ASIAVIEW: Standing up to scrutiny

Given The Blackstone Group’s currently unmatched heft in the marketplace, it is hardly surprising that its dealings are perennially scrutinized. So it was that the industry’s glare in Asia last month was on the firm’s A$826 million (€556 million; $763 million) investment with Sydney-based developer Mirvac.

Under terms of the deal, Blackstone agreed to buy a 50 percent stake in 275 Kent Street, the Sydney headquarters of Australian bank Westpac, for A$435 million. The firm also has been granted call options over a portfolio of seven other assets across Australia, which would cost a further A$391.4 million if exercised. 

The capital used to pay for these deals will be, as is customary at Blackstone these days, 80 percent drawn from its regional opportunity fund – in this instance, its maiden Blackstone Real Estate Partners (BREP) Asia fund – and 20 percent from its latest global opportunity fund, BREP VII. In other words, the capital has come totally via its opportunistic strategies. 

That said, Blackstone outbid core buyers, including REITs and superannuation funds typically looking for IRRs of up to 10 percent and not the opportunistic 20 percent IRR target that the BREP series targets. That has led certain observers to scratch their heads and ask how Blackstone’s underwriting fits together.

This is what the critics are thinking about: Westpac’s lease at 275 Kent Street expires in just four years and the building, developed around the turn of the millennium, is of a lesser quality than the colossal Barangaroo office complex of Mirvac’s local rival, Lend Lease. Set against a worrying current vacancy level in Sydney – CBRE’s latest market research shows the CBD vacancy rate rose to 9 percent from 7.2 percent in the last 12 months – Blackstone surely will face challenges when competing with the likes of Barangaroo for tenants wanting as much as the 753,500 square feet on offer at 275 Kent Street in the event Westpac doesn’t renew. And, even if the bank does negotiate a renewal, it has a strong basis for comparison to glean favorable rental terms from its new landlord.

It was concerns like these that prevented other opportunity funds from seriously competing, one rival GP told PERE. That Blackstone has justified the deal for its opportunistic funds “shocked the Australian market,” he said. 

However, as so often is the case with Blackstone, this deal could well stand up to scrutiny if you consider more elements. Let us start with the competition. 

Barangaroo, the main distraction for the sort of large floor plate occupiers Blackstone needs at 275 Kent Street, is being developed on a pre-leasing basis and its first two towers already are more than 70 percent leased to tenants, including auditor KPMG and law firm Gilbert & Tobin. Late in April, it was reported that auditor PwC and HSBC had signed up for the third tower already. While that means these blue-chip occupiers will not be coming to 275 Kent Street, it also means Westpac’s options, should it want to leave, are more limited.

In any event, PERE understands that Blackstone already has started negotiating with the bank on a lease extension significantly longer than another eight years. Westpac will want to get its occupational needs sorted sooner rather than later because, while Sydney’s vacancy has indeed grown, a combination of what is happening at Barangaroo and a more general trend of office-to-residential conversions should reduce vacancy significantly. As such, CBRE also reckons that prime net face rents should have a strong trajectory in 2014 and predicts rental growth of 4.5 percent by the time the year is out. Westpac should tie up its residency before market conditions become unfavorable.

Next, consider the relationships. It is easy to look at things purely at the property level, but Blackstone’s relationship with Westpac, as with other major institutions, extends well beyond their respective property teams and this transaction. Westpac is financier to many of Blackstone’s Australian investments, and it is understood to be providing financing for this transaction as well. You don’t finance a deal for your own property and then jeopardize its viability by vacating. 

Want more proof? Look at Blackstone’s acquisition of the Broadgate office complex in London. In that deal, much rested on UBS renewing its tenancy, which it did. Guess who provided the financing?

Finally, let us not forget that 275 Kent Street is half the deal, not all of it. Motivated greatly by “the dilutionary impact of non-core asset sales,” according to its announcement, Mirvac even is throwing in A$156 million of vendor financing to get the deal done. So there is preferred equity in the bag, and that gives Blackstone a better basis for borrowing the rest. 

As perennially as Blackstone’s deals are scrutinized for their flaws, it also is accused of lowering its return expectations simply to get money out the door, earn fees and enable another fundraise before the chickens come home to roost. Maybe there will be a deal undertaken by this firm that unravels its efforts so far, but close scrutiny suggests this Mirvac deal isn’t it.