Blackstone Group's 'Zell Buyout' Is Questionable At Best

 |  Includes: BX, EOP, EQR
by: William Trent, CFA

Sam Zell built the largest publicly traded real estate firms in Equity Office Properties (EOP) and Equity Residential Properties (NYSE:EQR). After years of acquisitions to build the portfolio, he is now cashing out just as many have called a peak in the real estate market. According to today's NY Times:

The Blackstone Group, a private investment firm, said yesterday that it had agreed to acquire Equity Office Properties Trust, the nation’s largest office-building owner and manager, for about $36 billion. Equity Office, with some 590 buildings and over 105 million square feet of office space in major metropolitan markets, was created in 1976 by Sam Zell, a real estate tycoon who built the business through dozens of acquisitions that were worth, in aggregate, more than $17 billion. Last year, Equity Office acquired the Verizon Building on Sixth Avenue in Manhattan for $515 million.

Matthew L. Ostrower, an analyst at Morgan Stanley, called the proposed deal “a ground-breaking transaction for the real estate world in general and an earthquake for the REIT industry.”

Well, actually no ground is being broken as this is a buy - rather than a build - decision. Nonetheless, the fact that residential real estate prices have softened considerably is surely not lost on Zell, who may now feel that office properties have peaked in value as well. The article continues:

For Mr. Zell, one of richest men in America and the owner of more real estate than Donald J. Trump, the sale is an opportunity to cash out of part of the empire he built while working from his office in the old Daily News Building in Chicago. But the sale by Mr. Zell, who made his first millions in the 1970’s buying distressed real estate, may also signal that he believes the market may have peaked.

Just last month, Ross L. Smotrich, an analysts at Bear Stearns, wrote in a note to investors: “REIT’s have outperformed the broader market in each of the past seven years, putting valuations at the high end of historical ranges.”

The only real question is why would anyone want to sit on the opposite side of the table and buy a huge real estate portfolio when Sam Zell is selling. The article also answers that question:

Private equity firms are vying to hold the crown of having led the biggest buyout in history, and, with this deal, Blackstone will be able to do so at least for now.

What a great reason to invest. Yet, it isn’t the first questionable buyout this year, nor do we expect it will be the last. Starting with massive buyouts of highly cyclical semiconductor firms and continuing to the largest ever real estate buy when most concede the market has topped, Private Equity funds are showing that they simply have too much money to invest. We highly doubt the future returns on private equity investments will even approach the levels of past returns, as the hot money is unlikely to find sufficient real value opportunities to be put to good use.

EOP-EQR 1-yr. comparison chart:

EOP-EQR 1-yr. chart