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Blackstone Planting Its Flag Even More Firmly in CRE

In the current lackluster environment for huge private-equity deals and leveraged M&A buyouts that marked the previous boom cycle, Blackstone Group LP has increasingly shifted its focus tocommercial real estate investments. The firm, credited with timing the market perfectly in the previous cycle with its acquisition and subsequent sell-off of the former Equity Office Properties portfolio, is hoping to again capture lightning in a bottle as investor demand heightens for core property assets in leading U.S. and European markets.

Despite the improving economic landscape, Blackstone's net income for its four main business segments fell 24% in the first quarter as the growth in the values of its asset slowed, including a 23% drop in Blackstone's real estate business from first-quarter 2011.

There appears to be a strong foundation behind the volatile quarterly numbers, however. Blackstone reported $190 billion in assets under management as of the end of the first quarter -- up almost 27% from a year earlier -- including $48.3 billion in real estate, which was up 38% from a year ago.

CRE generated the firm's highest revenue volume during the quarter at $427.2 million. Steadily improving fundamentals drove a 4% increase, or $1 billion, in the value of Blackstone’s carried portfolio, with the majority of value appreciation in the firm’s office and retail properties.

Blackstone’s credit business posted $50.8 billion under management, up 61% from last year, followed by smaller growth in private equity and hedge funds.

Tony James, president and chief operating officer, and Stephen A. Schwarzman, CEO and co-founder of the private-equity and alternative investment titan, attributed the decline in profits to continuing global uncertainty. But in calls with reporters and investors, they both expect business conditions will improve in the second half of 2012 and into 2013, and also noted that Blackstone has accumulated nearly $38 billion in dry powder for acquisitions.

"[CRE] deal flow is robust as the investing environment has remained favorable given the amount of distressed assets that need to deleverage around the globe," said Schwarzman, the legendary private equity financier and investment banker. "With little new supply and slowly increasing demand for commercial space, fundamentals continue to improve from the lows of the cycle. This has resulted in occupancy improvement and rent growth in most of our core markets."

"For key office assets in the United States, occupancy is up 300 basis points versus the prior year. In Northern California, our strongest office market, site of the tech boom in the United States, office rents are up more than 15% from the prior year. This gives you some sense of what happens when the law of supply and demand reasserts itself."

To take advantage of the upswing, Blackstone's James noted that the company could divert more of its capital raising efforts into core commercial properties, as well as funds in Asia and other emerging markets. The firm already tops all private-equity fundraisers in CRE, with its Blackstone Real Estate Partners VII accumulating $6.6 billion in the first quarter.

"Investors are hungry for yield, they’re hungry for inflation hedge, and we have, of course, tremendous market knowledge and ownership of assets throughout all the major regions," James said, noting Blackstone's successful closing of its global flagship fund in February.

In an asset class where fundraising has proven extremely difficult of late, Blackstone has raised over $10 billion of total capital, with a couple of billion more in commitments over the course of the year, "which will make it the largest real estate opportunity fund ever raised and multiples in terms of size of our nearest competitors, where that multiple of size gives us the ability for competitive purposes to do larger and more complex deals," Schwarzman said.

Blackstone is seeing similar trends in hospitality as in office and retail, with virtually no new supply and modest increases in demand leading to U.S. RevPAR gains.

"Positive absorption and declining vacancy is also evident in our industrial, retail, and senior living assets," Schwarzman said.

He also noted that Blackstone acquired a large portfolio of grocery-anchored shopping centers last year from Brixmor, formerly Centro Properties, in the largest deal in the world of any leverage type since the collapse of Lehman Bros. nearly five years ago, where occupancy is at its highest level since 2009 due to accelerating leasing activity.

Schwarzman said although improving, real estate debt markets are still constrained and competition for large complex transactions remains limited -- which is a good thing for Blackstone, one of the world’s largest providers of debt and equity capital. The firm deployed or committed $2.3 billion in capital in the first quarter, with 40% of this in Europe.

In addition to the retail power center portfolio acquired in an off-market transaction from highly leveraged Brixmor, Blackstone has acquired high-quality distressed industrial portfolios in the U.S. and the U.K., and most recently agreed to buy 65 U.S. warehouse properties from Australia-based Dexus Property Group, for $770 million. Blackstone also recapitalized Parc 55, a 1,000 room hotel in San Francisco, one of the nation’s strongest hotel markets.

"This is the distressed wave that people have been talking about. All are being purchased at a significant discount to replacement cost."

In terms of dispositions, Blackstone has sold or has under contract to sell nearly $800 million in assets so far in 2012, includes the sale of Pearlridge, a mall in Hawaii which closed in the second quarter. Schwarzman noted Blackstone's sale of $1 billion in assets in the last 12 months, completed largely at significant premiums to carrying value.

"Although we were delayed in the second half of last year with some of our plans for realizations due to market turbulence, the market appears to be opening up more, particularly for properties that are stabilized. As such, we expect more asset sales in the second half of this year and into next year."

Schwarzman acknowledged that the limited partner investors that drove such deals as the EOP acquisition "have been basically traumatized by their experience in opportunity real estate," with many casualties in the private-equity space during the downturn due to loan maturities that couldn’t be refinanced.

"A large number of our competitors have gone out of business and they’ve gone out of business because they were buying leveraged real estate at very high prices," he said.

Company proposals to Blackstone for potential equity infusions and refinancing offer "almost the same deal with different names, where some piece of real estate was bought by somebody, it’s valuation is in some cases down 20%, it needs sometimes more, it needs way more equity to refinance it to the extent that they can live in a world of changed (lending) ratios."

"Who’s going to put that money up? There are very few people around who will actually do that and we are the dominant group left in the world that will do that, so people come to us all the time."

Capital providers and their consultants who funded those busted deals remain extremely cautious about exposing more money to this sector, passing on opportunistic deals in favor of reliable core real estate that don’t required much additional reinvestment or debt.

"What they’re worried about isn’t maximizing return; they want some exposure to the asset class. They just don’t want to live through these losses again."

"So I think this asset class is going to stay under invested in, even though the opportunities are actually terrific. There will be a few firms that raise funds, as they have, but those will be relatively small funds compared to what most of them have done previously."

Blackstone does not expect realized income from investments to peak until late this year and into 2013, mostly because its assets, especially real estate are appreciating rapidly, with robust underlying portfolio performance.

"Why give that away? We’ve got a wonderful compounding going on. We’ve got rents going up, we’ve got occupancies going up, we’ve got debt going down, and they’re leveraged. And I don’t understand, frankly, this focus on premature liquidations. We’re in the business of managing money."

James attributed that to a combination of factors, including shrinking stock, no new supply, the improving economy and the release of pent-up leasing demand from 2008-10.

"All of that is coming through now and I think it’s going to be good. I hope it will be even better, that the economy will at some point get a bit more robust growth. We want to wait for that to happen, if it’s going to."

In explaining the delayed realizations in real estate disposition, "we tend to actually realize significantly more than that mark," Schwarzman said. "And given the volatility of the market, it’s very hard to get this right."

As lending ratios improve from 60%-65% to 75%-80% of loan to value, the rising value of properties that Blackstone holds "will go almost dollar for dollar to us as the holder of the real estate," Schwarzman said. At disposition, the return on equity for the new owner will be about the same, but will push up the sale price beyond the simple fundamentals of increasing rents and increasing occupancies.

"Giving that up to satisfy some type of target for realizations is something we just wouldn’t do," he said.

Top 10 Most (and Least) Expensive U.S. Commercial Real Estate Markets

With economic challenges in the commercial real estate market, few U.S. markets experienced significant rent increases in 2010 from the previous year, according to new data released in December based on the Building Owners and Managers Association’s (BOMA) 2011 Exchange Report.

“Rents are still compressed from the 2007 highs, but it looks like in most markets, the bottom has hit and it’s stable now,” said Lorie Damon, BOMA’s vice president of education and research. “There has been modest rent growth in some of the better-performing markets, which tend to be on the coast.”

At $48.27 per square foot, New York tops the list of the most expensive commercial real estate markets, Shreveport, La. ranks is the least expensive at $10.47 per square foot.

Washington, D.C. followed in second place for most expensive at $42.63 per square foot. Five California cities ranked among the 10 most expensive markets. New York and San Francisco were the only markets in the group of most expensive cities to show an increase in rental income from the previous year.













BOMA noted the data suggest that prices remain favorable for tenants seeking to pursue new leases or renegotiate existing ones. Damon said building owners appear confident that rents will remain stable.

“They may not grow, but they will remain stable and at least won’t continue downward,” Damon said.









In terms of least expensive markets, Nashville, Tenn., followed behind Shreveport at $13.31 per square foot. Of the least expensive markets, both Dayton, Ohio, and Omaha, Neb., recorded 10 percent increases from the previous year.

The data are based on BOMA’s 2011 Experience Exchange Report. The annual report offers an analysis of BOMA’s data regarding operating income and expenses in more than 65,000 commercial buildings in close to 300 markets. The rental rates in each market reflect total income divided by total rentable square feet for that market.

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Analysis: Borders facing critical real estate decisions on future of stores across U.S.

The Borders superstore on Lohr Road in Pittsfield Township is among more than 500 stores the Ann Arbor-based chain operates in the U.S.

Borders Group Inc., born in Ann Arbor and now fighting for survival, ended its fiscal year on Jan. 30 amid dramatically different business fundamentals from previous years.

The corporate value, based on stock price, was $29 million, close to its historic low -and down from $663 million three years earlier. The headcount at the Ann Arbor headquarters totaled less than half the 1,200 who worked there two years earlier. Annual sales, which once topped $4 billion, were trending toward half that.

Yet the physical footprint of the nation’s second-largest bookseller — which operates more than 500 superstores — remained relatively unchanged from peak years.

Borders publically has grappled with its turnaround for several years as it switched CEOs, laid off staff and sought financing in an industry that’s quickly shifting to electronic delivery.

Those elements make the reports that Borders is stepping closer to bankruptcy sound valid. The numbers need to change.

As Borders executives make critical decisions for the company’s future, it’s that physical footprint — the stores and the headquarters, one of Ann Arbor largest office buildings — stepping to the forefront of the list of action items. 

Experts have pointed to the number of stores, the lease durations and the rental payments as factors that must change if Borders is to survive. The company expanded quickly, starting in the years after it went public in 1995, and now holds more than $1 billion in lease obligations on stores that are too large for a business model turning to electronic delivery and online sales.

Now the company - as it reportedly considers a bankruptcy filing as early as this month - will be making a decision on the future of it 500-plus stores.

Those decisions, in turn, will create a ripple effect across hundreds of communities in the U.S.: Closures will yield lost jobs, lost tax payments and lost real estate value.

In Washtenaw County alone, where Borders operates three stores, the company generated $1.5 million in tax revenue last year.

THE STORES

“Our physical stores … remain integral to our future success,” the company wrote in its annual filing with the U.S. Securities and Exchange Commission in January 2010.

While that may still be true as the company makes what may be its most critical decision for future survival, the stores are both lifelines for the future and barriers to survival. They’re simply too big - and too costly, based on today’s revenue.

The most concrete example of that: The company admitted in late January that it had stopped making rental payments on some of its stores. 

The bookseller says more store closings are imminent, but little information is trickling out of headquarters that might indicate which stores are on the list.

“We’re all waiting to see what happens,” said Tony Schmitt, a commercial real estate broker at Mid-America Real Estate Group, where he specializes in retail properties from its Oakland County office. “And then we’ll see how the retail real estate landscape is gong to change or stay the same.

“We’re going to know that in the next 30-60 days,” he said.

All Borders stores are leased - and as of Jan. 30, 2010, the average unexpired term was 8.1 years. A full 369 stores are in leases that won’t expire until 2017 or later.

And the dollar obligation of the leases for the company is staggering: $562 million last year, or 19 times the $28 million value of its stock as of last week.

Standing behind those properties are owners - whether institutional or individuals - that now have a $562 million annual stake in the chain maintaining those lease payments.

If the company files for Chapter 11 bankruptcy, Borders will have 210 days to assume or reject each of its leases. 

As a result, the company could seek rental rate reductions - or just outright close stores.
Either way, the landlord has to be poised to absorb a loss.

“Landlords have to know the rate they’re getting from Borders is a rate they’ll never see again,” said Wendy Chapman, an Ann Arbor appraiser at Gerald Alcock Co.

Chuck Miller of Chuck Miller Development Co. in Orchard Lake owns 10 Borders stores in several states, including Michigan. He’s also among the landlords who’ve gone unpaid.

“I’m sure most owners are doing what I’m doing,” Miller said. “You try to take an objective look at each property. You note the prevalence of a vacancy in each store’s (location) and you gauge the replacement rent.”

Other factors to consider include the time and expense to the owner if a store like Borders leaves.

“At this point there are a lot of uncertainties,” Miller said. “Most owners don’t know what will happen. … Everything is being done speculatively until Borders comes out and gives definitive answers.”

Some experts indicate Borders may not have determined those answers yet. Sources said the most recent wave of layoffs included key real estate personnel based at the Ann Arbor headquarters.

Rob James, president of EXP Realty Advisors in New York, has specialized in real estate valuations for companies in bankruptcy.

He said the chain is likely in the midst of analyzing each of its 511 superstores, going beyond the annual sales per square foot - which averages $173 across the brand - to allocating each store its share of costs for corporate expenses: distribution center and headquarters functions, for example. 

“Once you allocate costs … that analysis will tell you which stores are profitable and which aren’t and will probably close,” James said.

Some high-sales stores could turn into profitable outlets with new leases that carry lower rates, James said.

But the chain has lost its chance to monetize one aspect of the bankruptcy code due to the economic downturn.

“Any leases that are below market traditionally would be sold,” James aid. “However, in the current market, where you see flat and declining rents, I doubt there’s much value in those leases (for another retailer).”

It’s unclear on a property-by-property basis what kind of impact that could have on individual stores. But the impact of waves of store closings on shopping centers is visible in the Ann Arbor area, where Borders stores operate near vacated Circuit City and Linens N Things stores following those chains’ bankruptcies.

Filling a 20,000-square-foot store has not been easy, thanks to the economy.

Nationally, that could be changing - giving hope to communities and landlords that any wave of Borders closings could result in new tenants for the vacated spaces.

“Retailers weren’t looking to take on new space,” said Malachy Kavanagh, a vice president at the International Council of Shopping Centers in New York. “That’s starting to change,” he said. “I’ve heard from a lot of shopping centers that there are now retailers looking to expand.”

He continued: “Had this happened last year, it would have been a much more difficult environment for a landlord to fill the space.”

LANDLORDS HOPEFUL

Owners of the Ann Arbor area stores did not return calls seeking comment for this story. But they’ve watched Borders try to reposition its business for years. Agree Realty, for one, has been diversifying its portfolio, which now includes 13 Borders leases.

Nationally, at least 13 Borders stores are listed for sale.

The listings detail part of the Borders story: The properties are all 20,000 square feet or more in size, except for one small store in Las Vegas, and many tout the duration of the leases.

Many have prices that signal a high degree of investor risk.

Two, each of which were developed by Kimco Realty Trust, are listed for prices that reflect a capitalization rate - or rate of return based on the net operating income - around 8 percent.

One of those is in Canton Township, next to Ikea. James, the listing agent, said that alone makes the property valuable beyond what happens with the Borders lease.

Borders, Miller said, has been known for picking prime retail locations in the best properties.

“Borders has exceptional real estate,” he said. “They’ve been disciplined about taking the best locations in the marketplace.”

That bodes well for landlords, and ultimately communities. It’s also part of the long history of the local company that became a national name.

“Borders was thought of as a great company not just by the general public, but by development companies,” Miller said. “It was a coup to have a Borders come into your property.”

IMPACT WILL BE FELT

As experts consider the future of Borders, many cite the example of Circuit City, which filed for liquidation in 2008 instead of trying to reorganize under bankruptcy laws. About 30,000 people lost their jobs as 567 stores closed.

In the Borders case, many - including James - expect reorganization, preserving the brand and thousands of the 19,000 jobs in the company.

“I think they’ll survive in a restructured format,” James said. “There are a lot of positive things (about Borders).”

He cited the social aspects of going to a bookstore. “It’s an experience you can’t replicate online. They provide an important aspect of community.”

That’s felt acutely in Ann Arbor, the home of the chain, which maintains its flagship store on East Liberty Steet downtown.

John Fingerle, owner of Fingerle Lumber in Ann Arbor, is managing partner for the owners of the property the downtown store occupies. He joins the many people in this community who wonder what could happen to the store if it’s on a list of Borders store closings.

“They still seem to get pretty good customer traffic,” he said.

Mayor John Hieftje agrees. He spoke about the circumstances at this month's Downtown Development Authority meeting, when he mentioned that even in the uncertainty, Agree seems to be exploring which other retailers may be potential tenants if the Borders store closes.

"That would be a real loss to us,” he said, describing the store’s role as a downtown anchor. “… It’s the last thing we would want to see happen."

As he watches the Borders situation and waits for resolution, Miller said he’s questioned whether he should have devoted so much of his resources to building Borders stores and keeping them in his portfolio.

But he also said he’s not regretting it. He’s respected Borders over the years for how it established its business and how it operated. The downturn is painful to watch, but he knows the company is doing the best thing it can for its business. He’s doing the same as a Borders landlord.

“I was proud of the fact that I was able to build bookstores,” Miller said. “I think bookstores are good things for communities.”

“Borders really did things right for a number of years,” he continued, recalling the time he met founders Tom and Louis Borders. “It’s a sad day to see a fine organization struggling to survive.”

http://www.annarbor.com/business-review/borders-real-estate-decisions-will-affect-company-communities-across-us/