Sam Zell: A Question of Timing

The real estate billionaire is selling Equity Office Properties Trust to Blackstone Group for $36 billion. But is he cashing out too early?

By Michael Arndt

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Samuel Zell turned himself into a billionaire by snapping up assets that most everyone else had written off. But the founder and chairman of Equity Office Properties Trust has blundered occasionally, too. Just as the dot-com bubble was bursting in early 2001, Zell engineered a $7.1 billion takeover of another real estate investment trust (REIT), Spieker Properties, whose offices crowded such high-tech capitals as San Francisco and San Jose, Calif. Equity Office shares would not recover for four years.

So, when the Chicago company announced on Nov. 19 that it was selling itself to Blackstone Group for $36 billion, including debt, in the biggest leveraged buyout in history, investors began wondering which Sam Zell was doing the dealmaking—the myopic one or the visionary.

If white-collar job growth stalls next year, eroding the value of office buildings, then Zell will have cashed out near the top of the red-hot REIT market, adding to his reputation for seeing trends that others miss. The small premium he accepted for his company—just 8.5% above its Nov. 17 trading price of $44.72 per share—seems to indicate that he was eager to get out.

"Take the Money and Run"

Indeed, based on prices of other recent commercial-sector sales, analyst Jonathan Litt of Citigroup figures Equity Office (EOP) could have fetched at least 10% more by putting itself up for auction rather than accepting Blackstone's unsolicited offer. But that would have taken more time. "It looks like the deal went on the cheap," he says. Litt notes, though, that Zell isn't the only veteran real-estate magnate selling out these days, suggesting that insiders believe today's valuations cannot last. REIT stocks are trading at a multiple of future earnings two percentage points higher than the Standard & Poor's 500-stock index today. Historically, they've traded at a seven-point discount. Why quibble with a sure thing? Litt says: "Take the money and run."

New York-based Blackstone didn't vault to the top of the private-equity business by making boneheaded deals, however. Almost to a person, commercial real-estate analysts are predicting rising rents and tighter vacancy rates in the near future. What's more, investor demand for commercial property is growing, as pension funds and other institutions look for holdings that pay better returns than government bonds but aren't as volatile as stocks. In this scenario, if Equity Office is worth $48.50 a share to Blackstone today, the Chicago-based REIT would be worth even more a year from now.

The deal turns Blackstone into far and away the nation's biggest office landlord. Six weeks earlier, in partnership with Brookfield Properties, Blackstone concluded a takeover of Trizec Properties for $7.2 billion. And that acquisition came after Blackstone paid $5.6 billion for CarrAmerica Realty in July. Add in Equity Office's 109 million square feet in 580 buildings and Blackstone and its affiliates would own some 160 million square feet of office space in the nation's big-city markets. That's more space than downtown Phoenix, Pittsburgh, and St. Louis offer combined.

Rent on the Rise

Blackstone got more interested in office real estate after making successful moves into hotel chains, including La Quinta for $3.4 billion last January, and travel-related outfits such as Cendant's Orbitz online travel site in August. Both industries posted their best performances in 2006 since before the September 11 attacks. Blackstone says it has $13 billion for more real estate purchases.

Similarly, commercial real estate is showing no signs of letting up. Developers have been slow to add space in most major markets since the 2000 recession, despite interest rates that have hovered at historic lows. As a result, landlords are now able to push up rents. Equity Office, for instance, says its vacancy rates have dropped to 9% on average and should fall to as low as 6% by the end of 2007. Meantime, the average rent for new tenants is up 13% from a year ago. Even before the sale to Blackstone was announced, Equity Office's share price was at an all-time high.

Rents in many markets will continue to climb by double-digit rates, predicts Michael Straneva, director of Ernst & Young's U.S. transaction real-estate practice. And investors, looking back on the outsize gains from REITs over the past five years, are clamoring to buy property. "Real estate has become the fourth class of investment, along with cash, stocks, and bonds," agrees Glenn Mueller, a real estate specialist with Dividend Capital in Denver. "It's seen as a safe haven. It can't evaporate like an Internet stock; it's still bricks and mortar and land."

Despite the better numbers, Equity Office executives had been complaining since last spring that the company was underappreciated by public investors, suggesting that private-equity firms might be able to get assets on the cheap. Zell, who did not return phone calls seeking comment, may have had another reason for selling now. He turned 65 in September. His 1.7% stake in Equity Office is worth $300 million—more than enough for retirement, or a new equity fund to be leveraged for goodies that others have overlooked.

Arndt is a senior correspondent for BusinessWeek in Chicago .