Equity Office Properties Trust

2 N. Riverside Plaza, Suite 2100
Chicago, Illinois 60606
U.S.A.
Telephone: (312) 466-3300
Fax: (312) 454-0332
Website: http://www.equityoffice.com

Public Company
Incorporated: 1996
Employees: 2,700
Sales: $3.6 billion (2002)
Stock Exchanges: New York
Ticker Symbol: EOP
NAIC: 525930 Real Estate Investment Trusts

Equity Office Properties Trust (EOP) is the largest real estate investment trust (REIT) and largest office building owner and manager in the United States, its portfolio comprised of more than 700 properties and 126 million square feet of office space. Moreover, the Chicago-based REIT is the first real estate company to be included in the S&P 500 and the only member of the Fortune 500. EOP is geographically diverse, with office space in almost all major metropolitan areas, as well as having its portfolio balanced between properties located in a market’s central business district and its suburbs. EOP is attempting to leverage its size and geographic reach to not only achieve economics of scale in order to lower operating costs but to also establish itself as a true real estate brand. The REIT is controlled by legendary Chicago real estate mogul Samuel Zell.

Fleeing Poland: 1939

Samuel Zell was the only son of a Polish Jewish couple who fled their native country only hours before it was invaded by German forces in 1939, the final step in the buildup to World War II. The couple immigrated to Chicago where Zell was born in 1941. The family was supported by the selling abilities of Zell’s father, who was known to peddle flour and jewelry as well as real estate. By 12 years of age Zell displayed his own entrepreneurial bent. Sent to Hebrew class in the suburbs each afternoon, he noticed at the train station a new Chicago-based magazine named Playboy, which was not generally available in his neighborhood. According to Zell, he began to buy issues for 50 cents at the train station, then resold them for $1.50 in the schoolyard.

After graduating high school in 1959, Zell went to college as a political science major at the University of Michigan, where he met his future long-term partner, Robert Lurie, the two men becoming fraternity brothers. As an undergraduate Zell began to manage some off-campus housing properties and was able to accumulate enough of a stake so that he and Lurie could enter the real estate business together. The two men were almost polar opposites in personality but nevertheless complemented one another. Zell was the outspoken, often abrasive, visionary—the rainmaker—while Lurie was the retiring numbers man who minded the store. Both men continued to run their fledgling real estate business in Ann Arbor when they went on to law school at the University of Michigan. By the time they graduated in 1966, they owned a city block of student housing, all resulting from a $1,500 down payment.

Zell intended to practice law rather than devote his energies to real estate and after earning his degree accepted a position with the Chicago firm of Yates Hollob and Michelson at a salary of $116 a week—with the possibility of earning more by bringing in new business. According to Zell he suffered through his first week of work by drafting a contract, then over the weekend took advantage of real estate contacts to cobble together an apartment project in Toledo, Ohio, which he then presented to the firm’s partners on Monday morning. All of them were impressed enough to invest in the deal. During the first year at Yates Hollob, he earned $93,000 in commissions, compared to $7,000 in salary, for a total compensation that eclipsed the firm’s senior partners. Zell only stayed on until 1968 before deciding to quit the practice of law, and he again joined forces with Lurie to pursue real estate ventures.

Zell and Lurie formed Equity Finance and Management Company in 1968. They became involved in two small development projects but quickly decided that there were too many uncontrollable elements in building and that the risks simply outweighed the rewards. Zell concluded that much of a developer’s compensation was psychological, the ability to point to a structure and declare that he had built it: “Look how big it is!” Instead Zell and Lurie decided to concentrate on acquiring existing properties at below replacement cost from distressed developers, a practice that would lead to Zell earning the nickname of the “Grave Dancer.” One of their first deals of this kind involved a 1,000-unit apartment and office complex in downtown Cleveland. The property was in such poor shape that it was mostly inhabited by squatters. The partners renovated the complex and turned it into a fully rented facility worth many times more than the nominal amount they paid to acquire it.

Zell and Lurie were well positioned to take advantage of the collapse of the real estate market in 1974, buying numerous properties on the cheap. With high inflation during the decade, those properties would then experience a tremendous increase in value. The partners concentrated on buying apartment buildings in fast-growing cities, mostly located in Sunbelt states. It was also a time of many dubious real estate tax shelter schemes, and in 1976 Zell became caught up in a federal investigation that nearly devastated the partnership. He and three Chicago tax attorneys, one of which was his brother-in-law Roger Baskes, were indicted for their part in transferring some assets to an offshore bank to avoid paying taxes. Zell was not the target of the investigation and received immunity in exchange for his testimony. Although he attempted to exculpate Baskes, his brother-in-law was still sentenced to two years in a federal penitentiary. The incident would haunt Zell for years to come, as competitors strategically reopened the wound, despite the fact that Baskes and Zell maintained warm relations.

Zell and Lurie received national attention in 1981 when Equity Finance acquired a controlling 68 percent stake in Great American Management & Investment Inc., an Atlanta-based REIT with some $500 million in assets, one of the largest REITs in the country before going bankrupt in 1977. The partners sold much of Great American’s assets, restructured its debt, and returned it to fiscal health. Zell and Lurie then moved beyond residential and commercial real estate, applying the same principles of buying properties at distressed prices to the corporate world. Moreover, with real estate values spiraling out of control, Zell sensed that a crash was coming, making it a good time to diversify into other areas. The partners bought stakes in Consolidated Fibers, Commodore Corp., and Itel Corp. They became involved in a wide range of businesses, including radio stations, fertilizer companies, dredging equipment, drugstores, mattresses, and rail cars. An investment in bicycle maker Schwinn was a notable failure, but the bulk of their turnaround activity proved lucrative.

Vulture Funds of 1980s Leading to Formation of EOF

Many real estate operators who had engaged in dubious tax shelter schemes during the 1970s faced a day of reckoning when the Tax Reform Act of 1986 undercut their activities, resulting in a crash that Zell anticipated. As in an earlier time, he and Lurie were able to take advantage of other people’s problems and acquire properties at a steep discount. In 1987 they began to set up real estate vulture funds with Merrill Lynch & Co. and acquired many of the properties that would form the basis of EOP and two other REITs. By the end of the decade, however, commercial banking money dried up and severely hampered Equity Finance. More importantly, Lurie was diagnosed with cancer during this period and the final years of his life were difficult for both men. Unable to accept the inevitable the partners reportedly stopped seeing each other to conduct business, instead talking by telephone on an hourly basis. Lurie died in 1990 and much of his day-to-day duties were taken over by Sheli Rosenberg, also an attorney with a flair for deal-making. She had done some work for Equity Finance during the 1970s while a partner at the Chicago firm of Schiff Hardin & Waite. She then went to work for Zell and Lurie in 1980 to start an in-house law firm and became their top lawyer, involved in the structuring of all their major deals.

Zell was able to scrape by during the recession of the early 1990s but his deal-making activity was curtailed. When real estate began to recover, he and others rediscovered the value of REITs. REITs were originally created by Congress in 1960 as a way for small investors to become involved in real estate in much the same way a mutual fund allowed them to pool resources to buy stocks. REITs could be taken public and their shares traded like any other stock, but they were required by law to pay out at least 95 percent of their taxable income to shareholders each year, thus severely limiting the ability of REITs to raise funds internally. REITs were also hindered because they were only allowed to own real estate. Third parties had to be engaged to operate or manage the properties. Moreover, the tax code made direct real estate investments an attractive tax shelter for many individuals, thereby absorbing funds that might have been invested in REITs. The Tax Reform Act of 1986 not only eliminated these tax shelters, it also permitted REITs to provide customary services for property, in effect allowing the trusts to operate and manage the properties they owned. Nevertheless, REITs were still not embraced as an investment option because banks, insurance companies, pension funds, and foreign investors (in particular the Japanese) were investing heavily in real estate. Overbuilding and a glutted marketplace, however, resulted in falling property values in the early 1990s, and lending institutions, as a result of the recent savings and loan debacle, were forced by regulators to be more circumspect about their investments. Capital essentially dried up and REITs finally became an attractive way for many private real estate companies to raise funds. Moreover, property owners such as Zell realized that by converting their holdings into REIT shares they could postpone paying capital gains taxes.

Company Perspectives:

Equity Office Mission: To be the office company of choice and to be valued by employees, customers and investors as partners in their success.

In 1993 Zell converted two of the Merrill investment funds into REITs, forming Equity Residential for apartments and Manufactured Home Communities Trust for mobile home communities. In the office property segment, Zell continued to build up his portfolio before launching a REIT, buying up top quality buildings, often at distressed prices due to the recession. Going against the grain he bought a number of trophy buildings in downtown areas while others focused solely on suburban properties. By 1996 he had accumulated some 90 properties and 32 million square feet of office space, worth approximately $4.8 billion, under the auspices of three subsidiaries: Equity Office, Equity Office Holdings, and Equity Office Properties. He now packaged these assets as part of a new REIT, Equity Office Properties Trust. When Zell took the venture public in July 1997, EOP met with enthusiastic reception from investors, the IPO so over-subscribed that the original offering of 15 million shares was increased by another 10 million. Once shares began trading on the New York Stock Exchange on July 8 the price jumped 28 percent, from $21 to $27.37 by the end of the first day.

Tabbed to handle the day-to-day running of EOP, while Zell maintained the big picture as chairman of the board, was Timothy H. Callahan, who had taken over the position in October 1996 when the REIT was formed. He had headed Equity Office Holdings and Equity Office Properties, as well as previously serving as the chief financial officer for the parent corporation of the subsidiaries, Equity Group Investments. Prior to working for Zell, Callahan spent several years working for another well known real estate mogul, Edward J. DeBartolo, and another 14 years at Chemical Bank where he held a number of positions. EOP had barely completed its IPO when it initiated an aggressive acquisition strategy and acquired two Chicago properties for $462 million. A much more significant deal was landed in September 1997 when EOP acquired its largest competitor, Beacon Properties Corp., at a cost of $4 billion (including the assumption of debt). In terms of market capitalization, EOP was now the largest REIT in the country, its portfolio comprised of 233 office buildings and 55.7 million square feet of space. Not only did the acquisition provide EOP with a greater presence in key markets, such as Atlanta, it also allowed the REIT to take advantage of its size to cut costs by eliminating some overlapping administrative functions.

In 1998 EOP generated revenues of $1.7 billion but produced a lackluster return for investors, resulting in a stagnant stock price that hindered the REIT’s ability to use stock to finance new deals. To fund acquisitions EOP began to sell off properties in smaller markets such as Oklahoma City and Columbus, Ohio, and looked to sell minority interests in some of its higher-profile buildings in major cities. In this way, EOP hoped to spur the price of its stock, which could then be used to fund larger deals. That next major acquisition came in February 2000 when EOP bought Cornerstone Properties for $1.1 billion in cash, $1.7 billion in stock, and the assumption of another $1.8 billion in debt. The deal made EOP an $18 billion office company, increasing its portfolio by 24 percent, so that the REIT now owned and operated 380 office buildings with 95.5 million square feet and a presence in 11 major metropolitan areas and 23 states and the District of Columbia. In a comparatively minor deal, in May 2000 EOP sold its parking operations in Boston, Indianapolis, Milwaukee, Pittsburgh, and Philadelphia to Urban Growth Property Trust for $180 million.

Acquisition of Spieker Properties: 2001

In sheer size EOP separated itself from its competitors even further in 2001, acquiring Spieker Properties Inc., the largest REIT on the West Coast. The $7.2 billion price included $905 million in cash, $431 million in stock, $3.6 billion in equity, and $2.1 billion in debt. The next largest office REIT, Boston Properties, owned just 37.6 million square feet of space, about a third of the amount controlled by EOP. As a result of its rapid expansion, in October 2001 EOP became the first REIT to be added to the S&P 500. The Spieker acquisition also provided EOP with a much greater presence in the San Francisco Bay area’s technology market, but even as the deal was being finalized the tech sector was faltering, California real estate values were beginning to sag, and the state was rocked by a power crisis. In fact, office vacancy rates began to grow across the country as the national economy slipped into recession and the real estate market entered a downturn. For once, it appeared that Zell had bought in at the high end of a real estate cycle. Moreover, his belief that big was necessarily better was being questioned by investors who found that EOP was not realizing the economics of scale that Zell had promised and that some smaller REITs were actually able to produce better returns. Nevertheless, Zell pursued a strategy of using the REIT’s size and nationwide presence to brand EOP, which would hopefully be a selling point for major companies that had offices in a number of cities and were looking for consistency. Zell spoke of transforming EOP from a leasing company into a true service provider, offering telecommunications and other more mundane services such as car washes in EOP office buildings. While these additions were not expected to allow the REIT to boost rentals above market rates, they were expected to provide a great help in retaining tenants.

Key Dates:

1969:

Samuel Zell and Robert Lurie form Equity Finance and Management Company.

1987:

Co-managed funds with Merrill Lynch form basis of Equity Residential.

1990:

Lurie dies of cancer.

1997:

Equity Office Properties Trust goes public.

2000:

Cornerstone Properties is acquired.

2001:

Spieker Properties Inc. is acquired.

In the midst of a difficult economic environment EOP faced a turnover in its top ranks of management. Callahan resigned as CEO in April 2002, citing personal reasons, and Zell stepped in on an interim basis. As the REIT searched for a new CEO, it began to sell off properties in smaller markets including Nashville, Tennessee; Charlotte, North Carolina; and Salt Lake City, Utah. In 2002 EOP sold more than $500 million in assets as it began to focus on its top 20 markets. According to Zell the time was right to sell, due to the poor performance of the stock market that caused many investors to turn to real estate and other investments in order to weather the slump. In November 2002 Zell turned over the CEO position to 40-year-old Richard D. Kincaid, EOP’s chief operating officer, who was in the early stages of being groomed for such a prominent role in the company but had proven himself to Zell and was promoted ahead of schedule. Kincaid had played a key role in effecting a cost-cutting initiative that he would now be responsible for rolling out companywide. It would be Samuel Zell, however, who continued to make the major decisions, as EOP attempted to weather difficult times and to prove that indeed bigger was better.

Principal Competitors

Boston Properties, Inc.; Catellus Development Corporation; Mack-Cali Realty Corporation.

Further Reading

Barboza, David, “Visions of a Brand-Name Office Empire,” New York Times, December 16, 2001, p. 1.

Barsky, Neil, “Buying Low: Sam Zell Was Right About Real Estate—and Still Overbought,” Wall Street Journal, July 9, 1992, p. Al.

Corfman, Thomas A., “Such a Deal: It’s Swell for Zell,” Crain’s Chicago Business, July 21, 1997, p. 1.

Daniels, Steve, “Vulture No More,” Crain’s Chicago Business, May 7, 2001, p. 1.

Fisk, Stephane, “Is Sam Too Big?” Forbes, July 5, 1999, pp. 242-44.

Gallun, Alby, “Office Market Corners Zell,” Crain’s Chicago Business, November 18, 2002, p. 4.

Gray, Patricia Bellew, “Unlikely Mogul: Breezy and Irreverent, Raider Sam Zell Runs a $2.5 Billion Empire,” Wall Street Journal, November 7, 1985, p. 1.

Henkoff, Ronald, “Property to the People,” Fortune, October 13, 1997, pp. 98–100.

Laing, Jonathan R., “The Vulture Capitalist,” Barron’s, July 30, 1990, p. 8.

Zastrow, Jane Bowar, “The Strong Get Stronger,” National Real Estate Investor, April 2001, pp. 42–44.

—Ed Dinger