Flaming Wreckage of Property Values Since Zell Sold Equity Office Prop To Blackstone

http://www.nytimes.com/2009/02/07/business/07properties.html?_r=1&hp

Sam Zell’s Empire, Underwater in a Big Way

By CHARLES V. BAGLI
Published: February 6, 2009


The Worldwide Plaza building in New York, left, was part of Macklowe Properties. Center and right, the Chicago Title and Trust building and the Chicago Mercantile building are part of Tishman Speyer.

It was, for a brief shining moment, the real estate deal of the century.

In 2007, Sam Zell, the billionaire Chicago investor, sold a portfolio of 573 properties he had assembled over three decades, Equity Office Properties Trust, to the Blackstone Group for $39 billion. It was the largest private equity deal in history, but Blackstone did not stop there: it immediately flipped hundreds of the buildings for $27 billion.

Today, the wreckage of those purchases is strewn across the country, from Southern California to Austin, Tex., to Chicago to New York. Many of the 16 companies that bought Equity Office buildings are now stuck with punishing debt, properties whose values are plummeting and millions of feet of office space they cannot fill.

Few deals better exemplify the excesses of the commercial real estate boom than the dismemberment of the Equity Office empire, and fewer still better underscore their bitter consequences.

Buyers purchased buildings at what, in retrospect, were vastly inflated prices. Lenders provided lavish, even excessive, financing based on unrealistic expectations of rising rents. And now that values are tumbling, vacancy rates are rising and credit has become impossibly tight, many on both sides are struggling against default, foreclosure or bankruptcy.

The impact could ripple beyond the companies that bought Equity Office buildings and the investment banks that financed them. If the owners cannot make their loan payments, it could create a financial crisis for the pension funds, hedge funds and insurance companies that hold securities based on Equity Office mortgages.

The list of Equity Office buyers reads like a Who’s Who in American real estate. In Stamford, Conn., RFR Properties, a partnership headed by Michael Fuchs and Aby Rosen, who owns Manhattan landmarks like Lever House and the Seagram Building, spent $850 million to buy seven Equity Office buildings that analysts say are now worth less than their mortgages.

In Los Angeles, the founder of Maguire Properties, one of the largest commercial landlords in Southern California, was forced to step down last year as the company struggled with crushing debt from buying 24 Equity Office buildings.

And in New York, the real estate mogul Harry B. Macklowe lost seven Equity Office towers he bought from Blackstone, along with much of his empire, after he was unable to refinance the $7 billion in short-term, high-interest debt he used to buy them.

“Those who bought from Blackstone have not fared well at all,” said Michael Knott, a real estate analyst at Green Street Advisors. “Blackstone was a huge winner at the time, although the value of what they still hold has fallen probably 20 percent.”

Mr. Zell, who became chairman and chief executive of the Tribune Company after selling Equity Office, amassed his supersize real estate portfolio over many years. But the deal to sell the properties to Blackstone, the big private equity firm run by Stephen A. Schwarzman, occurred with lightning speed and what one executive who participated in the transaction called, “short-form due diligence.”

Blackstone’s purchase of Equity Office in February 2007 began a series of other record-breaking deals in Stamford; San Francisco; Portland, Ore.; Orange County, Calif., and Chicago, as Blackstone quickly sold about 70 percent of the portfolio to 16 other companies. The company still owns 105 Equity Office properties.

“These were aggressive acquisitions under the best of circumstances,” said Paul E. Adornato, a senior real estate analyst at BMO Capital Markets.

The buyers found lenders only too willing to finance as much as 90 percent or more of the purchase price, even as profit margins shrank, on a bet that rents and values would continue to rise. The investment banks, including Morgan Stanley, Wachovia, Goldman Sachs, Bear Stearns and Lehman Brothers, in turn collected their fees as they packaged the loans as securities and sold them to investors.

“It certainly defined a period of time where debt was readily available in large quantities at low prices,” said Robert S. Underhill, who heads the capital transaction group at Shorenstein Properties L.L.C.

Not everyone who bought Equity Office buildings is in dire shape.

After looking at Blackstone’s Equity Office portfolio in many cities, Shorenstein settled on Portland, where it bought 46 buildings for $1.1 billion. It was the one place where price, initial returns and potential for growth made the most sense, Mr. Underhill said.

But elsewhere, problems with Equity Office properties have spread like a virus, weakening and even paralyzing major real estate developers.

In Stamford, the crisis on Wall Street and the consolidation of financial services has weakened the market, undermining the RFR Properties’ effort to raise rents at its seven Equity Office buildings by 15 percent. The purchase price of $850 million, roughly $515 a square foot, was close to a record for Stamford.

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RFR’s Equity Office buildings are now worth less than its mortgages, said Dan Fasulo, a managing director of Real Capital Analytics, a real estate research firm. But the company has not defaulted on its loans.

“Some of the rents they projected won’t come to fruition for many years,” Mr. Fasulo said.

RFR Properties did not return calls seeking comment.

The market has declined drastically in Chicago as well, and the vacancy rate is climbing at some Equity Office buildings owned by the real estate giant Tishman Speyer, brokers say. The company, which controls Rockefeller Center and properties in China, India and Brazil, bought six Equity Office buildings in Chicago for $1.7 billion. The company almost immediately tried to sell three of its new buildings, but received acceptable offers for only one, which sold for $145 million in 2007. Tishman declined to comment.

In New York, Mr. Macklowe made a characteristically aggressive gamble when he bought seven Midtown buildings from Blackstone for more than $6 billion, doubling the size of his real estate empire. He put down a mere $50 million, while lining up $7 billion in short-term financing from Deutsche Bank and the Fortress Investment Group for the acquisition.

But after the rollicking real estate boom came to an end, Mr. Macklowe was unable to get permanent financing. He narrowly avoided personal bankruptcy and was forced to turn over the seven towers and other properties, including his jewel, the General Motors building, to lenders.

Deutsche Bank recently sold two of the Macklowe buildings in New York to Shorenstein Properties for an average of $818 a square foot, or 25 percent less than the $1,100 a square foot that Mr. Macklowe paid. Real estate brokers say two other buildings from that portfolio will probably sell for a discount of at least 60 percent.

Mr. Macklowe’s company, Macklowe Properties, declined to comment.

In Los Angeles, Maguire Properties was already laboring under heavy debts when the company paid Blackstone $2.87 billion for 24 buildings, 22 of them in Orange County, the center of the subprime mortgage industry. From the beginning, the loan payments for the Equity Office buildings exceeded the monthly revenue from the properties, according to the company’s regulatory filings.

The company’s vow to raise rents by 25 percent at its newly acquired buildings dissolved quickly as the vacancy rate in Orange County swelled to 16 percent, from 7 percent in 2006, making it harder to make mortgage payments. Maguire sold a number of its Equity Office buildings, some at a loss, and the board forced its chairman and founder, Robert F. Maguire III, to step down.

“It was the straw that broke the camel’s back in terms of what it did for their operating results and their balance sheet,” said Mr. Knott of Green Street Advisors.

In Austin, when the Thomas Properties Group formed a partnership with the California teachers’ pension fund and Lehman Brothers, which was also a lender in the deal, to buy 10 Equity Office buildings downtown and in the surrounding suburbs for $1.15 billion, it instantly became the biggest commercial landlord in town.

Like many of the other deals, it was highly leveraged and dependent on rising rents. The problem is that rents are now declining in Austin, particularly in suburban areas, where vacancy rates have climbed to 14.4 percent as several new buildings are coming on line without tenants.

In November, Thomas filed a motion in the Lehman bankruptcy case saying it would “run out of cash” in January. On behalf of the partnership, Thomas asked the court to compel Lehman to make good on its commitment to provide a $100 million revolving loan, or allow the partnership to raise new financing elsewhere. The money, it said, was to lease, maintain and market the buildings.

Without additional financing, the motion said, there could be a series of defaults “leading to the threat of foreclosures and bankruptcy.”

The motion has been postponed, but the partnership did make an $18 million property tax payment that was due last month in Austin “in cooperation” with Lehman. The partnership is still facing significant liquidity problems.

“They’re going to face a difficult road because the buildings in the suburbs are getting more and more vacant,” said Volney Campbell, co-managing partner of HPI Corporate Services in Austin, a real estate company.

“It was the largest single transaction that’s ever occurred in Austin. Considering where we are now, it will stay that way for a while.”

 

Hard to outfox a Billionair that has been in real estate for 30 years and buy something from him at a "discount"

The REIT short of early 2007 was one of the easiest shorts in our generation...even easier than the homebuilder short as the dividends barely made a dent in tHE PE's at the time

 

Indeed.

We have been the generation that just lived through the biggest asset bubble in the history of man; made tulips and .com stock look like piker bubbles.

 

It's not that there was an attempt to outfox. It's that the guys running Blackstone are playing with other people's money.

What do they truly care? They already got paid huge bonuses in the previous years based on marking the value of their holdings on over-inflated asset prices. So they take a big hit here, blame it on the economy and simply get a small bonuses, but still a fat salary & expense accounts.

 

Remember that very fondly.
Got out of Equity Office at a price that wound up being slightly higher than the final price Blackstone paid.
It was a beautiful thing.