Did Sam Zell Get The Right Price?

Samuel Zell got rich by snapping up assets everyone else had written off for dead. But the founder and chairman of Equity Office Properties Trust (EOP ) has blundered, too. Just as the dot-com bubble was bursting in early 2001, Zell engineered a $7.1 billion takeover of another real estate investment trust, Spieker Properties Inc. (SPK ), whose offices were in San Francisco and San Jose. Equity Office's share price would not recover for four years.

So when the Chicago-based company announced on Nov. 19 that it was selling itself to New York's Blackstone Group for $36 billion, including debt, in the biggest leveraged buyout ever, investors began wondering which Sam Zell was doing the dealmaking--the visionary or the myope.

To many, it sure doesn't look like the visionary. Cohen & Steers, which is Equity Office's largest shareholder with an 8% stake, figures the company is worth more than $60 a share, says James S. Corl, its chief investment officer. Instead, Blackstone is paying $48.50, just 8.5% above Equity Office's Nov. 17 closing price of $44.72. "It looks like the deal went on the cheap," agrees analyst Jonathan Litt of Citigroup (C ).

Zell dismisses his critics. While Equity Office received "flirtations" from others, Blackstone's unsolicited offer was the only one that was fully financed. Zell also notes that the price was 20.5% above the company's three-month average share price. "It really doesn't matter what I do. There will always be someone who criticizes me," the billionaire says. "So be it."

Blackstone didn't vault to the top of the private-equity business by overpaying, of course. Most commercial real estate analysts are predicting rising rents and tighter vacancy rates in the near future as white-collar job growth outpaces office construction. What's more, investor demand for commercial property is growing as pension funds and other institutions look for holdings that pay better returns than government bonds but aren't as volatile as stocks.

The deal turns Blackstone into far and away the nation's biggest office landlord. Six weeks earlier, in partnership with Toronto's Brookfield Properties Corp. (BPO ), Blackstone concluded a $7.2 billion takeover of Trizec Properties Inc. (TRZ ), with office towers in New York and other big markets. That deal came after Blackstone paid $5.6 billion in July for CarrAmerica Realty Corp. (CRE ), which is big in Washington, D.C., and San Francisco. Add in Equity Office's 109 million square feet in 580 buildings, and Blackstone and its affiliates would own some 160 million sq. ft. of office space in the nation's big markets. That's more than downtown Phoenix, Pittsburgh, and St. Louis have combined.

For now, the office market shows no sign of letting up. Developers have been notably slow to add space in most major markets since the 2001 recession, despite interest rates that have hovered at historic lows. Slim inventories have allowed landlords to push up rents this year. Equity Office, for instance, says its vacancy rates have dropped to 9% on average and should fall to as low as 6% by the end of 2007. Meantime, average rent for its new tenants is up 13% from a year ago.

And investors, looking back on the outsize gains from REITs over the past five years, are clamoring to buy property. "Real estate has become the fourth class of investment along with cash, stocks, and bonds," says Glenn R. Mueller, a real estate specialist with Dividend Capital Group in Denver. "It's seen as a safe haven. It can't evaporate like an Internet stock; it's still bricks and mortar and land."

Zell continues to believe in real assets, too. He remains chairman of Equity Residential, which owns 616 apartment buildings in 26 states and is the largest player in the land. Don't expect the 65-year-old billionaire to retire just yet.

By Michael Arndt

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