An update on Blackstone’s commercial real estate activity

Implications: Blackstone has made the biggest bets in the history of commercial real estate and, now that they have gone public, we all get to see the results in greater detail. As to the Equity Office portfolio purchased from Sam Zell, the initial sales in the major markets have been consummated and the balance of the portfolio appears to have quieted regarding investment activity at the required levels. The credit markets are more restrictive now and promise to be so in the coming five years or so, so the battle looks to be uphill.

Analysis:  

What we don’t know is how much of a dent the sales to date have made in the total capital outlay, so the challenge for Blackstone to meet the schedule is not as clear as it might be for the outsider. But no doubt the profit is in the remainder, so Blackstone will need to raise rents considerably to meet increased capital costs and inflating operating costs, insurance and taxes. Whether they can do well, break even or suffer will be a test of the organization’s skill in light of generally lower prices for commercial property in the near future markets. The reduced market was recently written about as follows (thanks here again to The Real Estate Bloggers): US commercial real estate value falls - Daily Business Update - The Boston Globe

Posted: 16 Nov 2007 07:26 AM CST

For the first time in 5 years commercial real estate has lost value. The 3^rd quarter showed a 2.5 percent decline in the value of commercial real estate owned by large pension funds.

Of course, the run up has also been amazing and a pull back has been expected. In the past 5 years commercial real estate values have doubled. One could not reasonably expect that the prices would increase much more, but now we have to see in the face of tighter credit how the commercial real estate market holds up in the near term.

The drop may not only spell the end of a five-year rally during which commercial real estate prices effectively doubled, but it also may signal that weakness in the housing market is spilling over into commercial real estate, said the MIT Center, which added that the last time that prices fell more than 2.5 percent was in the fourth quarter of 2001, when prices fell 3.9 percent following the terrorist attacks of 9/11.

Commenting on the index for the third quarter of 2007, MIT center director David Geltner said in a statement, “The fall in our index is the first solid, quantitative evidence that the subprime mortgage debacle, which hit the broader capital markets in August, may be spreading to the commercial property markets.” The Boston Globe.

This may mean that those who purchased investment real estate in the latter part of the five year run-up including Blackstone may be hard-pressed to meet the returns projected if not just break-even. If you believe the trend-line will continue down as I do, there will be no continuation of the returns of the last five years and investments in other sectors will perform better.

This assumes that Blackstone’s investment in EOP will have no continuing operations after property dispositions are made. But that’s not the case with Hilton, where the disposition of property will probably enhance the profit line and facilitate expansion world-wide. Since this transaction is also a highly levered capital structure, the sale of Hilton’s property portfolio or a restructuring of debt from corporate to property specific is mandatory to generate the capital to afford rapid expansion. The challenge here too, however, is to avoid booking losses at such transaction events so that the capital markets will see the even earnings so desired. The Hilton purchase seems promising in contrast with the EOP portfolio as the reallocation of capital to corporate purposes promises to carry a much higher return.  This possible conversion of Hilton to a management and services company will build a more profitable income stream if that is to be the case.