Can someone explain me Blackstone's EOP real estate deal?


I'm currently reading King of Capital and I am fascinated by the EOP deal. Briefly one thing about me: I will shortly enter college in Switzerland with a finance / economics major and my whole PE knowledge stems from King of Capital and some investopedia articles - just so you know I'm not familiar with all the terms yet.

In the EOP deal, Blackstone partner gray and his friend Leventhal were convinced that the deal will be profitable due to the "replacement theory."

The replacement theory says (p. 245): ... in the best markets, where it was hard to build new offices, you would make money over the long run if you bought buildings below their replacement cost, because prices had a natural tendency to rise where the supply couldn't expand much." ... "an explose rise in construction costs on the coasts made it a good time to invest, even though building prices had been shooting up."

So it basically says that buildings / properties in great locations (where few new properties can be built) will be profitable despite buying at a market high / high price, right?

Blackstone continued to sell off all of EOP's assets in mediocre areas (and made good money because of the high real estate prices) and only kept the properties in prime locations (east coast (NY) & west coast (SF).) It did however sell the majority of its properties in New York - was the only reason for selling these because they received such an outstandingly high bid on them (6.6B)? I first thought that they would keep the NY properties because it correlates with the "keep the prime locations" approach but a 30x cash flow offer might have swung them.

Am I understanding this correctly? Please feel free to add additional insight, as I said, I am new to finance and am fascinated by PE! Can't wait to continue reading and then diving into Barbarians at the Gate and learning the accounting / finance basics later on.

Thank you for your time :)

Comments (5)

Apr 12, 2017 - 1:09pm

SwissArtPrints The basic idea behind their strategy (which you laid out above) is simply that construction costs on the coasts had gotten so out of hand, that it was cheaper to buy existing inventory and hold it as the increase in construction costs would continue to drive up the value of the inventory they purchased. The broader thought process behind this (and it is fairly obvious, but is the model they were working off of), is that in areas where there is limited land for expansion, the price of existing buildings will continue to rise as the scarcity of new product will only increase. Supply and Demand

Apr 12, 2017 - 6:27pm

Thanks! How do you evaluate the next few years of private equity? People are starting to fear a downwards economy again and those have been rough on PE / IB but at the same time proven to have good investment opportunities (buy low) when the timing is perfect. I wonder how it will continue, especially in regards to me entering the field in a few years down the road.

Apr 12, 2017 - 6:44pm

There will always be opportunities for investors in good and bad environments. The sectors and deal structures may shift, and the industry as a whole may contract, but there will still be quality shops with plenty of dry powder who will be able to take advantage of a down market. In regards to your future in the industry, there are plenty of posts on how to prepare both from a technical standpoint as well as a "soft skills" standpoint, on this site. Once you are closer to entering the industry, you'll have better visibility into what shops are active and growing, and what shops are hurting.

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