Blackstone's deal of a lifetime

Whenever Blackstone senior managing director Frank Cohen recalls the biggest deal in the history of real estate investing, he always thinks of elevators.

Shortly after completing the firm’s $39 billion take-private of real estate investment trust Equity Office Properties, Cohen and Blackstone real estate head Jon Gray spent months shuttling between floors of the Blackstone’s New York headquarters, sometimes passing each other along the way, to parse out the 543-property, 103.1 million-square-foot office portfolio.

“It was unbelievable,” Gray recounts. “The pace, the scale, the capital – everything was supersized.”

Blackstone has already tripled its money, but EOP’s first chapter under Blackstone is still closing with three sizable impending sales from its original portfolio: San Francisco’s Ferry Building, a city landmark that houses a food hall and offices; Boston’s 100 Summer Street; and the 12-building Santa Monica Business Park. The firm has since rebuilt an office portfolio on top of EOP’s foundations, creating a platform now comprising 50 million square feet of urban office.

Other real estate firms involved in this record-setting transaction have not been so fortunate. For them, the deal amounted to big punts made with excess leverage just before a recession that wiped out some of these businesses completely.

EOP’s former chairman Sam Zell never intended the company, which went public in 1997, to become a seminal deal. “I know this sounds funny, but I never envisioned an exit. I thought that EOP was of the size and scale that it was going to become an institution. Did the guys who built General Motors think about an exit? I doubt it. In the same manner, I, and a whole bunch of great people, looked at EOP and said it wasn’t built to be sold. The fact that it was sold was an accident.”

The accident happened because Zell was persuaded to exit, citing his fiduciary duty to shareholders, when the right buyer came calling.

The first bid was not from private equity but America’s biggest public pension fund. In November 2005, an investment advisor for the California Public Employees’ Retirement System submitted an exploratory offer of $25 billion, which the REIT turned down. After another rejected bid, CalPERS disappeared, but, months later, Vornado Realty, a New York-based REIT, expressed interest, only to be rejected as well.

Then, in August 2006, Blackstone and partner Brookfield came calling with an informal offer that EOP turned down before Blackstone returned alone with a higher bid in October. After some negotiating, the firms announced a sale agreement in November for $20 billion, plus $16 billion in debt. EOP set the deal’s breakup fee low, at $200 million, to encourage other potential bidders.

Vornado then led a trio of parties, along with Starwood Capital Group and Walton Street Capital, in starting a bidding war in mid-January 2007 with another stock-and-cash proposal. However, the consortium ultimately lost, and on February 6 EOP and Blackstone announced the final deal: $55.50 per share for a total of $39 billion, including debt. Typifying the pre-crisis high leverage levels adopted in the industry, Blackstone used just $3.8 billion of equity for the deal, drawing capital from its fifth and sixth opportunistic funds.

After the deal, Zell, famous for sending quirky gifts, posted to Vornado’s founder Steve Roth and then-CEO Michael Fascitelli, along with Starwood CEO Barry Sternlicht, luxury watches inscribed with the phrase “Timing is Everything.”

No watch was sent to Gray, even though timing played a crucial part in Blackstone recording strong returns. Blackstone typically targets a 15 percent net internal rate of return for its opportunistic fund series. As of June 30, Blackstone Real Estate Partners V, its 2005-vintage vehicle, generated an 11 percent net IRR, while BREP VI, a 2007-vintage, had a 13 percent net IRR – both stronger performances than other funds of those ill-fated vintages, according to Cambridge Associates’ value-added and opportunistic funds’ benchmark. Funds from 2005 had a -0.4 percent IRR benchmark, while 2007 funds had a 7.1 percent IRR in the consultancy’s first-quarter 2017 report.

Real casualties

One of Blackstone’s key ingredients to making EOP a success was a contingency Gray negotiated when buying the business: the ability to share information about EOP to prearrange the quick sales of certain buildings, which would help spread otherwise outsized risk for the firm. When Gray evaluated company-level transactions at the time, he says he kept the “arbitrage opportunity” at the forefront, expecting to sell half or two-thirds of the assets immediately, which he regarded as ultimately buying a company at a 20-30 percent discount.

For EOP, Blackstone sold $27 billion worth of assets within three months of closing and focused on parceling out suburban offices in non-core markets.

“Had we held onto suburban Orange County, California, or suburban Chicago, we would’ve ended up in a much worse place than we did,” Gray says.

The private buyers of these properties represented a who’s who of the largest investors and managers, including: the California State Teachers’ Retirement System, which partnered with sovereign wealth fund Abu Dhabi Investment Authority and two other firms to buy properties in Austin, Texas; Morgan Stanley Real Estate Investing, which teamed up with Canada Pension Plan Investment Board and the US pension State of Wisconsin Investment Board to buy Denver-area assets; and Shorenstein Properties, which picked up 46 Portland, Oregon, offices. Many of these buyers either declined to comment or could not be reached.

“The real casualties of the deal were some of those subsequent buyers who levered up to the hilt to pay peak-of-the-peak prices for assets that hit hard times very shortly after the ink had dried on the sales,” says Green Street Advisors’ senior analyst Jed Reagan. “Maguire and Macklowe were prime examples of that.”

Private real estate firm Macklowe Properties paid $50 million in equity for seven New York office buildings and took on $7 billion in debt, turning over the properties a year later to their lenders, including Deutsche Bank and private equity business Fortress Investment Group. The latter’s loan was collateralized by other Macklowe holdings in New York, including its prized General Motors Building, and by a personal guarantee from billionaire founder Harry Macklowe. In 2008, he was forced to sell the GM tower for $2.8 billion to repay the bridge loan to Fortress.

Maguire Properties, a Los Angeles-based REIT, meanwhile, replaced its founder in 2008 after suffering losses across the LA and Orange County portfolio it bought for nearly $3 billion. Its credit on the portfolio made it the most-levered REIT at the time. Many of the properties went into foreclosure, and the firm lost about $800 million on subsequent sales of the assets, according to data provider Real Capital Analytics.

“Some of the best quality suburban office buildings in housing-driven markets in Arizona, Florida and Southern California had major tenancies tied to subprime mortgage lenders, developers, brokers and other service providers hit by the GFC,” Jim Costello, RCA’s senior vice-president, recollects.

Regardless of location, Costello recalls that acquisitions were tied to unrealistic expectations of long-term rent growth, even in the double digits.

Not all the follow-on buyers ended their EOP saga at a loss, however. Tishman Speyer bought five Chicago CBD buildings and continues to hold two of the assets to this day, and unlike some of its peers at the time, a person familiar with the firm said Tishman did not lose money on the deal.

Patient strategy

EOP’s post-GFC buyers have a much different story to tell than the pre-recession group after the platform began to sell buildings again in 2013.

Oxford Properties Group, the real estate arm of Canada’s OMERS pension plan, snapped up a five-building Boston portfolio from EOP in 2014 for $2.1 billion, for example. The buildings ranged from a fully-leased property to one with 40 percent vacancy. Such discrepancies in the portfolio limited the number of potential bidders, says Chad Remis, the head of Oxford’s Boston group.

“Everyone knew this deal was out there but nobody could take the full bite, only some of the pieces. It was very similar, albeit smaller, to Blackstone’s original acquisition of EOP.”

After the deal, in another similarity to Blackstone’s original purchase, JPMorgan bought equity stakes in the core buildings, while Oxford worked on repositioning the value-added assets with full ownership. The initial transaction and subsequent partnership worked so well that JPMorgan and Oxford partnered again the following year to buy another two Boston offices from Blackstone.

Today, as the last of EOP’s initial portfolio is placed on the market, investors highlight the firm’s patient strategy.

“The South Dakota Investment Council has a long history with Blackstone having been a major investor since the firm’s first real estate fund,” spokesman Matthew Clark tells PERE. “The council had high confidence in Blackstone’s ability to successfully execute their EOP strategy of de-risking by rapidly selling a significant portion of the properties at premiums to the purchase price and using long-term financing to allow time to maximize the remaining assets. The council is pleased with the outcome and continues to have high confidence in the Blackstone team.”

“At the bottom of the crisis, we didn’t lose faith,” Gray recalls. “When the sun started coming out in 2010 and 2011, we were patient. Then, over the last four years, we have been methodical in selling buildings … A lot of people were forced to sell at the wrong moment. Being a disciplined fund manager is important because things invariably change, and the manager needs to have patience, when times do get better, to wait a little to ultimately maximize value.”


Blackstone is far from finished with the US office market. EOP now has about 50 million square feet in CBDs around the country, 90 percent of which was acquired after the original EOP purchase. Its focus has shifted, too – not in terms of an emphasis on quality product, but on how buildings are renovated for changing tenant needs.

EOP also has a new leader for its latest phase: Lisa Picard, who moved up from chief operating officer to CEO in June. Under Picard’s leadership, EOP is focusing on opening offices to the street, with more indoor and outdoor public spaces, refurbishing lobbies and adding tenant amenities, among other efforts.

In New York, the firm spent the last 18 months redeveloping the public plaza and lobby, as well as taking out the law firm’s basement file storage at 65 East 55th Street, just off Midtown’s Park Avenue, and replacing the space with a free (to tenants) club that includes game tables, conference rooms, a cafe and a health club, where one of the hedge fund tenants hosts yoga every Wednesday. Meanwhile, in Chicago, Blackstone is in the midst of a $500 million overhaul of the city’s landmark Willis Tower, with upgrades ranging from 300,000 square feet of retail at the base, which was previously closed off from the public, to a 30,000 square-foot gym. Chicago mayor Rahm Emanuel and Gray announced the project in February.

“You could build a building ground-up for less,” Cohen jokes. “Sometimes, there are projects where people will say, ‘Thank you.’ This is one of them.”