Jon Gray Skips Party, Afraid Record Buyout Will Fail (Update1)
By Hui-yong Yu and Bob Ivry - February 14, 2007 11:27 EST
Feb. 14 (Bloomberg) -- Henry Kravis celebrated his 1989 bagging of RJR Nabisco Inc., at the time the biggest leveraged buyout ever, by treating colleagues to lobster, Dom Perignon and a three-foot cake festooned with RJR Nabisco products at New York's Pierre Hotel.
Not so Jonathan Gray, who orchestrated Blackstone Group LP's purchase of Sam Zell's Equity Office Properties Trust for $39 billion including debt. That's now the biggest buyout ever. Before Gray's lips touched a glass of celebratory champagne, he was trying to sell many of the buildings he had just arranged to buy.
Fear is driving Gray, the 37-year-old co-head of Blackstone's real estate team. Gray is so scared his deal will meet a fate similar to Kravis's RJR Nabisco deal, which saw its profits eroded by debt costs, that he found a buyer for eight of Equity Office's Manhattan skyscrapers before Blackstone even owned them.
Now he's scrambling to sell buildings in cities with the highest rents and lowest vacancy rates -- even properties Blackstone would rather have kept.
``They're working their way out of this purchase,'' said Peter Hauspurg, chairman and chief executive officer of Eastern Consolidated Properties Inc., a New York-based real estate investment firm. ``When they had to up their bid, they had to shed these valuable assets to make this thing work. If they can sell the trophies and end up owning 50 buildings at no cost, that would be a home run.''
New York Sales
A bidding contest with Vornado Realty Trust for the 540 office buildings in Zell's portfolio drove up the price Blackstone paid by more than 14 percent, forcing the New York-based private-equity firm led by billionaire Stephen Schwarzman to borrow $31.9 billion, or 82.5 percent of the sale, plus $3.5 billion in bridge equity. With the clock ticking on that debt, Gray has embarked on a selling spree.
Macklowe Properties Inc., the owner of New York's General Motors Building, bought eight Manhattan office buildings for $7 billion on Feb. 9, the same day Blackstone closed on the purchase of Equity Office.
By having Equity Office sell the buildings to Macklowe at the same time the buyout closed, Blackstone avoided having to pay New York City and state transfer taxes, which would have been about $212 million, based on the price Macklowe paid for the eight buildings.
Gray also sold 19 properties in Washington and 17 in Seattle to Boston-based Beacon Capital Partners Inc. for $6.35 billion and 17 buildings in Portland, Oregon, to San Francisco-based Shorenstein Co. for $1.2 billion, according to three people with direct knowledge of the transactions.
A Toast
The purchase of Equity Office was the largest real estate deal in history, but Gray hasn't engaged in any king-of-the-world breast-beating. On Feb. 7, the day Equity Office shareholders approved the Blackstone buyout, Gray's wife took a bottle of champagne to Blackstone's Park Avenue headquarters and the two of them toasted. Then it was back to work.
Gray was just out of high school when Kohlberg Kravis Roberts & Co. arranged the takeover of RJR Nabisco, for 17 years the biggest leveraged buyout. Around the same time came the collapse of more than 1,000 U.S. savings and loans that had speculated on real estate, leading to the formation of so-called real estate opportunity funds like Blackstone's in the early 1990s.
Gray joined Blackstone fresh out of the Wharton School of the University of Pennsylvania in 1992 and rose to become co-head of Blackstone's real estate group with Chad Pike after the departure of senior executive John Kukral in 2005. Before buying from Zell, Gray led 10 takeovers of public real estate companies valued at more than $32 billion.
`Popular Guy'
``Jon Gray's the most popular guy at the party,'' said Brookfield Properties Corp. Chief Executive Officer Ric Clark, who was Gray's partner last year in the purchase of Trizec Properties Inc. ``Everybody wants to do deals with him.''
Gray grew up in Highland Park, Illinois, 20 miles north of Chicago. His father, Allen Gray, was an investment adviser and his stepfather, James Florsheim, was an executive with the Chicago Corp., an investment bank in the city of the same name.
Gray's junior-year high school yearbook lists him as involved in the school's educational assistance program, which helped younger students in reading, vocabulary and math. He wore uniform No. 24 for the Highland Park Giants basketball team.
Wedding Announcement
At Penn, where he majored in English and economics, Gray met Mindy Basser, the daughter of a Philadelphia advertising executive. Basser landed a job out of college in the marketing department at New York design firm Edwin Schlossberg Inc., according to a wedding announcement published in the New York Times. Gray and Basser married in 1995 and have four children, dividing their time between a co-op apartment on Manhattan's Upper East Side and a home in the Hamptons, the summer resort haven for the rich and famous at the east end of Long Island, according to property records.
``They are just good people,'' said Ira Hillman, a Wharton classmate.
Gray refused repeated requests to comment for this article.
Before turning his attention to office properties, Gray led a series of hotel acquisitions for Blackstone after values plummeted in the wake of the 2001 terrorist attacks. Those investments, which include Extended Stay America Inc., have produced returns in the high double-digits for Blackstone, according to investors.
Blackstone spotted Gray's potential early, promoting him to senior managing director when he was 30, making him one of the firm's youngest partners.
``He's got a great nose for value,'' said Blackstone President Hamilton James, who goes by Tony. ``He identified the hotel sector very early as something that was near a bottom. Almost to the minute, he got it right. Then, as hotel values started to go up and it became harder and harder to find good values, he shifted his focus to the office sector.''
Skipping the Super Bowl
Gray is a longtime Chicago Bears football fan, and he had a ticket for the team's Feb. 4 appearance in the Super Bowl, its first since 1986, with his brothers and father. He skipped the trip to Miami to stay in New York so he could monitor the bidding for Equity Office.
Vornado, a New York-based real estate investment trust led by Steven Roth, sweetened its offer for Zell's company just minutes before the game began. Gray missed the high point of the action for the Bears, a touchdown scored on the opening kickoff by Devin Hester, because he was on the phone scheduling a halftime conference call with lawyers and bankers. The Bears went on to lose to the Indianapolis Colts, 29-17.
Blackstone's victory highlights the advantages private-equity firms have over public companies in a takeover battle. After three weeks of offers and counter-offers between Gray and Roth, Gray won because Blackstone could pay cash, and because the firm could close on the deal two days after the Feb. 7 shareholder vote.
Transformation
``Jon and Blackstone have transformed the way private equity participates in the real estate business,'' said Christopher Nassetta, chief executive officer of Host Hotels & Resorts Inc. in Bethesda, Maryland.
Blackstone's takeover also signals a generational change in the real estate investment world. Gray is 28 years younger than Zell and Roth, who are both 65.
Gray is ``likeable, well-liked, well-trusted in a field where no one trusts anyone,'' said Blackstone's James.
Gray must fight the perception among some potential buyers that Zell's exit must mean prices for office buildings are at the height of the market.
``If Sam sold, it must be a good time to sell,'' said Richard Stein of Mesirow Financial Real Estate in Chicago, which manages $30 billion in assets. ``As smart as the Blackstone guys are -- and they're all smart -- I would never want to be buying when Sam is selling.''
Top of the Market?
Commercial real estate is more expensive relative to other income-producing assets than it's been for two decades, adding risk for buyers. While higher rents have fueled a rally in office REITs, higher prices have whacked the securities' yields.
Office REITs are offering 100 basis points on average less than the average corporate bond, a reversal of their historic premium to corporate bonds, according to Green Street Advisors Inc., a Newport Beach, California-based research firm. The crossover happened in 2005, according to the firm. Dividends are a prime reason why REITs, which must pay out at least 90 percent of their income to shareholders to avoid corporate taxes, are attractive to investors.
Another measure of the high price Blackstone is paying for Equity Office is the capitalization rate. The cap rate is the net operating income (rents minus operating expenses), divided by the purchase price. The lower the cap rate, the more expensive the property.
Difficult Returns
Blackstone is buying Equity Office at a cap rate of about 5.3 percent, a record low for a REIT purchase, according to Green Street. In 2006, Blackstone and Brookfield bought Trizec at a 5.7 percent cap rate and Blackstone bought CarrAmerica Realty Corp. at a 6.3 percent cap rate, according to the firm.
``It's going to be difficult for a buyer to make a substantial rate of return on this purchase,'' said Cedrik Lachance, an analyst at Green Street.
Institutional investors with about $12 trillion in assets have turned bearish on REITS and became net sellers for the first time in two years in November, according to the brokerage arm of State Street Corp., the world's third-biggest custodian of assets. The investors have sold as dividend yields on the trusts tumbled below that of government debt.
Blackstone will contribute about $3.75 billion of equity financing and receive $31.9 billion of debt financing to fund the purchase, according to a regulatory filing.
Bank of America Corp., Bear Stearns Cos., Goldman Sachs Group Inc. and Morgan Stanley are providing the $3.5 billion bridge loan. Those four are joined by Citigroup Inc., Wachovia Corp. and affiliates of Credit Suisse Group and Deutsche Bank AG in providing financing to Blackstone.
Being the buyer in the most expensive leveraged buyout ever was a motivation for Blackstone, said Ned Spieker, who was the biggest owner of commercial property on the West Coast before he sold his company to Sam Zell in 2001.
``Blackstone had a lot of capital and setting milestones is what they like to do,'' Spieker said.
To contact the reporters on this story: Hui-yong Yu in Seattle at hyu@bloomberg.net; Bob Ivry in New York at bivry@bloomberg.net.
To contact the editor responsible for this story: Rob Urban at robprag@bloomberg.net.
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