Gravedancing on San Felipe Plaza

In the late 1980s, Sam Zell, who had already made a name for himself in the real estate business, came up with a novel way to buy property: a private equity fund. Adopting the limited partnership model pioneered by the leveraged buyout firms of the prior decade, Zell teamed up with the investment bank Merrill Lynch to raise $410 million for Zell/Merrill Lynch Real Estate Opportunity Partners I, the first private equity real estate fund ever.

The vehicle's first acquisitions included a shopping center in Salt Lake City and an office building in San Francisco, but it was the acquisition of San Felipe Plaza, a 45-story, 100,000-squarefoot office tower in Houston, that was perhaps its most prominent. Built in 1984 by well-known developer Harold Farb, the $150-million building was hemorrhaging cash due to the city's overdeveloped office market and the significant concessions, typically three years' free rent, that were being offered to its tenants.

In 1986, Zell acquired a 70 percent stake in the building via a $135 million transaction, though much of the purchase price was funded by rolling over the $123 million construction loan into long-term financing. Two years later, Zell's new opportunity fund acquired 50 percent of his existing stake in San Felipe Plaza with a view that the Houston market would recover over the next five years.

Unfortunately, it took longer than expected. According to many industry practitioners, the first Zell/Merrill fund—three others followed— was “ahead of its time,” a backhanded compliment that means it bought properties too soon in the cycle, something that Zell himself has even admitted. In the case of San Felipe Plaza, the building was reportedly written down by $20 million in 1995.

Nevertheless, patience paid off. San Felipe Plaza, along with many of the properties from the four Zell/Merrill funds, eventually formed the basis for Equity Office Properties Trust, which went public in 1997 and is now the largest real estate investment trust in the US. In 2005, San Felipe Plaza was sold to a joint venture between Thomas Properties Group and the California State Teachers' Retirement System, along with three other Houston properties, for a combined total of $280 million.