Sam Zell Turns Selective

Sam Zell, the storied “grave dancer” who scooped up hundreds of discounted assets during the real-estate collapse of the early 1990s, is taking a much more selective approach this time around.

Some 18 months after office-building values began recovering in the country’s top markets, Mr. Zell has made his first U.S. office investment in years: the acquisition of a controlling stake in 200 South Wacker Drive, a 40-story tower that he can glimpse from his Chicago office. The deal values the property at about $106 million.

[DWEEK] Sam Zell’s first U.S. office investment in years is the 200 South Wacker Drive building in Chicago.

Mr. Zell’s minor role in the recovery so far speaks volumes about the differences between this downturn and the one in the early 1990s, when he made his fortune. Back then, the U.S. government’s Resolution Trust Corp. and major banks were dumping enormous portfolios of distressed assets at discount prices. Those who snapped them up, like Mr. Zell, saw their values soar much faster than expected.

Like many others, Mr. Zell looked for deals after the latest recession and the global financial crisis sent commercial real-estate values plummeting. But this time, lenders and regulators got wise. With the blessing of bank regulators, lenders have held on to assets and ridden the recovery up in many markets, keeping the increased values to themselves.

“I am a professional opportunist,” Mr. Zell wrote in an email. “This downturn has not produced a massive amount of opportunity in commercial real estate.”

But his deal raises the question of whether Mr. Zell has missed the best bargains in the current downturn. His re-emergence now comes as office values in the country’s top 10 markets are 40% off the bottom hit in the third quarter of 2009 to a level that is about 13.3% shy of the peak values in 2007’s second quarter, according to Moody’s/REAL Commercial Property Price Index report released last month.

It isn’t as if Mr. Zell, who is 69 years old, has been idle these past few years. He has invested globally, acquired apartment properties in the U.S. and bought distressed debt outside the real-estate market. Mr. Zell also had a major distraction: his botched investment in Tribune Co., which is still under bankruptcy protection.

Mr. Zell may not have lost his touch in real estate, though. Indeed, there are a number of glimpses of the younger Sam Zell in the 200 South Wacker deal.

The 755,000-square-foot building, located across the street from the Willis Tower, clearly was in the distress category. Owned by Behringer Harvard, a manager of nontraded real-estate investment trusts, its vacancy rate reached about 30%, and earlier this year its $95.5 million loan matured and was in technical default, according to a division of Morningstar Inc.

In a recapitalization earlier this month, Behringer Harvard agreed to sell a 90% stake in the property to affiliates of Mr. Zell’s Equity Group Investments LLC and Transwestern Investment Co., a closely held Chicago real-estate investment company. As part of the deal, the two new investors paid off the building’s $95.5 million mortgage that matured earlier this year and obtained a new smaller mortgage, according to people familiar with the property. The new ownership group plans to spend roughly $40 million to upgrade and reposition the building. Jaime Fink and Jeff Bramson, of Holliday Fenoglio Fowler, negotiated the transaction for Behringer Harvard.

The deal also is classic turnaround play for Mr. Zell. Initially, the property will produce net operating income of about $4 million, which translates into just a 4% yield on the $106 million value. That is well below the average return in the 6% range that investors expected to get on office buildings sold in Chicago and the U.S. over the past 12 months.

The key will be the new owners’ success at leasing the roughly 250,000 square feet in the building that is vacant. They have a good chance at doing this because their rents are in the low $30-a-square-foot range, a bargain compared with the $40 range that some newer buildings in the area command, according to people familiar with the matter.

Office vacancies in the Loop corridor that is a prime business address fell to 14.7% in the first quarter from 15.3% a year earlier, though they are still well above the healthier 10.8% level of 2007, according to Reis Inc.

“We’ve chosen this point to re-enter the market because we think the fundamentals are getting better,” Mr. Zell said in an interview. “This is an example of new capital diluting the existing holder but basically righting the ship and creating a long-term positive investment.”

Source:  WSJ

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