Friday Letter Blackstone magic

It was once asked by a reporter of a former bank robber: ‘Why do you rob banks?’ The incredulous answer that came back his way was: ‘Because that’s where all the money is.’ 

In the same way, you could ask private equity people why they go after Real Estate Investment Trusts in America and the obvious riposte would be because that is where the assets are.

Witness Blackstone’s record-busting deal this week to acquire Equity Office Properties Trust (EOP) for a record $36 billion, the largest real estate deal ever. If the deal completes, it will hand Blackstone the biggest publicly-owned portfolio of offices in America with full or partial ownership of 580 buildings.

The acquisition turns the spotlight on several fundamental issues about the current state of the private equity real estate market in the US.

The first is how real estate funds are becoming super-sized on the back of keen investor demand for the asset class. In June, Blackstone raised €5.25 billion for Blackstone Real Estate Partners V with ease. When combined with other equity commitments, the firm has over $7 billion of available capital. It is the largest pool for real estate in the world raised to date. However, with Morgan Stanley currently on the road with a planned $8 billion structure, Blackstone is unlikely to hold on to this record for very long.

The second talking point is the availability of cheap debt. Banks and other market are competing so hard to lend money that they have created the best environment for 50 years in which to raise acquisition finance. More than 80 percent of the Blackstone deal will be financed by debt.

Although worth contemplating is what the deal says about office space in America. Some have suggested that in cashing out, EOP founder Sam Zell has made a big call on the market, but Zell reportedly believes there will be 6-7 percent revenue growth from offices in the next 12 months. The reality is that Blackstone simply made Zell an offer he couldn’t refuse.

Fourth on the list is the fact that US REITs continue to trade at sharp discounts to the underlying value of the assets they own. Blackstone, which has already taken several REITs private this year, is offering EOP shareholders a 20.5 percent premium to the company’s three-month average stock price. This looks toppy, but as one experienced real estate financier observes, Blackstone stands to gain a portfolio without having to go through an auction. If EOP’s buildings were sold piece by piece in an auction process, they would probably fetch even more.

The fifth and final question to ponder is what the deal says about the future of real estate investing generally. It is easy to see why many US REITs are secretly hoping that a credit tightening occurs sooner rather than later. Using less leverage than private equity funds, REITs could weather the storm more easily if the debt markets suddenly tightened. Unfortunately for REITs, there is no sign yet of a reduction in credit availability to happen any time soon.

Perhaps this week’s Thanksgiving break comes at a good time for everyone. Blackstone has a massive acquisition to digest, while proprietors of US REITs can muster new energy from a well-roasted turkey. Come Monday, everyone will be back at work, and the next battle for a big, publicly quoted commercial property portfolio may only be around the corner.