Zell: Public REITs Not An Endangered Species

Sam Zell speaks at the University of San Diego Jan. 30. (Photo courtesy of John Riedy Photography)

Sam Zell doesn’t believe the parade of leveraged buyouts by private investors spells the end of the public REIT market.

Quite the contrary, said the chairman of Equity Office Properties Trust (NYSE: EOP), "If anything, the REIT world will be measurably larger in 10 years than it is today," the head of Chicago-based Equity Office and prospective beneficiary of the largest LBO in history told reporters prior to the Burnham-Moores Center for Real Estate’s 11th Annual Real Estate Conference at the University of San Diego.

"I think the public-to-private activity is nothing more than a validation of the fact that we’ve created a real market with real liquidity."

Just as nobody suggests that last year’s $22-billion private buyout of hospital giant HCA Inc. meant the end of public hospital companies, no one should conclude that the pending EOP transaction would mean the end of public REITs, Zell said. In addition to being stable and predictable, public investment trusts have exposed investors to an asset class they had little access to, or understanding of, prior to the mid-1990s, he asserted.

Zell believes, in fact, that many of the assets that have gone private will ultimately go public again. It’s part of the cycle, he said.

"I think there’s a circuitous game going on, just like in the non-real estate sector, where people are taking the companies private, will restructure them, change the debt levels and then take them public again," Zell said. "I think it’s likely to happen again in real estate. In the meantime, there’s a flow of new companies, and I think that will continue."

The famously salty executive told the group that despite the bull excrement they may have heard, "real estate is about capital, the availability of capital, the cost of capital, the demand for capital."

"We’re in the middle of the greatest monetization in the history of the world," he said.

In a humorous New Year’s message to business associates and played to the crowd Tuesday, Zell put his thesis to the tune of "Raindrops Keep Falling On My Head," altering the words to the once-popular B.J. Thomas song to say, "Capital Keeps Falling on my Head."

Apparently, Zell’s rain dance with Blackstone and Vornado has produced the desired results.

"We designed the deal with Blackstone to make it very easy for somebody to come in with a higher offer," he told reporters, pointing out that the original $48.50 offer in November included a $200 million breakup fee, less than 1% of the offer price -- far less than the usual breakup fee of 2-3%. Vornado then jumped into the ring earlier this month with a $52-a-share bid in cash and stock, prompting Blackstone to raise the stakes to $54 a share, with EOP now standing to lose $500 million if it backs out.

"The goal here was to create an auction with a floor, and we’ve obviously done that," he said.

The demand for investment income - and the amount of available capital to sustain it - has never been higher, he said, adding that the increase in liquidity and currency is worldwide. Zell predicted that it would be six to eight years before growth catches up with excess liquidity. Investment yields will remain soft, he predicted.

"It is as likely that cap rates will be slightly lower a year from now as it is cap rates will be higher a year from now."

He said the true cost of capital will be 150 basis points over the rate of inflation for the next few years, half of the average in the years since World War II.

"I think the cost of capital in our business is probably going to be less than we deserve," he said. "Hopefully we’re going to find way to take advantage of it."

Over the last five to 15 years, real estate indices have consistently outperformed the S&P, Zell noted.

"The savants [equity analysts] have now called the end of the real estate boom five times in the last five years, and they’ve been wrong five times," he said.