Blackstone Deal May Jolt
Market for Office Space

Blackstone Group's $23 billion buyout of the owner of the biggest portfolio of U.S. office buildings will send ripples through the real-estate world, with a good chance it will raise the ceiling on already-record prices.

With office buildings in red-hot demand as investment vehicles, Blackstone's control of prime properties likely will put it in position to demand prices on its individual buildings high enough to make the private-equity firm's bid pay off. The deal, approved yesterday by Equity Office Properties Trust after rival bidder Vornado Realty Trust bowed out following weeks of bidding, also cements Blackstone's clout as one of the most powerful investors on Wall Street.

Blackstone's final price of $55.50 a share was a 14.4% increase from its original bid of $48.50 in November, and reflects optimism that commercial-property demand will remain torrid. The private-equity outfit got a chance to hedge a bit, too: After Vornado entered the race in mid-January, Equity Office -- also known as EOP -- gave Blackstone permission to hold concrete talks with potential buyers about specific asset sales.

"The ability to talk to potential buyers gave us confidence that we had enough of a cushion," says Jonathan Gray, Blackstone's senior managing director in charge of real-estate investment activities.

To be sure, even though Blackstone can sell off the property, whoever buys the buildings could be burned if rents don't keep pace with rising price tags. "I don't know how long it can continue," says Peter Hennessy, president of the New York office of Staubach Co., a real-estate firm. "When things like this start to go wild like the last 12 months, how long can they sustain themselves?" he asks.

Losing out was a bitter disappointment for Vornado Chief Executive Steven Roth, who gave up for the second time in six months on his hope of acquiring Equity Office and its coveted office buildings in markets from Manhattan to San Francisco.

And for Equity Office founder and Chairman Sam Zell, who chatted with his longtime friend Mr. Roth after the shareholder vote, the deal represents a big payday. Factoring in stock options and other payments, Mr. Zell stands to make more than $800 million from the sale, according to proxy statements.

In the second-largest leveraged buyout ever -- factoring in Equity Office's debt of $16 billion -- after Kohlberg Kravis Roberts & Co.'s 1988 buyout of RJR Nabisco Inc., shareholders of the nation's largest publicly held office landlord overwhelmingly agreed to the all-cash offer. Vornado's final $56 bid was 50 cents higher than Blackstone's, but the Equity Office board considered Blackstone's offer superior to Vornado's, which was 45% stock.

The deal closes at the end of the week, but Blackstone already has agreed to sell -- or is close to lining up buyers for -- a substantial piece of Equity Office's holdings, including much of its prime Manhattan portfolio. Demand for such buildings has been frenzied. Sales of U.S. office buildings rose 32% in 2006, with relatively modest new construction. The investors include foreign oil magnates seeking a haven to park cash, pension funds looking for reliable returns and private-equity firms wanting a percentage of their portfolio in real estate. If Blackstone scares off some potential customers by demanding higher prices, it is confident others will queue up to take their place.

Market observers say Blackstone's win is a vivid illustration of how private-equity firms now have a leg up in the battle for control of companies and assets such as commercial real estate in the U.S. and elsewhere. Among the reasons: the closely held investment firms are more comfortable putting loads of debt on their targets than publicly traded buyers at a time when the debt market is willing to provide massive amounts of money at record low prices. In addition, private-equity firms can move more quickly, with no need for messy shareholder votes.

Equity Office and Vornado are both publicly traded real-estate investment trusts, or REITs, which invest in real-estate assets and aren't subject to corporate income tax as long as they pay out at least 90% of profits as dividends.

Blackstone "executed with surgical precision," says Tom Barrack, founder of Los Angeles-based Colony Capital, a large private-equity real-estate firm with close links to Equity Office, Blackstone and Vornado. Blackstone is expected to move quickly to sell off many of the office buildings in Equity Office's portfolio. By doing so, it will generate cash it can then use to pay down some of the debt it is taking on, lowering the risk that market conditions could change and leave it exposed. (See related articles on pages C1, C3 and C18.)

Already, Blackstone has agreed to sell an Equity Office portfolio of New York office buildings to Macklowe Properties, a private New York landlord, for around $7 billion, according to several people briefed on the deal. The sale would include around 6.5 million square feet of so-called Class A, or top-rated, Manhattan office space. The price would value the space at more than $1,000 a square foot. People familiar with the matter say other buyers could be involved in the deal. William Macklowe of Macklowe Properties declined to comment.

Equity Office's properties in New York are concentrated in midtown Manhattan, the most expensive office market in the U.S. Average per-square-foot sales prices for Manhattan were $611 in 2006, up 48% from the year before, according to Real Capital Analytics, a New York research firm. Prices tend to be higher in midtown, where several buildings sold for more than $1,000 a square foot last year.

Mr. Zell's strategy at Equity Office was to build a national collection of real estate whose broad reach would ride out the ups and downs of local markets. But he ended up paying too much for some buildings and owning in too many weak markets. Meanwhile, companies such as Vornado, with assets concentrated in hard-to-penetrate markets with strong economies such as Washington, D.C., flourished.

Paul Adornato, senior real-estate investment trust analyst for BMO Capital Markets, says the sale of Equity Office shows private-equity firms can swallow even behemoth publicly traded real-estate investment trusts.

Even Blackstone's original $48.50-a-share bid was a shock to Chicago-based Equity Office. "It started to get at a price that even exceeded our own estimates," Chief Executive Richard Kincaid said in an interview yesterday. Mr. Kincaid said its board favored the quick closing promised by Blackstone's all-cash bid over the uncertainties of Vornado's stock-and-cash bid, in part because of Equity Office's own uncertainties about how long the office-building market would enjoy falling vacancies and rising rents. "We weren't going to necessarily assume that the market was going to stay like this forever."

By coincidence, Mr. Zell and Mr. Roth ran into each other yesterday morning at separate breakfast meetings unrelated to this deal at the Carlyle Hotel in New York -- before Vornado announced it had given up. "He walked in and of course I'm not allowed to talk to him so I just told him I loved him," Mr. Zell said in an interview after the shareholder vote.

Mr. Zell said Mr. Roth didn't say whether Vornado would try to raise its bid and Mr. Zell said he didn't ask. "Then, when I got out of my 10 o'clock meeting, I got a call telling me that they had withdrawn."

Vornado executives declined requests for interviews but issued a public statement that said, "The premium it would have to pay to top Blackstone's latest bid, protected by a twice-increased breakup fee, would not be in its shareholders' interest." The company declined to comment further.

The company's shares closed up $8.75, or 6.9%, to $135.75 yesterday in New York Stock Exchange trading. Equity Office closed at $55.45, down 60 cents, or 1.1%, in NYSE trading.

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