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Is Sam Zell Predicting Another Cool Off? Equity Residential Sells Off $5.4B in Apartments

There have been rumblings of a cooling housing market, but with interest rates remaining low,activity has remained high. Almost too high.

Chicago-based real estate mogul Sam Zell added to the fodder Monday, when he announced his Equity Residential would be selling off 25% of its portfolio of apartments. More than 23,000 apartments were included in the deal, which the REIT sold to Starwood Capital Group for $5.4 billion.

Sam Zell Equity Group Investments Direct Investments
Equity Group Investments Direct Investments (via S&P Cap IQ)

Most of the apartments are in low- and mid-rise buildings and are in suburban markets including southern Florida, Denver, Seattle, Washington D.C., and southern California. Equity Residential indicated it plans to sell 4,700 suburban apartments in western Massachusetts and Connecticut soon, too.

Sam Zell focusing on investments in urban markets

Zell says that this was a strategic move; that Equity Residential was becoming “less aggressive as buyers of assets” and instead focusing its investments in urban markets like Boston, New York and areas in southern California where new building is more difficult. “There’s an awful lot of apartments under construction,” Zell said, “and the majority of them are garden apartments in suburban areas.”

The focus on urban apartments makes sense for a number of reasons. First and foremost, the homeowner rate continues a downward trend while average U.S. rents have climbed over 20% in the past five years. The country is also experiencing a demographic shift; minority populations are growing and minorities historically have low homeownership rates. Urban markets are poised to do particularly well under these circumstances, especially with so many Millennials and Baby Boomers fleeing the suburbs for 24-7 live/work/play environments.

“Our belief is that long-term risk-adjusted returns in the urban core will exceed those in other markets,” David Neithercut, Equity Residential CEO said during the REIT’s earnings call on Monday.

Yet analysts can’t help but wonder whether the suburban portfolio sell-off has a bigger meaning: that this move signals Zell’s belief that the market is overheated and ready for a correction; that prices have climbed too high, too fast.

All eyes are on Zell, who in 2007 gained notoriety by selling off one of this other companies, Equity Office Properties Trust, to the Blackstone Group for $39 billion – the largest private equity deal in history – again, at the top of the market. Shortly thereafter, the commercial property market crashed, values plummeted and debt defaults surged. By 2009, many of the 16 companies that purchased Equity Office buildings from Blackstone were crippled with debt and saddled with rising vacancy rates.

“Buyers purchased buildings at what, in retrospect, were vastly inflated prices. Lenders provided lavish, even excessive, financing based upon unrealistic expectations of rising rents,” the New York Times noted back in 2009. “These were aggressive acquisitions under the best of circumstances,” concurred Paul E. Adornato, senior real estate analyst at BMO Capital Markets.

Could it be that Zell is unloading apartments before the housing crash, much like he unloaded office buildings before the commercial property market crashed? For what it’s worth: “The buyer, Barry Sternlicht [of Starwood Capital], has been known to get his timing right, too,” says Jeffrey Goldfarb. “One big difference—Zell’s two extra decades of investing experience.”

Only time will tell which of real estate’s heaviest hitters knows the market best. For now, prudent investors will be keeping an eye on both.