasing nationwide.

If Blackstone follows its pattern after purchasing CarrAmerica, it will likely use many of the properties to borrow money, giving it a higher cash return, and sell off properties in markets where it doesn't intend to concentrate. Publicly traded REITs, which must answer to shareholders, have been reluctant to let their debt levels soar.

Blackstone's office-sector buying spree is in some respects similar to one it went on in the hotel industry from May 2004 to this February. Blackstone bought into that industry's recovery, taking $8 billion of public hotel companies ($15 billion including debt) private and wagering that revenue per available room and occupancy would rise. So far, the investment has paid off. The hotel industry set a record for profitability in 2005 and is expected to do so again each year through 2008, according to projections by PricewaterhouseCoopers.

Morgan Stanley's Mr. Ostrower says despite the trend toward going private, there is still a place for publicly traded REITs, noting that the buyouts have culled some of the weaker performers, including Equity Office.

"One thing that ties all these things together is they've generally involved companies that have very significantly underperformed for multiyear periods," Mr. Ostrower says.

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